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Filed Pursuant to Rule 424(b)(3)
Registration No. 333-190454

 

LOGO

21,881,800 Shares of Common Stock, $0.01 Par Value Per Share

 

 

This prospectus relates solely to the resale of up to an aggregate of 21,881,800 shares of our common stock by the selling stockholders identified in this prospectus. The selling stockholders acquired the shares of common stock offered by this prospectus in a private placement in June 2013 in reliance on exemptions from registration under the Securities Act of 1933, as amended and pursuant to our 2013 Equity Incentive Plan. We are registering the offer and sale of the shares of common stock to satisfy registration rights we have granted. See “Selling Stockholders” beginning on page 153 in this prospectus for a complete description of the selling stockholders.

The selling stockholders will receive all proceeds from the sale of our common stock, and therefore we will not receive any of the proceeds from their sale of shares of our common stock. The shares which may be resold by the selling stockholders constituted approximately 27.4% of our issued and outstanding common stock on January 28, 2014.

Prior to the offering pursuant to this prospectus, there has been no public market for our common stock. Our common stock has been approved for listing on the NASDAQ Global Market under the symbol “NGHC.”

On February 11, 2014, we priced a private offering of 11,800,000 shares of our common stock at $14.00 per share. Until shares of our common stock are listed on the NASDAQ Global Market, the selling stockholders will sell their shares at a price per share of $14.00, if any shares are sold, and thereafter at prevailing market prices or privately negotiated prices. See “Plan of Distribution.”

We are an “emerging growth company” under applicable Securities and Exchange Commission rules and will be eligible for reduced public company reporting requirements. See “Summary—We are an Emerging Growth Company.”

 

 

Investing in our common stock involves risks. You should read the section entitled “Risk Factors” beginning on page 13 for a discussion of certain risk factors that you should consider before investing in our common stock.

Neither the Securities and Exchange Commission (the “SEC”) nor any other regulatory body has passed upon the adequacy or accuracy of this prospectus. Any representation to the contrary is a criminal offense.

 

 

The date of this prospectus is February 20, 2014


Table of Contents

TABLE OF CONTENTS

 

      Page  

CERTAIN IMPORTANT INFORMATION

     ii   

SUMMARY

     1   

SUMMARY FINANCIAL DATA

     10   

RISK FACTORS

     13   

CAUTIONARY STATEMENT CONCERNING FORWARD-LOOKING STATEMENTS

     35   

USE OF PROCEEDS

     36   

DIVIDEND POLICY

     37   

CAPITALIZATION

     38   

SELECTED FINANCIAL DATA

     39   

MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

     43   

BUSINESS

     85   

REGULATION

     105   

MANAGEMENT

     113   

EXECUTIVE OFFICER AND DIRECTOR COMPENSATION

     118   

SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT

     133   

CERTAIN RELATIONSHIPS AND RELATED PARTY TRANSACTIONS

     134   

DESCRIPTION OF CAPITAL STOCK

     140   

CERTAIN U.S. FEDERAL INCOME TAX CONSIDERATIONS FOR NON-U.S. HOLDERS

     146   

SHARES AVAILABLE FOR FUTURE SALE

     150   

SELLING STOCKHOLDERS

     153   

PLAN OF DISTRIBUTION

     158   

LEGAL MATTERS

     161   

EXPERTS

     161   

ADDITIONAL INFORMATION

     161   

INDEX TO FINANCIAL STATEMENTS

     162   

 

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CERTAIN IMPORTANT INFORMATION

This Prospectus

You should rely only on the information contained in this prospectus. We have not authorized any other person to provide you with information that is different from that contained in this prospectus. If anyone provides you with different or inconsistent information, you should not rely on it. The selling stockholders are offering to sell and seeking offers to buy our common stock only in jurisdictions where such offers and sales are permitted. You should assume that the information contained in this prospectus is accurate only as of the date of this prospectus, regardless of the time of delivery of this prospectus or of any sale of our common stock. Our business, financial condition, results of operations and prospects may have changed since that date. Information contained on our website, or any other website operated by us, is not part of this prospectus.

Frequently Used Terms

In this prospectus, unless the context suggests otherwise:

 

   

references to “National General,” “the Company,” “we,” “us” or “our” refer to National General Holdings Corp. (formerly known as American Capital Acquisition Corporation) and all of its consolidated subsidiaries; and

 

   

references to “NGHC” refer solely to National General Holdings Corp.

  The following terms used in this prospectus have the meanings set forth below:

 

   

“accident/AD&D” refers to insurance coverage that indemnifies or pays a stated benefit to the insured or his/her beneficiary in the event of bodily injury or death due to accidental means (other than natural causes);

 

   

“incurred but not reported” or “IBNR” refers to reserves for estimated losses that have been incurred by insureds and reinsureds but not yet reported to the insurer or reinsurer, including unknown future developments on losses which are known to the insurer or reinsurer;

 

   

“quota share reinsurance” refers to reinsurance under which the insurer (the “ceding company”) transfers, or cedes, a fixed percentage of liabilities, premium and related losses for each policy covered on a pro rata basis in accordance with the terms and conditions of the relevant agreement. The reinsurer may pay the ceding company a commission, called a ceding commission, on the premiums ceded to compensate the ceding company for various expenses, such as underwriting and policy acquisition expenses, that the ceding company incurs in connection with the ceded business.

 

   

“stop loss insurance” refers to insurance coverage purchased by employers in order to limit their exposure under self-insurance medical plans. This coverage is available in two types: “specific stop loss-coverage” applies any time an employee claim reaches the threshold selected by the employer, after which the stop loss policy would pay claims up to the lifetime limit per employee for the self-insurance medical plan; and “aggregate stop loss coverage” applies when the employer’s self-insurance total group health claims for all its employees reach a threshold selected by the employer.

 

   

“PPACA” refers to the Patient Protection and Affordable Care Act, the healthcare reform legislation enacted in 2010 that establishes minimum standards for health insurance policies and employer and individual mandates requiring the provision or purchase of health insurance, expands public insurance programs and eliminates certain industry practices such as the denial of coverage due to pre-existing conditions, with the goals of extending coverage to millions of uninsured Americans and lowering health care costs.

 

   

“private placement” refers to NGHC’s June 6, 2013 issuance and private sale of 21,850,000 shares of its common stock pursuant to Section 4(a)(2) and other exemptions under the Securities Act of 1933, as amended (the “Securities Act”).

 

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All of the trade names and trademarks included in this prospectus are the property of their respective owners.

Market and Industry Data

Market and industry data used in this prospectus have been obtained from independent sources and publications as well as from research reports prepared for other purposes. Forward-looking information obtained from these sources is subject to the same qualifications and additional uncertainties regarding the other forward-looking statements in this prospectus.

 

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SUMMARY

This summary highlights information contained elsewhere in this prospectus, but it does not contain all of the information that you may consider important in making your investment decision. Therefore, you should read the entire prospectus carefully, including, in particular, the “Risk Factors” section beginning on page 13 of this prospectus and the financial statements and related notes included elsewhere in this prospectus before making an investment decision.

Overview

We are a specialty personal lines insurance holding company. Through our subsidiaries, we provide personal and commercial automobile insurance, health insurance products and other niche insurance products. We sell insurance products with a focus on underwriting profitability through a combination of our customized and predictive analytics and our technology driven low cost infrastructure.

Our property and casualty (“P&C”) insurance products protect our customers against losses due to physical damage to their motor vehicles, bodily injury and liability to others for personal injury or property damage arising out of auto accidents. We offer our P&C insurance products through a network of over 19,000 independent agents, more than a dozen affinity partners and through direct-response marketing programs. We have over one million P&C policyholders and, based on 2012 gross premium written, we are the 20th largest private passenger auto insurance carrier in the United States according to financial data compiled by SNL Financial.

We launched our accident and health (“A&H”) business in 2012 to provide accident and non-major medical health insurance products targeting our existing P&C policyholders and the anticipated emerging market of employed persons who are uninsured or underinsured. We market our and other carriers’ A&H insurance products through a multi-pronged distribution platform that includes a network of over 8,000 independent agents, direct-to-consumer marketing, wholesaling and worksite marketing. We believe that our A&H business is complementary to our P&C business and should enable us to enhance our relationships with our existing P&C agents, affinity partners and insureds.

Our company (formerly known as American Capital Acquisition Corporation) was formed in 2009 to acquire the private passenger auto business of the U.S. consumer property and casualty insurance segment of General Motors Acceptance Corporation (“GMAC,” now known as Ally Financial), which operations date back to 1939. We acquired this business on March 1, 2010.

We are licensed to operate in 50 states and the District of Columbia, but focus on underserved niche markets. A significant portion of our insurance, approximately 75% of our P&C premium written, is originated in six core states: North Carolina, New York, California, Florida, Virginia and Michigan. For the nine months ended September 30, 2013 and the years ended December 31, 2012 and 2011, our gross premium written was $1,021 million, $1,352 million and $1,179 million, net premium written was $478 million, $632 million and $538 million, total consolidated revenues were $666 million, $812 million and $678 million, and consolidated pre-tax income was $47 million, $45 million and $72 million, respectively. In addition, during 2012 the A&H businesses that we acquired placed approximately $126 million of written premium with other carriers.

Our net income reflects the fact that 50% of our P&C gross premium written and related losses (excluding premium ceded to state-run reinsurance facilities) have historically been ceded to our quota share reinsurers, reducing our retained underwriting income and investment income. With the net proceeds of a private capital raising transaction we completed in June 2013, as described below under the heading “—Private Placement,” we will retain more of our written business. Effective August 1, 2013, we terminated our cession of P&C premium to our quota share reinsurers and now retain 100% of such P&C gross premium written and related losses with respect to all new and renewal P&C policies bound after August 1, 2013. We will continue to cede 50% of P&C gross premium written and related losses with respect to policies in effect as of July 31, 2013 to the quota share reinsurers until the expiration of such policies. This retention of our P&C premium will provide us the opportunity to substantially increase our underwriting and investment income, while also increasing our exposure to losses. In addition, our results for the year ended December 31, 2012 as compared to the year ended December 31, 2011 included several charges that make the comparison of our net income for these periods less meaningful. These charges pertained to the adoption of a new accounting pronouncement relating to the recognition of deferred acquisition costs, the consolidation of certain operations to our new Cleveland regional operations center, continued maintenance of three costly legacy policy administration systems in addition to our new policy administration

 

 

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system, and the impact of an acquisition of an A&H business. We also believe that the efficiencies that we expect to realize from the implementation of our new policy administration system and our RAD 5.0 underwriting pricing tool will enable us to improve our future profitability.

Our wholly owned subsidiaries include eleven regulated domestic insurance companies, of which ten write primarily P&C insurance and one writes solely A&H insurance. Our property and casualty insurance subsidiaries have been assigned an “A-” (Excellent) group rating by A.M. Best Company, Inc. (“A.M. Best”).

Business Segments

We are a specialty national carrier with regional focuses. We manage our business through two segments:

 

   

Property and Casualty (“P&C”)Our P&C segment operates its business through two primary distribution channels: agency and affinity. Our agency channel focuses primarily on writing standard and sub-standard auto coverage through our network of over 19,000 independent agents. In our affinity channel, we partner with over a dozen affinity groups and membership organizations to deliver insurance products tailored to the needs of our affinity partners’ members or customers under our affinity partners’ brand name or label, which we refer to as selling on a “white label” basis. A primary focus of a number of our affinity relationships is providing recreational vehicle coverage, of which we believe we are one of the top writers in the U.S.

 

   

Accident and Health (“A&H”)Our A&H segment was formed in 2012 to provide accident and non-major medical health insurance products targeting our existing insureds and the anticipated emerging market of uninsured or underinsured employees. Through six recent acquisitions of both carriers and general agencies, including Velapoint, LLC, our call center general agency, and National Health Insurance Company, a life and health insurance carrier established in 1979, we have assembled a multi-pronged distribution platform that includes direct-to-consumer marketing through our call center agency, selling through independent agents, wholesaling insurance products through large general agencies/program managers and, through our affinity relationships, worksite marketing through employers.

Our Products

We offer a broad range of products through multiple distribution channels. In our P&C segment, products sold consist of:

 

   

Standard and preferred automobile insurance. These policies provide coverage designed for drivers with a less risky driving and claims history and are renewed with greater frequency than sub-standard policies.

 

   

Sub-standard automobile insurance. These policies are designed for drivers who represent a higher-than-normal level of risk as a result of factors such as their driving record, limited driving experience, claims history or credit history. The premium on these policies is generally higher than those for drivers who qualify for standard or preferred coverage. We also earn policy service fees from these policies.

 

   

Recreational vehicle (“RV”) insurance. Our policies carry RV-specific endorsements tailored to these vehicles, including automatic personal effects coverage, optional replacement cost coverage, RV storage coverage and full-time liability coverage. We also bundle coverage for RVs and passenger cars in a single policy for which the customer is billed on a combined statement.

 

   

Commercial automobile insurance. These policies include coverage for liability and physical damage caused by light-to-medium duty commercial vehicles, focused on artisan contractor vehicles, with an average of two vehicles per policy.

 

   

Motorcycle insurance. We provide coverage for most types of motorcycles, as well as golf carts and all-terrain vehicles. Our policy coverage offers flexibility to permit the customer to select the type (e.g., liability) and limit of insurance, and to include other risks, such as add-on equipment and towing.

 

 

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Homeowners’ insurance. Comprehensive homeowners’ insurance plans, which we sell on behalf of third-party carriers, include coverage for medical payments, personal liability and temporary living assistance in the event the insured’s home is declared uninhabitable. We do not retain any underwriting risk on these policies but instead receive commission income from these third-party carriers. We offer these policies to generate fee income and to provide a service to our insureds.

We believe there is a substantial existing and emerging market in the United States for supplemental healthcare products. Our focus in our A&H segment is offering products not covered by the Patient Protection and Affordable Care Act (“PPACA”) and concentrating on the anticipated emerging market of employed persons who are uninsured or underinsured. PPACA is the healthcare reform legislation enacted in 2010 that establishes minimum standards for health insurance policies and employer and individual mandates requiring the provision or purchase of health insurance, expands public insurance programs and eliminates certain industry practices such as the denial of coverage due to pre-existing conditions, with the goals of extending coverage to millions of uninsured Americans and lowering health care costs. In our A&H segment we provide accident and non-major medical health insurance, such as accident/AD&D, limited medical/hospital indemnity, short-term medical, cancer/critical illness, stop loss, travel accident/trip cancellation and dental/vision coverages. We intend to utilize our specialty P&C products and distribution channels to increase sales of these A&H products to this target market and enhance our relationships with our existing agents, affinity partners and insureds by being a provider of multiple products. We have filed and have received approvals for a significant number of our target A&H insurance products for individuals and groups.

Our Competitive Strengths

We believe that our product mix, distribution channels and technology systems, coupled with our focus on conservative underwriting, prudent reserving and efficient claims management, provide us with the following competitive strengths:

 

   

Concentrate on Niche Markets. We believe that our focus on specialty markets and niche distribution channels provides us with the greatest opportunity for achieving superior long-term growth and profitability. As a specialty national carrier with regional focuses, we concentrate our resources on writing insurance in our core markets in which we are experienced and recognize profitable opportunities. We are also seeking to increase sales of our niche products such as RV insurance and commercial vehicle insurance. Our diversification into the A&H insurance business continues this niche focus by enabling us to sell supplemental healthcare insurance products that are complementary to our existing businesses and customers.

 

   

Focus on Profitability, Disciplined Underwriting and Expense Management. We focus on profitability in all functional areas of the Company, from initial underwriting to claims management. We take an analytical approach to underwriting risks and adhere to a conservative reserving philosophy. Our new policy administration system allows for efficient servicing of policies that enables us to reduce operational expense and achieve strong future earning potential. We developed our RAD 5.0 underwriting pricing tool in order to more accurately evaluate specific risk exposures and assist us in profitably underwriting our P&C products. We plan to continue to leverage our strengths in underwriting, reserving, expense management and claims adjudication to further improve our profitability.

 

   

New Policy Administration System. During 2012 we launched our new policy administration system for our P&C insurance business to replace our three legacy policy administration systems. Since inception, we have reduced our information technology operating expenses significantly and we expect that we will continue to substantially reduce our information technology, policy sales and service and related back office operating expenses in the future as we fully retire the three legacy systems. We have integrated our new policy administration system across all lines of our P&C business, substantially retired the three legacy systems and significantly incorporated our RAD 5.0 underwriting pricing tool into this system.

 

   

Growth Opportunities. We believe that many of our competitors are running multiple or outdated legacy systems, which can be costly to operate and difficult to replace or upgrade. We designed our new advanced policy administration system specifically for our lines of business. Our scalable technology should afford us the opportunity to acquire companies and books of business that we believe are soundly underwritten but have higher cost structures and to realize increased profits from the expected costs savings from transitioning the acquired business onto our lower cost system.

 

 

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Extensive Agency Distribution Network. We are committed to the independent agent channel, which has proven to be a cost-effective distribution platform. We distribute our P&C insurance products through a network of over 19,000 independent agents and brokers, and unlike some of our competitors, we do not compete with our independent agents. We believe that our niche products, knowledgeable and responsive customer service staff, superior claims service, competitive commission structure and user-friendly technology platform have created a network of loyal, incentivized and productive agents. We believe that having our new A&H insurance products available to our existing agents will deepen the relationships with many of our existing P&C agents by providing complementary products and additional earning opportunities. We have also recently developed a risk sharing program for agents that will allow selected agents to participate in the underwriting risk on business produced by the agent through an ownership interest in a reinsurance program to which a portion of the business they produce is ceded. We believe this program will increase loyalty and enhance our relationships with the agents who participate in it.

 

   

Long-Standing Affinity Partnerships. The affinity distribution channel of our P&C insurance business has been operating since 1953 and is a leader in affinity marketing, relying on best-in-class marketing strategies and analytics to maximize the value of our longstanding affinity relationships. Since acquiring our P&C insurance business in 2010, we have worked to strengthen our affinity relationships, and recently entered into a 20-year extension of our relationship with two of our largest affinity partners. We target affinity partners with strong brands, actively managed mailing lists, high traffic web-sites and an active membership base. New affinity relationships are developed through an in-house sales force as well as through brokers, and are generally long-term in nature. Our affinity channel utilizes a specialized team that continuously refines our analytical tools and predictive modeling capabilities, which helps to influence all aspects of profitability. Our A&H business complements our affinity channel business because we believe that many of the customers of our affinity partners are purchasers of supplemental health insurance products.

 

   

Proven Leadership and Experienced Management. We have a highly experienced and capable management team, led by Michael Karfunkel, our chairman and chief executive officer, who is responsible for setting and directing the overall strategy for our company. Mr. Karfunkel has over 40 years of experience in insurance, banking, and real estate, and has been instrumental in founding certain of our affiliated companies, including AmTrust Financial Services, Inc. (“AmTrust”) and Maiden Holdings, Ltd. (“Maiden”). Mr. Karfunkel has a successful track record of acquiring businesses and developing high quality service and low cost expense structures. Mr. Karfunkel is a long-term investor in the companies that he has founded. Our management team is further supported by the leadership of our P&C president, Byron Storms, our chief financial officer, Michael Weiner, our executive vice president and chief marketing officer, Barry Karfunkel, our executive vice president – strategy and development, Robert Karfunkel, our chief product officer, Thomas Newgarden and our executive vice president – A&H, Michael Murphy.

Our Growth Strategies

We intend to continue our profitable growth by focusing on the following strategies:

 

   

Continue Growth Through Selective Acquisitions. Since forming the Company in 2009, we have completed 10 acquisitions of insurance companies, agencies or books of business and expanded into the A&H business. Our scalable technology should afford us the opportunity to acquire companies and books of business that we believe are soundly underwritten but have higher cost structures and to realize increased profits from the expected costs savings from transitioning the acquired business onto our lower cost system.

 

   

Increase Net Income by Reducing Our Reliance on Reinsurance. Using reinsurance, we have been able to generate a larger premium volume than otherwise would have been possible given the current level of our capital. Historically, we have ceded 50% of our P&C gross premium written and related losses (excluding premium ceded to state-run reinsurance facilities) to our quota share reinsurers. With the net

 

 

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proceeds from the private placement, we will retain more of our written business. Effective August 1, 2013, we terminated our cession of P&C premium to our quota share reinsurers and now retain 100% of such P&C gross premium written and related losses with respect to all new and renewal P&C policies bound after August 1, 2013. We will continue to cede 50% of P&C gross premium written and related losses with respect to policies in effect as of July 31, 2013 to the quota share reinsurers until the expiration of such policies. This retention of our P&C premium will provide us the opportunity to substantially increase our underwriting and investment income, while also increasing our exposure to losses.

 

   

Expand A&H Insurance Operations. Our A&H insurance products include products that are alternatives or supplemental to major medical coverage, and are either purchased by the customer directly or through groups and associations. We believe that these supplemental products generally produce attractive loss ratios. We plan to utilize our distribution platform and suite of products to achieve substantial growth in premium revenues. In addition, we believe that our new A&H insurance products will deepen our relationships with many of our existing agents by providing complementary products to our insureds and additional earning opportunities for our P&C agents. Once PPACA becomes fully implemented, we believe that the demand for these products will only increase. While PPACA will likely reduce the number of uninsured Americans, many individuals, smaller employers and families will remain exempt from PPACA’s individual and employer mandates under current regulations. In addition, we believe that, due to the high cost of providing health insurance to employees under the new regulations, it is possible that some employers will cease or reduce their health insurance offerings to their employees, which could increase the number of people who are employed yet uninsured or underinsured. We have designed cost-effective products for this population to help fill this gap. In addition, we expect an increase in the demand for self-insured stop loss policies, as self-insured plans covered by ERISA may be exempt from many of the mandates applicable to fully insured plans under PPACA.

 

   

Technology-Driven Product Offerings. We focus on profitable product opportunities that allow us to leverage our technology infrastructure. Consistent with this niche, technology-driven focus, we have recently entered into an arrangement with a managing general agency that has developed advanced vehicle telematics technology that monitors miles driven and other driver behavior, enabling us to offer lower cost, low mileage products with less exposure.

Private Placement

On June 6, 2013, we completed the sale of an aggregate of 21,850,000 shares of our common stock in a private placement exempt from registration under the Securities Act, which we refer to in this prospectus as the private placement, and received net proceeds of approximately $213 million. In the private placement, FBR Capital Markets & Co., or FBR, acted as the initial purchaser for the shares sold to investors pursuant to Rule 144A and Regulation S under the Securities Act, and as placement agent for the shares sold to investors pursuant to Regulation D under the Securities Act. The shares of common stock were sold to investors at an offering price of $10.50 per share, except for 485,532 shares that were sold to FBR and an affiliate of FBR, which were sold at a price of $9.765 per share representing the offering price per share sold to other investors less the amount of the initial purchaser discount or placement agent fee per share in the private placement. We determined the offering price per share in the private placement in consultation with FBR. In making such determination we considered many factors, including our business strategy and the amount of capital we needed to raise in the private placement to implement our business strategy, the market demand for our stock and our capital structure.

We used approximately $12.2 million of the net proceeds to pay dividends on our Series A Preferred Stock upon the conversion of our Series A Preferred Stock into shares of our common stock upon the completion of the private placement; and we intend to use the remaining proceeds for general corporate purposes, including for contribution to the capital of our insurance company subsidiaries to support the growth of our business and retain more of our written business by substantially reducing the percentage of the P&C premium that we cede to our quota share reinsurers, and for potential acquisitions.

In connection with the private placement, we entered into a registration rights agreement for the benefit of the holders of the shares sold in the private placement, which are being registered pursuant to the registration statement of which this prospectus is a part. See “Description of Capital Stock—Registration Rights—Purchasers in the Private Placement.”

 

 

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Determination of Offering Price for This Offering

On February 11, 2014, we priced a private offering of 11,800,000 shares of our common stock at $14.00 per share. Until shares of our common stock are listed on the NASDAQ Global Market, the selling stockholders will sell their shares at a price per share of $14.00, if any shares are sold, and thereafter at prevailing market prices or privately negotiated prices. See “Plan of Distribution.”

Our History

Michael Karfunkel, our chairman and chief executive officer, sponsored the formation of our company in 2009 (then known as American Capital Acquisition Corporation) for the purpose of acquiring the P&C insurance business from GMAC. The acquisition included ten insurance companies.

Michael Karfunkel is a successful businessman with over 40 years of experience and significant interests in the financial services industry, including insurance, banking and real estate. Together with his brother, George Karfunkel, he founded, built and managed American Stock Transfer & Trust Company, LLC, one of the largest independent stock transfer agents, which was founded in 1971 and sold in 2008. Mr. Karfunkel has been instrumental in founding certain of our affiliated companies, including AmTrust, where he serves as chairman of the board of directors, and Maiden, both of which are publicly traded companies. Mr. Karfunkel has a successful track record of acquiring and efficiently integrating businesses and developing low cost expense structures and is a long-term investor in the companies that he has founded.

At the time of our formation, AmTrust purchased 53,054 shares of our Series A Preferred Stock for approximately $53 million, which shares were converted into 12,295,430 shares of our common stock in connection with the completion of the private placement. Barry Zyskind, the president and chief executive officer of AmTrust is the son-in-law of Mr. Karfunkel. Mr. Karfunkel and Leah Karfunkel, as sole trustee of The Michael Karfunkel 2005 Grantor Retained Annuity Trust (the “Karfunkel Trust”), beneficially own 24.5% of the outstanding common stock of AmTrust. The shares of common stock held by Mr. Karfunkel, Leah Karfunkel, as sole trustee of the Karfunkel Trust, and AmTrust currently represent approximately 15.8%, 41.3% and 15.4%, respectively, of our outstanding shares of common stock. See “Certain Relationships and Related Party Transactions.”

Since acquiring our P&C insurance business from GMAC, our principal accomplishments include:

 

   

developing and implementing an advanced policy administration system to replace three costly legacy systems;

 

   

developing our new RAD 5.0 underwriting pricing tool, which allows us to more accurately evaluate specific risk exposures in order to assist us in profitably underwriting our P&C products;

 

   

renewing two of our largest affinity customer relationships for an additional 20 years;

 

   

transitioning a portion of our operations to our newly purchased regional operations center in Cleveland, Ohio, which we expect will result in additional operational efficiencies;

 

   

completing nine acquisitions of insurance companies, agencies or books of business and diversifying our insurance business by entering the A&H market to better serve our existing clients and enhance our relationships with our independent agents and affinity partners;

 

   

entering into an arrangement with a managing general agency that has developed vehicle telematics technology that monitors miles driven and other driver behavior, enabling us to offer lower cost, profitable low mileage products; and

 

   

successfully completing the private placement.

 

 

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Our Challenges and Risks

Our company and our business are subject to numerous risks. As part of your evaluation of our business, you should consider the challenges and risks we face in implementing our business strategies, as described in the section of this prospectus entitled “Risk Factors.”

 

   

Underwriting and pricing risk. To be profitable, we must accurately underwrite risk at the time we issue our policies and we must set our premium rates at levels that are profitable but also competitive in the market. If we fail to accurately assess the risks we insure or set premium rates too low, our premiums may not cover our losses and expenses. If our premium rates are too high, we may lose business to our competitors.

 

   

Loss reserves. We maintain loss reserves representing our best estimate of the amounts we will ultimately pay on incurred claims. There is inherent uncertainty in establishing appropriate loss reserves. If we fail to maintain loss reserves that are sufficient to meet our obligations, we will be forced to immediately recognize the unfavorable development and increase our reserves, each of which could significantly adversely affect our financial performance.

 

   

Competition. Both the private passenger automobile insurance industry and the A&H insurance industry are highly competitive. In each of these markets, we compete with both large national insurance carriers and smaller regional companies. Some of our competitors are significantly larger than we are and have more resources than we do. Smaller or more specialized insurance carriers may be better able to focus on a market or region in which we are a participant. We must therefore deliver superior service and maintain our relationships with independent agents and affinity groups to be successful. If we are unable to do so, our business will suffer.

 

   

Sub-standard auto insurance market. A significant percentage of our business is in the sub-standard private passenger automobile insurance market. As a result, developments which adversely affect this market and the consumers making up this market may have a disproportionate effect on our business when compared with a more diversified auto insurance carrier.

Recent Developments

On November 11, 2013, we entered into a purchase agreement to acquire Personal Express Insurance Company (“Personal Express”), a California domiciled personal auto and home insurer from Sequoia Insurance Company, an affiliate of AmTrust. The purchase price is approximately $20 million, subject to certain adjustments. Personal Express had approximately $15 million of direct written premium in 2012. We expect this acquisition to close in the first quarter of 2014.

On January 3, 2014, ACP Re, Ltd. (“ACP Re”), a Bermuda reinsurer that is a subsidiary of the Karfunkel Trust, entered into a merger agreement (the “Tower Merger Agreement”) with Tower Group International, Ltd (“Tower”) pursuant to which ACP Re has agreed to acquire Tower for the price of $3.00 per share. The transactions contemplated by the Tower Merger Agreement are subject to certain regulatory and shareholder approvals.

Simultaneously with the execution of the Tower Merger Agreement, we entered into a stock and asset purchase agreement (“Personal Lines Purchase Agreement”) with ACP Re pursuant to which we agreed to acquire the renewal rights and assets of the personal lines insurance operations of Tower (“Tower Personal Lines Business”), subject to the consummation of the transactions contemplated by the Tower Merger Agreement. Under the Personal Lines Purchase Agreement, we expect to acquire the assets necessary to support the Tower Personal Lines Business, including certain of Tower’s domestic insurance companies, the Tower Personal Lines Business renewal rights, the systems, books and records required to effectively conduct the Tower Personal Lines Business as well as the right to offer employment to certain Tower employees engaged in the conduct of the Tower Personal Lines Business.

We expect to acquire these assets from ACP Re for cash in an amount equal to approximately $130 million. The acquired companies will be used to support the Tower Personal Lines Business and will contain cash and other assets in an amount equivalent to the purchase price. Through a reinsurance agreement that will be fully collateralized, ACP Re will retain and be liable for, and run off, all losses of the acquired companies occurring prior to January 1, 2014. The acquisition is expected to close in the summer of 2014, pending the receipt of regulatory approvals and closing of the transactions contemplated by the Tower Merger Agreement.

        In addition, Integon National Insurance Company, our wholly-owned subsidiary, has entered into a reinsurance agreement (the “Cut-Through Reinsurance Agreement”) with several Tower subsidiaries. Under the Cut-Through Reinsurance Agreement, Integon has reinsured on a 100% quota share basis with a cut-through endorsement all of Tower’s new and renewal personal lines business and has assumed 100% of Tower’s unearned premium reserves with respect to in-force personal lines policies, in each case, net of reinsurance already in effect. The agreement is effective solely with respect to losses occurring on or after January 1, 2014 and has a duration of one year unless earlier terminated. We will pay a 20% ceding commission and up to a 4% claims handling expense reimbursement to Tower on all Tower premium subject to the Cut-Through Reinsurance Agreement. As of January 14, 2014, all required insurance regulatory approvals have been obtained for the Cut-Through Reinsurance Agreement.

We recently acquired two additional Luxembourg-domiciled reinsurance companies that, at the time of acquisition, collectively had $88.5 million in equalization reserves and an associated deferred tax liability of $26.5 million. See “Risk Factors—We may be subject to taxes on our Luxembourg affiliates’ equalization reserves.”

On February 11, 2014, we entered into a Purchase/Placement Agreement with FBR with respect to the sale of an aggregate of 11,800,000 shares of our common stock in a private placement exempt from registration under the Securities Act and we expect to receive net proceeds of approximately $154.3 million. We have granted FBR an option to purchase or place up to an additional 1,770,000 shares of our common stock within 5 trading days after February 11, 2014, to cover additional allotments, if any, made by FBR, and if exercised, we expect to receive additional net proceeds of approximately $23.3 million. In this private placement, FBR acted as the initial purchaser for the shares sold to investors pursuant to Rule 144A and Regulation S under the Securities Act, and as placement agent for the shares sold to investors pursuant to Regulation D under the Securities Act. The shares of common stock were sold to investors at an offering price of $14.00 per share. We expect this private placement to be completed on or about February 19, 2014. We expect that the shares of our common stock registered under this registration statement, which do not include the shares to be sold in this private placement, will be listed and begin trading on the NASDAQ Global Market on or about February 20, 2014. Upon completion of this private placement, we will enter into a registration rights agreement for the benefit of the holders of the shares sold in this private placement.

We are an Emerging Growth Company

As a company with less than $1.0 billion in revenue during our last fiscal year, we qualify as an “emerging growth company” as defined in the Jumpstart our Business Startups Act of 2012, commonly known as the JOBS Act. An emerging growth company may take advantage of specified reduced disclosure obligations and reductions in other requirements that are otherwise applicable generally to public companies. We do not intend to take advantage of the reduced disclosure requirements applicable to emerging growth companies, except that we will not provide otherwise required financial disclosures for any period prior to the earliest audited period presented in this registration statement. We would cease to be an emerging growth company if we have more than $1.0 billion in annual revenues, have more than $700 million in market value of our capital stock held by non-affiliates, or issue more than $1.0 billion of non-convertible debt over a three-year period. For the year ended December 31, 2012, we reported approximately $812 million in total revenue. If we exceed $1.0 billion in revenue for the year ended December 31, 2013, we would cease to be an emerging growth company beginning in 2014. In such event, consistent with interpretations by the staff of the SEC, in subsequently filed registration statements and periodic reports, we would continue to not present financial disclosures for any period prior to the earliest audited period presented in this registration statement.

Section 107 of the JOBS Act also provides that an “emerging growth company” can take advantage of the extended transition period provided in Section 7(a)(2)(B) of the Securities Act for complying with new or revised accounting standards. However, we are choosing to opt out of any extended transition period, and as a result we will comply with new or revised accounting standards on the relevant dates on which adoption of such standards is required for publicly reporting companies which are not emerging growth companies. Section 107 provides that our decision to opt out of the extended transition period for complying with new or revised accounting standards is irrevocable.

 

 

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Company Information

Our executive offices are located at 59 Maiden Lane, 38th Floor, New York, New York, 10038 and our telephone number is 212-380-9500. Our website address is www.nationalgeneral.com. Information contained on our website is not incorporated by reference into this prospectus, and such information should not be considered to be part of this prospectus.

 

 

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The Offering

 

Common Stock Offered by the Selling Stockholders

A total of up to 21,881,800 shares of our common stock. The selling stockholders may from time to time sell some, all or none of the shares of common stock pursuant to the registration statement of which this prospectus is a part.

 

Shares of Common Stock Outstanding(1)

79,731,800

 

Use of Proceeds

The selling stockholders will receive all of the proceeds from the sale of shares of our common stock. We will not receive any proceeds from the sale of shares of our common stock by the selling stockholder.

 

Dividend Policy

Our board of directors declared a quarterly dividend of $0.01 per share for the third and fourth quarters of 2013. Our board of directors currently intends to continue to authorize the payment of a nominal quarterly cash dividend to our stockholders of record. Any declaration and payment of dividends by our board of directors will depend on many factors, including general economic and business conditions, our strategic plans, our financial results and condition, legal and regulatory requirements and other factors that our board of directors deems relevant. See “Dividend Policy.”

 

Stock Exchange Symbol

Shares of our common stock are not currently listed on any national securities exchange. Our common stock has been approved for listing on the NASDAQ Global Market under the symbol “NGHC.”

 

Risk Factors

Investing in our common stock involves a high degree of risk. For a discussion of factors you should consider in making an investment, see “Risk Factors” beginning on page 14.

 

(1) Throughout this prospectus, unless the context expressly states otherwise, the number of shares of common stock outstanding excludes: (i) 5,058,348 shares of common stock issuable upon the exercise of stock options outstanding as of the date of this prospectus with a weighted average exercise price of $8.48 per share; and (ii) 2,344,852 additional shares of common stock available for future issuance under our 2013 Equity Incentive Plan. In addition, throughout this prospectus, unless the context states otherwise, all share amounts give effect to a 286.22 to 1 stock split in the form of a stock dividend which was effected immediately prior to the consummation of the private placement.

 

 

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SUMMARY FINANCIAL DATA

The following tables set forth our historical consolidated summary financial data for the periods ended and as of the dates indicated. The summary income statement data for the years ended December 31, 2012 and 2011 and the period from March 1, 2010 (inception) to December 31, 2010 are derived from our audited consolidated financial statements included elsewhere in this prospectus. The summary income statement data for the nine months ended September 30, 2013 and 2012 and the balance sheet data as of September 30, 2013 are derived from our unaudited consolidated financial statements included elsewhere in this prospectus. Our unaudited consolidated financial statements have been prepared on the same basis as our audited consolidated financial statements and, in our opinion, include all adjustments, consisting of only normal recurring adjustments, necessary for a fair presentation of such financial statements in all material respects. The results of any interim period are not necessarily indicative of results that may be expected for a full year or any future period.

You should read the following selected consolidated financial information together with the other information contained in this prospectus, including the section captioned “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and the consolidated financial statements and related notes included elsewhere in this prospectus.

 

(amounts in thousands)    Nine Months Ended
September 30,
    (As Restated)(2)
Year Ended December 31,
    (As Restated)(2)
Period from
March 1, 2010
(Inception) to
December 31,
 
     2013     2012     2012     2011     2010  

Income Statement Data:

          

Gross premium written

   $ 1,021,016      $ 1,029,398      $ 1,351,925      $ 1,178,891      $ 911,991   

Ceded premiums(1)

     (543,373     (538,040     (719,431     (640,655     (463,422
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Net premium written

   $ 477,643      $ 491,358      $ 632,494      $ 538,236      $ 448,570   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Change in unearned premium

     (4,811     (68,184     (58,242     (40,026     112,347   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Net earned premium

   $ 472,832      $ 423,174      $ 574,252      $ 498,210      $ 560,917   

Ceding commission income (primarily related parties)

     76,439        67,080        93,300        80,384        49,656   

Service and fee income

     93,053        68,946        93,739        66,116        53,539   

Net investment income

     22,093        22,981        30,550        28,355        25,391   

Net realized gain on investments

     1,463        15,856        16,612        4,775        3,293   

Bargain purchase gain and other revenue

     16        (32     3,728        —          33,238   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total revenues

   $ 665,896      $ 598,005      $ 812,181      $ 677,840      $ 726,034   

Loss and loss adjustment expense (“LAE”)

     302,403        279,016        394,666        333,848        391,633   

Acquisition and other underwriting costs

     94,265        81,352        110,771        75,191        36,755   

General and administrative

     220,515        184,225        258,604        218,152        155,108   

Interest expense

     1,456        1,342        1,787        1,994        1,795   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total expenses

   $ 618,639      $ 545,935      $ 765,828      $ 629,185      $ 585,291   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

 

 

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(amounts in thousands)    Nine Months Ended
September 30,
    (As Restated)(2)
Year Ended December 31,
    (As Restated)(2)
Period from
March 1, 2010
(Inception) to
December 31,
 
     2013     2012             2012                     2011             2010  

Income before provision for income taxes and equity in earnings (losses) of unconsolidated subsidiaries

   $ 47,257      $ 52,070      $ 46,353      $ 48,655      $ 140,743   

Provision for income taxes

     12,392        17,240        12,309        28,301        42,416   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Income before equity in earnings (losses) of unconsolidated subsidiaries and non-controlling interest

   $ 34,865      $ 34,830      $ 34,044      $ 20,354      $ 98,327   

Equity in earnings (losses) of unconsolidated subsidiaries

     (452     (2,693     (1,338     23,760        3,876   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Net income

   $ 34,413      $ 32,137      $ 32,706      $ 44,114      $ 102,203   

Non-controlling interest

     (44     —          —          (14     —     
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Net income attributable to National General Holdings Corp.

   $ 34,369      $ 32,137      $ 32,706      $ 44,100      $ 102,203   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

 

(1) Premiums ceded to related parties were $422,380 and $415,968 for the nine months ended September 30, 2013 and 2012, respectively, and $561,317, $491,689 and $246,909 for the years ended December 31, 2012, 2011 and the period from March 1, 2010 (inception) to December 31, 2010, respectively.
(2) Certain amounts for the years ended December 31, 2012 and 2011 and the period from March 1, 2010 (Inception) to December 31, 2010 have been restated. Please refer to Note 2 to our audited financial statements for the year ended December 31, 2012 for further detail.

 

 

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(amounts in thousands)    As of September 30,
2013
 

Balance Sheet Data

  

Cash, cash equivalents and restricted cash

   $ 35,810   

Investments

   $ 1,024,463   

Reinsurance recoverable

   $ 984,547   

Premiums and other receivable, net

   $ 464,060   

Goodwill and intangibles assets

   $ 148,371   

Total assets

   $ 2,824,350   

Reserves for loss and LAE

   $ 1,269,458   

Unearned premium

   $ 492,830   

Deferred income tax liability

   $ 12,546   

Notes payable

   $ 80,987   

Common stock, additional paid-in capital, retained earnings, accumulated other comprehensive income and non-controlling interests

   $ 635,005   

Total stockholders’ equity

   $ 635,005   

 

 

 

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RISK FACTORS

An investment in our common stock involves a high degree of risk. Before making an investment decision, you should carefully consider each of the following risk factors and all of the other information set forth in this prospectus. If any one or more of the risks discussed in this prospectus actually occurs, our business, financial condition and results of operations could be materially and adversely affected. If this were to happen, the price of shares of our common stock could decline significantly, and you may lose all or a part of your investment. The risk factors described below are not the only ones that may affect us. Additional risks and uncertainties that we do not currently know about or that we currently deem immaterial may also adversely affect our business, financial condition and results of operations. See “Cautionary Statement Concerning Forward-Looking Statements.”

Risks Relating to Our Business Generally

If we are unable to accurately underwrite risks and charge competitive yet profitable rates to our policyholders, our business, financial condition and results of operations may be adversely affected.

In general, the premiums for our insurance policies are established at the time a policy is issued and, therefore, before all of our underlying costs are known. Like other insurance companies, we rely on estimates and assumptions in setting our premium rates. Establishing adequate premiums is necessary, together with investment income, to generate sufficient revenue to offset losses, loss adjustment expenses (“LAE”) and other underwriting costs and to earn a profit. If we do not accurately assess the risks that we assume, we may not charge adequate premiums to cover our losses and expenses, which would negatively affect our results of operations and our profitability. Alternatively, we could set our premiums too high, which could reduce our competitiveness and lead to lower revenues.

Pricing involves the acquisition and analysis of historical loss data, and the projection of future trends, loss costs and expenses, and inflation trends, among other factors, for each of our products in multiple risk tiers and many different markets. In order to accurately price our policies, we:

 

   

collect and properly analyze a substantial volume of data from our insureds;

 

   

develop, test and apply appropriate actuarial projections and rating formulas;

 

   

closely monitor and timely recognize changes in trends; and

 

   

project both frequency and severity of our insureds’ losses with reasonable accuracy.

We seek to implement our pricing accurately in accordance with our assumptions. Over the past 24 months, we have generally increased our private passenger auto rates approximately 15%. Our ability to undertake these efforts successfully and, as a result, accurately price our policies, is subject to a number of risks and uncertainties, including:

 

   

insufficient or unreliable data;

 

   

incorrect or incomplete analysis of available data;

 

   

uncertainties generally inherent in estimates and assumptions;

 

   

our failure to implement appropriate actuarial projections and rating formulas or other pricing methodologies;

 

   

regulatory constraints on rate increases;

 

   

unexpected escalation in the costs of ongoing medical treatment;

 

   

our failure to accurately estimate investment yields and the duration of our liability for loss and LAE; and

 

   

unanticipated court decisions, legislation or regulatory action.

 

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If we are unable to establish and maintain accurate loss reserves, our business, financial condition and results of operations may be materially adversely affected.

Our financial statements include loss reserves, which represent our best estimate of the amounts that our insurance subsidiaries ultimately will pay on claims that have been incurred, and the related costs of adjusting those claims, as of the date of the financial statements. There is inherent uncertainty in the process of establishing insurance loss reserves.

As a result of these uncertainties, the ultimate paid loss and LAE may deviate, perhaps substantially, from the point-in-time estimates of such losses and expenses, as reflected in the loss reserves included in our financial statements. To the extent that loss and LAE exceed our estimates, we will be required to immediately recognize the unfavorable development and increase loss reserves, with a corresponding reduction in our net income in the period in which the deficiency is identified. Consequently, ultimate losses paid could materially exceed reported loss reserves and have a materially adverse effect on our business, financial condition and results of operations.

We have recently transitioned our advertising and marketing to our new brand name, “National General Insurance” from our prior name “GMAC Insurance.”

Since we acquired our P&C business from GMAC in March 2010, we have marketed many of our products and services using the “GMAC Insurance” brand name and logo. During 2013 we decided to transition to our new brand name “National General Insurance” and did not extend our license to use the “GMAC Insurance” brand. Effective July 1, 2013, we transitioned our marketing materials, operating materials and legal entity names containing “GMAC Insurance” to our new brand name, “National General.” We currently market under several of our own and our affinity partners’ brand names, and do not believe that brand name is a significant component in our customers’ decision to purchase insurance. Nonetheless, it is possible that our association with the “GMAC Insurance” brand may have provided us with some brand recognition among certain of our agents, affinity partners and insureds and this change could adversely affect our business, financial condition and results of operation.

Ongoing economic uncertainty could materially and adversely affect our business, our liquidity and financial condition.

Global economies and financial markets have experienced significant weakness and volatility since 2008, although the most extreme of these circumstances have abated since that time. Despite improved financial market performance since 2009, near-term U.S. economic prospects have only very gradually improved, with unemployment continuing at historically elevated levels. In addition, U.S. federal and state governments continue to experience significant structural fiscal deficits, creating uncertainty as to levels of taxation, inflation, regulation and other economic fundamentals that may impact future growth prospects. Significantly greater economic, fiscal and monetary uncertainty remains in Europe, due to the combination of poor economic growth, high unemployment and significant sovereign deficits which have called into question the future of the common currency used across most of Europe. While immediate concerns regarding the prospects of the European common currency abated somewhat in the second half of 2012, these issues remain unresolved and may have an indirect and potentially significant impact on the U.S. economy, although these prospects are not clearly defined at this time. Continuation of these conditions may potentially affect (among other aspects of our business) the demand for and claims made under our products, the ability of customers, counterparties and others to establish or maintain their relationships with us, our ability to access and efficiently use internal and external capital resources and our investment performance. In the event that these conditions persist and result in a prolonged period of economic uncertainty, our results of operations, our financial condition and/or liquidity, our prospects and competitor landscape could be materially and adversely affected.

 

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Our business is dependent on the efforts of our executive officers and other personnel. If we are unsuccessful in our efforts to attract, train and retain qualified personnel, our business may be materially adversely affected.

Our success is dependent on the efforts of our executive officers because of their industry expertise, knowledge of our markets, and relationships with our independent agents. Our principal executive officers are Michael Karfunkel, our chairman and chief executive officer; Byron Storms, our P&C president; Michael Weiner, our chief financial officer; Barry Karfunkel, our executive vice president and chief marketing officer; Robert Karfunkel, our executive vice president – strategy and development; Thomas Newgarden, our chief product officer; and Michael Murphy, our executive vice president – A&H. Should any of our executive officers cease working for us, we may be unable to find acceptable replacements with comparable skills and experience in the specialty P&C and A&H sectors that we target. In addition, our business is also dependent on skilled underwriters and other skilled employees. We cannot assure you that we will be able to attract, train and retain, on a timely basis and on anticipated economic and other terms, experienced and capable senior management, underwriters and support staff. We intend to pay competitive salaries, bonuses and equity-based rewards in order to attract and retain such personnel, but there can be no assurance that we will be successful in such endeavors. The loss of key personnel, or the inability to recruit and retain qualified personnel in the future, could have an adverse effect on our business, financial condition or operating results. We do not currently maintain life insurance policies with respect to our executive officers or other employees.

Revenues and operating profits from our P&C segment depend on our production in several key states and adverse developments in these key states could have a material adverse effect on our business, financial condition and results of operations.

For the nine months ended September 30, 2013, our P&C segment derived 74.4% of its gross premium written from the following six states: North Carolina (26.8%); New York (13.9%); California (13.2%), Florida (7.5%), Virginia (6.5%) and Michigan (6.6%). As a result, our financial results are subject to prevailing regulatory, legal, economic, demographic, competitive, and other conditions in these states. Adverse developments relating to any of these conditions could have a material adverse impact on our business, financial condition and results of operations.

If we cannot sustain our business relationships, including our relationships with independent agents and agencies, we may be unable to compete effectively and operate profitably.

We market our P&C segment products primarily through a network of over 19,000 independent agents. Our relationships with our agents are generally governed by agreements that may be terminated on short notice. Independent agencies generally are not obligated to promote our products and may sell insurance offered by our competitors. As a result, our ability to compete and remain profitable depends, in part, on our maintaining our business relationship with our independent agents and agencies, the marketing efforts of our independent agents and agencies and on our ability to offer insurance products and maintain financial strength ratings that meet the requirements and preferences of our independent agents and agencies and their policyholders. Any failure on our part to be effective in any of these areas could have a material adverse effect on our business and results of operations.

Our affinity channel depends on a relatively small number of affinity partner relationships for a significant percentage of the net premium revenue that it generates, and the loss of one of these significant affinity partner relationships could have a material adverse effect on our business, financial condition and results of operations.

Our affinity channel operates primarily through relationships with affinity partners, which include major retailers and membership organizations. See “Business—P&C Segment—Distribution and Marketing—Affinity Distribution Channel.” Our top five affinity relationships collectively represent 77.9% of our affinity channel written premium. Although our relationships with these and most of our other affinity partners are long-standing, in the event of the termination of any of our significant affinity partner relationships, our net earned premium could be adversely affected.

If we, together with our affiliates and the other third parties that we contract with, are unable to maintain our technology platform or our technology platform fails to operate properly, or meet the technological demands of our customers with respect to the products and services we offer, our business and financial performance could be significantly harmed.

In 2010, we engaged AmTrust to develop a new policy administration system to replace our three legacy mainframe systems. This system is now integrated across all lines of our P&C business. In addition, we recently developed our new RAD 5.0 underwriting pricing tool, which allows us to more

 

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accurately evaluate specific risk exposures in order to assist us in profitably underwriting our P&C products. However, the transition to our new policy administration system is not yet complete, and we have not yet implemented our RAD 5.0 technology. There can be no assurance that the transition and implementation of these systems will be completed successfully or within the time frame that we contemplate. Our inability to successfully complete the transition and implementation of these systems could cause disruptions in our business and have a material adverse effect on our ability to conduct our business profitably.

If we are unable to properly maintain our policy administration system and the remainder of our technology systems or if our technology systems otherwise fail to perform in the manner we currently contemplate, our ability to effectively underwrite and issue policies, process claims and perform other business functions could be significantly impaired and our business and financial performance could be significantly harmed. In addition, the success of our business is dependent on our ability to resolve any issues identified with our technology arrangements during operations and make any necessary improvements in a timely manner. Further, we will need to match or exceed the technological capabilities of our competitors over time. We cannot predict with certainty the cost of such maintenance and improvements, but failure to make such improvements could have an adverse effect on our business. See “Business—Technology” and “Certain Relationships and Related Party Transactions—Master Services Agreement.”

Also, we use e-commerce and other technology to provide, expand and market our products and services. Accordingly, we believe that it will be essential to continue to invest resources in maintaining electronic connectivity with customers and, more generally, in e-commerce and technology. Our business may suffer if we do not maintain these arrangements or keep pace with the technological demands of customers.

If we experience security breaches or other disruptions involving our technology, our ability to conduct our business could be adversely affected, we could be liable to third parties and our reputation could suffer, which could have a material adverse effect on our business.

Our business is dependent upon the uninterrupted functioning of our information technology and telecommunication systems. We rely upon our systems, as well as the systems of our vendors, for all our business operations, including underwriting and issuing policies, processing claims, providing customer service, complying with insurance regulatory requirements and performing actuarial and other analytical functions necessary for underwriting, pricing and product development. Our operations are dependent upon our ability to timely and efficiently maintain and improve our information and telecommunications systems and protect them from physical loss, telecommunications failure or other similar catastrophic events, as well as from security breaches. A shut-down of, or inability to access, one or more of our facilities; a power outage; or a failure of one or more of our information technology, telecommunications or other systems could significantly impair our ability to perform such functions on a timely basis. In the event of a disaster such as a natural catastrophe, terrorist attack or industrial accident, or due to a computer virus, our systems could be inaccessible for an extended period of time. While we have implemented business contingency plans and other reasonable and appropriate internal controls to protect our systems from interruption, loss or security breaches, a sustained business interruption or system failure could adversely impact our ability to process our business, provide customer service, pay claims in a timely manner or perform other necessary business functions.

Our operations depend on the reliable and secure processing, storage and transmission of confidential and other information in our computer systems and networks. Computer viruses, hackers, employee misconduct and other external hazards could expose our data systems to security breaches, cyber-attacks or other disruptions. In addition, we routinely transmit and receive personal, confidential and proprietary information by electronic means. We have implemented security measures designed to protect against breaches of security and other interference with our systems and networks resulting from attacks by third parties, including hackers, and from employee or advisor error or malfeasance. We also assess and monitor the security measures of our third-party business partners, who in the provision of services to us are provided with or process information pertaining to our business or our customers. Despite these measures, we cannot assure that our systems and networks will not be subject to breaches or interference. Any such event may result in operational disruptions as well as unauthorized access to or the disclosure or loss of our proprietary information or our customers’ information, which in turn may result in legal claims, regulatory scrutiny and liability, reputational damage, the incurrence of costs to eliminate or mitigate further exposure, the loss of customers or affiliated advisors or other damage to our business. In addition, the trend toward

 

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broad consumer and general public notification of such incidents could exacerbate the harm to our business, financial condition and results of operations. Even if we successfully protect our technology infrastructure and the confidentiality of sensitive data, we could suffer harm to our business and reputation if attempted security breaches are publicized. We cannot be certain that advances in criminal capabilities, discovery of new vulnerabilities, attempts to exploit vulnerabilities in our systems, data thefts, physical system or network break-ins or inappropriate access, or other developments will not compromise or breach the technology or other security measures protecting the networks and systems used in connection with our business.

We may not be able to successfully acquire or integrate additional businesses or manage the growth of our operations, which could make it difficult for us to compete and could adversely affect our profitability.

Since our formation in 2009, we have grown our business primarily through 10 acquisitions of insurance companies, agencies or books of business. Part of our growth strategy is to continue to grow our business through acquisitions. This strategy of growing through acquisitions subjects us to numerous risks, including risks associated with:

 

   

our ability to identify profitable geographic markets for entry;

 

   

our ability to identify potential acquisition targets and successfully acquire them on acceptable terms and in a timely manner;

 

   

our ability to integrate acquired businesses smoothly and efficiently;

 

   

our ability to achieve expected synergies, profitability and return on our investment;

 

   

the diversion of management’s attention from the day-to day operations of our business;

 

   

our ability to attract and retain qualified personnel for expanded operations;

 

   

encountering unforeseen operating difficulties or incurring unforeseen costs and liabilities;

 

   

our ability to manage risks associated with entering into geographic and product markets with which we are less familiar;

 

   

our ability to obtain necessary regulatory approvals;

 

   

our ability to expand existing agency relationships; and

 

   

our ability to augment our financial, administrative and other operating systems to accommodate the growth of our business.

Due to any of the above risks, we cannot assure you that (i) we will be able to successfully identify and acquire additional businesses on acceptable terms or at all, (ii) we will be able to successfully integrate any business we acquire, (iii) we will be able effectively manage our growth or (iv) any new business that we acquire or enter into will be profitable. Our failure in any of these areas could have a material adverse effect on our business, financial condition and results of operations.

Recently we have diversified our insurance business by expanding into the A&H segment through six acquisitions. The A&H insurance business is a relatively new business for us, and we have a limited operating history in this market. As a result, the risks describe above with respect to growing our business by expanding into new product markets are particularly relevant with respect to our A&H business. Our plans for our A&H segment include selling new accident and non-major medical health insurance products, and we have recently commenced sales of some of these products. While we have received the necessary regulatory approvals to begin selling some of these products in many jurisdictions, we are still awaiting regulatory approvals for certain of our products in certain jurisdictions and for the licensing, or lifting of certain restrictions with respect to its license, of our A&H insurance subsidiary, National Health Insurance Company, in certain jurisdictions. We have received substantially all of these regulatory approvals and the remaining approvals are expected in the first quarter of 2014. We cannot assure you that we will

 

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obtain the regulatory approvals necessary for us to conduct this business as planned or that any approval granted will not be subject to conditions that restrict our operations. Our inability to successfully implement our business plan for our A&H segment could have a material adverse effect on our financial condition and results of operations.

In addition, we have recently entered into an agreement to acquire the Tower Personal Lines Business, including certain of Tower’s domestic insurance companies, the Tower Personal Lines Business renewal rights, the systems, books and records required to effectively conduct the Tower Personal Lines Business as well as the right to offer employment to certain Tower employees engaged in the conduct of the Tower Personal Lines Business. Our inability to successfully integrate the Tower Personal Lines Business and related assets into our P&C business could have a material adverse effect on our financial condition and results of operations.

If our businesses, including businesses we have acquired, do not perform well, we may be required to recognize an impairment of our goodwill or other intangible assets, which could have a material adverse effect on our financial condition and results of operations.

As of September 30, 2013, we had $80.3 million of goodwill recorded on our balance sheet. Goodwill represents the excess of the amounts we paid to acquire subsidiaries and other businesses over the fair value of their net assets at the date of acquisition. We are required to perform goodwill impairment tests at least annually and whenever events or circumstances indicate that the carrying value may not be recoverable from estimated future cash flows. If we determine that the goodwill has been impaired, we would be required to write down the goodwill by the amount of the impairment, with a corresponding charge to net income. Such write-downs could have a material adverse effect on our financial condition and results of operations.

As of September 30, 2013, we had $68.1 million aggregate amount of intangible assets, excluding goodwill, recorded on our balance sheet. Intangible assets represent the amount of fair value assigned to certain assets when we acquire a subsidiary or a book of business. Intangible assets are classified as having either a finite or an indefinite life. We test the recoverability of our intangible assets at least annually. We test the recoverability of finite life intangibles whenever events or changes in circumstances indicate that the carrying value of a finite life intangible may not be recoverable. We recognize an impairment if the carrying value of an intangible asset is not recoverable and exceeds its fair value, in which circumstances we must write down the intangible asset by the amount of the impairment with a corresponding charge to net income. Such write downs could have a material adverse effect on our financial condition and results of operations.

Our principal stockholders have the ability to control our business, which may be disadvantageous to other stockholders.

Michael Karfunkel, Leah Karfunkel, the wife of Michael Karfunkel and the sole trustee of the Karfunkel Trust, and AmTrust, collectively, beneficially own or control approximately 72.6% of our outstanding shares of common stock. As a result, these holders have the ability to control all matters requiring approval by our stockholders, including the election and removal of directors, amendments to our certificate of incorporation (other than changes to the rights of the common stock) and bylaws, any proposed merger, consolidation or sale of all or substantially all of our assets and other corporate transactions. These individuals may have interests that are different from those of other stockholders.

In addition, we are a “controlled company” pursuant to Rule 5615(c) of the corporate governance standards of the NASDAQ Global Market because Michael Karfunkel, Leah Karfunkel, as sole trustee of the Karfunkel Trust, and AmTrust collectively own approximately 72.6% of our voting power. Our common stock has been approved for listing on the NASDAQ Global Market. Therefore, we are exempt from the NASDAQ listing requirements with respect to having a majority of the members of the board of directors be independent; having our Compensation Committee and Nominating and Corporate Governance Committee be composed solely of independent directors; the compensation of our executive officers determined by a majority of our independent directors or a Compensation Committee composed solely of independent directors; and director nominees being selected or recommended for selection, either by a majority of our independent directors or by a nominating committee composed solely of independent directors. We intend to rely on these exemptions.

In addition, Michael Karfunkel, through entities that he controls, has entered into transactions with us and may from time to time in the future enter into other transactions with us. As a result, he may have interests that are different from, or are in addition to, his interest as a stockholder in our company. Such transactions may adversely affect our results or operations or financial condition. See the next two risk factors immediately following this risk factor and “Certain Relationships and Related Party Transactions.”

 

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Our officers, directors and principal stockholders could delay or prevent an acquisition or merger of our company even if the transaction would benefit other stockholders. Moreover, this concentration of share ownership makes it impossible for other stockholders to replace directors and management without the consent of Michael Karfunkel, Leah Karfunkel and AmTrust. In addition, this significant concentration of share ownership may adversely affect the price at which prospective buyers are willing to pay for our common stock because investors often perceive disadvantages in owning stock in companies with controlling stockholders. See “Security Ownership of Certain Beneficial Owners and Management” for a more detailed description of our share ownership.

Our relationship with AmTrust and its subsidiaries may present, and make us vulnerable to, difficult conflicts of interest, related party transactions, business opportunity issues and legal challenges.

AmTrust is a publicly-traded insurance holding company controlled by Michael Karfunkel, Leah Karfunkel, as the sole trustee of the Karfunkel Trust, George Karfunkel, Michael Karfunkel’s brother, and Barry Zyskind. AmTrust beneficially owns or controls approximately 15.4% of our outstanding shares of common stock. Mr. Zyskind is the chief executive officer of AmTrust, the son-in-law of Mr. Karfunkel and is a member of our board of directors. See “Security Ownership of Certain Beneficial Owners and Management” for a more detailed description of our share ownership. Also, AmTrust (through a subsidiary) is a reinsurer under our quota share reinsurance treaty (“Personal Lines Quota Share”) pursuant to which we have historically ceded 50% of our P&C gross premium written and related losses (excluding premium ceded to state-run reinsurance facilities) to our quota share reinsurers. AmTrust currently receives 10% of such ceded premium and assumes 10% of the related losses solely with respect to policies in effect as of July 31, 2013.

We are party to a number of other arrangements with AmTrust and its affiliates, including, among others, an asset management agreement pursuant to which a subsidiary of AmTrust provides investment management services to us; a master services agreement pursuant to which AmTrust provides us and our affiliates with information technology development services in connection with the development and licensing of our policy administration system; a consulting and marketing agreement pursuant to which a subsidiary of AmTrust provides certain consulting and marketing services to promote our captive insurance program; joint investments in entities owning life settlement contracts; a joint investment in an entity owning an office building in Cleveland, Ohio; and an aircraft timeshare agreement with a subsidiary of AmTrust. These and other arrangements with AmTrust are described under the heading “Certain Relationships and Related Party Transactions.” Conflicts of interest could arise with respect to any of our contractual arrangements with AmTrust and its affiliates, as well as any other business opportunities that could be advantageous to AmTrust or its subsidiaries, on the one hand, and disadvantageous to us or our subsidiaries, on the other hand. AmTrust’s interests may be different from the interests of our company and the interests of our other stockholders.

Our relationship with Maiden and its subsidiaries may present, and make us vulnerable to, difficult conflicts of interest, related party transactions, business opportunity issues and legal challenges.

Maiden is a publicly-held Bermuda insurance holding company (NASDAQ: MHLD) of which Michael Karfunkel, our founder, major stockholder and chairman and chief executive officer, was a founding stockholder. As of December 31, 2012, Michael Karfunkel, Leah Karfunkel, as the sole trustee of the Karfunkel Trust, George Karfunkel and Barry Zyskind owned or controlled approximately 6.2%, 7.6%, 9.4% and 5.1%, respectively, of the issued and outstanding capital stock of Maiden. Mr. Zyskind serves as the non-executive chairman of Maiden’s board of directors. Maiden Insurance Company, Ltd. (“Maiden Insurance”), a wholly owned subsidiary of Maiden, is a Bermuda reinsurer.

Maiden Insurance was the primary reinsurer under the Personal Lines Quota Share pursuant to which we historically ceded 50% of our P&C gross premium written and related losses (excluding premium ceded to state-run reinsurance facilities) from our P&C business to our quota share reinsurers. Maiden Insurance currently receives 25% of the ceded premium and assumes 25% of the related losses solely with respect to policies in effect as of July 31, 2013. See “Certain Relationships and Related Party Transactions—Personal Lines Quota Share.” Conflicts of interest could arise with respect to matters relating to the Personal Lines Quota Share, as well as business opportunities that could be advantageous to Maiden or its subsidiaries, on the one hand, and disadvantageous to us or our subsidiaries, on the other hand. See “Certain Relationships and Related Party Transactions.”

 

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Our relationship with ACP Re may present, and make us vulnerable to, difficult conflicts of interest, related party transactions, business opportunity issues and legal challenges.

ACP Re, Ltd. (“ACP Re”) is a Bermuda reinsurer that is a subsidiary of the Karfunkel Trust. ACP Re is a reinsurer under the Personal Lines Quota Share pursuant to which we have historically ceded 50% of our P&C gross premium written and related losses (excluding premium ceded to state-run reinsurance facilities) to our quota share reinsurers. ACP Re currently receives 15% of the ceded premium and assumes 15% of the related losses under this agreement solely with respect to policies in effect as of July 31, 2013. We also provide management services to ACP Re pursuant to a services agreement we entered into effective November 1, 2012, and owe $18.7 million under an amended and restated note for that amount we issued to ACP Re effective February 20, 2013. In addition, we have entered into a stock and asset purchase agreement with ACP Re pursuant to which we agreed to acquire the renewal rights and assets of the personal lines insurance operations of Tower Group International, Ltd., following ACP Re’s acquisition of Tower. Conflicts of interest could arise with respect to any of the contractual arrangements between us and ACP Re, as well as business opportunities that could be advantageous to ACP Re, on the one hand, and disadvantageous to us or our subsidiaries, on the other hand. For a more detailed description of our arrangements with ACP Re, see “Certain Relationships and Related Party Transactions.”

A downgrade in the A.M. Best rating of our insurance subsidiaries would likely reduce the amount of business we are able to write and could materially adversely impact the competitive positions of our insurance subsidiaries.

Rating agencies evaluate insurance companies based on their ability to pay claims. A.M. Best Company, Inc. has currently assigned our property and casualty insurance subsidiaries a group rating of “A-” (Excellent), which is the fourth highest out of fifteen ratings. Our recently acquired A&H insurance subsidiary, National Health Insurance Company (“NHIC”) is not yet rated, though we intend to seek a favorable A.M. Best rating for NHIC. The ratings of A.M. Best are subject to periodic review using, among other things, proprietary capital adequacy models, and are subject to revision or withdrawal at any time. Our competitive position relative to other companies is determined in part by the A.M. Best rating of our insurance subsidiaries. A.M. Best ratings are directed toward the concerns of policyholders and insurance agencies and are not intended for the protection of investors or as a recommendation to buy, hold or sell securities.

There can be no assurances that our insurance subsidiaries will be able to maintain their current ratings or, in the case of NHIC, obtain a favorable rating. Any downgrade in ratings, or failure to obtain a favorable rating in the case of NHIC, would likely adversely affect our business through the loss of certain existing and potential policyholders and the loss of relationships with independent agencies that might move to other companies with higher ratings. We are not able to quantify the percentage of our business, in terms of premiums or otherwise, that would be affected by a downgrade in our A.M. Best ratings.

Performance of our investment portfolio is subject to a variety of investment risks that may adversely affect our financial results.

Our results are affected, in part, by the performance of our investment portfolio. Our investment portfolio contains interest rate sensitive investments, such as fixed-income securities. As of September 30, 2013, our investment in fixed-income securities was approximately $896.0 million, or 83.8% of our total investment portfolio, including cash and accrued interest. Increases in market interest rates may have an adverse impact on the value of our investment portfolio by decreasing the value of fixed-income securities. Conversely, declining market interest rates could have an adverse impact on our investment income as we invest positive cash flows from operations and as we reinvest proceeds from maturing and called investments in new investments that could yield lower rates than our investments have historically generated. Defaults in our investment portfolio may produce operating losses and adversely impact our results of operations.

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. Although we take measures to manage the risks of investing in a changing interest rate environment, we may not be able to manage interest rate sensitivity effectively. Despite our efforts to maintain a high quality portfolio and manage the duration of the portfolio to reduce the effect of interest rate changes, a significant change in interest rates could have a material adverse effect on our financial condition and results of operations.

 

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In addition, the performance of our investment portfolio generally is subject to other risks, including the following:

 

   

the risk of decrease in value due to a deterioration in the financial condition, operating performance or business prospects of one or more issuers of our fixed-income securities;

 

   

the risk that our portfolio may be too heavily concentrated in the securities of one or more issuers, sectors or industries;

 

   

the risk that we will not be able to convert investment securities into cash on favorable terms and on a timely basis; and

 

   

general movements in the values of securities markets.

If our investment portfolio were to suffer a substantial decrease in value due to market, sector or issuer-specific conditions, our liquidity, financial condition and results of operations could be materially adversely affected. A decrease in value of an insurance subsidiary’s investment portfolio could also put the subsidiary at risk of failing to satisfy regulatory minimum capital requirements and could limit the subsidiary’s ability to write new business.

Our holding company structure and certain regulatory and other constraints, including adverse business performance, could affect our ability to satisfy our obligations.

We are a holding company and conduct our business operations through our various subsidiaries. Our principal sources of funds are dividends and other payments from our insurance subsidiaries, income from our investment portfolio and funds that may be raised from time to time in the capital markets. We will be largely dependent on amounts from our insurance subsidiaries to pay principal and interest on any indebtedness that we may incur, to pay holding company operating expenses, to make capital investments in our other subsidiaries and to pay dividends on our common stock. In addition, our credit agreement contains covenants that limit our ability to pay cash dividends to our stockholders under certain circumstances. See “—The covenants in our credit agreement limit our financial and operational flexibility, which could have an adverse effect on our financial condition.”

Our insurance subsidiaries are subject to statutory and regulatory restrictions imposed on insurance companies by their states of domicile, which limit the amount of cash dividends or distributions that they may pay to us unless special permission is received from the insurance regulator of the relevant domiciliary state. In general, the maximum amount of dividends that the insurance subsidiaries may pay in any 12-month period without regulatory approval is the greater of adjusted statutory net income or 10% of statutory policyholders’ surplus as of the preceding calendar year end. Adjusted statutory net income is generally defined for this purpose to be statutory net income, net of realized capital gains, for the calendar year preceding the date of the dividend. In addition, other states may limit or restrict our insurance subsidiaries’ ability to pay stockholder dividends generally or as a condition to issuance of a certificate of authority.

The aggregate amount of dividends that could be paid by our insurance subsidiaries without prior approval by the various domiciliary states of our insurance subsidiaries was approximately $19.0 million as of December 31, 2012, taking into account dividends paid in the prior twelve month period. During the years ended December 31, 2012 and 2011 and the period from March 1, 2010 (inception) to December 31, 2010, there were $133.5 million, $0 million and $0 million dividends paid by the insurance subsidiaries to National General Management Corp. (formerly, GMAC Insurance Management Corporation) (“Management Corp.”) or the Company. We obtained permission from the states of domicile before the extraordinary dividends were paid in 2012. After receiving the dividend, in 2012, Management Corp. paid $120.0 million in the form of a capital contribution to its subsidiary, Integon National. During 2012, the insurance subsidiaries also paid to Management Corp. a return of capital of $18.5 million. See “Management’s Discussion and Analysis of Financial Condition and Results of Operations—Liquidity and Capital Resources.”

 

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Our insurance subsidiaries are subject to minimum capital and surplus requirements. Our failure to meet these requirements could subject us to regulatory action.

The laws of the states of domicile of our insurance subsidiaries impose risk-based capital standards and other minimum capital and surplus requirements. Failure to meet applicable risk-based capital requirements or minimum statutory capital requirements could subject us to further examination or corrective action imposed by state regulators, including limitations on our writing of additional business, state supervision or liquidation. Any changes in existing risk-based capital requirements or minimum statutory capital requirements may require us to increase our statutory capital levels, which we may be unable to do. See “Regulation—State Insurance RegulationFinancial Oversight—Risk-Based Capital Regulations.”

The insurance industry is subject to extensive regulation, which may affect our ability to execute our business plan and grow our business.

We are subject to comprehensive regulation and supervision by government agencies in each of the 6 states in which our insurance subsidiaries are domiciled or commercially domiciled, as well as all states in which they are licensed, sell insurance products, issue policies, or handle claims. Some states impose restrictions or require prior regulatory approval of specific corporate actions, which may adversely affect our ability to operate, innovate, obtain necessary rate adjustments in a timely manner or grow our business profitably. These regulations provide safeguards for policyholders and are not intended to protect the interests of stockholders. Our ability to comply with these laws and regulations, and to obtain necessary regulatory action in a timely manner is, and will continue to be, critical to our success. Some of these regulations include:

 

   

Required Licensing. We operate under licenses issued by the insurance department in the states in which we sell insurance. If a regulatory authority denies or delays granting a new license, our ability to enter that market quickly or offer new insurance products in that market may be substantially impaired. In addition, if the insurance department in any state in which we currently operate suspends, non-renews, or revokes an existing license, we would not be able to offer affected products in that state.

 

   

Transactions Between Insurance Companies and Their Affiliates. Transactions between us or other of our affiliates and our insurance companies generally must be disclosed, and prior approval is required before any material or extraordinary transaction may be consummated. Approval may be refused or the time required to obtain approval may delay some transactions, which may adversely affect our ability to innovate or operate efficiently.

 

   

Regulation of Insurance Rates and Approval of Policy Forms. The insurance laws of most states in which we conduct business require insurance companies to file insurance rate schedules and insurance policy forms for review and approval. If, as permitted in some states, we begin using new rates before they are approved, we may be required to issue refunds or credits to the policyholders if the new rates are ultimately deemed excessive or unfair and disapproved by the applicable insurance department. In other states, prior approval of rate changes is required and there may be long delays in the approval process or the rates may not be approved. Accordingly, our ability to respond to market developments or increased costs in that state could be adversely affected.

 

   

Restrictions on Cancellation, Non-Renewal or Withdrawal. Many of the states in which we operate have laws and regulations that limit our ability to exit a market. For example, some states limit a private passenger auto insurer’s ability to cancel and refuse to renew policies and some prohibit insurers from withdrawing one or more lines of insurance business from the state unless prior approval is received. In some states, these regulations extend to significant reductions in the amount of insurance written, not just to a complete withdrawal. Laws and regulations that limit our ability to cancel and refuse to renew policies in some states or locations and that subject withdrawal plans to prior approval requirements may restrict our ability to exit unprofitable markets, which may harm our business, financial condition and results of operations.

 

   

Other Regulations. We must also comply with regulations involving, among other matters:

 

   

the use of non-public consumer information and related privacy issues;

 

   

the use of credit history in underwriting and rating policies;

 

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limitations on the ability to charge policy fees;

 

   

limitations on types and amounts of investments;

 

   

restrictions on the payment of dividends by our insurance subsidiaries;

 

   

the acquisition or disposition of an insurance company or of any company controlling an insurance company;

 

   

involuntary assignments of high-risk policies, participation in reinsurance facilities and underwriting associations, assessments and other governmental charges;

 

   

reporting with respect to financial condition; and

 

   

periodic financial and market conduct examinations performed by state insurance department examiners.

The failure to comply with these laws and regulations may also result in regulatory actions, fines and penalties, and in extreme cases, revocation of our ability to do business in a particular jurisdiction. In the past we have been fined by state insurance departments for failing to comply with certain laws and regulations. In addition, we may face individual and class action lawsuits by insured and other parties for alleged violations of certain of these laws or regulations.

Our failure to accurately and timely pay claims could adversely affect our business, financial results and liquidity.

We must accurately and timely evaluate and pay claims that are made under our policies. Many factors affect our ability to pay claims accurately and timely, including the training and experience of our claims representatives, our claims organization’s culture and the effectiveness of our management, our ability to develop or select and implement appropriate procedures and systems to support our claims functions and other factors. Our failure to pay claims accurately and timely could lead to material litigation, undermine our reputation in the marketplace and materially adversely affect our financial results and liquidity.

In addition, if we do not train new claims employees effectively or lose a significant number of experienced claims employees, our claims department’s ability to handle an increasing workload could be adversely affected. In addition to potentially requiring that growth be slowed in the affected markets, our business could suffer from decreased quality of claims work which, in turn, could lower our operating margins.

Regulation may become more extensive in the future, which may adversely affect our business, financial condition and results of operations.

Compliance with applicable laws and regulations is time-consuming and personnel-intensive, and changes in these laws and regulations may materially increase our direct and indirect compliance and other expenses of doing business, thus adversely affecting our business, financial condition and results of operations.

In the future, states may make existing insurance laws and regulation more restrictive or enact new restrictive laws. In such event, we may seek to reduce our business in, or withdraw entirely from, these states. Additionally, from time to time, the United States Congress and certain federal agencies investigate the current condition of the insurance industry to determine whether federal regulation is necessary. Currently, the U.S. federal government does not directly regulate the P&C insurance business. However, The Dodd-Frank Wall Street Reform and Consumer Protection Act (“Dodd-Frank Act”) established a Federal Insurance Office (“FIO”) within the Department of the Treasury. The duties of the FIO include studying and reporting on how to modernize and improve the system of insurance regulation in the United States considering the ability of any federal regulation or a federal regulator to “provide robust consumer protection for policyholders” as well as “the potential consequences of subjecting insurers to a federal resolution authority.” On June 12, 2013, the FIO issued its annual report on the state of the insurance industry which outlines current industry issues, such as the impact of low interest rates, natural catastrophes, changing demographics in the United States and growth opportunities in emerging markets. The FIO stated that it expects to produce several additional reports this year, including a report on proposals to modernize and improve the system of insurance regulation in the United States. We cannot predict whether any of these proposals will be adopted, or what impact, if any, these proposals or, if enacted, these laws may have on our business, financial condition and results of operations. See “Regulation.”

 

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Reform of the health insurance industry could materially reduce the profitability of our A&H segment.

In March 2010, President Obama signed PPACA into law. Provisions of PPACA and related reforms have and will continue to become effective at various dates over the next several years and will make significant changes to the U.S. health care system that are expected to significantly affect the health insurance industry. For more information on PPACA and its impact on our A&H segment, see “Business—A&H Segment.”

We continue to review our product offerings and make changes to adapt to the new environment and the opportunities presented. However, we could be adversely affected if our plans for operating in the new environment are unsuccessful or if there is less demand than we expect for our A&H products in the new environment. Uncertainty remains with respect to a number of provisions of PPACA, including the mechanics of the public and private exchanges required by PPACA, the application of PPACA’s requirements to various types of health insurance plans and the timing of the implementation of certain of PPACA’s requirements. For example, recently the implementation of the mandate under PPACA that employers with 50 or more full-time employees offer affordable health insurance or pay penalties has been delayed one year until 2015.

New guidance and regulations continue to be issued under PPACA. If we are unable to adapt our A&H business to current and/or future requirements of PPACA, or if significant uncertainty continues with respect to implementation of PPACA, our A&H business could be materially adversely affected. Furthermore, should Congress extend the scope of PPACA to include some or all of our current and proposed A&H products, such a development could have a material adverse effect on our A&H business.

Assessments and other surcharges for guaranty funds, second-injury funds, catastrophe funds, and other mandatory pooling arrangements for insurers may reduce our profitability.

Virtually all states require insurers licensed to do business in their state to bear a portion of the loss suffered by some insured parties as the result of impaired or insolvent insurance companies. These losses are funded by assessments that are levied by state guaranty associations, up to prescribed limits, on all member insurance companies in the state based on their proportionate share of premiums written in the lines of business in which the impaired or insolvent insurance companies are engaged. The assessments levied on us may increase as we increase our written premium. In addition, as a condition to the ability to conduct business in various states, our insurance subsidiaries must participate in mandatory property and casualty shared market mechanisms or pooling arrangements, which provide various types of insurance coverage to individuals or entities that otherwise are unable to purchase that coverage from private insurers. The effect of these assessments and mandatory shared-market mechanisms or changes in them could reduce our profitability in any given period or limit our ability to grow our business.

We will require additional capital in the future and such additional capital may not be available to us, or only available to us on unfavorable terms.

To support our current and future policy writings, especially in light of the termination of the Personal Lines Quota Share effective August 1, 2013, the Cut-Through Reinsurance Agreement we have entered into and our expected acquisition of the Tower Personal Lines Business, we intend to raise substantial additional capital in the near term using a combination of debt and equity. Our future capital requirements depend on many factors, including our ability to write new business successfully and to establish premium rates and reserves at levels sufficient to cover losses. To the extent that the funds generated by our ongoing operations and initial capitalization are insufficient to fund future operating requirements, we may need to raise additional funds through financings or curtail our growth and reduce our assets. We cannot be sure that we will be able to raise equity or debt financing on terms favorable to us and our stockholders and in the amounts that we require, or at all. If we cannot obtain adequate capital, our business and financial condition could be adversely affected. Issuances of stock may result in dilution of our existing stockholders or a decrease in the per share price of our common stock.

In addition, the terms of a capital raising transaction could require us to agree to stringent financial and operating covenants and to grant security interests on our assets to lenders or holders of our debt securities that could limit our flexibility in operating our business or our ability to pay dividends on our common stock and could make it more difficult for us to obtain capital in the future.

 

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The covenants in our credit agreement limit our financial and operational flexibility, which could have an adverse effect on our financial condition.

Our credit agreement contains covenants that limit our ability, among other things, to borrow money, sell assets, merge or consolidate and make particular types of investments or other restricted payments, including the payment of cash dividends if an event of default has occurred and is continuing or if we are out of compliance with our financial covenants. These covenants could restrict our ability to achieve our business objectives, and therefore, could have an adverse effect on our financial condition. In addition, this agreement also requires us to maintain specific financial ratios. If we fail to comply with these covenants or meet these financial ratios, the lenders under our credit agreement could declare a default and demand immediate repayment of all amounts owed to them, cancel their commitments to lend and/or issue letters of credit, any of which could have a material adverse effect on our liquidity, financial condition and business in general.

The consummation of the transactions contemplated by the Personal Lines Purchase Agreement will, absent a waiver or amendment, result in our being in violation of certain covenants in the credit agreement, including negative covenants limiting the amount of consideration we may spend on acquisitions in a fiscal year and limiting the creation or acquisition of subsidiaries. If we are unable to obtain relief from these covenants by an amendment to the credit agreement or a waiver from the lenders, the lenders under our credit agreement could declare a default and demand immediate repayment of all amounts owed to them, cancel their commitments to lend and/or issue letters of credit, any of which could have a material adverse effect on our liquidity, financial condition and business in general.

Our operations and business activities outside of the United States are subject to a number of risks, which could have an adverse effect on our business, financial condition and results of operations.

We currently conduct a limited amount of business outside the United States, primarily in Bermuda, Luxembourg and Sweden. In these jurisdictions, we are subject to a number of significant risks in conducting such business. These risks include restrictions such as price controls, capital controls, exchange controls and other restrictive government actions, which could have an adverse effect on our business and our reputation. Investments outside the United States also subject us to additional domestic and foreign laws and regulations, including the Foreign Corrupt Practices Act and similar laws in other countries that prohibit the making of improper payments to foreign officials. In addition, some countries have laws and regulations that lack clarity and, even with local expertise and effective controls, it can be difficult to determine the exact requirements of the local laws. Failure to comply with local laws in a particular market could have a significant and negative effect not only on our business in that market but also on our reputation generally.

We may be subject to taxes on our Luxembourg affiliates’ equalization reserves.

In 2012, we formed a Luxembourg holding company and acquired a Luxembourg-domiciled reinsurance company. In connection with the acquisition, we acquired a licensed Luxembourg reinsurer together with its cash and associated equalization reserves. An “equalization reserve” is a compulsory volatility or catastrophe reserve in excess of ordinary reserves determined by a formula based on the volatility of the business ceded to the reinsurance company. Equalization reserves are required to be established for Luxembourg statutory and tax purposes, but are not recognized under U. S. GAAP. Equalization reserves are calculated on a line of business basis and are subject to a theoretical maximum amount, or cap, based on the expected premium volume described in the business plan of the reinsurance company as approved by the Luxembourg regulators, which cap is reassessed every five years. At the time we acquired the Luxembourg reinsurer for a purchase price of approximately $125 million, it had cash of approximately $135 million, established equalization reserves of approximately $129.6 million, and was subject to an equalization reserve cap of approximately $211 million. Each year, the Luxembourg reinsurer is required to adjust its equalization reserves by an amount equal to its statutory net income or net loss, determined based on premiums and investment income less incurred losses and other operating expenses. The yearly adjustment of the equalization reserve generally results in zero pretax income on a Luxembourg statutory and tax basis, as follows: in a year in which the reinsurer’s operations result in a statutory loss, the equalization reserves are taken down in an amount to balance the income statement to zero pretax income, and in a year in which the operations result in a gain, the equalization reserves are increased in an amount to balance the income statement to zero pretax income. If the reinsurer were to produce underwriting income in excess of the equalization reserve cap, or if the cap were to be reduced below the amount of the carried equalization reserves, the reinsurer would incur Luxembourg tax on the amount of such excess income or the amount by which the reserves exceeded the reduced cap, as applicable.

        We have entered into a stop loss reinsurance agreement with the Luxembourg reinsurer under which we pay reinsurance premiums and cede losses and expenses in excess of the attachment point to the reinsurer. Provided that we are able to cede losses to the reinsurance company through this intercompany reinsurance agreement that are sufficient to utilize all of the reinsurance company’s equalization reserves, Luxembourg would not, under laws currently in effect, impose any income, corporation or profits tax on the reinsurance company. However, if the reinsurance company were to cease reinsuring business without exhausting the equalization reserves, it would recognize income in the amount of the unutilized equalization reserves that would be taxed by Luxembourg at a rate of approximately 30%. We must establish a deferred tax liability on our financial statements equal to approximately 30% of the unutilized equalization reserves. We adjust the deferred tax liability each reporting period based on premiums and investment income less losses and other expenses ceded to the Luxembourg reinsurer under the intercompany reinsurance agreement. As of September 30, 2013, we had approximately $105.5 million of unutilized equalization reserves and an associated deferred tax liability of approximately $31.7 million. Under our business plan currently in effect, we expect that the ceded losses and expenses net of reinsurance premiums paid under the intercompany reinsurance agreement will cause the equalization reserve to be fully utilized in three to five years at which point the deferred tax liability relating to the equalization reserves will be extinguished. The effects of this intercompany reinsurance agreement are appropriately eliminated in consolidation.

We recently acquired two additional Luxembourg-domiciled reinsurance companies that, at the time of acquisition, collectively had $88.5 million in equalization reserves and an associated deferred tax liability of $26.5 million. We have entered into intercompany reinsurance agreements with these reinsurers under which we expect these equalization reserves to be fully utilized, and the related deferred tax liability to be extinguished, in 3 to 5 years.

A portion of our financial assets consists of life settlement contracts that are subject to certain risks.

As of September 30, 2013, we have a 50% ownership interest in entities that hold certain life settlement contracts (the “LSC Entities”), and the fair value of these contracts owned by the LSC Entities is $227.2 million, with our proportionate interest being $113.6 million.

 

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Estimates of fair value of the life settlement contracts held by the LSC Entities are subjective and based upon estimates of, among other factors: (i) the life expectancy of the insured person, (ii) the projected premium payments on the contract, including projections of possible rate increases from the related insurance carrier, (iii) the projected costs of administration relating to the contract and (iv) the projected risk of non-payment, including the financial health of the related insurance carrier, the possibility of legal challenges from such insurance carrier or others and the possibility of regulatory changes that may affect payment. The actual value of any life settlement contract cannot be determined until the policy matures (i.e., the insured has died and the insurance carrier has paid out the death benefit to the holder). A significant negative difference between the estimated fair value of a contract and actual death benefits received at maturity for any life settlement contract could adversely affect our financial condition and results of operations.

Some of the critical factors considered in determining the fair value of a life settlement contract are related to the discounted value of future cash flows from death benefits and the discounted value of future premiums due on the contract. If the rate used to discount the future death benefits or the future premiums changes, the value of the life settlement contract will also change. Generally, if discount rates increase, the fair value of a life settlement contract decreases. If a life settlement contract is sold or otherwise disposed of in the future under a relatively higher interest rate environment, the contract may have a lower value than the value it had when it was acquired.

The life expectancy of an insured under a life insurance policy is a key element in determining the anticipated cash flow associated with the policy and, ultimately, its value. For example, if an insured under a life insurance policy lives longer than estimated, premiums on that policy will be required to be paid for a longer period of time than anticipated (and in a greater total amount) in order to maintain the policy in force. Estimating life expectancies is inherently inexact and imprecise. Past mortality experience is not an accurate indicator of future mortality rates, and it is possible for insureds under life insurance policies to experience lower mortality rates in the future than those historically experienced by other persons having similar traits. The process of developing an estimate of life expectancy may include, but is not necessarily limited to, subjective interpretation of lifestyle, medical history, ancestry, educational background, improvements in mortality rates, wealth and access to and impact of changes in medical techniques. Subjective interpretation of these and other variables leads to vast complexities which ultimately present a degree of imprecision. In addition, the types of individuals who are insured under substantial life insurance policies may have longer life expectancies than the general population as a result of such factors as better access to medical care and healthier lifestyles. These factors may make it harder to correctly estimate their life expectancies.

Life expectancy providers have historically changed, and may in the future change, from time to time their respective underwriting methodologies in an effort to improve the precision of their life expectancy estimates. For example, certain changes effected by several leading life expectancy providers in 2008 and 2009 resulted in significantly longer life expectancies for many insureds under policies in the life settlement market, which led to a meaningful reduction in the fair value of those policies. Future changes by one or more life expectancy providers could similarly lengthen or shorten the life expectancy estimates of the insureds under life insurance policies in which the LSC Entities have an interest and significantly impact the market value and/or liquidity of the affected policies. Developments of this nature could have a material adverse effect on the value of our investment in the LSC Entities holding the life settlements contracts.

In addition, our results of operations and earnings may fluctuate depending on the number of life settlement contracts held by the LSC Entities in a given period and the fair value of those assets at the end of the applicable period. Any reduction in the fair value of these assets will impact our income in the period in which the reduction occurs and could adversely affect our financial results for that period.

Finally, the market for life settlement contracts is relatively illiquid when compared to that for other asset classes, and there is currently no established trading platform or market by which investors in the life settlement market buy and sell life settlement contracts. If any of the LSC Entities need to sell significant numbers of life settlement contracts in the secondary life settlement market, it is possible that the lack of liquidity at that time could make the sale of such life settlement contract difficult or impossible. Therefore, we bear the risks of any of the LSC Entities having to sell life settlement contracts at substantial discounts or not being able to sell life settlement contracts in a timely manner or at all which may result in a material adverse effect on our financial condition and results of operations.

 

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Risks Relating to Our Insurance Operations

The private passenger auto insurance industry and the A&H insurance industry are highly competitive, and we may not be able to compete effectively against larger companies.

The automobile insurance industry and the A&H insurance industry are highly competitive and, except for regulatory considerations, there are relatively few barriers to entry. We compete with both large national insurance providers and smaller regional companies on the basis of price, coverages offered, claims handling, customer service, agent commissions, geographic coverage and financial strength ratings. Some of our competitors have more capital, higher ratings and greater resources than we have, and may offer a broader range of products than we offer. Many of our competitors invest heavily in advertising and marketing efforts and/or expanding their online service offerings. Many of these competitors have better brand recognition than we have and have a significantly larger market share that we do. As a result, these larger competitors may be better able to offer lower rates to consumers, to withstand larger losses, and to more effectively take advantage of new marketing opportunities. Our ability to compete against these larger competitors depends on our ability to deliver superior service and maintain our relationships with independent agents and affinity groups.

We may undertake strategic marketing and operating initiatives to improve our competitive position and drive growth. If we are unable to successfully implement new strategic initiatives or if our marketing campaigns do not attract new customers, our competitive position may be harmed, which could adversely affect our business, financial condition and results of operations.

We write a significant amount of business in the sub-standard auto insurance market, which could make us more susceptible to unfavorable market conditions which have a disproportionate effect on that customer base.

Approximately 63% of our P&C premium currently is written in the sub-standard auto insurance market. As a result, adverse developments in the economic, competitive or regulatory environment affecting the sub-standard customer base or the sub-standard auto insurance industry in general may have a greater effect on us as compared to a more diversified auto insurance carrier with a larger percentage of its business in other types of auto insurance products. Adverse developments of this type may have a material adverse effect on our business.

We generate significant revenue from service fees generated from our P&C policyholders, which could be adversely affected by additional insurance or consumer protection regulation.

For the nine months ended September 30, 2013 and the year ended December 31, 2012, we generated $63.0 and $77.4 million in service and fee revenue from our P&C policyholders, which included origination fees, installment fees relating to installment payment plans, late payment fees, policy cancellation fees and reinstatement fees. The revenue we generate from these service fees could be reduced by changes in consumer protection or insurance regulation that restrict or prohibit our ability to charge these fees. If our ability to charge fees for these services were to be restricted or prohibited, there can be no assurance that we would be able to obtain rate increases or take other action to offset the lost revenue and the direct and indirect costs associated with providing the services, which could adversely affect our business, financial condition and results of operations.

The rates we charge under the policies we write are subject to prior regulatory approval in most of the states in which we operate.

In most of the states in which we operate, we must obtain prior regulatory approval of insurance rates charged to our customers, including any increases in those rates. If we are unable to receive approval for the rate changes we request, or if such approval were delayed, our ability to operate our business in a profitable manner may be limited and our financial condition, results of operations, and liquidity may be adversely affected.

The property and casualty insurance industry is cyclical in nature, which may affect our overall financial performance.

Historically, the financial performance of the property and casualty insurance industry has tended to fluctuate in cyclical periods of price competition and excess capacity (known as a soft market) followed by periods of high premium rates and shortages of underwriting capacity (known as a hard market). Although an individual insurance company’s financial performance is also dependent on its own specific business characteristics, the profitability of most property and casualty insurance companies tends to follow this cyclical market pattern. We cannot predict with certainty the timing or duration of changes in the market cycle because the cyclicality is due in large part to the actions of our competitors and general economic factors beyond our control. These cyclical patterns, the actions of our competitors, and general economic factors could cause our revenues and net income to fluctuate, which may adversely affect our business.

 

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Catastrophic losses or the frequency of smaller insured losses may exceed our expectations as well as the limits of our reinsurance, which could adversely affect our financial condition and results of operations.

Our auto insurance business is subject to claims arising from catastrophes, such as hurricanes, tornadoes, windstorms, floods, earthquakes, hailstorms, severe winter weather, and fires, or other events, such as explosions, terrorist attacks, riots, and hazardous material releases. For example, as of September 30, 2013, we recorded $7.4 million in loss and LAE attributable to Hurricane Sandy. The incidence and severity of such events are inherently unpredictable, and our losses from catastrophes could be substantial.

Longer-term weather trends are changing and new types of catastrophe losses may be developing due to climate change, a phenomenon that may be associated with extreme weather events linked to rising temperatures, including effects on global weather patterns, sea, land and air temperature, sea levels, rain and snow. Climate change could increase the frequency and severity of catastrophe losses we experience in both coastal and non-coastal areas.

In addition, it is possible that we may experience an unusual frequency of smaller losses in a particular period. In either case, the consequences could be substantial volatility in our financial condition or results of operations for any fiscal quarter or year, which could have a material adverse effect on our financial condition or results of operations and our ability to write new business. Although we believe that our geographic and product mix creates limited exposure to catastrophic events and we attempt to manage our exposure to these types of catastrophic and cumulative losses, including through the use of reinsurance, the severity or frequency of these types of losses may exceed our expectations as well as the limits of our reinsurance coverage.

We rely on the use of credit scoring in pricing and underwriting our auto insurance policies and any legal or regulatory requirements which restrict our ability to access credit score information could decrease the accuracy of our pricing and underwriting process and thus decrease our ability to be profitable.

We use credit scoring as a factor in pricing and underwriting decisions where allowed by state law. Consumer groups and regulators have questioned whether the use of credit scoring unfairly discriminates against some groups of people and are calling for laws and regulations to prohibit or restrict the use of credit scoring in underwriting and pricing. Laws or regulations that significantly curtail or regulate the use of credit scoring, if enacted in a large number of states in which we operate, could impact the integrity of our pricing and underwriting process, which could, in turn, adversely affect our business, financial condition and results of operations and make it harder for us to be profitable over time.

If market conditions cause our reinsurance to be more costly or unavailable, we may be required to bear increased risks or reduce the level of our underwriting commitments.

As part of our overall risk and capacity management strategy, we purchase excess of loss catastrophic and casualty reinsurance for protection against catastrophic events and other large losses. Market conditions beyond our control, in terms of price and available capacity, may affect the amount of reinsurance we acquire and our profitability.

We may be unable to maintain our current reinsurance arrangements or to obtain other reinsurance in adequate amounts and at favorable rates. Increases in the cost of reinsurance would adversely affect our profitability. In addition, if we are unable to renew our expiring arrangements or to obtain new reinsurance on favorable terms, either our net exposure to risk would increase, which would increase our costs, or, if we are unwilling to bear an increase in net risk exposures, we would have to reduce the amount of risk we underwrite, which would reduce our revenues.

 

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We have reduced our dependence on reinsurance and will retain a greater percentage of our premium writings, which increases our exposure to the underlying policy risks.

We have historically utilized reinsurance arrangements with other insurance carriers to be able to generate a larger premium volume, and larger resulting infrastructure, than otherwise would have been possible given our capital position. With the net proceeds from the private placement, we will retain more of our written business. Effective August 1, 2013, we terminated our cession of P&C premium to our quota share reinsurers and now retain 100% of such P&C gross premium written and related losses with respect to all new and renewal P&C policies bound after August 1, 2013. We will continue to cede 50% of P&C gross premium written and related losses with respect to policies in effect as of July 31, 2013 to the quota share reinsurers until the expiration of such policies. The increase in the percentage of premium writings retained will provide us the opportunity to realize greater underwriting income and investment income from our premium writing base. However, it also increases the risks to our business through greater exposure to policy claims. In the event our actual product experience varies adversely from the assumptions we used to price our products, our increased exposure to the underlying policy risks could have a material adverse effect on our financial condition and results of operations.

We may not be able to recover amounts due from our reinsurers, which would adversely affect our financial condition.

Reinsurance does not discharge our obligations under the insurance policies we write; it merely provides us with a contractual right to seek reimbursement on certain claims. We remain liable to our policyholders even if we are unable to make recoveries that we are entitled to receive under our reinsurance contracts. As a result, we are subject to credit risk with respect to our reinsurers. Losses are recovered from our reinsurers after underlying policy claims are paid. The creditworthiness of our reinsurers may change before we recover amounts to which we are entitled. Therefore, if a reinsurer is unable to meet its obligations to us, we would be responsible for claims and claim settlement expenses for which we would have otherwise received payment from the reinsurer. If we were unable to collect these amounts from our reinsurers, our costs would increase and our financial condition would be adversely affected. As of September 30, 2013, we had an aggregate amount of approximately $984.5 million of recoverables from third-party reinsurers for unpaid losses.

Our largest reinsurance recoverables are from the North Carolina Reinsurance Facility (“NCRF”) and the Michigan Catastrophic Claims Association (“MCCA”). The NCRF is a non-profit organization established to provide automobile liability reinsurance to those insurance companies that write automobile insurance in North Carolina. The MCCA is a Michigan reinsurance mechanism that covers no-fault first party medical losses of retentions in excess of $500,000 in 2013. At September 30, 2013, the amount of reinsurance recoverable from the NCRF and the MCCA was approximately $74.5 million and $704.3 million, respectively. In addition, at September 30, 2013, the amount of reinsurance recoverable from Maiden Insurance, ACP Re, AmTrust and other reinsurers was approximately $100.4 million, $60.2 million, $40.2 million and $4.9 million, respectively. If any of our principal reinsurers were unable to meet its obligations to us, our financial condition and results of operations would be materially adversely affected. For additional information, see “Management’s Discussion and Analysis of Financial Condition and Results of Operations—Reinsurance.”

The effects of emerging claim and coverage issues on our business are uncertain and negative developments in this area could have an adverse effect on our business.

As industry practices and legal, judicial, social and other environmental conditions change, unexpected and unintended issues related to claims and coverage may emerge. These issues may adversely affect our business by either extending coverage beyond our underwriting intent or by increasing the number or size of claims. In some instances, these changes may not become apparent until after we have issued insurance policies that are affected by the changes. As a result, the full extent of our liability under an insurance policy may not be known until many years after the policy is issued. For example, medical costs associated with permanent and partial disabilities may increase more rapidly or be higher than we currently expect. Changes of this nature may expose us to higher claims than we anticipated when we wrote the underlying policy. Unexpected increases in our claim costs many years after policies

 

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are issued may also result in our inability to recover from certain of our reinsurers the full amount that they would otherwise owe us for such claims costs because certain of the reinsurance agreements covering our business include commutation clauses that permit the reinsurers to terminate their obligations by making a final payment to us based on an estimate of their remaining liabilities. In addition, the potential passage of new legislation designed to expand the right to sue, to remove limitations on recovery, to deem by statute the existence of a covered occurrence, to extend the statutes of limitations or otherwise repeal or weaken tort reforms could have an adverse impact on our business. The effects of these and other unforeseen emerging claim and coverage issues are extremely hard to predict and could be harmful to our business and have a material adverse effect on our results of operations.

The effects of litigation on our business are uncertain and could have an adverse effect on our business.

Although we are not currently involved in any material litigation with our customers, other members of the insurance industry are the target of class action lawsuits and other types of litigation, some of which involve claims for substantial or indeterminate amounts, and the outcomes of which are unpredictable. This litigation is based on a variety of issues, including insurance and claim settlement practices. We cannot predict with any certainty whether we will be involved in such litigation in the future or what impact such litigation would have on our business.

Risks Related to an Investment in our Common Stock

There is currently no public market for our common stock, and an active public trading market for our common stock may never develop.

Currently, there is no established public trading market for our common stock. Our common stock has been approved for listing on the NASDAQ Global Market under the symbol “NGHC.” However, we cannot assure you that an active public trading market for the shares will develop. Accordingly, we cannot assure you as to:

 

   

the likelihood that an active market will develop for our common stock;

 

   

the liquidity of any such market;

 

   

the ability of our stockholders to sell their shares of our common stock; or

 

   

the price that our stockholders may obtain for their shares of our common stock.

If an active public trading market does not develop or is not maintained, holders of the shares may experience difficulty in reselling, or an inability to sell, the shares. Future trading prices for the shares may be adversely affected by many factors, including changes in our financial performance, changes in the overall market for similar shares and performance or prospects for companies in our industry.

The price of our common stock could be volatile.

The market price for shares of our common stock may be highly volatile and you may not be able to resell your shares of our common stock at or above the price you paid to purchase the shares or at all. Our performance, as well as government regulatory action, interest rates and general market conditions, could have a significant impact on the future market price of our common stock. Some of the factors that could negatively affect our share price or result in fluctuations in the price of our common stock include:

 

   

our operating results in any future quarter not meeting the expectations of market analysts or investors;

 

   

reductions in our earnings estimates by us or market analysts;

 

   

publication of negative research or other unfavorable publicity or speculation in the press or investment community about our company or the insurance industry in general;

 

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increases in interest rates causing investors to demand a higher yield or return on investment than an investment in our common stock may be projected to provide;

 

   

changes in market valuations of similar companies;

 

   

additions or departures of key personnel;

 

   

changes in the economic or regulatory environment in the markets in which we operate;

 

   

the occurrence of any of the other risk factors presented in this prospectus; and

 

   

general market, economic and political conditions.

In order to comply with the requirements of being a public company we will have to enhance certain of our corporate processes, which will require significant company resources and management attention.

Following the effectiveness of the shelf registration statement of which this prospectus is a part, we will be a public company. As a public company with listed equity securities, we will need to comply with new laws, regulations and requirements, certain corporate governance provisions of The Sarbanes-Oxley Act of 2002 (“SOX”), periodic reporting requirements of the Exchange Act and other regulations of the SEC and the requirements of the NASDAQ Global Market, with which we are not required to comply as a private company. In order to comply with these laws, rules and regulations, we will have to enhance certain of our corporate processes, which will require us to incur significant legal, accounting and other expenses. These efforts will also require a significant amount of time from our board of directors and management, possibly diverting their attention from the implementation of our business plan and growth strategy. We will need to, among other things:

 

   

institute a more comprehensive compliance function;

 

   

hire additional qualified personnel in our finance and accounting departments;

 

   

design, establish, evaluate and maintain a system of internal controls over financial reporting in compliance with the requirements of Section 404 of SOX and the related rules and regulations of the SEC and the Public Company Accounting Oversight Board;

 

   

comply with rules promulgated by the NASDAQ Global Market;

 

   

prepare and distribute annual, quarterly and other periodic public reports in compliance with our obligations under the federal securities laws;

 

   

establish new internal policies, such as those relating to disclosure controls and procedures and insider trading;

 

   

involve and retain to a greater degree outside counsel and accountants in the foregoing activities; and

 

   

establish an investor relations function.

We have made, and will continue to make, changes to our corporate governance standards, disclosure controls, financial reporting and accounting systems to meet our obligations as a public company. We cannot assure you that the changes we have made and will continue to make to satisfy our obligations as a public company will be successful, and any failure on our part to do so could subject us to delisting of our common stock, fines, sanctions and other regulatory action and potential litigation.

The financial statements included in this prospectus have been restated.

As discussed in “Note 2—Presentation of Restated Financial Statements” to our audited financial statements for the fiscal year ended December 31, 2012, certain revenue and expense items included in the consolidated statements of income for the years ended December 31, 2012 and 2011 and for the period from March 1, 2010 (inception) to December 31, 2010 have been restated from previously reported results. A restatement of financial statements generally results from a material weakness in internal controls over financial reporting. We expect that our independent auditor will identify one or more material weaknesses in our controls over financial reporting in connection with the restatement of our financial statements. Effective internal controls are necessary for us to provide reliable financial reports. If we cannot provide reliable financial reports, our reputation and operating results could be harmed. Any failure to implement required new or improved controls, or difficulties encountered in their implementation, could harm our operating results or cause us to fail to meet our reporting obligations. Inferior internal controls could also cause investors to lose confidence in our reported financial information, which could have a negative effect on the trading price of our common stock. We have not assessed the effectiveness of our disclosure controls and procedures or our internal controls over financial reporting.

 

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If we become publicly traded, our senior executive officers and several of our directors may not be able to organize and effectively manage a publicly traded operating company, which could adversely affect our overall financial condition.

Some of our senior executive officers and directors have not previously organized or managed a publicly traded operating company, and our senior executive officers and directors may not be successful in doing so. As described in the risk factor above, the demands of organizing and managing a publicly traded operating company are much greater than those relating to a private company, and some of our senior executive officers and directors may not be able to meet those increased demands. Failure to organize and effectively manage our business could adversely affect our overall financial condition.

Future sales and issuances of shares of our capital stock may depress our share price.

We may in the future issue our previously authorized and unissued securities. We have an authorized capitalization of 150 million shares of our common stock and 10 million shares of preferred stock with such designations, preferences and rights as are contained in our charter or bylaws and as determined by our board of directors. Issuances of stock may result in dilution of our existing stockholders or a decrease in the per share price of our common stock. It is not possible to state the actual effect of the issuance of any shares of our preferred stock on the rights of holders of our common stock until our board of directors determines the specific rights attached to that class or series of preferred stock.

In addition to the registration rights agreement pursuant to which shares are being registered hereunder, we have entered into a registration rights agreement with Michael Karfunkel, our chairman and chief executive officer, the Karfunkel Trust, and AmTrust (collectively, the “founding stockholders”) pursuant to which we have agreed to provide the founding stockholders certain rights to require us to register their shares of common stock. In connection with the private placement, the founding stockholders have agreed to waive any right to have their shares included in this shelf registration statement and have further agreed not to sell their shares of common stock for 90 days following the effectiveness of this shelf registration statement. Additionally, the founding stockholders have waived any rights they may have under the initial registration rights agreement for a period of 180 days following the effectiveness of this shelf registration statement. However, after the 180-day period following the effectiveness of the shelf registration statement, the founding stockholders have the right to cause us to register with the SEC all of their shares for resale in the public market.

We cannot predict what effect, if any, future sales of our common stock, or the availability of shares for future sale, will have on the price prospective buyers are willing to pay for our common stock. Sales of a substantial number of shares of our common stock by us or our principal stockholders, or the perception that such sales could occur, may adversely affect the price prospective buyers are willing to pay for our common stock and may make it more difficult for you to sell your shares at a time and price that you determine appropriate. See “Shares Available for Future Sale” for further information regarding circumstances under which additional shares of our common stock may be sold.

Provisions contained in our organizational documents, as well as provisions of Delaware law, could delay or prevent a change of control of us, which could adversely affect the price of shares of our common stock.

Our bylaws and Delaware law contain provisions that could have the effect of rendering more difficult or discouraging an acquisition deemed undesirable by our board of directors. Our corporate governance documents include provisions that:

 

   

provide that special meetings of our stockholders generally can only be called by the chairman of the board of directors, the chief executive officer, the president or by resolution of the board of directors;

 

   

provide our board of directors the ability to issue undesignated preferred stock, the terms of which may be established and the shares of which may be issued without stockholder approval, and which may grant preferred holders super voting, special approval, dividend or other rights or preferences superior to the rights of the holder of common stock;

 

   

provide our board of directors the ability to issue common stock and warrants within the amount of authorized capital; and

 

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provide that stockholders seeking to bring business before our annual meeting of stockholders, or to nominate candidates for election as directors at our annual meeting of stockholders, generally must provide timely advance notice of their intent in writing and certain other information not less than 90 days nor more than 120 days prior to the meeting.

These provisions, alone or together, could delay hostile takeovers and changes of control of our company or changes in our management, even if such transactions would be beneficial to our stockholders.

As a Delaware corporation, we will also be subject to anti-takeover provisions of Delaware law. The Delaware General Corporation Law (“DGCL”) provides that stockholders are not entitled to cumulative voting rights in the election of directors unless a corporation’s certificate of incorporation provides otherwise. Our certificate of incorporation does not provide for cumulative voting in the election of directors.

In addition, we are subject to Section 203 of the DGCL, which, subject to certain exceptions, prohibits a public Delaware corporation from engaging in a business combination (as defined in such section) with an “interested stockholder” (defined generally as any person who beneficially owns 15% or more of the outstanding voting stock of such corporation or any person affiliated with such person) for a period of three years following the time that such stockholder became an interested stockholder, unless (1) prior to such time, the board of directors of such corporation approved either the business combination or the transaction that resulted in the stockholder becoming an interested stockholder; (2) upon consummation of the transaction that resulted in the stockholder becoming an interested stockholder, the interested stockholder owned at least 85% of the voting stock of such corporation at the time the transaction commenced (excluding for purposes of determining the voting stock outstanding (but not the outstanding voting stock owned by the interested stockholder) the voting stock owned by directors who are also officers or held in employee benefit plans in which the employees do not have a confidential right to tender or vote stock held by the plan); or (3) on or subsequent to such time the business combination is approved by the board of directors of such corporation and authorized at a meeting of stockholders by the affirmative vote of at least two-thirds of the outstanding voting stock of such corporation not owned by the interested stockholder.

Any provision of our certificate of incorporation or bylaws or Delaware law that has the effect of delaying or deterring a change in control could limit the opportunity for our stockholders to receive a premium for their shares of common stock, and could also affect the price that some investors are willing to pay for shares of our common stock. See “Description of Capital Stock—Certain Anti-Takeover Effects of Provisions of Our Bylaws and Delaware Law.”

Applicable insurance laws may make it difficult to effect a change of control of our company.

State insurance holding company laws require prior approval by the respective state insurance departments of any change of control of an insurer. “Control” is generally defined as the possession, direct or indirect, of the power to direct or cause the direction of the management and policies of the company, whether through the ownership of voting securities, by contract or otherwise. Control is generally presumed to exist through the direct or indirect ownership of 10% or more of the voting securities of a domestic insurance company or any entity that controls a domestic insurance company. In addition, two of our insurance subsidiaries are currently deemed to be commercially domiciled in Florida and, as such, are subject to regulation by the Florida Office of Insurance Regulation (“OIR”). Florida insurance law prohibits any person from acquiring 5% or more of our outstanding voting securities or those of any of our insurance subsidiaries without the prior approval of the Florida OIR. However, a party may acquire less than 10% of our voting securities without prior approval if the party files a disclaimer of affiliation and control. Any person wishing to acquire control of us or of any substantial portion of our outstanding shares would first be required to obtain the approval of the domestic regulators (including those asserting “commercial domicile”) of our insurance subsidiaries or file appropriate disclaimers.

These laws may discourage potential acquisition proposals and may delay, deter or prevent a change of control of us, including through transactions, and in particular unsolicited transactions, that some or all of our stockholders might consider to be desirable. See “Regulation—Holding Company Regulation—Change of Control.”

 

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Future issuance of debt or preferred stock, which would rank senior to our common stock upon our liquidation, and future offerings of equity securities, which would dilute our existing stockholders, may adversely affect the market value of our common stock.

In the future, we may attempt to increase our capital resources by issuing debt or making additional offerings of equity securities, including bank debt, commercial paper, medium-term notes, senior or subordinated notes and classes of shares of preferred stock. Upon liquidation, holders of our debt securities and preferred stock and lenders with respect to other borrowings will receive a distribution of our available assets prior to the holders of shares of our common stock. Additional equity offerings may dilute the holdings of our existing stockholders or reduce the market value of our common stock, or both. Our preferred stock, if issued, could have a preference on liquidating distributions or a preference on dividend payments that would limit amounts available for distribution to holders of shares of our common stock. Because our decision to issue securities in any future offering will depend on market conditions and other factors beyond our control, we cannot predict or estimate the amount, timing or nature of our future offerings. Thus, holders of shares of our common stock bear the risk of our future offerings reducing the market value of our common stock and diluting their stockholdings in us.

 

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CAUTIONARY STATEMENT CONCERNING FORWARD-LOOKING STATEMENTS

Various statements contained in this prospectus, including those that express a belief, expectation or intention, as well as those that are not statements of historical fact, are forward-looking statements. These forward-looking statements may include projections and estimates concerning the timing and success of specific projects and our future production, revenues, income and capital spending. Our forward-looking statements are generally, but not always, accompanied by words such as “estimate,” “project,” “predict,” “believe,” “expect,” “anticipate,” “potential,” “should,” “may,” “plan,” “goal,” “can,” “could,” “continuing,” “ongoing,” “intend” or other words that convey the uncertainty of future events or outcomes. While our management considers these expectations and assumptions to be reasonable, they are inherently subject to significant business, economic, competitive, regulatory and other risks, contingencies and uncertainties, most of which are difficult to predict and many of which are beyond our control.

Examples of forward-looking statements include the plans and objectives of management for future operations, including those relating to future growth of our business, particularly our A&H business, reduction in our operating expense, the impact of terminating our cession of our P&C premium to our quota share reinsurers and availability of funds, and are based on current expectations that involve assumptions that are difficult or impossible to predict accurately and many of which are beyond our control. There can be no assurance that actual developments will be those anticipated by us. Actual results may differ materially from those expressed or implied in these statements as a result of significant risks and uncertainties, including, but not limited to, our ability to accurately underwrite and price our products and to maintain and establish accurate loss reserves, non-receipt of expected payments from insureds or reinsurers, changes in interest rates, a downgrade in the financial strength ratings of our insurance subsidiaries, the effect of the performance of financial markets on our investment portfolio, our estimates of the fair value of our life settlement contracts, development of claims and the effect on loss reserves, accuracy in projecting loss reserves, the cost and availability of reinsurance coverage, the effects of emerging claim and coverage issues, changes in the demand for our products, our degree of success in integrating of acquired businesses, the effect of general economic conditions, state and federal legislation, regulations and regulatory investigations into industry practices, risks associated with conducting business outside the United States, developments relating to existing agreements, disruptions to our business relationships with AmTrust Financial Services, Inc., Maiden Holdings, Ltd., or third-party agencies, breaches in data security or other disruptions with our technology, heightened competition, changes in pricing environments, and changes in asset valuations. The forward-looking statements in this prospectus speak only as of the date of this report and we undertake no obligation to update or revise any forward-looking statement, whether as a result of new information, future developments or otherwise, except as may be required by law.

These and other important factors, including those discussed under “Risk Factors” and “Management’s Discussion and Analysis of Financial Condition and Results of Operations” may cause our actual results, performance or achievements to differ materially from any future results, performance or achievements expressed or implied by these forward-looking statements.

Any or all of our forward-looking statements in this prospectus may turn out to be inaccurate. The inclusion of this forward-looking information should not be regarded as a representation by us, the selling stockholders or any other person that the future plans, estimates or expectations contemplated by us will be achieved. We have based these forward-looking statements largely on our current expectations and projections about future events and financial trends that we believe may affect our financial condition, results of operations, business strategy and financial needs.

All forward-looking statements are necessarily only estimates of future results, and there can be no assurance that actual results will not differ materially from expectations, and, therefore, you are cautioned not to place undue reliance on such statements. Any forward-looking statements are qualified in their entirety by reference to the factors discussed throughout this prospectus. Further, any forward-looking statement speaks only as of the date on which it is made, and we undertake no obligation to update any forward-looking statement to reflect events or circumstances after the date on which the statement is made or to reflect the occurrence of unanticipated events.

 

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USE OF PROCEEDS

We will not receive any proceeds from the sale of shares of our common stock by the selling stockholders pursuant to this prospectus.

 

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DIVIDEND POLICY

Our board of directors declared a quarterly dividend of $0.01 per share for the third and fourth quarters of 2013. Our board of directors currently intends to continue to authorize the payment of a nominal quarterly cash dividend to our stockholders of record. Any declaration and payment of dividends by our board of directors will depend on many factors, including general economic and business conditions, our strategic plans, our financial results and condition, legal and regulatory requirements and other factors that our board of directors deems relevant.

National General Holdings Corp. is a holding company and has no direct operations. Our ability to pay dividends in the future depends on the ability of our operating subsidiaries, including our insurance subsidiaries, to pay dividends to us. The laws of the jurisdictions in which our insurance subsidiaries are organized regulate and restrict, under certain circumstances, their ability to pay dividends to us. The aggregate amount of dividends that could be paid to us by our insurance subsidiaries without prior approval by the various domiciliary states of our insurance subsidiaries was approximately $19.0 million as of December 31, 2012, taking into account dividends paid in the prior twelve month period. Under the terms of our credit agreement, we are not prohibited from paying cash dividends so long as no event of default has occurred and is continuing and we are not out of compliance with our financial covenants. In addition, we may enter into credit agreements or other debt arrangements in the future that will further restrict our ability to declare or pay cash dividends on our common stock. See “Risk Factors—Risks Relating to Our Business Generally—Our holding company structure and certain regulatory and other constraints, including adverse business performance, could affect our ability to satisfy our obligations.”

 

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CAPITALIZATION

The following table shows our capitalization as of September 30, 2013.

You should refer to “Selected Financial Data” and “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and the financial statements included elsewhere in this prospectus in evaluating the material presented below.

 

(amounts in thousands)    As of
September 30,
2013
 

Debt outstanding:

  

Notes payable

   $ 80,987   

Stockholders’ equity:

  

Common stock: par value $0.01 per share; 150,000,000 shares authorized, 79,700,000 shares issued and outstanding

   $ 797   

Preferred stock: par value $0.01 per share; 10,000,000 shares authorized, no shares issued and outstanding

     —     

Additional paid-in capital

     435,908   

Retained Earnings

     190,409   

Accumulated other comprehensive income

     7,842   
  

 

 

 

Total National General Holdings Corp. stockholders’ equity

   $ 634,956   
  

 

 

 

Non-controlling interest

   $ 49   
  

 

 

 

Total stockholders’ equity

   $ 635,005   
  

 

 

 

Total capitalization

   $ 715,992   
  

 

 

 

The table does not reflect (i) 5,058,348 shares of common stock issuable upon the exercise of stock options outstanding as of the date of this prospectus with a weighted average exercise price of $8.48 per share; and (ii) 2,344,852 additional shares of common stock available for future issuance under our 2013 Equity Incentive Plan.

 

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SELECTED FINANCIAL DATA

The following tables set forth our selected historical consolidated financial and operating information for the periods ended and as of the dates indicated. The income statement data for the years ended December 31, 2012 and 2011 and the period from March 1, 2010 (inception) to December 31, 2010 and the balance sheet data as of December 31, 2012 and 2011 are derived from our audited financial statements included elsewhere in this prospectus. The balance sheet data as of December 31, 2010 are derived from our audited financial statements that are not included in this prospectus. The income statement data for the nine months ended September 30, 2013 and 2012 and the balance sheet data as of September 30, 2013 are each derived from our unaudited financial statements included elsewhere in this prospectus. Our unaudited consolidated financial statements have been prepared on the same basis as our audited consolidated financial statements and, in our opinion, include all adjustments, consisting of only normal recurring adjustments, necessary for a fair presentation of such financial statements in all material respects. The results of any interim period are not necessarily indicative of results that may be expected for a full year or any future period.

You should read the following selected consolidated financial information together with the other information contained in this prospectus, including the section captioned “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and the consolidated financial statements and related notes included elsewhere in this prospectus.

 

(amounts in thousands, except share data)    Nine Months Ended
September 30,
    (As Restated)(10)
Year Ended December 31,
    (As Restated)(10)
Period from
March 1,

2010 (Inception)
to December 31,
 
     2013     2012     2012     2011     2010  

Income Statement Data(1)

  

       

Gross premium written

   $ 1,021,016      $ 1,029,398      $ 1,351,925      $ 1,178,891      $ 911,991   

Ceded premiums(2)

     (543,373 )     (538,040     (719,431     (640,655     (463,422
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Net premium written

   $ 477,643      $ 491,358      $ 632,494      $ 538,236      $ 448,570   

Change in unearned premium

     (4,811     (68,184     (58,242     (40,026     112,347   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Net earned premium

   $ 472,832      $ 423,174      $ 574,252      $ 498,210      $ 560,917   

Ceding commission income (primarily related parties)

     76,439        67,080        93,300        80,384        49,656   

Service and fee income

     93,053        68,946        93,739        66,116        53,539   

Net investment income

     22,093        22,981        30,550        28,355        25,391   

Net realized gain on investments

     1,463        15,856        16,612        4,775        3,293   

Bargain purchase gain and other revenues

     16        (32     3,728        —          33,238   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total revenues

   $ 665,896      $ 598,005      $ 812,181      $ 677,840      $ 726,034   

 

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(amounts in thousands, except share data)    Nine Months Ended
September 30,
    (As Restated)(10)
Year  Ended December 31,
    (As Restated)(10)
Period from
March 1,

2010 (Inception)
to December 31,
 
     2013     2012     2012     2011     2010  

Loss and LAE

     302,403        279,016        394,666        333,848        391,633   

Acquisition and other underwriting costs(3)

     94,265        81,352        110,771        75,191        36,755   

General and administrative(4)

     220,515        184,225        258,604        218,152        155,108   

Interest expense

     1,456        1,342        1,787        1,994        1,795   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total expenses

   $ 618,639      $ 545,935      $ 765,828      $ 629,185      $ 585,291   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Income before provision for income taxes and equity in earnings (losses) of unconsolidated subsidiaries

   $ 47,257      $ 52,070      $ 46,353      $ 48,655      $ 140,743   

Provision for income taxes

     12,392        17,240        12,309        28,301        42,416   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Income before equity in earnings (losses) of unconsolidated subsidiaries and non-controlling interest

   $ 34,865      $ 34,830      $ 34,044      $ 20,354      $ 98,327   

Equity in earnings (losses) of unconsolidated subsidiaries

     (452     (2,693     (1,338     23,760        3,876   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Net income

   $ 34,413      $ 32,137      $ 32,706      $ 44,114      $ 102,203   

Non-controlling interest

     (44     —          —          (14     —     
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Net income attributable to National General Holdings Corp.

   $ 34,369      $ 32,137      $ 32,706      $ 44,100      $ 102,203   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

 

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(amounts in thousands, except share data)

   Nine Months Ended
September 30,
    (As Restated)(10)
Year Ended December 31,
    (As Restated)(10)
Period from
March 1,

2010 (Inception)
to December 31,
 
     2013     2012     2012     2011     2010  

Less: cumulative dividends on preferred shares

   $ 2,158      $ 3,507      $ 4,674      $ 4,328      $ 3,537   

Net income attributable to National General Holdings Corp. common stockholders

   $ 32,211      $ 28,630      $ 28,032      $ 39,772      $ 98,666   

Basic earnings per share(5)

   $ 0.54      $ 0.63      $ 0.62      $ 0.87      $ 2.17   

Weighted average shares outstanding – basic

     60,063        45,555        45,555        45,555        45,555  

Diluted earnings per share

   $ 0.50      $ 0.55      $ 0.56      $ 0.75      $ 1.77   

Weighted average shares outstanding – diluted

     68,691        58,195        58,287        58,469        57,850   

Insurance Ratios

          

Net loss ratio(6)

     64.0     65.9     68.7     67.0     69.8

Net operating expense ratio (non-GAAP)(7)(8)

     30.7     30.6     31.8     29.5     15.8
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Net combined ratio (non-GAAP)(7)(9)

     94.7     96.5     100.5     96.5     85.6

Balance sheet data

          

Cash and cash equivalents

   $ 35,810        $ 34,198      $ 11,695      $ 8,275   

Investments

   $ 1,024,463        $ 951,928      $ 949,733      $ 874,910   

Reinsurance recoverable

   $ 984,547        $ 991,837      $ 920,719      $ 695,023   

Premiums and other receivable, net

   $ 464,060        $ 455,879      $ 387,558      $ 328,017   

Goodwill and intangibles assets

   $ 148,371        $ 115,491      $ 77,433      $ 79,481   

Total assets

   $ 2,824,350        $ 2,718,647      $ 2,524,891      $ 2,178,229   

Reserves for loss and LAE

   $ 1,269,458        $ 1,286,533      $ 1,218,412      $ 1,081,630   

Unearned premium

   $ 492,830        $ 488,598      $ 449,598      $ 436,375   

Deferred income tax liability

   $ 12,546        $ 34,393      $ 17,262      $ 6,742   

Notes payable

   $ 80,987        $ 70,114      $ 85,550      $ 90,000   

Common stock and additional paid in capital

   $ 436,705        $ 158,470      $ 159,940      $ 212,214   

Preferred Stock

   $ —          $ 53,054      $ 53,054      $ 53,054   

Total equity

   $ 635,005        $ 413,042      $ 361,596      $ 310,090   

 

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(1) Results for a number of periods were affected by our various acquisitions from 2010 to 2012.
(2) Premiums ceded to related parties were $422,380 and $415,968 for the nine months ended September 30, 2013 and 2012, respectively, and $561,317, $491,689 and $246,909 for the years ended December 31, 2012, 2011 and the period from March 1, 2010 (inception) to December 31, 2010, respectively.
(3) Acquisition and other underwriting costs include policy acquisition expenses, commissions paid directly to producers, premium taxes and assessments, salary and benefits and other insurance general and administrative expense which represents other costs that are directly attributable to insurance activities.
(4) General and administrative expense is composed of all other operating expenses, including various departmental salaries and benefits expenses for employees that are directly involved in the maintenance of policies, information systems, and accounting for insurance transactions, and other insurance expenses such as federal excise tax, postage, telephones and internet access charges, as well as legal and auditing fees and board and bureau charges. In addition, general and administrative expense includes those charges that are related to the amortization of tangible and intangible assets and non-insurance activities in which we engage.
(5) No effect is given to the dilutive effect of outstanding stock options during the relevant period.
(6) Net loss ratio is calculated by dividing the loss and LAE by net earned premiums.
(7) Net operating expense ratio and net combined ratio are considered non-GAAP financial measures under applicable SEC rules because a component of those ratios, net operating expense, is calculated by offsetting acquisition and other underwriting costs and general and administrative expense by ceding commission income and service and fee income. Management uses net operating expense ratio (non-GAAP) and net combined ratio (non-GAAP) to evaluate financial performance against historical results and establish targets on a consolidated basis. Other companies may calculate these measures differently, and, therefore, their measures may not be comparable to those used by the Company’s management. For a reconciliation showing the total amounts by which acquisition and other underwriting costs and general and administrative expense were offset by ceding commission income and service and fee income, see “Management’s Discussion and Analysis of Financial Condition and Results of Operation—Results of Operations—Consolidated Results of Operations” below.
(8) Net operating expense ratio (non-GAAP) is calculated by dividing the net operating expense by net earned premium. Net operating expense consists of the sum of acquisition and other underwriting costs and general and administrative expense less ceding commission income and service and fee income.
(9) Net combined ratio (non-GAAP) is calculated by adding net loss ratio and net operating expense ratio (non-GAAP) together.
(10) Certain amounts for the years ended December 31, 2012 and 2011 and the period from March 1, 2010 (Inception) to December 31, 2010 have been restated. Please refer to Note 2 to our audited financial statements for the year ended December 31, 2012 for further detail.

 

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MANAGEMENT’S DISCUSSION AND ANALYSIS

OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

Forward-Looking and Other Statements

The following discussion of our financial condition and results of operations should be read in conjunction with our consolidated financial statements and the notes thereto included elsewhere in this prospectus. This discussion includes forward-looking statements that are subject to risks, uncertainties and other factors described under the captions “Risk Factors” and “Cautionary Statement Concerning Forward-Looking Statements.” These factors could cause our actual results to differ materially from those expressed in, or implied by, those forward-looking statements.

Overview

We are a specialty personal lines insurance holding company. Through our subsidiaries, we provide personal and commercial automobile insurance, health insurance products and other niche insurance products. We sell insurance products with a focus on underwriting profitability through a combination of our customized and predictive analytics and our technology driven low cost infrastructure.

Our property and casualty (“P&C”) insurance products protect our customers against losses due to physical damage to their motor vehicles, bodily injury and liability to others for personal injury or property damage arising out of auto accidents. We offer our P&C insurance products through a network of over 19,000 independent agents, more than a dozen affinity partners and through direct-response marketing programs. We have over one million P&C policyholders and, based on 2012 gross premium written, we are the 20th largest private passenger auto insurance carrier in the United States according to financial data compiled by SNL Financial.

We launched our accident and health (“A&H”) business in 2012 to provide accident and non-major medical health insurance products targeting our existing P&C policyholders and the anticipated emerging market of employed persons who are uninsured or underinsured. We market our and other carriers’ A&H insurance products through a multi-pronged distribution platform that includes a network of over 8,000 independent agents, direct-to-consumer marketing, wholesaling and worksite marketing. We believe that our A&H business is complementary to our P&C business and should enable us to enhance our relationships with our existing P&C agents, affinity partners and insureds.

We manage our business through two segments: P&C and A&H. We transact business primarily through our eleven regulated domestic insurance subsidiaries: Integon Casualty Insurance Company, Integon General Insurance Company, Integon Indemnity Corporation, Integon National Insurance Company (“Integon National”), Integon Preferred Insurance Company, New South Insurance Company, MIC General Insurance Corporation, National General Insurance Company, National General Assurance Company, National General Insurance Online, Inc. and National Health Insurance Company.

The operating results of property and casualty insurance companies are subject to quarterly and yearly fluctuations due to the effect of competition on pricing, the frequency and severity of losses, the effect of weather and natural disasters on losses, general economic conditions, the general regulatory environment in states in which an insurer operates, state regulation of premium rates, changes in fair value of investments, and other factors such as changes in tax laws. The property and casualty industry has been highly cyclical with periods of high premium rates and shortages of underwriting capacity followed by periods of severe price competition and excess capacity. While these cycles can have a large impact on a company’s ability to grow and retain business, we have sought to focus on niche markets and regions where we are able to maintain premium rates at generally consistent levels and maintain underwriting discipline throughout these cycles. We believe that the nature of our P&C insurance products, including their relatively low limits, the relatively short duration of time between when claims are reported and when they are settled, and the broad geographic distribution of our customers, have allowed us to grow and retain our business throughout these cycles. In addition, we have limited our exposure to catastrophe losses through reinsurance. With regard to seasonality, we tend to experience higher claims and claims expense in our P&C segment during periods of severe or inclement weather.

 

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We evaluate our operations by monitoring key measures of growth and profitability, including net loss ratio, net combined ratio (non-GAAP) and operating leverage. We target a net combined ratio (non-GAAP) of 95.0% or lower over the near term, and between 90% and 95% over the long term, while seeking to maintain optimal operating leverage in our insurance subsidiaries commensurate with our A.M. Best rating objectives. To achieve our targeted net combined ratio (non-GAAP) we continually seek ways to reduce our operating costs and lower our expense ratio, including, for example, our consolidation of three legacy policy administration systems into one new system and the consolidation of certain operations to our new regional operations center in Cleveland, Ohio. See “—Principal Revenue and Expense Items—Insurance Ratios.” For the year ended December 31, 2012, our operating leverage (the ratio of net premiums earned to average total stockholders’ equity) was 1.5x. Once we have fully deployed the additional capital from the private placement, we plan to target an operating leverage between 1.5x and 2.0x.

Investment income is also an important part of our business. Because we often do not settle claims until several months or longer after we receive the original policy premiums, we are able to invest cash from premiums for significant periods of time. We invest our capital and surplus in accordance with state and regulatory guidelines. Our net investment income was $30.6 million and $28.4 million for the years ended December 31, 2012 and 2011, respectively. We held 3.5% and 1.2% of total invested assets in cash and cash equivalents as of December 31, 2012 and 2011, respectively.

Our most significant balance sheet liability is our reserves for loss and loss adjustment expenses (“LAE”). As of September 30, 2013 and December 31, 2012 and 2011, our reserves, net of reinsurance recoverables, were $284.9 million, $294.7 million and $297.7 million, respectively. We record reserves for estimated losses under insurance policies that we write and for LAE related to the investigation and settlement of policy claims. Our reserves for loss and LAE represents the estimated cost of all reported and unreported loss and LAE incurred and unpaid at any time based on known facts and circumstances. Our reserves, excluding life reserves, for loss and LAE incurred and unpaid are not discounted using present value factors. Our loss reserves are reviewed quarterly by internal actuaries and at least annually by our external actuaries. Reserves are based on estimates of the most likely ultimate cost of individual claims. These estimates are inherently uncertain. Judgment is required to determine the relevance of our historical experience and industry information under current facts and circumstances. The interpretation of this historical and industry data can be impacted by external forces, principally frequency and severity of future claims, the length of time needed to achieve ultimate settlement of claims, inflation of medical costs, insurance policy coverage interpretations, jury determinations and legislative changes. Accordingly, our reserves may prove to be inadequate to cover our actual losses. If we change our estimates, these changes would be reflected in our results of operations during the period in which they are made, with increases in our reserves resulting in decreases in our earnings.

Our results for the year ended December 31, 2012 as compared to the year ended December 31, 2011 included several charges that make the comparison of our net income for these periods less meaningful. These charges pertained to the adoption of a new accounting pronouncement relating to the recognition of deferred acquisition costs, the consolidation of certain operations to our new Cleveland regional operations center, continued maintenance of three costly legacy policy administration systems in addition to our new policy administration system, and the impact of an acquisition of an A&H business.

Reduction in Quota Share Reinsurance

Our net income reflects the fact that 50% of our P&C gross premium written and related losses (excluding premium ceded to state-run reinsurance facilities) have historically been ceded to our quota share reinsurers, reducing our retained underwriting income and investment income. With the net proceeds from the private placement, we will retain more of our written business. Effective August 1, 2013, we terminated our cession of P&C premium to our quota share reinsurers and now retain 100% of such P&C gross premium written and related losses with respect to all new and renewal P&C policies bound after August 1, 2013. We will continue to cede 50% of P&C gross premium written and related losses with respect to policies in effect as of July 31, 2013 to the quota share reinsurers until the expiration of such policies. See “—Personal Lines Quota Share.” The increase in the percentage of premium writings retained will provide us the opportunity to realize greater underwriting income and investment income from our premium writing base. However, it also increases the risks to our business through greater exposure to policy claims. See “Risk Factors—Risks Relating to Our Insurance Operations—We have reduced our dependence on reinsurance and will retain a greater percentage of our premium writings, which increases our exposure to the underlying policy risks.”

 

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Recent Acquisitions

Since we acquired our P&C insurance business in 2010, we have entered into a renewal rights transaction and acquired another insurance company and an insurance agency. These additional operations have increased our presence in our target markets and broadened our distribution capabilities.

 

   

In July 2011, we acquired the renewal rights to a book of RV and trailer business (the “RV Business”) from American Modern Home Insurance Company and its affiliates. We also assumed 100% of the in-force RV Business, net of external reinsurance starting January 1, 2012. The primary states for this RV business are California, New Jersey, Texas, Florida, New York and North Carolina.

 

   

In September 2011, we completed our acquisition of Agent Alliance Insurance Company (“AAIC”), an Alabama-domiciled insurer focused on private passenger auto business in North Carolina. Following a 2012 sale of AAIC to ACP Re, we continue to reinsure 100% of all existing and renewal private passenger auto insurance business of AAIC. See “Certain Relationships and Related Party Transactions—Integon National Reinsurance Agreements.”

 

   

In November 2011, we acquired 70% of the equity interests of ClearSide General Insurance Services, LLC, a California-based general agency that specializes in personal and commercial property and casualty lines insurance products. In June 2012, we completed our acquisition of the remaining 30% of the equity interests of Clearside General Insurance Services, LLC.

Principally through the following acquisitions that we recently completed in our A&H segment, we have built a platform to market our and other carriers’ A&H products. This platform consists of the following operations:

 

   

In November 2012, we acquired National Health Insurance Company (“NHIC”), a Texas-domiciled life and health insurer currently licensed in 48 states and the District of Columbia, to write our A&H risks. NHIC was established as a life and health insurer in 1979. We have filed and are in the process of receiving approvals for a significant number of our target A&H insurance products for individuals and groups, which include accident, limited medical/hospital indemnity, short-term medical, cancer/critical illness, stop loss, travel accident/trip cancellation and dental/vision coverages.

 

   

In February 2012, we acquired VelaPoint, LLC, a general agency that operates a call center with approximately 50 licensed agents selling a full range of supplemental medical insurance products, as well as individual major medical policies underwritten through a wide range of third-party insurance companies. For the year ended December 31, 2012, VelaPoint produced approximately $41 million in premium on behalf of third parties. Once NHIC receives the requisite product approvals and licensing authority to write this business, we expect a significant percentage of VelaPoint’s sales of supplemental health products will be written by NHIC. We have received substantially all of these regulatory approvals and the remaining approvals are expected in the first quarter of 2014.

 

   

In February 2012, we acquired America’s HealthCare Plan (“AHCP”), a managing general agent/program manager. AHCP works with over 8,000 independent agents and general agents across the country to provide an array of insurance products, including those offered by third-party insurers, and will serve as a significant method of distribution for NHIC’s products.

 

   

In September 2012, we acquired from the Coca-Cola Bottlers’ Association a health insurance administration company that administers specialty self-insurance arrangements, offering ERISA qualified self-insured plans to employers in affinity associations or trade groups and selling medical stop loss coverage to employers through captive insurers (collectively, the “TABS” companies). We believe the TABS companies, which wrote approximately $23 million in stop loss premium in 2012, have significant growth potential.

 

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In January 2013, we assumed 100% of an in-force book of A&H business from Wesco Insurance Company, an affiliate of AmTrust. In connection therewith, we acquired certain operating assets and hired the related program development personnel who work with outside insurers and wholesalers/program managers to create programs for specialty A&H products like travel, student and international business. See “Certain Relationships and Related Party Transactions—Accident and Health Portfolio Transfer and Quota Share.”

 

   

In April 2013, we acquired Euro Accident Health & Care Insurance Aktiebolag (“EuroAccident”), a European group life and health insurance managing general agent. The agency distributes life and health insurance to groups as well as individuals. Distribution predominantly takes place through broker channels and affinity partners. For the year ended December 31, 2012, EuroAccident produced approximately $62 million in premium on behalf of third parties. We are in the process of obtaining the necessary licenses and approvals in Luxembourg to enable us to write these products on our own behalf. We expect to complete the licensing and approval process during the fourth quarter of 2013.

On January 3, 2014, ACP Re, Ltd. (“ACP Re”), a Bermuda reinsurer that is a subsidiary of the Karfunkel Trust, entered into a merger agreement (the “Tower Merger Agreement”) with Tower Group International, Ltd (“Tower”) pursuant to which ACP Re has agreed to acquire Tower for the price of $3.00 per share. The transactions contemplated by the Tower Merger Agreement are subject to certain regulatory and shareholder approvals.

Simultaneously with the execution of the Tower Merger Agreement, we entered into a stock and asset purchase agreement (“Personal Lines Purchase Agreement”) with ACP Re pursuant to which we agreed to acquire the renewal rights and assets of the personal lines insurance operations of Tower (“Tower Personal Lines Business”), subject to the consummation of the transactions contemplated by the Tower Merger Agreement. Under the Personal Lines Purchase Agreement, we expect to acquire the assets necessary to support the Tower Personal Lines Business, including certain of Tower’s domestic insurance companies, the Tower Personal Lines Business renewal rights, the systems, books and records required to effectively conduct the Tower Personal Lines Business as well as the right to offer employment to certain Tower employees engaged in the conduct of the Tower Personal Lines Business.

We expect to acquire these assets from ACP Re for cash in an amount equal to approximately $130 million. The acquired companies will be used to support the Tower Personal Lines Business and will contain cash and other assets in an amount equivalent to the purchase price. Through a reinsurance agreement that will be fully collateralized, ACP Re will retain and be liable for, and run off, all losses of the acquired companies occurring prior to January 1, 2014. The acquisition is expected to close in the summer of 2014, pending the receipt of regulatory approvals and closing of the transactions contemplated by the Tower Merger Agreement.

In addition, Integon National Insurance Company, our wholly-owned subsidiary, has entered into a reinsurance agreement (the “Cut-Through Reinsurance Agreement”) with several Tower subsidiaries. Under the Cut-Through Reinsurance Agreement, Integon has reinsured on a 100% quota share basis with a cut-through endorsement all of Tower’s new and renewal personal lines business and has assumed 100% of Tower’s unearned premium reserves with respect to in-force personal lines policies, in each case, net of reinsurance already in effect. The cut-through endorsement allows insureds to pursue claims directly against Integon if the ceding company becomes insolvent. The agreement is effective solely with respect to losses occurring on or after January 1, 2014 and has a duration of one year unless earlier terminated. We will pay a 20% ceding commission and up to a 4% claims handling expense reimbursement to Tower on all Tower premium subject to the Cut-Through Reinsurance Agreement. As of January 14, 2014, all required insurance regulatory approvals have been obtained for the Cut-Through Reinsurance Agreement.

We believe our acquisition of the Tower Personal Lines Business will add increased product offerings to our customers, agents and brokers. We expect that this transaction will permit us to introduce homeowners and umbrella coverage into our product offerings, allow us to bundle these coverages with our existing auto business and make our product offerings even more competitive. In addition, we expect this transaction will also add geographic expansion to our auto business. We believe that the additional premium we expect to assume under the Cut-Through Reinsurance Agreement, together with the unearned premium reserves that we assume, will provide us with the opportunity to significantly increase our earned premiums over time.

To support our current and future policy writings, especially in light of the termination of the Personal Lines Quota Share effective August 1, 2013, the Cut-Through Reinsurance Agreement we have entered into and our expected acquisition of the Tower Personal Lines Business, we intend to raise substantial additional capital in the near term using a combination of debt and equity.

Expectations Regarding Tower Transactions

        Set forth below are certain of our expectations regarding the Tower personal lines transactions described above. We caution you that these expectations may not materialize and are not indicative of the actual results that we will achieve. Our expectations are based in large part on Tower’s historical financial performance as reported in its public SEC and statutory filings. We have assumed the accuracy of this information in setting our expectations. There can be no assurance that the future performance of the Tower Personal Lines Business will be comparable to its historical performance, or that our ability to manage the Tower Personal Lines Business will be comparable to Tower’s management of that business, or that our expectations as to the level and profitability of the Tower Personal Lines Business that we may have access to as a result of the Tower transactions will be realized. Many factors and future developments may cause our actual results to differ materially and significantly from the information set forth below. See “Risk Factors” and “Cautionary Statement Concerning Forward-Looking Statements.”

As part of the Personal Lines Purchase Agreement, we anticipate that we will have access to approximately $650 million of potential annual gross premium that we expect will be generated by the Tower personal lines companies. We expect to earn service and fee income only (and not bear underwriting risk) on approximately one-third of these premiums by providing management and administration services to the issuing companies which are structured as reciprocal insurers, and we expect our insurance companies to insure approximately two-thirds of these premiums, and utilize quota share and catastrophe reinsurance to reduce our exposure. Excluding the impact of catastrophic losses, we expect to target a loss ratio on the premiums under the Personal Lines Purchase Agreement within an approximate range of between 50% and 60%. Of course, there can be no assurance that we will complete the

Tower transactions in the manner currently planned or at all, or that the results of the Tower transactions will match our expectations as to premium volume, profitability or otherwise.

Principal Revenue and Expense Items

Gross premium written. Gross premium written represents premium from each insurance policy that we write, including as a servicing carrier for assigned risk plans, during a reporting period based on the effective date of the individual policy, prior to ceding reinsurance to third parties.

Net premium written. Net premium written is gross premium written less that portion of premium that we cede to third-party reinsurers under reinsurance agreements. The amount ceded under these reinsurance agreements is based on a contractual formula contained in the individual reinsurance agreement.

Change in unearned premium. Change in unearned premium is the change in the balance of the portion of premium that we have written but have yet to earn during the relevant period because the policy is unexpired.

Net earned premium. Net earned premium is the earned portion of our net premium written. We generally earn insurance premium on a pro rata basis over the term of the policy. At the end of each reporting period, premium written that is not earned is classified as unearned premium, which is earned in subsequent periods over the remaining term of the policy. Our policies typically have a term of six months or one year. For a six-month policy written on October 1, 2012, we would earn half of the premium in the fourth quarter of 2012 and the other half in the first quarter of 2013.

Ceding commission income. Ceding commission income is a commission we receive based on the earned premium ceded to third-party reinsurers to reimburse us for our acquisition, underwriting and other operating expenses. We earn commissions on reinsurance premium ceded in a manner consistent with the recognition of the earned premium on the underlying insurance policies, generally on a pro-rata basis over the terms of the policies reinsured. The portion of ceding commission income which represents reimbursement of successful acquisition costs related to the underlying policies is recorded as an offset to acquisition and other underwriting expenses. The ceding commission ratio is equal to ceding commission income divided by net earned premium.

Service and fee income. We currently generate policy service and fee income from installment fees, late payment fees, and other finance and processing fees related to policy cancellation, policy reinstatement, and non-sufficient fund check returns. These fees are generally designed to offset expenses incurred in the administration of our insurance business, and are generated as follows. Installment fees are charged to permit a policyholder to pay premiums in installments rather than in a lump sum. Late payment fees are charged when premiums are remitted after the due date and any applicable grace periods. Policy cancellation fees are charged to policyholders when a policy is terminated by the policyholder prior to the expiration of the policy’s term or renewal term, as applicable. Reinstatement fees are charged to reinstate a policy that has lapsed, generally as a result of non-payment of premiums. Non-sufficient fund fees are charged when the customer’s payment is returned by the financial institution.

All fee income is recognized as follows. An installment fee is recognized at the time each policy installment bill is due. A late payment fee is recognized when the customer’s payment is not received after the listed due date and any applicable grace period. A policy cancellation fee is recognized at the time the customer’s policy is cancelled. A policy reinstatement fee is recognized when the customer’s policy is reinstated. A non-sufficient fund fee is recognized when the customer’s payment is returned by the financial institution. The amounts charged are primarily intended to compensate us for the administrative costs associated with processing and administering policies that generate insurance premium; however, the amounts of fees charged are not dependent on the amount or period of insurance coverage provided and do not entail any obligation to return any portion of those funds. The direct and indirect costs associated with generating fee income are not separately tracked.

We also collect service fees in the form of commissions and general agent fees by selling policies issued by third-party insurance companies. We do not bear insurance underwriting risk with respect to these policies. Commission income and general agent fees are recognized, net of an allowance for estimated policy cancellations, at the date the customer is initially billed or as of the effective date of the insurance policy, whichever is later. The allowance for estimated third-party cancellations is periodically evaluated and adjusted as necessary.

Net investment income and realized gains and (losses). We invest our statutory surplus funds and the funds supporting our insurance liabilities primarily in cash and cash equivalents, fixed-maturity and equity securities. Our net investment income includes interest and dividends earned on our invested assets. We report net realized gains and losses on our investments separately from our net investment income. Net realized gains occur when we sell our

 

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investment securities for more than their costs or amortized costs, as applicable. Net realized losses occur when we sell our investment securities for less than their costs or amortized costs, as applicable, or we write down the investment securities as a result of other-than-temporary impairment. We classify equity securities and our fixed-maturity securities as available-for-sale. We report net unrealized gains (losses) on those securities classified as available-for-sale separately within other comprehensive income.

Bargain purchase gain. We record bargain purchase gain in an amount equal to the excess of fair value of acquired net assets over the fair value of consideration paid.

Loss and loss adjustment expenses. Loss and LAE represent our largest expense item and, for any given reporting period, include estimates of future claim payments, changes in those estimates from prior reporting periods and costs associated with investigating, defending and servicing claims. These expenses fluctuate based on the amount and types of risks we insure. We record loss and LAE related to estimates of future claim payments based on case-by-case valuations and statistical analyses. We seek to establish all reserves at the most likely ultimate exposure based on our historical claims experience. It is typical for our more serious bodily injury claims to take several years to settle, and we revise our estimates as we receive additional information about the condition of claimants and the costs of their medical treatment. Our ability to estimate loss and LAE accurately at the time of pricing our insurance policies is a critical factor in our profitability.

Acquisition and other underwriting costs. Acquisition and other underwriting costs consist of policy acquisition and marketing expenses, salaries and benefits expenses. Policy acquisition expenses comprise commissions directly attributable to those agents, wholesalers or brokers that produce premiums written on our behalf and promotional fees directly attributable to our affinity relationships. Acquisition costs also include costs that are related to the successful acquisition of new or renewal insurance contracts including comprehensive loss underwriting exchange reports, motor vehicle reports, credit score checks, and policy issuance costs.

General and administrative expense. General and administrative expense is composed of all other operating expenses, including various departmental salaries and benefits expenses for employees that are directly involved in the maintenance of policies, information systems, and accounting for insurance transactions, and other insurance expenses such as federal excise tax, postage, telephones and internet access charges, as well as legal and auditing fees and board and bureau charges. In addition, general and administrative expense includes those charges that are related to the amortization of tangible and intangible assets and non-insurance activities in which we engage.

Interest expense. Interest expense represents amounts we incur on our outstanding indebtedness at the then-applicable interest rates.

Income tax expense. We incur federal, state and local income tax expenses as well as income tax expenses in certain foreign jurisdictions in which we operate.

Net operating expense. These expenses consist of the sum of general and administrative expense and acquisition and other underwriting costs less ceding commission income and service and fee income.

 

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Underwriting income. Underwriting income is a measure of an insurance company’s overall operating profitability before items such as investment income, interest expense and income taxes. Underwriting income is calculated as net earned premium plus ceding commission income and service and fee income less loss and LAE, acquisition and other underwriting costs, and general and administrative expense.

Equity in earnings (losses) from unconsolidated subsidiaries. This represents primarily our share in earnings or losses of our investment in three companies that own life settlement contracts, which includes the gain realized upon a mortality event and the change in fair value of the investments in life settlements as evaluated at the end of each reporting period. These unconsolidated subsidiaries determine the fair value of life settlement contracts based upon an estimate of the discounted cash flow of the anticipated death benefits incorporating a number of factors, such as current life expectancy assumptions, expected premium payment obligations and increased cost assumptions, credit exposure to the insurance companies that issued the life insurance policies and the rate of return that a buyer would require on the policies. The gain realized upon a mortality event is the difference between the death benefit received and the recorded fair value of that particular policy.

Insurance Ratios

Net loss ratio. The net loss ratio is a measure of the underwriting profitability of an insurance company’s business. Expressed as a percentage, this is the ratio of loss and LAE incurred to net earned premiums.

Net operating expense ratio (non-GAAP). The net operating expense ratio (non-GAAP) is one component of an insurance company’s operational efficiency in administering its business. Expressed as a percentage, this is the ratio of net operating expense to net earned premium.

Net combined ratio (non-GAAP). The net combined ratio (non-GAAP) is a measure of an insurance company’s overall underwriting profit. This is the sum of the net loss and net operating expense ratio (non-GAAP). If the net combined ratio (non-GAAP) is at or above 100 percent, an insurance company cannot be profitable without investment income, and may not be profitable if investment income is insufficient.

Net operating expense ratio and net combined ratio are considered non-GAAP financial measures under applicable SEC rules because a component of those ratios, net operating expense, is calculated by offsetting acquisition and other underwriting costs and general and administrative expense by ceding commission income and service and fee income, and is therefore a non-GAAP measure. Management uses net operating expense ratio (non-GAAP) and net combined ratio (non-GAAP) to evaluate financial performance against historical results and establish targets on a consolidated basis. Other companies may calculate these measures differently, and, therefore, their measures may not be comparable to those used by the Company’s management. For a reconciliation showing the total amounts by which acquisition and other underwriting costs and general and administrative expense were offset by ceding commission income and service and fee income in the calculation of net operating expense, see “—Results of Operations—Consolidated Results of Operations” below.

Personal Lines Quota Share

Effective March 1, 2010, Integon National entered into a 50% quota share reinsurance treaty (the “Personal Lines Quota Share”), pursuant to which Integon National ceded 50% of the gross premium written of its P&C business (excluding premium ceded to state-run reinsurance facilities) to a group of affiliated reinsurers consisting of a subsidiary of AmTrust, ACP Re and Maiden Insurance. Quota share reinsurance refers to reinsurance under which the insurer (the “ceding company,” which under the Personal Lines Quota Share is Integon National) transfers, or cedes, a fixed percentage of liabilities, premium and related losses for each policy covered on a pro rata basis in accordance with the terms and conditions of the relevant agreement. The reinsurer pays the ceding company a ceding commission on the premiums ceded to compensate the ceding company for various expenses, such as underwriting and policy acquisition expenses, that the ceding company incurs in connection with the ceded business.

The Personal Lines Quota Share provides that the reinsurers, severally, in accordance with their participation percentages, receive 50% of our P&C gross premium written (excluding premium ceded to state-run reinsurance facilities) and assume 50% of the related losses and allocated LAE. The participation percentages are: Maiden Insurance, 25%; ACP Re, 15%; and AmTrust, 10%. The Personal Lines Quota Share had an initial term of three years and was renewed through March 1, 2016.

        The Personal Lines Quota Share provides that the reinsurers pay a provisional ceding commission equal to 32.0% of ceded earned premium, net of premiums ceded by Integon National for inuring third-party reinsurance, subject to adjustment to a maximum of 34.5% if the loss ratio for the reinsured business is 60.0% or less and a minimum of 30.0% if the loss ratio is 64.5% or higher. The Personal Lines Quota Share provides for the net settlement of claims and the provisional ceding commission on a quarterly basis during the month following the end of each quarter. The net payments are based on earned premiums less paid losses and LAE less the provisional ceding commission for the quarter. The adjustment to the provisional ceding commission is calculated at the end of, and with respect to, each calendar year during the term of the Quota Share (an “adjustment period”), with the final adjustment period following termination of the Quota Share ending at the end of the run-off period. The adjusted commission rate, which is calculated and reported by the reinsurers to the Company within 30 days after the end of each adjustment period, is calculated by first determining the “actual loss ratio” for the adjustment period, which loss ratio is calculated in the same manner as the net loss ratio as disclosed in this prospectus. The adjusted commission rate is set based on the actual loss ratio within a range between 30.0% and 34.5%, and varies inversely with a range of actual loss ratios between 60.0% and 64.5%, such that the adjusted commission rate will be higher than 32.0% if the actual loss ratio is lower than 62.5%, and lower than 32.0% if the actual loss ratio is higher than 62.5%, subject to the caps described above. The Company accrues any adjustments to the provisional ceding commission based on the loss experience of the ceded business on a quarterly basis. Remittance of any positive difference between the adjusted commission rate over the provisional ceding commission is paid by the reinsurer to the Company, and any negative difference is paid by the Company to the reinsurer within 12 months after the end of the final adjustment period (other than with respect to the initial year of the agreement with respect to which initial remittance was made 24 months after the end of the first adjustment period).

Effective August 1, 2013, as permitted by the Personal Lines Quota Share, we terminated our cession of P&C premium to our quota share reinsurers and now retain 100% of such P&C gross premium written and related losses with respect to all new and renewal P&C policies bound after August 1, 2013. We will continue to cede 50% of P&C gross premium written and related losses with respect to policies in effect as of July 31, 2013 to the quota share reinsurers until the expiration of such policies. This retention of our P&C premium will provide us the opportunity to substantially increase our underwriting and investment income, while also increasing our exposure to losses. See “Risk Factors—Risks Relating to Our Insurance Operations—We have reduced our dependence on reinsurance and will retain a greater percentage of our premium writings, which increases our exposure to the underlying policy risks.”

Critical Accounting Policies

It is important to understand our accounting policies in order to understand our financial statements. These policies require us to make estimates and assumptions. Our management has reviewed our financial policies and results. These reviews affect the reported amounts of our assets, liabilities, revenues and expenses and the related disclosures. Some of the estimates result from judgments that can be subjective and complex, and, consequently, actual results in future periods might differ significantly from these estimates.

 

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We believe that the most critical accounting policies relate to the reporting of reserves for loss and LAE, including losses that have occurred but have not been reported prior to the reporting date, amounts recoverable from third-party reinsurers, assessments, deferred policy acquisition costs, deferred income taxes, the impairment of investment securities, goodwill and other intangible assets.

The following is a description of our critical accounting policies.

Premium. We recognize premium earned on a pro rata basis over the terms of the policies, generally, periods of six or twelve months. Unearned premium represents the portion of premiums written applicable to the unexpired terms of the policies. Net premium receivables represent premium written and not yet collected, net of an allowance for uncollectible premium. We regularly evaluate premium and other receivables and adjust for uncollectible amounts as appropriate. Receivables specifically identified as uncollectible are charged to expense in the period the determination is made.

Service and fee income. We currently generate policy service and fee income from installment fees, late payment fees, and other finance and processing fees related to policy cancellation, policy reinstatement, and non-sufficient fund check returns. These fees are generally designed to offset expenses incurred in the administration of our insurance business, and are generated as follows. Installment fees are charged to permit a policyholder to pay premiums in installments rather than in a lump sum. Late payment fees are charged when premiums are remitted after the due date and any applicable grace periods. Policy cancellation fees are charged to policyholders when a policy is terminated by the policyholder prior to the expiration of the policy’s term or renewal term, as applicable. Reinstatement fees are charged to reinstate a policy that has lapsed, generally as a result of non-payment of premiums. Non-sufficient fund fees are charged when the customer’s payment is returned by the financial institution.

All fee income is recognized as follows. An installment fee is recognized at the time each policy installment bill is due. A late payment fee is recognized when the customer’s payment is not received after the listed due date and any applicable grace period. A policy cancellation fee is recognized at the time the customer’s policy is cancelled. A policy reinstatement fee is recognized when the customer’s policy is reinstated. A non-sufficient fund fee is recognized when the customer’s payment is returned by the financial institution. The amounts charged are primarily intended to compensate us for the administrative costs associated with processing and administering policies that generate insurance premium; however, the amounts of fees charged are not dependent on the amount or period of insurance coverage provided and do not entail any obligation to return any portion of those funds. The direct and indirect costs associated with generating fee income are not separately tracked.

We also collect service fees in the form of commissions and general agent fees by selling policies issued by third-party insurance companies. We do not bear insurance underwriting risk with respect to these policies. Commission income and general agent fees are recognized, net of an allowance for estimated policy cancellations, at the date the customer is initially billed or as of the effective date of the insurance policy, whichever is later. The allowance for estimated third-party cancellations is periodically evaluated and adjusted as necessary.

Reserves for loss and loss adjustment expenses. We record reserves for estimated losses under insurance policies that we write and for LAE related to the investigation and settlement of policy claims. Our reserves for loss and LAE represent the estimated cost of all reported and unreported loss and LAE incurred and unpaid at any given point in time based on known facts and circumstances.

Loss reserves include statistical reserves and case estimates for individual claims that have been reported and estimates for claims that have been incurred but not reported at the balance sheet date as well as estimates of the expenses associated with processing and settling all reported and unreported claims, less estimates of anticipated salvage and subrogation recoveries. Estimates are based upon past loss experience modified for current trends as well as economic, legal and social conditions. Loss reserves, except life reserves, are not discounted to present value, which would involve recognizing the time value of money and offsetting estimates of future payments by future expected investment income.

In establishing these estimates, we make various assumptions regarding a number of factors, including frequency and severity of claims, the length of time needed to achieve ultimate settlement of claims, inflation of medical costs, insurance policy coverage interpretations, jury determinations and legislative changes. Due to the inherent uncertainty associated with these estimates, and the cost of incurred but unreported claims, our actual liabilities may be different from our original estimates. On a quarterly basis, we review our reserves for loss and loss adjustment expenses to determine whether further adjustments are required. Any resulting adjustments are included in the current period’s results. Additional information regarding the judgments and uncertainties surrounding our estimated reserves for loss and loss adjustment expenses can be found in “Business—Loss Reserves.”

Reinsurance. We account for reinsurance premiums, losses and LAE ceded to other companies on a basis consistent with those used in accounting for the original policies issued and the terms of the reinsurance contracts. Premiums earned and losses and LAE incurred ceded to other companies have been recorded as a reduction of premium revenue and losses and LAE. Commissions allowed by reinsurers on business ceded have been recorded as ceding commission revenue. Ceding commission is a commission we receive based on the earned premium ceded to third party reinsurers to reimburse us for our unallocated LAE and other operating expenses. We earn commissions on reinsurance premiums ceded in a manner consistent with the recognition of the earned premium on the

 

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underlying insurance policies, on a pro rata basis over the terms of the policies reinsured. In connection with the Personal Lines Quota Share, the amount we received is based on a contractual formula contained in the reinsurance agreements and is based on the ceded losses as a percentage of ceded premium. Reinsurance recoverables are reported based on the portion of reserves and paid losses and LAE that are ceded to other companies. Assessing whether or not a reinsurance contract meets the condition for risk transfer requires judgment. The determination of risk transfer is critical to reporting premiums and losses, and is based, in part, on the use of actuarial and pricing models and assumptions. If we determine that a reinsurance contract does not transfer sufficient risk, we account for the contract under deposit accounting.

Deferred policy acquisition costs. Deferred acquisition costs include commissions, premium taxes, payments to affinity partners, promotional fees, and other direct sales costs that vary and are directly related to the successful acquisition of insurance policies. These costs are deferred and amortized to the extent recoverable over the policy period in which the related premiums are earned. We may consider anticipated investment income in determining the recoverability of these costs. Management believes that these costs are recoverable in the near term. If management determined that these costs were not recoverable, then we could not continue to record deferred acquisition costs as an asset and would be required to establish a liability for a premium deficiency reserve.

Assessments related to insurance premiums. We are subject to a variety of insurance-related assessments, such as assessments by state guaranty funds used by state insurance regulators to cover losses of policyholders of insolvent insurance companies and for the operating expenses of such agencies. A typical obligating event would be the issuance of an insurance policy or the occurrence of a claim. These assessments are accrued in the period in which they have been incurred. We use estimated assessment rates in determining the appropriate assessment expense and accrual. We use estimates derived from state regulators and/or National Association of Insurance Commissioners (“NAIC”) Tax and Assessments Guidelines.

Unearned premium reserves. Unearned premium reserves represent the portion of premiums written applicable to the unexpired terms of the policies. Net premium receivables represent premiums written and not yet collected, net of an allowance for uncollectible premiums.

Cash and cash equivalents. Cash and cash equivalents are presented at cost, which approximates fair value. We consider all highly liquid investments with original maturities of three months or less to be cash equivalents. We maintain our cash balances at several financial institutions. The Federal Deposit Insurance Corporation secures accounts up to $250,000 at these institutions. Management monitors balances in excess of insured limits and believes these balances do not represent a significant credit risk to us.

Investments. We account for investments in accordance with Financial Accounting Standards Board (“FASB”) Accounting Standards Codification (“ASC”) 320, “Investments — Debt and Equity Securities”, which requires that fixed-maturity and equity securities that have readily determinable fair values be segregated into categories based upon our intention for those securities. Except for our equity investments in unconsolidated subsidiaries, we have classified our investments as available-for-sale and may sell our available-for-sale securities in response to changes in interest rates, risk/reward characteristics, liquidity needs or other factors. Available-for-sale securities are reported at their estimated fair values based on a recognized pricing service, with unrealized gains and losses, net of tax effects, reported as a separate component of other comprehensive income in the consolidated statement of comprehensive income.

Purchases and sales of investments are recorded on a trade date basis. Realized gains and losses are determined based on the specific identification method. Net investment income is recognized when earned and includes interest and dividend income together with amortization of market premiums and discounts using the effective yield method and is net of investment management fees and other expenses. For mortgage-backed securities and any other holdings for which there is a prepayment risk, prepayment assumptions are evaluated and revised as necessary. Any adjustments required due to the change in effective yields and maturities are recognized on a prospective basis through yield adjustments.

 

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We use a set of quantitative and qualitative criteria to evaluate the necessity of recording impairment losses for other-than-temporary declines in fair value. These criteria include:

 

   

the current fair value compared to amortized cost;

 

   

the length of time that the security’s fair value has been below its amortized cost;

 

   

specific credit issues related to the issuer such as changes in credit rating or non-payment of scheduled interest payments;

 

   

whether management intends to sell the security and, if not, whether it is not more likely than not that we will be required to sell the security before recovery of its amortized cost basis;

 

   

the financial condition and near-term prospects of the issuer of the security, including any specific events that may affect its operations or earnings;

 

   

the occurrence of a discrete credit event resulting in the issuer defaulting on a material outstanding obligation or the issuer seeking protection under bankruptcy laws; and

 

   

other items, including management, media exposure, sponsors, marketing and advertising agreements, debt restructurings, regulatory changes, acquisitions and dispositions, pending litigation, distribution agreements and general industry trends.

Impairment of investment securities results in a charge to operations when a market decline below cost is deemed to be other than temporary. We immediately write down investments that we consider to be impaired based on the foregoing criteria collectively.

In the event of the decline in fair value of a debt security, a holder of that security that does not intend to sell the debt security and for whom it is not more likely than not that such holder will be required to sell the debt security before recovery of its amortized cost basis is required to separate the decline in fair value into (a) the amount representing the credit loss and (b) the amount related to other factors. The amount of total decline in fair value related to the credit loss shall be recognized in earnings as an other-than-temporary impairment (“OTTI”) with the amount related to other factors recognized in accumulated other comprehensive income or loss, net of tax. OTTI credit losses result in a permanent reduction of the cost basis of the underlying investment. The determination of OTTI is a subjective process, and different judgments and assumptions could affect the timing of the loss realization.

Our investments include the following: short-term investments; fixed-maturity and equity securities; mortgage-backed securities; limited partnership interests; securities sold under agreements to repurchase (repurchase agreements); securities purchased under agreements to resell (reverse repurchase agreements); and securities sold but not yet purchased.

Repurchase and reverse repurchase agreements are used to earn spread income, borrow funds, or to facilitate trading activities. Securities repurchase and resale agreements are generally short-term, and therefore, the carrying amounts of these instruments approximate fair value.

Equity investments in unconsolidated subsidiaries. We use the equity method of accounting for investments in subsidiaries in which our ownership interest enables us to influence operating or financial decisions of the subsidiary, but our interest does not require consolidation. In applying the equity method, we record our investment at cost, and subsequently increase or decrease the carrying amount of the investment by our proportionate share of the net earnings or losses and other comprehensive income of the investee. Any dividends or distributions received are recorded as a decrease in the carrying value of the investment. Our proportionate share of net income is reported in our consolidated statement of income.

Goodwill and intangible assets. We account for goodwill and intangible assets in accordance with ASC 350, “Intangibles — Goodwill and Other.” A purchase price paid that is in excess of net assets (“goodwill”) arising from a business combination is recorded as an asset and is not amortized. Intangible assets with a finite life are amortized over the estimated useful life of the asset. Intangible assets with an indefinite useful life are not amortized. Goodwill and intangible assets are tested for impairment on an annual basis or more frequently if changes in circumstances indicate that the carrying amount may not be recoverable. If the goodwill or intangible asset is impaired, it is written down to its realizable value with a corresponding expense reflected in the consolidated statement of income.

 

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Use of estimates and assumptions. The preparation of financial statements in accordance with GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Our principal estimates include unpaid losses and LAE reserves; deferred acquisition costs; reinsurance recoverables, including the provision for uncollectible premiums; the valuation of intangibles and the determination of goodwill; and income taxes. In developing the estimates and assumptions, management uses all available evidence. Because of uncertainties associated with estimating the amounts, timing and likelihood of possible outcomes, actual results could differ from estimates.

Business combinations. We account for business combinations under the acquisition method of accounting, which requires us to record assets acquired, liabilities assumed and any non-controlling interest in the acquiree at their respective fair values as of the acquisition date. We account for the insurance and reinsurance contracts under the acquisition method as new contracts, which requires us to record assets and liabilities at fair value. We adjust the fair value loss and LAE reserves by taking the acquired loss reserves recorded and discounting them based on expected reserve payout patterns using a current risk-free rate of interest. This risk free interest rate is then adjusted based on different cash flow scenarios that use different payout and ultimate reserve assumptions deemed to be reasonably possible based upon the inherent uncertainties present in determining the amount and timing of payment of such reserves. The difference between the acquired loss and LAE reserves and our best estimate of the fair value of such reserves at acquisition date is amortized ratably over the estimated payout period of the acquired loss and LAE reserves. We assign fair values to intangible assets acquired based on valuation techniques including the income and market approaches. We record contingent consideration at fair value based on the terms of the purchase agreement with subsequent changes in fair value recorded through earnings. The determination of fair value may require management to make significant estimates and assumptions. The purchase price is the fair value of the total consideration conveyed to the seller and we record the excess of the purchase price over the fair value of the acquired net assets, where applicable, as goodwill. We expense costs associated with the acquisition of a business in the period incurred.

Fair value of financial instruments. Our estimates of fair value for financial assets and financial liabilities are based on the framework established in ASC 820, “Fair Value Measurements and Disclosures.” The framework is based on the inputs used in valuation and gives the highest priority to quoted prices in active markets and requires that observable inputs be used in the valuations when available. The disclosure of fair value estimates in the ASC 820 hierarchy is based on whether the significant inputs into the valuation are observable. In determining the level of the hierarchy in which the estimate is disclosed, the highest priority is given to unadjusted quoted prices in active markets and the lowest priority to unobservable inputs that reflect our significant market assumptions. Additionally, valuation of fixed-maturity investments is more subjective when markets are less liquid due to lack of market-based inputs, which may increase the potential that the estimated fair value of an investment is not reflective of the price at which an actual transaction could occur. Fair values of other financial instruments approximate their carrying values.

ASC 820 defines fair value as the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. ASC 820 clarifies that fair value should be based on the assumptions market participants would use when pricing an asset or liability and establishes a fair value hierarchy that prioritizes the information used to develop those assumptions. Additionally, ASC 820 requires an entity to consider all aspects of nonperformance risk, including the entity’s own credit standing, when measuring the fair value of a liability.

ASC 820 establishes a three-level hierarchy to be used when measuring and disclosing fair value. An instrument’s categorization within the fair value hierarchy is based on the lowest level of significant input to its valuation. Following is a description of the three hierarchy levels:

Level 1—Inputs are quoted prices in active markets for identical assets or liabilities as of the measurement date. Additionally, the entity must have the ability to access the active market and the quoted prices cannot be adjusted by the entity.

 

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Level 2—Inputs are other than quoted prices included within Level 1 that are observable for the asset or liability, either directly or indirectly. Level 2 inputs include quoted prices in active markets for similar assets or liabilities; quoted prices in inactive markets for identical or similar assets or liabilities; or inputs that are observable or can be corroborated by observable market data by correlation or other means for substantially the full term of the assets or liabilities.

Level 3—Unobservable inputs are supported by little or no market activity. The unobservable inputs represent management’s best assumptions of how market participants would price the assets or liabilities. Generally, Level 3 assets and liabilities are valued using pricing models, discounted cash flow methodologies, or similar techniques that require significant judgment or estimation.

The availability of observable inputs can vary from financial instrument to financial instrument and is affected by a wide variety of factors, including, for example, the type of financial instrument, whether the financial instrument is new and not yet established in the marketplace, and other characteristics particular to the transaction. To the extent that valuation is based on models or inputs that are less observable or unobservable in the market, the determination of fair value requires significantly more judgment. Accordingly, the degree of judgment exercised by management in determining fair value is greatest for instruments categorized in Level 3. We use prices and inputs that are current as of the measurement date. In periods of market dislocation, the observability of prices and inputs may be reduced for many instruments. This condition could cause an instrument to be reclassified between levels.

For investments that have quoted market prices in active markets, the Company uses the quoted market prices as fair value and includes these prices in the amounts disclosed in the Level 1 hierarchy. To date, we have only included U.S. Treasury and Federal Agency fixed maturity instruments as Level 1. The Company receives the quoted market prices from third party, nationally recognized pricing services (“pricing service”). When quoted market prices are unavailable, the Company utilizes the pricing service to determine an estimate of fair value. The fair value estimates are included in the Level 2 hierarchy. The pricing service utilizes evaluated pricing models that vary by asset class and incorporate available trade, bid and other market information and for structured securities, cash flow and, when available, loan performance data. The pricing service’s evaluated pricing applications apply available information as applicable through processes such as benchmark curves, benchmarking of like securities, sector groupings and matrix pricing, to prepare evaluations. In addition, the pricing service uses model processes, such as the Option Adjusted Spread model, to assess interest rate impact and develop prepayment scenarios. The market inputs that the pricing service normally seeks for evaluations of securities, listed in approximate order of priority, include: benchmark yields, reported trades, broker/dealer quotes, issuer spreads, two-sided markets, benchmark securities, bids, offers and reference data including market research publications.

The Company typically utilizes the fair values received from the pricing service. If quoted market prices and an estimate from the pricing service are unavailable, the Company produces an estimate of fair value based on dealer quotations for recent activity in positions with the same or similar characteristics to that being valued or through consensus pricing of a pricing service. Depending on the level of observable inputs, the Company will then determine if the estimate is Level 2 or Level 3 hierarchy. In the past we have not adjusted any pricing provided by the pricing services based on the review performed by our investment managers.

To validate prices, the Company compares the fair value estimates to its knowledge of the current market and will investigate prices that it considers not to be representative of fair value. In addition, our process to validate the market prices obtained from the pricing service includes, but is not limited to, periodic evaluation of model pricing methodologies and analytical reviews of certain prices. We also periodically perform testing, as appropriate, of the market to determine trading activity, or lack of trading activity, as well as evaluating the variability of market prices.

The following describes the valuation techniques we used to determine the fair value of financial instruments held as of December 31, 2012:

Equity securities — For publicly traded common and preferred stocks, we received prices from a nationally recognized pricing service that were based on observable market transactions and included these estimates in the amount disclosed in Level 1. When current market quotes in active markets were unavailable for certain non-redeemable preferred stocks, we received an estimate of fair value from the pricing service that provided fair value estimates for our fixed-maturity securities because the pricing service utilizes some of the same methodologies to price the non-redeemable preferred stocks as it does for the fixed-maturity securities. We include the estimate of the fair value of the non-redeemable preferred stock in the amount disclosed in Level 2 of the fair value hierarchy.

 

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U.S. Treasury and federal agencies — These investments are composed primarily of bonds issued by the U.S. Treasury, the Federal Home Loan Bank, the Federal Home Loan Mortgage Corporation, Government National Mortgage Association and the Federal National Mortgage Association. The fair values of U.S. government securities are based on quoted market prices in active markets, and are included in the Level 1 fair value hierarchy. We believe the market for U.S. Treasury securities is an actively traded market given the high level of daily trading volume. The fair values of U.S. government and agency securities are priced using the spread above the risk-free yield curve. As the yields for the risk-free yield curve and the spreads for these securities are observable market inputs, the fair values of U.S. government and agency securities are included in Level 1 of the fair value hierarchy.

State and political subdivision bonds — These investments are composed of bonds and auction rate securities issued by U.S. state and municipal entities or agencies. The fair values of municipal bonds are generally priced by pricing services. The pricing services typically use spreads obtained from broker-dealers, trade prices and the new issue market. As the significant inputs used to price the municipal bonds are observable market inputs, these are classified within Level 2 of the fair value hierarchy. Municipal auction rate securities are reported in our consolidated balance sheets at cost, which approximates their fair value.

Corporate bonds — These investments are composed of bonds issued by corporations and are generally priced by pricing services. The fair values of short-term corporate bonds are priced, by the pricing services, using the spread above the London Interbank Offering Rate (“LIBOR”) yield curve and the fair value of long-term corporate bonds are priced using the spread above the risk-free yield curve. The spreads are sourced from broker-dealers, trade prices and the new issue market. Where pricing is unavailable from pricing services, we obtain non-binding quotes from broker-dealers. As the significant inputs used to price corporate bonds are observable market inputs, the fair values of corporate bonds are included in Level 2 of the fair value hierarchy.

Mortgage-backed securities — These securities are composed of commercial and residential mortgage-backed securities. These securities are priced by independent pricing services and brokers. The pricing provider applies dealer quotes and other available trade information, prepayment spreads, yield curves and credit spreads to the valuation. As the significant inputs used to price these securities are observable market inputs, the fair values of these securities are included in the Level 2 fair value hierarchy.

Premiums and other receivables — The carrying values reported in the accompanying balance sheets for these financial instruments approximate their fair values due to the short-term nature of these assets.

Notes payable — The amount reported in the accompanying balance sheets for this financial instrument represents the carrying value of the debt. The fair value of the debt was derived using the Black-Derman-Toy model.

Stock compensation expense. We recognize compensation expense for our share-based awards over the estimated vesting period based on estimated grant date fair value. Share-based payments include stock option grants under our 2010 Equity Incentive Plan and our 2013 Equity Incentive Plan.

Earnings per share. Basic earnings per share are computed based on the weighted-average number of shares of common stock outstanding. Dilutive earnings per share are computed using the weighted-average number of shares of common stock outstanding during the period adjusted for the dilutive impact of share options and convertible preferred stock using the treasury stock method.

Income taxes. We join our subsidiaries in the filing of a consolidated federal income tax return and are party to federal income tax allocation agreements. Under the tax allocation agreements, we pay to or receive from our subsidiaries the amount, if any, by which the group’s federal income tax liability was affected by virtue of inclusion of the subsidiary in the consolidated federal return.

 

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Deferred income taxes reflect the impact of “temporary differences” between the amount of our assets and liabilities for financial reporting purposes and such amounts as measured by tax laws and regulations. The deferred tax asset primarily consists of book versus tax differences for premiums earned, loss and LAE reserve discounting, policy acquisition costs, earned but unbilled premiums, and unrealized holding gains and losses on marketable equity securities. We record changes in deferred income tax assets and liabilities that are associated with components of other comprehensive income and primarily unrealized investment gains and losses, directly to other comprehensive income. We include changes in deferred income tax assets and liabilities as a component of income tax expense.

In assessing the recoverability of deferred tax assets, management considers whether it is more likely than not that we will generate future taxable income during the periods in which those temporary differences become deductible. Management considers the scheduled reversal of deferred tax liabilities, tax planning strategies and projected future taxable income in making this assessment. If necessary, we establish a valuation allowance to reduce the deferred tax assets to the amounts that are more likely than not to be realized.

We recognize tax benefits only for tax positions that are more likely than not to be sustained upon examination by taxing authorities. Our policy is to prospectively classify accrued interest and penalties related to any unrecognized tax benefits in its income tax provision. We file our consolidated tax returns as prescribed by the tax laws of the jurisdictions in which we and our subsidiaries operate.

Results of Operations

Consolidated Results of Operations

 

(amounts in thousands)    Nine-Months Ended
September 30,
    (As Restated)(1)
Year Ended
December 31,
    (As Restated)(1)
Period from
March 1, 2010
(Inception) to
December 31,
 
     2013     2012     2012     2011     2010  

Gross premium written

   $ 1,021,016      $ 1,029,398      $ 1,351,925      $ 1,178,891      $ 911,991   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Ceded premiums (related parties - $422,380, $415,968, $561,317, $491,689, $246,909)

     (543,373     (538,040     (719,431     (640,655     (463,422

Net premium written

   $ 477,643      $ 491,358      $ 632,494      $ 538,236      $ 448,570   

Change in unearned premiums

     (4,811     (68,184     (58,242     (40,026     112,347   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Net earned premium

   $ 472,832      $ 423,174      $ 574,252      $ 498,210      $ 560,917   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Ceding Commission Income (primarily related parties)

     76,439        67,080        93,300        80,384        49,656   

Service, Fees, and Other Income

     93,053        68,946        93,739        66,116        53,539   

Underwriting expenses:

          

Loss and LAE

     302,403        279,016        394,666        333,848        391,633   

Acquisition costs and other

     94,265        81,352        110,771        75,191        36,755   

General and administrative

     220,515        184,225        258,604        218,152        155,108   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total underwriting expenses

   $ 617,183      $ 544,593      $ 764,041      $ 627,191      $ 583,496   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Underwriting income

   $ 25,141      $ 14,607      $ (2,750   $ 17,519      $ 80,616   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Net investment income

     22,093        22,981        30,550        28,355        25,391   

Net realized gains

     1,463        15,856        16,612        4,775        3,293   

Bargain purchase gain and other revenue

     16        (32     3,728        -        33,238   

 

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(amounts in thousands)    Nine-Months Ended
September 30,
    (As Restated)(1)
Year Ended
December 31,
    (As Restated)(1)
Period from
March 1, 2010
(Inception) to
December 31,
 
     2013     2012     2012     2011     2010  

Equity in earnings (losses) of unconsolidated subsidiaries

     (452     (2,693     (1,338     23,760        3,876   

Interest expense

     1,456        1,342        1,787        1,994        1,795   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Income Before Provision for Income Taxes

   $ 46,805      $ 49,377      $ 45,015      $ 72,415      $ 144,619   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Provision for income taxes

     12,392        17,240        12,309        28,301        42,416   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Net income

   $ 34,413      $ 32,137      $ 32,706      $ 44,114      $ 102,203   

Net income attributable to NCI

     (44     —          —          (14     —     
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Net income attributable to NGHC

   $ 34,369      $ 32,137      $ 32,706      $ 44,100      $ 102,203   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Net loss ratio

     64.0     65.9     68.7     67.0     69.8

Net operating expense ratio (non-GAAP)

     30.7     30.6     31.8     29.5     15.8
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Net combined ratio (non-GAAP)

     94.7     96.5     100.5     96.5     85.6
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Reconciliation of net operating expense ratio (non-GAAP):

          

Total expenses

   $ 618,639      $ 545,935      $ 765,828      $ 629,185      $ 585,291   

Less: Loss and loss adjustment expense

     302,403        279,016        394,666        333,848        391,633   

Less: Interest expense

     1,456        1,342        1,787        1,994        1,795   

Less: Ceding Commission Income

     76,439        67,080        93,300        80,384        49,656   

Less: Service, Fees and Other Income

     93,053        68,946        93,739        66,116        53,539   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Net operating expense

     145,288        129,551        182,336        146,843        88,668   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Net earned premium

   $ 472,832      $ 423,174      $ 574,252      $ 498,210      $ 560,917   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Net operating expense ratio (non-GAAP)

     30.7     30.6     31.8     29.5     15.8

 

(1) Certain amounts for the years ended December 31, 2012 and 2011 and the period from March 1, 2010 (Inception) to December 31, 2010 have been restated. Please refer to Note 2 to our audited financial statements for the year ended December 31, 2012 for further detail.

During 2011, we expanded into a number of states beyond the states where our core P&C business operated (the “P&C Non-Core States”). This expansion significantly increased premium in 2012 but also reduced profitability. During 2012, we completed a strategic review of this expansion into P&C Non-Core States and made the decision to exit, restrict, or initiate runoff in certain of these unprofitable businesses. Generally, we expect these actions will improve our net loss ratio and combined ratio in 2013.

Our A&H segment, established in 2012, provides accident and health insurance through six businesses (the “A&H Startup”). Since most of the acquisition activity occurred later in the year, the comparisons between 2012 and 2013 for the A&H segment will not be meaningful until the fourth quarter of 2013. Our 2012 results of operations were negatively impacted by expected underwriting losses from our acquisition of the TABS companies in September 2012. At the time of acquisition we expected underwriting losses for the remainder of 2012 and into 2013.

Our results for 2012 and 2013 have been impacted by the acceleration of the amortization of certain assets. In connection with the implementation of our new policy administration system, we accelerated the amortization of our legacy systems and accordingly all value associated with the legacy systems has been amortized as of December 31, 2012. The accelerated amortization resulted in an additional charge of approximately $233,000 to 2012 pre-tax income. In addition, as a result of our rebranding that was effective July 1, 2013, we accelerated and have fully amortized the intangible asset associated with the Company’s previous brand name, GMAC Insurance. This accelerated amortization resulted in a charge of approximately $732,000 to the year-to-date 2013 pre-tax income.

 

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Consolidated Results of Operations for the Nine-Month Period Ended September 30, 2013 Compared with the Nine-Month Period Ended September 30, 2012

Gross premium written. Gross premium written decreased by $8.4 million from $1,029.4 million for the nine-month period ended September 30, 2012 to $1,021.0 million for the nine-month period ended September 30, 2013, due to an increase of $23.0 million in premiums received from the A&H segment offset by a decrease of $31.4 million in premiums received from the P&C segment as we exited or restricted business in the P&C Non-Core States.

Net premium written. Net premium written decreased by $13.8 million, or 2.8%, from $491.4 million for the nine-month period ended September 30, 2012 to $477.6 million for the nine-month period ended September 30, 2013. Net premium written for the P&C segment decreased by $36.5 million for the nine-month period ended September 30, 2013 compared to the same period in 2012 primarily due to our exit or restriction of business in the P&C Non-Core States. In connection with the A&H Startup, net premium written for the A&H segment increased by $22.8 million.

Net earned premium. Net earned premium increased by $49.6 million, or 11.7%, from $423.2 million for the nine-month period ended September 30, 2012 to $472.8 million for the nine-month period ended September 30, 2013. The increase by segment was: P&C — $26.8 million and A&H — $22.8 million. The increase was primarily attributable to timing differences between the receipt of written premium and the recognition of earned premium and the effect of the A&H Startup, partially offset by the effect of the termination of the Personal Lines Quota Share.

Ceding commission income. Ceding commission income increased from $67.1 million for the nine-month period ended September 30, 2012 to $76.4 million for the nine-month period ended September 30, 2013. Our ceding commission ratio increased from 15.9% to 16.2%.

Service and fee income. Service and fee income increased by $24.2 million, or 35.1%, from $68.9 million for the nine-month period ended September 30, 2012 to $93.1 million for the nine-month period ended September 30, 2013. The increase was primarily attributable to the increase of $19.8 million in service and fee income related to the A&H Startup. The components of service and fee income are as follows:

 

(amounts in thousands)    Nine months ended
September 30, 2013
     Nine months ended
September 30, 2012
     Change  

Installment fees

   $ 24,021       $ 31,512       $ (7,491

Commission revenue

     35,376         13,858         21,517   

General agent fees

     14,747         8,607         6,142   

Late payment fees

     8,299         8,120         179   

Finance and processing fees

     10,610         6,849         3,761   
  

 

 

    

 

 

    

 

 

 

Total

   $ 93,053       $ 68,946       $ 24,108   

Loss and loss adjustment expenses; net loss ratio. Loss and LAE increased by $23.4 million, or 8.4%, from $279.0 million for the nine-month period ended September 30, 2012 to $302.4 million for the nine-month period ended September 30, 2013 due to higher P&C earned premium primarily attributable to timing differences between the receipt of written premium and the recognition of earned premium and the A&H Startup. The changes by segment were: P&C — increase of $10.0 million and A&H —increase of $13.4 million. Our net loss ratio decreased from 65.9% for the nine-month period ended September 30, 2012 to 64.0% for the nine-month period ended September 30, 2013 primarily due to improvements in the net loss ratio from our core P&C business and our decision to exit or restrict business in the P&C Non-Core States.

Acquisition and other underwriting costs. Acquisition and other underwriting costs increased by $12.9 million, or 15.9%, from $81.4 million for the nine-month period ended September 30, 2012 to $94.3 million for the nine-month period ended September 30, 2013 due to A&H Startup expenses.

General and administrative expense. General and administrative expense increased by $36.3 million, or 19.7%, from $184.2 million for the nine-month period ended September 30, 2012 to $220.5 million for the nine-month period ended September 30, 2013 primarily as a result of the ongoing costs for our three legacy policy administration systems in addition to the costs of our new policy administration system during 2013, the effect of the hiring of additional employees for the transition to our new operations center in Cleveland and A&H Startup expenses.

Net operating expense; net operating expense ratio (non-GAAP). Net operating expense increased by $15.7 million, or 12.1%, from $129.6 million for the nine-month period ended September 30, 2012 to $145.3 million for the nine-month period ended September 30, 2013. The net operating expense ratio (non-GAAP) to 30.7% in 2013 from 30.6% in 2012 primarily as a result of the increase in general and administrative expenses, partially offset by an increase in ceding commission income.

 

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Net investment income. Net investment income decreased by $0.9 million, or 3.9%, from $23.0 million for the nine-month period ended September 30, 2012 to $22.1 million for the nine-month period ended September 30, 2013 due to a lower average yield. The average yield, net of investment expense, on our investment portfolio was 3.5% and 3.8% for the nine-month periods ended September 30, 2013 and 2012.

Net realized gains on investments. Net realized gains on investments decreased by $14.4 million from $15.9 million for the nine-month period ended September 30, 2012 to $1.5 million for the nine-month period ended September 30, 2013 due to the decision to sell more securities during the nine-month period ended September 30, 2012 than during the nine-month period ended September 30, 2013.

Equity in earnings (losses) of unconsolidated subsidiaries. Equity in earnings (losses) of unconsolidated subsidiaries, which primarily relates to our 50% interest in entities that own life settlement contracts, increased by $2.2 million, from a $2.7 million loss for the nine-month period ended September 30, 2012 to a $0.5 million loss for the nine-month period ended September 30, 2013, due primarily to an increase in the value of the life settlement contracts.

Interest expense. Interest expense for the nine-month periods ended September 30, 2013 and 2012 was $1.5 million and $1.3 million, respectively, reflecting the scheduled interest payment on our bank line of credit and the interest due on the final deferred purchase price payment made to GMAC on February 28, 2012.

Provision for income taxes. Income tax expense decreased by $4.8 million, or 27.9%, from $17.2 million for the nine-month period ended September 30, 2012, reflecting an effective tax rate of 34.9%, to $12.4 million for the nine-month period ended September 30, 2013, reflecting an effective tax rate of 26.5%. Income tax expense included a tax benefit of $2.4 million attributable to the reduction of the deferred tax liability associated with the equalization reserves of our Luxembourg reinsurer. The effect of this $2.4 million tax benefit reduced the effective tax rate by 5%.

Consolidated Results of Operations for the Year Ended December 31, 2012 Compared to the Year Ended December 31, 2011

Gross premium written. Gross premium written increased by $173.0 million, or 14.7%, from $1,178.9 million for the year ended December 31, 2011 to $1,351.9 million for the year ended December 31, 2012. The increase by segment was: P&C — $164.8 million and A&H — $8.3 million. Gross premium written increased for the year ended December 31, 2012 compared to the same period in 2011 primarily due to our entry into P&C Non-Core States and the A&H Startup.

Net premium written. Net premium written increased by $94.3 million, or 17.5%, from $538.2 million for the year ended December 31, 2011 to $632.5 million for the year ended December 31, 2012. The increase by segment was: P&C — $86.2 million and A&H — $8.0 million. Net premium written increased for the year ended December 31, 2012 compared to the same period in 2011 primarily due to our entry into P&C Non-Core States and the A&H Startup.

Net earned premium. Net earned premium increased by $76.1 million, or 15.3%, from $498.2 million for the year ended December 31, 2011 to $574.3 million for the year ended December 31, 2012. The increase by segment was: P&C — $68.0 million and A&H — $8.0 million. The increase for the year ended December 31, 2012 compared to the same period in 2011 was primarily due to our entry into P&C Non-Core States and the A&H Startup.

Ceding commission income. Ceding commission income increased by $12.9 million, or 16.0%, from $80.4 million for the year ended December 31, 2011 to $93.3 million for the year ended December 31, 2012. Our ceding commission ratio increased from 16.1% for the year ended December 31, 2011 to 16.2% for the year ended December 31, 2012 as a result of increased net earned premium.

Service and fee income. Service and fee income increased by $27.6 million, or 41.8%, from $66.1 million for the year ended December 31, 2011 to $93.7 million for the year ended December 31, 2012. The increase was attributable to an increase in the P&C policy fee-related income of $11.3 million due to our entry into P&C Non-Core States and $16.4 million attributable to the A&H Startup. The components of service and fee income are as follows:

 

     Year ended December 31,         
(amounts in thousands)    2012      2011      Change  

Installment fees

   $ 38,340       $ 41,268       $ (2,927

Commission revenue

     20,770         7,111         13,659   

General agent fees

     13,233         5,772         7,460   

Late payment fees

     10,962         9,127         1,836   

Finance and processing fees

     10,434         2,839         7,595   
  

 

 

    

 

 

    

 

 

 

Total

   $ 93,739       $ 66,116       $ 27,623   

Loss and loss adjustment expenses; net loss ratio. Loss and LAE increased by $60.9 million, or 18.2%, from $333.8 million for the year ended December 31, 2011 to $394.7 million for the year ended December 31, 2012 due to our entry into the P&C Non-Core States and the A&H Startup. Our net loss ratio increased from 67.0% for the year ended December 31, 2011 to 68.7% for the year ended December 31, 2012. The net loss ratio in 2012 increased 0.6% due to catastrophic losses related to Hurricane Sandy. The net loss ratio was also negatively affected by the effect of our entry into P&C Non-Core States and the A&H Startup, partially offset by improvements in our core products.

 

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Acquisition and other underwriting costs. Our acquisition and other underwriting costs increased by $35.6 million, or 47.3%, from $75.2 million for the year ended December 31, 2011 to $110.8 million for the year ended December 31, 2012 primarily due to an increase in earned premiums, the adoption of a new deferred acquisition cost accounting pronouncement ($6.5 million), the hiring of additional employees for the transition to a new operations center in Cleveland and related startup costs and our entry into the P&C Non-Core States and the A&H Startup.

General and administrative expense. General and administrative expense increased by $40.5 million, or 18.5%, from $218.2 million for the year ended December 31, 2011 to $258.6 million for the year ended December 31, 2012 due to our entry into the P&C Non-Core States, the A&H Startup, the transition to a new operations center in Cleveland and related startup costs.

Net operating expense; Net operating expense ratio (non-GAAP). Net operating expense increased by $35.5 million, or 24.2%, from $146.8 million for the year ended December 31, 2011 to $182.3 million for the year ended December 31, 2012. The net operating expense ratio (non-GAAP) increased from 29.5% in 2011 to 31.8% in 2012 primarily due to the adoption of a deferred acquisition cost accounting pronouncement ($6.5 million), the hiring of additional employees for the transition to a new operations center in Cleveland and related start-up costs ($16.9 million) partially offset by increases in ceding commission income, service and fee income and net earned premium.

Net investment income. Net investment income increased by $2.2 million, or 7.7%, from $28.4 million for the year ended December 31, 2011 to $30.6 million for the year ended December 31, 2012. The increase resulted primarily from having a higher average balance of fixed-income investment securities during 2012.

Net realized gains on investments. Net realized gains on investments increased by $11.8 million from $4.8 million for the year ended December 31, 2011 to $16.6 million for the year ended December 31, 2012 due to our decision to sell more securities during the year ended December 31, 2012 than we did during the year ended December 31, 2011.

Bargain purchase gain. For the year ended December 31, 2012, we had a bargain purchase gain of $3.7 million as a result of our acquisition of NHIC. We had no bargain purchase gain for the year ended December 31, 2011.

Equity in earnings (losses) of unconsolidated subsidiaries. Equity in earnings (losses) of unconsolidated subsidiaries, which primarily related to our 50% interest in entities that own life settlement contracts, decreased by $25.1 million from a $23.8 million gain for the year ended December 31, 2011 to a loss of $1.3 million for the year ended December 31, 2012. The gain in the year ended December 31, 2011 was generated by the purchase of a large pool of life settlement contracts in 2011 and the conversion of premium finance loans acquired in 2010 into life settlement contracts in 2011 through voluntary surrenders of the policies in satisfaction of the loans or in lieu of foreclosure. During the year ended December 31, 2012, fewer contracts were purchased or converted. The loss for 2012 was attributable to a decrease in fair value of the life settlement contracts.

Interest expense. Interest expense for the years ended December 31, 2012 and 2011 was $1.8 million and $2.0 million, respectively, reflecting the scheduled interest payment on our bank line of credit and the interest due on the deferred purchase price payment related to the original acquisition of our P&C business.

Provision for income taxes. Income tax expense decreased from $28.3 million for the year ended December 31, 2011, reflecting an effective tax rate of 39.1%, to $12.3 million for the year ended December 31, 2012, reflecting an effective tax rate of 27.3%. Income tax expense included a tax benefit of $4.8 million attributable to the reduction of the deferred tax liability associated with the equalization reserves of our Luxembourg reinsurer. The effect of this $4.8 million tax benefit reduced the effective tax rate by 11%.

 

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Consolidated Results of Operations for the Year Ended December 31, 2011 Compared to the Ten-Month Period from March 1, 2010 (inception) to December 31, 2010

All data and comparisons between the year ended December 31, 2011 and the ten-month period from March 1, 2010 (inception) to December 31, 2010 were affected by the following three significant factors, which had a significant impact on 2010 pre-tax income:

 

1) We started operations on March 1, 2010, so our 2010 results reflect only ten months of business.

 

2) In connection with the acquisition of our P&C business in March 2010, we assumed approximately $389.0 million of unearned premium net of deferred acquisition costs. The absence of amortization of deferred acquisition costs related to this unearned premium significantly improved our results of operations during 2010. In addition, this unearned premium was retained by us and was not subject to the Personal Lines Quota Share agreement.

 

3) In connection with the acquisition, we recorded a bargain purchase gain of approximately $33.2 million in 2010.

Gross premium written. Gross premium written increased by $266.9 million, or 29.3%, from $912.0 million for the ten-month period ended December 31, 2010 to $1,178.9 million for the year ended December 31, 2011. Gross premium written was higher in 2011 reflecting a full year of business in 2011 as compared with only ten months in 2010 and growth in the business.

Net premium written. Net premium written increased by $89.6 million, or 20.0%, from $448.6 million for the ten-month period ended December 31, 2010 to $538.2 million for the year ended December 31, 2011. Net premium written was higher in 2011 reflecting a full year of business in 2011 as compared with only ten months in 2010 and growth in the business.

Net earned premium. Net earned premium decreased by $62.7 million, or 11.2%, from $560.9 million for the ten-month period ended December 31, 2010 to $498.2 million for the year ended December 31, 2011. As premium written is earned ratably over a six- or twelve-month period, the decrease in net earned premium reflects our retention of the earned premium from the 2010 acquisition, which was not subject to the Personal Lines Quota Share in 2010, offset in part by the fact that we had a full year of business in 2011 as compared with only ten months in 2010.

Ceding commission income. Ceding commission income increased by $30.7 million, or 61.8%, from $49.7 million for the ten-month period ended December 31, 2010 to $80.4 million for the year ended December 31, 2011 as a result of increased written premium being subject to the Personal Lines Quota Share Our ceding commission ratio increased from 8.9% for the ten-month period ended December 31, 2010 to 16.1% for the year ended December 31, 2011.

Service and fee income. Service and fee income increased by $12.6 million, or 23.5%, from $53.5 million for the ten-month period ended December 31, 2010 to $66.1 million for the year ended December 31, 2011. The components of service and fee income are as follows:

 

(amounts in thousands)    Year ended December 31,
2011
     Period from March 1,
2010 (Inception) to
December 31, 2010
     Change  

Installment fees

   $ 41,268       $ 33,162       $ 8,106   

Commission revenue

     7,111         6,714         397   

General agent fees

     5,772         4,355         1,418   

Late payment fees

     9,127         7,580         1,547   

Finance and processing fees

     2,839         1,729         1,111   
  

 

 

    

 

 

    

 

 

 

Total

   $ 66,116       $ 53,539       $ 12,578   

Loss and loss adjustment expenses; net loss ratio. Loss and LAE decreased by $57.8 million, or 14.8% from $391.6 million for the ten-month period ended December 31, 2010 to $333.8 million for the year ended December 31, 2011. Our net loss ratio decreased from 69.8% for the ten-month period ended December 31, 2010 to 67.0% for the year ended December 31, 2011. These decreases primarily reflect the our retention of the earned premium from the 2010 acquisition, which was not subject to the Personal Lines Quota Share in 2010.

Acquisition and other underwriting costs. Acquisition and other underwriting costs increased by $38.4 million, or 104.6%, from $36.8 million for the ten-month period ended December 31, 2010 to $75.2 million for the year ended December 31, 2011 resulting from the fact that we had a full year of business in 2011 as compared with only ten months in 2010 and the absence of amortization of deferred acquisition costs related to the unearned premium from the 2010 acquisition.

 

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General and administrative expense. General and administrative expense increased by $63.1 million, or 40.6%, from $155.1 million for the ten-month period ended December 31, 2010 to $218.2 million for the year ended December 31, 2011 resulting from the fact that we had a full year of business in 2011 as compared with only ten months in 2010 and the absence of amortization of deferred acquisition costs related to the unearned premium from the 2010 acquisition.

Net operating expense; net operating expense ratio (non-GAAP). Net operating expense increased by $58.1 million, or 65.5%, from $88.7 million for the ten-month period ended December 31, 2010 to $146.8 million for the year ended December 31, 2011. The net operating expense ratio (non-GAAP) increased from 15.8% in 2010 to 29.5% in 2011 driven primarily by the increases in acquisition and other underwriting costs and general and administrative expense and the decrease in net earned premium, as described above.

Net investment income. Net investment income increased by $3.0 million, or 11.8%, from $25.4 million for the ten-month period ended December 31, 2010 to $28.4 million for the year ended December 31, 2011 due to the fact that we had a full year of interest income in 2011 as compared with only ten months in 2010.

Net realized gains (losses) on investments. Net realized gains on investments increased by $1.5 million, or 45.0%, from $3.3 million for the ten-month period ended December 31, 2010 to $4.8 million for the year ended December 31, 2011. In the year ended December 31, 2011, we realized higher gains on investments due to our decision to sell more positions in 2011 than we had sold in the ten-month period ended December 31, 2010.

Equity in earnings (losses) of unconsolidated subsidiaries. Equity in earnings (losses) of unconsolidated subsidiaries, which primarily related to our 50% interest in entities that own life settlement contracts, increased by $19.9 million, or 510.3%, from $3.9 million for the ten-month period ended December 31, 2010 to $23.8 million for the year ended December 31, 2011 reflecting, primarily, the gain realized upon a mortality event in 2011 and the acquisition of a higher number of life settlement contracts purchased by or surrendered to one of the entities in satisfaction of premium finance loans during the year ended December 31, 2011 as compared to the ten-month period ended December 31, 2010.

Bargain purchase gain. We had a bargain purchase gain of $33.2 million for the ten-month period ended December 31, 2010 as a result of our acquisition of the P&C business. We did not have any bargain purchase gain for the year ended December 31, 2011.

Interest expense. Interest expense for the year ended December 31, 2011 and the ten-month period ended December 31, 2010 was $2.0 million and $1.8 million, respectively, reflecting the scheduled interest payment on our bank line of credit and the interest due on the deferred purchase price payment related to the original acquisition of our P&C business.

Provision for income taxes. Income tax expense decreased from $42.4 million for the ten-month period ended December 31, 2010, reflecting an effective tax rate of 33.6%, to $28.3 million for the year ended December 31, 2011, reflecting an effective tax rate of 39.1%.

 

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P&C Segment — Results of Operations

 

(amounts in thousands)    Nine-Months Ended
September 30,
    Year Ended December 31,     Period from
March 1, 2010
(Inception) to
December 31,
 
     2013     2012     2012     2011     2010  

Gross premium written

   $ 996,034      $ 1,027,351      $ 1,343,658      $ 1,178,891      $ 911,991   

Ceded premiums

     (543,218     (538,007     (719,205     (640,655     (463,422
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Net premium written

   $ 452,816      $ 489,344      $ 624,453      $ 538,236      $ 448,570   

Change in unearned premium

     (4,816     (68,184     (58,243     (40,026     112,347   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Net earned premium

   $ 448,000      $ 421,160      $ 566,210      $ 498,210      $ 560,917   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Ceding commission income (primarily related parties)

     76,439        67,080        93,300        80,384        49,656   

Service and fee income

     62,996        58,612        77,373        66,116        53,539   

Underwriting expenses:

          

Loss and LAE

     285,671        275,716        379,608        333,848        391,633   

Acquisition and other underwriting costs

     76,850        73,722        99,699        75,191        36,755   

General and administrative

     202,741        180,402        253,006        218,152        155,108   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total underwriting expenses

   $ 565,262      $ 529,840      $ 732,313      $ 627,191      $ 583,496   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Underwriting income

   $ 22,173      $ 17,012      $ 4,570      $ 17,519      $ 80,616   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Net loss ratio

     63.8     65.5     67.0     67.0     69.8

Net operating expense ratio (non-GAAP)

     31.3     30.5     32.1     29.5     15.8
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Net combined ratio (non-GAAP)

     95.1     96.0     99.1     96.5     85.6
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

 

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Reconciliation of net operating expense ratio (non-GAAP):

          

Total expenses

   $ 565,262      $ 529,840      $ 732,313      $ 627,191      $ 583,496   

Less: Loss and loss adjustment expense

     285,671        275,716        379,608        333,848        391,633   

Less: Ceding Commission Income

     76,439        67,080        93,300        80,384        49,656   

Less: Service, Fees and Other Income

     62,996        58,612        77,373        66,116        53,539   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Net operating expense

     140,156        128,432        182,032        146,843        88,668   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Net earned premium

   $ 448,000      $ 421,160      $ 566,210      $ 498,210      $ 560,917   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Net operating expense ratio (non-GAAP)

     31.3     30.5     32.1     29.5     15.8

P&C Segment Results of Operations for the Nine-month period ended September 30, 2013 Compared with the Nine-month period ended September 30, 2012

Gross premium written. Gross premium written decreased by $31.4 million, or 3.0%, from $1,027.4 million for the nine-month period ended September 30, 2012 to $996.0 million for the nine-month period ended September 30, 2013, primarily due to our exit or restriction of business in the P&C Non-Core States.

Net premium written. Net premium written decreased by $36.5 million, or 7.5%, from $489.3 million for the nine-month period ended September 30, 2012 to $452.8 million for the nine-month period ended September 30, 2013, primarily due to our exit or restriction of business in the P&C Non-Core States.

Net earned premium. Net earned premium increased by $26.8 million, or 6.4%, from $421.2 million for the nine-month period ended September 30, 2012 to $448.0 million for the nine-month period ended September 30, 2013, primarily as a result of the timing differences between the receipt of written premium and the recognition of earned premium.

Ceding commission income. Our ceding commission income increased by $9.3 million, or 13.9%, from $67.1 million for the nine-month period ended September 30, 2012 to $76.4 million for the nine-month period ended September 30, 2013 as a result of an increase in net earned premiums. Our ceding commission ratio increased from 15.9% to 17.1% for the nine-month periods ended September 30, 2012 and 2013

Service and fee income. Service and fee income increased by $4.4 million, or 7.5%, from $58.6 million for the nine-month period ended September 30, 2012 to $63.0 million for the nine-month period ended September 30, 2013, primarily as a result of improved fee monitoring and collection.

Loss and loss adjustment expenses; net loss ratio. Loss and LAE increased by $10.0 million, or 3.6%, from $275.7 million for the nine-month period ended September 30, 2012, to $285.7 million for the nine-month period ended September 30, 2013. Our net loss ratio decreased from 65.5% for the nine-month period ended September 30, 2012 to 63.8% for the nine-month period ended September 30, 2013. The loss ratio in 2013 was positively affected by significant improvements in our core businesses and our exit or restriction of business in the P&C Non-Core States.

Acquisition and other underwriting costs. Acquisition and other underwriting costs increased by $3.2 million from $73.7 million for the nine-month period ended September 30, 2012 to $76.9 million for the nine-month period ended September 30, 2013.

 

 

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General and administrative expense. General and administrative expense increased by $22.3 million, or 12.4%, from $180.4 million for the nine-month period ended September 30, 2012 to $202.7 million for the nine-month period ended September 30, 2013 primarily as a result of the ongoing costs for our three legacy policy administration systems in addition to the new policy administration system, the effect of the hiring of additional employees in connection with our transition to our new operations center in Cleveland and related expenses.

Net operating expense; net operating expense ratio (non-GAAP). Net operating expense increased by $11.7 million, or 9.1%, from $128.4 million for the nine-month period ended September 30, 2012 to $140.1 million for the nine-month period ended September 30, 2013. The net operating expense ratio (non-GAAP) increased from 30.5% in 2012 to 31.3% in 2013 primarily as a result of the increase in general and administrative expense, partially offset by an increase in ceding commission income.

Underwriting income. Underwriting income increased from $17.0 million for the nine-month period ended September 30, 2012 to $22.2 million for nine-month period ended September 30, 2013. The combined ratio for the nine-month period ended September 30, 2013 decreased to 95.1% compared to 96.0% for the same period in 2012 primarily as the result of our lower loss ratio due to our exit or restriction of business in the P&C Non-Core States.

P&C Segment Results of Operations for the Year Ended December 31, 2012 Compared to the Year Ended December 31, 2011

Gross premium written. Gross premium written increased by $164.8 million, or 14.0%, from $1,178.9 million for the year ended December 31, 2011 to $1,343.7 million for the year ended December 31, 2012 primarily due to our entry into P&C Non-Core States.

Net premium written. Net premium written increased by $86.2 million, or 16.0%, from $538.2 million for the year ended December 31, 2011 to $624.5 million for the year ended December 31, 2012 primarily due to our entry into P&C Non-Core States.

Net earned premium. Net earned premium increased by $68.0 million, or 13.6%, from $498.2 million for the year ended December 31, 2011 to $566.2 million for the year ended December 31, 2012 primarily due to our entry into P&C Non-Core States.

Ceding commission income. Our ceding commission income increased from $80.4 million for the year ended December 31, 2011 to $93.3 million for the year ended December 31, 2012. Our ceding commission ratio increased slightly from 16.1% for the year ended December 31, 2011 to 16.5% for the year ended December 31, 2012.

Service and fee income. Service and fee income increased by $11.3 million, or 17.0%, from $66.1 million for the year ended December 31, 2011 to $77.4 million for the year ended December 31, 2012 primarily due to our entry into P&C Non-Core States.

Loss and loss adjustment expenses; net loss ratio. Loss and LAE increased by $45.8 million, or 13.7%, from $333.8 million for the year ended December 31, 2011 to $379.6 million for the year ended December 31, 2012 due to increased premium related to the entry into the P&C Non-Core States. Our net loss ratio remained constant at 67.0% with our entry into the P&C Non-Core States and catastrophic losses related to Hurricane Sandy being offset by net loss ratio improvements in core products.

Acquisition and other underwriting costs. Acquisition and other underwriting costs increased by $24.5 million, or 32.6%, from $75.2 million for the year ended December 31, 2011 to $99.7 million for the year ended December 31, 2012 primarily due to the adoption of a new deferred acquisition cost accounting pronouncement ($6.5 million), the hiring of additional employees for the transition to a new operations center in Cleveland and related startup costs and our entry into the P&C Non-Core States.

General and administrative expense. General and administrative expense increased by $34.8 million, or 15.9%, from $218.2 million for the year ended December 31, 2011 to $253.0 million for the year ended December 31, 2012 due to our entry into the P&C Non-Core States, the transition to a new operations center in Cleveland and related startup costs.

 

 

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Net operating expense; net operating expense ratio (non-GAAP). Net operating expense increased by $35.2 million, or 24%, from $146.8 million for the year ended December 31, 2011 to $182.0 million for the year ended December 31, 2012 due to the increase in general and administrative expenses and acquisition and other underwriting costs offset in part by increases in ceding commission income and service and fee income. The net operating expense ratio (non-GAAP) increased from 29.5% for the year ended December 31, 2011 to 32.1% for the year ended December 31, 2012 primarily due to increases in net operating expense offset in part by an increase in net earned premium.

Underwriting income. Underwriting income decreased by $12.9 million, or 73.9%, from $17.5 million for the year ended December 31, 2011 to $4.6 million for the year ended December 31, 2012. The combined ratio increased from 96.5% in 2011 to 99.2% in 2012 due to the increases in loss and LAE and net operating expense more than offset the increase in net earned premium, as described above.

P&C Segment Results of Operations for the Year Ended December 31, 2011 Compared to the Ten-Month Period from March 1, 2010 (inception) to December 31, 2010.

All data and comparisons between the year ended December 31, 2011 and the ten-month period ended December 31, 2010 were affected by the following three significant factors which had a significant impact on 2010 pre-tax income:

 

  1) We started operations on March 1, 2010, so our 2010 results reflect only ten months of business.

 

  2) In connection with the acquisition, we assumed approximately $389.0 million of unearned premium net of deferred acquisition costs. The absence of amortization of deferred acquisition costs related to this unearned premium significantly improved our results of operations during 2010. In addition, this unearned premium was retained by us and was not subject to the Personal Lines Quota Share agreement.

 

  3) In connection with the acquisition, we recorded a bargain purchase gain of approximately $33.2

Gross premium written. Gross premium written increased by $266.9 million, or 29.3%, from $912.0 million for the ten-month period ended December 31, 2010 to $1,178.9 million for the year ended December 31, 2011. Gross premium written was higher in 2011 reflecting a full year of business in 2011 as compared with only ten months in 2010 and growth in the business.

Net premium written. Net premium written increased by $89.6 million, or 20.0%, from $448.6 million for the ten-month period ended December 31, 2010 to $538.2 million for the year ended December 31, 2011. Net premium written was higher in 2011 reflecting a full year of business in 2011 as compared with only ten months in 2010 and growth in the business.

Net earned premium. Net earned premium decreased by $62.7 million, or 11.2%, from $560.9 million for the ten-month period ended December 31, 2010 to $498.2 million for the year ended December 31, 2011, reflecting our retention of the earned premium from the 2010 acquisition, which was not subject to the Personal Lines Quota Share in 2010, offset by our completion of a full year of business in 2011 as compared with only 10 months in 2010.

Ceding commission income. Our ceding commission income increased by $30.7 million, or 61.8%, from $49.7 million for the ten-month period ended December 31, 2010 to $80.4 million for the year ended December 31, 2011. Our ceding commission ratio increased from 8.9% for the ten-month period ended December 31, 2010 to 16.1% for the year ended December 31, 2011 as a result of increased premium writings subject to the Personal Lines Quota Share for the full year 2011 compared to 10 months in 2010.

 

 

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Loss and loss adjustment expenses; net loss ratio. Loss and LAE decreased by $57.8 million, or 14.8%, from $391.6 million for the ten-month period ended December 31, 2010 to $333.8 million for the year ended December 31, 2011. Our net loss ratio for the segment decreased from 69.8% for the ten-month period ended December 31, 2010 to 67.0% for the year ended December 31, 2011. These decreases reflected the full effect of the premiums ceded in respect of the Personal Lines Quota Share in 2011.

Acquisition and other underwriting costs. Acquisition and other underwriting costs increased by $38.4 million, or 104.3%, from $36.8 million for the ten-month period ended December 31, 2010 to $75.2 million for the year ended December 31, resulting from the fact that we had a full year of business in 2011 as compared with only ten months in 2010 and the absence of amortization of deferred acquisition costs related to the unearned premium from the 2010 acquisition.

General and administrative expense. General and administrative expense increased by $63.0 million, or 40.6%, from $155.1 million for the ten-month period year December 31, 2010 to $218.2 million for the year ended December 31, 2011 resulting from the fact that we had a full year of business in 2011 as compared with only ten months in 2010.

Net operating expense; net operating expense ratio (non-GAAP). Net operating expense increased by $58.1 million, or 65.6%, from $88.7 million for the ten-month period ended December 31, 2010 to $146.8 million for the year ended December 31, 2011. The net operating expense ratio (non-GAAP) increased from 15.8% for the ten-month period ended December 31, 2010 to 29.5% for the year ended December 31, 2011 due to the increases in acquisition and other underwriting costs and general and administrative expense and the decrease in net earned premium, as described above.

Underwriting income. Underwriting income decreased by $63.1 million, or 78.3%, from $80.6 million for the ten-month period ended December 31, 2010 to $17.5 million for the year ended December 31, 2011, primarily due to the absence of amortization of deferred acquisition costs related to the unearned premium from the 2010 acquisition, and our retention of the earned premium from the 2010 acquisition, which was not subject to the Personal Lines Quota Share in 2010. The combined ratio increased to 96.5% in 2011 from 85.6% in 2010 due to the increases in loss and LAE and net operating expense and the decrease in net earned premium, as described above.

 

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A&H Segment — Results of Operations

 

(amounts in thousands)    Nine Months Ended
September 30,
    Year Ended
December 31,
 
     2013     2012     2012  

Gross premium written

   $ 24,982      $ 2,047      $ 8,267   

Ceded premiums

     (155     (33     (226
  

 

 

   

 

 

   

 

 

 

Net premium written

   $ 24,827      $ 2,014      $ 8,041   

Change in unearned premium

     5        —          1   
  

 

 

   

 

 

   

 

 

 

Net earned premium

   $ 24,832      $ 2,014      $ 8,042   
  

 

 

   

 

 

   

 

 

 

Service and fee income

     30,057        10,334        16,366   

Underwriting Expenses:

      

Loss and LAE

     16,732        3,300        15,058   

Acquisition and other underwriting costs

     17,415        7,630        11,072   

General and administrative

     17,774        3,823        5,598   
  

 

 

   

 

 

   

 

 

 

Total underwriting expenses

   $ 51,921      $ 14,753      $ 31,728   
  

 

 

   

 

 

   

 

 

 

Underwriting income

     2,968        (2,405   ($ 7,320
  

 

 

   

 

 

   

 

 

 

Net loss ratio

     67.4     163.9     187.2

Net operating expense ratio (non-GAAP)

     20.7     55.6     3.8
  

 

 

   

 

 

   

 

 

 

Net combined ratio (non-GAAP)

     88.1     219.5     191.0
  

 

 

   

 

 

   

 

 

 

Reconciliation of net operating expense ratio (non-GAAP):

      

Total expenses

   $ 51,921      $ 14,753      $ 31,728   

Less: Loss and loss adjustment expense

     16,732        3,300        15,058   

Less: Service, Fees and Other Income

     30,057        10,334        16,366   
  

 

 

   

 

 

   

 

 

 

Net operating expense

     5,132        1,119        304   
  

 

 

   

 

 

   

 

 

 

Net earned premium

   $ 24,832      $ 2,014      $ 8,042   
  

 

 

   

 

 

   

 

 

 

Net operating expense ratio (non-GAAP)

     20.7 %      55.6     3.8

A&H Segment Results of Operations

Our A&H segment, established in 2012, provides accident and health insurance through six recently acquired businesses. Since most of the acquisition activity occurred during the second half of 2012, the results of the A&H segment had a limited impact on our overall results. The 2012 results were negatively impacted by the expected underwriting losses from our acquisition of A&H businesses, particularly the TABS companies, which produced expected underwriting losses of $7.1 million from acquisition through December 31, 2012.

In April 2013, we acquired Euro Accident Health and Care Insurance Aktiebolag (“EA”), a Swedish group life and health insurance provider focused on health. EA currently operates as a Managing General Agent, which means that it is a registered insurance intermediary and as such operates as a non-risk bearing insurer. The financial impact of this acquisition on our results will not be material until 2014 when we expect that our Luxembourg insurance carrier will begin underwriting EA’s business.

 

 

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Investment Portfolio

Our investment strategy emphasizes, first, the preservation of capital and, second, maximization of an appropriate risk-adjusted return. We seek to maximize investment returns using investment guidelines that stress prudent allocation among cash and cash equivalents, fixed-maturity securities and, to a lesser extent, equity securities. Cash and cash equivalents include cash on deposit, commercial paper, pooled short-term money market funds and certificates of deposit with an original maturity of 90 days or less. Our fixed-maturity securities include obligations of the U.S. Treasury or U.S. government agencies, obligations of U.S. and Canadian corporations, mortgages guaranteed by the Federal National Mortgage Association, the Government National Mortgage Association, the Federal Home Loan Mortgage Corporation, Federal Farm Credit entities, and asset-backed securities and commercial mortgage obligations. Our equity securities include preferred stock of U.S. and Canadian corporations.

The average yield on our investment portfolio was 3.5% and 3.8% and the average duration of the portfolio was 5.8 and 4.6 years for the nine-months ended at September 30, 2013 and 2012, respectively.

For each year or shorter period specified below, the cost, fair value, and gross unrealized gains and losses on available-for-sale securities were as follows:

 

September 30, 2013 (amounts in thousands)

                          
     Cost or
Amortized
Cost
     Gross
Unrealized
Gains
     Gross
Unrealized
Losses
    Fair Value  

Preferred stock

   $ 5,000       $ —         ($ 622   $ 4,378   

Common stock

     4,808         —           (792     4,016   

U.S. Treasury and Federal agencies

     32,804         1,150         (2,014     31,940   

States and political subdivisions

     99,475         1,565         (2,399     98,641   

Residential mortgage-backed securities

     282,175         6,480         (3,708     284,947   

Corporate bonds

     460,361         19,845         (7,589     472,617   

Commercial mortgage-backed securities

     7,972         30         (143     7,859   
  

 

 

    

 

 

    

 

 

   

 

 

 

Total

   $ 892,595       $ 29,070       ($ 17,267   $ 904,398   
  

 

 

    

 

 

    

 

 

   

 

 

 

 

December 31, 2012 (amounts in thousands)

                          
     Cost or
Amortized

Cost
     Gross
Unrealized
Gains
     Gross
Unrealized
Losses
    Fair Value  

Preferred Stock

   $ 5,000       $ —         ($ 28   $ 4,972   

U.S. Treasury and Federal agencies

     22,976         10,139         (1     33,114   

States and political subdivisions

     85,259         1,870         (352     86,777   

Residential mortgage-backed securities

     158,031         7,062         (1,048     164,045   

Corporate bonds

     465,742         38,011         (949     502,804   

Commercial mortgage-backed securities

     11,398         74         —          11,472   
  

 

 

    

 

 

    

 

 

   

 

 

 

Total

   $ 748,406       $ 57,156       ($ 2,378   $ 803,184   
  

 

 

    

 

 

    

 

 

   

 

 

 

 

December 31, 2011 (amounts in thousands)

                          
     Cost or
Amortized

Cost
     Gross
Unrealized
Gains
     Gross
Unrealized
Losses
    Fair Value  

U.S. Treasury and Federal agencies

   $ 33,368       $ 8,208       ($ 370   $ 41,206   

States and political subdivisions

     92,374         1,789         (1,058     93,105   

Residential mortgage-backed securities

     263,029         9,938         (3,154     269,813   

Corporate bonds

     357,340         13,522         (8,622     362,240   

Commercial mortgage-backed securities

     19,879         1         (1     19,879   
  

 

 

    

 

 

    

 

 

   

 

 

 

Total

   $ 765,990       $ 33,458       ($ 13,205   $ 786,243   
  

 

 

    

 

 

    

 

 

   

 

 

 

The increase in gross unrealized losses from $2.4 million at December 31, 2012 to $16.5 million at September 30, 2013 resulted from fluctuations in market interest rates.

 

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The table below summarizes the credit quality of our fixed-maturity, preferred securities and short-term investments as of September 30, 2013, as rated by Standard and Poor’s.

 

(amounts in thousands)                     
    

Cost or Amortized

Cost

     Fair Value      Percentage of
Fixed-Maturity
and Preferred
Securities
 

U.S. Treasury

   $ 32,804       $ 31,940         3.5

AAA

     346,889         349,929         38.6   

AA

     105,094         105,315         11.6   

A

     144,334         154,756         17.1   

BBB, BBB+, BBB-

     224,305         225,511         24.9   

BB+ and lower

     40,390         38,691         4.3   

Total

   $ 893,546       $ 906,142         100.0

The table below summarizes the investment quality of our corporate bond holdings and industry concentrations as of September 30, 2013.

 

     AAA     AA+,
AA,
AA-
    A+,A,A-     BBB+,
BBB,
BBB-
    B+ or
Lower
    Fair
Value
($ in
Millions)
     % of
Corporate
Bonds
Portfolio
 

Corporate Bonds

               

Financial Institutions

     2.6 %      12.6 %      28.8 %      15.2 %      0.5 %      281.8         59.7

Industrials

     —       —   %      1.0 %      29.2 %      4.8 %      165.8         35.0

Utilities/Other

     —   %      —   %      —   %      3.3 %      2.0 %      25.0         5.3
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

    

 

 

 
     2.6 %      12.6 %      29.8 %      47.7 %      7.3 %      472.6         100.0
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

    

 

 

 

The amortized cost and fair value of available-for-sale debt securities held as of September 30, 2013, by contractual maturity, are shown in the table below. Actual maturities may differ from contractual maturities because some borrowers may have the right to call or prepay obligations with or without call or prepayment penalties.

 

September 30, 2013 (amounts in thousands)

             
     Cost or
Amortized Cost
     Fair Value  

Due in one year or less

   $ 16,860       $ 14,891   

Due after one year through five years

     80,167         83,800   

Due after five years through ten years

     408,637         418,764   

Due after ten years

     86,976         85,743   

Mortgage-backed securities

     290,147         292,806   
  

 

 

    

 

 

 

Total

   $ 882,787       $ 896,004   
  

 

 

    

 

 

 

 

 

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Gross Unrealized Losses. The tables below summarize the gross unrealized losses of fixed-maturity and equity securities by the length of time the security had continuously been in an unrealized loss position as of September 30, 2013, December 31, 2012 and December 31, 2011:

 

September 30, 2013 (amounts in thousands)

               
     Less Than 12 Months      12 Months or More      Total  
     Fair
Market
Value
     Unrealized
Losses
    No. of
Positions
Held
     Fair
Market
Value
     Unrealized
Losses
    No. of
Positions
Held
     Fair
Market
Value
     Unrealized
Losses
 

Preferred Stock

   $ 4,378       ($ 622     1       $ —         $ —          —         $ 4,378       ($ 622

Common stock

     4,016         (792     1         —           —          —           4,016         (792

U.S. Treasury and Federal agency

     10,887         (2,014     1         —           —          —           10,887         (2,014

States and political subdivisions

     48,911         (2,399     22         —           —          —           48,911         (2,399

Residential Mortgage-backed

     135,013         (3,708     4         —           —          —           135,013         (3,708

Corporate bonds

     131,298         (7,561     40         3,090         (28     1         134,388         (7,589

Commercial mortgage-backed

     4,800         (143     2         —           —          —           4,800         (143
  

 

 

    

 

 

   

 

 

    

 

 

    

 

 

   

 

 

    

 

 

    

 

 

 

Total

   $ 339,303       ($ 17,239     71       $ 3,090       ($ 28     1       $ 342,393       ($ 17,267
  

 

 

    

 

 

   

 

 

    

 

 

    

 

 

   

 

 

    

 

 

    

 

 

 

 

December 31, 2012 (amounts in thousands)

               
     Less Than 12 Months      12 Months or More      Total  
     Fair
Market
Value
     Unrealized
Losses
    No. of
Positions
Held
     Fair
Market
Value
     Unrealized
Losses
    No. of
Positions
Held
     Fair
Market
Value
     Unrealized
Losses
 

Preferred Stock

   $ 4,972       ($ 28     1       $ —         $ —          —         $ 4,972       ($ 28

U.S. Treasury and Federal agency

     574         (1     1         —           —          —           574         (1

States and political subdivisions

     28,948         (300     13         594         (52     1         29,542         (352

Residential Mortgage-backed

     25,143         (456     5         18,826         (592     4         43,969         (1,048

Corporate bonds

     89,886         (853     40         4,513         (96     4         94,399         (949
  

 

 

    

 

 

   

 

 

    

 

 

    

 

 

   

 

 

    

 

 

    

 

 

 

Total

   $ 149,523       ($ 1,638     60       $ 23,933       ($ 740     9       $ 173,456       ($ 2,378
  

 

 

    

 

 

   

 

 

    

 

 

    

 

 

   

 

 

    

 

 

    

 

 

 

 

December 31, 2011 (amounts in thousands)

               
     Less Than 12 Months      12 Months or More      Total  
     Fair
Market
Value
     Unrealized
Losses
    No. of
Positions
Held
     Fair
Market
Value
     Unrealized
Losses
    No. of
Positions
Held
     Fair
Market
Value
     Unrealized
Losses
 

U.S. Treasury and Federal agency

   $ 4,483       ($ 370     3       $ —         $ —          —         $ 4,483       ($ 370

States and political subdivisions

     11,680         (1,055     6         94         (3     1         11,774         (1,058

Residential Mortgage-backed

     130,684         (2,983     124         5,258         (171     1         135,942         (3,154

Commercial Mortgage- backed

     9,959         (1     1         —           —          —           9,959         (1

Corporate bonds

     106,840         (8,157     62         13,346         (465     3         120,186         (8,622
  

 

 

    

 

 

   

 

 

    

 

 

    

 

 

   

 

 

    

 

 

    

 

 

 

Total

   $ 263,646       ($ 12,566     196       $ 18,698       ($ 639     5       $ 282,344       ($ 13,205
  

 

 

    

 

 

   

 

 

    

 

 

    

 

 

   

 

 

    

 

 

    

 

 

 

There were 72, 69 and 201 positions at September 30, 2013, December 31, 2012 and December 31, 2011, respectively, that account for the gross unrealized loss, none of which we deemed to be OTTI. Significant factors influencing our determination that none of the securities were OTTI included the magnitude of unrealized losses in relation to cost, the nature of the investment and management’s intent not to sell these securities and our determination that it was more likely than not that we would not be required to sell these investments before anticipated recovery of fair value to our cost basis.

 

 

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Restricted Cash and Investments. In order to conduct business in certain states, we are required to maintain letters of credit or assets on deposit to support state-mandated insurance regulatory requirements and certain third party agreements. We also utilize trust accounts to collateralize business with our reinsurance counterparties, both for business we assume and for business assumed by our reinsurance counterparties. Assets held on deposit or in trust accounts are primarily in the form of cash or certain high-grade securities. The fair values of our restricted assets as of September 30, 2013, December 31, 2012 and 2011 are as follows:

 

(amounts in thousands)                     
     As of September 30,      As of December 31,  
     2013      2012      2011  

Restricted cash

   $ 2,676       $ 8,509       $ 1,237   

Restricted investments—fixed-maturity securities

     38,649         34,081         40,186   
  

 

 

    

 

 

    

 

 

 

Total restricted cash and investments

   $ 41,325       $ 42,590       $ 41,423   
  

 

 

    

 

 

    

 

 

 

Other. We enter into reverse repurchase and repurchase agreements, which are accounted for as either collateralized lending or borrowing transactions and are recorded at contract amounts which approximate fair value. For the collateralized borrowing transactions (i.e., repurchase agreements), we receive cash or securities that we invest or hold in short-term or fixed-income securities. As of September 30, 2013, we had collateralized borrowing transaction principal outstanding of $28.3 million at interest rates between 0.17% and 0.19%. As of December 31, 2012, we had collateralized borrowing transaction principal outstanding of $86.7 million at interest rates between 0.42% and 0.50%. Interest expense associated with the repurchase borrowing agreements for the nine months ended September 30, 2013 and 2012 was $238,000 and $322,000, respectively. We had approximately $31.4 million and $95.4 million of collateral pledged in support for these agreements as of September 30, 2013 and December 31, 2012,

respectively. As of September 30, 2013 and December 31, 2012, we had collateralized lending transaction principal of $0 and $57.0 million at an interest rate of 0% and 0.03%, which is reflected as short-term investments in our condensed consolidated balance sheets. Interest income associated with the lending agreements for the three and nine months ended September 30, 2013 was $0 and $61,000. We held collateral with a fair market value of approximately $0 and $56.7 million in support of this agreement as of September 30, 2013 and December 31, 2012.

Fair value of financial instruments. ASC 820, “Fair Value Measurements and Disclosures”, provides a definition of fair value, establishes a framework for measuring fair value, and requires expanded disclosures about fair value measurements. The standard applies when GAAP requires or allows assets or liabilities to be measured at fair value; therefore, it does not expand the use of fair value in any new circumstance.

In accordance with ASC 820, assets and liabilities measured at fair value on a recurring basis are as follows:

 

September 30, 2013 (amounts in thousands)

                           
     Recurring Fair Value Measures         
     Level 1      Level 2      Level 3      Total  

Assets

           

Preferred stock

   $ —         $ 4,378       $ —         $ 4,378   

Common stock

     4.016         —           —           4,016   

U.S. Treasury and Federal agency

     31,940         —           —