Document

UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
 
FORM 10-Q
 

(Mark One)
x
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the Quarterly Period Ended March 31, 2018

OR
o
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the Transition Period from to
Commission File Number: 001-36311
 

NATIONAL GENERAL HOLDINGS CORP.
(Exact Name of Registrant as Specified in Its Charter)

Delaware
 
27-1046208
(State or Other Jurisdiction of
Incorporation or Organization)
 
(I.R.S. Employer
Identification No.)

59 Maiden Lane, 38th Floor
New York, New York
 
10038
(Address of Principal Executive Offices)
 
(Zip Code)
(212) 380-9500
(Registrant’s Telephone Number, Including Area Code)

Indicate by check mark whether the registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes x No o

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes x No o

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

If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. o

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes o No x

As of May 3, 2018, the number of common shares of the registrant outstanding was 106,923,327.





NATIONAL GENERAL HOLDINGS CORP.

TABLE OF CONTENTS


 
 
Page
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 



i


PART I - FINANCIAL INFORMATION


Item 1. Financial Statements

NATIONAL GENERAL HOLDINGS CORP.
CONDENSED CONSOLIDATED BALANCE SHEETS
(In Thousands, Except Shares and Par Value per Share)
(Unaudited)
 
 
 
 
 
March 31,
 
December 31,
 
2018
 
2017
ASSETS
 
 
 
Investments:
 
 
 
Debt securities, available-for-sale, at fair value (Exchanges - $310,740 and $304,934)
$
3,244,320

 
$
3,139,889

Equity securities, at fair value
50,157

 
50,341

Short-term investments (Exchanges - $21,825 and $22,279)
39,969

 
38,266

Other investments (related parties - $241,801 and $347,548)
315,870

 
421,292

Total investments
3,650,316

 
3,649,788

Cash and cash equivalents (Exchanges - $5,880 and $5,442)
321,937

 
292,282

Restricted cash and cash equivalents (Exchanges - $674 and $609)
56,116

 
65,202

Accrued investment income (related parties - $1,174 and $2,334)
(Exchanges - $2,229 and $1,805)
23,091

 
22,372

Premiums and other receivables, net (Exchanges - $49,581 and $56,792)
1,497,871

 
1,324,321

Deferred acquisition costs (Exchanges - $21,635 and $20,837)
233,600

 
216,389

Reinsurance recoverable (related parties - $11,399 and $15,688)
(Exchanges - $107,250 and $94,204)
1,334,726

 
1,294,165

Prepaid reinsurance premiums (Exchanges - $97,248 and $100,980)
528,770

 
517,122

Premises and equipment, net (Exchanges - $3,527 and $4,269)
316,392

 
324,049

Intangible assets, net (Exchanges - $3,640 and $3,685)
397,406

 
404,070

Goodwill
174,153

 
174,153

Prepaid and other assets (Exchanges - $2,318 and $2,263)
134,768

 
155,830

Total assets
$
8,669,146

 
$
8,439,743

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 

See accompanying notes to unaudited condensed consolidated financial statements.
1


NATIONAL GENERAL HOLDINGS CORP.
CONDENSED CONSOLIDATED BALANCE SHEETS
(In Thousands, Except Shares and Par Value per Share)
(Unaudited)
 
 
 
 
 
March 31,
 
December 31,
 
2018
 
2017
LIABILITIES AND STOCKHOLDERS’ EQUITY
 
 
 
Liabilities:
 
 
 
Unpaid loss and loss adjustment expense reserves (Exchanges - $158,796 and $143,353)
$
2,678,917

 
$
2,663,557

Unearned premiums and other revenue (Exchanges - $228,198 and $225,395)
2,230,544

 
2,032,605

Reinsurance payable (Exchanges - $58,554 and $68,275)
437,071

 
398,047

Accounts payable and accrued expenses (related parties - $72,641 and $140,057)
(Exchanges - $10,140 and $8,827)
411,547

 
431,881

Debt
713,893

 
713,710

Other liabilities (Exchanges - $55,513 and $41,582)
232,521

 
246,518

Total liabilities
$
6,704,493

 
$
6,486,318

 
 
 
 
Stockholders’ equity:
 
 
 
Common stock, $0.01 par value - authorized 150,000,000 shares, issued and outstanding 106,887,566 shares - 2018; authorized 150,000,000 shares, issued and outstanding 106,697,648 shares - 2017.
$
1,069

 
$
1,067

Preferred stock, $0.01 par value - authorized 10,000,000 shares, issued and outstanding 2,565,000 shares - 2018; authorized 10,000,000 shares, issued and outstanding 2,565,000 shares - 2017.
Aggregate liquidation preference $420,000 - 2018, $420,000 - 2017.
420,000

 
420,000

Additional paid-in capital
919,029

 
917,751

Accumulated other comprehensive income:
 
 
 
Unrealized foreign currency translation adjustment, net of tax
(8,529
)
 
(7,810
)
Unrealized losses on investments, net of tax
(37,193
)
 
(302
)
Total accumulated other comprehensive income (loss)
(45,722
)
 
(8,112
)
Retained earnings
662,713

 
597,863

Total National General Holdings Corp. Stockholders’ Equity
1,957,089

 
1,928,569

Non-controlling interest
7,564

 
24,856

Total stockholders’ equity
$
1,964,653

 
$
1,953,425

Total liabilities and stockholders’ equity
$
8,669,146

 
$
8,439,743




See accompanying notes to unaudited condensed consolidated financial statements.
2


NATONAL GENERAL HOLDINGS CORP.
CONDENSED CONSOLIDATED STATEMENTS OF INCOME
(In Thousands, Except Shares and Per Share Data)
(Unaudited)

 
 
 
 
 
Three Months Ended March 31,
 
2018
 
2017
Revenues:
 
 
 
Net earned premium
$
905,538

 
$
918,485

Ceding commission income
44,468

 
19,994

Service and fee income
142,122

 
125,942

Net investment income
25,011

 
29,044

Net gain (loss) on investments
118

 
(1,412
)
Other income
—

 
9,801

Total revenues
1,117,257

 
1,101,854

Expenses:
 
 
 
Loss and loss adjustment expense
634,166

 
618,817

Acquisition costs and other underwriting expenses
168,710

 
174,720

General and administrative expenses
231,005

 
255,185

Interest expense
11,154

 
11,545

Total expenses
1,045,035

 
1,060,267

Income before provision for income taxes
72,222

 
41,587

Provision for income taxes
16,202

 
10,789

Net income
56,020

 
30,798

Net (income) loss attributable to non-controlling interest
12,188

 
6,125

Net income attributable to NGHC
68,208

 
36,923

Dividends on preferred stock
(7,875
)
 
(7,875
)
Net income attributable to NGHC common stockholders
$
60,333

 
$
29,048

 
 
 
 
Earnings per common share:
 
 
 
Basic
$
0.57

 
$
0.27

Diluted
$
0.55

 
$
0.27

Dividends declared per common share
$
0.04

 
$
0.04

 
 
 
 
Weighted average common shares outstanding:
 
 
 
Basic
106,758,641

 
106,467,599

Diluted
108,950,984

 
109,166,681


See accompanying notes to unaudited condensed consolidated financial statements.
3


NATIONAL GENERAL HOLDINGS CORP.
CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
(In Thousands)
(Unaudited)

 
 
Three Months Ended March 31,
 
 
2018
 
2017
Net income
 
$
56,020

 
$
30,798

Other comprehensive income, net of tax:
 
 
 
 
Foreign currency translation adjustment, net of tax (tax - $(188) and $(385))
 
(719
)
 
(714
)
Gross gain (loss) on investments, net of tax (tax - $(11,173) and $6,616)
 
(42,033
)
 
12,286

Reclassification adjustments for investment gain/loss included in net income:
 
 
 
 
Other (gain) loss on investments, net of tax (tax - $0 and $(1,260))
 
2

 
(2,341
)
Other comprehensive income (loss), net of tax
 
(42,750
)
 
9,231

Comprehensive income
 
13,270

 
40,029

Comprehensive (income) loss attributable to non-controlling interest
 
17,292

 
5,299

Comprehensive income attributable to NGHC
 
$
30,562

 
$
45,328




See accompanying notes to unaudited condensed consolidated financial statements.
4


NATIONAL GENERAL HOLDINGS CORP.
CONDENSED CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS’ EQUITY
(In Thousands, Except Shares)
(Unaudited)

 
Three Months Ended March 31, 2018
 
Common Stock
 
Preferred Stock
 
 
 
 
 
 
 
 
 
 
 
Shares
 
$
 
Shares
 
$
 
Additional Paid-in Capital
 
Accumulated Other Comprehensive Income (Loss)
 
Retained Earnings
 
Non-controlling Interest
 
Total
Balance January 1, 2018
106,697,648

 
$
1,067

 
2,565,000

 
$
420,000

 
$
917,751

 
$
(8,112
)
 
$
597,863

 
$
24,856

 
$
1,953,425

Cumulative-effect adjustment of change in accounting principles
—

 
—

 
—

 
—

 
—

 
36

 
8,794

 
—

 
8,830

Net income (loss)
—

 
—

 
—

 
—

 
—

 
—

 
68,208

 
(12,188
)
 
56,020

Foreign currency translation adjustment, net of tax
—

 
—

 
—

 
—

 
—

 
(719
)
 
—

 
—

 
(719
)
Change in unrealized loss on investments, net of tax
—

 
—

 
—

 
—

 
—

 
(36,927
)
 
—

 
(5,104
)
 
(42,031
)
Common stock dividends
—

 
—

 
—

 
—

 
—

 
—

 
(4,277
)
 
—

 
(4,277
)
Preferred stock dividends
—

 
—

 
—

 
—

 
—

 
—

 
(7,875
)
 
—

 
(7,875
)
Common stock issued under employee stock plans and exercises of stock options
251,491

 
2

 
—

 
—

 
490

 
—

 
—

 
—

 
492

Shares withheld related to net share settlement
(61,573
)
 
—

 
—

 
—

 
(1,342
)
 
—

 
—

 
—

 
(1,342
)
Stock-based compensation
—

 
—

 
—

 
—

 
2,130

 
—

 
—

 
—

 
2,130

Balance March 31, 2018
106,887,566

 
$
1,069

 
2,565,000

 
$
420,000

 
$
919,029

 
$
(45,722
)
 
$
662,713

 
$
7,564

 
$
1,964,653


 
Three Months Ended March 31, 2017
 
Common Stock
 
Preferred Stock
 
 
 
 
 
 
 
 
 
 
 
Shares
 
$
 
Shares
 
$
 
Additional Paid-in Capital
 
Accumulated Other Comprehensive Income
 
Retained Earnings
 
Non-controlling Interest
 
Total
Balance January 1, 2017
106,428,092

 
$
1,064

 
2,565,000

 
$
420,000

 
$
913,787

 
$
11,475

 
$
539,114

 
$
31,918

 
$
1,917,358

Net income (loss)
—

 
—

 
—

 
—

 
—

 
—

 
36,923

 
(6,125
)
 
30,798

Foreign currency translation adjustment, net of tax
—

 
—

 
—

 
—

 
—

 
(714
)
 
—

 
—

 
(714
)
Change in unrealized gain on investments, net of tax
—

 
—

 
—

 
—

 
—

 
9,119

 
—

 
826

 
9,945

Common stock dividends
—

 
—

 
—

 
—

 
—

 
—

 
(4,260
)
 
—

 
(4,260
)
Preferred stock dividends
—

 
—

 
—

 
—

 
—

 
—

 
(7,875
)
 
—

 
(7,875
)
Common stock issued under employee stock plans and exercises of stock options
107,141

 
1

 
—

 
—

 
171

 
—

 
—

 
—

 
172

Shares withheld related to net share settlement
(32,983
)
 
—

 
—

 
—

 
(834
)
 
—

 
—

 
—

 
(834
)
Stock-based compensation
—

 
—

 
—

 
—

 
2,180

 
—

 
—

 
—

 
2,180

Balance March 31, 2017
106,502,250

 
$
1,065

 
2,565,000

 
$
420,000

 
$
915,304

 
$
19,880

 
$
563,902

 
$
26,619

 
$
1,946,770




See accompanying notes to unaudited condensed consolidated financial statements.
5


NATIONAL GENERAL HOLDINGS CORP.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(In Thousands)
(Unaudited)
 
 
 
 
 
Three Months Ended March 31,
 
2018
 
2017
Cash flows from operating activities:
 
 
 
Net income
$
56,020

 
$
30,798

Reconciliation of net income to net cash provided by (used in) operating activities:
 
 
 
Net (gain) loss on investments
(118
)
 
1,412

Bad debt expense
20,184

 
15,545

Depreciation and amortization
20,141

 
35,273

Stock-compensation expense
2,130

 
2,180

Deferred income taxes
(4,512
)
 
(18,928
)
Other, net
(2,576
)
 
(7,687
)
Changes in assets and liabilities:
 
 
 
Accrued investment income
(1,082
)
 
(1,306
)
Premiums and other receivables
(200,150
)
 
(319,067
)
Deferred acquisition costs
(20,755
)
 
(21,790
)
Reinsurance recoverable
(40,537
)
 
(20,087
)
Prepaid reinsurance premiums
(11,648
)
 
(13,002
)
Prepaid expenses and other assets
38,712

 
(5,801
)
Unpaid loss and loss adjustment expense reserves
17,044

 
4,582

Unearned premiums and other revenue
213,465

 
231,123

Reinsurance payable
39,036

 
35,661

Accounts payable
(52,811
)
 
118,396

Other liabilities
(20,601
)
 
70,839

Net cash provided by operating activities
$
51,942

 
$
138,141

Cash flows from investing activities:
 
 
 
Purchases of debt securities, available-for-sale
$
(310,241
)
 
$
(82,163
)
Proceeds from sale and maturity of debt securities, available-for-sale
193,733

 
41,469

Purchases of equity securities
—

 
(23,433
)
Proceeds from sale of equity securities
—

 
23,778

Purchases of debt securities, trading
—

 
(78,340
)
Proceeds from sale and maturity of debt securities, trading
—

 
52,810

Purchases of short-term investments
(906,325
)
 
(231,502
)
Proceeds from sale of short-term investments
904,788

 
194,061

Purchases of other investments
(2,979
)
 
(21,203
)
Proceeds from sale and return of other investments
109,793

 
2,741

Purchases of premises and equipment
(5,716
)
 
(17,704
)
Acquisition of consolidated subsidiaries, net of cash
—

 
(16,968
)
Net cash used in investing activities
$
(16,947
)
 
$
(156,454
)
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 

See accompanying notes to unaudited condensed consolidated financial statements.
6


NATIONAL GENERAL HOLDINGS CORP.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(In Thousands)
(Unaudited)
 
 
 
 
 
Three Months Ended March 31,
 
2018
 
2017
Cash flows from financing activities:
 
 
 
Dividends paid to common shareholders
$
(4,268
)
 
$
(4,257
)
Dividends paid to preferred shareholders
(7,875
)
 
(7,875
)
Taxes paid related to net share settlement of equity awards
(1,342
)
 
(834
)
Other financing activities, net
492

 
128

Net cash used in financing activities
$
(12,993
)
 
$
(12,838
)
Effect of exchange rate changes on cash and cash equivalents
$
(1,433
)
 
$
246

Net increase (decrease) in cash, cash equivalents, and restricted cash
20,569

 
(30,905
)
Cash, cash equivalents, and restricted cash at beginning of the period
357,484

 
285,900

Cash, cash equivalents, and restricted cash at end of the period
$
378,053

 
$
254,995

 
 
 
 
Supplemental disclosures of non-cash investing and financing activities:
 
 
 
Unsettled securities purchases
$
27,598

 
$
106,858

Unsettled securities sales
10,962

 
82,173

Accrued common stock dividends
4,277

 
4,260

Accrued preferred stock dividends
7,875

 
7,875


See accompanying notes to unaudited condensed consolidated financial statements.
7

NATIONAL GENERAL HOLDINGS CORP.
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(In Thousands, Except Shares and Per Share Data)


1. Basis of Reporting

The accompanying unaudited interim condensed consolidated financial statements include the accounts of National General Holdings Corp. and its subsidiaries (the “Company” or “NGHC”) and have been prepared in accordance with accounting principles generally accepted in the United States (“GAAP”) for interim financial statements and with the instructions to Form 10-Q and Article 10 of Regulation S-X as promulgated by the U.S. Securities and Exchange Commission (the “SEC”). Accordingly, they do not include all of the information and footnotes required by GAAP for complete financial statements. These interim condensed consolidated financial statements should be read in conjunction with the financial statements and notes thereto included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2017 previously filed with the SEC on February 26, 2018. The balance sheet at December 31, 2017, has been derived from the audited consolidated financial statements at that date. The interim condensed consolidated financial statements as of and for the three months ended March 31, 2017 have been adjusted from the information set forth in the Form 10-Q for the quarterly period ended March 31, 2017. See Note 3, “Revisions of Previously Issued Financial Statements” in the Company’s 2017 Form 10-K.

These interim condensed consolidated financial statements reflect all adjustments that are, in the opinion of management, necessary for a fair presentation of the results for the interim period and all such adjustments are of a normal recurring nature. The results of operations for the interim period are not necessarily indicative, if annualized, of those to be expected for the full year. The preparation of financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the amounts reported in the condensed consolidated financial statements and accompanying notes. Actual results could differ from those estimates.

The unaudited condensed consolidated financial statements include the accounts and operations of Adirondack Insurance Exchange, a New York reciprocal insurer, and New Jersey Skylands Insurance Association, a New Jersey reciprocal insurer (together with their subsidiaries, the “Exchanges” or “Reciprocal Exchanges”). The Company has no ownership interest in the Reciprocal Exchanges but manages their business operations and has the ability to direct their activities through its wholly-owned management companies. The Reciprocal Exchanges are property and casualty insurers.

To conform to the current-year quarter presentation, the Company reclassified earnings (losses) of equity method investments with related parties as a component of net investment income on its condensed consolidated statements of income.

A detailed description of the Company’s significant accounting policies and management judgments is located in the notes to the audited consolidated financial statements, included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2017, filed with the SEC.



8

NATIONAL GENERAL HOLDINGS CORP.
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(In Thousands, Except Shares and Per Share Data)

2. Recent Accounting Pronouncements

Adopted During 2018

In May 2014, the FASB issued ASU 2014-09, “Revenue from Contracts with Customers,” to remove inconsistencies and weaknesses in revenue requirements, provide a more robust framework for addressing revenue issues, improve comparability of revenue recognition practices, and provide improved disclosure requirements. While the guidance excludes revenue from insurance contracts, investments and financial instruments from its scope, the guidance is applicable to the Company’s service and fee income not specifically exempted from the guidance. The Company adopted ASU 2014-09 effective January 1, 2018, using the modified retrospective method and recorded a cumulative-effect adjustment to the opening balance sheet, increasing retained earnings by $8,830. See Note 3, “Service and Fee Income” for additional information.

In January 2016, the FASB issued ASU 2016-01, “Financial Instruments-Overall (Subtopic 825-10): Recognition and Measurement of Financial Assets and Financial Liabilities” to provide users of financial statements with more useful information on the recognition, measurement, presentation, and disclosure of financial instruments. Specifically, under ASU 2016-01, equity investments (other than those accounted for using the equity method of accounting or those subject to consolidation) are to be measured at fair value with changes in fair value recognized in earnings. The Company adopted ASU 2016-01 effective January 1, 2018, and recorded a cumulative-effect adjustment to the opening balance sheet, increasing Accumulated Other Comprehensive Income (“AOCI”) by $36 and decreasing retained earnings by the same amount. To conform to the current-year quarter presentation, equity securities are presented in a single line in the Company’s condensed consolidated balance sheets and statements of cash flows.

In October 2016, the FASB issued ASU 2016-16 “Income Taxes (Topic 740): Intra-Entity Transfers of Assets Other Than Inventory,” which requires an entity to recognize the income tax consequences of an intra-entity transfer of an asset other than inventory when the transfer occurs. The Company adopted ASU 2016-16 effective January 1, 2018. Based on the intra-entity transfers of assets executed by the Company, the adoption of this guidance did not have an effect on the Company’s results of operations, financial position or liquidity.

Not Yet Adopted

With the exception of those adopted above or discussed below, there have been no recent accounting pronouncements, changes in accounting pronouncements, or quantitative or qualitative progress made towards implementation of outstanding accounting pronouncements during the three months ended March 31, 2018, as compared to those described in the Company’s Annual Report on Form 10-K for the year ended December 31, 2017, that are of significance, or potential significance, to the Company.

In February 2016, the FASB issued ASU 2016-02, “Leases (Topic 842)” to increase transparency and comparability among organizations by recognizing lease assets and lease liabilities on the balance sheet and disclosing key information about leasing arrangements. The new standard establishes a right-of-use (ROU) model that requires a lessee to record a ROU asset and a lease liability on the balance sheet for all leases with terms longer than 12 months. Leases will be classified as either finance or operating, with classification affecting the pattern of expense recognition in the income statement. The new standard is effective for fiscal years beginning after December 15, 2018. A modified retrospective transition approach is required for lessees for capital and operating leases existing at, or entered into after, the beginning of the earliest comparative period presented in the financial statements, with certain practical expedients available. The Company is in the early stages of evaluating the impact this guidance will have on its results of operations, financial position or liquidity and disclosures. The Company expects the adoption will have a significant impact on its consolidated financial statements, primarily to the consolidated balance sheets by recognizing a right-of-use asset and corresponding lease liability and related disclosures, due to the addition of operating leases previously accounted for as off-balance sheet transactions. The Company is currently unable to quantify the impact of adopting this guidance.



9

NATIONAL GENERAL HOLDINGS CORP.
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(In Thousands, Except Shares and Per Share Data)

3. Service and Fee Income

On January 1, 2018, the Company adopted ASU 2014-09 and all the related amendments (“ASC 606”) for in scope contracts with customers using the modified retrospective method. Financial statements presented prior to the adoption of ASC 606 are reported under the previous guidance of ASC 605, “Revenue Recognition.” ASC 606 is applicable to the Company’s service and fee income, primarily related to the recognition of commission revenue in the Accident and Health segment.

Disaggregation of Revenue by Type and Operating Segment

The following table summarizes revenue by type and operating segment within service and fee income:
 
 
Three Months Ended March 31,
 
 
2018
 
2017
 
 
Property
and
Casualty
 
Accident
and
Health (1)
 
Total
 
Property
and
Casualty
 
Accident
and
Health
 
Total
Commission revenue
 
$
21,709

 
$
17,524

 
$
39,233

 
$
29,745

 
$
10,669

 
$
40,414

Finance and processing fees
 
32,060

 
1,255

 
33,315

 
23,600

 
2,484

 
26,084

Installment fees
 
21,302

 
—

 
21,302

 
18,502

 
—

 
18,502

Group health administrative fees
 
—

 
19,291

 
19,291

 
—

 
14,561

 
14,561

Late payment fees
 
7,558

 
25

 
7,583

 
7,600

 
31

 
7,631

Other service and fee income
 
14,306

 
7,092

 
21,398

 
14,222

 
4,528

 
18,750

Total
 
$
96,935

 
$
45,187

 
$
142,122

 
$
93,669

 
$
32,273

 
$
125,942

NGHC
 
$
94,489

 
$
45,187

 
$
139,676

 
$
91,589

 
$
32,273

 
$
123,862

Reciprocal Exchanges
 
2,446

 
—

 
2,446

 
2,080

 
—

 
2,080

Total
 
$
96,935

 
$
45,187

 
$
142,122

 
$
93,669

 
$
32,273

 
$
125,942

(1) The impact to commission revenue for the three months ended March 31, 2018 was an increase of $2,501 as a result of applying ASC 606. Prior period amounts have not been adjusted under the modified retrospective method.



10

NATIONAL GENERAL HOLDINGS CORP.
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(In Thousands, Except Shares and Per Share Data)

4. Investments

(a) Available-For-Sale Debt Securities

The amortized cost, gross unrealized gains and losses, and fair value on available-for-sale debt securities were as follows:
March 31, 2018
 
Amortized Cost
 
Gross
Unrealized Gains
 
Gross
Unrealized Losses
 
Fair Value
U.S. Treasury
 
$
35,830

 
$
860

 
$
(372
)
 
$
36,318

Federal agencies
 
25,711

 
—

 
(371
)
 
25,340

States and political subdivision bonds
 
384,342

 
1,510

 
(7,595
)
 
378,257

Foreign government
 
87,393

 
1,714

 
(28
)
 
89,079

Corporate bonds
 
1,118,188

 
3,525

 
(22,890
)
 
1,098,823

Residential mortgage-backed securities
 
1,052,632

 
566

 
(27,207
)
 
1,025,991

Commercial mortgage-backed securities
 
229,624

 
593

 
(6,741
)
 
223,476

Asset-backed securities
 
5,605

 
236

 
(103
)
 
5,738

Structured securities
 
358,518

 
3,308

 
(528
)
 
361,298

Total
 
$
3,297,843

 
$
12,312

 
$
(65,835
)
 
$
3,244,320

NGHC
 
$
2,981,076

 
$
11,504

 
$
(59,000
)
 
$
2,933,580

Reciprocal Exchanges
 
316,767

 
808

 
(6,835
)
 
310,740

Total
 
$
3,297,843

 
$
12,312

 
$
(65,835
)
 
$
3,244,320

December 31, 2017
 
Amortized Cost
 
Gross
Unrealized Gains
 
Gross
Unrealized Losses
 
Fair Value
U.S. Treasury
 
$
36,236

 
$
987

 
$
(230
)
 
$
36,993

Federal agencies
 
20,711

 
5

 
(27
)
 
20,689

States and political subdivision bonds
 
418,557

 
4,431

 
(3,907
)
 
419,081

Foreign government
 
55,575

 
2,736

 
(57
)
 
58,254

Corporate bonds
 
1,053,777

 
14,809

 
(7,697
)
 
1,060,889

Residential mortgage-backed securities
 
1,020,481

 
211

 
(15,953
)
 
1,004,739

Commercial mortgage-backed securities
 
143,519

 
2,340

 
(1,816
)
 
144,043

Asset-backed securities
 
421

 
—

 
(7
)
 
414

Structured securities
 
390,514

 
4,959

 
(686
)
 
394,787

Total
 
$
3,139,791

 
$
30,478

 
$
(30,380
)
 
$
3,139,889

NGHC
 
$
2,835,293

 
$
27,117

 
$
(27,455
)
 
$
2,834,955

Reciprocal Exchanges
 
304,498

 
3,361

 
(2,925
)
 
304,934

Total
 
$
3,139,791

 
$
30,478

 
$
(30,380
)
 
$
3,139,889


As of March 31, 2018 and December 31, 2017, the Company had no other-than-temporary impairments (“OTTI”) in AOCI related to available-for-sale debt securities.


11

NATIONAL GENERAL HOLDINGS CORP.
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(In Thousands, Except Shares and Per Share Data)

The amortized cost and fair value of available-for-sale debt securities held as of March 31, 2018, 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.
 
 
NGHC
 
Reciprocal Exchanges
 
Total
March 31, 2018
 
Amortized
Cost
 
Fair
Value
 
Amortized
Cost
 
Fair
Value
 
Amortized
Cost
 
Fair
Value
Due in one year or less
 
$
32,184

 
$
31,994

 
$
5,149

 
$
5,182

 
$
37,333

 
$
37,176

Due after one year through five years
 
574,994

 
568,786

 
150,573

 
146,766

 
725,567

 
715,552

Due after five years through ten years
 
868,737

 
856,975

 
66,330

 
65,344

 
935,067

 
922,319

Due after ten years
 
297,644

 
299,553

 
14,371

 
14,515

 
312,015

 
314,068

Mortgage-backed securities
 
1,207,517

 
1,176,272

 
80,344

 
78,933

 
1,287,861

 
1,255,205

Total
 
$
2,981,076

 
$
2,933,580

 
$
316,767

 
$
310,740

 
$
3,297,843

 
$
3,244,320


(b) Gross Unrealized Losses

The tables below summarize the gross unrealized losses on debt securities classified as available for sale, by length of time the security has continuously been in an unrealized loss position.
 
 
Less Than 12 Months
 
12 Months or More
 
Total
March 31, 2018
 
Fair
Value
 
Unrealized
Losses
 
No. of
Positions
Held
 
Fair
Value
 
Unrealized
Losses
 
No. of
Positions
Held
 
Fair
Value
 
Unrealized
Losses
U.S. Treasury
 
$
20,464

 
$
(270
)
 
131

 
$
11,543

 
$
(102
)
 
134

 
$
32,007

 
$
(372
)
Federal agencies
 
24,738

 
(343
)
 
15

 
602

 
(28
)
 
4

 
25,340

 
(371
)
States and political subdivision bonds
 
192,758

 
(4,198
)
 
302

 
82,744

 
(3,397
)
 
119

 
275,502

 
(7,595
)
Foreign government
 
21,588

 
(28
)
 
2

 
—

 
—

 
—

 
21,588

 
(28
)
Corporate bonds
 
726,521

 
(17,230
)
 
738

 
109,865

 
(5,660
)
 
96

 
836,386

 
(22,890
)
Residential mortgage-backed securities
 
890,769

 
(22,670
)
 
99

 
84,388

 
(4,537
)
 
7

 
975,157

 
(27,207
)
Commercial mortgage-backed securities
 
164,033

 
(5,987
)
 
17

 
12,360

 
(754
)
 
14

 
176,393

 
(6,741
)
Asset-backed securities
 
318

 
(47
)
 
1

 
1,585

 
(56
)
 
7

 
1,903

 
(103
)
Structured securities
 
52,459

 
(399
)
 
34

 
6,022

 
(129
)
 
3

 
58,481

 
(528
)
Total
 
$
2,093,648

 
$
(51,172
)
 
1,339

 
$
309,109

 
$
(14,663
)
 
384

 
$
2,402,757

 
$
(65,835
)
NGHC
 
$
1,857,583

 
$
(45,042
)
 
1,203

 
$
292,084

 
$
(13,958
)
 
375

 
$
2,149,667

 
$
(59,000
)
Reciprocal Exchanges
 
236,065

 
(6,130
)
 
136

 
17,025

 
(705
)
 
9

 
253,090

 
(6,835
)
Total
 
$
2,093,648

 
$
(51,172
)
 
1,339

 
$
309,109

 
$
(14,663
)
 
384

 
$
2,402,757

 
$
(65,835
)

12

NATIONAL GENERAL HOLDINGS CORP.
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(In Thousands, Except Shares and Per Share Data)

 
 
Less Than 12 Months
 
12 Months or More
 
Total
December 31, 2017
 
Fair
Value
 
Unrealized
Losses
 
No. of
Positions
Held
 
Fair
Value
 
Unrealized
Losses
 
No. of
Positions
Held
 
Fair
Value
 
Unrealized
Losses
U.S. Treasury
 
$
21,567

 
$
(131
)
 
62

 
$
10,555

 
$
(99
)
 
20

 
$
32,122

 
$
(230
)
Federal agencies
 
10,069

 
(11
)
 
6

 
615

 
(16
)
 
4

 
10,684

 
(27
)
States and political subdivision bonds
 
145,396

 
(1,851
)
 
215

 
86,894

 
(2,056
)
 
125

 
232,290

 
(3,907
)
Foreign government
 
—

 
—

 
—

 
2,443

 
(57
)
 
2

 
2,443

 
(57
)
Corporate bonds
 
402,236

 
(4,564
)
 
341

 
110,207

 
(3,133
)
 
93

 
512,443

 
(7,697
)
Residential mortgage-backed securities
 
886,032

 
(13,476
)
 
72

 
89,412

 
(2,477
)
 
9

 
975,444

 
(15,953
)
Commercial mortgage-backed securities
 
50,537

 
(727
)
 
14

 
27,072

 
(1,089
)
 
27

 
77,609

 
(1,816
)
Asset-backed securities
 
—

 
—

 
—

 
414

 
(7
)
 
2

 
414

 
(7
)
Structured securities
 
73,561

 
(631
)
 
18

 
3,727

 
(55
)
 
4

 
77,288

 
(686
)
Total
 
$
1,589,398

 
$
(21,391
)
 
728

 
$
331,339

 
$
(8,989
)
 
286

 
$
1,920,737

 
$
(30,380
)
NGHC
 
$
1,408,081

 
$
(19,254
)
 
623

 
$
300,732

 
$
(8,201
)
 
268

 
$
1,708,813

 
$
(27,455
)
Reciprocal Exchanges
 
181,317

 
(2,137
)
 
105

 
30,607

 
(788
)
 
18

 
211,924

 
(2,925
)
Total
 
$
1,589,398

 
$
(21,391
)
 
728

 
$
331,339

 
$
(8,989
)
 
286

 
$
1,920,737

 
$
(30,380
)

There were 1,723 and 1,014 securities at March 31, 2018 and December 31, 2017, respectively, that account for the gross unrealized loss, none of which are deemed by the Company to be other-than-temporary impairments. Significant factors influencing the Company’s determination that none of these securities were OTTI included the length of time and/or magnitude of unrealized losses in relation to cost, the nature of the investment, the current financial condition of the issuer and its future prospects, the ability to recover to cost in the near term, and management’s intent not to sell these securities and it being more likely than not that the Company will not be required to sell these investments before anticipated recovery of fair value to the Company’s cost basis.

As of March 31, 2018 and December 31, 2017, of the $14,663 and $8,989, respectively, of unrealized losses in unrealized loss positions for a period of twelve or more consecutive months, none of those were greater than or equal to 25% of its amortized cost.

The Company regularly monitors its investments that have fair values less than cost or amortized cost for indicators of other-than-temporary impairment, an assessment that requires significant management judgment regarding the evidence known. Such judgments could change in the future as more information becomes known, which could negatively impact the amounts reported.

(c) Equity Securities

The fair values on equity securities were as follows:
 
 
March 31, 2018
 
December 31, 2017
Common stock
 
$
47,993

 
$
48,119

Preferred stock
 
2,164

 
2,222

Total
 
$
50,157

 
$
50,341

NGHC
 
$
50,157

 
$
50,341

Reciprocal Exchanges
 
—

 
—

Total
 
$
50,157

 
$
50,341



13

NATIONAL GENERAL HOLDINGS CORP.
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(In Thousands, Except Shares and Per Share Data)

(d) Investment Income

The components of net investment income consisted of the following:
 
 
Three Months Ended March 31,
 
 
2018
 
2017
Cash and short-term investments
 
$
187

 
$
34

Debt securities
 
24,256

 
26,818

Equity securities
 
155

 
75

Other income, net (related parties - $(295) and $3,814)
 
1,821

 
3,818

Investment income
 
26,419

 
30,745

Investment expenses
 
(1,408
)
 
(1,701
)
Net Investment Income
 
$
25,011

 
$
29,044

NGHC
 
$
22,867

 
$
26,160

Reciprocal Exchanges
 
2,144

 
2,884

Net Investment Income
 
$
25,011

 
$
29,044


(e) Net Realized Gains (Losses)

Purchases and sales of investments are recorded on a trade date basis. Realized gains and losses are determined based on the specific identification method. The table below indicates realized gains and losses.
 
 
Three Months Ended March 31,
 
 
2018
 
2017
 
 
Gross
Gains
 
Gross
Losses
 
Net Gains (Losses)
 
Gross
Gains
 
Gross
Losses
 
Net Gains (Losses)
Debt securities, available-for-sale
 
$
1,169

 
$
(1,171
)
 
$
(2
)
 
$
2,487

 
$
(1,745
)
 
$
742

Debt securities, trading
 
—

 
—

 
—

 
6,902

 
(9,545
)
 
(2,643
)
Equity securities
 
725

 
(1,773
)
 
(1,048
)
 
8,027

 
(8,187
)
 
(160
)
Foreign exchange and other investments, net
 
1,168

 
—

 
1,168

 
649

 
—

 
649

Net realized gain (loss) on investments
 
$
3,062

 
$
(2,944
)
 
$
118

 
$
18,065

 
$
(19,477
)
 
$
(1,412
)
NGHC
 
$
2,437

 
$
(2,188
)
 
$
249

 
$
18,065

 
$
(19,477
)
 
$
(1,412
)
Reciprocal Exchanges
 
625

 
(756
)
 
(131
)
 
—

 
—

 
—

Net realized gain (loss) on investments
 
$
3,062

 
$
(2,944
)
 
$
118

 
$
18,065

 
$
(19,477
)
 
$
(1,412
)

Net gains and losses recognized during the reporting period on equity securities and debt securities classified as trading still held at the reporting date were as follows:
 
 
Three Months Ended March 31,
 
 
2018
 
2017
 
 
Equity
Securities
 
Equity Securities and Debt Securities
Net losses recognized during the period
 
$
(1,048
)
 
$
(5,662
)
Less: Net losses recognized during the period on securities sold during the period
 
—

 
(1,800
)
Net losses recognized during the reporting period on securities still held at the reporting date
 
$
(1,048
)
 
$
(3,862
)


14

NATIONAL GENERAL HOLDINGS CORP.
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(In Thousands, Except Shares and Per Share Data)

(f) Credit Quality of Investments

The tables below summarize the credit quality of the Company’s debt securities and preferred stock securities, as rated by Standard & Poor’s.
 
 
NGHC
 
Reciprocal Exchanges
March 31, 2018
 
Cost or
Amortized Cost
 
Fair Value
 
Percentage
 
Cost or Amortized Cost
 
Fair Value
 
Percentage
U.S. Treasury
 
$
29,333

 
$
29,801

 
1.0
%
 
$
6,497

 
$
6,517

 
2.1
%
AAA
 
281,886

 
282,501

 
9.6
%
 
13,245

 
12,846

 
4.1
%
AA, AA+, AA-
 
1,438,345

 
1,401,862

 
47.8
%
 
126,409

 
124,086

 
39.9
%
A, A+, A-
 
557,155

 
548,341

 
18.7
%
 
154,305

 
151,145

 
48.6
%
BBB, BBB+, BBB-
 
570,184

 
568,001

 
19.3
%
 
10,278

 
10,115

 
3.3
%
BB+ and lower
 
106,292

 
105,238

 
3.6
%
 
6,033

 
6,031

 
2.0
%
Total
 
$
2,983,195

 
$
2,935,744

 
100.0
%
 
$
316,767

 
$
310,740

 
100.0
%
 
 
NGHC
 
Reciprocal Exchanges
December 31, 2017
 
Cost or
Amortized Cost
 
Fair Value
 
Percentage
 
Cost or Amortized Cost
 
Fair Value
 
Percentage
U.S. Treasury
 
$
30,244

 
$
31,026

 
1.1
%
 
$
5,992

 
$
5,967

 
2.0
%
AAA
 
255,132

 
259,506

 
9.1
%
 
29,540

 
28,961

 
9.5
%
AA, AA+, AA-
 
1,399,287

 
1,382,191

 
48.7
%
 
133,250

 
133,316

 
43.7
%
A, A+, A-
 
531,185

 
534,298

 
18.8
%
 
135,682

 
136,657

 
44.8
%
BBB, BBB+, BBB-
 
574,456

 
581,406

 
20.5
%
 
—

 
—

 
—
%
BB+ and lower
 
47,542

 
48,759

 
1.8
%
 
34

 
33

 
—
%
Total
 
$
2,837,846

 
$
2,837,186

 
100.0
%
 
$
304,498

 
$
304,934

 
100.0
%

The tables below summarize the investment quality of the Company’s corporate bond holdings and industry concentrations.
March 31, 2018
 
AAA
 
AA+,
AA,
AA-
 
A+,A,A-
 
BBB+,
BBB,
BBB-
 
BB+ or
Lower
 
Fair
Value
 
% of
Corporate
Bonds
Portfolio
Corporate Bonds:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Financial Institutions
 
3.6
%
 
2.1
%
 
25.4
%
 
10.4
%
 
2.0
%
 
$
477,583

 
43.5
%
Industrials
 
0.5
%
 
4.3
%
 
23.9
%
 
24.2
%
 
2.4
%
 
607,146

 
55.3
%
Utilities/Other
 
—
%
 
—
%
 
1.1
%
 
0.1
%
 
—
%
 
14,094

 
1.2
%
Total
 
4.1
%
 
6.4
%
 
50.4
%
 
34.7
%
 
4.4
%
 
$
1,098,823

 
100.0
%
NGHC
 
3.7
%
 
2.3
%
 
36.6
%
 
33.8
%
 
4.4
%
 
$
888,297

 
80.8
%
Reciprocal Exchanges
 
0.4
%
 
4.1
%
 
13.8
%
 
0.9
%
 
—
%
 
210,526

 
19.2
%
Total
 
4.1
%
 
6.4
%
 
50.4
%
 
34.7
%
 
4.4
%
 
$
1,098,823

 
100.0
%

15

NATIONAL GENERAL HOLDINGS CORP.
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(In Thousands, Except Shares and Per Share Data)

December 31, 2017
 
AAA
 
AA+,
AA,
AA-
 
A+,A,A-
 
BBB+,
BBB,
BBB-
 
BB+ or
Lower
 
Fair
Value
 
% of
Corporate
Bonds
Portfolio
Corporate Bonds:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Financial Institutions
 
2.9
%
 
7.8
%
 
31.7
%
 
11.9
%
 
—
%
 
$
575,746

 
54.3
%
Industrials
 
0.7
%
 
3.0
%
 
16.9
%
 
21.8
%
 
0.5
%
 
454,764

 
42.9
%
Utilities/Other
 
—
%
 
—
%
 
1.3
%
 
1.5
%
 
—
%
 
30,388

 
2.8
%
Total
 
3.6
%
 
10.8
%
 
49.9
%
 
35.2
%
 
0.5
%
 
$
1,060,898

 
100.0
%
NGHC
 
2.9
%
 
3.4
%
 
37.1
%
 
35.2
%
 
0.5
%
 
$
839,615

 
79.1
%
Reciprocal Exchanges
 
0.7
%
 
7.4
%
 
12.8
%
 
—
%
 
—
%
 
221,283

 
20.9
%
Total
 
3.6
%
 
10.8
%
 
49.9
%
 
35.2
%
 
0.5
%
 
$
1,060,898

 
100.0
%

(g) Cash and Cash Equivalents, Restricted Cash and Restricted Investments

The Company, in order to conduct business in certain states, is required to maintain letters of credit or assets on deposit to support state mandated regulatory requirements and certain third party agreements. The Company also utilizes trust accounts to collateralize business with its reinsurance counterparties. These assets held are primarily in the form of cash or certain high grade securities.

The Company’s cash, cash equivalents, and restricted cash are as follows:
 
 
March 31, 2018
 
December 31, 2017
Cash and cash equivalents
 
$
321,937

 
$
292,282

Restricted cash and cash equivalents
 
56,116

 
65,202

Cash, cash equivalents and restricted cash
 
$
378,053

 
$
357,484


The fair values of the Company’s restricted investments are as follows:
 
 
March 31, 2018
 
December 31, 2017
State deposits, at fair value
 
$
76,083

 
$
76,996

Restricted investments to trusts, at fair value
 
108,786

 
110,314

Total
 
$
184,869

 
$
187,310


(h) Short-term and Other Investments

Short-term investments consist of money market funds rated by Standard & Poor’s as AAA.

The table below summarizes the composition of other investments:
 
 
March 31, 2018
 
December 31, 2017
Equity method investments (related parties - $114,871 and $221,375)
 
$
149,883

 
$
256,321

Note receivable - related party. See Note 13, "Related Party Transactions"
 
126,930

 
126,173

Long-term Certificates of Deposit (CDs), at cost
 
20,339

 
20,339

Investments, at fair value
 
11,050

 
10,791

Investments, at cost or amortized cost
 
7,668

 
7,668

Total
 
$
315,870

 
$
421,292


Equity method investments represent limited liability companies and limited partnership investments in real estate. Investments at fair value, primarily represent the Company’s right to receive the excess servicing spread related to servicing rights, for which the Company has elected the fair value option with changes in fair value recorded in earnings. Investments at cost or

16

NATIONAL GENERAL HOLDINGS CORP.
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(In Thousands, Except Shares and Per Share Data)

amortized cost, represent limited partnerships, loans and trusts. The Company believes its exposure to risk associated with these investments is generally limited to the investment carrying amounts.

The Company’s cost-method investments are assessed for impairment quarterly. No impairment losses were recorded for the three months ended March 31, 2018 and 2017.

Equity Method Investments - Related Parties

The significant shareholder of the Company has an ownership interest in AmTrust Financial Services, Inc. (“AmTrust”) and ACP Re Ltd. (“ACP Re”).

The following entities formed with related parties are considered by the Company to be VIEs, for which the Company is not the primary beneficiary. The Company accounts for these entities using the equity method of accounting. In determining whether it is the primary beneficiary of a VIE, the Company considered qualitative and quantitative factors, including, but not limited to, activities that most significantly impact the VIE’s economic performance and which party controls such activities. The Company does not have the ability to direct the activities that most significantly impact the VIE’s economic performance. The Company believes its exposure to risk associated with these investments is generally limited to the investment carrying amounts.

LSC Entities

The Company has a 50% ownership interest in two entities (collectively, the “LSC Entities”) formed for the purpose of acquiring life settlement contracts, with AmTrust owning the remaining 50%. The LSC Entities used the contributed capital to pay premiums and purchase policies. A life settlement contract is a contract between the owner of a life insurance policy and a third party who obtains the ownership and beneficiary rights of the underlying life insurance policy. The LSC Entities account for these life settlement contracts using the fair value method.

On December 28, 2017, the LSC Entities contributed 136 life settlement contracts to a limited partnership managed and operated by an unrelated third party. The consideration for the transaction included $217,831 cash (including an advance of $39,724 on future payments from the limited partnership) and the right to receive certain contingent earn-out payments. As of December 31, 2017, the LSC Entities had a 30% non-controlling equity interest in the limited partnership and the carrying value of their investment in the limited partnership was $68,085. As of March 31, 2018 and December 31, 2017, the LSC Entities directly held five and six life settlement contracts, respectively.

The Company’s equity interest in the LSC Entities as of March 31, 2018 and December 31, 2017, was $56,348 and $160,683, respectively. For the three months ended March 31, 2018 and 2017, the Company recorded equity in earnings (losses) from the LSC Entities of $700 and $3,875, respectively, made contributions of $2,000 and $10,000, respectively, and received distributions of $107,035 and $0, respectively.

800 Superior, LLC

The Company holds an investment in 800 Superior, LLC, a limited liability company that owns an office building in Cleveland, Ohio, with AmTrust. AmTrust has been appointed managing member of 800 Superior, LLC. The Company and AmTrust each have a 50% ownership interest in 800 Superior, LLC. Additionally, the Company entered into an office lease with 800 Superior, LLC. The Company paid 800 Superior, LLC $722 and $703 in rent for the three months ended March 31, 2018 and 2017, respectively. The Company’s equity interest in 800 Superior, LLC as of March 31, 2018 and December 31, 2017 was $335 and $1,405, respectively. For the three months ended March 31, 2018 and 2017, the Company recorded equity in earnings (losses) from 800 Superior, LLC of $(1,070) and $(117), respectively.


17

NATIONAL GENERAL HOLDINGS CORP.
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(In Thousands, Except Shares and Per Share Data)

East Ninth & Superior, LLC

The Company holds an investment in East Ninth & Superior, LLC and 800 Superior NMTC Investment Fund II, LLC with AmTrust (collectively “East Ninth & Superior”). The Company and AmTrust each have a 50% ownership interest in East Ninth and Superior, LLC and a 24.5% ownership interest in 800 Superior NMTC Investment Fund II, LLC. The Company’s equity interest in East Ninth & Superior as of March 31, 2018 and December 31, 2017 was $4,267 and $4,251, respectively. For the three months ended March 31, 2018 and 2017, the Company recorded equity in earnings (losses) from East Ninth & Superior of $16 and $10, respectively.

North Dearborn Building Company, L.P.

The Company holds an investment in North Dearborn Building Company, L.P. (“North Dearborn”), a limited partnership that owns an office building in Chicago, Illinois. AmTrust is also a limited partner in North Dearborn, and the general partner is NA Advisors GP LLC (“NA Advisors”), a related party, owned by Karfunkel family members which is managed by an unrelated third party. The Company and AmTrust each hold a 45% limited partnership interest in North Dearborn, while NA Advisors holds a 10% general partnership interest and a 10% profit interest, which NA Advisors pays to the unrelated third party manager. North Dearborn appointed NA Advisors as the general manager to oversee the day-to-day operations of the office building. The Company’s equity interest in North Dearborn as of March 31, 2018 and December 31, 2017 was $7,573 and $7,582, respectively. For the three months ended March 31, 2018 and 2017, the Company recorded equity in earnings (losses) from North Dearborn of $(9) and $(250), respectively.

4455 LBJ Freeway, LLC

The Company holds an investment in 4455 LBJ Freeway, LLC, a limited liability company that owns an office building in Dallas, Texas, with AmTrust. AmTrust has been appointed managing member of 4455 LBJ Freeway, LLC. The Company and AmTrust each have a 50% ownership interest in 4455 LBJ Freeway, LLC. Additionally, the Company entered into a lease agreement with 4455 LBJ Freeway, LLC. The Company paid 4455 LBJ Freeway, LLC $574 and $424 in rent for the three months ended March 31, 2018 and 2017, respectively. The Company’s equity interest in 4455 LBJ Freeway, LLC as of March 31, 2018 and December 31, 2017 was $742 and $740, respectively. For the three months ended March 31, 2018 and 2017, the Company recorded equity in earnings (losses) from 4455 LBJ Freeway, LLC of $2 and $125, respectively.

Illinois Center Building, L.P.

The Company holds an investment in Illinois Center Building, L.P. (“Illinois Center”), a limited partnership that owns an office building in Chicago, Illinois. AmTrust and ACP Re are also limited partners in Illinois Center and the general partner is NA Advisors. The Company and AmTrust each hold a 37.5% limited partnership interest in Illinois Center, while ACP Re holds a 15.0% limited partnership interest. NA Advisors holds a 10.0% general partnership interest and a 10.0% profit interest, which NA Advisors pays to the unrelated third party manager. Illinois Center appointed NA Advisors as the general manager to oversee the day-to-day operations of the office building. The Company’s equity interest in Illinois Center as of March 31, 2018 and December 31, 2017 was $45,606 and $46,715, respectively. For the three months ended March 31, 2018 and 2017, the Company recorded equity in earnings (losses) from Illinois Center of $(1,109) and $(1,163), respectively.



18

NATIONAL GENERAL HOLDINGS CORP.
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(In Thousands, Except Shares and Per Share Data)

5. Fair Value of Financial Instruments

The Company carries certain financial instruments at fair value. Assets and liabilities recorded at fair value in the condensed consolidated balance sheets are measured and classified in accordance with a fair value hierarchy consisting of three “levels” based on the observability of valuation inputs:

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.

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 following describes the valuation techniques used by the Company to determine the fair value measurements on a recurring basis of financial instruments held as of March 31, 2018 and December 31, 2017. The Company utilizes a pricing service (“pricing service”) to estimate fair value measurements for all its debt and equity securities.

Level 1 measurements:
•
U.S. Treasury and federal agencies. The fair values of U.S. government securities are based on quoted market prices in active markets. The Company believes the market for U.S. government securities is an actively traded market given the high level of daily trading volume.
•
Common stock. The pricing service utilizes market quotations for equity securities that have quoted market prices in active markets and their respective quoted prices are provided at fair value.
•
Short-term investments. Comprised of money market funds that are traded in active markets and fair values are based on quoted market prices.

Level 2 measurements:
•
States and political subdivision bonds, and foreign government. The primary inputs to the valuation include quoted prices for identical or similar assets in markets that are not active.
•
Corporate bonds. Comprised of bonds issued by corporations, public and privately placed. The fair values of short-term corporate bonds are priced 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, the Company obtains non-binding quotes from broker-dealers. The primary inputs to the valuation include quoted prices for identical or similar assets in markets that are not active.
•
Residential and commercial mortgage-backed securities, asset-backed securities and structured securities. The primary inputs to the valuation include quoted prices for identical or similar assets in markets that are not active, contractual cash flows, benchmark yields, prepayment speeds, collateral performance and credit spreads.
•
Preferred stock. The pricing service also provides fair value estimates for certain equity securities whose fair value is based on observable market information rather than market quotes.

Level 3 measurements:
•
States and political subdivision bonds. The Company holds certain municipal bonds that finance economic development, infrastructure and environmental projects which do not have an active market. These bonds are valued based on non-binding broker quotes where the inputs have not been corroborated to be market observable.
•
Foreign government bonds. The Company holds certain foreign government bonds that are valued based on non-binding broker quotes where the inputs have not been corroborated to be market observable.
•
Corporate bonds. The Company holds certain structured notes and term loans that do not have an active market. These bonds are valued based on non-binding broker quotes where the inputs have not been corroborated to be market observable.

19

NATIONAL GENERAL HOLDINGS CORP.
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(In Thousands, Except Shares and Per Share Data)

•
Residential and commercial mortgage-backed securities and structured securities. The Company holds certain mortgage and structured securities valued based on non-binding broker quotes received from brokers who are familiar with the investments and where the inputs have not been corroborated to be market observable.
•
Common stock and preferred stock. From time to time, the Company also holds certain equity securities that are issued by privately-held entities or direct equity investments that do not have an active market. The Company estimates the fair value of these securities primarily based on inputs such as third-party broker quotes, issuers’ book value, market multiples, and other inputs. These bonds are valued based on non-binding broker quotes where the inputs have not been corroborated to be market observable.
•
Other investments, at fair value. Comprised of the Company’s right to receive the Excess Servicing Spread (“ESS”) related to servicing rights. The Company uses a discounted cash flow method to estimate their fair value. The key inputs used in the estimation of ESS include prepayment speed and discount rate. Changes in the fair value of the ESS are recorded in earnings.

Assets measured at fair value on a recurring basis are as follows:
March 31, 2018
 
Recurring Fair Value Measurements
 
 
Level 1
 
Level 2
 
Level 3
 
Total
Available-for-sale debt securities:
 
 
 
 
 
 
 
 
U.S. Treasury
 
$
36,318

 
$
—

 
$
—

 
$
36,318

Federal agencies
 
25,340

 
—

 
—

 
25,340

States and political subdivision bonds
 
—

 
374,130

 
4,127

 
378,257

Foreign government
 
—

 
89,079

 
—

 
89,079

Corporate bonds
 
—

 
1,074,310

 
24,513

 
1,098,823

Residential mortgage-backed securities
 
—

 
1,025,991

 
—

 
1,025,991

Commercial mortgage-backed securities
 
—

 
223,476

 
—

 
223,476

Asset-backed securities
 
—

 
5,738

 
—

 
5,738

Structured securities
 
—

 
361,298

 
—

 
361,298

Total available-for-sale debt securities
 
61,658

 
3,154,022

 
28,640

 
3,244,320

Equity securities:
 
 
 
 
 
 
 
 
Common stock
 
44,127

 
—

 
3,866

 
47,993

Preferred stock
 
—

 
1,882

 
282

 
2,164

Total equity securities
 
44,127

 
1,882

 
4,148

 
50,157

Short-term investments
 
39,969

 
—

 
—

 
39,969

Other investments
 
—

 
—

 
11,050

 
11,050

Total
 
$
145,754

 
$
3,155,904

 
$
43,838

 
$
3,345,496

NGHC
 
$
117,412

 
$
2,851,681

 
$
43,838

 
$
3,012,931

Reciprocal Exchanges
 
28,342

 
304,223

 
—

 
332,565

Total
 
$
145,754

 
$
3,155,904

 
$
43,838

 
$
3,345,496



20

NATIONAL GENERAL HOLDINGS CORP.
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(In Thousands, Except Shares and Per Share Data)

December 31, 2017
 
Recurring Fair Value Measurements
 
 
Level 1
 
Level 2
 
Level 3
 
Total
Available-for-sale debt securities:
 
 
 
 
 
 
 
 
U.S. Treasury
 
$
36,993

 
$
—

 
$
—

 
$
36,993

Federal agencies
 
20,689

 
—

 
—

 
20,689

States and political subdivision bonds
 
—

 
415,000

 
4,081

 
419,081

Foreign government
 
—

 
58,254

 
—

 
58,254

Corporate bonds
 
—

 
1,036,344

 
24,545

 
1,060,889

Residential mortgage-backed securities
 
—

 
1,004,739

 
—

 
1,004,739

Commercial mortgage-backed securities
 
—

 
144,043

 
—

 
144,043

Asset-backed securities
 
—

 
414

 
—

 
414

Structured securities
 
—

 
394,787

 
—

 
394,787

Total available-for-sale debt securities
 
57,682

 
3,053,581

 
28,626

 
3,139,889

Equity securities:
 
 
 
 
 
 
 
 
Common stock
 
43,067

 
—

 
5,052

 
48,119

Preferred stock
 
—

 
1,952

 
270

 
2,222

Total equity securities
 
43,067

 
1,952

 
5,322

 
50,341

Short-term investments
 
38,266

 
—

 
—

 
38,266

Other investments
 
—

 
9

 
10,782

 
10,791

Total
 
$
139,015

 
$
3,055,542

 
$
44,730

 
$
3,239,287

NGHC
 
$
110,769

 
$
2,756,575

 
$
44,730

 
$
2,912,074

Reciprocal Exchanges
 
28,246

 
298,967

 
—

 
327,213

Total
 
$
139,015

 
$
3,055,542

 
$
44,730

 
$
3,239,287


The following tables provide a reconciliation of recurring fair value measurements of the Company’s Level 3 financial assets:
 
 
 
 
Total gains (losses) included in:
 
 
 
 
 
 
 
 
 
 
 
 
Balance as of January 1, 2018
 
Net
income
 
Other
comprehensive
income
 
Purchases
 
Sales
 
Net transfers
into (out of)
Level 3
 
Balance as of March 31, 2018
 
Net gains (losses) included in net income on instruments held at end of period
States and political subdivision bonds
 
$
4,081

 
$
—

 
$
46

 
$
—

 
$
—

 
$
—

 
$
4,127

 
$
—

Corporate bonds
 
24,545

 
—

 
(32
)
 
—

 
—

 
—

 
24,513

 
—

Common stock
 
5,052

 
(1,186
)
 
—

 
—

 
—

 
—

 
3,866

 
(1,186
)
Preferred stock
 
270

 
12

 
—

 
—

 
—

 
—

 
282

 
12

Other investments(1)
 
10,782

 
794

 
—

 
—

 
(526
)
 
—

 
11,050

 
794

Total
 
$
44,730

 
$
(380
)
 
$
14

 
$
—

 
$
(526
)
 
$
—

 
$
43,838

 
$
(380
)


21

NATIONAL GENERAL HOLDINGS CORP.
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(In Thousands, Except Shares and Per Share Data)

 
 
 
 
Total gains (losses) included in:
 
 
 
 
 
 
 
 
 
 
 
 
Balance as of January 1, 2017
 
Net
income
 
Other
comprehensive
income
 
Purchases
 
Sales
 
Net transfers
into (out of)
Level 3
 
Balance as of March 31, 2017
 
Net gains (losses) included in net income on instruments held at end of period
States and political subdivision bonds
 
$
4,732

 
$
—

 
$
—

 
$
—

 
$
—

 
$
(4,732
)
 
$
—

 
$
—

Foreign government
 
1,910

 
—

 
—

 
—

 
—

 
(1,910
)
 
—

 
—

Corporate bonds
 
36,044

 
—

 
530

 
—

 
(9,620
)
 
287

 
27,241

 
—

Residential mortgage-backed securities
 
7,423

 
—

 
—

 
—

 
—

 
(7,422
)
 
1

 
—

Commercial mortgage-backed securities
 
4,849

 
—

 
—

 
—

 
—

 
(4,849
)
 
—

 
—

Structured securities
 
9,055

 
—

 
—

 
—

 
—

 
(7,054
)
 
2,001

 
—

Common stock
 
6,297

 
—

 
—

 
4,119

 
(6,297
)
 
1

 
4,120

 
—

Preferred stock
 
—

 
—

 
—

 
—

 
—

 
280

 
280

 
—

Other investments(1)
 
9,427

 
184

 
—

 
3,986

 
(755
)
 
—

 
12,842

 
184

Total
 
$
79,737

 
$
184

 
$
530

 
$
8,105

 
$
(16,672
)
 
$
(25,399
)
 
$
46,485

 
$
184

(1) Other investments gains and losses recognized in net income are reported within net investment income in the condensed consolidated statements of income.

During the three months ended March 31, 2018, there were no transfers between Level 1 and Level 2 or between Level 2 and Level 3.

During the three months ended March 31, 2017, there were no transfers between Level 1 and Level 2. During the three months ended March 31, 2017, the Company transferred $31,917 out of Level 3 into Level 2, due to changes in broker quotes where the inputs included quoted prices for identical or similar assets in markets that are not active resulting in the securities being classified as Level 2; and $6,518 out of Level 2 into Level 3, due to changes in broker quotes where the inputs had not been corroborated to be market observable resulting in the securities being classified as Level 3.

The Company’s policy is to recognize transfers between levels as of the end of each reporting period, consistent with the date of determination of fair value.

At March 31, 2018 and December 31, 2017, the carrying values of the Company’s short-term investments, cash and cash equivalents, premiums and other receivables, and accounts payable approximate the fair value given their short-term nature and are classified as Level 1.

Fair value information about financial instruments not measured at fair value

Debt - The amount reported in the accompanying condensed consolidated balance sheets for these financial instruments represents the carrying value of the debt. See Note 9, “Debt” for additional information.

The Company’s 7.625% Notes are publicly traded and classified as Level 2. The Company’s 6.75% Notes, the Subordinated Debentures, the Imperial Surplus Notes, the SPCIC Surplus Notes and the Credit Agreement are not publicly traded and are classified as Level 3. As of March 31, 2018 and December 31, 2017, the fair values of the Company’s 6.75% Notes and the Credit Agreement were determined using analytical procedures on similar publicly traded corporate bonds and loans, and were valued using the discounted cash flow method of the income approach. The cash flows were discounted at a market yield, calculated using the risk-free rate plus a credit spread. As of March 31, 2018 and December 31, 2017, the fair values of the Company’s Subordinated Debentures, Imperial Surplus Notes and SPCIC Surplus Notes were valued using the Black-Derman-Toy interest rate lattice model.


22

NATIONAL GENERAL HOLDINGS CORP.
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(In Thousands, Except Shares and Per Share Data)

The following table presents the carrying amount and fair value estimates of debt not carried at fair value:
 
March 31, 2018
 
December 31, 2017
 
Carrying amount
 
Fair value
 
Carrying amount
 
Fair value
7.625% Notes
$
96,778

 
$
99,226

 
$
96,756

 
$
101,640

6.75% Notes
345,947

 
362,828

 
345,786

 
366,131

Subordinated Debentures
72,168

 
72,084

 
72,168

 
72,101

Imperial Surplus Notes
5,000

 
4,984

 
5,000

 
4,984

SPCIC Surplus Notes
4,000

 
3,995

 
4,000

 
3,996

Credit Agreement
190,000

 
194,167

 
190,000

 
195,420

Total
$
713,893

 
$
737,284

 
$
713,710

 
$
744,272



6. Deferred Acquisition Costs

The following table reflects the amounts of policy acquisition costs deferred and amortized:
 
Three Months Ended March 31,
 
2018
 
2017
 
Property
and
Casualty
 
Accident
and
Health
 
Total
 
Property
and
Casualty
 
Accident
and
Health
 
Total
Balance at beginning of the period
$
198,283

 
$
18,106

 
$
216,389

 
$
207,597

 
$
13,325

 
$
220,922

Additions
139,132

 
5,940

 
145,072

 
155,535

 
21,121

 
176,656

Amortization
(120,332
)
 
(7,529
)
 
(127,861
)
 
(135,114
)
 
(19,680
)
 
(154,794
)
Change in DAC
18,800

 
(1,589
)
 
17,211

 
20,421

 
1,441

 
21,862

Balance at end of the period
$
217,083

 
$
16,517

 
$
233,600

 
$
228,018

 
$
14,766

 
$
242,784

NGHC
$
195,448

 
$
16,517

 
$
211,965

 
$
194,740

 
$
14,766

 
$
209,506

Reciprocal Exchanges
21,635

 
—

 
21,635

 
33,278

 
—

 
33,278

Balance at end of the period
$
217,083

 
$
16,517

 
$
233,600

 
$
228,018

 
$
14,766

 
$
242,784



7. Unpaid Losses and Loss Adjustment Expense Reserves

The unpaid losses and loss adjustment expense (“LAE”) reserves are the result of ongoing analysis of recent loss development trends and emerging historical experience. Original estimates are increased or decreased as additional information becomes known regarding individual claims. In setting its reserves, the Company reviews its loss data to estimate expected loss development. Management believes that its use of standard actuarial methodology applied to its analyses of its historical experience provides a reasonable estimate of future losses. However, actual future losses may differ from the Company’s estimate, and future events beyond the control of management, such as changes in law, judicial interpretations of law and inflation, may favorably or unfavorably impact the ultimate settlement of the Company’s losses and LAE.

The anticipated effect of inflation is implicitly considered when estimating liabilities for losses and LAE. In addition to inflation, the average severity of claims is affected by a number of factors that may vary by types and features of policies written. Future average severities are projected from historical trends, adjusted for implemented changes in underwriting standards and policy provisions, and general economic trends. These estimated trends are monitored and revised as necessary based on actual development.


23

NATIONAL GENERAL HOLDINGS CORP.
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(In Thousands, Except Shares and Per Share Data)

The table below shows the rollforward of loss reserves on a gross and net of reinsurance basis, reflecting changes in losses incurred and paid losses:
 
Three Months Ended March 31,
 
2018
 
2017
 
Property
and
Casualty
 
Accident
and
Health
 
NGHC
 
Reciprocal
Exchanges
 
Total
 
Property
and
Casualty
 
Accident
and
Health
 
NGHC
 
Reciprocal
Exchanges
 
Total
Unpaid losses and LAE, gross of related reinsurance recoverable at beginning of the period
$
2,270,551

 
$
249,653

 
$
2,520,204

 
$
143,353

 
$
2,663,557

 
$
1,936,391

 
$
200,400

 
$
2,136,791

 
$
137,075

 
$
2,273,866

Less: Reinsurance recoverables at beginning of the period
(1,067,495
)
 
(9,840
)
 
(1,077,335
)
 
(52,408
)
 
(1,129,743
)
 
(827,672
)
 
(10,933
)
 
(838,605
)
 
(42,192
)
 
(880,797
)
Net balance at beginning of the period
1,203,056

 
239,813

 
1,442,869

 
90,945

 
1,533,814

 
1,108,719

 
189,467

 
1,298,186

 
94,883

 
1,393,069

Incurred losses and LAE related to:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Current year
513,526

 
94,661

 
608,187

 
45,917

 
654,104

 
525,688

 
77,703

 
603,391

 
30,020

 
633,411

Prior year
(15,169
)
 
(3,383
)
 
(18,552
)
 
(1,386
)
 
(19,938
)
 
(4,354
)
 
(8,320
)
 
(12,674
)
 
(1,920
)
 
(14,594
)
Total incurred
498,357

 
91,278

 
589,635

 
44,531

 
634,166

 
521,334

 
69,383

 
590,717

 
28,100

 
618,817

Paid losses and LAE related to:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Current year
(202,967
)
 
(20,290
)
 
(223,257
)
 
(19,686
)
 
(242,943
)
 
(165,950
)
 
(14,568
)
 
(180,518
)
 
(12,886
)
 
(193,404
)
Prior year
(306,126
)
 
(47,992
)
 
(354,118
)
 
(17,455
)
 
(371,573
)
 
(347,864
)
 
(51,432
)
 
(399,296
)
 
(15,246
)
 
(414,542
)
Total paid
(509,093
)
 
(68,282
)
 
(577,375
)
 
(37,141
)
 
(614,516
)
 
(513,814
)
 
(66,000
)
 
(579,814
)
 
(28,132
)
 
(607,946
)
Effect of foreign exchange rates
—

 
(1,679
)
 
(1,679
)
 
—

 
(1,679
)
 
—

 
1,043

 
1,043

 
—

 
1,043

Net balance at end of the period
1,192,320

 
261,130

 
1,453,450

 
98,335

 
1,551,785

 
1,116,239

 
193,893

 
1,310,132

 
94,851

 
1,404,983

Plus reinsurance recoverables at end of the period
1,058,106

 
8,565

 
1,066,671

 
60,461

 
1,127,132

 
819,538

 
10,732

 
830,270

 
44,234

 
874,504

Gross balance at end of period
$
2,250,426

 
$
269,695

 
$
2,520,121

 
$
158,796

 
$
2,678,917

 
$
1,935,777

 
$
204,625

 
$
2,140,402

 
$
139,085

 
$
2,279,487


Prior year loss development, net of reinsurance

Prior year development is based upon numerous estimates by line of business and accident year. No additional premiums or return premiums have been accrued as a result of the prior year effects.

2018. Loss and LAE for the three months ended March 31, 2018 included $19,938 of favorable development on prior accident year loss and LAE reserves. The $16,555 of favorable development in the property and casualty business (including $1,386 of favorable development for the Reciprocal Exchanges) was driven by favorable development in the Company’s auto physical damage and homeowners business, while the $3,383 of favorable development in the accident and health business was primarily driven by favorable development in the Company’s domestic business.

2017. Loss and LAE for the three months ended March 31, 2017 included $14,594 of favorable development on prior accident year loss and LAE reserves. The $6,274 of favorable development in the property and casualty business (including $1,920 of favorable development for the Reciprocal Exchanges) was primarily driven by favorable development in the Company’s homeowners business which was partially offset by unfavorable development in private passenger auto bodily injury coverage, while $8,320 of favorable development in the accident and health business was primarily driven by favorable development in the Company’s domestic stop loss programs.



24

NATIONAL GENERAL HOLDINGS CORP.
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(In Thousands, Except Shares and Per Share Data)

8. Reinsurance

The Company’s insurance subsidiaries utilize reinsurance agreements to transfer portions of the underlying risk of the business the Company writes to various affiliated and third-party reinsurance companies. Reinsurance does not discharge or diminish the Company’s obligation to pay claims covered by the insurance policies it issues; however, it does permit the Company to recover certain incurred losses from its reinsurers and the Company’s reinsurance recoveries reduce the maximum loss that it may incur as a result of a covered loss event. The Company’s reinsurers generally carry at least an A.M. Best Company, Inc. rating of “A-” (Excellent) or are fully collateralized at the time they enter into the Company’s reinsurance agreements. The Company also enters reinsurance relationships with third-party captives formed by agents as a mechanism for sharing risk and profit. The total amount, cost and limits relating to the reinsurance coverage the Company purchases may vary from year to year based upon a variety of factors, including the availability of quality reinsurance at an acceptable price and the level of risk that the Company chooses to retain for its own account.

The Company assumes and cedes insurance risks under various reinsurance agreements, on both a pro rata basis and excess of loss basis. The Company purchases reinsurance to mitigate the volatility of direct and assumed business, which may be caused by the aggregate value or the concentration of written exposures in a particular geographic area or business segment and may arise from catastrophes or other events. The Company pays a premium as consideration for ceding the risk.

The following is the effect of reinsurance on unpaid loss and LAE reserves and unearned premiums:
 
 
March 31, 2018
 
December 31, 2017
 
 
Assumed
 
Ceded
 
Assumed
 
Ceded
Unpaid Loss and LAE reserves
 
$
106,476

 
$
1,127,132

 
$
134,246

 
$
1,129,743

Unearned premiums
 
35,385

 
528,770

 
45,182

 
517,122


The following is a summary of the effect of reinsurance on premiums and losses:
 
 
Three Months Ended March 31,
 
 
2018
 
2017
 
 
Written
 
Earned
 
Written
 
Earned
Premium:
 
 
 
 
 
 
 
 
Direct
 
$
1,413,877

 
$
1,191,327

 
$
1,195,221

 
$
935,775

Assumed
 
19,253

 
29,051

 
58,162

 
98,038

Total Gross Premium
 
1,433,130

 
1,220,378

 
1,253,383

 
1,033,813

Ceded
 
(326,487
)
 
(314,840
)
 
(128,330
)
 
(115,328
)
Net Premium
 
$
1,106,643

 
$
905,538

 
$
1,125,053

 
$
918,485

 
 
Three Months Ended March 31,
 
 
2018
 
2017
 
 
Assumed
 
Ceded
 
Assumed
 
Ceded
Loss and LAE
 
$
(1,321
)
 
$
197,317

 
$
29,946

 
$
91,552


Quota Share Agreements

Effective July 1, 2017, the Company entered into an Auto Quota Share Agreement (the “Auto Quota Share Agreement”) covering the Company’s auto lines of business, under which the Company cedes 15.0% of net liability under auto policies in force as of the effective date and new and renewal policies issued during the two-year term of the agreement to an unaffiliated third-party reinsurance provider. Under the Auto Quota Share Agreement, the Company receives a 31.2% provisional ceding commission on premiums ceded to the reinsurer during the term of the Auto Quota Share Agreement, subject to a sliding scale adjustment to a maximum of 32.8% if the loss ratio for the reinsured business is 63.4% or less and a minimum of 29.6% if the loss ratio is 66.6% or higher. The liability of the reinsurer is capped at $5,000 per risk or $70,000 per event. The cession may be increased, under certain conditions, up to a maximum cession of 20.0%.

25

NATIONAL GENERAL HOLDINGS CORP.
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(In Thousands, Except Shares and Per Share Data)

Effective July 1, 2017, the Company entered into a Homeowners Quota Share Agreement (the “HO Quota Share Agreement”) covering the Company’s homeowners line of business, under which the Company cedes 29.6% of net liability under homeowners policies, including lender-placed property policies, in force as of the effective date and new and renewal policies issued during the two-year term of the agreement to unaffiliated third-party reinsurance providers. Under the HO Quota Share Agreement, the Company receives a 42.5% ceding commission on premiums ceded to the reinsurers during the term of the HO Quota Share Agreement. The liability of the reinsurers is capped at $5,000 per risk or $70,000 per event. Effective May 1, 2018, the Company cedes an additional 12.4% of net liability (for a total cession of 42.0%) and receives a 38.0% ceding commission on the additional 12.4% in ceded premiums.

Catastrophe Reinsurance

As of May 1, 2017, the Company’s reinsurance property catastrophe excess of loss program went into effect protecting the Company against catastrophic events and other large losses. The property catastrophe program provides a total of $575,000 in coverage in excess of a $70,000 retention, with one reinstatement. Effective July 1, 2017, the casualty program provides $45,000 in coverage in excess of a $5,000 retention. The Company pays a premium as consideration for ceding the risk. The Company renewed its property catastrophe excess of loss program under the same coverages effective May 1, 2018.

As of July 1, 2017, a reinsurance property catastrophe excess of loss program went into effect protecting the Reciprocal Exchanges against accumulations of losses resulting from a catastrophic event. The property catastrophe program provides a total of $375,000 in coverage in excess of a $20,000 retention, with one reinstatement.


9. Debt

7.625% Subordinated Notes due 2055

The Company previously issued $100,000 aggregate principal amount of the Company’s 7.625% subordinated notes due 2055 (the “7.625% Notes”) in a public offering. The net proceeds the Company received from the issuance were approximately $96,550, after deducting the underwriting discount, commissions and expenses. The 7.625% Notes bear interest at a rate equal to 7.625% per year, payable quarterly in arrears on March 15, June 15, September 15 and December 15 of each year. The 7.625% Notes are the Company’s subordinated unsecured obligations and rank (i) senior in right of payment to any future junior subordinated debt, (ii) equal in right of payment with any unsecured, subordinated debt that the Company incurs in the future that ranks equally with the 7.625% Notes, and (iii) subordinate in right of payment to any of the Company’s existing and future senior debt, including amounts outstanding under the Company’s revolving credit facility, the Company’s 6.75% notes and certain of the Company’s other obligations. In addition, the 7.625% Notes are structurally subordinated to all existing and future indebtedness, liabilities and other obligations of the Company’s subsidiaries. The 7.625% Notes mature on September 15, 2055, unless earlier redeemed or purchased by the Company. Interest expense on the 7.625% Notes for the three months ended March 31, 2018 and 2017, was $1,906 and $1,880, respectively.

The indenture contains customary covenants, such as reporting of annual and quarterly financial results, and restrictions on certain mergers and consolidations. The indenture also includes covenants relating to the incurrence of debt if the Company’s consolidated leverage ratio would exceed 0.35 to 1.00, a limitation on liens, a limitation on the disposition of stock of certain of the Company’s subsidiaries and a limitation on transactions with certain of the Company’s affiliates. The Company was in compliance with all of the covenants contained in the indenture as of March 31, 2018.

6.75% Notes due 2024

The Company previously issued $350,000 aggregate principal amount of the Company’s 6.75% notes due 2024 (the “6.75% Notes”) to certain purchasers in two private placements. The net proceeds the Company received from the issuances were approximately $343,850, after deducting issuance expenses. The 6.75% Notes bear interest at a rate equal to 6.75% per year, payable semiannually in arrears on May 15 and November 15 of each year. The 6.75% Notes are the Company’s general unsecured obligations and rank equally in right of payment with its other existing and future senior unsecured indebtedness and senior in right of payment to any of its indebtedness that is contractually subordinated to the 6.75% Notes. The 6.75% Notes are also effectively subordinated to any of the Company’s existing and future secured indebtedness to the extent of the value of the collateral

26

NATIONAL GENERAL HOLDINGS CORP.
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(In Thousands, Except Shares and Per Share Data)

securing such indebtedness and are structurally subordinated to the existing and future indebtedness of the Company’s subsidiaries (including trade payables). The 6.75% Notes mature on May 15, 2024, unless earlier redeemed or purchased by the Company. Interest expense on the 6.75% Notes for the three months ended March 31, 2018 and 2017, was $5,906 and $5,825, respectively.

The indenture contains customary covenants, such as reporting of annual and quarterly financial results, and restrictions on certain mergers and consolidations. The indenture also includes covenants relating to the incurrence of debt if the Company’s consolidated leverage ratio would exceed 0.35 to 1.00, a limitation on liens, a limitation on the disposition of stock of certain of the Company’s subsidiaries and a limitation on transactions with certain of the Company’s affiliates. The Company was in compliance with all of the covenants contained in the indenture as of March 31, 2018.

Subordinated Debentures

The Company’s subsidiary, Direct General Corporation, is the issuer of junior subordinated debentures (the “Subordinated Debentures”) relating to an issuance of trust preferred securities. The Subordinated Debentures require interest-only payments to be made on a quarterly basis, with principal due at maturity. The Subordinated Debentures’ principal amounts of $41,238 and $30,930 mature on 2035 and 2037, respectively, and bear interest at an annual rate equal to LIBOR plus 3.40% and LIBOR plus 4.25%, respectively. The Subordinated Debentures are redeemable by the Company at a redemption price equal to 100% of their principal amount. Interest expense on the Subordinated Debentures for the three months ended March 31, 2018 and 2017, was $986 and $1,003, respectively.

Imperial-related Debt

The Company’s subsidiary, Imperial Fire and Casualty Insurance Company, is the issuer of $5,000 principal amount of Surplus Notes due 2034 (“Imperial Surplus Notes”). The notes bear interest at an annual rate equal to LIBOR plus 4.05%, payable quarterly. The notes are redeemable by the Company at a redemption price equal to 100% of their principal amount. Interest expense on the Imperial Surplus Notes for the three months ended March 31, 2018 and 2017, was $71 and $63, respectively.

SPCIC-related Debt

The Company’s subsidiary, Standard Property and Casualty Insurance Company, is the issuer of $4,000 principal amount of Surplus Notes due 2033 (“SPCIC Surplus Notes”). The notes bear interest at an annual rate equal to LIBOR plus 4.15%, payable quarterly. The notes are redeemable by the Company at a redemption price equal to 100% of their principal amount. On April 2, 2018, the Company redeemed the SPCIC Surplus Notes. Interest expense on the SPCIC Surplus Notes for the three months ended March 31, 2018 and 2017, was $58 and $51, respectively.

Revolving Credit Agreement

On January 25, 2016, the Company entered into a credit agreement (the “Credit Agreement”), among JPMorgan Chase Bank, N.A., as Administrative Agent, KeyBank National Association as Syndication Agent, and Associated Bank, National Association and First Niagara Bank, N.A., as Co-Documentation Agents, and the various lending institutions party thereto. The credit facility is a $245,000 base revolving credit facility with a letter of credit sublimit of $112,500 and an expansion feature not to exceed $50,000. Proceeds of borrowings under the Credit Agreement may be used for working capital, acquisitions and general corporate purposes. The Credit Agreement has a maturity date of January 25, 2020.

The Credit Agreement contains certain restrictive covenants customary for facilities of this type (subject to negotiated exceptions and baskets), including restrictions on indebtedness, liens, acquisitions and investments, restricted payments and dispositions. There are also financial covenants that require the Company to maintain a minimum consolidated net worth, a maximum consolidated leverage ratio, a minimum fixed charge coverage ratio, a minimum risk-based capital and a minimum statutory surplus. The Credit Agreement also provides for customary events of default, with grace periods where customary, including failure to pay principal when due, failure to pay interest or fees within three business days after becoming due, failure to comply with covenants, breaches of representations and warranties, default under certain other indebtedness, certain insolvency or receivership events affecting the Company and its subsidiaries, the occurrence of certain material judgments, or a change in control of the Company. Upon the occurrence and during the continuation of an event of default, the administrative agent, upon the request of the requisite percentage of the lenders, may terminate the obligations of the lenders to make loans and to issue letters

27

NATIONAL GENERAL HOLDINGS CORP.
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(In Thousands, Except Shares and Per Share Data)

of credit under the Credit Agreement, declare the Company’s obligations under the Credit Agreement to become immediately due and payable and/or exercise any and all remedies and other rights under the Credit Agreement.

Borrowings under the Credit Agreement bear interest at either the Alternate Base Rate (“ABR”) or LIBOR. ABR borrowings (which are borrowings bearing interest at a rate determined by reference to the ABR) under the Credit Agreement will bear interest at the greatest of (a) the prime rate in effect on such day, (b) the federal funds effective rate on such day plus 0.5 percent or (c) the adjusted LIBOR for a one-month interest period on such day plus 1 percent. Eurodollar borrowings under the Credit Agreement will bear interest at the adjusted LIBOR for the interest period in effect. Fees payable by the Company under the Credit Agreement include a letter of credit participation fee (the margin applicable to Eurodollar borrowings), a letter of credit fronting fee with respect to each letter of credit (0.125%) and a commitment fee on the available commitments of the lenders (a range of 0.20% to 0.30% based on the Company’s consolidated leverage ratio, and which rate was 0.30% as of March 31, 2018).

As of March 31, 2018, there was $190,000 outstanding under the Credit Agreement. The weighted average interest rate on the amount outstanding as of March 31, 2018 was 4.23%. Interest payments are due the last day of the interest period in intervals of three months duration, commencing on the date of such borrowing. Interest expense on the Credit Agreement for the three months ended March 31, 2018 and 2017, was $1,684 and $439, respectively. The Company was in compliance with all of the covenants under the Credit Agreement as of March 31, 2018.

Maturities of the Company’s debt for the years subsequent to March 31, 2018 are as follows:
 
2018 (remaining nine months)
 
2019
 
2020
 
2021
 
2022
 
2023
 
Thereafter
 
Total
7.625% Notes
$
—

 
$
—

 
$
—

 
$
—

 
$
—

 
$
—

 
$
100,000

 
$
100,000

6.75% Notes
—

 
—

 
—

 
—

 
—

 
—

 
350,000

 
350,000

Subordinated Debentures
—

 
—

 
—

 
—

 
—

 
—

 
72,168

 
72,168

Imperial Surplus Notes
—

 
—

 
—

 
—

 
—

 
—

 
5,000

 
5,000

SPCIC Surplus Notes
—

 
—

 
—

 
—

 
—

 
—

 
4,000

 
4,000

Credit Agreement
—

 
—

 
190,000

 
—

 
—

 
—

 
—

 
190,000

Total principal amount of debt
$
—

 
$
—

 
$
190,000

 
$
—

 
$
—

 
$
—

 
$
531,168

 
$
721,168

Less: Unamortized debt issuance costs and unamortized discount
 
 
 
 
 
 
 
 
 
 
 
 
 
 
(7,275
)
Carrying amount of debt
 
 
 
 
 
 
 
 
 
 
 
 
 
 
$
713,893




28

NATIONAL GENERAL HOLDINGS CORP.
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(In Thousands, Except Shares and Per Share Data)

10. Income Taxes

The Company files a consolidated federal income tax return. The Reciprocal Exchanges are not included in the Company’s consolidated tax return as the Company does not have an ownership interest in the Reciprocal Exchanges, and they are not a part of the consolidated tax sharing agreement.

The Tax Cuts and Jobs Act was enacted on December 22, 2017 (the “Act”). The Act reduces the U.S. federal corporate tax rate from 35% to 21%, requires companies to pay a one-time transition tax on earnings of certain foreign subsidiaries that were previously tax deferred, creates new taxes on certain foreign sourced earnings, and revises the tax treatment of certain items for property and casualty insurers. As of March 31, 2018, the Company has not completed the accounting for the tax effects of enactment of the Act and additional information and analysis is required; however, under the guidance, Staff Accounting Bulletin No. 118 (“SAB 118”), in certain cases, as described below, the Company has made a reasonable estimate of the effects on the existing deferred tax balances. For the items for which the Company was able to determine a reasonable estimate, the Company recognized a provisional expense (benefit) of $25,783 for NGHC and $(5,194) for the Reciprocal Exchanges during 2017. These amounts are primarily related to the restatement of deferred taxes from 35% to the newly enacted 2018 rate of 21%, and were recorded to income tax expense for the year ended December 31, 2017. No changes to these provisional amounts were recorded during the three months ended March 31, 2018. The Company will continue to make and refine calculations as additional analysis is completed. In addition, the Company’s estimates may also be affected as the Company gains a more thorough understanding of the tax law and/or as regulations are promulgated.

The Company uses the estimated annual effective tax rate method. Certain items, including those deemed to be unusual, infrequent or that cannot be reliably estimated, are excluded from the estimated annual effective tax rate. In these cases, the actual tax expense or benefit is reported in the same period as the related item. Certain tax effects are also not reflected in the estimated annual effective tax rate, primarily certain changes in the realizability of deferred tax assets and uncertain tax positions.

The following table is a reconciliation of the difference in the Company’s income tax expense compared to the federal statutory rate of 21% and 35% for the three months ended March 31, 2018 and 2017, respectively.
 
Three Months Ended March 31,
 
2018
 
2017
 
NGHC
 
Reciprocal Exchanges
 
Total
 
NGHC
 
Reciprocal Exchanges
 
Total
Income (loss) before provision for income taxes
$
86,779

 
$
(14,557
)
 
$
72,222

 
$
49,990

 
$
(8,403
)
 
$
41,587

Tax at federal statutory rate
$
18,224

 
$
(3,057
)
 
$
15,167

 
$
17,497

 
$
(2,941
)
 
$
14,556

Tax effects resulting from:
 
 
 
 
 
 
 
 
 
 
 
Exempt foreign income
(989
)
 
—

 
(989
)
 
(7,196
)
 
—

 
(7,196
)
Statutory equalization reserves
—

 
—

 
—

 
451

 
—

 
451

Other
1,336

 
688

 
2,024

 
2,285

 
693

 
2,978

Total income tax reported
$
18,571

 
$
(2,369
)
 
$
16,202

 
$
13,037

 
$
(2,248
)
 
$
10,789

Effective tax rate
21.4
%
 
16.3
%
 
22.4
%
 
26.1
%
 
26.8
%
 
25.9
%

The Company’s consolidated effective tax rate decreased from 25.9% for the three months ended March 31, 2017 to 22.4% for the three months ended March 31, 2018. The decrease was primarily driven by the change of the federal statutory rate and a reduction in exempt foreign income.

All tax liabilities are payable to the Internal Revenue Service (“IRS”) and various state and local taxing agencies. The Company’s subsidiaries are currently open to audit by the IRS for the year ended December 31, 2015, and open to years thereafter for federal tax purposes. For state and local tax purposes, the Company is open to audit for tax years ended December 31, 2014 forward, depending on jurisdiction.



29

NATIONAL GENERAL HOLDINGS CORP.
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(In Thousands, Except Shares and Per Share Data)

11. Share-Based Compensation

The Company currently has two equity incentive plans (the “Plans”). The Plans authorize up to an aggregate of 7,435,000 shares of Company stock for awards of options to purchase shares of the Company’s common stock, stock appreciation rights, restricted stock, restricted stock units (“RSU”), unrestricted stock and other performance awards. The aggregate number of shares of common stock for which awards may be issued may not exceed 7,435,000 shares, subject to the authority of the Company’s Board of Directors to adjust this amount in the event of a consolidation, reorganization, stock dividend, recapitalization or similar transaction affecting the Company’s common stock. As of March 31, 2018, 599,007 shares of Company’s common stock remained available for grants under the Plans.

A summary of the Company’s stock option awards is shown below:
 
 
Shares Subject to Options Outstanding
March 31, 2018
 
Number of Shares
 
Weighted-Average Exercise Price
 
Weighted-Average Remaining Contractual Term (in years)
 
Aggregate Intrinsic Value (1)
Outstanding at beginning of period
 
3,450,585

 
$
9.37

 
 
 
 
Exercised
 
(86,080
)
 
6.51

 
 
 
 
Outstanding at end of period
 
3,364,505

 
$
9.44

 
4.7
 
$
50,032

Exercisable at end of period
 
3,320,755

 
$
9.33

 
4.7
 
$
49,738

(1) The aggregate intrinsic value is calculated as the difference between the exercise price of the underlying stock option awards and the closing price of the Company’s common stock of $24.31, as reported on the Nasdaq Global Select Market on March 31, 2018.

No options were granted, forfeited or expired during the three months ended March 31, 2018. The total intrinsic value of the options exercised for the three months ended March 31, 2018 and 2017 was $1,502 and $396, respectively. The total fair value of stock options vested for the three months ended March 31, 2018 and 2017 was $221 and $236, respectively.

A summary of the Company’s RSUs is shown below:
 
 
RSUs
March 31, 2018
 
Number of RSUs
 
Weighted-Average Grant Date Fair Value
Non-vested at beginning of period
 
845,459

 
$
21.83

Granted
 
380,850

 
20.15

Vested
 
(174,411
)
 
22.26

Forfeited
 
(13,296
)
 
19.92

Non-vested at end of period
 
1,038,602

 
$
21.16


The weighted-average grant date fair value of RSUs granted for the three months ended March 31, 2018 and 2017 was $20.15 and $24.62, respectively. The total fair value of the RSUs vested for the three months ended March 31, 2018 and 2017 was $3,882 and $1,637, respectively.

Compensation expense, included in general and administrative expenses, for all share-based compensation plans was $2,130 and $2,180 for the three months ended March 31, 2018 and 2017, respectively.

As of March 31, 2018, the Company had approximately $16,708 of unrecognized share-based compensation expense, of which $16,567 was related to RSUs and $141 to stock options. This unrecognized compensation expense is expected to be recognized over a weighted-average period of approximately 1.7 years.



30

NATIONAL GENERAL HOLDINGS CORP.
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(In Thousands, Except Shares and Per Share Data)

12. Earnings Per Share

The following is a summary of the elements used in calculating basic and diluted earnings per common share:
 
 
Three Months Ended March 31,
 
 
2018
 
2017
Numerator:
 
 
 
 
Net income attributable to NGHC
 
$
68,208

 
$
36,923

Less: Dividends on preferred stock
 
(7,875
)
 
(7,875
)
Net income attributable to NGHC common stockholders
 
$
60,333

 
$
29,048

 
 
 
 
 
Denominator:
 
 
 
 
Weighted average number of common shares outstanding – basic
 
106,758,641

 
106,467,599

Potentially dilutive securities:
 
 
 
 
Employee stock options
 
1,922,885

 
2,154,209

RSUs
 
269,458

 
544,873

Weighted average number of common shares outstanding – diluted
 
108,950,984

 
109,166,681

 
 
 
 
 
Basic earnings per share attributable to NGHC common stockholders
 
$
0.57

 
$
0.27

Diluted earnings per share attributable to NGHC common stockholders
 
$
0.55

 
$
0.27


Certain options and RSUs were excluded from the earnings per share calculation because the impact would have been anti-dilutive. These excluded options and RSUs were not material for the three months ended March 31, 2018 and 2017, respectively.



31

NATIONAL GENERAL HOLDINGS CORP.
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(In Thousands, Except Shares and Per Share Data)

13. Related Party Transactions

The significant shareholder of the Company has an ownership interest in AmTrust, Maiden Holdings Ltd. (“Maiden”) and ACP Re. The Company provides and receives services to and from these related entities as follows:

Agreements with AmTrust and Affiliated Entities

Asset Management Agreement

Pursuant to an asset management agreement among the Company and AmTrust, the Company pays AmTrust a fee for managing the Company’s investment portfolio. AmTrust provides investment management services for a quarterly fee of 0.0375% of the average value of assets under management if the average value of the account for the previous calendar quarter is greater than $1 billion. The amounts charged for such expenses were $651 and $1,115 for the three months ended March 31, 2018 and 2017, respectively. As of March 31, 2018 and December 31, 2017, there was a payable to AmTrust related to these services in the amount of $1,416 and $1,208, respectively. The asset management agreement was terminated effective May 1, 2018.

Asset Purchase and Master Services Agreements

On September 13, 2017, the Company entered into an asset purchase and license agreement (the “Agreement”) with AmTrust, pursuant to which the Company acquired ownership of a policy management system and the related intellectual property, as well as a non-exclusive perpetual license to certain software programs used by the system (the “System”), for a purchase price of $200,000, including license fees which would have been payable for use of the System during the third quarter 2017. The purchase price is payable in three equal installments in the amount of $66,667, with the first payment made upon the execution of the Agreement, the second payment made upon the 6-month anniversary of the Agreement, and the third payment payable upon the later of the completion of the full separation and transfer of the System to the Company’s operating environment and the 18-month anniversary of the Agreement. In addition, the Company will be required to pay AmTrust costs for the implementation of the System within the Company's technology environment (up to $5,000).

The Agreement also terminated the existing master services agreement between the Company and AmTrust. AmTrust will continue to provide printing and mailing services, and management of the premium receipts from its lockbox facilities during a transition period pursuant to the Agreement under the same terms as those provided under the master services agreement. The Company recorded expenses related to this agreement of $3,756 and $15,056 for the three months ended March 31, 2018 and 2017, respectively.

NGHC Quota Share Agreement

The Company participated in a quota share reinsurance treaty with ACP Re, Maiden and AmTrust, whereby the Company ceded 50% of the total net earned premiums, net of a ceding commission, and net incurred losses and LAE on business with effective dates after March 1, 2010 (“NGHC Quota Share”). In August 2013, the Company terminated the NGHC Quota Share agreement on a run-off basis. The net reinsurance recoverable is $11,399 and $15,688 at March 31, 2018 and December 31, 2017, respectively. The net recovery under the agreement was $97 and $2,436 during the three months ended March 31, 2018 and 2017, respectively.

The agreement also stipulates that if the Company would be denied full statutory credit for reinsurance ceded pursuant to the credit for reinsurance laws or regulations in any applicable jurisdiction, the reinsurers will secure an amount equal to that obligation through a letter of credit; assets held in trust for the benefit of the Company or cash. ACP Re and Maiden held assets in trust in the amount of $6,492 and $11,438, respectively, as of March 31, 2018 and $6,530 and $13,834, respectively, as of December 31, 2017.

Equity Method Investments

The Company has ownership interests in LSC Entities, limited liability companies and limited partnerships with related parties. See Note 4, “Investments - Equity Method Investments - Related Parties” for additional information.


32

NATIONAL GENERAL HOLDINGS CORP.
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(In Thousands, Except Shares and Per Share Data)

Agreements with ACP Re

Credit Agreement

In 2014, the Company entered into a credit agreement (the “ACP Re Credit Agreement”) by and among AmTrust, as administrative agent, ACP Re, as borrower, ACP Re Holdings, LLC, parent company of ACP Re, as guarantor, and AmTrust and the Company, as lenders, pursuant to which the lenders made a $250,000 loan ($125,000 made by each Lender) to the borrowers on the terms and conditions contained within the ACP Re Credit Agreement.

In 2016, the parties entered into a restatement agreement (the “Restatement Agreement”) to the ACP Re Credit Agreement. Under the restated terms, the borrower became ACP Re Holdings, LLC, a Delaware limited liability company owned by a related-party trust, the Michael Karfunkel Family 2005 Trust (the “Trust”). The Trust will cause ACP Re Holdings, LLC to maintain assets having a value greater than 115% of the value of the then outstanding loan balance, and if there is a shortfall, the Trust will make a contribution to ACP Re Holdings, LLC of assets having a market value of at least the shortfall (the “Maintenance Covenant”). The amounts borrowed are secured by equity interests, cash and cash equivalents, other investments held by ACP Re Holdings, LLC and proceeds of the foregoing in an amount equal to the requirements of the Maintenance Covenant. The maturity date of the loan changed to September 20, 2036. The interest rate on the outstanding principal balance of $250,000 changed to a fixed annual rate of 3.7%, provided that up to 1.2% thereof may be paid in kind. Commencing on September 20, 2026, and for each year thereafter, two percent of the then outstanding principal balance of the loan (inclusive of any amounts previously paid in kind) is due and payable. A change of control of greater than 50% and an uncured breach of the Maintenance Covenant are included as events of default.

As of March 31, 2018 and December 31, 2017 there was a receivable related to the ACP Re Credit Agreement of $126,930 and $126,173, respectively. The Company recorded interest income of $1,174 and $1,160 for the three months ended March 31, 2018 and 2017, respectively, under the ACP Re Credit Agreement. Management evaluates the loan for impairment on a quarterly basis, including the adequacy of the Company’s reserve position based on collateral levels maintained. Management determined no reserve was needed for the carrying value of the loan at March 31, 2018 and December 31, 2017.

Other Related Party Transactions

Lease Agreements

The Company leases office space at 59 Maiden Lane in New York, New York from 59 Maiden Lane Associates LLC, an entity that is wholly-owned by the Karfunkel family. The lease term is through 2022. The Company paid $207 and $187 in rent for the three months ended March 31, 2018 and 2017, respectively.

The Company leases office space at 30 North LaSalle Street, Chicago, Illinois from 30 North LaSalle Street Partners LLC, an entity that is wholly-owned by the Karfunkel family. The lease term is through 2020. The Company paid $75 and $73 in rent for the three months ended March 31, 2018 and 2017, respectively.



33

NATIONAL GENERAL HOLDINGS CORP.
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(In Thousands, Except Shares and Per Share Data)

14. Segment Information

The Company currently operates two business segments, “Property and Casualty” and “Accident and Health.” The “Corporate and Other” column represents the activities of the holding company, as well as income from the Company’s investment portfolio. The Company evaluates segment performance based on segment profit separately from the results of the Company’s investment portfolio. Other operating expenses allocated to the segments are called “General and administrative expenses” which are allocated on an actual basis except salaries and benefits where management’s judgment is applied. In determining total assets by segment, the Company identifies those assets that are attributable to a particular segment such as premiums, deferred acquisition costs, reinsurance recoverable, prepaid reinsurance premiums, intangible assets and goodwill, while the remaining assets are allocated to Corporate and Other.

The Property and Casualty segment, which includes the Reciprocal Exchanges and the management companies, reports the management fees earned by the Company from the Reciprocal Exchanges for underwriting, investment management and other services as service and fee income. The effects of these transactions between the Company and the Reciprocal Exchanges are eliminated in consolidation to derive consolidated net income. However, the management fee income is reported in net income attributable to NGHC and included in the basic and diluted earnings per share.

The following tables summarize the results of operations of the Company’s operating segments:
 
 
Three Months Ended March 31, 2018
 
 
Property
and
Casualty
 
Accident
and
Health
 
Corporate
and
Other
 
Total
Underwriting revenue:
 
 
 
 
 
 
 
 
Gross premium written
 
$
1,199,354

 
$
233,776

 
$
—

 
$
1,433,130

Ceded premiums
 
(316,064
)
 
(10,423
)
 
—

 
(326,487
)
Net premium written
 
883,290

 
223,353

 
—

 
1,106,643

Change in unearned premium
 
(131,628
)
 
(69,477
)
 
—

 
(201,105
)
Net earned premium
 
751,662

 
153,876

 
—

 
905,538

Ceding commission income
 
44,210

 
258

 
—

 
44,468

Service and fee income
 
96,935

 
45,187

 
—

 
142,122

Total underwriting revenues
 
892,807

 
199,321

 
—

 
1,092,128

Underwriting expenses:
 
 
 
 
 
 
 
 
Loss and loss adjustment expense
 
542,888

 
91,278

 
—

 
634,166

Acquisition costs and other underwriting expenses
 
125,102

 
43,608

 
—

 
168,710

General and administrative expenses
 
180,397

 
50,608

 
—

 
231,005

Total underwriting expenses
 
848,387

 
185,494

 
—

 
1,033,881

Underwriting income
 
44,420

 
13,827

 
—

 
58,247

Net investment income
 
—

 
—

 
25,011

 
25,011

Net gain on investments
 
—

 
—

 
118

 
118

Interest expense
 
—

 
—

 
(11,154
)
 
(11,154
)
Provision for income taxes
 
—

 
—

 
(16,202
)
 
(16,202
)
Net (income) loss attributable to non-controlling interest
 
—

 
—

 
12,188

 
12,188

Net income attributable to NGHC
 
$
44,420

 
$
13,827

 
$
9,961

 
$
68,208


34

NATIONAL GENERAL HOLDINGS CORP.
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(In Thousands, Except Shares and Per Share Data)

 
 
Three Months Ended March 31, 2017
 
 
Property
and
Casualty
 
Accident
and
Health
 
Corporate
and
Other
 
Total
Underwriting revenue:
 
 
 
 
 
 
 
 
Gross premium written
 
$
1,061,428

 
$
191,955

 
$
—

 
$
1,253,383

Ceded premiums
 
(117,489
)
 
(10,841
)
 
—

 
(128,330
)
Net premium written
 
943,939

 
181,114

 
—

 
1,125,053

Change in unearned premium
 
(154,380
)
 
(52,188
)
 
—

 
(206,568
)
Net earned premium
 
789,559

 
128,926

 
—

 
918,485

Ceding commission income
 
19,707

 
287

 
—

 
19,994

Service and fee income
 
93,669

 
32,273

 
—

 
125,942

Total underwriting revenues
 
902,935

 
161,486

 
—

 
1,064,421

Underwriting expenses:
 
 
 
 
 
 
 
 
Loss and loss adjustment expense
 
549,434

 
69,383

 
—

 
618,817

Acquisition costs and other underwriting expenses
 
143,230

 
31,490

 
—

 
174,720

General and administrative expenses
 
209,972

 
45,213

 
—

 
255,185

Total underwriting expenses
 
902,636

 
146,086

 
—

 
1,048,722

Underwriting income
 
299

 
15,400

 
—

 
15,699

Net investment income
 
—

 
—

 
29,044

 
29,044

Net loss on investments
 
—

 
—

 
(1,412
)
 
(1,412
)
Other expense
 
—

 
—

 
9,801

 
9,801

Interest expense
 
—

 
—

 
(11,545
)
 
(11,545
)
Provision for income taxes
 
—

 
—

 
(10,789
)
 
(10,789
)
Net (income) loss attributable to non-controlling interest
 
—

 
—

 
6,125

 
6,125

Net income attributable to NGHC
 
$
299

 
$
15,400

 
$
21,224

 
$
36,923


The following tables summarize the total assets of the Company’s operating segments:
 
 
March 31, 2018
 
 
Property
and
Casualty
 
Accident
and
Health
 
Corporate
and
Other
 
Total
Premiums and other receivables, net
 
$
1,277,197

 
$
209,712

 
$
10,962

 
$
1,497,871

Deferred acquisition costs
 
217,083

 
16,517

 
—

 
233,600

Reinsurance recoverable
 
1,326,151

 
8,575

 
—

 
1,334,726

Prepaid reinsurance premiums
 
528,770

 
—

 
—

 
528,770

Intangible assets, net and Goodwill
 
458,712

 
112,847

 
—

 
571,559

Prepaid and other assets
 
15,555

 
31,163

 
88,050

 
134,768

Corporate and other assets
 
—

 
—

 
4,367,852

 
4,367,852

Total assets
 
$
3,823,468

 
$
378,814

 
$
4,466,864

 
$
8,669,146


35

NATIONAL GENERAL HOLDINGS CORP.
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(In Thousands, Except Shares and Per Share Data)

 
 
December 31, 2017
 
 
Property
and
Casualty
 
Accident
and
Health
 
Corporate
and
Other
 
Total
Premiums and other receivables, net
 
$
1,177,350

 
$
117,000

 
$
29,971

 
$
1,324,321

Deferred acquisition costs
 
198,283

 
18,106

 
—

 
216,389

Reinsurance recoverable
 
1,284,325

 
9,840

 
—

 
1,294,165

Prepaid reinsurance premiums
 
517,122

 
—

 
—

 
517,122

Intangible assets, net and Goodwill
 
464,153

 
114,070

 
—

 
578,223

Prepaid and other assets
 
21,141

 
35,608

 
99,081

 
155,830

Corporate and other assets
 
—

 
—

 
4,353,693

 
4,353,693

Total assets
 
$
3,662,374

 
$
294,624

 
$
4,482,745

 
$
8,439,743


The following tables show an analysis of the Company’s premiums by geographical location:
 
Three Months Ended March 31,
 
2018
 
2017
 
NGHC
 
Reciprocal
Exchanges
 
Total
 
NGHC
 
Reciprocal
Exchanges
 
Total
Gross premium written - North America
$
1,232,772

 
$
97,689

 
$
1,330,461

 
$
1,094,983

 
$
82,216

 
$
1,177,199

Gross premium written - Europe
102,669

 
—

 
102,669

 
76,184

 
—

 
76,184

Total
$
1,335,441

 
$
97,689

 
$
1,433,130

 
$
1,171,167

 
$
82,216

 
$
1,253,383

 
 
 
 
 
 
 
 
 
 
 
 
Net premium written - North America
$
953,396

 
$
50,578

 
$
1,003,974

 
$
1,007,168

 
$
41,701

 
$
1,048,869

Net premium written - Europe
102,669

 
—

 
102,669

 
76,184

 
—

 
76,184

Total
$
1,056,065

 
$
50,578

 
$
1,106,643

 
$
1,083,352

 
$
41,701

 
$
1,125,053

 
 
 
 
 
 
 
 
 
 
 
 
Net earned premium - North America
$
825,112

 
$
46,055

 
$
871,167

 
$
853,528

 
$
39,032

 
$
892,560

Net earned premium - Europe
34,371

 
—

 
34,371

 
25,925

 
—

 
25,925

Total
$
859,483

 
$
46,055

 
$
905,538

 
$
879,453

 
$
39,032

 
$
918,485



36

NATIONAL GENERAL HOLDINGS CORP.
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(In Thousands, Except Shares and Per Share Data)

The following tables show an analysis of the Company’s premium by product type:
 
 
Three Months Ended March 31,
Gross Premium Written
 
2018
 
2017
Property and Casualty
 
 
 
 
Personal Auto
 
$
724,645

 
$
646,904

Homeowners
 
140,253

 
114,201

RV/Packaged
 
49,464

 
44,754

Small Business Auto
 
86,244

 
86,376

Lender-placed insurance
 
84,934

 
76,270

Other
 
16,125

 
10,707

Property and Casualty
 
$
1,101,665

 
$
979,212

Accident and Health
 
233,776

 
191,955

NGHC Total
 
$
1,335,441

 
$
1,171,167

 
 
 
 
 
Reciprocal Exchanges
 
 
 
 
Personal Auto
 
$
34,297

 
$
28,159

Homeowners
 
62,521

 
53,327

Other
 
871

 
730

Reciprocal Exchanges Total
 
$
97,689

 
$
82,216

 
 
 
 
 
Total
 
$
1,433,130

 
$
1,253,383


 
 
Three Months Ended March 31,
Net Premium Written
 
2018
 
2017
Property and Casualty
 
 
 
 
Personal Auto
 
$
553,997

 
$
596,879

Homeowners
 
92,596

 
104,545

RV/Packaged
 
49,189

 
44,519

Small Business Auto
 
64,727

 
79,208

Lender-placed insurance
 
63,214

 
72,832

Other
 
8,989

 
4,255

Property and Casualty
 
$
832,712

 
$
902,238

Accident and Health
 
223,353

 
181,114

NGHC Total
 
$
1,056,065

 
$
1,083,352

 
 
 
 
 
Reciprocal Exchanges
 
 
 
 
Personal Auto
 
$
13,495

 
$
17,106

Homeowners
 
36,808

 
24,216

Other
 
275

 
379

Reciprocal Exchanges Total
 
$
50,578

 
$
41,701

 
 
 
 
 
Total
 
$
1,106,643

 
$
1,125,053


37

NATIONAL GENERAL HOLDINGS CORP.
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(In Thousands, Except Shares and Per Share Data)

 
 
Three Months Ended March 31,
Net Earned Premium
 
2018
 
2017
Property and Casualty
 
 
 
 
Personal Auto
 
$
454,216

 
$
454,415

Homeowners
 
82,195

 
104,129

RV/Packaged
 
45,689

 
40,650

Small Business Auto
 
58,562

 
63,241

Lender-placed insurance
 
60,469

 
83,741

Other
 
4,476

 
4,351

Property and Casualty
 
$
705,607

 
$
750,527

Accident and Health
 
153,876

 
128,926

NGHC Total
 
$
859,483

 
$
879,453

 
 
 
 
 
Reciprocal Exchanges
 
 
 
 
Personal Auto
 
$
12,997

 
$
16,117

Homeowners
 
32,771

 
22,538

Other
 
287

 
377

Reciprocal Exchanges Total
 
$
46,055

 
$
39,032

 
 
 
 
 
Total
 
$
905,538

 
$
918,485




38


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

The following discussion and analysis of our financial condition and results of operations should be read in conjunction with our condensed consolidated financial statements and related notes included elsewhere in this Form 10-Q.

Note on Forward-Looking Statements

This Form 10-Q contains certain forward-looking statements that are intended to be covered by the safe harbors created by The Private Securities Litigation Reform Act of 1995. When we use words such as “anticipate,” “intend,” “plan,” “believe,” “estimate,” “expect,” or similar expressions, we do so to identify forward-looking statements. Examples of forward-looking statements include the plans and objectives of management for future operations, including those relating to future growth of our business activities 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, 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 ability to accurately underwrite and price our products and to maintain and establish accurate loss reserves, estimates of the fair value of our investments, development of claims and the effect on 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 acquired businesses, the effect of general economic conditions, state and federal legislation, the effects of tax reform, 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 our vendors or other counterparties, breaches in data security or other disruptions with our technology, heightened competition, changes in pricing environments, and changes in asset valuations. Additional information about these risks and uncertainties, as well as others that may cause actual results to differ materially from those projected, is contained in Item 1A, “Risk Factors” included in our Annual Report on Form 10-K for the year ended December 31, 2017, and our quarterly reports on Form 10-Q. The projections and statements in this report 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.


Overview

We are a specialty personal lines insurance holding company. Through our subsidiaries, we provide a variety of insurance products, including personal and small business automobile, homeowners, umbrella, recreational vehicle, motorcycle, lender-placed, supplemental health 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.

We manage our business through two segments: Property and Casualty (“P&C”) and Accident and Health (“A&H”). We transact business primarily through our twenty-two regulated domestic insurance subsidiaries: Integon Casualty Insurance Company, Integon General Insurance Corporation, 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., National Health Insurance Company, National General Premier Insurance Company, Imperial Fire and Casualty Insurance Company, Agent Alliance Insurance Company, Century-National Insurance Company, Standard Property and Casualty Insurance Company, Direct General Insurance Company, Direct General Insurance Company of Louisiana, Direct General Insurance Company of Mississippi, Direct General Life Insurance Company, Direct Insurance Company and Direct National Insurance Company. Our insurance subsidiaries have an “A-” (Excellent) group rating by A.M. Best Company, Inc. (“A.M. Best”). We currently conduct a limited amount of business outside the United States, primarily in Bermuda, Luxembourg and Sweden.

Two of our wholly-owned subsidiaries are management companies that act as attorneys-in-fact for Adirondack Insurance Exchange, a New York reciprocal insurer, and New Jersey Skylands Insurance Association, a New Jersey reciprocal insurer (together, the “Reciprocal Exchanges” or “Exchanges”). We do not own the Reciprocal Exchanges but are paid a fee to manage their business operations through our wholly-owned management companies. The Reciprocal Exchanges are included in our P&C segment.


39


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.

We evaluate our operations by monitoring key measures of growth and profitability, including net combined ratio (non-GAAP) and operating leverage. We target a net combined ratio (non-GAAP) in the low-to-mid 90s 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. For the three months ended March 31, 2018, our annualized operating leverage (the ratio of net earned premium to average total stockholders’ equity) was 1.8x, which was within our planned target operating leverage of 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 $25.0 million and $29.0 million for the three months ended March 31, 2018 and 2017, respectively. We held 9.4% and 8.9% of total invested assets in cash, cash equivalents and restricted cash as of March 31, 2018 and December 31, 2017, respectively.

Our most significant balance sheet liability is our unpaid loss and loss adjustment expense reserves. As of March 31, 2018 and December 31, 2017, our reserves, net of reinsurance recoverables on unpaid losses, were $1.6 billion and $1.5 billion, respectively. We record reserves for estimated losses under insurance policies that we write and for loss adjustment expenses related to the investigation and settlement of policy claims. Our reserves for loss and loss adjustment expenses represent the estimated cost of all reported and unreported loss and loss adjustment expenses incurred and unpaid at any given point in time based on known facts and circumstances. 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, length of time to achieve ultimate settlement of claims, inflation of medical costs and wages, 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.




40


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 January 1, 2018, we would earn half of the premium in the first quarter of 2018 and the other half in the second quarter of 2018.

Ceding commission income. Ceding commission income is 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 revenue which represents reimbursement of successful acquisition costs related to the underlying policies is recorded as an offset to acquisition costs and other underwriting expenses.

Service and fee income. We also 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 insufficient 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. Insufficient 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 canceled. A policy reinstatement fee is recognized when the customer’s policy is reinstated. An insufficient 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. Commission income and general agent fees are recognized, net of an allowance for estimated policy cancellations, as of the effective date of the insurance policy. The allowance for estimated third-party cancellations is periodically evaluated and adjusted as necessary.

Net investment income. We invest our statutory surplus funds and the funds supporting our insurance liabilities primarily in cash and cash equivalents, debt and equity securities. Our net investment income includes interest and dividends earned on our invested assets and earnings or losses on our equity method investments.

Net gains and losses on investments. Net realized gains occur when we sell our 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


41


or amortized costs, as applicable, or we write down the investment securities as a result of other-than-temporary impairment loss. We report net unrealized gains (losses) on debt securities classified as available for sale within accumulated other comprehensive income (loss) in our balance sheet. Additionally, we have a small portfolio of equity securities and debt securities classified as trading. We report all gains (losses) on equity securities and debt securities classified as trading within net gains (losses) on investments in our statement of income. Net gains and losses on investments also include foreign exchange gains and losses which are generated by the remeasurement of our subsidiaries’ financial statements that are denominated or stated in another currency into the Company’s functional currency.

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 costs and other underwriting expenses. Acquisition costs and other underwriting expenses 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 expenses. General and administrative expenses are 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 expenses include 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 expenses and acquisition costs and other underwriting expenses less ceding commission income and service and fee income.

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 costs and other underwriting expenses, and general and administrative expenses.




42


Insurance Ratios

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 ratio 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. Our definition of net loss ratio and net operating expense ratio is as follows:
•
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 premium.
•
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 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 costs and other underwriting expenses and general and administrative expenses 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. We believe this presentation enhances the understanding of our results by eliminating what we believe are volatile and unusual events and presenting the ratios with what we believe are the underlying run rates of the business. 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 costs and other underwriting expenses and general and administrative expenses 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.


Critical Accounting Policies

Our discussion and analysis of our results of operations, financial condition and liquidity are based upon our condensed consolidated financial statements, which have been prepared in accordance with U.S. generally accepted accounting principles. The preparation of these financial statements requires us to make estimates and judgments that affect the amounts of assets and liabilities, revenues and expenses and disclosure of contingent assets and liabilities as of the date of the financial statements. As more information becomes known, these estimates and assumptions could change, which would have an impact on actual results that may differ materially from these estimates and judgments under different assumptions. We have not made any changes in estimates or judgments that have had a significant effect on the reported amounts as previously disclosed in our Annual Report on Form 10-K for the year ended December 31, 2017.

For more information related to recent accounting pronouncements that we adopted during the three months ended March 31, 2018, see Note 2, “Recent Accounting Pronouncements” in the notes to our condensed consolidated financial statements.




43


Results of Operations

Consolidated Results of Operations for the Three Months Ended March 31, 2018 and 2017 (Unaudited)

 
Three Months Ended March 31,
 
2018
 
2017
 
NGHC
 
Reciprocal Exchanges
 
Eliminations
 
Total
 
NGHC
 
Reciprocal Exchanges
 
Eliminations
 
Total
 
(amounts in thousands)
Gross premium written
$
1,337,042

 
$
97,689

 
$
(1,601
)
 
$
1,433,130

 
$
1,171,968

 
$
82,216

 
$
(801
)
 
$
1,253,383

Ceded premiums
(280,977
)
 
(47,111
)
 
1,601

 
(326,487
)
 
(88,616
)
 
(40,515
)
 
801

 
(128,330
)
Net premium written
$
1,056,065

 
$
50,578

 
$
—

 
$
1,106,643

 
$
1,083,352

 
$
41,701

 
$
—

 
$
1,125,053

Change in unearned premium
(196,582
)
 
(4,523
)
 
—

 
(201,105
)
 
(203,899
)
 
(2,669
)
 
—

 
(206,568
)
Net earned premium
$
859,483

 
$
46,055

 
$
—

 
$
905,538

 
$
879,453

 
$
39,032

 
$
—

 
$
918,485

Ceding commission income
32,958

 
11,510

 
—

 
44,468

 
2,747

 
17,247

 
—

 
19,994

Service and fee income
154,760

 
2,446

 
(15,084
)
 
142,122

 
135,863

 
2,080

 
(12,001
)
 
125,942

Total underwriting revenues
$
1,047,201

 
$
60,011

 
$
(15,084
)
 
$
1,092,128

 
$
1,018,063

 
$
58,359

 
$
(12,001
)
 
$
1,064,421

Underwriting expenses:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Loss and loss adjustment expense
589,635

 
44,531

 
—

 
634,166

 
590,717

 
28,100

 
—

 
618,817

Acquisition costs and other underwriting expenses
157,608

 
11,102

 
—

 
168,710

 
160,540

 
14,180

 
—

 
174,720

General and administrative expenses
227,293

 
18,796

 
(15,084
)
 
231,005

 
242,083

 
25,103

 
(12,001
)
 
255,185

Total underwriting expenses
$
974,536

 
$
74,429

 
$
(15,084
)
 
$
1,033,881

 
$
993,340

 
$
67,383

 
$
(12,001
)
 
$
1,048,722

Underwriting income (loss)
$
72,665

 
$
(14,418
)
 
$
—

 
$
58,247

 
$
24,723

 
$
(9,024
)
 
$
—

 
$
15,699

Net investment income
25,019

 
2,144

 
(2,152
)
 
25,011

 
28,423

 
2,884

 
(2,263
)
 
29,044

Net gain (loss) on investments
249

 
(131
)
 
—

 
118

 
(1,412
)
 
—

 
—

 
(1,412
)
Other income
—

 
—

 
—

 
—

 
9,801

 
—

 
—

 
9,801

Interest expense
(11,154
)
 
(2,152
)
 
2,152

 
(11,154
)
 
(11,545
)
 
(2,263
)
 
2,263

 
(11,545
)
Income (loss) before provision (benefit) for income taxes
$
86,779

 
$
(14,557
)
 
$
—

 
$
72,222

 
$
49,990

 
$
(8,403
)
 
$
—

 
$
41,587

Less: Provision (benefit) for income taxes
18,571

 
(2,369
)
 
—

 
16,202

 
13,037

 
(2,248
)
 
—

 
10,789

Net income (loss)
$
68,208

 
$
(12,188
)
 
$
—

 
$
56,020

 
$
36,953

 
$
(6,155
)
 
$
—

 
$
30,798

Less: Net (income) loss attributable to non-controlling interest
—

 
12,188

 
—

 
12,188

 
(30
)
 
6,155

 
—

 
6,125

Net income attributable NGHC
$
68,208

 
$
—

 
$
—

 
$
68,208

 
$
36,923

 
$
—

 
$
—

 
$
36,923

Net loss ratio
68.6
%
 
96.7
%
 
 
 
70.0
%
 
67.2
%
 
72.0
%
 
 
 
67.4
%
Net operating expense ratio (non-GAAP)
22.9
%
 
34.6
%
 
 
 
23.5
%
 
30.0
%
 
51.1
%
 
 
 
30.9
%
Net combined ratio (non-GAAP)
91.5
%
 
131.3
%
 
 
 
93.5
%
 
97.2
%
 
123.1
%
 
 
 
98.3
%
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Three Months Ended March 31,
 
2018
 
2017
Reconciliation of net operating expense ratio (non-GAAP):
NGHC
 
Reciprocal Exchanges
 
Eliminations
 
Total
 
NGHC
 
Reciprocal Exchanges
 
Eliminations
 
Total
 
(amounts in thousands)
Total expenses
$
985,690

 
$
76,581

 
$
(17,236
)
 
$
1,045,035

 
$
1,004,885

 
$
69,646

 
$
(14,264
)
 
$
1,060,267

Less: Loss and loss adjustment expense
589,635

 
44,531

 
—

 
634,166

 
590,717

 
28,100

 
—

 
618,817

Less: Interest expense
11,154

 
2,152

 
(2,152
)
 
11,154

 
11,545

 
2,263

 
(2,263
)
 
11,545

Less: Ceding commission income
32,958

 
11,510

 
—

 
44,468

 
2,747

 
17,247

 
—

 
19,994

Less: Service and fee income
154,760

 
2,446

 
(15,084
)
 
142,122

 
135,863

 
2,080

 
(12,001
)
 
125,942

Net operating expense
$
197,183

 
$
15,942

 
$
—

 
$
213,125

 
$
264,013

 
$
19,956

 
$
—

 
$
283,969

Net earned premium
$
859,483

 
$
46,055

 
$
—

 
$
905,538

 
$
879,453

 
$
39,032

 
$
—

 
$
918,485

Net operating expense ratio (non-GAAP)
22.9
%
 
34.6
%
 
 
 
23.5
%
 
30.0
%
 
51.1
%
 
 
 
30.9
%



44


Effective July 1, 2017, we entered into an auto quota share agreement, pursuant to which we cede 15.0% of net liability under our auto policies to third party reinsurers and into a homeowners quota share agreement, pursuant to which we cede 29.6% of net liability under homeowners policies to third party reinsurers (collectively, the “Quota Shares”). Ceded premium under the Quota Shares for the three months ended March 31, 2018 were $181.6 million. For more information on our reinsurance agreements, refer to our Annual Report on Form 10-K for the year ended December 31, 2017, and Note 8, “Reinsurance” in the notes to our condensed consolidated financial statements.

As a result of the Quota Shares, comparisons between the three months ended March 31, 2018 and 2017 results will be less meaningful. This transaction impacted our P&C segment only.

Consolidated Results of Operations for the Three Months Ended March 31, 2018 Compared to the Three Months Ended March 31, 2017 (Unaudited)

Gross premium written. Gross premium written increased by $179.7 million, or 14.3%, from $1,253.4 million for the three months ended March 31, 2017 to $1,433.1 million for the three months ended March 31, 2018, due to an increase of $137.9 million from the P&C segment as a result of organic growth ($122.5 million) and growth in the Reciprocal Exchanges ($15.5 million); and an increase of $41.8 million from the A&H segment as a result of organic growth, both domestic and international.

Net premium written. Net premium written decreased by $18.4 million, or 1.6%, from $1,125.1 million for the three months ended March 31, 2017 to $1,106.6 million for the three months ended March 31, 2018. Net premium written for the P&C segment decreased by $60.6 million for the three months ended March 31, 2018 compared to the same period in 2017, as a result of premium ceded to the Quota Shares ($181.6 million), partially offset by organic growth ($112.1 million) and growth in the Reciprocal Exchanges ($8.9 million). Net premium written for the A&H segment increased by $42.2 million for the three months ended March 31, 2018 compared to the same period in 2017, as a result of organic growth, both domestic and international.

Net earned premium. Net earned premium decreased by $12.9 million, or 1.4%, from $918.5 million for the three months ended March 31, 2017 to $905.5 million for the three months ended March 31, 2018. The change by segment was: P&C decreased by $37.9 million and A&H increased by $25.0 million. The decrease in the P&C segment was attributable to premium ceded to the Quota Shares ($164.0 million), partially offset by organic growth ($119.0 million) and growth in the Reciprocal Exchanges ($7.0 million). The increase in the A&H segment was primarily due to organic growth, both domestic and international.

Ceding commission income. Ceding commission income increased by $24.5 million, from $20.0 million for the three months ended March 31, 2017 to $44.5 million for the three months ended March 31, 2018, primarily driven by an increase in the P&C segment from the Quota Shares.

Service and fee income. Service and fee income increased by $16.2 million, or 12.8%, from $125.9 million for the three months ended March 31, 2017 to $142.1 million for the three months ended March 31, 2018. The increase was primarily attributable to our A&H segment ($12.9 million), primarily due to growth in our domestic business. Service and fee income is discussed in more detail in the segment discussions that follow.

The components of service and fee income are as follows:
 
 
Three Months Ended March 31,
 
 
 
 
 
 
2018
 
2017
 
Change
 
% Change
 
 
(amounts in thousands)
 
 
Commission revenue
 
$
39,233

 
$
40,414

 
$
(1,181
)
 
(2.9
)%
Finance and processing fees
 
33,315

 
26,084

 
7,231

 
27.7
 %
Installment fees
 
21,302

 
18,502

 
2,800

 
15.1
 %
Group health administrative fees
 
19,291

 
14,561

 
4,730

 
32.5
 %
Late payment fees
 
7,583

 
7,631

 
(48
)
 
(0.6
)%
Other service and fee income
 
21,398

 
18,750

 
2,648

 
14.1
 %
Total
 
$
142,122

 
$
125,942

 
$
16,180

 
12.8
 %



45


Loss and loss adjustment expense; net loss ratio. Loss and LAE increased by $15.3 million, or 2.5%, from $618.8 million for the three months ended March 31, 2017 to $634.2 million for the three months ended March 31, 2018, primarily reflecting organic growth ($104.0 million) and growth in the Reciprocal Exchanges ($16.4 million), partially offset by losses ceded to the Quota Shares ($105.1 million). The changes by segment were: P&C - decreased by $6.5 million and A&H - increased by $21.9 million.

Loss and LAE for the three months ended March 31, 2018 included $19.9 million of favorable development on prior accident year loss and LAE reserves. This development was composed of $16.6 million of favorable development in the P&C segment (including $1.4 million of favorable development for the Reciprocal Exchanges) primarily driven by favorable development in our auto physical damage and homeowners business, and $3.4 million of favorable development in the A&H segment primarily driven by favorable development in our domestic A&H business. Loss and LAE for the three months ended March 31, 2017 included $14.6 million of favorable development on prior accident year loss and LAE reserves. This development was composed of $6.3 million of favorable development in the P&C segment primarily driven by favorable development in our homeowners business which was partially offset by unfavorable development in private passenger auto bodily injury coverage, and $8.3 million of favorable development in the A&H segment primarily driven by favorable development in our domestic stop loss program.

Our consolidated net loss ratio increased from 67.4% for the three months ended March 31, 2017 to 70.0% for the three months ended March 31, 2018, with higher net loss ratios in the P&C and A&H segments in 2018 compared to 2017. Net loss ratio is discussed in more detail in the segment discussions that follow.

Acquisition costs and other underwriting expenses. Acquisition costs and other underwriting expenses decreased by $6.0 million, or 3.4%, from $174.7 million for the three months ended March 31, 2017 to $168.7 million for the three months ended March 31, 2018, due to a decrease of $18.1 million in the P&C segment, primarily as a result of the Quota Shares ($27.8 million), partially offset by organic growth ($12.7 million); and an increase of $12.1 million in the A&H segment, primarily from organic growth.

General and administrative expenses. General and administrative expenses decreased by $24.2 million, or 9.5%, from $255.2 million for the three months ended March 31, 2017 to $231.0 million for the three months ended March 31, 2018, due to a decrease of $29.6 million in the P&C segment, partially offset by an increase of $5.4 million in the A&H segment.

Net operating expense; net operating expense ratio (non-GAAP). Net operating expense decreased by $70.8 million, or 24.9%, from $284.0 million for the three months ended March 31, 2017 to $213.1 million for the three months ended March 31, 2018, primarily due to a decrease of $75.5 million from the P&C segment.

The consolidated net operating expense ratio decreased from 30.9% for the three months ended March 31, 2017 to 23.5% for the three months ended March 31, 2018. Excluding the Reciprocal Exchanges, the net operating expense ratio was 22.9% and 30.0% for the three months ended March 31, 2018 and 2017, respectively. The Reciprocal Exchanges' net operating expense ratio was 34.6% and 51.1% for the three months ended March 31, 2018 and 2017, respectively. Net operating expense ratio is discussed in more detail in the segment discussions that follow.


46


P&C Segment - Results of Operations for the Three Months Ended March 31, 2018 and 2017 (Unaudited)

 
Three Months Ended March 31,
 
2018
 
2017
 
NGHC
 
Reciprocal Exchanges
 
Eliminations
 
Total
 
NGHC
 
Reciprocal Exchanges
 
Eliminations
 
Total
 
(amounts in thousands)
Gross premium written
$
1,103,266

 
$
97,689

 
$
(1,601
)
 
$
1,199,354

 
$
980,013

 
$
82,216

 
$
(801
)
 
$
1,061,428

Ceded premiums
(270,554
)
 
(47,111
)
 
1,601

 
(316,064
)
 
(77,775
)
 
(40,515
)
 
801

 
(117,489
)
Net premium written
$
832,712

 
$
50,578

 
$
—

 
$
883,290

 
$
902,238

 
$
41,701

 
$
—

 
$
943,939

Change in unearned premium
(127,105
)
 
(4,523
)
 
—

 
(131,628
)
 
(151,711
)
 
(2,669
)
 
—

 
(154,380
)
Net earned premium
$
705,607

 
$
46,055

 
$
—

 
$
751,662

 
$
750,527

 
$
39,032

 
$
—

 
$
789,559

Ceding commission income
32,700

 
11,510

 
—

 
44,210

 
2,460

 
17,247

 
—

 
19,707

Service and fee income
109,573

 
2,446

 
(15,084
)
 
96,935

 
103,590

 
2,080

 
(12,001
)
 
93,669

Total underwriting revenues
$
847,880

 
$
60,011

 
$
(15,084
)
 
$
892,807

 
$
856,577

 
$
58,359

 
$
(12,001
)
 
$
902,935

Underwriting expenses:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Loss and loss adjustment expense
498,357

 
44,531

 
—

 
542,888

 
521,334

 
28,100

 
—

 
549,434

Acquisition costs and other underwriting expenses
114,000

 
11,102

 
—

 
125,102

 
129,050

 
14,180

 
—

 
143,230

General and administrative expenses
176,685

 
18,796

 
(15,084
)
 
180,397

 
196,870

 
25,103

 
(12,001
)
 
209,972

Total underwriting expenses
$
789,042

 
$
74,429

 
$
(15,084
)
 
$
848,387

 
$
847,254

 
$
67,383

 
$
(12,001
)
 
$
902,636

Underwriting income (loss)
$
58,838

 
$
(14,418
)
 
$
—

 
$
44,420

 
$
9,323

 
$
(9,024
)
 
$
—

 
$
299

Net loss ratio
70.6
%
 
96.7
%
 
 
 
72.2
%
 
69.5
%
 
72.0
%
 
 
 
69.6
%
Net operating expense ratio (non-GAAP)
21.0
%
 
34.6
%
 
 
 
21.9
%
 
29.3
%
 
51.1
%
 
 
 
30.4
%
Net combined ratio (non-GAAP)
91.6
%
 
131.3
%
 
 
 
94.1
%
 
98.8
%
 
123.1
%
 
 
 
100.0
%
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Three Months Ended March 31,
 
2018
 
2017
Reconciliation of net operating expense ratio (non-GAAP):
NGHC
 
Reciprocal Exchanges
 
Eliminations
 
Total
 
NGHC
 
Reciprocal Exchanges
 
Eliminations
 
Total
 
(amounts in thousands)
Total underwriting expenses
$
789,042

 
$
74,429

 
$
(15,084
)
 
$
848,387

 
$
847,254

 
$
67,383

 
$
(12,001
)
 
$
902,636

Less: Loss and loss adjustment expense
498,357

 
44,531

 
—

 
542,888

 
521,334

 
28,100

 
—

 
549,434

Less: Ceding commission income
32,700

 
11,510

 
—

 
44,210

 
2,460

 
17,247

 
—

 
19,707

Less: Service and fee income
109,573

 
2,446

 
(15,084
)
 
96,935

 
103,590

 
2,080

 
(12,001
)
 
93,669

Net operating expense
$
148,412

 
$
15,942

 
$
—

 
$
164,354

 
$
219,870

 
$
19,956

 
$
—

 
$
239,826

Net earned premium
$
705,607

 
$
46,055

 
$
—

 
$
751,662

 
$
750,527

 
$
39,032

 
$
—

 
$
789,559

Net operating expense ratio (non-GAAP)
21.0
%
 
34.6
%
 
 
 
21.9
%
 
29.3
%
 
51.1
%
 
 
 
30.4
%

P&C Segment Results of Operations for the Three Months Ended March 31, 2018 Compared to the Three Months Ended March 31, 2017 (Unaudited)

Gross premium written. Gross premium written increased by $137.9 million, or 13.0%, from $1,061.4 million for the three months ended March 31, 2017 to $1,199.4 million for the three months ended March 31, 2018, as a result of organic growth ($122.5 million) and growth in the Reciprocal Exchanges ($15.5 million).

Net premium written. Net premium written decreased by $60.6 million, or 6.4%, from $943.9 million for the three months ended March 31, 2017 to $883.3 million for the three months ended March 31, 2018, as a result of premium ceded to the Quota Shares ($181.6 million), partially offset by organic growth ($112.1 million) and growth in the Reciprocal Exchanges ($8.9 million).

Net earned premium. Net earned premium decreased by $37.9 million, or 4.8%, from $789.6 million for the three months ended March 31, 2017 to $751.7 million for the three months ended March 31, 2018, attributable to premium ceded to the Quota Shares ($164.0 million), partially offset by organic growth ($119.0 million) and growth in the Reciprocal Exchanges ($7.0 million).



47


Ceding commission income. Ceding commission income increased by $24.5 million, from $19.7 million for the three months ended March 31, 2017 to $44.2 million for the three months ended March 31, 2018, primarily from the Quota Shares ($32.1 million), partially offset by the Reciprocal Exchanges ($5.7 million).

Service and fee income. Service and fee income increased by $3.3 million, or 3.5%, from $93.7 million for the three months ended March 31, 2017 to $96.9 million for the three months ended March 31, 2018.

The components of service and fee income are as follows:
 
 
Three Months Ended March 31,
 
 
 
 
 
 
2018
 
2017
 
Change
 
% Change
 
 
(amounts in thousands)
 
 
Finance and processing fees
 
$
32,060

 
$
23,600

 
$
8,460

 
35.8
 %
Commission revenue
 
21,709

 
29,745

 
(8,036
)
 
(27.0
)%
Installment fees
 
21,302

 
18,502

 
2,800

 
15.1
 %
Late payment fees
 
7,558

 
7,600

 
(42
)
 
(0.6
)%
Other service and fee income
 
14,306

 
14,222

 
84

 
0.6
 %
Total
 
$
96,935

 
$
93,669

 
$
3,266

 
3.5
 %

Loss and loss adjustment expense; net loss ratio. Loss and LAE decreased by $6.5 million, or 1.2%, from $549.4 million for the three months ended March 31, 2017 to $542.9 million for the three months ended March 31, 2018, reflecting losses ceded to the Quota Shares ($105.1 million), partially offset by organic growth ($82.1 million) and growth in the Reciprocal Exchanges ($16.4 million).

Our P&C segment net loss ratio, which includes the Reciprocal Exchanges, increased from 69.6% for the three months ended March 31, 2017 to 72.2% for the three months ended March 31, 2018. Excluding the Reciprocal Exchanges, the net loss ratio was 70.6% and 69.5% for the three months ended March 31, 2018 and 2017, respectively. The Reciprocal Exchanges’ net loss ratio was 96.7% and 72.0% for the three months ended March 31, 2018 and 2017, respectively, with the 2018 increase primarily due to weather-related losses, mainly in the Northeastern section of the United States.

Acquisition costs and other underwriting expenses. Acquisition costs and other underwriting expenses decreased by $18.1 million, or 12.7%, from $143.2 million for the three months ended March 31, 2017 to $125.1 million for the three months ended March 31, 2018, primarily as a result of the Quota Shares ($27.8 million), partially offset by organic growth ($12.7 million).

General and administrative expenses. General and administrative expenses decreased by $29.6 million, or 14.1%, from $210.0 million for the three months ended March 31, 2017 to $180.4 million for the three months ended March 31, 2018.

Net operating expense; net operating expense ratio (non-GAAP). Net operating expense decreased by $75.5 million, or 31.5%, from $239.8 million for the three months ended March 31, 2017 to $164.4 million for the three months ended March 31, 2018, primarily as a result of commission revenue from the Quota Shares. Our P&C segment net operating expense ratio decreased from 30.4% for the three months ended March 31, 2017 to 21.9% for the three months ended March 31, 2018, primarily as a result of increased scale, lower integration costs and the impact of the Quota Shares.

Underwriting income; net combined ratio (non-GAAP). Underwriting income increased from $0.3 million for the three months ended March 31, 2017 to $44.4 million for the three months ended March 31, 2018. Our P&C segment net combined ratio decreased from 100.0% for the three months ended March 31, 2017 to 94.1% for the three months ended March 31, 2018, with a lower net operating expense ratio in 2018 compared to 2017.



48


A&H Segment - Results of Operations for the Three Months Ended March 31, 2018 and 2017 (Unaudited)

 
 
Three Months Ended March 31,
 
 
2018
 
2017
 
 
(amounts in thousands)
Gross premium written
 
$
233,776

 
$
191,955

Ceded premiums
 
(10,423
)
 
(10,841
)
Net premium written
 
$
223,353

 
$
181,114

Change in unearned premium
 
(69,477
)
 
(52,188
)
Net earned premium
 
$
153,876

 
$
128,926

Ceding commission income
 
258

 
287

Service and fee income
 
45,187

 
32,273

Total underwriting revenues
 
$
199,321

 
$
161,486

Underwriting expenses:
 
 
 
 
Loss and loss adjustment expense
 
91,278

 
69,383

Acquisition costs and other underwriting expenses
 
43,608

 
31,490

General and administrative expenses
 
50,608

 
45,213

Total underwriting expenses
 
$
185,494

 
$
146,086

Underwriting income
 
$
13,827

 
$
15,400

Net loss ratio
 
59.3
%
 
53.8
%
Net operating expense ratio (non-GAAP)
 
31.7
%
 
34.2
%
Net combined ratio (non-GAAP)
 
91.0
%
 
88.0
%
 
 
 
 
 
 
 
Three Months Ended March 31,
Reconciliation of net operating expense ratio (non-GAAP):
 
2018
 
2017
 
 
(amounts in thousands)
Total underwriting expenses
 
$
185,494

 
$
146,086

Less: Loss and loss adjustment expense
 
91,278

 
69,383

Less: Ceding commission income
 
258

 
287

Less: Service and fee income
 
45,187

 
32,273

Net operating expense
 
$
48,771

 
$
44,143

Net earned premium
 
$
153,876

 
$
128,926

Net operating expense ratio (non-GAAP)
 
31.7
%
 
34.2
%

A&H Segment Results of Operations for the Three Months Ended March 31, 2018 Compared to the Three Months Ended March 31, 2017 (Unaudited)

Gross premium written. Gross premium written increased by $41.8 million, or 21.8%, from $192.0 million for the three months ended March 31, 2017 to $233.8 million for the three months ended March 31, 2018, as a result of organic growth, both domestic and international.

Net premium written. Net premium written increased by $42.2 million, or 23.3%, from $181.1 million for the three months ended March 31, 2017 to $223.4 million for the three months ended March 31, 2018, as a result of organic growth, both domestic and international.

Net earned premium. Net earned premium increased by $25.0 million, or 19.4%, from $128.9 million for the three months ended March 31, 2017 to $153.9 million for the three months ended March 31, 2018, as a result of organic growth, both domestic and international.


49


Service and fee income. Service and fee income increased by $12.9 million, or 40.0%, from $32.3 million for the three months ended March 31, 2017 to $45.2 million for the three months ended March 31, 2018, primarily due to growth in our domestic business and the adoption of the new revenue recognition standard. See Note 3, “Service and Fee Income” in the notes to our condensed consolidated financial statements for additional information.

The components of service and fee income are as follows:
 
 
Three Months Ended March 31,
 
 
 
 
 
 
2018
 
2017
 
Change
 
% Change
 
 
(amounts in thousands)
 
 
Group health administrative fees
 
$
19,291

 
$
14,561

 
$
4,730

 
32.5
 %
Commission revenue
 
17,524

 
10,669

 
6,855

 
64.3
 %
Finance and processing fees
 
1,255

 
2,484

 
(1,229
)
 
(49.5
)%
Late payment fees
 
25

 
31

 
(6
)
 
(19.4
)%
Other service and fee income
 
7,092

 
4,528

 
2,564

 
56.6
 %
Total
 
$
45,187

 
$
32,273

 
$
12,914

 
40.0
 %

Loss and loss adjustment expense; net loss ratio. Loss and LAE increased by $21.9 million, or 31.6%, from $69.4 million for the three months ended March 31, 2017 to $91.3 million for the three months ended March 31, 2018. Our A&H net loss ratio increased from 53.8% for the three months ended March 31, 2017 to 59.3% for the three months ended March 31, 2018. The loss ratio increase was a result of higher loss experience due to a change in product mix primarily in our domestic business.

Acquisition costs and other underwriting expenses. Acquisition costs and other underwriting expenses increased by $12.1 million, or 38.5%, from $31.5 million for the three months ended March 31, 2017 to $43.6 million for the three months ended March 31, 2018.

General and administrative expenses. General and administrative expenses increased by $5.4 million, or 11.9%, from $45.2 million for the three months ended March 31, 2017 to $50.6 million for the three months ended March 31, 2018.

Net operating expense; net operating expense ratio (non-GAAP). Net operating expense increased by $4.6 million, or 10.5%, from $44.1 million for the three months ended March 31, 2017 to $48.8 million for the three months ended March 31, 2018. Our A&H net operating expense ratio decreased from 34.2% for the three months ended March 31, 2017 to 31.7% for the three months ended March 31, 2018.

Underwriting income; net combined ratio (non-GAAP). Underwriting income decreased from $15.4 million for the three months ended March 31, 2017 to $13.8 million for the three months ended March 31, 2018. Our A&H net combined ratio increased from 88.0% for the three months ended March 31, 2017 to 91.0% for the three months ended March 31, 2018. The net combined ratio increase was primarily a result of a higher net loss ratio, partially offset by a lower net operating expense ratio.




50


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, debt 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 debt securities include obligations of the U.S. Treasury or U.S. government agencies, obligations of local and foreign governments, 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, commercial mortgage obligations, and structured securities primarily consisting of collateralized loan and debt obligations. Our equity securities include common and preferred stock primarily of U.S. and Canadian corporations.

The average yield on our investment portfolio was 2.7% and 2.8% for the three months ended March 31, 2018 and 2017, respectively, and the average duration of the portfolio was 4.16 and 4.96 years as of March 31, 2018 and 2017, respectively.

For more information related to our investments, see Note 4, “Investments” in the notes to our condensed consolidated financial statements.


Liquidity and Capital Resources

We are organized as a holding company with twenty-two domestic insurance company subsidiaries, various foreign insurance and reinsurance subsidiaries, as well as various other non-insurance subsidiaries. Our principal sources of operating funds are premiums, service and fee income, investment income and proceeds from sales and maturities of investments. The primary sources of cash for the management companies of the Reciprocal Exchanges are management fees for acting as the attorneys-in-fact for the exchanges. Our primary uses of operating funds include payments of claims and operating expenses. Currently, we pay claims using cash flow from operations and invest our excess cash primarily in debt securities and, to a lesser extent, equity securities. Except as set forth below, we expect that projected cash flows from operations, as well as the net proceeds from our debt and equity issuances, will provide us with sufficient liquidity to fund our anticipated growth by providing capital to increase the surplus of our insurance subsidiaries, as well as to pay claims and operating expenses, and to pay interest and principal on debt and debt facilities and other holding company expenses for the foreseeable future. However, if our growth attributable to potential acquisitions, internally generated growth, or a combination of these factors, exceeds our expectations, we may have to raise additional capital. If we cannot obtain adequate capital on favorable terms or at all, we may be unable to support future growth or operating requirements and, as a result, our business, financial condition and results of operations could be adversely affected. To support our current and future policy writings, we have raised substantial capital using a combination of debt and equity, and entered into third party quota share reinsurance agreements. We may raise additional capital over the next twelve months or obtain additional capital support in the form of third party quota share reinsurance.

We may generate liquidity through the issuance of debt or equity securities or financing through borrowings under credit facilities, or a combination thereof. We also have a $245.0 million credit agreement, under which there was $190.0 million outstanding as of March 31, 2018. The proceeds of borrowings under the credit agreement may be used for working capital, acquisitions and general corporate purposes. See “Revolving Credit Agreement” below.

Our insurance subsidiaries are subject to statutory and regulatory restrictions imposed on insurance companies by their place 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 domicile. The aggregate limit imposed by the various domiciliary regulatory authorities of our insurance subsidiaries was approximately $319.9 million and $387.6 million as of March 31, 2018 and December 31, 2017, respectively, taking into account dividends paid in the prior twelve month periods. During the three months ended March 31, 2018 and 2017, there were $80.0 million and $0.0 million, respectively, of dividends or return of capital paid by our insurance subsidiaries to their parent company or National General Holdings Corp.

We forecast claim payments based on our historical experience. We seek to manage the funding of claim payments by actively managing available cash and forecasting cash flows on both a short-term and long-term basis. Cash payments for claims were $614.5 million and $607.9 million in the three months ended March 31, 2018 and 2017, respectively. Historically, we have funded claim payments from cash flow from operations (principally premiums), net of amounts ceded to our third-party reinsurers. We


51


presently expect to maintain sufficient cash flow from operations to meet our anticipated claim obligations and operating and capital expenditure needs. Our cash and cash equivalents (including restricted cash) and total investments were $4.0 billion at March 31, 2018 and $4.0 billion at December 31, 2017. We do not anticipate selling securities in our investment portfolio to pay claims or to fund operating expenses. Should circumstances arise that would require us to do so, we may incur losses on such sales, which would adversely affect our results of operations and financial condition and could reduce investment income in future periods.

Pursuant to a tax allocation agreement by and among us and certain of our direct and indirect subsidiaries, we compute and pay federal income taxes on a consolidated basis. Each subsidiary party to this agreement computes and pays to us its respective share of the federal income tax liability primarily based on separate return calculations.

The following table is a summary of our statement of cash flows:
 
 
Three Months Ended March 31,
 
 
 
 
 
 
2018
 
2017
 
Change
 
% Change
 
 
(amounts in thousands)
 
 
Net cash provided by operating activities
 
$
51,942

 
$
138,141

 
$
(86,199
)
 
(62.4
)%
Net cash used in investing activities
 
(16,947
)
 
(156,454
)
 
139,507

 
(89.2
)%
Net cash used in financing activities
 
(12,993
)
 
(12,838
)
 
(155
)
 
1.2
 %
Effect of exchange rate changes on cash and cash equivalents
 
(1,433
)
 
246

 
(1,679
)
 
nm

Net increase (decrease) in cash, cash equivalents, and restricted cash
 
$
20,569

 
$
(30,905
)
 
$
51,474

 
nm

nm - not meaningful

Comparison of the Three Months Ended March 31, 2018 and 2017

Net cash provided by operating activities decreased by $86.2 million, primarily reflecting a reduction in accounts payable offset by higher net income.

Net cash used in investing activities decreased by $139.5 million, primarily reflecting an increase of $110.6 million in net proceeds from purchases and sales of investments.




52


Condensed Consolidated Balance Sheets
 
March 31, 2018
 
NGHC
 
Reciprocal Exchanges
 
Eliminations
 
Total
ASSETS
(amounts in thousands)
Investments:
 
 
 
 
 
 
 
Debt securities, available-for-sale, at fair value
$
2,933,580

 
$
310,740

 
$
—

 
$
3,244,320

Equity securities, at fair value
50,157

 
—

 
—

 
50,157

Short-term investments
18,144

 
21,825

 
—

 
39,969

Other investments
405,062

 
—

 
(89,192
)
 
315,870

Total investments
3,406,943

 
332,565

 
(89,192
)
 
3,650,316

Cash and cash equivalents
316,057

 
5,880

 
—

 
321,937

Restricted cash and cash equivalents
55,442

 
674

 
—

 
56,116

Accrued investment income
38,832

 
2,229

 
(17,970
)
 
23,091

Premiums and other receivables, net
1,449,891

 
49,581

 
(1,601
)
 
1,497,871

Deferred acquisition costs
211,965

 
21,635

 
—

 
233,600

Reinsurance recoverable
1,227,476

 
107,250

 
—

 
1,334,726

Prepaid reinsurance premiums
431,342

 
98,229

 
(801
)
 
528,770

Premises and equipment, net
312,865

 
3,527

 
—

 
316,392

Intangible assets, net
393,766

 
3,640

 
—

 
397,406

Goodwill
174,153

 
—

 
—

 
174,153

Prepaid and other assets
132,450

 
2,318

 
—

 
134,768

Total assets
$
8,151,182

 
$
627,528

 
$
(109,564
)
 
$
8,669,146

LIABILITIES AND STOCKHOLDERS’ EQUITY
 
 
 
 
 
 
 
Liabilities:
 
 
 
 
 
 
 
Unpaid loss and loss adjustment expense reserves
$
2,520,121

 
$
158,796

 
$
—

 
$
2,678,917

Unearned premiums and other revenue
2,003,147

 
228,198

 
(801
)
 
2,230,544

Reinsurance payable
378,517

 
60,155

 
(1,601
)
 
437,071

Accounts payable and accrued expenses
401,407

 
28,110

 
(17,970
)
 
411,547

Debt
713,893

 
89,192

 
(89,192
)
 
713,893

Other liabilities
177,008

 
55,513

 
—

 
232,521

Total liabilities
$
6,194,093

 
$
619,964

 
$
(109,564
)
 
$
6,704,493

Stockholders’ equity:
 
 
 
 
 
 
 
Common stock
$
1,069

 
$
—

 
$
—

 
$
1,069

Preferred stock
420,000

 
—

 
—

 
420,000

Additional paid-in capital
919,029

 
—

 
—

 
919,029

Accumulated other comprehensive loss
(45,722
)
 
—

 
—

 
(45,722
)
Retained earnings
662,713

 
—

 
—

 
662,713

Total National General Holdings Corp. Stockholders’ Equity
1,957,089

 
—

 
—

 
1,957,089

Non-controlling interest
—

 
7,564

 
—

 
7,564

Total stockholders’ equity
$
1,957,089

 
$
7,564

 
$
—

 
$
1,964,653

Total liabilities and stockholders’ equity
$
8,151,182

 
$
627,528

 
$
(109,564
)
 
$
8,669,146



53



 
December 31, 2017
 
NGHC
 
Reciprocal Exchanges
 
Eliminations
 
Total
ASSETS
(amounts in thousands)
Investments:
 
 
 
 
 
 
 
Debt securities, available-for-sale, at fair value
$
2,834,955

 
$
304,934

 
$
—

 
$
3,139,889

Equity securities, at fair value
50,341

 
—

 
—

 
50,341

Short-term investments
15,987

 
22,279

 
—

 
38,266

Other investments
510,447

 
—

 
(89,155
)
 
421,292

Total investments
3,411,730

 
327,213

 
(89,155
)
 
3,649,788

Cash and cash equivalents
286,840

 
5,442

 
—

 
292,282

Restricted cash and cash equivalents
64,593

 
609

 
—

 
65,202

Accrued investment income
36,422

 
1,805

 
(15,855
)
 
22,372

Premiums and other receivables, net
1,268,330

 
56,792

 
(801
)
 
1,324,321

Deferred acquisition costs
195,552

 
20,837

 
—

 
216,389

Reinsurance recoverable
1,199,961

 
94,204

 
—

 
1,294,165

Prepaid reinsurance premiums
416,142

 
100,980

 
—

 
517,122

Premises and equipment, net
319,780

 
4,269

 
—

 
324,049

Intangible assets, net
400,385

 
3,685

 
—

 
404,070

Goodwill
174,153

 
—

 
—

 
174,153

Prepaid and other assets
153,567

 
2,263

 
—

 
155,830

Total assets
$
7,927,455

 
$
618,099

 
$
(105,811
)
 
$
8,439,743

LIABILITIES AND STOCKHOLDERS’ EQUITY
 
 
 
 
 
 
 
Liabilities:
 
 
 
 
 
 
 
Unpaid loss and loss adjustment expense reserves
$
2,520,204

 
$
143,353

 
$
—

 
$
2,663,557

Unearned premiums and other revenue
1,807,210

 
225,395

 
—

 
2,032,605

Reinsurance payable
329,772

 
69,076

 
(801
)
 
398,047

Accounts payable and accrued expenses
423,054

 
24,682

 
(15,855
)
 
431,881

Debt
713,710

 
89,155

 
(89,155
)
 
713,710

Other liabilities
204,936

 
41,582

 
—

 
246,518

Total liabilities
$
5,998,886

 
$
593,243

 
$
(105,811
)
 
$
6,486,318

Stockholders’ equity:
 
 
 
 
 
 
 
Common stock
$
1,067

 
$
—

 
$
—

 
$
1,067

Preferred stock
420,000

 
—

 
—

 
420,000

Additional paid-in capital
917,751

 
—

 
—

 
917,751

Accumulated other comprehensive loss
(8,112
)
 
—

 
—

 
(8,112
)
Retained earnings
597,863

 
—

 
—

 
597,863

Total National General Holdings Corp. Stockholders’ Equity
1,928,569

 
—

 
—

 
1,928,569

Non-controlling interest
—

 
24,856

 
—

 
24,856

Total stockholders’ equity
$
1,928,569

 
$
24,856

 
$
—

 
$
1,953,425

Total liabilities and stockholders’ equity
$
7,927,455

 
$
618,099

 
$
(105,811
)
 
$
8,439,743



54


Other Material Changes in Financial Position
 
March 31, 2018
 
December 31, 2017
 
Change
 
% Change
 
(amounts in thousands)
 
 
Selected Assets:
 
 
 
 
 
 
 
Premiums and other receivables, net
$
1,497,871

 
$
1,324,321

 
$
173,550

 
13.1
%
 
 
 
 
 
 
 
 
Selected Liabilities:
 
 
 
 
 
 
 
Unearned premiums and other revenue
$
2,230,544

 
$
2,032,605

 
$
197,939

 
9.7
%

Changes in Financial Position During the Three Months Ended March 31, 2018 Compared to December 31, 2017

Premiums and other receivables increased by $173.6 million, primarily driven by growth in our P&C segment ($99.8 million) and A&H segment ($92.7 million). Unearned premiums and other revenue increased by $197.9 million, driven by growth in our P&C segment ($149.9 million) and A&H segment ($48.0 million).


Reinsurance

Our insurance subsidiaries utilize reinsurance agreements to transfer portions of the underlying risk of the business we write to various affiliated and third-party reinsurers. Reinsurance does not discharge or diminish our obligation to pay claims covered by the insurance policies we issue; however, it does permit us to recover certain incurred losses from our reinsurers and our reinsurance recoveries reduce the maximum loss that we may incur as a result of a covered loss event. We believe it is important to ensure that our reinsurance partners are financially strong and they generally carry at least an A.M. Best rating of “A-” (Excellent) or are fully collateralized at the time we enter into our reinsurance agreements. We also enter into reinsurance relationships with third-party captives formed by agents as a mechanism for sharing risk and profit. The total amount, cost and limits relating to the reinsurance coverage we purchase may vary from year to year based upon a variety of factors, including the availability of quality reinsurance at an acceptable price and the level of risk that we choose to retain for our own account.

We assume and cede insurance risks under various reinsurance agreements, on both a pro rata basis and an excess of loss basis. We purchase reinsurance to mitigate the volatility of direct and assumed business, which may be caused by the aggregate value or the concentration of written exposures in a particular geographic area or business segment and may arise from catastrophes or other events. As part of our overall risk and capacity management strategy, we purchase various quota share, excess of loss catastrophic and casualty reinsurance for protection against catastrophic events and other large losses.

For more information on our reinsurance agreements, refer to our Annual Report on Form 10-K for the year ended December 31, 2017, and Note 8, “Reinsurance” in the notes to our condensed consolidated financial statements.




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Debt

7.625% Subordinated Notes due 2055

We have $100.0 million aggregate principal amount outstanding of our 7.625% subordinated notes due 2055 (the “7.625% Notes”). The 7.625% Notes bear interest at a rate equal to 7.625% per year, payable quarterly in arrears on March 15, June 15, September 15 and December 15 of each year. The 7.625% Notes are our subordinated unsecured obligations and are structurally subordinated to all existing and future indebtedness, liabilities and other obligations of our subsidiaries. The 7.625% Notes mature on September 15, 2055, unless earlier redeemed or purchased by us. Interest expense on the 7.625% Notes for the three months ended March 31, 2018 and 2017, was $1.9 million and $1.9 million, respectively. For more information on the 7.625% Notes including ranking and restrictive covenants, see Note 9, “Debt” in the notes to our condensed consolidated financial statements.


6.75% Notes due 2024

We have $350.0 million aggregate principal amount outstanding of our 6.75% Notes due 2024 (the “6.75% Notes”). The 6.75% Notes bear interest at a rate equal to 6.75% per year, payable semiannually in arrears on May 15 and November 15 of each year. The 6.75% Notes are our general unsecured obligations and rank equally in right of payment with our other existing and future senior unsecured indebtedness and senior in right of payment to any of our indebtedness that is contractually subordinated to the 6.75% Notes. The 6.75% Notes mature on May 15, 2024, unless earlier redeemed or purchased by us. Interest expense on the 6.75% Notes for the three months ended March 31, 2018 and 2017, was $5.9 million and $5.8 million, respectively. For more information on the 6.75% Notes including ranking and restrictive covenants, see Note 9, “Debt” in the notes to our condensed consolidated financial statements.


Revolving Credit Agreement

On January 25, 2016, we entered into a credit agreement (the “Credit Agreement”), among JPMorgan Chase Bank, N.A., as Administrative Agent, KeyBank National Association as Syndication Agent, and Associated Bank, National Association and First Niagara Bank, N.A., as Co-Documentation Agents, and the various lending institutions party thereto. The credit facility is a $245.0 million base revolving credit facility with a letter of credit sublimit of $112.5 million and an expansion feature not to exceed $50.0 million. Proceeds of borrowings under the Credit Agreement may be used for working capital, acquisitions and general corporate purposes. The Credit Agreement has a maturity date of January 25, 2020.

Borrowings under the Credit Agreement bear interest at either the Alternate Base Rate (“ABR”) or LIBOR. ABR borrowings (which are borrowings bearing interest at a rate determined by reference to the ABR) under the Credit Agreement will bear interest at the greatest of (a) the prime rate in effect on such day, (b) the federal funds effective rate on such day plus 0.5 percent or (c) the adjusted LIBOR for a one-month interest period on such day plus 1.0 percent. Eurodollar borrowings under the Credit Agreement will bear interest at the adjusted LIBOR for the interest period in effect. Fees payable by us under the Credit Agreement include a letter of credit participation fee (the margin applicable to Eurodollar borrowings), a letter of credit fronting fee with respect to each letter of credit (0.125%) and a commitment fee on the available commitments of the lenders (a range of 0.20% to 0.30% based on our consolidated leverage ratio, and which rate was 0.30% as of March 31, 2018).

As March 31, 2018, there was $190.0 million outstanding under the Credit Agreement. The weighted average interest rate on the amount outstanding as of March 31, 2018 was 4.23%. Interest payments are due the last day of the interest period in intervals of three months duration, commencing on the date of such borrowing. Interest expense on the Credit Agreement for the three months ended March 31, 2018 and 2017 was $1.7 million and $0.4 million, respectively. For more information on the Credit Agreement including ranking and restrictive covenants, see Note 9, “Debt” in the notes to our condensed consolidated financial statements.




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Item 3. Quantitative and Qualitative Disclosures About Market Risk

Liquidity Risk. Liquidity risk represents our potential inability to meet all payment obligations when they become due. We maintain sufficient cash and marketable securities to fund claim payments and operations. We purchase reinsurance coverage to mitigate the risk of an unexpected rise in claims severity or frequency from catastrophic events or a single large loss. The availability, amount and cost of reinsurance depend on market conditions and may vary significantly.

Credit Risk. Credit risk is the potential loss arising principally from adverse changes in the financial condition of the issuers of our debt securities and the financial condition of our reinsurers.

We address the credit risk related to the issuers of our debt securities by investing primarily in debt securities that are rated “BBB-” or higher by Standard & Poor’s. We also independently monitor the financial condition of all issuers of our debt securities. To limit our risk exposure, we employ diversification policies that limit the credit exposure to any single issuer or business sector.

We are subject to credit risk with respect to our reinsurers. Although our reinsurers are obligated to reimburse us to the extent we cede risk to them, we are ultimately liable to our policyholders on all risks we have ceded. As a result, reinsurance contracts do not limit our ultimate obligations to pay claims covered under the insurance policies we issue and we might not collect amounts recoverable from our reinsurers. We address this credit risk by selecting reinsurers that generally carry at least an A.M. Best rating of “A-” (Excellent) or are fully collateralized at the time we enter into the agreement and by performing, along with our reinsurance broker, periodic credit reviews of our reinsurers. If one of our reinsurers suffers a credit downgrade, we may consider various options to lessen the risk of asset impairment, including commutation, novation and letters of credit. See Item 2, “Management’s Discussion and Analysis of Financial Condition and Results of Operations — Reinsurance.”

Market Risk. Market risk is the risk of potential economic loss principally arising from adverse changes in the fair value of financial instruments. The major components of market risk affecting us are interest rate risk and equity price risk.

Interest Rate Risk. We had debt securities and preferred stock securities with a fair value of $3.2 billion as of March 31, 2018 that are subject to interest rate risk. Interest rate risk is the risk that we may incur losses due to adverse changes in interest rates. Fluctuations in interest rates have a direct impact on the market valuation of our debt securities. We manage our exposure to interest rate risk through a disciplined asset and liability matching and capital management process. In the management of this risk, the characteristics of duration, credit and variability of cash flows are critical elements. These risks are assessed regularly and balanced within the context of our liability and capital position.

The table below summarizes the interest rate risk by illustrating the sensitivity of the fair value and carrying value of our debt securities as of March 31, 2018 to selected hypothetical changes in interest rates, and the associated impact on our stockholders’ equity. We anticipate that we will continue to meet our obligations out of income. We classify our debt securities primarily as available for sale. Temporary changes in the fair value of our debt securities impact the carrying value of these securities and are reported in our stockholders’ equity as a component of accumulated other comprehensive income, net of taxes.

The selected scenarios with our debt securities (and excluding $2.2 million of preferred stock securities), in the table below are not predictions of future events, but rather are intended to illustrate the effect such events may have on the fair value and carrying value of our debt securities and on our stockholders’ equity, each as of March 31, 2018.
Hypothetical Change in Interest Rates
 
Fair Value
 
Estimated
Change in
Fair Value
 
Hypothetical Percentage
Increase (Decrease) in
Stockholders’ Equity
 
 
(amounts in thousands)
 
 
200 basis point increase
 
$
2,994,507

 
$
(249,813
)
 
(10.0
)%
100 basis point increase
 
3,114,547

 
(129,773
)
 
(5.2
)
No change
 
3,244,320

 
—

 
—

100 basis point decrease
 
3,377,337

 
133,017

 
5.3

200 basis point decrease
 
3,516,843

 
272,523

 
11.0


Changes in interest rates would affect the fair market value of our fixed-rate debt instruments but would not have an impact on our earnings or cash flow. We currently have $721.2 million principal amount of debt instruments of which $450.0 million are


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fixed-rate debt instruments. A fluctuation of 100 basis points in interest on our variable-rate debt instruments, which are tied to LIBOR, would affect our earnings and cash flows by $2.7 million before income tax, on an annual basis, but would not affect the fair market value of the variable-rate debt.

Off-Balance Sheet Risk. As of March 31, 2018 we did not have any off-balance sheet arrangements that have or are likely to have a material effect on our financial condition or results of operations.




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Item 4. Controls and Procedures

Disclosure Controls and Procedures

Our management, with the participation and under the supervision of our Chief Executive Officer and Chief Financial Officer, has evaluated the effectiveness of our disclosure controls and procedures (as such term is defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934, as amended (the “Exchange Act”)) as of the end of the period covered by this report. Based on such evaluation, our Chief Executive Officer and Chief Financial Officer have concluded that, as of the end of such period, our disclosure controls and procedures are effective in ensuring that information required to be disclosed by us in the reports we file or submit under the Exchange Act is timely recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and forms, and accumulated and communicated to our management, including our principal executive officer and principal financial officer, as appropriate, to allow timely decisions regarding required disclosure.

Changes in Internal Controls Over Financial Reporting

There have not been any changes in our internal control over financial reporting (as such term is defined in Rules 13a-15(f) and 15d-15(f) under the Exchange Act) during the fiscal quarter ended March 31, 2018 that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.




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PART II - OTHER INFORMATION

Item 1. Legal Proceedings

We are routinely involved in legal proceedings arising in the ordinary course of business, in particular in connection with claims adjudication with respect to our policies. We believe we have recorded adequate reserves for these liabilities and that there is no individual case pending that is likely to have a material adverse effect on our financial condition or results of operations.


Item 1A. Risk Factors

There have been no material changes to the Risk Factors described in Part I “Item 1A. Risk Factors” in the Company’s Annual Report on Form 10-K for the fiscal year ended December 31, 2017 as filed with the SEC.


Item 6. Exhibits

INDEX TO EXHIBITS

The following documents are filed as exhibits to this report:
Exhibit No.
 
Description
 
 
 
12.1
 
31.1
 
31.2
 
32.1
 
32.2
 
101.1
 
The following materials from the Company’s Quarterly Report on Form 10-Q for the quarter ended March 31, 2018, formatted in XBRL (Extensible Business Reporting Language): (i) the Condensed Consolidated Balance Sheets at March 31, 2018 and December 31, 2017; (ii) the Condensed Consolidated Statements of Income for the three months ended March 31, 2018 and 2017; (iii) the Condensed Consolidated Statements of Comprehensive Income for the three months ended March 31, 2018 and 2017; (iv) the Condensed Consolidated Statements of Changes in Stockholders’ Equity for the three months ended March 31, 2018 and 2017; (v) the Condensed Consolidated Statements of Cash Flows for the three months ended March 31, 2018 and 2017; and (vi) the Notes to Unaudited Condensed Consolidated Financial Statements (submitted electronically herewith)


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SIGNATURES

Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.


 
NATIONAL GENERAL HOLDINGS CORP.
May 7, 2018
 
 
 
By:
/s/ Barry Karfunkel
 
 
Name: Barry Karfunkel
Title: Chief Executive Officer
(Principal Executive Officer)
 
 
 
 
By:
/s/ Michael Weiner
 
 
Name: Michael Weiner
Title: Chief Financial Officer
(Principal Financial Officer)




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