Document

UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, DC 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 June 30, 2016

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)
 
(IRS 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, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):

Large Accelerated Filer x
 
Accelerated Filer o
 
Non-Accelerated Filer o
(Do not check if a smaller
reporting company)
 
Smaller Reporting Company 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 August 3, 2016, the number of common shares of the registrant outstanding was 105,932,281.





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)
 
June 30,
2016
 
December 31,
2015
ASSETS
(unaudited)
 
(audited)
Investments - NGHC
 
 
 
Fixed maturities, available-for-sale, at fair value (amortized cost $2,299,155 and $2,081,456)
$
2,385,461

 
$
2,063,051

Equity securities, available-for-sale, at fair value (cost $126,787 and $63,303)
110,500

 
57,216

Short-term investments
52,708

 
1,528

Equity investment in unconsolidated subsidiaries
245,703

 
234,948

Other investments
59,360

 
13,031

Securities pledged (amortized cost $132,300 and $54,955)
137,448

 
55,394

Investments - Exchanges
 
 
 
Fixed maturities, available-for-sale, at fair value (amortized cost $277,473 and $244,069)
290,569

 
238,969

Equity securities, available-for-sale, at fair value (cost $0 and $1,501)

 
1,574

Short-term investments

 
1,999

Total investments
3,281,749

 
2,667,710

Cash and cash equivalents (Exchanges - $12,990 and $8,393)
271,694

 
282,277

Accrued investment income (Exchanges - $2,643 and $2,347)
25,337

 
20,402

Premiums and other receivables, net (Related parties $32,362 and $62,306) (Exchanges - $58,402 and $56,194)
893,373

 
758,633

Deferred acquisition costs (Exchanges - $14,362 and $23,803)
174,660

 
160,531

Reinsurance recoverable on unpaid losses (Related parties - $33,746 and $42,774) (Exchanges - $39,617 and $39,085)
853,559

 
833,176

Prepaid reinsurance premiums (Exchanges - $61,912 and $61,730)
146,405

 
128,343

Income tax receivable (Exchanges - $300 and $300)
300

 
300

Notes receivable from related party
125,000

 
125,057

Due from affiliate (Exchanges - $0 and $12,060)
29,774

 
41,536

Premises and equipment, net (Exchanges - $2,812 and $332)
79,224

 
42,931

Intangible assets, net (Exchanges - $25,433 and $4,825)
383,700

 
348,898

Goodwill
208,971

 
112,414

Prepaid and other assets (Exchanges - $89 and $93)
39,195

 
41,184

Total assets
$
6,512,941

 
$
5,563,392

LIABILITIES AND STOCKHOLDERS’ EQUITY
 
 
 
Liabilities:
 
 
 
Unpaid loss and loss adjustment expense reserves (Exchanges - $133,531 and $132,392)
$
1,966,752

 
$
1,755,624

Unearned premiums (Exchanges - $148,502 and $146,186)
1,425,139

 
1,192,499

Unearned service contract and other revenue
22,330

 
12,504

Reinsurance payable (Related parties - $31,511 and $31,923) (Exchanges - $21,928 and $14,357)
91,961

 
69,172

Accounts payable and accrued expenses (Related parties - $27,930 and $51,755) (Exchanges - $4,497 and $19,845)
279,281

 
284,902

Due to affiliate (Exchanges - $7,520 and $0)
7,520

 

Securities sold under agreements to repurchase, at contract value
119,472

 
52,484

Deferred tax liability (Exchanges - $26,993 and $32,724)
21,436

 
12,247

Income tax payable
24,883

 
5,593

Debt (Exchanges owed to related party - $0 and $45,476)
678,715

 
491,537


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)
Other liabilities (Exchanges - $38,246 and $38,105)
167,886

 
150,190

Total liabilities
4,805,375

 
4,026,752

Commitments (Note 16)


 


Stockholders’ equity:
 
 
 
Common stock, $0.01 par value - authorized 150,000,000 shares, issued and outstanding 105,932,281 shares - 2016; authorized 150,000,000 shares, issued and outstanding 105,554,331 shares - 2015
1,059

 
1,056

Preferred stock, $0.01 par value - authorized 10,000,000 shares, issued and outstanding 2,365,000 shares - 2016; authorized 10,000,000 shares, issued and outstanding 2,365,000 shares - 2015. Aggregate liquidation preference $220,000 - 2016, $220,000 - 2015
220,000

 
220,000

Additional paid-in capital
908,276

 
900,114

Accumulated other comprehensive income (loss):
 
 
 
Unrealized foreign currency translation adjustments
(4,135
)
 
(3,780
)
Unrealized gains (losses) on investments
48,859

 
(15,634
)
Total accumulated other comprehensive income (loss)
44,724

 
(19,414
)
Retained earnings
502,741

 
412,044

Total National General Holdings Corp. Stockholders' Equity
1,676,800

 
1,513,800

Non-controlling interest (Exchanges - $30,588 and $22,619)
30,766

 
22,840

Total stockholders’ equity
1,707,566

 
1,536,640

Total liabilities and stockholders' equity
$
6,512,941

 
$
5,563,392


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 June 30,
 
Six Months Ended June 30,
 
2016
 
2015
 
2016
 
2015
Revenues:
 
 
 
 
 
 
 
Premium income:
 
 
 
 
 
 
 
Gross premium written
$
850,507

 
$
575,681

 
$
1,666,701

 
$
1,219,136

Ceded premiums (related parties - three months $733; $373 and six months $1,141; $721)
(113,058
)
 
(96,271
)
 
(184,665
)
 
(209,701
)
Net premium written
737,449

 
479,410

 
1,482,036

 
1,009,435

Change in unearned premium
(24,509
)
 
(10,594
)
 
(114,176
)
 
(61,454
)
Net earned premium
712,940

 
468,816

 
1,367,860

 
947,981

Ceding commission income
11,704

 
9,970

 
9,809

 
15,050

Service and fee income
90,017

 
57,558

 
186,961

 
112,428

Net investment income
27,528

 
18,335

 
49,198

 
34,483

Net realized gain on investments
4,382

 
389

 
7,999

 
1,576

Other revenue (expense)
(387
)
 
(1,415
)
 
314

 
(170
)
Total revenues
846,184

 
553,653

 
1,622,141

 
1,111,348

Expenses:
 
 
 
 
 
 
 
Loss and loss adjustment expense
472,358

 
286,829

 
881,408

 
593,515

Acquisition costs and other underwriting expenses
108,874

 
96,502

 
221,773

 
186,387

General and administrative expenses
191,120

 
119,158

 
367,747

 
224,845

Interest expense
8,939

 
8,601

 
18,080

 
17,681

Total expenses
781,291

 
511,090

 
1,489,008

 
1,022,428

Income before provision for income taxes and equity in earnings of unconsolidated subsidiaries
64,893

 
42,563

 
133,133

 
88,920

Provision for income taxes
14,551

 
7,891

 
32,634

 
16,278

Income before equity in earnings of unconsolidated subsidiaries
50,342

 
34,672

 
100,499

 
72,642

Equity in earnings of unconsolidated subsidiaries
7,356

 
1,654

 
14,038

 
6,612

Net income
57,698

 
36,326

 
114,537

 
79,254

Less: Net (income) loss attributable to non-controlling interest
(9,228
)
 
2,201

 
(9,240
)
 
2,041

Net income attributable to National General Holdings Corp. ("NGHC")
$
48,470

 
$
38,527

 
$
105,297

 
$
81,295

Dividends on preferred stock
(4,125
)
 
(4,744
)
 
(8,250
)
 
(5,775
)
Net income attributable to NGHC common stockholders
$
44,345

 
$
33,783

 
$
97,047

 
$
75,520

Earnings per common share:
 
 
 
 
 
 
 
Basic earnings per share
$
0.42

 
$
0.36

 
$
0.92

 
$
0.81

Diluted earnings per share
$
0.41

 
$
0.35

 
$
0.90

 
$
0.79

Dividends declared per common share
$
0.03

 
$
0.02

 
$
0.06

 
$
0.04

Weighted average common shares outstanding:
 
 
 
 
 
 
 
Basic
105,803,802

 
93,597,448

 
105,700,682

 
93,527,977

Diluted
108,197,897

 
96,181,037

 
107,987,406

 
96,005,397

Net realized gain on investments:
 
 
 
 
 
 
 
Other-than-temporary impairment loss
$

 
$
(1,467
)
 
$

 
$
(2,483
)
Portion of loss recognized in other comprehensive income

 

 

 

Net impairment losses recognized in earnings

 
(1,467
)
 

 
(2,483
)
Other net realized gain on investments
4,382

 
1,856

 
7,999

 
4,059

Net realized gain on investments
$
4,382

 
$
389

 
$
7,999

 
$
1,576


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 June 30,
 
Six Months Ended June 30,
 
2016
 
2015
 
2016
 
2015
Net income
$
57,698

 
$
36,326

 
$
114,537

 
$
79,254

Other comprehensive income (loss), net of tax:
 
 
 
 
 
 
 
Foreign currency translation adjustment
(1,221
)
 
2,728

 
(355
)
 
3,752

Gross unrealized holding gain (loss) on securities, net of tax of $27,351 and $(10,932) for the three months ended June 30, 2016 and 2015, respectively, and $41,046 and $(4,527) for the six months ended June 30, 2016 and 2015, respectively
50,796

 
(25,005
)
 
76,229

 
(11,065
)
Reclassification adjustments for investment gain/loss included in net income:
 
 
 
 
 
 
 
Other-than-temporary impairment loss, net of tax of $0 and $513 for the three months ended June 30, 2016 and 2015, respectively, and $0 and $869 for the six months ended June 30, 2016 and 2015, respectively

 
954

 

 
1,614

Other net realized gain on investments, net of tax of $(1,534) and $(650) for the three months ended June 30, 2016 and 2015, respectively, and $(2,800) and $(1,421) for the six months ended June 30, 2016 and 2015, respectively
(2,848
)
 
(1,206
)
 
(5,199
)
 
(2,638
)
Other comprehensive income (loss), net of tax
46,727

 
(22,529
)
 
70,675

 
(8,337
)
Comprehensive income
104,425

 
13,797

 
185,212

 
70,917

Less: Comprehensive (income) loss attributable to non-controlling interest
(15,765
)
 
7,040

 
(15,777
)
 
5,179

Comprehensive income attributable to NGHC
$
88,660

 
$
20,837

 
$
169,435

 
$
76,096




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)

 
Six Months Ended June 30, 2016
 
Common Stock
 
Preferred Stock
 
 
 
 
 
 
 
 
 
 
 
Shares
 
$
 
Shares
 
$
 
Additional Paid-in Capital
 
Retained Earnings
 
Accumulated Other Comprehensive Income (Loss)
 
Non-controlling Interest
 
Total
Balance January 1, 2016
105,554,331

 
$
1,056

 
2,365,000

 
$
220,000

 
$
900,114

 
$
412,044

 
$
(19,414
)
 
$
22,840

 
$
1,536,640

Cumulative effect adjustment of change in accounting principle

 

 

 

 

 

 

 
(22,619
)
 
(22,619
)
Net income

 

 

 

 

 
105,297

 

 
9,240

 
114,537

Foreign currency translation adjustment, net of tax

 

 

 

 

 

 
(355
)
 

 
(355
)
Change in unrealized gain on investments, net of tax

 

 

 

 

 

 
64,493

 
6,537

 
71,030

Reciprocal Exchanges' equity on March 31, 2016, date of consolidation

 

 

 

 

 

 

 
14,768

 
14,768

Preferred stock dividends

 

 

 

 

 
(8,250
)
 

 

 
(8,250
)
Common stock dividends

 

 

 

 

 
(6,350
)
 

 

 
(6,350
)
Return of capital

 

 

 

 
(150
)
 

 

 

 
(150
)
Common stock issued under employee stock plans and exercises of stock options
377,950

 
3

 

 

 
3,064

 

 

 

 
3,067

Stock-based compensation

 

 

 

 
4,148

 

 

 

 
4,148

Tax benefit from stock-based compensation

 

 

 

 
1,100

 

 

 

 
1,100

Balance June 30, 2016
105,932,281

 
$
1,059

 
2,365,000

 
$
220,000

 
$
908,276

 
$
502,741

 
$
44,724

 
$
30,766

 
$
1,707,566


 
Six Months Ended June 30, 2015
 
Common Stock
 
Preferred Stock
 
 
 
 
 
 
 
 
 
 
 
Shares
 
$
 
Shares
 
$
 
Additional Paid-in Capital
 
Retained Earnings
 
Accumulated Other Comprehensive Income
 
Non-controlling Interest
 
Total
Balance January 1, 2015
93,427,382

 
$
934

 
2,200,000

 
$
55,000

 
$
690,736

 
$
292,832

 
$
20,192

 
$
13,756

 
$
1,073,450

Net income

 

 

 

 

 
81,295

 

 
(2,041
)
 
79,254

Foreign currency translation adjustment, net of tax

 

 

 

 

 

 
3,752

 

 
3,752

Change in unrealized loss on investments, net of tax

 

 

 

 

 

 
(8,951
)
 
(3,138
)
 
(12,089
)
Change in non-controlling interest

 

 

 

 

 

 

 
(942
)
 
(942
)
Preferred stock dividends

 

 

 

 

 
(5,775
)
 

 

 
(5,775
)
Common stock dividends

 

 

 

 

 
(3,743
)
 

 

 
(3,743
)
Issuance of preferred stock

 

 
165,000

 
165,000

 
(5,448
)
 

 

 

 
159,552

Common stock issued under employee stock plans and exercises of stock options
286,604

 
3

 

 

 
1,415

 

 

 

 
1,418

Stock-based compensation

 

 

 

 
2,264

 

 

 

 
2,264

Balance June 30, 2015
93,713,986

 
$
937

 
2,365,000

 
$
220,000

 
$
688,967

 
$
364,609

 
$
14,993

 
$
7,635

 
$
1,297,141




See accompanying notes to unaudited condensed consolidated financial statements.
5



NATIONAL GENERAL HOLDINGS CORP.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(In Thousands)
(Unaudited)
 
 
 
 
 
 
 
 
 
Six Months Ended June 30,
 
2016
 
2015
Cash flows from operating activities:
 
 
 
Net income
$
114,537

 
$
79,254

Reconciliation of net income to net cash provided by (used in) operating activities:
 
 
 
Depreciation and amortization
27,378

 
14,751

Net amortization of premium on fixed maturities
(1,936
)
 
2,565

Net amortization of discount on debt
366

 
4,173

Stock-compensation expense
4,148

 
2,264

Equity in earnings of unconsolidated subsidiaries
(14,038
)
 
(6,612
)
Net realized gain on investments
(7,999
)
 
(4,059
)
Other-than-temporary impairment loss

 
2,483

Bad debt expense
14,061

 
10,722

Foreign currency translation adjustment, net of tax
461

 
1,204

Changes in assets and liabilities:
 
 
 
Accrued investment income
(1,010
)
 
(988
)
Premiums and other receivables
(101,789
)
 
(102,993
)
Deferred acquisition costs, net
(37,095
)
 
(15,261
)
Reinsurance recoverable on unpaid losses
(3,165
)
 
33,132

Prepaid reinsurance premiums
(20,086
)
 
(21,133
)
Prepaid expenses and other assets
10,443

 
809

Unpaid loss and loss adjustment expense reserves
63,369

 
(8,581
)
Unearned premiums
134,920

 
81,339

Unearned service contract and other revenue
9,826

 
30,424

Reinsurance payable
18,422

 
(21,958
)
Accounts payable
(73,884
)
 
(23,163
)
Income tax payable
19,290

 
15,651

Deferred tax liability
(14,363
)
 
(32,107
)
Other liabilities
13,277

 
42,358

Net cash provided by operating activities
155,133

 
84,274

Cash flows from investing activities:
 
 
 
Investment in unconsolidated subsidiaries
(6,625
)
 
(17,425
)
Distributions from unconsolidated subsidiaries
10,158

 
1,923

Purchases of other investments
(133,180
)
 
(3,315
)
Proceeds from sale of other investments
2,834

 

Decrease in cash due to deconsolidation of the Reciprocal Exchanges
(8,393
)
 

Increase in cash due to consolidation of the Reciprocal Exchanges
2,673

 

Acquisition of consolidated subsidiaries, net of cash
(115,505
)
 
(61,413
)
Purchases of equity securities
(15,873
)
 
(245
)
Proceeds from sale of equity securities
15,142

 
1,259

Purchases of short-term investments
(63,919
)
 
(82,162
)
Proceeds from sale of short-term investments
12,149

 
83,391

Purchases of premises and equipment
(14,466
)
 
(3,670
)
Purchases of fixed maturities
(298,015
)
 
(355,504
)

See accompanying notes to unaudited condensed consolidated financial statements.
6



NATIONAL GENERAL HOLDINGS CORP.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(In Thousands)
(Unaudited)

Proceeds from sale and maturity of fixed maturities
343,252

 
219,595

Net cash used in investing activities
(269,768
)
 
(217,566
)
Cash flows from financing activities:
 
 
 
Securities sold under agreements to repurchase, net
66,989

 
14,350

Proceeds from long-term debt
50,000

 

Repayments of debt

 
(631
)
Issuance of preferred stock, net (fees $0 and $5,448, respectively)

 
159,552

Exercises of stock options
3,067

 
1,418

Return of capital
(150
)
 

Dividends paid to preferred shareholders
(8,250
)
 
(2,062
)
Dividends paid to common shareholders
(6,350
)
 
(3,736
)
Net cash provided by financing activities
105,306

 
168,891

Effect of exchange rate changes on cash and cash equivalents
(1,254
)
 
(153
)
Net increase (decrease) in cash and cash equivalents
(10,583
)
 
35,446

Cash and cash equivalents, beginning of the period
282,277

 
132,615

Cash and cash equivalents, end of the period
$
271,694

 
$
168,061

 
 
 
 
Supplemental disclosures of cash flow information:
 
 
 
Cash paid for income taxes
$
4,200

 
$
31,100

Cash paid for interest
15,740

 
8,469

Supplemental disclosures of non-cash investing and financing activities:
 
 
 
Promissory note issued for acquisition
$
182,287

 
$

Unsettled investment security purchases
23,230

 

Decrease in non-controlling interest due to deconsolidation of the Reciprocal Exchanges
22,619

 

Increase in non-controlling interest due to consolidation of the Reciprocal Exchanges
14,768

 

Accrued preferred stock dividends
4,125

 
4,744

Accrued common stock dividends
3,178

 
1,875


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” or “U.S. 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 (“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, 2015, previously filed with the SEC on February 29, 2016. The balance sheet at December 31, 2015 has been derived from the audited consolidated financial statements at that date but does not include all of the information and footnotes required by GAAP for complete financial statements.

The unaudited condensed consolidated balance sheet as of June 30, 2016 and the audited condensed consolidated balance sheet as of December 31, 2015, also 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 “Reciprocal Exchanges” or "Exchanges"). The unaudited condensed financial statements for the six months ended June 30, 2016 excludes the accounts and operations of the Reciprocal Exchanges, from January 1, 2016 to March 31, 2016, as these entities did not meet the criteria for consolidation under FASB ASU 2015-02, "Consolidation (Topic 810): Amendments to the Consolidation Analysis," during that period but met the criteria on March 31, 2016. As discussed in Note 2, “Recent Accounting Pronouncements,” ASU 2015-02 was adopted using a modified retrospective approach by recording a cumulative effect adjustment as of January 1, 2016. As a result, periods prior to the adoption were not impacted by the deconsolidation of the Reciprocal Exchanges.

The Company does not own the Reciprocal Exchanges but manages their business operations through its wholly-owned management companies.

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.

A detailed description of the Company’s significant accounting policies and management judgments is located in the audited consolidated financial statements, included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2015 filed with the SEC.

All significant inter-company transactions and accounts have been eliminated in the condensed consolidated financial statements.


2. Recent Accounting Pronouncements

With the exception of those discussed below, there have been no recent accounting pronouncements or changes in accounting pronouncements during the six months ended June 30, 2016, as compared to those described in the Company's Annual Report on Form 10-K for the year ended December 31, 2015, that are of significance, or potential significance, to the Company.

In November 2014, the FASB issued ASU 2014-16, "Determining Whether the Host Contract in a Hybrid Financial Instrument Issued in the Form of a Share is More Akin to Debt or Equity (a consensus of the FASB Emerging Issues Task Force)", to reduce diversity in practice in the accounting for hybrid financial instruments issued in the form of a share. The amendments in ASU 2014-16 do not change the current criteria in GAAP for determining when separation of certain embedded derivative features in a hybrid financial instrument is required. An entity will continue to evaluate whether the economic characteristics and risks of the embedded derivative feature are clearly and closely related to those of the host contract, among other relevant criteria. ASU 2014-16 clarifies how current GAAP should be interpreted in evaluating the economic characteristics and risks of a host contract in a hybrid financial instrument that is issued in the form of a share. Specifically, ASU 2014-16 clarifies that an entity should consider all relevant terms and features-including the embedded derivative feature being evaluated for bifurcation-in evaluating the nature of

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NATIONAL GENERAL HOLDINGS CORP.

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(In Thousands, Except Shares and Per Share Data)

the host contract. Furthermore, ASU 2014-16 clarifies that no single term or feature would necessarily determine the economic characteristics and risks of the host contract. Rather, the nature of the host contract depends upon the economic characteristics and risks of the entire hybrid financial instrument. In addition, the amendments in ASU 2014-16 clarify that, in evaluating the nature of a host contract, an entity should assess the substance of the relevant terms and features (that is, the relative strength of the debt-like or equity-like terms and features given the facts and circumstances) when considering how to weight those terms and features. The effects of initially adopting the amendments in ASU 2014-16 are to be applied on a modified retrospective basis to existing hybrid financial instruments issued in the form of a share as of the beginning of the fiscal year for which the amendments are effective. Retrospective application is permitted to all relevant prior periods. The amendments in ASU 2014-16 are effective for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2015. The Company adopted ASU 2014-16 on January 1, 2016 and the implementation of the standard did not have an impact on the Company’s results of operations, financial position or liquidity.

In January 2015, the FASB issued ASU 2015-01, "Income Statement-Extraordinary and Unusual Items (Subtopic 225-20) (simplifying income statement presentation by eliminating the concept of extraordinary items)”, as part of its initiative to reduce complexity in accounting standards. ASU No. 2015-01 eliminates from GAAP the concept of extraordinary items. Subtopic 225-20, Income Statement-Extraordinary and Unusual Items, required that an entity separately classify, present, and disclose extraordinary events and transactions. Previously, an event or transaction was presumed to be an ordinary and usual activity of the reporting entity unless evidence clearly supports its classification as an extraordinary item. If an event or transaction met the criteria for extraordinary classification, an entity was required to segregate the extraordinary item from the results of ordinary operations and show the item separately in the income statement, net of tax, after income from continuing operations. The entity also was required to disclose applicable income taxes and either present or disclose earnings-per-share data applicable to the extraordinary item. An entity has a choice of transition methods. It may apply the amendments in ASU 2015-01 either prospectively or retrospectively to all prior periods presented in the financial statements. The amendments in ASU 2015-01 are effective for annual periods, and interim periods within those annual periods, beginning after December 15, 2015. An entity has the option to adopt the changes earlier provided that the guidance is applied from the beginning of the fiscal year of adoption. The Company adopted ASU 2015-01 prospectively on January 1, 2016 and the implementation of the standard did not have an impact on the Company’s results of operations, financial position or liquidity.

In February 2015, the FASB issued ASU 2015-02, "Consolidation (Topic 810): Amendments to the Consolidation Analysis" to address concerns that GAAP might require a reporting entity to consolidate another legal entity in situations in which the reporting entity's contractual rights do not give it the ability to act primarily on its own behalf, the reporting entity does not hold a majority of the legal entity's voting rights, or the reporting entity is not exposed to a majority of the legal entity's economic benefits or obligations. Specifically, the amendments: (1) modify the evaluation of whether limited partnerships and similar legal entities are variable interest entities ("VIEs") or voting interest entities; (2) eliminate the presumption that a general partner should consolidate a limited partnership; (3) affect the consolidation analysis of reporting entities that are involved with VIEs, particularly those that have fee arrangements and related party relationships; and (4) provide a scope exception from consolidation guidance for reporting entities with interests in legal entities that are required to comply with or operate in accordance with requirements that are similar to those in Rule 2a-7 of the Investment Company Act of 1940 for registered money market funds. ASU 2015-02 amends certain areas in the consolidation analysis including: (i) the effect of related parties on the primary beneficiary determination; (ii) the evaluation of fees paid to a decision maker or a service provider as a variable interest; (iii) the effect of fee arrangements on the primary beneficiary determination; and (iv) certain investment funds. The amendments in ASU 2015-02 are effective for public business entities for fiscal years, and for interim periods within those fiscal years, beginning after December 15, 2015. The adoption of ASU 2015-02 on January 1, 2016 required the Company to evaluate whether its VIEs met the amended criteria for consolidation at the earliest date of involvement unless certain reconsideration events existed. The Reciprocal Exchanges were evaluated based on the facts and circumstances that existed in September 2014 when the Company acquired the managing entities for the Reciprocal Exchanges. As a result of the evaluation, the Company was not required to consolidate the Reciprocal Exchanges as of January 1, 2016 (the Reciprocal Exchanges had previously been included in the Company’s consolidated results). The Company adopted ASU 2015-02 using a modified retrospective approach by recording a cumulative effect adjustment as of January 1, 2016. The total NGHC stockholders’ equity was not affected by this change. On March 31, 2016, the Company purchased the surplus notes representing the obligation of the Reciprocal Exchanges from a related party for consideration of $88,900 (see Note 3, "Reciprocal Exchanges" for additional information). The Company has significant economic interest in the Reciprocal Exchanges due to its ownership of the surplus notes. In addition, the Company, through its wholly-owned subsidiaries, earns fees from the Reciprocal Exchanges that are variable interests. The Company is the primary beneficiary because it, through its wholly-owned management companies, has both the power to direct the activities of the Reciprocal Exchanges that most significantly impact their economic performance and the Company, through its wholly-owned subsidiary that holds the surplus notes, would absorb

9

NATIONAL GENERAL HOLDINGS CORP.

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(In Thousands, Except Shares and Per Share Data)

more than an insignificant amount of expected losses or residual returns of the Reciprocal Exchanges. Therefore, the Company was required to consolidate the Reciprocal Exchanges at March 31, 2016.

In May 2015, the FASB issued ASU 2015-07, "Fair Value Measurement (Topic 820): Disclosure for Investments in Certain Entities That Calculate Net Asset Value per Share (or Its Equivalent)", which provides guidance that removes the requirement to categorize within the fair value hierarchy all investments for which fair value is measured using the net asset value per share practical expedient as well as limits certain disclosure requirements only to investments for which the entity elects to measure the fair value using that practical expedient. The updated guidance is effective for reporting periods beginning after December 15, 2015, and should be applied retrospectively for all periods presented. Early adoption is permitted. The Company adopted ASU 2015-07 on January 1, 2016 and the implementation of the standard did not have an impact on the Company’s results of operations, financial position or liquidity.

In September 2015, the FASB issued ASU 2015-16, "Business Combinations (Topic 805): Simplifying the Accounting for Measurement-Period Adjustments" which applies to all entities that have reported provisional amounts for items in a business combination for which the accounting is incomplete by the end of the reporting period in which the combination occurs and during the measurement period have an adjustment to provisional amounts recognized. The amendments in ASU 2015-16 require that an acquirer recognize adjustments to provisional amounts that are identified during the measurement period in the reporting period in which the adjustment amounts are determined. The amendments in ASU 2015-16 require that the acquirer record, in the same period’s financial statements, the effect on earnings of changes in depreciation, amortization, or other income effects, if any, as a result of the change to the provisional amounts, calculated as if the accounting had been completed at the acquisition date. The amendments in ASU 2015-16 require an entity to present separately on the face of the income statement or disclose in the notes the portion of the amount recorded in current-period earnings by line item that would have been recorded in previous reporting periods if the adjustment to the provisional amounts had been recognized as of the acquisition date. The amendments in ASU 2015-16 are effective for fiscal years beginning after December 15, 2015, including interim periods within those fiscal years, and should be applied prospectively to adjustments to provisional amounts that occur after the effective date with earlier application permitted for financial statements that have not been issued. The only disclosures required at transition will be the nature of and reason for the change in accounting principle. An entity should disclose that information in the first annual period of adoption and in the interim periods within the first annual period if there is a measurement-period adjustment during the first annual period in which the changes are effective. The Company adopted ASU 2015-16 on January 1, 2016 and the effects of adoption will be limited to disclosures relating to adjustments for acquisitions to provisional amounts when identified during the measurement period in which the adjustment amounts are determined. The implementation of the standard did not have a material impact on the Company’s results of operations, financial position or liquidity.

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. The amendments in ASU 2016-01 affect all entities that hold financial assets or owe financial liabilities and make targeted improvements to existing GAAP by: (1) requiring equity investments (except those accounted for under the equity method of accounting, or those that result in consolidation of the investee) to be measured at fair value with changes in fair value recognized in net income. However, an entity may choose to measure equity investments that do not have readily determinable fair values at cost minus impairment, if any, plus or minus changes resulting from observable price changes in orderly transactions for the identical or a similar investment of the same issuer; (2) simplifying the impairment assessment of equity investments without readily determinable fair values by requiring a qualitative assessment to identify impairment. When a qualitative assessment indicates that impairment exists, an entity is required to measure the investment at fair value; (3) eliminating the requirement to disclose the fair value of financial instruments measured at amortized cost for entities that are not public business entities; (4) eliminating the requirement for public business entities to disclose the method(s) and significant assumptions used to estimate the fair value that is required to be disclosed for financial instruments measured at amortized cost on the balance sheet; (5) requiring public business entities to use the exit price notion when measuring the fair value of financial instruments for disclosure purposes; (6) requiring an entity to present separately in other comprehensive income ("OCI") the portion of the total change in the fair value of a liability resulting from a change in the instrument-specific credit risk (also referred to as "own credit") when the entity has elected to measure the liability at fair value in accordance with the fair value option for financial instruments; (7) requiring separate presentation of financial assets and financial liabilities by measurement category and form of financial asset (that is, securities or loans and receivables) on the balance sheet or the accompanying notes to the financial statements; and (8) clarifying that an entity should evaluate the need for a valuation allowance on a deferred tax asset related to available-for-sale securities in combination with the entity’s other deferred tax assets. The amendments in ASU 2016-01 are effective for fiscal years beginning after December 15, 2017, including interim periods within those fiscal years. Early application of the following provisions in ASU 2016-01 is permitted as of the beginning of the fiscal year

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NATIONAL GENERAL HOLDINGS CORP.

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(In Thousands, Except Shares and Per Share Data)

of adoption: (i) the "own credit" provision, in which an organization should present separately in OCI the portion of the total change in the fair value of a liability resulting from a change in the instrument-specific credit risk if the organization has elected to measure the liability at fair value in accordance with the fair value option for financial instruments; and (ii) the provision that exempts entities that are not public business entities from the requirement to apply the fair value of financial instruments disclosure guidance. Except for the early application guidance discussed above, early adoption of the amendments in ASU 2016-01 is not permitted. The amendments should be applied by means of a cumulative-effect adjustment to the balance sheet as of the beginning of the fiscal year of adoption. The amendments related to equity securities without readily determinable fair values (including disclosure requirements) should be applied prospectively to equity investments that exist as of the date of adoption. The Company currently records equity securities, available-for-sale, at fair value. As of June 30, 2016 and December 31, 2015, the Company had $10,587 and $3,909 net unrealized losses, net of tax, recognized as a component of accumulated other comprehensive income (loss).

In March 2016, the FASB issued ASU 2016-07, "Investments-Equity Method and Joint Ventures (Topic 323): Simplifying the Transition to the Equity Method of Accounting" as part of its initiative to reduce complexity in accounting standards. The amendments in ASU 2016-07 eliminate the requirement that when an investment qualifies for use of the equity method as a result of an increase in the level of ownership interest or degree of influence, an investor must adjust the investment, results of operations, and retained earnings retroactively on a step-by-step basis as if the equity method had been in effect during all previous periods that the investment had been held. The amendments require that the equity method investor add the cost of acquiring the additional interest in the investee to the current basis of the investor’s previously held interest and adopt the equity method of accounting as of the date the investment becomes qualified for equity method accounting. Therefore, upon qualifying for the equity method of accounting, no retroactive adjustment of the investment is required. In addition, the amendments in ASU 2016-07 require that an entity that has an available-for-sale equity security that becomes qualified for the equity method of accounting recognize through earnings the unrealized holding gain or loss in accumulated other comprehensive income at the date the investment becomes qualified for use of the equity method. The amendments in ASU 2016-07 are effective for all entities for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2016. The amendments should be applied prospectively upon their effective date to increases in the level of ownership interest or degree of influence that result in the adoption of the equity method. Earlier application is permitted. No additional disclosures are required at transition. The adoption of ASU 2016-07 is not expected to have a material effect on the Company’s results of operations, financial position or liquidity.

In March 2016, the FASB issued ASU 2016-08, "Revenue from Contracts with Customers (Topic 606): Principal versus Agent Considerations", which improves the operability and understandability of the implementation guidance on principal versus agent considerations by clarifying that: 1) an entity determines whether it is a principal or an agent for each specific good or service promised to the customer; 2) an entity determines the nature of each specific good or service; 3) when another party is involved in providing goods or services to a customer, an entity that is a principal obtains control of (a) a good or another asset from the other party that it then transfers to the customer; (b) a right to a service that will be performed by another party, which gives the entity the ability to direct that party to provide the service to the customer on the entity's behalf, or (c) a good or service from the other party that it combines with other goods or services to provide the specific good or service to the customer; and 4) the purpose of the indicators in paragraph 606-10-55-39 in Topic 606 is to support or assist in the assessment of control. The effective date and transition requirement for ASU 2016-08 are the same as the effective date and transition requirements of ASU 2014-09, which were deferred to the quarter ending March 31, 2018 by ASU 2015-14. The Company is currently evaluating the impact this guidance will have on its results of operations, financial position or liquidity.

In March 2016, the FASB issued ASU 2016-09, "Compensation-Stock Compensation (Topic 718): Improvements to Employee Share-Based Payment Accounting" as part of its initiative to reduce complexity in accounting standards. The areas for simplification in ASU 2016-09 involve several aspects of the accounting for share-based payment transactions, including the income tax consequences, classification of awards as either equity or liabilities, and classification on the statement of cash flows. Specifically, the amendments require: (1) All excess tax benefits and tax deficiencies (including tax benefits of dividends on share-based payment awards) should be recognized as income tax expense or benefit in the income statement. The tax effects of exercised or vested awards should be treated as discrete items in the reporting period in which they occur. An entity also should recognize excess tax benefits regardless of whether the benefit reduces taxes payable in the current period; (2) Excess tax benefits should be classified along with other income tax cash flows as an operating activity; (3) An entity can make an entity-wide accounting policy election to either estimate the number of awards that are expected to vest (current GAAP) or account for forfeitures when they occur; (4) The threshold to qualify for equity classification permits withholding up to the maximum statutory tax rates in the applicable jurisdictions; and (5) Cash paid by an employer when directly withholding shares for tax withholding purposes should be classified as a financing activity. The amendments in ASU 2016-09 are effective for annual periods beginning after December 15, 2016, and interim periods within those annual periods. Early adoption is permitted for any entity in any interim or annual period. If an entity

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NATIONAL GENERAL HOLDINGS CORP.

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(In Thousands, Except Shares and Per Share Data)

early adopts the amendments in an interim period, any adjustments should be reflected as of the beginning of the fiscal year that includes that interim period. An entity that elects early adoption must adopt all of the amendments in the same period. Amendments related to the timing of when excess tax benefits are recognized, minimum statutory withholding requirements, and forfeitures, should be applied using a modified retrospective transition method by means of a cumulative-effect adjustment to equity as of the beginning of the period in which the guidance is adopted. Amendments related to the presentation of employee taxes paid on the statement of cash flows when an employer withholds shares to meet the minimum statutory withholding requirement should be applied retrospectively. Amendments requiring recognition of excess tax benefits and tax deficiencies in the income statement should be applied prospectively. An entity may elect to apply the amendments related to the presentation of excess tax benefits on the statement of cash flows using either a prospective transition method or a retrospective transition method. The Company is currently evaluating the impact this guidance will have on its consolidated financial condition, results of operations, cash flows and disclosures and is currently unable to estimate the impact of adopting this guidance.

In April 2016, the FASB issued ASU 2016-10, "Revenue from Contracts with Customers (Topic 606): Identifying Performance Obligations and Licensing", which sought to address certain issues identified in the guidance on identifying performance obligation and licensing by reducing the potential for diversity in practice at initial application and the cost and complexity of applying the guidance in Topic 606 both at transition and on an ongoing basis as noted: 1) identifying performance obligations (a) when identifying performance obligations, whether it is necessary to assess whether promised goods or services are performance obligations if they are immaterial in the context of the contract; (b) determining whether promised goods and services are separately identifiable (that is, distinct within the context of the contract); (c) determining whether shipping and handling activities are a promised service in a contract or are activities to fulfill an entity’s other promises in the contract; (2) licensing; (a) determining whether the nature of an entity’s promise in granting a license is to provide a right to access the entity’s intellectual property, which is satisfied over time and for which revenue is recognized over time, or to provide a right to use the entity’s intellectual property, which is satisfied at a point in time and for which revenue is recognized at a point in time; (b) the scope and applicability of the guidance about when to recognize revenue for sales-based or usage-based royalties promised in exchange for a license of intellectual property; (c) distinguishing contractual provisions that require an entity to transfer additional licenses (that is, rights to use or access intellectual property) to a customer from contractual provisions that define the attributes of a promised license (for example, restrictions of time, geographical region, or use). The effective date and transition requirement for ASU 2016-10 are the same as the effective date and transition requirements of ASU 2014-09, which were deferred to the quarter ending March 31, 2018 by ASU 2015-14. The Company is currently evaluating the impact this guidance will have on its results of operations, financial position or liquidity.

In May 2016, the FASB issued ASU 2016-12, "Revenue from Contracts with Customers (Topic 606): Narrow-Scope Improvements and Practical Expedients", which sought to address certain issues identified in the guidance by reducing the potential for diversity in practice at initial application and the cost and complexity of applying the guidance in Topic 606 both at transition and on an ongoing basis as noted: 1) assessing the collectibility criterion in paragraph 606-10-25-1(e) and accounting for contracts that do not meet the criteria for Step 1 (applying paragraph 606-10-25-7), the amendments in ASU 2016-12 clarify the objective of the collectibility criterion in Step 1. The objective of this assessment is to determine whether the contract is valid and represents a substantive transaction on the basis of whether a customer has the ability and intention to pay the promised consideration in exchange for the goods or services that will be transferred to the customer. The amendments in ASU 2016-12 also add a new criterion to paragraph 606-10-25-7 to clarify when revenue would be recognized for a contract that fails to meet the criteria in Step 1. That criterion allows an entity to recognize revenue in the amount of consideration received when the entity has transferred control of the goods or services, the entity has stopped transferring goods or services (if applicable) and has no obligation under the contract to transfer additional goods or services, and the consideration received from the customer is nonrefundable; 2) presentation of sales taxes and other similar taxes collected from customers, the amendments in ASU 2016-12 permit an entity, as an accounting policy election, to exclude amounts collected from customers for all sales (and other similar) taxes from the transaction price; 3) noncash consideration, the amendments in ASU 2016-12 specify that the measurement date for noncash consideration is contract inception and clarify that the variable consideration guidance applies only to variability resulting from reasons other than the form of the consideration; 4) contract modifications at transition, the amendments in ASU 2016-12 provide a practical expedient that permits an entity to reflect the aggregate effect of all modifications that occur before the beginning of the earliest period presented in accordance with the guidance in Topic 606 when identifying the satisfied and unsatisfied performance obligations, determining the transaction price, and allocating the transaction price to the satisfied and unsatisfied performance obligations; 5) completed contracts at transition, the amendments in ASU 2016-12 clarify that a completed contract for purposes of transition is a contract for which all (or substantially all) of the revenue was recognized under legacy generally accepted accounting principles (GAAP) before the date of initial application. Accounting for elements of a contract that do not affect revenue under legacy GAAP are irrelevant to the assessment of whether a contract is complete. In addition, the amendments permit an entity to apply the modified retrospective transition method either to all contracts or only to contracts that are not completed contracts; 6) technical

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NATIONAL GENERAL HOLDINGS CORP.

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(In Thousands, Except Shares and Per Share Data)

correction, the amendments in ASU 2016-12 clarify that an entity that retrospectively applies the guidance in Topic 606 to each prior reporting period is not required to disclose the effect of the accounting change for the period of adoption. However, an entity is still required to disclose the effect of the changes on any prior periods retrospectively adjusted. The effective date and transition requirement for ASU 2016-12 are the same as the effective date and transition requirements of ASU 2014-09, which were deferred to the quarter ending March 31, 2018 by ASU 2015-14. The Company is currently evaluating the impact this guidance will have on its results of operations, financial position or liquidity.

In June 2016, the FASB issued ASU 2016-13, "Financial Instruments-Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments", which is intended to provide financial statement users with more decision-useful information about the expected credit losses on financial instruments and other commitments to extend credit held by a reporting entity at each reporting date. To achieve this objective, the amendments in ASU 2016-13 replace the incurred loss impairment methodology in current GAAP with a methodology that reflects expected credit losses and requires consideration of a broader range of reasonable and supportable information to inform credit loss estimates. Specifically, the amendments require, a financial asset (or a group of financial assets) measured at amortized cost basis to be presented at the net amount expected to be collected. The allowance for credit losses is a valuation account that is deducted from the amortized cost basis of the financial asset(s) to present the net carrying value at the amount expected to be collected on the financial asset. The income statement reflects the measurement of credit losses for newly recognized financial assets, as well as the expected increases or decreases of expected credit losses that have taken place during the period. The measurement of expected credit losses is based on relevant information about past events, including historical experience, current conditions, and reasonable and supportable forecasts that affect the collectibility of the reported amount. An entity must use judgment in determining the relevant information and estimation methods that are appropriate in its circumstances. The allowance for credit losses for purchased financial assets with a more-than insignificant amount of credit deterioration since origination (PCD assets) that are measured at amortized cost basis is determined in a similar manner to other financial assets measured at amortized cost basis; however, the initial allowance for credit losses is added to the purchase price rather than being reported as a credit loss expense. Only subsequent changes in the allowance for credit losses are recorded as a credit loss expense for these assets. Interest income for PCD assets should be recognized based on the effective interest rate, excluding the discount embedded in the purchase price that is attributable to the acquirer’s assessment of credit losses at acquisition. Credit losses relating to available-for-sale debt securities should be recorded through an allowance for credit losses. Available-for-sale accounting recognizes that value may be realized either through collection of contractual cash flows or through sale of the security. Therefore, the amendments limit the amount of the allowance for credit losses to the amount by which fair value is below amortized cost because the classification as available for sale is premised on an investment strategy that recognizes that the investment could be sold at fair value, if cash collection would result in the realization of an amount less than fair value. The allowance for credit losses for purchased available-for-sale securities with a more-than-insignificant amount of credit deterioration since origination is determined in a similar manner to other available-for-sale debt securities; however, the initial allowance for credit losses is added to the purchase price rather than reported as a credit loss expense. Only subsequent changes in the allowance for credit losses are recorded in credit loss expense. Interest income should be recognized based on the effective interest rate, excluding the discount embedded in the purchase price that is attributable to the acquirer’s assessment of credit losses at acquisition. The amendments in ASU 2016-13 are effective for fiscal years beginning after December 15, 2019, including interim periods within those fiscal years. All entities may adopt the amendments in ASU 2016-13 earlier as of the fiscal years beginning after December 15, 2018, including interim periods within those fiscal years. An entity will apply the amendments in ASU 2016-13 through a cumulative-effect adjustment to retained earnings as of the beginning of the first reporting period in which the guidance is effective (that is, a modified-retrospective approach). A prospective transition approach is required for debt securities for which an other-than-temporary impairment had been recognized before the effective date. The effect of a prospective transition approach is to maintain the same amortized cost basis before and after the effective date of ASU 2016-13. Amounts previously recognized in accumulated other comprehensive income as of the date of adoption that relate to improvements in cash flows expected to be collected should continue to be accreted into income over the remaining life of the asset. Recoveries of amounts previously written off relating to improvements in cash flows after the date of adoption should be recorded in earnings when received. The Financial Accounting Standards Board determined that financial assets for which the guidance in Subtopic 310-30, Receivables-Loans and Debt Securities Acquired with Deteriorated Credit Quality, has previously been applied should prospectively apply the guidance in ASU 2016-13 for PCD assets. A prospective transition approach should be used for PCD assets where upon adoption, the amortized cost basis should be adjusted to reflect the addition of the allowance for credit losses. This transition relief will avoid the need for a reporting entity to reassess its purchased financial assets that exist as of the date of adoption to determine whether they would have met at acquisition the new criteria of more-than insignificant credit deterioration since origination. The transition relief also will allow an entity to accrete the remaining noncredit discount (based on the revised amortized cost basis) into interest income at the effective interest rate at the adoption date of ASU 2016-13. The same transition requirements should be applied to beneficial interests that previously applied Subtopic 310-30 or have a significant difference between contractual cash flows and expected cash flows. The Company

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NATIONAL GENERAL HOLDINGS CORP.

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(In Thousands, Except Shares and Per Share Data)

is currently evaluating the impact this guidance will have on its consolidated financial condition, results of operations, cash flows and disclosures and is currently unable to estimate the impact of adopting this guidance.


3. Reciprocal Exchanges

As of September 15, 2014, through its wholly-owned management companies, the Company manages the business operations of the Reciprocal Exchanges and has the ability to direct their activities. The Reciprocal Exchanges are insurance carriers organized as unincorporated associations. Each policyholder insured by the Reciprocal Exchanges shares risk with the other policyholders.

In the event of dissolution, policyholders would share any residual unassigned surplus in the same proportion as the amount of insurance purchased but are not subject to assessment for any deficit in unassigned surplus of the Reciprocal Exchanges. The Company receives management fee income for the services provided to the Reciprocal Exchanges. The assets of the Reciprocal Exchanges can be used only to settle the obligations of the Reciprocal Exchanges and general creditors to their liabilities have no recourse to the Company.

Effective March 31, 2016, a subsidiary of the Company, purchased from subsidiaries of ACP Re Ltd. ("ACP Re"), a related party, the surplus notes that were issued by the Reciprocal Exchanges when they were originally capitalized. The purchase price of $88,900 was based on an independent third party valuation of the fair market value of the surplus notes. The obligation to repay principal and interest on the surplus notes is subordinated to the Reciprocal Exchanges’ other liabilities including obligations to policyholders and claimants for benefits under insurance policies. Principal and interest on the surplus notes are payable only with regulatory approval. The Company has no ownership interest in the Reciprocal Exchanges.

Under ASU 2015-02, as a result of the Company's purchase of the surplus notes effective March 31, 2016, the Company determined that it holds a variable interest in each of the Reciprocal Exchanges. The Company would absorb more than an insignificant amount of the Reciprocal Exchanges expected losses or residual returns through its ownership of the surplus notes. In addition, the Company, through its wholly-owned subsidiaries, earns fees from the Reciprocal Exchanges that are variable interests. Each of the Reciprocal Exchanges qualifies as a Variable Interest Entity ("VIE") because they do not have sufficient equity to finance their operations without the surplus notes. The policyholders of the Reciprocal Exchanges lack the ability to direct the activities of the Reciprocal Exchanges that have a significant impact on the Reciprocal Exchanges' economic performance. The Company is the primary beneficiary because it, through its wholly-owned management companies, has both the power to direct the activities of the Reciprocal Exchanges that most significantly impact their economic performance and the Company, through its wholly-owned subsidiary that holds surplus notes, would absorb more than an insignificant amount of expected losses or residual returns of the Reciprocal Exchanges. Accordingly, the Company consolidates these Reciprocal Exchanges as of March 31, 2016 and for the periods thereafter, and eliminates all intercompany balances and transactions with the Company.

Prior to the adoption of ASU 2015-02 on January 1, 2016, the Company consolidated the Reciprocal Exchanges under the previous guidance. Upon adoption of ASU 2015-02, on January 1, 2016, and before the purchase of the surplus notes, the Company did not meet the requirements for consolidation as it did not hold a variable interest in the Reciprocal Exchanges. Therefore, the operations of the Reciprocal Exchanges for the period from January 1, 2016 to March 31, 2016 are not included in the Company's condensed consolidated financial statements.


14

NATIONAL GENERAL HOLDINGS CORP.

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(In Thousands, Except Shares and Per Share Data)

The following table presents the opening balance sheet of the Reciprocal Exchanges as of March 31, 2016:
March 2016
 
Assets:
 
Cash and investments
$
258,274

Accrued investment income
2,658

Premiums and other receivables, net
52,922

Reinsurance recoverable on unpaid losses
43,401

Prepaid reinsurance premiums
59,706

Income tax receivable
300

Due from affiliate
11,703

Premises and equipment, net
2,386

Intangible assets, net
32,638

Prepaid and other assets
187

Total assets
$
464,175

 
 
Liabilities:
 
Unpaid loss and loss adjustment expense reserves
$
137,093

Unearned premiums
143,194

Reinsurance payable
11,982

Accounts payable and accrued expenses
6,972

Deferred tax liability
23,716

Debt
88,900

Other liabilities
37,550

Total liabilities
449,407

Stockholders’ equity:
 
Non-controlling interest
14,768

Total stockholders’ equity
14,768

Total liabilities and stockholders' equity
$
464,175


The consolidation of the Reciprocal Exchanges at March 31, 2016 is treated as a business combination with the assets, liabilities and non-controlling interest recognized at fair value at the date of consolidation. The Company has no ownership in the Reciprocal Exchanges. Therefore, the difference between the fair value of the assets and liabilities acquired represents the fair value of non-controlling interest acquired.

For the three and six months ended June 30, 2016, the Reciprocal Exchanges recognized total revenues, total expenses and net income of $54,521, $45,297 and $9,224, respectively. For the three months ended June 30, 2015, the Reciprocal Exchanges recognized total revenues, total expenses and net loss of $34,754, $36,975 and $(2,221), respectively. For the six months ended June 30, 2015, the Reciprocal Exchanges recognized total revenues, total expenses and net loss of $84,204, $86,289 and $(2,085), respectively.

For the three months ended June 30, 2016 and 2015, the Company earned service and fee income from the Reciprocal Exchanges in the amounts of $10,807 and $10,732, respectively. For the six months ended June 30, 2016 and 2015, the Company earned service and fee income from the Reciprocal Exchanges in the amounts of $20,397 and $19,310, respectively. Such amounts are eliminated in the Company's consolidated earnings, except for $9,590 of service and fee income included in the six months ended June 30, 2016, for the period in which the Company and the Reciprocal Exchanges did not meet requirements for consolidation.



15

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 Securities

The cost or amortized cost, fair value, and gross unrealized gains and losses on available-for-sale securities were as follows:
June 30, 2016
 
Cost or
Amortized
Cost
 
Gross
Unrealized
Gains
 
Gross
Unrealized
Losses
 
Fair
Value
Equity securities:
 
 
 
 
 
 
 
 
   Common stock
 
$
110,752

 
$
7,153

 
$
(23,156
)
 
$
94,749

   Preferred stock
 
16,035

 
296

 
(580
)
 
15,751

Fixed maturities:
 
 
 
 
 
 
 
 
   U.S. Treasury
 
27,174

 
1,851

 

 
29,025

   States and political subdivision bonds
 
399,438

 
14,414

 
(192
)
 
413,660

   Foreign government
 
59,644

 
1,283

 
(340
)
 
60,587

   Corporate bonds
 
1,533,488

 
93,788

 
(17,588
)
 
1,609,688

   Residential mortgage-backed securities
 
336,498

 
13,594

 
(60
)
 
350,032

   Commercial mortgage-backed securities
 
106,290

 
3,281

 
(1,053
)
 
108,518

   Structured securities
 
246,396

 
1,675

 
(6,103
)
 
241,968

Total
 
$
2,835,715

 
$
137,335

 
$
(49,072
)
 
$
2,923,978

Less: Securities pledged
 
132,300

 
5,148

 

 
137,448

Total net of Securities pledged
 
$
2,703,415

 
$
132,187

 
$
(49,072
)
 
$
2,786,530

NGHC
 
$
2,558,242

 
$
123,177

 
$
(48,010
)
 
$
2,633,409

Reciprocal Exchanges
 
277,473

 
14,158

 
(1,062
)
 
290,569

Total
 
$
2,835,715

 
$
137,335

 
$
(49,072
)
 
$
2,923,978


December 31, 2015
 
Cost or
Amortized
Cost
 
Gross
Unrealized
Gains
 
Gross
Unrealized
Losses
 
Fair
Value
Equity securities:
 
 
 
 
 
 
 
 
   Common stock
 
$
53,356

 
$
569

 
$
(6,960
)
 
$
46,965

   Preferred stock
 
11,448

 
377

 

 
11,825

Fixed maturities:
 
 
 
 
 
 
 
 
   U.S. Treasury
 
19,348

 
1,052

 
(48
)
 
20,352

   Federal agencies
 
1,945

 
7

 

 
1,952

   States and political subdivision bonds
 
193,017

 
4,516

 
(609
)
 
196,924

   Foreign government
 
31,383

 
31

 
(352
)
 
31,062

   Corporate bonds
 
1,375,336

 
22,224

 
(47,902
)
 
1,349,658

   Residential mortgage-backed securities
 
419,293

 
6,254

 
(978
)
 
424,569

   Commercial mortgage-backed securities
 
135,134

 
720

 
(3,649
)
 
132,205

   Structured securities
 
205,024

 
15

 
(4,347
)
 
200,692

Total
 
$
2,445,284

 
$
35,765

 
$
(64,845
)
 
$
2,416,204

Less: Securities pledged
 
54,955

 
439

 

 
55,394

Total net of Securities pledged
 
$
2,390,329

 
$
35,326

 
$
(64,845
)
 
$
2,360,810

NGHC
 
$
2,199,714

 
$
34,773

 
$
(58,826
)
 
$
2,175,661

Reciprocal Exchanges
 
245,570

 
992

 
(6,019
)
 
240,543

Total
 
$
2,445,284

 
$
35,765

 
$
(64,845
)
 
$
2,416,204


16

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 fixed maturities and securities pledged, held as of June 30, 2016, 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
June 30, 2016
 
Amortized
Cost
 
Fair
Value
 
Amortized
Cost
 
Fair
Value
 
Amortized
Cost
 
Fair
Value
Due in one year or less
 
$
25,213

 
$
25,338

 
$

 
$

 
$
25,213

 
$
25,338

Due after one year through five years
 
323,244

 
344,450

 
34,416

 
36,626

 
357,660

 
381,076

Due after five years through ten years
 
1,250,796

 
1,303,856

 
181,099

 
190,721

 
1,431,895

 
1,494,577

Due after ten years
 
414,001

 
415,519

 
37,371

 
38,418

 
451,372

 
453,937

Mortgage-backed securities
 
418,201

 
433,746

 
24,587

 
24,804

 
442,788

 
458,550

Total
 
$
2,431,455

 
$
2,522,909

 
$
277,473

 
$
290,569

 
$
2,708,928

 
$
2,813,478


(b) Investment Income

The components of net investment income consisted of the following:
 
 
Three Months Ended June 30,
 
Six Months Ended June 30,
 
 
2016
 
2015
 
2016
 
2015
Interest
 
 
 
 
 
 
 
 
Cash and short-term investments
 
$
2,173

 
$
4

 
$
2,857

 
$
9

Equity securities
 
58

 
122

 
391

 
197

Fixed maturities
 
23,879

 
15,916

 
43,618

 
30,922

Investment income
 
26,110

 
16,042

 
46,866

 
31,128

Investment expense
 
(1,046
)
 
(59
)
 
(2,684
)
 
(1,271
)
Repurchase agreements interest expense
 
(176
)
 
(33
)
 
(320
)
 
(103
)
Other income (1)
 
2,640

 
2,385

 
5,336

 
4,729

Net Investment Income
 
$
27,528

 
$
18,335

 
$
49,198

 
$
34,483

NGHC
 
$
25,280

 
$
16,154

 
$
46,950

 
$
30,263

Reciprocal Exchanges
 
2,248

 
2,181

 
2,248

 
4,220

Net Investment Income
 
$
27,528

 
$
18,335

 
$
49,198

 
$
34,483


(1) Includes interest income of $2,187 and $2,211 for the three months ended June 30, 2016 and 2015, respectively, and $4,375 and $4,399 for the six months ended June 30, 2016 and 2015, respectively, under the ACP Re Credit Agreement (see Note 14, "Related Party Transactions" for additional information).

(c) Realized Gains and Losses

Proceeds from sales of equity securities and fixed maturities during the six months ended June 30, 2016 and 2015 were $188,397 and $114,496, respectively. For the three and six months ended June 30, 2016, the Company did not recognize any other-than-temporary impairment ("OTTI") loss. For the three and six months ended June 30, 2015, the Company recognized an OTTI loss of $1,467 and $2,483, respectively, on investments, based on the Company's qualitative and quantitative review.

The tables below indicate the gross realized gains and losses (including any OTTI) for the three and six months ended June 30, 2016 and 2015.

17

NATIONAL GENERAL HOLDINGS CORP.

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(In Thousands, Except Shares and Per Share Data)

Three Months Ended June 30, 2016
 
Gross Gains
 
Gross Losses
 
Net Gains (Losses)
Equity securities
 
$
262

 
$
(291
)
 
$
(29
)
Fixed maturities
 
5,653

 
(1,242
)
 
4,411

Total gross realized gains and losses
 
$
5,915

 
$
(1,533
)
 
$
4,382

NGHC
 
$
5,745

 
$
(1,504
)
 
$
4,241

Reciprocal Exchanges
 
170

 
(29
)
 
141

Total gross realized gains and losses
 
$
5,915

 
$
(1,533
)
 
$
4,382

Three Months Ended June 30, 2015
 
Gross Gains
 
Gross Losses
 
Net Gains (Losses)
Equity securities
 
$
5

 
$

 
$
5

Fixed maturities
 
2,466

 
(615
)
 
1,851

OTTI
 

 
(1,467
)
 
(1,467
)
Total gross realized gains and losses
 
$
2,471

 
$
(2,082
)
 
$
389

NGHC
 
$
2,415

 
$
(1,480
)
 
$
935

Reciprocal Exchanges
 
56

 
(602
)
 
(546
)
Total gross realized gains and losses
 
$
2,471

 
$
(2,082
)
 
$
389

Six Months Ended June 30, 2016
 
Gross Gains
 
Gross Losses
 
Net Gains (Losses)
Equity securities
 
$
704

 
$
(293
)
 
$
411

Fixed maturities
 
9,852

 
(2,264
)
 
7,588

Total gross realized gains and losses
 
$
10,556

 
$
(2,557
)
 
$
7,999

NGHC
 
$
10,386

 
$
(2,528
)
 
$
7,858

Reciprocal Exchanges
 
170

 
(29
)
 
141

Total gross realized gains and losses
 
$
10,556

 
$
(2,557
)
 
$
7,999

Six Months Ended June 30, 2015
 
Gross Gains
 
Gross Losses
 
Net Gains (Losses)
Equity securities
 
$
5

 
$

 
$
5

Fixed maturities
 
5,090

 
(1,036
)
 
4,054

OTTI
 

 
(2,483
)
 
(2,483
)
Total gross realized gains and losses
 
$
5,095

 
$
(3,519
)
 
$
1,576

NGHC
 
$
4,188

 
$
(2,759
)
 
$
1,429

Reciprocal Exchanges
 
907

 
(760
)
 
147

Total gross realized gains and losses
 
$
5,095

 
$
(3,519
)
 
$
1,576



18

NATIONAL GENERAL HOLDINGS CORP.

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(In Thousands, Except Shares and Per Share Data)

(d) Unrealized Gains and Losses

Unrealized gains (losses) on investments as of June 30, 2016 and December 31, 2015 consisted of the following:
 
 
June 30, 2016
 
December 31, 2015
Net unrealized loss on common stock
 
$
(16,003
)
 
$
(6,391
)
Net unrealized gain on preferred stock
 
(284
)
 
377

Net unrealized gain (loss) on fixed maturities
 
104,550

 
(23,066
)
Net unrealized loss on other
 

 
(20
)
Deferred income tax
 
(30,893
)
 
10,185

Net unrealized gain (loss), net of deferred income tax
 
$
57,370

 
$
(18,915
)
NGHC
 
$
48,859

 
$
(15,634
)
Reciprocal Exchanges
 
8,511

 
(3,281
)
Net unrealized gain (loss), net of deferred income tax
 
57,370

 
(18,915
)
Non-controlling interest
 
(8,511
)
 
3,281

NGHC net unrealized gain (loss), net of deferred income tax
 
$
48,859

 
$
(15,634
)
 
 
 
 
 
Six months ended June 30, 2016 and 2015:
 
June 30, 2016
 
June 30, 2015
NGHC net unrealized gain (loss), net of deferred income tax
 
$
64,493

 
$
(8,591
)
Non-controlling interest net unrealized gain (loss), net of deferred income tax
 
$
6,537

 
$
(3,138
)

(e) Gross Unrealized Losses

The tables below summarize the gross unrealized losses on equity securities and fixed maturities by length of time the security has continuously been in an unrealized loss position as of June 30, 2016 and December 31, 2015:
 
 
Less Than 12 Months
 
12 Months or More
 
Total
June 30, 2016
 
Fair
Market
Value
 
Unrealized
Losses
 
No. of
Positions
Held
 
Fair
Market
Value
 
Unrealized
Losses
 
No. of
Positions
Held
 
Fair
Market
Value
 
Unrealized
Losses
Common stock
 
$
45,129

 
$
(23,136
)
 
65

 
$
154

 
$
(20
)
 
3

 
$
45,283

 
$
(23,156
)
Preferred stock
 
7,957

 
(580
)
 
4

 

 

 

 
7,957

 
(580
)
States and political subdivision bonds
 
4,254

 
(10
)
 
11

 
5,763

 
(182
)
 
11

 
10,017

 
(192
)
Foreign government
 
1,913

 
(340
)
 
1

 

 

 

 
1,913

 
(340
)
Corporate bonds
 
129,782

 
(6,751
)
 
79

 
60,155

 
(10,837
)
 
29

 
189,937

 
(17,588
)
Residential mortgage-backed securities
 
1,162

 
(10
)
 
3

 
1,209

 
(50
)
 
3

 
2,371

 
(60
)
Commercial mortgage-backed securities
 
20,834

 
(305
)
 
7

 
28,114

 
(748
)
 
12

 
48,948

 
(1,053
)
Structured securities
 
99,167

 
(3,854
)
 
47

 
43,237

 
(2,249
)
 
21

 
142,404

 
(6,103
)
Total
 
$
310,198

 
$
(34,986
)
 
217

 
$
138,632

 
$
(14,086
)
 
79

 
$
448,830

 
$
(49,072
)
NGHC
 
$
291,501

 
$
(34,368
)
 
207

 
$
127,478

 
$
(13,642
)
 
65

 
$
418,979

 
$
(48,010
)
Reciprocal Exchanges
 
18,697

 
(618
)
 
10

 
11,154

 
(444
)
 
14

 
29,851

 
(1,062
)
Total
 
$
310,198

 
$
(34,986
)
 
217

 
$
138,632

 
$
(14,086
)
 
79

 
$
448,830

 
$
(49,072
)

19

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, 2015
 
Fair
Market
Value
 
Unrealized
Losses
 
No. of
Positions
Held
 
Fair
Market
Value
 
Unrealized
Losses
 
No. of
Positions
Held
 
Fair
Market
Value
 
Unrealized
Losses
Common stock
 
$
39,490

 
$
(6,932
)
 
5

 
$
130

 
$
(28
)
 
2

 
$
39,620

 
$
(6,960
)
U.S. Treasury
 
7,141

 
(48
)
 
5

 

 

 

 
7,141

 
(48
)
States and political subdivision bonds
 
17,674

 
(501
)
 
22

 
4,878

 
(108
)
 
10

 
22,552

 
(609
)
Foreign government
 
21,322

 
(352
)
 
4

 

 

 

 
21,322

 
(352
)
Corporate bonds
 
684,613

 
(37,919
)
 
229

 
32,121

 
(9,983
)
 
38

 
716,734

 
(47,902
)
Residential mortgage-backed securities
 
102,889

 
(919
)
 
23

 
1,655

 
(59
)
 
9

 
104,544

 
(978
)
Commercial mortgage-backed securities
 
66,222

 
(3,472
)
 
30

 
2,364

 
(177
)
 
2

 
68,586

 
(3,649
)
Structured securities
 
153,042

 
(4,347
)
 
65

 

 

 

 
153,042

 
(4,347
)
Total
 
$
1,092,393

 
$
(54,490
)
 
383

 
$
41,148

 
$
(10,355
)
 
61

 
$
1,133,541

 
$
(64,845
)
NGHC
 
$
988,188

 
$
(50,599
)
 
284

 
$
28,691

 
$
(8,227
)
 
34

 
$
1,016,879

 
$
(58,826
)
Reciprocal Exchanges
 
104,205

 
(3,891
)
 
99

 
12,457

 
(2,128
)
 
27

 
116,662

 
(6,019
)
Total
 
$
1,092,393

 
$
(54,490
)
 
383

 
$
41,148

 
$
(10,355
)
 
61

 
$
1,133,541

 
$
(64,845
)

There were 296 and 444 securities at June 30, 2016 and December 31, 2015, respectively, that account for the gross unrealized loss, none of which are deemed by the Company to be an OTTI. At June 30, 2016, the Company determined that the unrealized losses on fixed maturities were primarily due to market interest rate and credit quality movements since their date of purchase. At June 30, 2016, the Company determined that the unrealized losses on common stock were primarily due to continued weakness in the equities market for the communications, energy, industrial and transportation sectors during the second quarter of 2016, and to a lesser extent the expansion of the Company's investment portfolio to include Century-National. 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 June 30, 2016 and December 31, 2015, of the $14,086 and $10,355, respectively, of unrealized losses related to securities in unrealized loss positions for a period of twelve or more consecutive months, $8,244 and $8,466, respectively, of those unrealized losses were related to securities in unrealized loss positions greater than or equal to 20% of amortized cost or cost. Those unrealized losses were evaluated based on factors such as discounted cash flows and near-term and long-term prospects of the issue or issuer and were determined to have adequate resources to fulfill contractual obligations.

20

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 fixed maturities, securities pledged and preferred securities as of June 30, 2016 and December 31, 2015, as rated by Standard & Poor’s.
 
 
NGHC
 
Reciprocal Exchanges
June 30, 2016
 
Cost or Amortized Cost
 
Fair Value
 
Percentage of Fixed Maturities and Preferred Securities
 
Cost or Amortized Cost
 
Fair Value
 
Percentage of Fixed Maturities and Preferred Securities
U.S. Treasury
 
$
21,241

 
$
23,014

 
1.0
%
 
$
5,933

 
$
6,011

 
2.1
%
AAA
 
428,111

 
444,619

 
17.5
%
 
21,114

 
21,362

 
7.4
%
AA, AA+, AA-
 
460,813

 
475,871

 
18.7
%
 
26,936

 
28,862

 
9.9
%
A, A+, A-
 
611,384

 
637,830

 
25.1
%
 
92,339

 
97,848

 
33.7
%
BBB, BBB+, BBB-
 
729,736

 
748,770

 
29.5
%
 
116,480

 
121,092

 
41.7
%
BB+ and lower
 
196,205

 
208,556

 
8.2
%
 
14,671

 
15,394

 
5.2
%
Total
 
$
2,447,490

 
$
2,538,660

 
100.0
%
 
$
277,473

 
$
290,569

 
100.0
%
 
 
NGHC
 
Reciprocal Exchanges
December 31, 2015
 
Cost or Amortized Cost
 
Fair Value
 
Percentage of Fixed Maturities and Preferred Securities
 
Cost or Amortized Cost
 
Fair Value
 
Percentage of Fixed Maturities and Preferred Securities
U.S. Treasury
 
$
13,416

 
$
14,448

 
0.7
%
 
$
5,932

 
$
5,904

 
2.5
%
AAA
 
343,128

 
348,073

 
16.4
%
 
39,724

 
38,888

 
16.2
%
AA, AA+, AA-
 
379,560

 
383,888

 
18.0
%
 
36,866

 
36,934

 
15.4
%
A, A+, A-
 
501,409

 
508,884

 
23.9
%
 
50,612

 
50,153

 
20.8
%
BBB, BBB+, BBB-
 
634,250

 
623,742

 
29.3
%
 
82,417

 
80,322

 
33.4
%
BB+ and lower
 
274,594

 
249,660

 
11.7
%
 
30,020

 
28,343

 
11.7
%
Total
 
$
2,146,357

 
$
2,128,695

 
100.0
%
 
$
245,571

 
$
240,544

 
100.0
%

The tables below summarize the investment quality of the Company's corporate bond holdings and industry concentrations as of June 30, 2016 and December 31, 2015.
June 30, 2016
 
AAA
 
AA+,
AA,
AA-
 
A+,A,A-
 
BBB+,
BBB,
BBB-
 
BB+ or
Lower
 
Fair
Value
 
% of
Corporate
Bonds
Portfolio
Corporate Bonds:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Financial institutions
 
1.0
%
 
2.7
%
 
17.7
%
 
12.8
%
 
0.7
%
 
$
563,234

 
34.9
%
Industrials
 
0.2
%
 
3.2
%
 
14.8
%
 
31.8
%
 
9.0
%
 
949,006

 
59.0
%
Utilities/Other
 
0.9
%
 
%
 
1.3
%
 
3.6
%
 
0.3
%
 
97,448

 
6.1
%
Total
 
2.1
%
 
5.9
%
 
33.8
%
 
48.2
%
 
10.0
%
 
$
1,609,688

 
100.0
%
NGHC
 
2.1
%
 
5.3
%
 
28.3
%
 
40.6
%
 
9.2
%
 
$
1,376,376

 
85.5
%
Reciprocal Exchanges
 
%
 
0.6
%
 
5.5
%
 
7.6
%
 
0.8
%
 
233,312

 
14.5
%
Total
 
2.1
%
 
5.9
%
 
33.8
%
 
48.2
%
 
10.0
%
 
$
1,609,688

 
100.0
%

21

NATIONAL GENERAL HOLDINGS CORP.

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(In Thousands, Except Shares and Per Share Data)

December 31, 2015
 
AAA
 
AA+,
AA,
AA-
 
A+,A,A-
 
BBB+,
BBB,
BBB-
 
BB+ or
Lower
 
Fair
Value
 
% of
Corporate
Bonds
Portfolio
Corporate Bonds:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Financial institutions
 
%
 
2.8
%
 
21.2
%
 
12.7
%
 
2.1
%
 
$
524,250

 
38.8
%
Industrials
 
%
 
3.9
%
 
15.4
%
 
32.3
%
 
4.6
%
 
757,907

 
56.2
%
Utilities/Other
 
0.4
%
 
%
 
0.4
%
 
3.4
%
 
0.8
%
 
67,501

 
5.0
%
Total
 
0.4
%
 
6.7
%
 
37.0
%
 
48.4
%
 
7.5
%
 
$
1,349,658

 
100.0
%
NGHC
 
0.4
%
 
6.1
%
 
33.9
%
 
42.7
%
 
6.3
%
 
$
1,206,442

 
89.4
%
Reciprocal Exchanges
 
%
 
0.6
%
 
3.1
%
 
5.7
%
 
1.2
%
 
143,216

 
10.6
%
Total
 
0.4
%
 
6.7
%
 
37.0
%
 
48.4
%
 
7.5
%
 
$
1,349,658

 
100.0
%

(g) Restricted Cash and 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 fair values of the Company's restricted assets as of June 30, 2016 and December 31, 2015 are as follows:

 
 
June 30, 2016
 
December 31, 2015
Restricted cash
 
$
10,899

 
$
13,776

Restricted investments - fixed maturities, at fair value
 
42,476

 
40,174

Total
 
$
53,375

 
$
53,950


(h) Other Investments

The table below summarizes the composition of other investments as of June 30, 2016 and December 31, 2015:
 
 
June 30, 2016
 
December 31, 2015
Limited partnerships, equity method
 
$
37,996

 
$
5,691

Investments at cost or amortized cost
 
21,364

 
7,340

Total
 
$
59,360

 
$
13,031


(i) Reverse Repurchase and Repurchase Agreements

The Company enters into reverse repurchase and repurchase agreements, which are accounted for as either collateralized lending or borrowing transactions and are recorded at contract amounts, which approximate fair value. For the collateralized borrowing transactions (i.e., repurchase agreements), the Company receives cash or securities that it invests or holds in short-term or fixed income securities.

As of June 30, 2016 and December 31, 2015, the Company had no collateralized lending transaction principal outstanding.

As of June 30, 2016 and December 31, 2015, the Company had collateralized borrowing transaction principal outstanding of $119,472 and $52,484, respectively, at interest rates of 0.70% and 0.80%, respectively. Interest expense associated with these repurchase borrowing agreements for the three and six months ended June 30, 2016 was $176 and $320, respectively, and for the three and six months ended June 30, 2015 was $33 and $103, respectively. The Company had $137,448 and $55,394 of collateral pledged in support for these agreements as of June 30, 2016 and December 31, 2015, respectively.


22

NATIONAL GENERAL HOLDINGS CORP.

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(In Thousands, Except Shares and Per Share Data)

The table below summarizes the remaining contractual maturity of the Company's repurchase agreements as of June 30, 2016 and December 31, 2015.
 
June 30, 2016
 
Remaining Contractual Maturity of the Repurchase Agreements
 
Overnight and Continuous
 
Up to 30 days
 
30 - 90 days
 
Greater Than 90 days
 
Total
Repurchase agreements:
 
 
 
 
 
 
 
 
 
   Residential mortgage-backed securities
$

 
$
119,472

 
$

 
$

 
$
119,472

Total Securities sold under agreements to repurchase, at contract value
$

 
$
119,472

 
$

 
$

 
$
119,472

 
 
 
 
 
 
 
 
 
 
 
December 31, 2015
 
Remaining Contractual Maturity of the Repurchase Agreements
 
Overnight and Continuous
 
Up to 30 days
 
30 - 90 days
 
Greater Than 90 days
 
Total
Repurchase agreements:
 
 
 
 
 
 
 
 
 
   Residential mortgage-backed securities
$

 
$
52,484

 
$

 
$

 
$
52,484

Total Securities sold under agreements to repurchase, at contract value
$

 
$
52,484

 
$

 
$

 
$
52,484


Securities sold under agreements to repurchase (repurchase agreements), at contract value are accounted for as collateralized borrowing transactions and are recorded at their contracted repurchase amounts, plus accrued interest. Under repurchase agreements, the Company borrows cash from a counterparty at an agreed-upon interest rate for an agreed-upon time frame and the Company transfers either corporate debt securities or U.S. government or government agency securities (pledged collateral). For securities repurchase agreements, the cash received is typically invested in cash equivalents, short-term investments or fixed maturities, with the offsetting obligation to repay the loan included as a liability in the consolidated balance sheets. At the end of the agreement, the counterparty returns the collateral to the Company, and the Company, in turn, repays the loan amount along with the agreed-upon interest.

There are potential risks associated with repurchase agreements and the related collateral pledged, including obligations arising from a decline in the market value of the collateral pledged. The Company is generally required to maintain collateral in the amount of 105.0% to 110.0% of the value of the securities we have sold with agreement to repurchase, which are subject to daily mark-to-market margining (i.e., if the collateral falls in value, a margin call can be triggered requiring the Company to pay cash or post extra securities to maintain the 105.0% to 110.0% threshold). Conversely, if the value of the Company’s collateral pledged appreciates in value there is credit risk that the lending counterparty could default and not return/sell the securities back.

The Company minimizes the credit risk that counterparties might be unable to fulfill their contractual obligations by monitoring its counterparty exposure and related collateral pledged. Additionally, repurchase agreements are only transacted with pre-approved counterparties.


5. Fair Value of Financial Instruments

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

The Company utilized a pricing service to estimate fair value measurements for approximately 100.0% of its fixed maturities. For investments that have quoted market prices in active markets, the Company uses the quoted market prices as fair value and includes these prices in the amounts disclosed in Level 1 of the fair value hierarchy. The Company receives the quoted market prices from nationally recognized third-party pricing services (“pricing services”). When quoted market prices are unavailable, the Company utilizes a pricing service to determine an estimate of fair value. This pricing method is used, primarily, for fixed

23

NATIONAL GENERAL HOLDINGS CORP.

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(In Thousands, Except Shares and Per Share Data)

maturities. The fair value estimates provided by the pricing service are included in Level 2 of the fair value hierarchy. If the Company determines that the fair value estimate provided by the pricing service does not represent fair value or if quoted market prices and an estimate from pricing services are unavailable, the Company produces an estimate of fair value based on dealer quotations of the bid price for recent activity in positions with the same or similar characteristics to that being valued or through consensus pricing of a pricing service. Depending on the level of observable inputs, the Company will then determine if the estimate is in Level 2 or Level 3 of the fair value hierarchy.

The following describes the valuation techniques used by the Company to determine the fair value of financial instruments held as of June 30, 2016.

Equity Securities ‑ The Company utilized a pricing service to estimate the fair value of the majority of its available for sale and trading equity securities. The pricing service utilizes market quotations for equity securities that have quoted market prices in active markets and their respective quoted prices are provided as fair value. The Company classifies the values of these equity securities as Level 1. 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. The Company classifies the value of these equity securities as Level 2. 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 quote, issuers' book value, market multiples, and other inputs. These equity securities are classified as Level 3 due to significant unobservable inputs used in the valuation.

U.S. Treasury and Federal Agencies ‑ Comprised of primarily bonds issued by the U.S. Treasury, the Federal Home Loan Bank, the Federal Home Loan Mortgage Corporation, Government National Mortgage Association and the Federal National Mortgage Association. The fair values of U.S. government securities are based on quoted market prices in active markets, and are included in the Level 1 fair value hierarchy. The Company believes the market for U.S. Treasury securities is an actively traded market given the high level of daily trading volume. The fair values of U.S. government agency securities are priced using the spread above the risk-free yield curve. As the yields for the risk-free yield curve and the spreads for these securities are observable market inputs, the fair values of U.S. government agency securities are included in the Level 2 fair value hierarchy.

States and Political Subdivision Bonds ‑ Comprised of bonds and auction rate securities issued by U.S. state and municipal entities or agencies. The fair values of municipal bonds are generally priced by pricing services. The pricing services typically use spreads obtained from broker-dealers, trade prices and the new issue market. As the significant inputs used to price the municipal bonds are observable market inputs, these are classified within Level 2. Municipal auction rate securities are reported in the condensed consolidated balance sheets at cost which approximates their fair value.

Foreign Government ‑ Comprised of bonds issued by foreign governments, and are generally priced by pricing services. As the significant inputs used to price foreign government bonds are observable market inputs, the fair values of foreign government bonds are included in the Level 2 fair value hierarchy.

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

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

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 1 in the fair value hierarchy. The Company's 6.75% Notes are not publicly traded and their fair value as of June 30, 2016 was determined using market-based metrics and the magnitude and timing of contractual interest and principal payments. The fair value of the Company’s 6.75% Notes as of

24

NATIONAL GENERAL HOLDINGS CORP.

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(In Thousands, Except Shares and Per Share Data)

December 31, 2015 was determined using the direct transaction method of the Market Approach. The Company executed an arm’s length private market transaction in the 6.75% Notes in the fourth quarter of 2015 which provided reasonably supportable indication of fair value for the 6.75% Notes as of December 31, 2015. Non-direct market-based metrics and the magnitude and timing of contractual interest and principal payments were analyzed to support the indication of fair value provided by the direct transaction method of the Market Approach as of December 31, 2015. As of June 30, 2016 and December 31, 2015, the fair value of the Company's Imperial Surplus Notes, which are not publicly traded were valued using the Black-Derman-Toy interest rate lattice model. As of June 30, 2016, the fair value of the Credit Agreement was determined using the discounted cash flow method. As of June 30, 2016, the fair value of the Century-National Promissory Note was determined using the direct transaction method of the Market Approach. The Century-National Promissory Note is not a publicly traded instrument. The Company executed an arm’s length private market transaction on June 1, 2016 which provided reasonably supportable indication of fair value for the Century-National Promissory Note as of June 30, 2016 given the proximity to the valuation date. Non-direct market-based metrics and the magnitude and timing of contractual interest and principal payments were analyzed to support the indication of fair value provided by the direct transaction method of the Market Approach as of June 30, 2016.

The Company's 6.75% Notes, Imperial Surplus Notes, Credit Agreement, Century-National Promissory Note and Reciprocal Exchanges' Surplus Notes are classified as Level 3 in the fair value hierarchy. Effective March 31, 2016, the Company purchased the Reciprocal Exchanges' Surplus Notes from ACP Re for an aggregate amount of approximately $88,900. The purchase price was based on an independent third party valuation of the fair market value of the surplus notes. At June 30, 2016, the surplus notes receivable and surplus notes payable are eliminated upon consolidation. (See Note 14, "Related Party Transactions" for additional information).

The following table presents the carrying amount and fair value estimates of debt not carried at fair value:
 
June 30, 2016
 
December 31, 2015
 
Carrying amount
 
Fair value
 
Carrying amount
 
Fair value
7.625% Notes
$
96,627

 
$
101,200

 
$
96,583

 
$
98,240

6.75% Notes
344,801

 
377,219

 
344,478

 
350,000

Credit Agreement
50,000

 
52,296

 

 

Imperial Surplus Notes
5,000

 
4,987

 
5,000

 
4,979

Century-National Promissory Note
182,287

 
182,287

 

 

Reciprocal Exchanges' Surplus Notes

 

 
45,476

 
50,300

Total
$
678,715

 
$
717,989

 
$
491,537

 
$
503,519



Contingent payments - represents the fair value of the contingent payments based on discounted cash flows under the Personal Lines Master Agreement (see Note 14, "Related Party Transactions" for additional information), and the ARS (see Note 7, "Acquisitions" for additional information) and HST contingent payments, and are classified as Level 3 in the fair value hierarchy.


25

NATIONAL GENERAL HOLDINGS CORP.

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(In Thousands, Except Shares and Per Share Data)

In accordance with ASC 820, assets and liabilities measured at fair value on a recurring basis are as follows:
June 30, 2016
 
Recurring Fair Value Measures
 
 
Level 1
 
Level 2
 
Level 3
 
Total
Assets
 
 
 
 
 
 
 
 
Equity securities:
 
 
 
 
 
 
 
 
Common stock
 
$
94,749

 
$

 
$

 
$
94,749

Preferred stock
 

 
15,751

 

 
15,751

Fixed maturities:
 
 
 
 
 
 
 
 
U.S. Treasury
 
29,025

 

 

 
29,025

States and political subdivision bonds
 

 
413,660

 

 
413,660

Foreign government
 

 
60,587

 

 
60,587

Corporate bonds
 

 
1,609,688

 

 
1,609,688

Residential mortgage-backed securities
 

 
350,032

 

 
350,032

Commercial mortgage-backed securities
 

 
108,518

 

 
108,518

Structured securities
 

 
241,968

 

 
241,968

Short-term investments
 

 
52,708

 

 
52,708

Total assets
 
$
123,774

 
$
2,852,912

 
$

 
$
2,976,686

NGHC
 
$
117,762

 
$
2,568,355

 
$

 
$
2,686,117

Reciprocal Exchanges
 
6,012

 
284,557

 

 
290,569

Total assets
 
$
123,774

 
$
2,852,912

 
$

 
$
2,976,686

 
 
 
 
 
 
 
 
 
Liabilities
 
 
 
 
 
 
 
 
Contingent payments
 
$

 
$

 
$
8,086

 
$
8,086

Total liabilities
 
$

 
$

 
$
8,086

 
$
8,086

NGHC
 
$

 
$

 
$
8,086

 
$
8,086

Reciprocal Exchanges
 

 

 

 

Total liabilities
 
$

 
$

 
$
8,086

 
$
8,086



26

NATIONAL GENERAL HOLDINGS CORP.

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(In Thousands, Except Shares and Per Share Data)

December 31, 2015
 
Recurring Fair Value Measures
 
 
Level 1
 
Level 2
 
Level 3
 
Total
Assets
 
 
 
 
 
 
 
 
Equity securities:
 
 
 
 
 
 
 
 
Common stock
 
$
46,965

 
$

 
$

 
$
46,965

Preferred stock
 

 
11,825

 

 
11,825

Fixed maturities:
 
 
 
 
 
 
 
 
U.S. Treasury
 
20,352

 

 

 
20,352

Federal agencies
 
1,952

 

 

 
1,952

States and political subdivision bonds
 

 
196,924

 

 
196,924

Foreign government
 

 
31,062

 

 
31,062

Corporate bonds
 

 
1,349,658

 

 
1,349,658

Residential mortgage-backed securities
 

 
424,569

 

 
424,569

Commercial mortgage-backed securities
 

 
132,205

 

 
132,205

Structured securities
 

 
200,692

 

 
200,692

Short-term investments
 

 
3,527

 

 
3,527

Total assets
 
$
69,269

 
$
2,350,462

 
$

 
$
2,419,731

NGHC
 
$
61,413

 
$
2,115,776

 
$

 
$
2,177,189

Reciprocal Exchanges
 
7,856

 
234,686

 

 
242,542

Total assets
 
$
69,269

 
$
2,350,462

 
$

 
$
2,419,731

 
 
 
 
 
 
 
 
 
Liabilities
 
 
 
 
 
 
 
 
Contingent payments
 
$

 
$

 
$
24,652

 
$
24,652

Total liabilities
 
$

 
$

 
$
24,652

 
$
24,652

NGHC
 
$

 
$

 
$
24,652

 
$
24,652

Reciprocal Exchanges
 

 

 

 

Total liabilities
 
$

 
$

 
$
24,652

 
$
24,652


The following tables provide a summary of changes in fair value of the Company’s Level 3 financial assets and liabilities for the six months ended June 30, 2016 and the year ended December 31, 2015:

 
 
Balance as of
January 1, 2016
 
Net income / loss
 
Other comprehensive
income (loss)
 
Purchases and
issuances
 
Payments, sales and
settlements
 
Net transfers
into (out of)
Level 3
 
Balance as of June 30, 2016
Contingent payments
 
$
24,652

 
$
(773
)
 
$

 
$

 
$
(15,793
)
 
$

 
$
8,086

Total liabilities
 
$
24,652

 
$
(773
)
 
$

 
$

 
$
(15,793
)
 
$

 
$
8,086

 
 
Balance as of
January 1, 2015
 
Net income / loss
 
Other comprehensive
income (loss)
 
Purchases and
issuances
 
Payments, sales and
settlements
 
Net transfers
into (out of)
Level 3
 
Balance as of
December 31, 2015
Common stock
 
$
34,389

 
$

 
$
2,526

 
$

 
$

 
$
(36,915
)
 
$

Total assets
 
$
34,389

 
$

 
$
2,526

 
$

 
$

 
$
(36,915
)
 
$

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Contingent payments
 
$
23,499

 
$
2,357

 
$

 
$
8,581

 
$
(9,785
)
 
$

 
$
24,652

Total liabilities
 
$
23,499

 
$
2,357

 
$

 
$
8,581

 
$
(9,785
)
 
$

 
$
24,652



27

NATIONAL GENERAL HOLDINGS CORP.

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(In Thousands, Except Shares and Per Share Data)

As of June 30, 2016 and December 31, 2015, the fair value measurement for the Company's Level 3 ACP Re Contingent Payments of $3,159 and $16,071, respectively, were valued based on discounted cash flows. As of June 30, 2016 and December 31, 2015, the fair value measurement for the Company's Level 3 ARS Contingent Payments of $2,677 and $4,081, respectively, and and HST Contingent Payments of $2,250 and $4,500, respectively, were valued based on estimated earnings and projected payouts.

There have not been any transfers between Level 1 and Level 2, or Level 2 and Level 3, respectively, during the three and six months ended June 30, 2016. During the year ended December 31, 2015, there were no transfers between Level 1 and Level 2. During the year ended December 31, 2015, the Company transferred $36,915 out of Level 3 and into Level 1 due to the public offering of a previously privately-placed common stock investment. 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.

Other than Goodwill, the Company does not measure any assets or liabilities at fair value on a nonrecurring basis at June 30, 2016 and December 31, 2015. Goodwill is classified as Level 3 in the fair value hierarchy. See Note 8, "Goodwill and Intangible Assets, Net" for additional information on how the Company tested goodwill for impairment.

The carrying value of the Company’s cash and cash equivalents, premiums and other receivables, accrued investment income and accounts payable and accrued expenses approximates fair value given the short-term nature of such items and are classified as Level 1 in the fair value hierarchy. The carrying value of the Company’s securities sold under agreements to repurchase approximates fair value given the short-term nature of the agreements and are classified as Level 2 in the fair value hierarchy.


6. Equity Investments in Unconsolidated Subsidiaries

In 2010, the Company and AmTrust Financial Services, Inc. (“AmTrust”) formed Tiger Capital LLC (“Tiger”) for the purposes of acquiring certain life settlement contracts whereby each holds a 50% ownership interests in Tiger. In 2011, the Company, through its wholly-owned subsidiary, American Capital Acquisition Investments, Ltd. (“ACAI”), formed AMT Capital Alpha, LLC (“AMT Alpha”) with AmTrust for the purposes of acquiring additional life settlement contracts.

In March 2013, the Company entered into a Stock Purchase Agreement with ACP Re to acquire 50% of the issued and outstanding shares of AMT Capital Holdings S.A. (“AMTCH”), a Luxembourg Societe Anonyme, for a cash contribution in the amount of $12,136. ACP Re and the Company are majority owned and controlled by a common parent and the transaction was accounted for as between entities under common control. AMTCH’s primary purpose is to acquire certain life settlement contracts. AmTrust owns the remaining 50% of AMTCH. The Company accounts for AMTCH using the equity method of accounting. The Company’s 50% equity interest in AMTCH at the acquisition date was approximately $22,411. The difference between the equity interest and consideration paid was recorded as additional paid-in capital of $10,275.

In December 2013, ACAI and AmTrust formed AMT Capital Holdings II S.A. (“AMTCH II”). The company is equally owned by both parties and was established for the purpose of acquiring additional life settlement contracts.

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 Company, along with AmTrust, is obligated to pay premiums on these life insurance policies as they come due. A third party serves as the administrator for two of the life settlement contract portfolios, for which it receives an administrative fee. The third-party administrator is eligible to receive a percentage of profits after certain time and performance thresholds have been met.

Tiger, AMT Alpha, AMTCH and AMTCH II (collectively “LSC Entities”) are considered to be VIEs, for which the Company is not a primary beneficiary. 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 of the LSC Entities that most significantly impact its economic performance. The Company’s maximum exposure to a loss as a result of its involvement with the unconsolidated VIE is limited to its recorded investment plus additional capital commitments. The Company uses the equity method of accounting to account for its investments in the LSC Entities.

The Company currently has a fifty percent ownership interest in the LSC Entities. AmTrust owns the remaining fifty percent interest in the LSC Entities.


28

NATIONAL GENERAL HOLDINGS CORP.

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(In Thousands, Except Shares and Per Share Data)

The following tables present the investment activity in the LSC Entities.
 
Six Months Ended June 30,
 
2016
 
2015
Balance at beginning of the period
$
153,661

 
$
146,089

Distributions

 
(1,923
)
Contributions
5,500

 
565

Equity in earnings of unconsolidated subsidiaries
10,532

 
6,511

Change in equity method investments
16,032

 
5,153

Balance at end of the period
$
169,693

 
$
151,242


The following tables summarize total assets, total liabilities and members' equity as of June 30, 2016 and December 31, 2015 and the results of operations for the Company’s unconsolidated equity method investment in the LSC Entities for the three and six months ended June 30, 2016 and 2015.

Condensed balance sheet data
 
June 30, 2016
 
December 31, 2015
Investments in life settlement contracts, at fair value
 
$
304,434

 
$
264,001

Total assets
 
362,691

 
334,026

Total liabilities
 
23,305

 
26,704

Members' equity
 
339,386

 
307,322

NGHC's 50% ownership interest
 
$
169,693

 
$
153,661

 
 
 
 
 
 
 
Three Months Ended June 30,
Condensed results of operations
 
2016
 
2015
Revenue, net of commission
 
$
13,291

 
$
4,063

Total expenses
 
1,883

 
1,277

Net income
 
$
11,408

 
$
2,786

NGHC's 50% ownership interest
 
$
5,704

 
$
1,393

 
 
 
 
 
 
 
Six Months Ended June 30,
Condensed results of operations
 
2016
 
2015
Revenue, net of commission
 
$
24,650

 
$
16,141

Total expenses
 
3,586

 
3,119

Net income
 
$
21,064

 
$
13,022

NGHC's 50% ownership interest
 
$
10,532

 
$
6,511


The LSC Entities account for investments in life settlements in accordance with ASC 325-30, "Investments in Insurance Contracts", which states that an investor shall elect to account for its investments in life settlement contracts by using either the investment method or the fair value method. The election is made on an instrument-by-instrument basis and is irrevocable. The LSC Entities have elected to account for these policies using the fair value method.

The fair value of life settlement contracts as well as life settlement profit commission liability is based on information available to the LSC Entities at the end of the reporting period. The LSC Entities consider the following factors in their fair value estimates: cost at date of purchase, recent purchases and sales of similar investments (if available and applicable), financial standing of the issuer, changes in economic conditions affecting the issuer, maintenance cost, premiums, benefits, standard actuarially developed mortality tables and life expectancy reports prepared by nationally recognized and independent third party medical underwriters. The LSC Entities estimate the fair value of a life insurance policy by applying an investment discount rate based on the cost of funding their life settlement contracts as compared to returns on investments in asset classes with comparable credit quality, which the LSC Entities have determined to be 7.5% to the expected cash flow generated by the policies in the life settlement portfolio

29

NATIONAL GENERAL HOLDINGS CORP.

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(In Thousands, Except Shares and Per Share Data)

(death benefits less premium payments), net of policy specific adjustments and reserves. In order to confirm the integrity of their calculation of fair value, the LSC Entities, quarterly, retain an independent third-party actuary to verify that the actuarial modeling used by the LSC Entities to determine fair value was performed correctly and that the valuation, as determined through the LSC Entities’ actuarial modeling, is consistent with other methodologies. The LSC Entities consider this information in their assessment of the reasonableness of the life expectancy and discount rate inputs used in the valuation of these investments.

The LSC Entities adjust the standard mortality for each insured for the insured’s life expectancy based on reviews of the insured’s medical records and the independent life expectancy report based thereon. The LSC Entities establish policy specific reserves for the following uncertainties: improvements in mortality, the possibility that the high net worth individuals represented in their portfolios may have access to better health care, the volatility inherent in determining the life expectancy of insureds with significant reported health impairments, the possibility that the issuer of the policy or a third party will contest the payment of the death benefit payable to the LSC Entities, and the future expenses related to the administration of the portfolio. The application of the investment discount rate to the expected cash flow generated by the portfolio, net of the policy specific reserves, yields the fair value of the portfolio. The effective discount rate reflects the relationship between the fair value and the expected cash flow gross of these reserves.

The following summarizes data utilized in estimating the fair value of the portfolio of life insurance policies as of June 30, 2016 and December 31, 2015 and, only includes data for policies to which the LSC Entities assigned value at those dates:

 
 
June 30, 2016
 
December 31, 2015
Average age of insured
 
82.5 years

 
82.0 years

Average life expectancy, months(1)
 
108

 
114

Average face amount per policy
 
$
6,365

 
$
6,564

Effective discount rate(2)
 
12.8
%
 
13.7
%

(1)  Standard life expectancy as adjusted for specific circumstances.
(2)  Effective Discount Rate ("EDR") is the LSC Entities' estimated internal rate of return on its life settlement contract portfolio and is determined from the gross expected cash flows and valuation of the portfolio. The valuation of the portfolio is calculated net of all reserves using a 7.5% discount rate. The EDR is inclusive of the reserves and the gross expected cash flows of the portfolio. The LSC Entities anticipate that the EDR's range is between 12.5% and 17.5% and reflects the uncertainty that exists surrounding the information available as of the reporting date. As the accuracy and reliability of information improves (declines), the EDR will decrease (increase).

The LSC Entities' assumptions are, by their nature, inherently uncertain and the effect of changes in estimates may be significant. The fair value measurements used in estimating the present value calculation are derived from valuation techniques generally used in the industry that include inputs for the asset that are not based on observable market data. The extent to which the fair value could reasonably vary in the near term has been quantified by evaluating the effect of changes in significant underlying assumptions used to estimate the fair value amount. If the life expectancies were increased or decreased by 4 months and the discount factors were increased or decreased by 1% while all other variables were held constant, the carrying value of the investment in life insurance policies would increase or (decrease) by the unaudited amounts summarized below as of June 30, 2016 and December 31, 2015:

 
 
Change in life expectancy
 
 
Plus 4 Months
 
Minus 4 Months
Investment in life policies:
 
 
 
 
June 30, 2016
 
$
(38,254
)
 
$
45,092

December 31, 2015
 
$
(37,697
)
 
$
40,997



30

NATIONAL GENERAL HOLDINGS CORP.

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(In Thousands, Except Shares and Per Share Data)

 
 
Change in discount rate(1)
 
 
Plus 1%
 
Minus 1%
Investment in life policies:
 
 
 
 
June 30, 2016
 
$
(26,601
)
 
$
29,514

December 31, 2015
 
$
(26,558
)
 
$
29,644

(1)  Discount rate is a present value calculation that considers legal risk, credit risk and liquidity risk and is a component of EDR.

The Company and AmTrust are committed to providing additional capital support to the LSC Entities to keep the life settlement policies in-force. The Company and AmTrust, each, are committed to provide 50% of the additional required capital. Below is a summary of total premiums to be paid for each of the five succeeding fiscal years to keep the existing life insurance policies in force as of June 30, 2016. The actual capital commitment may differ from the amounts shown based on policy lapses and terminations, death benefits received and other operating cash flows of the LSC Entities:

 
 
Premiums Due on Life Settlement Contracts
2016
 
$
64,353

2017
 
42,020

2018
 
43,105

2019
 
41,350

2020
 
37,788

Thereafter
 
443,511

Total
 
$
672,127


In August 2011, the Company formed 800 Superior, LLC with AmTrust, for the purposes of acquiring an office building in Cleveland, Ohio. The cost of the building was approximately $7,500. AmTrust has been appointed managing member of 800 Superior, LLC. The Company and AmTrust each have a 50% ownership interest in 800 Superior, LLC for which the Company is not the primary beneficiary. Additionally, in 2012, the Company entered into an office lease with 800 Superior, LLC, which as of June 30, 2016, was approximately 156,176 square feet. The lease period is for 15 years and the Company paid 800 Superior, LLC $683 and $1,366 in rent for the three and six months ended June 30, 2016, respectively. For the three and six months ended June 30, 2015, the Company paid 800 Superior, LLC $664 and $1,328, respectively.

The Company’s equity interest in 800 Superior, LLC as of June 30, 2016 and December 31, 2015 was $1,612 and $1,720, respectively. For the three and six months ended June 30, 2016, the Company recorded equity in earnings (losses) from 800 Superior, LLC of $(78) and $(108), respectively. For the three and six months ended June 30, 2015, the Company recorded equity in earnings (losses) from 800 Superior, LLC of $32 and $(159), respectively. (See Note 14, "Related Party Transactions" for additional information).

In September 2012, the Company formed 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 for which the Company is not a primary beneficiary.

The Company’s equity interest in East Ninth & Superior as of June 30, 2016 and December 31, 2015 was $4,167 and $4,139, respectively. For the three and six months ended June 30, 2016, the Company recorded equity in earnings (losses) from East Ninth & Superior of $10 and $28, respectively. For the three and six months ended June 30, 2015, the Company recorded equity in earnings (losses) from East Ninth & Superior of $5 and $37, respectively.

In February 2015, the Company invested $9,714 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”), an entity controlled by Leah Karfunkel and managed by an unrelated third party. The Company and AmTrust each received a 45% limited partnership interest in North Dearborn for their respective $9,714

31

NATIONAL GENERAL HOLDINGS CORP.

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(In Thousands, Except Shares and Per Share Data)

investments, while NA Advisors invested approximately $2,200 and 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. North Dearborn is considered to be a VIE, for which the Company is not a primary beneficiary. The Company accounts for North Dearborn using the equity method of accounting. The Company's total exposure to loss is limited to its equity investment.

The Company’s equity interest in North Dearborn as of June 30, 2016 and December 31, 2015 was $11,604 and $9,862, respectively. For the three and six months ended June 30, 2016, the Company recorded equity in earnings (losses) from North Dearborn of $(57) and $617, respectively, and made contributions of $0 and $1,125, respectively. For the three and six months ended June 30, 2015, the Company recorded equity in earnings (losses) from North Dearborn of $223 and $223, respectively. (See Note 14, "Related Party Transactions" for additional information).

In August 2015, the Company formed 4455 LBJ Freeway, LLC with AmTrust, for the purposes of acquiring an office building in Dallas, Texas. The cost of the building was approximately $21,000. 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. The Company accounts for 4455 LBJ Freeway, LLC using the equity method of accounting. Additionally, in March 2016, the Company entered into a lease agreement with 4455 LBJ Freeway, LLC for approximately 81,822 square feet. The lease period is for 12 years and the Company paid 4455 LBJ Freeway, LLC $413 and $543 in rent for the three and six months ended June 30, 2016, respectively.

The Company’s equity interest in 4455 LBJ Freeway, LLC as of June 30, 2016 and December 31, 2015 was $654 and $10,559, respectively. For the three and six months ended June 30, 2016, the Company recorded equity in earnings (losses) from 4455 LBJ Freeway, LLC of $402 and $253, respectively, and received distributions of $10,158 and $10,158, respectively. (See Note 14, "Related Party Transactions" for additional information).

In August 2015, the Company invested $53,715 in Illinois Center Building, L.P. (“Illinois Center”), a limited partnership that owns an office building in Chicago, Illinois. AmTrust and ACP Re Group, Inc. ("ACP Re Group") are also limited partners in Illinois Center and the general partner is NA Advisors. The Company and AmTrust each received a 37.5% limited partnership interest in Illinois Center for their respective $53,715 investments, while ACP Re Group invested $21,486 for its 15.0% limited partnership interest. NA Advisors invested $14,324 and 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. Illinois Center is considered to be a VIE, for which the Company is not a primary beneficiary. The Company accounts for Illinois Center using the equity method of accounting. The Company's total exposure to loss is limited to its equity investment.

The Company’s equity interest in Illinois Center as of June 30, 2016 and December 31, 2015 was $57,908 and $55,007, respectively. For the three and six months ended June 30, 2016, the Company recorded equity in earnings (losses) from Illinois Center of $1,561 and $2,901. (See Note 14, "Related Party Transactions" for additional information).


7. Acquisitions

Century-National

On June 1, 2016, the Company closed the acquisition of all of the issued and outstanding shares of capital stock of Century-National Insurance Company ("Century-National"), a California domiciled property and casualty insurance company, and Western General Agency, Inc. ("Western General"), a California corporation from Kramer-Wilson Company, Inc. The purchase price for the transaction was approximately $326,087, subject to an adjustment based on the final closing balance sheet. The purchase price equates to a $50,000 premium to tangible book value, and includes an upfront cash payment of approximately $143,800 with the remaining balance of $182,287 in the form of a promissory note, payable over a period of two years. (See Note 9, "Debt - Century-National Promissory Note" for additional information).


32

NATIONAL GENERAL HOLDINGS CORP.

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(In Thousands, Except Shares and Per Share Data)

The following table summarizes the estimated fair value of assets acquired and liabilities assumed at the acquisition date:
June 2016
 
 
Assets
 
 
Cash and invested assets
 
$
424,137

Accrued interest
 
3,531

Premium receivable
 
69,321

Reinsurance recoverable
 
12,904

Premises and equipment
 
5,216

Intangible assets
 
26,875

Deferred tax asset
 
4,185

Other assets
 
7,414

Total Assets
 
553,583

Liabilities
 
 
Unpaid loss and loss adjustment expense reserves
 
135,065

Accounts payable and accrued expenses
 
32,467

Unearned premiums
 
100,885

Reinsurance payable
 
6,873

Advance premiums
 
4,974

Total Liabilities
 
280,264

Net assets purchased
 
273,319

Purchase price
 
326,087

Goodwill recorded
 
$
52,768


The goodwill and intangible assets related to the acquisition of Century-National and Western General were assigned to the Property and Casualty segment. Goodwill of $52,768 is deductible for tax purposes. Intangible assets acquired in the acquisition of Century-National consisted of State licenses of $7,875 with an indefinite life and Value in policies in force of $19,000 with a weighted average amortization life of one year.

As a result of the acquisition of Century-National and Western General, the Company recorded $19,984 of gross premium written and $2,243 of service and fee income for the three and six months ended June 30, 2016.

LPI Business

On October 1, 2015, the Company closed on a master transaction agreement with QBE Investments (North America), Inc. (“QBE Parent”) and its subsidiary, QBE Holdings, Inc. (together with QBE Parent, “QBE”), pursuant to which the Company acquired QBE’s lender-placed insurance business (“LPI Business”), including certain of QBE’s affiliates engaged in the LPI Business. The transaction included the acquisition of certain assets, including loan-tracking systems and technology, client servicing accounts, intellectual property, and vendor relationships, as well as the assumption of the related insurance liabilities in a reinsurance transaction through which the Company received the loss reserves, unearned premium reserves, and invested assets. The aggregate consideration for the transaction was approximately $95,726, subject to certain adjustments.


33

NATIONAL GENERAL HOLDINGS CORP.

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(In Thousands, Except Shares and Per Share Data)

The following table summarizes the estimated fair value of assets acquired and liabilities assumed at the acquisition date:
October 2015
 
 
Assets
 
 
Cash and invested assets
 
$
293,182

Premium receivable
 
102,061

Premises and equipment
 
1,540

Intangible assets
 
61,645

Other assets
 
1,013

Total Assets
 
459,441

Liabilities
 
 
Unpaid loss and loss adjustment expense reserves
 
102,913

Accounts payable and accrued expenses
 
67,949

Unearned premiums
 
245,827

Total Liabilities
 
416,689

Net assets purchased
 
42,752

Purchase price
 
95,726

Goodwill recorded
 
$
52,974


The goodwill and intangible assets related to the acquisition of the LPI Business were assigned to the Property and Casualty segment. Goodwill of $52,974 is deductible for tax purposes. Intangible assets acquired in the acquisition of the LPI Business consisted of Agent/Customer relationships of $50,000, Proprietary technology of $10,000 and Other of $1,645, with weighted average amortization lives of 15, 10 and 7 years, respectively.

The increase in goodwill of $33,248 from December 31, 2015 to June 30, 2016 was related to the increase in the provisional amounts recorded for Cash and invested assets and Accounts payable and accrued expenses, and the decrease in Premium receivable, Premises and equipment, and Other assets, since the initial accounting was in the process of being completed. As of June 30, 2016 the Company believes it has substantially completed the opening balance sheet for the acquisition with the exception of potential tax elections that could impact our tax basis in assets acquired.

As a result of the acquisition of the LPI Business, the Company recorded $108,190 and $220,187 of gross premium written and $8,924 and $17,167 of service and fee income for the three and six months ended June 30, 2016, respectively.

Assurant Health

On October 1, 2015, the Company closed its acquisition of certain business lines and assets from Assurant Health, which is a business segment of Assurant, Inc. As part of the transaction, the Company acquired the small group self-funded and supplemental product lines, as well as North Star Marketing, a proprietary small group sales channel. The purchase price was an aggregate cash payment of $14,000.


34

NATIONAL GENERAL HOLDINGS CORP.

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(In Thousands, Except Shares and Per Share Data)

The following table summarizes the estimated fair value of assets acquired and liabilities assumed at the acquisition date:
October 2015
 
 
Assets
 
 
Cash and invested assets
 
$
43,448

Premium receivable
 
16,440

Intangible assets
 
10,493

Total Assets
 
70,381

Liabilities
 
 
Unpaid loss and loss adjustment expense reserves
 
74,671

Accounts payable and accrued expenses
 
281

Unearned premiums
 
2,505

Deferred tax liability
 
3,887

Other liabilities
 
678

Total Liabilities
 
82,022

Net assets purchased
 
(11,641
)
Purchase price
 
14,000

Goodwill recorded
 
$
25,641


The goodwill and intangible assets related to the acquisition of the business lines and assets from Assurant Health were assigned to the Accident and Health segment. Goodwill of $7,288 is deductible for tax purposes.

The increase in goodwill of $10,532 from December 31, 2015 to June 30, 2016 was related to the decrease in the provisional amounts recorded for Premium receivable and an increase in Unpaid loss and loss adjustment expense reserves, since the initial accounting was in the process of being completed. As of June 30, 2016 the Company believes it has substantially completed the opening balance sheet for the acquisition with the exception of tax allocations to be mutually agreed upon with the seller that could impact our tax basis in assets acquired.

As a result of the acquisition of Assurant Health, the Company recorded $47,288 and $98,163 of gross premium written and $14,885 and $30,025 of service and fee income for the three and six months ended June 30, 2016, respectively.

Assigned Risk Solutions

On April 1, 2015, the Company closed on the acquisition of Assigned Risk Solutions Ltd. ("ARS"), a New Jersey based managing general agency that services assigned risk, personal auto, and commercial lines of business, for a purchase price of approximately $48,000 in cash and potential future earnout payments ("ARS Contingent Payments"). The fair value of the ARS Contingent Payments was $2,677 and $4,081 as of June 30, 2016 and December 31, 2015, respectively. Goodwill recorded on the acquisition of ARS was $14,600. No goodwill is expected to be deductible for tax purposes.

No individual acquisition or acquisitions in the aggregate were materially significant that required any pro forma financial information.



35

NATIONAL GENERAL HOLDINGS CORP.

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(In Thousands, Except Shares and Per Share Data)

8. Goodwill and Intangible Assets, Net

Goodwill

Goodwill is calculated as the excess of purchase price over the net fair value of assets acquired. The Company performs an annual impairment analysis to identify potential goodwill impairment and measures the amount of a goodwill impairment loss to be recognized. This annual test is performed during the fourth quarter of each year, or more frequently, if events or circumstances change in a way that requires the Company to perform the impairment analysis on an interim basis. Goodwill impairment testing requires an evaluation of the estimated fair value of each reporting unit to its carrying value, including goodwill. An impairment charge is recorded if the estimated fair value is less than the carrying amount of the reporting unit.

Intangible Assets

Intangible assets consist of finite and indefinite life assets. Finite life intangible assets include customer and producer relationships and trademarks. Insurance company licenses and managements contracts are considered indefinite life intangible assets subject to annual impairment testing.

The composition of goodwill and intangible assets at June 30, 2016 and December 31, 2015 consisted of the following:
June 30, 2016
 
Gross
Balance
 
Accumulated
Amortization
 
Net Value
 
Useful Life
Trademarks
 
$
900

 
$
45

 
$
855

 
5 years
Loss reserve discount
 
12,694

 
11,593

 
1,101

 
7 years
Agent/Customer relationships
 
148,462

 
25,013

 
123,449

 
11 - 17 years
Affinity partners
 
800

 
472

 
328

 
11 years
Renewal rights
 
26,100

 
9,332

 
16,768

 
7 years
Value in policies in force
 
47,638

 
8,743

 
38,895

 
1 year
Property technology
 
11,800

 
1,136

 
10,664

 
3 - 10 years
Management contracts
 
118,600

 

 
118,600

 
indefinite life
State licenses
 
73,040

 

 
73,040

 
indefinite life
Goodwill
 
208,971

 

 
208,971

 
indefinite life
Total
 
$
649,005

 
$
56,334

 
$
592,671

 
 
NGHC
 
$
616,367

 
$
49,129

 
$
567,238

 
 
Reciprocal Exchanges
 
32,638

 
7,205

 
25,433

 
 
Total
 
$
649,005

 
$
56,334

 
$
592,671

 
 

36

NATIONAL GENERAL HOLDINGS CORP.

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(In Thousands, Except Shares and Per Share Data)

December 31, 2015
 
Gross
Balance
 
Accumulated
Amortization
 
Net Value
 
Useful Life
Trademarks
 
$
8,200

 
$
6,744

 
$
1,456

 
5 years
Loss reserve discount
 
15,089

 
12,779

 
2,310

 
7 years
Agent/Customer relationships
 
148,419

 
18,562

 
129,857

 
11 - 17 years
Affinity partners
 
800

 
436

 
364

 
11 years
Renewal rights
 
26,100

 
6,375

 
19,725

 
7 years
Proprietary technology
 
11,800

 
379

 
11,421

 
3 - 10 years
Management contracts
 
118,600

 

 
118,600

 
indefinite life
State licenses
 
65,165

 

 
65,165

 
indefinite life
Goodwill
 
112,414

 

 
112,414

 
indefinite life
Total
 
$
506,587

 
$
45,275

 
$
461,312

 
 
NGHC
 
$
501,187

 
$
44,700

 
$
456,487

 
 
Reciprocal Exchanges
 
5,400

 
575

 
4,825

 
 
Total
 
$
506,587

 
$
45,275

 
$
461,312

 
 

The increase in intangible assets before accumulated amortization of $45,861 from December 31, 2015 to June 30, 2016 was related to the Company's Reciprocal Exchanges consolidation and the Century-National acquisition. The increase in goodwill of $96,557 from December 31, 2015 to June 30, 2016 was related to the Company's Century-National acquisition and the adjustments to provisional amounts recorded to the LPI Business and Assurant Health acquisitions. (See Note 7, "Acquisitions" for additional information).

Goodwill and intangible assets are subject to annual impairment testing or on an interim basis whenever events or changes in circumstances indicate that the carrying value of a reporting unit may not be recoverable. Included in the Company’s amortization expense for the three and six months ended June 30, 2016 is an impairment charge of $132 and $132, respectively, related to indefinite-lived state license intangible asset. Included in the Company’s amortization expense for the three and six months ended June 30, 2015 is an impairment charge of $367 and $367, respectively, related to certain agent and customer relationships intangible assets. No goodwill impairment was recorded for the three and six months ended June 30, 2016 and 2015.

Finite-lived intangible assets are amortized under the straight-line method, except for loss reserve discount, which the Company amortizes using an accelerated method, which approximates underlying claim payments. The Company also uses the accelerated method of amortization for affinity partners and agents’ relationships based on the estimated attrition of those relationships.

For the three and six months ended June 30, 2016, the Company amortized $14,452 and $20,059, respectively, related to its intangible assets with a finite life, which includes amortization relating to intangible assets owned by the Reciprocal Exchanges of $7,205 and $7,205, respectively. For the three and six months ended June 30, 2015, the Company amortized approximately $4,415 and $9,234, respectively, related to its intangible assets with a finite life, which includes amortization relating to intangible assets owned by the Reciprocal Exchanges of $1,614 and $3,865, respectively.


37

NATIONAL GENERAL HOLDINGS CORP.

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(In Thousands, Except Shares and Per Share Data)

The estimated aggregate amortization expense for each of the next five years and thereafter is:
Year ending
NGHC
 
Reciprocal
Exchanges
 
Total
2016 (remaining six months)
$
20,178

 
$
14,407

 
$
34,585

2017
27,885

 
7,339

 
35,224

2018
15,618

 
180

 
15,798

2019
14,260

 
180

 
14,440

2020
13,822

 
180

 
14,002

2021
11,866

 
45

 
11,911

Thereafter
66,100

 

 
66,100

Total
$
169,729

 
$
22,331

 
$
192,060



9. Debt

7.625% Subordinated Notes due 2055

On August 18, 2015, the Company sold $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 was 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, beginning on December 15, 2015. 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 and six months ended June 30, 2016 was $1,901 and $3,781, 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 June 30, 2016.

6.75% Notes due 2024

On May 23, 2014, the Company sold $250,000 aggregate principal amount of the Company’s 6.75% notes due 2024 (the “6.75% Notes”) to certain purchasers in a private placement. The net proceeds the Company received from the issuance was approximately $245,000, after deducting the 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, beginning on November 15, 2014. 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 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.

On October 8, 2015, the Company sold an additional $100,000 aggregate principal amount of the Company’s 6.75% Notes to certain purchasers in a private placement. The additional 6.75% Notes bear interest at a rate equal to 6.75% per year, payable

38

NATIONAL GENERAL HOLDINGS CORP.

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(In Thousands, Except Shares and Per Share Data)

semiannually in arrears on May 15 and November 15 of each year, beginning on November 15, 2015. The additional 6.75% Notes mature on May 15, 2024, unless earlier redeemed or purchased by the Company. The net proceeds the Company received from the issuance was approximately $98,850, after deducting the estimated issuance expenses payable by the Company. The Company intends to use the net proceeds from the issuance for general corporate purposes, including strategic acquisitions and to support its current and future policy writings. The additional 6.75% Notes were issued under the same indenture as the original 6.75% Notes.

Interest expense on the 6.75% Notes for the three and six months ended June 30, 2016 was $5,890 and $11,715, respectively. Interest expense on the 6.75% Notes for the three and six months ended June 30, 2015 was $4,269 and $8,492, 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 June 30, 2016.

Revolving Credit Agreement

On January 25, 2016, the Company entered into a $225,000 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 revolving credit facility with a letter of credit sublimit of $25,000 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 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 (x) 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 June 30, 2016).

On May 31, 2016, the Company borrowed $50,000 under the Credit Agreement, Eurodollar borrowings was elected for interest rate. Interest payments are due the last day of the interest period in intervals of three months duration, commencing on the date of such borrowing. The borrowing bears interest at the adjusted LIBOR rate which was 3.00% as of June 30, 2016 and will reset in November 30, 2016. Interest expense on the Credit Agreement for the three and six months ended June 30, 2016 was $123 and $123, respectively. The Company was in compliance with all of the covenants under the Credit Agreement as of June 30, 2016.


39

NATIONAL GENERAL HOLDINGS CORP.

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(In Thousands, Except Shares and Per Share Data)

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 and six months ended June 30, 2016 was $59 and $116, respectively. Interest expense on the Imperial Surplus Notes for the three and six months ended June 30, 2015 was $54 and $108, respectively.

Reciprocal Exchanges' Surplus Notes

The Reciprocal Exchanges issued surplus notes ("Reciprocal Exchanges' Surplus Notes") when they were originally capitalized. The obligation to repay principal and interest on these surplus notes is subordinated to the Reciprocal Exchanges’ other liabilities, including obligations to policyholders and claimants for benefits under insurance policies. Principal and interest on these surplus notes are payable only with regulatory approval. Interest expense on the Reciprocal Exchanges' Surplus Notes for the three and six months ended June 30, 2015 was $3,797 and $7,494, respectively, which includes amortization of $2,130 and $4,173, respectively. Effective March 31, 2016, the Company purchased the Reciprocal Exchanges' Surplus Notes from subsidiaries of ACP Re for an aggregate amount of approximately $88,900. The purchase price was based on an independent third party valuation of the fair market value of the surplus notes. At June 30, 2016, the surplus notes receivable and surplus notes payable are eliminated upon consolidation. Interest income and interest expense from the purchased date were also eliminated upon consolidation. (See Note 3, "Reciprocal Exchanges" and Note 14, "Related Party Transactions" for additional information).

Century-National Promissory Note

On June 1, 2016, in connection with the closing of the Company's acquisition of all of the issued and outstanding shares of capital stock of Century-National and Western General, the Company issued a promissory note ("Century-National Promissory Note") in the approximate amount of $182,287 to the seller to fund a portion of the purchase price for the acquisition. The Century-National Promissory Note is unsecured and has a two-year term. Principal on the Century-National Promissory Note is payable in two equal installments of approximately $91,144 on June 1, 2017 and 2018, respectively. Interest on the outstanding principal balance of the Century-National Promissory Note accrues at an annual rate of 4.4% and is payable in arrears on each of the two payment dates. The Century-National Promissory Note may be prepaid at any time, without penalty. The Century-National Promissory Note contains a cross-acceleration provision that is triggered in the event that payment under the Company’s Credit Agreement is accelerated and such acceleration is not revoked, rescinded or withdrawn within 30 days of such acceleration. The Century-National Promissory Note also contains customary events of default. Interest expense on the Century-National Promissory Note for the three and six months ended June 30, 2016 was $637 and $637, respectively. (See Note 7, "Acquisitions" for additional information).

Maturities of the Company's debt for the five years subsequent to June 30, 2016 are as follows:
 
 
2016 (remaining six months)
 
2017
 
2018
 
2019
 
2020
 
2021
 
Thereafter
 
Total
7.625% Notes
 
$

 
$

 
$

 
$

 
$

 
$

 
$
100,000

 
$
100,000

6.75% Notes
 

 

 

 

 

 

 
350,000

 
350,000

Credit Agreement
 

 

 

 

 
50,000

 

 

 
50,000

Imperial Surplus Notes
 

 

 

 

 

 

 
5,000

 
5,000

Century-National Promissory Note
 

 
91,143

 
91,144

 

 

 

 

 
182,287

Total principal amount of debt
 
$

 
$
91,143

 
$
91,144

 
$

 
$
50,000

 
$

 
$
455,000

 
$
687,287

Less: Unamortized debt issuance costs and unamortized discount
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
(8,572
)
Carrying amount of debt
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
$
678,715




40

NATIONAL GENERAL HOLDINGS CORP.

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(In Thousands, Except Shares and Per Share Data)

10. Earnings Per Share

The following is a summary of the elements used in calculating basic and diluted earnings per common share:
 
Three Months Ended June 30,
 
Six Months Ended June 30,
 
2016
 
2015
 
2016
 
2015
Numerator:
 
 
 
 
 
 
 
Net income attributable to NGHC
$
48,470

 
$
38,527

 
$
105,297

 
$
81,295

Less: Dividends on preferred stock
(4,125
)
 
(4,744
)
 
(8,250
)
 
(5,775
)
Net income attributable to common NGHC stockholders
$
44,345

 
$
33,783

 
$
97,047

 
$
75,520

 
 
 
 
 
 
 
 
Denominator:
 
 
 
 
 
 
 
Weighted average number of common shares outstanding – basic
105,803,802

 
93,597,448

 
105,700,682

 
93,527,977

Potentially dilutive securities:
 
 
 
 
 
 
 
Share options
1,923,247

 
2,234,672

 
1,854,405

 
2,128,503

Restricted stock units
470,848

 
348,917

 
432,319

 
348,917

Weighted average number of common shares outstanding – diluted
108,197,897

 
96,181,037

 
107,987,406

 
96,005,397

 
 
 
 
 
 
 
 
Basic earnings per share attributable to NGHC common stockholders
$
0.42

 
$
0.36

 
$
0.92

 
$
0.81

Diluted earnings per share attributable to NGHC common stockholders
$
0.41

 
$
0.35

 
$
0.90

 
$
0.79


As of June 30, 2016 and 2015, 1,666,255 and 2,306,328 share options, respectively, were excluded from diluted earnings per common share as they were anti-dilutive.


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 ("RSUs"), 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, stock split, recapitalization or similar transaction affecting the Company’s common stock. As of June 30, 2016, 1,604,878 shares of Company common stock remained available for grants under the Plans.

The Company recognizes compensation expense under ASC 718-10-25 for its share-based payments based on the fair value of the awards. The Company grants stock options at exercise prices equal to the fair market value of the Company’s stock on the dates the options are granted. The options have a maximum term of ten years from the date of grant and vest primarily in equal annual installments over a range of one to five years following the date of grant for employee options. If a participant’s employment relationship ends, the participant’s vested awards will remain exercisable for the shorter of a period of 30 days or the period ending on the latest date on which such award could have been exercisable. The fair value of each option grant is separately estimated for each grant date. The fair value of each option is amortized into compensation expense on a straight-line basis between the grant date for the award and each vesting date. The Company has estimated the fair value of all stock option awards as of the date of the grant by applying the Black-Scholes-Merton multiple-option pricing valuation model. The application of this valuation model involves assumptions that are judgmental and highly sensitive in the determination of compensation expense. The Company grants RSUs with a grant date value equal to the closing stock price of the Company’s stock on the dates the units are granted and the RSUs generally vest over a period of three or four years.


41

NATIONAL GENERAL HOLDINGS CORP.

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(In Thousands, Except Shares and Per Share Data)

A summary of the Company’s stock option activity for the six months ended June 30, 2016 and 2015 is shown below:
 
Six Months Ended June 30,
 
2016
 
2015
 
Shares
 
Weighted
Average
Exercise
Price
 
Shares
 
Weighted
Average
Exercise
Price
Outstanding at beginning of period
4,123,809

 
$
9.31

 
5,110,593

 
$
8.88

Forfeited
(11,448
)
 
7.52

 
(22,173
)
 
8.55

Exercised
(348,593
)
 
7.54

 
(271,928
)
 
5.24

Outstanding at end of period
3,763,768

 
$
9.48

 
4,816,492

 
$
9.09


No options were granted during the six months ended June 30, 2016 and 2015.

The Company had approximately $6,163 and $9,069 of unrecognized compensation cost related to unvested stock options as of June 30, 2016 and December 31, 2015, respectively. As of June 30, 2016 and December 31, 2015, all option grants outstanding had an approximate weighted average remaining life of 6.5 and 6.8 years, respectively. As of June 30, 2016 and December 31, 2015, options exercisable had an approximate weighted average remaining life of 6.3 and 6.7 years, respectively. As of June 30, 2016 and December 31, 2015, there were 2,776,376 and 2,686,762 exercisable shares with a weighted average exercise price of $9.03 and $8.79, respectively. The intrinsic value of stock options exercised during the six months ended June 30, 2016 and 2015 was $4,596 and $3,806, respectively. The intrinsic value of stock options that were outstanding as of June 30, 2016 and 2015 was $45,032 and $56,594, respectively. The intrinsic value of stock options that were exercisable as of June 30, 2016 and 2015 was $35,294 and $24,174, respectively.

Cash received from options exercised was $3,067 and $1,418 during the six months ended June 30, 2016 and 2015, respectively.

A summary of the Company's RSU activity for the six months ended June 30, 2016 and 2015 is shown below:
 
Six Months Ended June 30,
 
2016
 
2015
 
RSUs
 
Weighted
Average
Grant Date Fair Value
 
RSUs
 
Weighted
Average
Grant Date Fair Value
Non-vested at beginning of period
362,674

 
$
19.16

 
327,555

 
$
17.44

Granted
188,792

 
20.11

 
127,910

 
18.57

Vested
(29,357
)
 
17.85

 
(22,740
)
 
15.91

Forfeited
(13,352
)
 
17.84

 
(83,808
)
 
17.70

Withheld (1)
(19,118
)
 
17.94

 

 

Non-vested at end of period
489,639

 
$
19.69

 
348,917

 
$
17.89

 
 
 
 
 
 
 
 
(1) Represents shares withheld by the Company to satisfy income tax withholding liability and exercise price in connection with RSU vesting.

Compensation expense for all share-based compensation under ASC 718-10-30 was $2,030 and $4,148 for the three and six months ended June 30, 2016, respectively, and $1,176 and $2,264 for the three and six months ended June 30, 2015, respectively.



42

NATIONAL GENERAL HOLDINGS CORP.

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(In Thousands, Except Shares and Per Share Data)

12. Service and Fee Income

The following table summarizes service and fee income by category:
 
 
Three Months Ended June 30,
 
Six Months Ended June 30,
 
 
2016
 
2015
 
2016
 
2015
Installment fees
 
$
9,454

 
$
8,307

 
$
17,922

 
$
16,432

Commission revenue
 
32,978

 
15,035

 
56,835

 
29,277

General agent fees
 
18,822

 
19,305

 
36,783

 
35,432

Late payment fees
 
3,599

 
2,987

 
6,779

 
5,933

Group health administrative fees
 
17,846

 
3,148

 
36,706

 
5,937

Finance and processing fees
 
1,281

 
7,330

 
19,865

 
16,811

Lender service fees
 
3,832

 

 
7,912

 

Other
 
2,205

 
1,446

 
4,159

 
2,606

Total
 
$
90,017

 
$
57,558

 
$
186,961

 
$
112,428



13. 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 Company uses the estimated annual effective tax rate method as prescribed under ASC 740, "Income Taxes". 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 Company establishes deferred tax liabilities equal to approximately 30% of the unutilized statutory equalization reserves carried at its Luxembourg reinsurance companies. The deferred tax liability is adjusted each reporting period based primarily on amounts ceded to the Luxembourg reinsurer under the intercompany reinsurance agreements. As the income or loss of the Luxembourg entity is primarily from intercompany activity, the impact on the consolidated pre-tax income for the consolidated group is generally zero. Accordingly, the reduction of the deferred tax liability for the utilization of equalization reserves creates a deferred tax benefit reflected in the income tax provision in the accompanying condensed consolidated statements of income. As there is no net effect on the consolidated pre-tax income from the intercompany reinsurance activity, the deferred tax benefit related to these transactions reduces the consolidated effective tax rate of the Company. As of June 30, 2016 and December 31, 2015, the Company had approximately $15,003 and $45,927, respectively, of unutilized equalization reserves and an associated deferred tax liability of approximately $4,501 and $13,778, respectively.


43

NATIONAL GENERAL HOLDINGS CORP.

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(In Thousands, Except Shares and Per Share Data)

The following table is a reconciliation of the difference in the Company’s income tax expense compared to the statutory rate of 35%:
 
Three Months Ended June 30,
 
2016
 
2015
 
NGHC
 
Reciprocal Exchanges
 
Total
 
NGHC
 
Reciprocal Exchanges
 
Total
Income (loss) before provision (benefit) for income taxes and equity in earnings of unconsolidated subsidiaries
$
55,943

 
$
8,950

 
$
64,893

 
$
46,003

 
$
(3,440
)
 
$
42,563

Tax at Federal statutory rate 35%
$
19,580

 
$
3,133

 
$
22,713

 
$
16,101

 
$
(1,204
)
 
$
14,897

Tax effects resulting from:
 
 
 
 
 
 
 
 
 
 
 
Exempt foreign income
(2,151
)
 

 
(2,151
)
 
(1,637
)
 

 
(1,637
)
Statutory equalization reserves
(7,450
)
 

 
(7,450
)
 
(2,359
)
 

 
(2,359
)
Other, net
4,846

 
(3,407
)
 
1,439

 
(2,995
)
 
(15
)
 
(3,010
)
Total income tax reported
$
14,825

 
$
(274
)
 
$
14,551

 
$
9,110

 
$
(1,219
)
 
$
7,891

Effective tax rate
26.5
%
 
(3.1
)%
 
22.4
%
 
19.8
%
 
35.4
%
 
18.5
%
 
Six Months Ended June 30,
 
2016
 
2015
 
NGHC
 
Reciprocal Exchanges
 
Total
 
NGHC
 
Reciprocal Exchanges
 
Total
Income before provision (benefit) for income taxes and equity in earnings of unconsolidated subsidiaries
$
124,183

 
$
8,950

 
$
133,133

 
$
92,256

 
$
(3,336
)
 
$
88,920

Tax at Federal statutory rate 35%
$
43,464

 
$
3,133

 
$
46,597

 
$
32,290

 
$
(1,168
)
 
$
31,122

Tax effects resulting from:
 
 
 
 
 
 
 
 
 
 
 
Exempt foreign income
(4,056
)
 

 
(4,056
)
 
(4,699
)
 

 
(4,699
)
Statutory equalization reserves
(9,277
)
 

 
(9,277
)
 
(12,288
)
 

 
(12,288
)
Other, net
2,777

 
(3,407
)
 
(630
)
 
2,226

 
(83
)
 
2,143

Total income tax reported
$
32,908

 
$
(274
)
 
$
32,634

 
$
17,529

 
$
(1,251
)
 
$
16,278

Effective tax rate
26.5
%
 
(3.1
)%
 
24.5
%
 
19.0
%
 
37.5
%
 
18.3
%

The Company’s consolidated effective tax rate increased by 6.2% from 18.3% for the six months ended June 30, 2015 to 24.5% for the six months ended June 30, 2016. This increase was primarily driven by a decrease in the utilization of the Luxembourg statutory equalization reserves.

As permitted by ASC 740, "Income Taxes", the Company recognizes interest and penalties, if any, related to unrecognized tax benefits in its income tax provision. The Company does not have any unrecognized tax benefits and, therefore, has not recorded any unrecognized tax benefits, or any related interest and penalties, as of June 30, 2016 and December 31, 2015. No interest or penalties have been recorded by the Company for the three and six months ended June 30, 2016 or for the three and six months ended June 30, 2015. The Company does not anticipate any significant changes to its total unrecognized tax benefits in the next 12 months.

All tax liabilities are payable to the Internal Revenue Service (“IRS”) and various state and local taxing agencies. Excluding the Reciprocal Exchanges, the Company’s subsidiaries are currently open to audit by the IRS for the years ended December 31, 2012 and thereafter for Federal tax purposes. Excluding the Reciprocal Exchanges, for state and local tax purposes, the Company is open to audit for tax years ended December 31, 2011 forward, depending on jurisdiction.



44

NATIONAL GENERAL HOLDINGS CORP.

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(In Thousands, Except Shares and Per Share Data)

14. 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 from these related entities as follows:

Agreements with AmTrust and Affiliated Entities

Asset Management Agreement

Pursuant to an Asset Management Agreement among NGHC and AII Insurance Management Limited (“AIIM”), a subsidiary of AmTrust, the Company pays AIIM a fee for managing the Company’s investment portfolio. Pursuant to the asset management agreement, AIIM provides investment management services for a quarterly fee of 0.05% of the average value of assets under management if the average value of the account for the previous calendar quarter is less than or equal to $1 billion, and 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. Following the initial one-year term, the agreement may be terminated upon 30 days written notice by either party. The amounts charged for such expenses were $1,455 and $1,798 for the three and six months ended June 30, 2016, respectively, while the amounts charged for such expenses were $537 and $1,089 for the three and six months ended June 30, 2015, respectively. As of June 30, 2016 and December 31, 2015, there was a payable to AIIM related to these services in the amount of $1,634 and $1,909, respectively.

Master Services Agreement

AmTrust provides postage and billing services to the Company for premiums written on the Company’s new policy system pursuant to a Master Services Agreement with National General Management Corp., a wholly-owned subsidiary of the Company. The agreement is effective for ten years from the acceptance of all phases of the initial work statement and can be automatically renewed thereafter for subsequent five-year terms. The agreement is cancellable for material breach of contract that is not cured within thirty days, if either party fails to perform obligations under contract, if either party is declared bankrupt or insolvent, and in the event of a proposed change of control by either party to a competitor. The services are charged on a work-per-piece basis and are billed to the Company at cost. The Company has the right to audit the books and records as appropriate. AmTrust also provides the Company information technology development services in connection with the development of a policy management system at cost pursuant to a Master Services Agreement with National General Management Corp. In addition, as consideration for a license for the Company to use that system, AmTrust receives a license fee in the amount of 1.25% of gross premium of NGHC and its affiliates written on the system plus the costs for support services. In 2014, AmTrust also began providing the Company services in managing the premium receipts from its lockbox facilities at a fixed cost per item processed.

The Company recorded expenses and capitalized costs related to the Master Services Agreement of $11,351 and $21,627 for the three and six months ended June 30, 2016, respectively, while the amounts for such expenses and capitalized costs were $6,840 and $14,902 for the three and six months ended June 30, 2015, respectively. As of June 30, 2016 and December 31, 2015, there was a payable related to the services received under this agreement in the amount of $24,134 and $30,122, respectively.

Reinsurance Agreements

On July 1, 2012, a wholly-owned subsidiary of the Company, Integon National Insurance Company ("Integon National"), entered into an agreement with an AmTrust subsidiary, Risk Services, LLC (“RSL”). RSL provides certain consulting and marketing services to promote the Company’s captive insurance program to potential agents. RSL receives 1.5% of all net premiums written generated to the program. The amounts charged for such fees for the three and six months ended June 30, 2016 were $42 and $100, respectively, while the amounts charged for such fees were $37 and $74 for the three and six months ended June 30, 2015, respectively. As of June 30, 2016 and December 31, 2015, there was a payable for these services in the amount of $42 and $34, respectively.

On March 22, 2012, Integon National entered into a reinsurance agreement with an AmTrust subsidiary, Agent Alliance Reinsurance Company (“AARC”), whereby the Company cedes 25% of the business written by certain agents who are members of the Company’s captive agent program along with 25% of any related losses. The Company receives a ceding commission of 25% of the associated ceded premiums. Each party may terminate the agreement by providing 90 days written notice.


45

NATIONAL GENERAL HOLDINGS CORP.

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(In Thousands, Except Shares and Per Share Data)

On January 1, 2013, the Company entered into a quota share agreement with Wesco Insurance Company (“Wesco”), a subsidiary of AmTrust, to assume 100% of the accident and health business written before January 1, 2013. The Company reinsures 100% of the existing obligations with respect to the accident and health program, including a loss portfolio transfer of 100% of loss and LAE reserves and unearned premium as of the effective date in exchange for an amount equal to 100% of the loss and LAE reserves and unearned premium reserves related to the existing contracts and 100% of the business fronted by Wesco on behalf of the Company after the effective date less the fronted ceded commission of 5% of premiums written, plus the related fronting acquisition costs and fronting inuring reinsurance costs, both meaning the actual costs paid by Wesco to the third parties with respect to those transactions.

The amounts related to these reinsurance treaties are as follows:
June 30, 2016
Recoverable (Payable) on Paid and Unpaid Losses and LAE
 
Commission Receivable
 
Premium Receivable (Payable)
Wesco
$
(5
)
 
$

 
$

AARC
959

 
218

 
(733
)
December 31, 2015
Recoverable (Payable) on Paid and Unpaid Losses and LAE
 
Commission Receivable
 
Premium Receivable (Payable)
Wesco
$
(45
)
 
$

 
$

AARC
829

 
107

 
(395
)
Three Months Ended June 30, 2016
Assumed (Ceded) Earned Premiums
 
Commission Income (Expense)
 
Assumed (Ceded) Losses and LAE
Wesco
$

 
$
(90
)
 
$
3

AARC
(732
)
 
204

 
(353
)
Three Months Ended June 30, 2015
Assumed (Ceded) Earned Premiums
 
Commission Income (Expense)
 
Assumed (Ceded) Losses and LAE
Wesco
$
(81
)
 
$
12

 
$
(811
)
AARC
(373
)
 
112

 
(149
)
Six Months Ended June 30, 2016
Assumed (Ceded) Earned Premiums
 
Commission Income (Expense)
 
Assumed (Ceded) Losses and LAE
Wesco
$

 
$
(90
)
 
$
(23
)
AARC
(1,140
)
 
316

 
(543
)
Six Months Ended June 30, 2015
Assumed (Ceded) Earned Premiums
 
Commission Income (Expense)
 
Assumed (Ceded) Losses and LAE
Wesco
$
71

 
$
211

 
$
(105
)
AARC
(721
)
 
210

 
(365
)

NGHC Quota Share Agreement

The Company participated in a quota share reinsurance treaty with the related entities listed below whereby it ceded 50% of the total net earned premiums and net incurred losses and LAE on business with effective dates after March 1, 2010 (“NGHC Quota Share”).

On August 1, 2013, the Company provided notice to parties of the NGHC Quota Share agreement that it was terminating the agreement. The Company no longer cedes any net earned premiums and net incurred losses and LAE on business with effective dates after July 31, 2013. The termination was on a run-off basis, meaning the Company continued to cede 50% of the net premiums and the related net losses with respect to policies in force as of July 31, 2013 through the expiration of such policies, the last of which expired on July 31, 2014.


46

NATIONAL GENERAL HOLDINGS CORP.

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(In Thousands, Except Shares and Per Share Data)

The NGHC Quota Share provided that the reinsurers pay a provisional ceding commission equal to 32.5% of ceded earned premium, net of premiums ceded by the Company for inuring reinsurance, subject to adjustment. The ceding commission is subject to adjustment to a maximum of 34.5% if the loss ratio for the reinsured business is 60.0% or less and a minimum of 30.5% if the loss ratio is 64.5% or greater. Effective October 1, 2012, the parties amended the NGHC Quota Share to decrease the provisional ceding commission from 32.5% to 32.0% of ceded earned premium, net of premiums ceded by the Company for inuring reinsurance, subject to adjustment. The ceding commission is subject to adjustment to a minimum of 30.0% (changed from 30.5%), if the loss ratio is 64.5% or greater. The Company believes that the terms, conditions and pricing of the NGHC Quota Share were determined by arm's length negotiations and reflect market terms and conditions.

The percentage breakdown by reinsurer of such 50% is as follows:
Name of Insurer
Quota Share Percentage
ACP Re
15%
Maiden Insurance Company, a subsidiary of Maiden
25%
Technology Insurance Company, a subsidiary of AmTrust
10%

The amounts related to this reinsurance treaty are as follows:
June 30, 2016
Reinsurance Recoverable on Paid and Unpaid Losses and LAE
 
Ceded Commission Payable
 
Ceded Premium Payable
ACP Re
$
11,354

 
$

 
$
11,059

Maiden Insurance Company
27,383

 

 
18,433

Technology Insurance Company
8,268

 

 
7,374

Total
$
47,005

 
$

 
$
36,866

December 31, 2015
Reinsurance Recoverable on Paid and Unpaid Losses and LAE
 
Ceded Commission Payable
 
Ceded Premium Payable
ACP Re
$
17,298

 
$

 
$
9,025

Maiden Insurance Company
28,830

 

 
15,041

Technology Insurance Company
11,532

 

 
6,016

Total
$
57,660

 
$

 
$
30,082

Three Months Ended June 30, 2016
Ceded Earned Premiums
 
Ceding Commission Income (Expense)
 
Ceded Losses and LAE
ACP Re
$

 
$
(1,430
)
 
$
1,361

Maiden Insurance Company

 
(2,383
)
 
2,268

Technology Insurance Company

 
(954
)
 
907

Total
$

 
$
(4,767
)
 
$
4,536

Three Months Ended June 30, 2015
Ceded Earned Premiums
 
Ceding Commission Income (Expense)
 
Ceded Losses and LAE
ACP Re
$

 
$
(107
)
 
$
327

Maiden Insurance Company

 
(182
)
 
545

Technology Insurance Company

 
(54
)
 
218

Total
$

 
$
(343
)
 
$
1,090


47

NATIONAL GENERAL HOLDINGS CORP.

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(In Thousands, Except Shares and Per Share Data)

Six Months Ended June 30, 2016
Ceded Earned Premiums
 
Ceding Commission Income (Expense)
 
Ceded Losses and LAE
ACP Re
$

 
$
(2,035
)
 
$
3,156

Maiden Insurance Company

 
(3,391
)
 
5,260

Technology Insurance Company

 
(1,357
)
 
2,104

Total
$

 
$
(6,783
)
 
$
10,520

Six Months Ended June 30, 2015
Ceded Earned Premiums
 
Ceding Commission Income (Expense)
 
Ceded Losses and LAE
ACP Re
$

 
$
91

 
$
814

Maiden Insurance Company

 
149

 
1,369

Technology Insurance Company

 
78

 
529

Total
$

 
$
318

 
$
2,712


The Company nets the ceded commission receivable against ceded premium payable in the condensed consolidated balance sheets as the NGHC Quota Share Agreement allows for net settlement. 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 Insurance Company held assets in trust in the amount of $10,433 and $24,725, respectively, as of June 30, 2016 and $18,677 and $30,797, respectively, as of December 31, 2015.

The Company and AmTrust have formed the LSC Entities for the purposes of acquiring certain life settlement contracts. For further discussion on the LSC Entities' arrangements (see Note 6, “Equity Investments in Unconsolidated Subsidiaries” for additional information).

800 Superior, LLC

As described in Note 6, "Equity Investments in Unconsolidated Subsidiaries", the Company formed 800 Superior, LLC along with AmTrust, whereby each entity owns a 50% interest. In 2012, the Company also entered into a lease agreement with 800 Superior, LLC for a period of 15 years whereby the Company leases as of June 30, 2016 approximately 156,176 square feet. The Company paid 800 Superior, LLC $683 and $1,366 in rent for the three and six months ended June 30, 2016, respectively. For the three and six months ended June 30, 2015, the Company paid 800 Superior, LLC $664 and $1,328, respectively.

The Company’s equity interest in 800 Superior, LLC as of June 30, 2016 and December 31, 2015 was $1,612 and $1,720, respectively. For the three and six months ended June 30, 2016, the Company recorded equity in earnings (losses) from 800 Superior, LLC of $(78) and $(108), respectively. For the three and six months ended June 30, 2015, the Company recorded equity in earnings (losses) from 800 Superior, LLC of $32 and $(159), respectively.

For more information on the 800 Superior, LLC related party transactions, see Note 16, "Related Party Transactions - 800 Superior, LLC" of the Company's Annual Report on Form 10-K for the year ended December 31, 2015.

East Ninth & Superior, LLC

In September 2012, the Company formed 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 for which the Company is not a primary beneficiary.

The Company’s equity interest in East Ninth & Superior as of June 30, 2016 and December 31, 2015 was $4,167 and $4,139, respectively. For the three and six months ended June 30, 2016, the Company recorded equity in earnings (losses) from East Ninth & Superior of $10 and $28, respectively. For the three and six months ended June 30, 2015, the Company recorded equity in earnings (losses) from East Ninth & Superior of $5 and $37, respectively.


48

NATIONAL GENERAL HOLDINGS CORP.

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(In Thousands, Except Shares and Per Share Data)

North Dearborn Building Company, L.P.

In February 2015, the Company invested $9,714 in 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, an entity controlled by Leah Karfunkel and managed by an unrelated third party. The Company and AmTrust each received a 45% limited partnership interest in North Dearborn for their respective $9,714 investments, while NA Advisors invested approximately $2,200 and 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. North Dearborn is considered to be a VIE, for which the Company is not a primary beneficiary. The Company accounts for North Dearborn using the equity method of accounting. The Company's total exposure to loss is limited to its equity investment.

The Company’s equity interest in North Dearborn as of June 30, 2016 and December 31, 2015 was $11,604 and $9,862, respectively. For the three and six months ended June 30, 2016, the Company recorded equity in earnings (losses) from North Dearborn of $(57) and $617, respectively, and made contributions of $0 and $1,125, respectively. For the three and six months ended June 30, 2015, the Company recorded equity in earnings (losses) from North Dearborn of $223 and $223, respectively.

4455 LBJ Freeway, LLC

In August 2015, the Company formed 4455 LBJ Freeway, LLC with AmTrust, for the purposes of acquiring an office building in Dallas, Texas. The cost of the building was approximately $21,000. 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. The Company accounts for 4455 LBJ Freeway, LLC using the equity method of accounting. In March 2016, the Company also entered into a lease agreement with 4455 LBJ Freeway, LLC for a period of 12 years whereby the Company leased approximately 81,822 square feet. The Company paid 4455 LBJ Freeway, LLC $413 and $543 in rent for the three and six months ended June 30, 2016, respectively.

The Company’s equity interest in 4455 LBJ Freeway, LLC as of June 30, 2016 and December 31, 2015 was $654 and $10,559, respectively. For the three and six months ended June 30, 2016, the Company recorded equity in earnings (losses) from 4455 LBJ Freeway, LLC of $402 and $253, respectively, and received distributions of $10,158 and $10,158, respectively.

Illinois Center Building, L.P.

In August 2015, the Company invested $53,715 in Illinois Center, a limited partnership that owns an office building in Chicago, Illinois. AmTrust and ACP Re Group are also limited partners in Illinois Center and the general partner is NA Advisors. The Company and AmTrust each received a 37.5% limited partnership interest in Illinois Center for their respective $53,715 investments, while ACP Re Group invested $21,486 for its 15.0% limited partnership interest. NA Advisors invested $14,324 and 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. Illinois Center is considered to be a VIE, for which the Company is not a primary beneficiary. The Company accounts for Illinois Center using the equity method of accounting. The Company's total exposure to loss is limited to its equity investment.

The Company’s equity interest in Illinois Center as of June 30, 2016 and December 31, 2015 was $57,908 and $55,007, respectively. For the three and six months ended June 30, 2016, the Company recorded equity in earnings (losses) from Illinois Center of $1,561 and $2,901.


49

NATIONAL GENERAL HOLDINGS CORP.

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(In Thousands, Except Shares and Per Share Data)

Agreements with ACP Re and Affiliated Entities

In connection with the acquisition of Tower Group International, Ltd. ("Tower") by ACP Re, the Company entered into the agreements described below.

Personal Lines Master Agreement

On July 23, 2014, the Company and ACP Re entered into the Amended and Restated Personal Lines Master Agreement (the "Master Agreement"). The Master Agreement provided for the implementation of the various transactions associated with the acquisition of Tower by ACP Re. In addition, the Master Agreement requires the Company to pay ACP Re contingent consideration in the form of a three-year earnout (the "Contingent Payments") of 3% of gross premium written of the Tower personal lines business written or assumed by the Company following the Merger. The Contingent Payments are subject to a maximum of $30,000, in the aggregate, over the three-year period. As of June 30, 2016 and December 31, 2015, the fair value for the remaining ACP Re Contingent Payments were $3,159 and $16,071, respectively.

PL Reinsurance Agreement and the Personal Lines Cut-Through Quota Share Reinsurance Agreement

Integon National entered into the Personal Lines Quota Share Reinsurance Agreement (the "PL Reinsurance Agreement"), with Tower’s ten statutory insurance companies (collectively, the “Tower Companies”), pursuant to which Integon National reinsures 100% of all losses under the Tower Companies’ new and renewal personal lines business written after September 15, 2014. The ceding commission payable by Integon National under the PL Reinsurance Agreement is equal to the sum of (i) reimbursement of the Tower Companies’ acquisition costs in respect of the business covered, including commission payable to National General Insurance Marketing, Inc. (“NGIM”), a subsidiary of the Company, pursuant to the PL MGA Agreement (as defined below), and premium taxes and (ii) 2% of gross premium written (net of cancellations and return premiums) collected pursuant to the PL MGA Agreement. In connection with the execution of the PL Reinsurance Agreement, the Personal Lines Cut-Through Quota Share Reinsurance Agreement, dated January 3, 2014, by and among the Tower Companies and Integon National (the “Cut-Through Reinsurance Agreement”), was terminated on a run-off basis, with the reinsurance of all policies reinsured under such agreement remaining in effect.

As of June 30, 2016 and December 31, 2015, there was a net receivable due from the Tower Companies of $18,122 and $46,565, respectively. As a result of the PL Reinsurance Agreement and the Cut-Through Reinsurance Agreement, during the three and six months ended June 30, 2016, the Company assumed $3,562 and $9,239, respectively, of premium from the Tower Companies and recorded $616 and $896, respectively, of ceding commission expense, while during the three and six months ended June 30, 2015, the Company assumed $24,435 and $100,480, respectively, of premium from the Tower Companies and recorded $7,902 and $32,717, respectively, of ceding commission expense. Additionally, during the three and six months ended June 30, 2016, the Company earned premium of $17,096 and $40,987, respectively, while during the three and six months ended June 30, 2015, the Company earned premium of $70,929 and $157,572, respectively, under these reinsurance agreements. During the three and six months ended June 30, 2016, the Company incurred losses and loss adjustment expenses of $12,197 and $34,223, respectively, and during the three and six months ended June 30, 2015, the Company incurred losses and loss adjustment expenses of $46,449 and $92,255, respectively, under these reinsurance agreements.

PL MGA Agreement

NGIM produces and manages all new and renewal personal lines business of the Tower Companies pursuant to a Personal Lines Managing General Agency Agreement (the "PL MGA Agreement"). As described above, all post-September 15, 2014 personal lines business written by the Tower Companies is reinsured by Integon National pursuant to the PL Reinsurance Agreement. The Tower Companies pay NGIM a 10% commission on all business written pursuant to the PL MGA Agreement. All payments by the Tower Companies to NGIM pursuant to the PL MGA Agreement are netted out of the ceding commission payable by Integon National to the Tower Companies pursuant to the PL Reinsurance Agreement. During the three and six months ended June 30, 2016, the Company recorded $354 and $924, respectively, while during the three and six months ended June 30, 2015, the Company recorded $2,444 and $8,027, respectively, of commission income, as a result of the PL MGA Agreement.

PL Administrative Services Agreement

National General Management Corp. ("Management Corp."), a subsidiary of the Company, the Tower Companies and an affiliated company, CastlePoint Reinsurance Company, Ltd (“CP Re”), entered into the Personal Lines LPTA Administrative

50

NATIONAL GENERAL HOLDINGS CORP.

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(In Thousands, Except Shares and Per Share Data)

Services Agreement (the "PL Administrative Agreement"), pursuant to which Management Corp. administers the run-off of CP Re’s and the Tower Companies’ personal lines business written prior to September 15, 2014 at cost. CP Re and the Tower Companies reimburse Management Corp. for its actual costs, including costs incurred in connection with claims operations, out-of-pocket expenses, costs incurred in connection with any required modifications to Management Corp.'s claims systems and an allocated portion of the claims service expenses paid by Integon National to the Tower Companies pursuant to the Cut-Through Reinsurance Agreement. As a result of the PL Administrative Agreement, the Company was reimbursed $12,388 and $37,541 during the three and six months ended June 30, 2016, respectively, while during the three and six months ended June 30, 2015, the Company was reimbursed $4,836 and $5,768, respectively. As of June 30, 2016 and December 31, 2015, there was a receivable related to the PL Administrative Agreement of $13,368 and $11,795, respectively.

Stop-Loss and Retrocession Agreements

National General Re, Ltd.(“NG Re Ltd.”), a subsidiary of the Company, along with AmTrust International Insurance, Ltd., an affiliate of the Company (“AII”), as reinsurers, entered into a $250,000 Aggregate Stop Loss Reinsurance Agreement (the "Stop-Loss Agreement") with CP Re. NG Re Ltd. and AII also entered into an Aggregate Stop Loss Retrocession Contract (the "Retrocession Agreement") with ACP Re pursuant to which ACP Re is obligated to reinsure the full amount of any payments that NG Re Ltd. and AII are obligated to make to CP Re under the Stop-Loss Agreement. Pursuant to the Stop-Loss Agreement, each of NG Re Ltd. and AII provide, severally, $125,000 of stop loss coverage with respect to the run-off of the Tower business written on or before September 15, 2014. The reinsurers’ obligation to indemnify CP Re under the Stop-Loss Agreement will be triggered only at such time as CP Re’s ultimate paid net loss related to the run-off of the pre-September 15, 2014 Tower business exceeds a retention equal to the Tower Companies’ loss and loss adjustment reserves and unearned premium reserves as of September 15, 2014, which, the parties to the Loss Portfolio Transfer Agreement have agreed will be established upon reevaluation as of December 31, 2015. CP Re will pay AII and NG Re Ltd. total premium of $56,000 on the fifth anniversary of the Stop-Loss Agreement. The premium payable by NG Re Ltd. and AII to ACP Re pursuant to the Retrocession Agreement will be $56,000 in the aggregate, less a ceding commission of 5.5% to be retained by NG Re Ltd. and AII. The Company records this reinsurance transaction under the deposit method of accounting. (See Note 17, "Subsequent Events - ACP Re Credit Agreement" for additional information).

Credit Agreement

On September 15, 2014, NG Re Ltd. entered into a credit agreement (the “ACP Re Credit Agreement”) by and among AmTrust, as Administrative Agent, ACP Re and London Acquisition Company Limited, a wholly-owned subsidiary of ACP Re, as the borrowers (collectively, the “Borrowers”), ACP Re Holdings, LLC, as Guarantor, and AII and NG Re Ltd., 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.

The ACP Re Credit Agreement has a maturity date of September 15, 2021. Outstanding principal under the ACP Re Credit Agreement bears interest at a fixed annual rate of seven percent (7%), payable semi-annually on the last day of January and July. The obligations of the Borrowers are secured by (i) a first-priority pledge of 100% of the stock of ACP Re and certain of ACP Re’s U.S. subsidiaries and 65% of the stock of certain of ACP Re’s foreign subsidiaries and (ii) a first-priority lien on the assets of the Borrowers and Guarantor and certain of the assets of ACP Re’s subsidiaries (other than the Tower Companies).

The Company recorded interest income of $2,187 and $2,211 for the three months ended June 30, 2016 and 2015, respectively, and $4,375 and $4,399 for the six months ended June 30, 2016 and 2015, respectively, under the ACP Re Credit Agreement.

At June 30, 2016, based on the consolidated financial condition of ACP Re and the continued losses from its subsidiaries' legacy Tower book of business, management of the Company identified the loan for impairment evaluation. Management determined that it was probable that the Company will be unable to collect all the contractual interest and principal payments as scheduled in the ACP Re Credit Agreement, deeming the loan impaired. While the loan was considered impaired at June 30, 2016 the Company possessed a collateral interest which exceeded the $125,000 outstanding balance. As such, management determined no write down or reserve was needed for the carrying value of the loan. Management will evaluate for impairment and the need to write down or reserve for the loan quarterly. The Company continues to accrue interest on the loan as all contractually required interest payments have been made in accordance with the terms of the ACP Re Credit Agreement. (See Note 17, "Subsequent Events - ACP Re Credit Agreement" for additional information).


51

NATIONAL GENERAL HOLDINGS CORP.

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(In Thousands, Except Shares and Per Share Data)

Surplus Notes of the Reciprocal Exchanges

The Reciprocal Exchanges issued the Reciprocal Exchanges' Surplus Notes when they were originally capitalized. The obligation to repay principal and interest on the Reciprocal Exchanges’ Surplus Notes is subordinated to the Reciprocal Exchanges’ other liabilities. Principal and interest on the Reciprocal Exchanges’ Surplus Notes are payable only with regulatory approval. Effective March 31, 2016, the Company purchased the Reciprocal Exchanges' Surplus Notes from subsidiaries of ACP Re for an aggregate amount of approximately $88,900. The purchase price was based on an independent third party valuation of the fair market value of the surplus notes. At June 30, 2016, the surplus notes receivable and the surplus notes payable are eliminated upon consolidation. (See Note 9, "Debt" for additional information).

AIBD Health Plan

On September 1, 2012, the Company purchased The Association Benefits Solution companies, a group of companies affiliated with the accident and health insurance industry. As part of the purchase, the Company is now affiliated with AIBD Health Plan which is a welfare benefit plan for several member groups. As of June 30, 2016 and December 31, 2015, the Company had a receivable of $5,418 and $5,418, respectively. Also, as part of this plan, the Company utilizes an employer trust to administer additional claims. As of June 30, 2016 and December 31, 2015, the Company had a receivable to the employer trust in the amount of $2,905 and $2,950, respectively.


15. 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 deferred acquisition cost, reinsurance recoverable, goodwill, intangible assets and prepaid reinsurance 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 NGHC from the Reciprocal Exchanges for underwriting, investment management and other services as service and fee income for the Company. The effects of these transactions between NGHC and the Reciprocal Exchanges are eliminated in consolidation to derive consolidated net income.


52

NATIONAL GENERAL HOLDINGS CORP.

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(In Thousands, Except Shares and Per Share Data)

The following tables summarize the results of operations of the Company’s operating segments:
Three Months Ended June 30, 2016
 
Property and Casualty
 
Accident and Health
 
Corporate and Other
 
Total
Underwriting revenue:
 
 
 
 
 
 
 
 
Gross premium written
 
$
747,616

 
$
102,891

 
$

 
$
850,507

Ceded premiums
 
(100,544
)
 
(12,514
)
 

 
(113,058
)
Net premium written
 
647,072

 
90,377

 

 
737,449

Change in unearned premium
 
(36,042
)
 
11,533

 

 
(24,509
)
Net earned premium
 
611,030

 
101,910

 

 
712,940

Ceding commission income
 
11,345

 
359

 

 
11,704

Service and fee income
 
51,161

 
38,856

 

 
90,017

Total underwriting revenue
 
673,536

 
141,125

 

 
814,661

Underwriting expenses:
 
 
 
 
 
 
 
 
Loss and loss adjustment expense
 
393,629

 
78,729

 

 
472,358

Acquisition costs and other underwriting expenses
 
81,778

 
27,096

 

 
108,874

General and administrative expenses
 
161,573

 
29,547

 

 
191,120

Total underwriting expenses
 
636,980

 
135,372

 

 
772,352

Underwriting income
 
36,556

 
5,753

 

 
42,309

Net investment income
 

 

 
27,528

 
27,528

Net realized gains on investments
 

 

 
4,382

 
4,382

Other revenue (expense)
 

 

 
(387
)
 
(387
)
Equity in earnings of unconsolidated subsidiaries
 

 

 
7,356

 
7,356

Interest expense
 

 

 
(8,939
)
 
(8,939
)
Provision for income taxes
 

 

 
(14,551
)
 
(14,551
)
Net (income) loss attributable to non-controlling interest
 

 

 
(9,228
)
 
(9,228
)
Net income attributable NGHC
 
$
36,556

 
$
5,753

 
$
6,161

 
$
48,470

NGHC
 
$
27,914

 
$
5,753

 
$
14,803

 
$
48,470

Reciprocal Exchanges
 
8,642

 

 
(8,642
)
 

Net income attributable NGHC
 
$
36,556

 
$
5,753

 
$
6,161

 
$
48,470


53

NATIONAL GENERAL HOLDINGS CORP.

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(In Thousands, Except Shares and Per Share Data)

Three Months Ended June 30, 2015
 
Property and Casualty
 
Accident and Health
 
Corporate and Other
 
Total
Underwriting revenue:
 
 
 
 
 
 
 
 
Gross premium written
 
$
541,223

 
$
34,458

 
$

 
$
575,681

Ceded premiums
 
(87,619
)
 
(8,652
)
 

 
(96,271
)
Net premium written
 
453,604

 
25,806

 

 
479,410

Change in unearned premium
 
(21,055
)
 
10,461

 

 
(10,594
)
Net earned premium
 
432,549

 
36,267

 

 
468,816

Ceding commission income
 
9,699

 
271

 

 
9,970

Service and fee income
 
39,886

 
17,672

 

 
57,558

Total underwriting revenue
 
482,134

 
54,210

 

 
536,344

Underwriting expenses:
 
 
 
 
 
 
 
 
Loss and loss adjustment expense
 
260,699

 
26,130

 

 
286,829

Acquisition costs and other underwriting expenses
 
84,883

 
11,619

 

 
96,502

General and administrative expenses
 
105,127

 
14,031

 

 
119,158

Total underwriting expenses
 
450,709

 
51,780

 

 
502,489

Underwriting income
 
31,425

 
2,430

 

 
33,855

Net investment income
 

 

 
18,335

 
18,335

Net realized gains on investments
 

 

 
389

 
389

Other revenue (expenses)
 

 

 
(1,415
)
 
(1,415
)
Equity in earnings of unconsolidated subsidiaries
 

 

 
1,654

 
1,654

Interest expense
 

 

 
(8,601
)
 
(8,601
)
Provision for income taxes
 

 

 
(7,891
)
 
(7,891
)
Net (income) loss attributable to non-controlling interest
 

 

 
2,201

 
2,201

Net income attributable NGHC
 
$
31,425

 
$
2,430

 
$
4,672

 
$
38,527

NGHC
 
$
32,703

 
$
2,430

 
$
3,394

 
$
38,527

Reciprocal Exchanges
 
(1,278
)
 

 
1,278

 

Net income attributable NGHC
 
$
31,425

 
$
2,430

 
$
4,672

 
$
38,527


54

NATIONAL GENERAL HOLDINGS CORP.

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(In Thousands, Except Shares and Per Share Data)

Six Months Ended June 30, 2016
 
Property and Casualty
 
Accident and Health
 
Corporate and Other
 
Total
Underwriting revenue:
 
 
 
 
 
 
 
 
Gross premium written
 
$
1,408,953

 
$
257,748

 
$

 
$
1,666,701

Ceded premiums
 
(161,107
)
 
(23,558
)
 

 
(184,665
)
Net premium written
 
1,247,846

 
234,190

 

 
1,482,036

Change in unearned premium
 
(82,768
)
 
(31,408
)
 

 
(114,176
)
Net earned premium
 
1,165,078

 
202,782

 

 
1,367,860

Ceding commission income
 
9,081

 
728

 

 
9,809

Service and fee income
 
114,649

 
72,312

 

 
186,961

Total underwriting revenue
 
1,288,808

 
275,822

 

 
1,564,630

Underwriting expenses:
 
 
 
 
 
 
 
 
Loss and loss adjustment expense
 
726,288

 
155,120

 

 
881,408

Acquisition costs and other underwriting expenses
 
173,437

 
48,336

 

 
221,773

General and administrative expenses
 
306,267

 
61,480

 

 
367,747

Total underwriting expenses
 
1,205,992

 
264,936

 

 
1,470,928

Underwriting income
 
82,816

 
10,886

 

 
93,702

Net investment income
 

 

 
49,198

 
49,198

Net realized gains on investments
 

 

 
7,999

 
7,999

Other revenue (expense)
 

 

 
314

 
314

Equity in earnings of unconsolidated subsidiaries
 

 

 
14,038

 
14,038

Interest expense
 

 

 
(18,080
)
 
(18,080
)
Provision for income taxes
 

 

 
(32,634
)
 
(32,634
)
Net (income) loss attributable to non-controlling interest
 

 

 
(9,240
)
 
(9,240
)
Net income attributable NGHC
 
$
82,816

 
$
10,886

 
$
11,595

 
$
105,297

NGHC
 
$
74,174

 
$
10,886

 
$
20,237

 
$
105,297

Reciprocal Exchanges
 
8,642

 

 
(8,642
)
 

Net income attributable NGHC
 
$
82,816

 
$
10,886

 
$
11,595

 
$
105,297


55

NATIONAL GENERAL HOLDINGS CORP.

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(In Thousands, Except Shares and Per Share Data)

Six Months Ended June 30, 2015
 
Property and Casualty
 
Accident and Health
 
Corporate and Other
 
Total
Underwriting revenue:
 
 
 
 
 
 
 
 
Gross premium written
 
$
1,109,321

 
$
109,815

 
$

 
$
1,219,136

Ceded premiums
 
(192,820
)
 
(16,881
)
 

 
(209,701
)
Net premium written
 
916,501

 
92,934

 

 
1,009,435

Change in unearned premium
 
(35,962
)
 
(25,492
)
 

 
(61,454
)
Net earned premium
 
880,539

 
67,442

 

 
947,981

Ceding commission income
 
14,497

 
553

 

 
15,050

Service and fee income
 
77,337

 
35,091

 

 
112,428

Total underwriting revenue
 
972,373

 
103,086

 

 
1,075,459

Underwriting expenses:
 
 
 
 
 
 
 
 
Loss and loss adjustment expense
 
547,282

 
46,233

 

 
593,515

Acquisition costs and other underwriting expenses
 
163,476

 
22,911

 

 
186,387

General and administrative expenses
 
196,667

 
28,178

 

 
224,845

Total underwriting expenses
 
907,425

 
97,322

 

 
1,004,747

Underwriting income
 
64,948

 
5,764

 

 
70,712

Net investment income
 

 

 
34,483

 
34,483

Net realized gains on investments
 

 

 
1,576

 
1,576

Other revenue (expense)
 

 

 
(170
)
 
(170
)
Equity in earnings of unconsolidated subsidiaries
 

 

 
6,612

 
6,612

Interest expense
 

 

 
(17,681
)
 
(17,681
)
Provision for income taxes
 

 

 
(16,278
)
 
(16,278
)
Net (income) loss attributable to non-controlling interest
 

 

 
2,041

 
2,041

Net income attributable NGHC
 
$
64,948

 
$
5,764

 
$
10,583

 
$
81,295

NGHC
 
$
65,157

 
$
5,764

 
$
10,374

 
$
81,295

Reciprocal Exchanges
 
(209
)
 

 
209

 

Net income attributable NGHC
 
$
64,948

 
$
5,764

 
$
10,583

 
$
81,295


The following tables summarize the financial position of the Company's operating segments as of June 30, 2016 and December 31, 2015:
June 30, 2016
 
Property and Casualty
 
Accident and Health
 
Corporate and Other
 
Total
Premiums and other receivables, net
 
$
773,970

 
$
119,403

 
$

 
$
893,373

Deferred acquisition costs
 
163,398

 
11,262

 

 
174,660

Reinsurance recoverable on unpaid losses
 
845,715

 
7,844

 

 
853,559

Prepaid reinsurance premiums
 
146,405

 

 

 
146,405

Goodwill and Intangible assets, net
 
490,654

 
102,017

 

 
592,671

Prepaid and other assets
 
6,276

 
25,995

 
6,924

 
39,195

Corporate and other assets
 

 

 
3,813,078

 
3,813,078

Total assets
 
$
2,426,418

 
$
266,521

 
$
3,820,002

 
$
6,512,941



56

NATIONAL GENERAL HOLDINGS CORP.

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(In Thousands, Except Shares and Per Share Data)

December 31, 2015
 
Property and Casualty
 
Accident and Health
 
Corporate and Other
 
Total
Premiums and other receivables, net
 
$
684,857

 
$
73,776

 
$

 
$
758,633

Deferred acquisition costs
 
153,767

 
6,764

 

 
160,531

Reinsurance recoverable on unpaid losses
 
832,593

 
583

 

 
833,176

Prepaid reinsurance premiums
 
128,343

 

 

 
128,343

Goodwill and Intangible assets, net
 
366,021

 
95,291

 

 
461,312

Prepaid and other assets
 
19,914

 
17,504

 
3,766

 
41,184

Corporate and other assets
 

 

 
3,180,213

 
3,180,213

Total assets
 
$
2,185,495

 
$
193,918

 
$
3,183,979

 
$
5,563,392


The following table shows an analysis of the Company's gross and net premiums written and net earned premium by geographical location for the three and six months ended June 30, 2016 and 2015:
 
Three Months Ended June 30,
 
2016
 
2015
 
NGHC
 
Reciprocal
Exchanges
 
Total
 
NGHC
 
Reciprocal
Exchanges
 
Total
Gross premium written - North America
$
760,289

 
$
77,170

 
$
837,459

 
$
488,930

 
$
76,729

 
$
565,659

Gross premium written - Europe
13,048

 

 
13,048

 
10,022

 

 
10,022

Total
$
773,337

 
$
77,170

 
$
850,507

 
$
498,952

 
$
76,729

 
$
575,681

 
 
 
 
 
 
 
 
 
 
 
 
Net premium written - North America
$
467,787

 
$
39,130

 
$
506,917

 
$
189,336

 
$
30,766

 
$
220,102

Net premium written - Bermuda
213,119

 

 
213,119

 
234,454

 

 
234,454

Net premium written - Europe
17,413

 

 
17,413

 
24,854

 

 
24,854

Total
$
698,319

 
$
39,130

 
$
737,449

 
$
448,644

 
$
30,766

 
$
479,410

 
 
 
 
 
 
 
 
 
 
 
 
Net earned premium - North America
$
434,989

 
$
36,028

 
$
471,017

 
$
175,943

 
$
22,248

 
$
198,191

Net earned premium - Bermuda
213,119

 

 
213,119

 
235,345

 

 
235,345

Net earned premium - Europe
28,804

 

 
28,804

 
35,280

 

 
35,280

Total
$
676,912

 
$
36,028

 
$
712,940

 
$
446,568

 
$
22,248

 
$
468,816

 
Six Months Ended June 30,
 
2016
 
2015
 
NGHC
 
Reciprocal
Exchanges
 
Total
 
NGHC
 
Reciprocal
Exchanges
 
Total
Gross premium written - North America
$
1,509,825

 
$
77,170

 
$
1,586,995

 
$
1,017,001

 
$
137,966

 
$
1,154,967

Gross premium written - Europe
79,706

 

 
79,706

 
64,169

 

 
64,169

Total
$
1,589,531

 
$
77,170

 
$
1,666,701

 
$
1,081,170

 
$
137,966

 
$
1,219,136

 
 
 
 
 
 
 
 
 
 
 
 
Net premium written - North America
$
810,375

 
$
39,130

 
$
849,505

 
$
390,996

 
$
49,403

 
$
440,399

Net premium written - Bermuda
525,825

 

 
525,825

 
464,867

 

 
464,867

Net premium written - Europe
106,706

 

 
106,706

 
104,169

 

 
104,169

Total
$
1,442,906

 
$
39,130

 
$
1,482,036

 
$
960,032

 
$
49,403

 
$
1,009,435

 
 
 
 
 
 
 
 
 
 
 
 
Net earned premium - North America
$
730,924

 
$
36,028

 
$
766,952

 
$
342,120

 
$
64,144

 
$
406,264

Net earned premium - Bermuda
525,825

 

 
525,825

 
463,067

 

 
463,067

Net earned premium - Europe
75,083

 

 
75,083

 
78,650

 

 
78,650

Total
$
1,331,832

 
$
36,028

 
$
1,367,860

 
$
883,837

 
$
64,144

 
$
947,981


57

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 gross premium written, net premium written and net earned premium by product type for the three and six months ended June 30, 2016 and 2015:
 
 
Three Months Ended June 30,
 
Six Months Ended June 30,
Gross Premium Written
 
2016
 
2015
 
2016
 
2015
Property and Casualty
 
 
 
 
 
 
 
 
Personal Auto
 
$
337,875

 
$
289,264

 
$
723,073

 
$
627,540

Homeowners
 
100,226

 
74,438

 
170,527

 
160,121

RV/Packaged
 
46,693

 
43,096

 
86,296

 
80,646

Commercial Auto
 
68,366

 
50,482

 
118,517

 
91,828

Lender-placed insurance
 
108,190

 

 
220,187

 

Other
 
9,096

 
7,214

 
13,183

 
11,220

Property and Casualty
 
$
670,446

 
$
464,494

 
$
1,331,783

 
$
971,355

Accident and Health
 
102,891

 
34,458

 
257,748

 
109,815

NGHC Total
 
$
773,337

 
$
498,952

 
$
1,589,531

 
$
1,081,170

 
 
 
 
 
 
 
 
 
Reciprocal Exchanges
 
 
 
 
 
 
 
 
Personal Auto
 
$
23,121

 
$
25,773

 
$
23,121

 
$
43,464

Homeowners
 
51,636

 
48,752

 
51,636

 
90,365

Other
 
2,413

 
2,204

 
2,413

 
4,137

Reciprocal Exchanges Total
 
$
77,170

 
$
76,729

 
$
77,170

 
$
137,966

 
 
 
 
 
 
 
 
 
Total
 
$
850,507

 
$
575,681

 
$
1,666,701

 
$
1,219,136


 
 
Three Months Ended June 30,
 
Six Months Ended June 30,
Net Premium Written
 
2016
 
2015
 
2016
 
2015
Property and Casualty
 
 
 
 
 
 
 
 
Personal Auto
 
$
297,281

 
$
252,406

 
$
632,607

 
$
547,649

Homeowners
 
90,559

 
75,456

 
156,435

 
145,846

RV/Packaged
 
46,421

 
42,774

 
85,877

 
79,668

Commercial Auto
 
62,948

 
46,258

 
107,941

 
84,251

Lender-placed insurance
 
105,385

 

 
217,382

 

Other
 
5,348

 
5,944

 
8,474

 
9,684

Property and Casualty
 
$
607,942

 
$
422,838

 
$
1,208,716

 
$
867,098

Accident and Health
 
90,377

 
25,806

 
234,190

 
92,934

NGHC Total
 
$
698,319

 
$
448,644

 
$
1,442,906

 
$
960,032

 
 
 
 
 
 
 
 
 
Reciprocal Exchanges
 
 
 
 
 
 
 
 
Personal Auto
 
$
13,453

 
$
25,696

 
$
13,453

 
$
42,302

Homeowners
 
23,535

 
2,585

 
23,535

 
2,549

Other
 
2,142

 
2,485

 
2,142

 
4,552

Reciprocal Exchanges Total
 
$
39,130

 
$
30,766

 
$
39,130

 
$
49,403

 
 
 
 
 
 
 
 
 
Total
 
$
737,449

 
$
479,410

 
$
1,482,036

 
$
1,009,435



58

NATIONAL GENERAL HOLDINGS CORP.

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(In Thousands, Except Shares and Per Share Data)

 
 
Three Months Ended June 30,
 
Six Months Ended June 30,
Net Earned Premium
 
2016
 
2015
 
2016
 
2015
Property and Casualty
 
 
 
 
 
 
 
 
Personal Auto
 
$
290,829

 
$
267,112

 
$
562,826

 
$
534,643

Homeowners
 
81,556

 
63,227

 
155,995

 
127,350

RV/Packaged
 
39,015

 
37,576

 
76,534

 
73,552

Commercial Auto
 
51,470

 
37,429

 
95,314

 
72,051

Lender-placed insurance
 
108,519

 

 
231,325

 

Other
 
3,613

 
4,957

 
7,056

 
8,799

Property and Casualty
 
$
575,002

 
$
410,301

 
$
1,129,050

 
$
816,395

Accident and Health
 
101,910

 
36,267

 
202,782

 
67,442

NGHC Total
 
$
676,912

 
$
446,568

 
$
1,331,832

 
$
883,837

 
 
 
 
 
 
 
 
 
Reciprocal Exchanges
 
 
 
 
 
 
 
 
Personal Auto
 
$
12,980

 
$
23,541

 
$
12,980

 
$
46,471

Homeowners
 
19,604

 
(2,668
)
 
19,604

 
15,048

Other
 
3,444

 
1,375

 
3,444

 
2,625

Reciprocal Exchanges Total
 
$
36,028

 
$
22,248

 
$
36,028

 
$
64,144

 
 
 
 
 
 
 
 
 
Total
 
$
712,940

 
$
468,816

 
$
1,367,860

 
$
947,981



16. Commitments

Direct General Corporation

On June 24, 2016, the Company entered into an Agreement and Plan of Merger (the “Merger Agreement”) with Elara Holdings, Inc. (the “Acquired Company”), a Delaware corporation and parent company of Direct General Corporation, a Tennessee based property and casualty insurance company, Bluebird Acquisition Corp., a Delaware corporation and wholly-owned subsidiary of the Company (“Merger Sub”) and Shareholder Representative Services LLC, a Colorado limited liability company, solely in its capacity as the Company Holders’ Representative thereunder. Pursuant to the Merger Agreement, subject to the satisfaction or waiver of the conditions set forth therein, the Company agreed to purchase all of the issued and outstanding shares of capital stock of the Acquired Company in a reverse subsidiary merger transaction, whereby Merger Sub will be merged with and into the Acquired Company, with the Acquired Company continuing as the surviving corporation and wholly-owned subsidiary of the Company. The aggregate consideration for the transaction is approximately $165,000. The acquisition is expected to close in the fourth quarter of 2016, pending receipt of regulatory approvals and the satisfaction of other customary closing conditions.


17. Subsequent Events

Series C Preferred Stock

On July 7, 2016, the Company completed a public offering of 8,000,000 of its depositary shares, each representing a1/40th interest in a share of its 7.50% Non-Cumulative Preferred Stock, Series C, $0.01 par value per share (the "Series C Preferred Stock"), with a liquidation preference of $1,000 per share (equivalent to $25 per depositary share). Each depositary share entitles the holder to a proportional fractional interest in all rights and preferences of the Series C Preferred Stock represented thereby (including any dividend, liquidation, redemption and voting rights). Dividends on the Series C Preferred Stock represented by the depositary shares will be payable on the liquidation preference amount, on a non-cumulative basis, when, as and if declared by the Company’s Board of Directors, at a rate of 7.50% per annum, quarterly in arrears, on January 15, April 15, July 15, and October 15 of each year, beginning on October 15, 2016, from and including the date of original issuance. The Series C Preferred Stock represented by the depositary shares is not redeemable prior to July 15, 2021. After that date, the Company may redeem at its option, in whole or in part, the Series C Preferred Stock represented by the depositary shares at a redemption price of $1,000 per

59

NATIONAL GENERAL HOLDINGS CORP.

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(In Thousands, Except Shares and Per Share Data)

share (equivalent to $25 per depositary share) plus any declared and unpaid dividends for prior dividend periods and accrued but unpaid dividends (whether or not declared) for the then current dividend period. A total of 8,000,000 depositary shares (equivalent to 200,000 shares of Series C Preferred Stock) were issued, including the underwriters' over-allotment option. Net proceeds from this offering were $193,525. The Company incurred approximately $6,475 in underwriting discounts, commissions and expenses, which were recognized as a reduction to additional paid-in capital.

ACP Re Credit Agreement

On July 28, 2016, NG Re Ltd. a subsidiary of the Company, AmTrust and its wholly-owned subsidiary AII, entered into a restatement agreement (the “Restatement Agreement”) to the ACP Re Credit Agreement, dated September 15, 2014, among AmTrust, as Administrative Agent, ACP Re, ACP Re Holdings, LLC, as guarantor, and AII and NG Re Ltd., as Lenders. The parties to the Restatement Agreement have agreed to restate the ACP Re Credit Agreement as a result of a $200,000 contribution (the "Contribution") by the Michael Karfunkel Family 2005 Trust (the “Trust”) and members of the Michael Karfunkel family to CastlePoint National Insurance Company (“CNIC”). The Contribution will be made in connection with the Conservation Plan developed by the Commissioner of Insurance of the State of California for CNIC as successor by merger to all of its affiliated Tower Group International Ltd. (the “Tower Group”) U.S. insurance companies (the “Conservation Plan”). The following restated terms of the ACP Re Credit Agreement will become effective upon the approval of the Conservation Plan by the Superior Court of the State of California, which is supervising the Conservation Plan process:

The borrower will become ACP Re Holdings, LLC, a Delaware limited liability company owned by 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 will be 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 will change from September 15, 2021 to the twentieth anniversary of the date on which the restatement becomes effective;
Interest on the outstanding principal balance of $250,000 will change from a fixed annual rate of 7% (payable in cash, semi-annually in arrears) to a fixed annual rate of 3.7% (payable in cash, semi-annually in arrears), provided that up to 1.2% thereof may be paid in kind;
Commencing on the tenth anniversary of the date on which the restatement becomes effective, and for each year thereafter, two percent of the then outstanding principal balance of the loan (inclusive of any amounts previously paid in kind) will be due and payable;
At the Lenders’ discretion, ACP Re Holdings, LLC may repay the loan using cash or tradeable stock of an equivalent market value of any publicly traded company on the NYSE, NASDAQ or London stock exchange; and
A change of control of greater than 50% and an uncured breach of the Maintenance Covenant are included as events of default.

When the Contribution has been made, the following agreements will be terminated: (a) the Stop-Loss Agreement, (b) the Retrocession Contract and (c) the PL Administrative Agreement. National General Management Corp. will enter into an agreement with the Insurance Commissioner of the State of California, in his capacity as Conservator of and on behalf of CNIC, to continue to provide the services it is currently providing under the PL Administrative Agreement, which are to administer the run-off of the Tower Group’s personal lines business written prior to September 15, 2014. The Contribution and consequent termination of these three agreements is subject to approval of the Conservation Plan by the Superior Court of the State of California.

Such modification of terms is deemed to be a troubled debt restructuring (“TDR”). The Company will possess a collateral interest of at least 115% of the $125,000 outstanding balance based on the Maintenance Covenant within the Restatement Agreement. As such, management determined no write down or reserve in the carrying value of the loan will be required as a result of the terms of the Restatement Agreement. The need to evaluate the loan for impairment and classification as a TDR will be evaluated quarterly, as will the adequacy of the Company's reserve position based on collateral levels maintained.



60



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 life settlement contracts, development of claims and the effect on loss reserves, accuracy in projecting loss reserves, the cost and availability of reinsurance coverage, the effects of emerging claim and coverage issues, changes in the demand for our products, our degree of success in integrating acquired businesses, the effect of general economic conditions, state and federal legislation, regulations and regulatory investigations into industry practices, risks associated with conducting business outside the United States, developments relating to existing agreements, disruptions to our business relationships with AmTrust Financial Services, Inc., ACP Re Ltd., Maiden Holdings, Ltd., or third party agencies, breaches in data security or other disruptions with our technology, heightened competition, changes in pricing environments, and changes in asset valuations. 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 our filings with the SEC, including our Annual Report on Form 10-K for the year ended December 31, 2015, 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 commercial automobile, homeowners and umbrella, supplemental health, lender-placed 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 fifteen 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, Personal Express Insurance Company, Imperial Fire and Casualty Insurance Company, Agent Alliance Insurance Company and Century-National Insurance Company (“Century-National”). Our insurance subsidiaries have been assigned an "A-" (Excellent) group rating by A.M. Best. We currently conduct a limited amount of business outside the United States, primarily in Bermuda, Luxembourg and Sweden.

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


61



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 loss ratio, net combined ratio (non-GAAP) and operating leverage. We target a net combined ratio (non-GAAP) between 90% and 95% 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 six months ended June 30, 2016, our annualized operating leverage (the ratio of net earned premium to average total stockholders’ equity) was 1.7x, 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 $49.2 million and $34.5 million for the six months ended June 30, 2016 and 2015, respectively. We held 7.6% and 9.6% of total invested assets in cash and cash equivalents as of June 30, 2016 and December 31, 2015, respectively.

Our most significant balance sheet liability is our unpaid loss and loss adjustment expense (“LAE”) reserves. As of June 30, 2016 and December 31, 2015, our reserves, net of reinsurance recoverables, were $1,113.2 million and $922.4 million, respectively. We record reserves for estimated losses under insurance policies that we write and for LAE related to the investigation and settlement of policy claims. Our reserves for loss and LAE represent the estimated cost of all reported and unreported loss and LAE incurred and unpaid at any time based on known facts and circumstances. Our reserves, excluding life reserves, for loss and LAE incurred and unpaid are not discounted using present value factors. Our loss reserves are reviewed quarterly by internal actuaries and at least annually by our external actuaries. Reserves are based on estimates of the most likely ultimate cost of individual claims. These estimates are inherently uncertain. Judgment is required to determine the relevance of our historical experience and industry information under current facts and circumstances. The interpretation of this historical and industry data can be impacted by external forces, principally frequency and severity of future claims, the length of time needed to achieve ultimate settlement of claims, inflation of medical costs, insurance policy coverage interpretations, jury determinations and legislative changes. Accordingly, our reserves may prove to be inadequate to cover our actual losses. If we change our estimates, these changes would be reflected in our results of operations during the period in which they are made, with increases in our reserves resulting in decreases in our earnings.


Recent Acquisitions

On June 1, 2016, we closed the acquisition of Century-National, a California domiciled property and casualty insurance company, and Western General Agency, Inc. (“Western General"), a California corporation from Kramer-Wilson Company, Inc. The purchase price for the transaction was approximately $326.1 million, subject to an adjustment based on the final closing balance sheet. The purchase price equates to a $50.0 million premium to tangible book value, and includes an upfront cash payment of approximately $143.8 million with the remaining balance of $182.3 million in the form of a promissory note, payable over a period of two years.


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


62



typically have a term of six months or one year. For a six-month policy written on January 1, 2016, we would earn half of the premium in the first quarter of 2016 and the other half in the second quarter of 2016.

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

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

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

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

Net investment income and realized gains and (losses). We invest our statutory surplus funds and the funds supporting our insurance liabilities primarily in cash and cash equivalents, fixed-maturity and equity securities. Our net investment income includes interest and dividends earned on our invested assets. We report net realized gains and losses on our investments separately from our net investment income. Net realized gains occur when we sell our investment securities for more than their costs or amortized costs, as applicable. Net realized losses occur when we sell our investment securities for less than their costs or amortized costs, as applicable, or we write down the investment securities as a result of other-than-temporary impairment loss. We classify equity securities and our fixed-maturity securities as available-for-sale. We report net unrealized gains (losses) on those securities classified as available-for-sale separately within other comprehensive income.

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.



63



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

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

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

Net operating expense. These expenses consist of the sum of general and administrative 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.

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


Insurance Ratios

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

Net operating expense ratio and net combined ratio are considered non-GAAP financial measures under applicable SEC rules because a component of those ratios, net operating expense, is calculated by offsetting acquisition 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. 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


64



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 for the Three and Six Months Ended June 30, 2016 and 2015 (Unaudited)” 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, 2015.

For more information related to recent accounting pronouncements that we adopted during the six months ended June 30, 2016, see Note 2, "Recent Accounting Pronouncements" in the notes to our condensed consolidated financial statements.




65



Results of Operations

Consolidated Results of Operations for the Three Months Ended June 30, 2016 and 2015 (Unaudited)

 
Three Months Ended June 30,
 
2016
 
2015
 
NGHC
 
Reciprocal Exchanges
 
Eliminations
 
Total
 
NGHC
 
Reciprocal Exchanges
 
Eliminations
 
Total
 
(Amounts in Thousands)
Gross premium written
$
774,048

 
$
77,170

 
$
(711
)
 
$
850,507

 
$
498,952

 
$
76,729

 
$

 
$
575,681

Ceded premiums
(75,729
)
 
(38,040
)
 
711

 
(113,058
)
 
(50,308
)
 
(45,963
)
 

 
(96,271
)
Net premium written
$
698,319

 
$
39,130

 
$

 
$
737,449

 
$
448,644

 
$
30,766

 
$

 
$
479,410

Change in unearned premium
(21,407
)
 
(3,102
)
 

 
(24,509
)
 
(2,076
)
 
(8,518
)
 

 
(10,594
)
Net earned premium
$
676,912

 
$
36,028

 
$

 
$
712,940

 
$
446,568

 
$
22,248

 
$

 
$
468,816

Ceding commission income (loss)
(3,205
)
 
14,909

 

 
11,704

 
46

 
9,924

 

 
9,970

Service and fee income
99,629

 
1,195

 
(10,807
)
 
90,017

 
67,343

 
947

 
(10,732
)
 
57,558

Underwriting expenses:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Loss and loss adjustment expense
454,622

 
17,736

 

 
472,358

 
271,584

 
15,245

 

 
286,829

Acquisition costs and other underwriting expenses
108,387

 
493

 
(6
)
 
108,874

 
88,912

 
7,611

 
(21
)
 
96,502

General and administrative expenses
176,660

 
25,261

 
(10,801
)
 
191,120

 
118,328

 
11,541

 
(10,711
)
 
119,158

Total underwriting expenses
$
739,669

 
$
43,490

 
$
(10,807
)
 
$
772,352

 
$
478,824

 
$
34,397

 
$
(10,732
)
 
$
502,489

Underwriting income (loss)
$
33,667

 
$
8,642

 
$

 
$
42,309

 
$
35,133

 
$
(1,278
)
 
$

 
$
33,855

Net investment income
27,361

 
2,248

 
(2,081
)
 
27,528

 
16,154

 
2,181

 

 
18,335

Net realized gain (loss) on investments
4,241

 
141

 

 
4,382

 
935

 
(546
)
 

 
389

Other revenue (expense)
(387
)
 

 

 
(387
)
 
(1,415
)
 

 

 
(1,415
)
Equity in earnings (losses) of unconsolidated subsidiaries
7,356

 

 

 
7,356

 
1,654

 

 

 
1,654

Interest expense
(8,939
)
 
(2,081
)
 
2,081

 
(8,939
)
 
(4,804
)
 
(3,797
)
 

 
(8,601
)
Income (loss) before provision (benefit) for income taxes
$
63,299

 
$
8,950

 
$

 
$
72,249

 
$
47,657

 
$
(3,440
)
 
$

 
$
44,217

Less: Provision (benefit) for income taxes
14,825

 
(274
)
 

 
14,551

 
9,110

 
(1,219
)
 

 
7,891

Net income (loss)
$
48,474

 
$
9,224

 
$

 
$
57,698

 
$
38,547

 
$
(2,221
)
 
$

 
$
36,326

Less: Net (income) loss attributable to non-controlling interest
(4
)
 
(9,224
)
 

 
(9,228
)
 
(20
)
 
2,221

 

 
2,201

Net income attributable NGHC
$
48,470

 
$

 
$

 
$
48,470

 
$
38,527

 
$

 
$

 
$
38,527

Net loss ratio
67.2
%
 
49.2
%
 
 
 
66.3
%
 
60.8
%
 
68.5
%
 
 
 
61.2
%
Net operating expense ratio (non-GAAP)
27.9
%
 
26.8
%
 
 
 
27.8
%
 
31.3
%
 
37.2
%
 
 
 
31.6
%
Net combined ratio (non-GAAP)
95.1
%
 
76.0
%
 
 
 
94.1
%
 
92.1
%
 
105.7
%
 
 
 
92.8
%
 
Three Months Ended June 30,
Reconciliation of net operating expense ratio (non-GAAP):
2016
 
2015
 
NGHC
 
Reciprocal Exchanges
 
Eliminations
 
Total
 
NGHC
 
Reciprocal Exchanges
 
Eliminations
 
Total
 
(Amounts in Thousands)
Total expenses
$
748,608

 
$
45,571

 
$
(12,888
)
 
$
781,291

 
$
483,628

 
$
38,194

 
$
(10,732
)
 
$
511,090

Less: Loss and loss adjustment expense
454,622

 
17,736

 

 
472,358

 
271,584

 
15,245

 

 
286,829

Less: Interest expense
8,939

 
2,081

 
(2,081
)
 
8,939

 
4,804

 
3,797

 

 
8,601

Less: Ceding commission income (loss)
(3,205
)
 
14,909

 

 
11,704

 
46

 
9,924

 

 
9,970

Less: Service and fee income
99,629

 
1,195

 
(10,807
)
 
90,017

 
67,343

 
947

 
(10,732
)
 
57,558

Net operating expense
$
188,623

 
$
9,650

 
$

 
$
198,273

 
$
139,851

 
$
8,281

 
$

 
$
148,132

Net earned premium
$
676,912

 
$
36,028

 
$

 
$
712,940

 
$
446,568

 
$
22,248

 
$

 
$
468,816

Net operating expense ratio (non-GAAP)
27.9
%
 
26.8
%
 
 
 
27.8
%
 
31.3
%
 
37.2
%
 
 
 
31.6
%



66



Consolidated Results of Operations for the Six Months Ended June 30, 2016 and 2015 (Unaudited)

 
Six Months Ended June 30,
 
2016
 
2015
 
NGHC
 
Reciprocal Exchanges
 
Eliminations
 
Total
 
NGHC
 
Reciprocal Exchanges
 
Eliminations
 
Total
 
(Amounts in Thousands)
Gross premium written
$
1,590,242

 
$
77,170

 
$
(711
)
 
$
1,666,701

 
$
1,084,760

 
$
137,966

 
$
(3,590
)
 
$
1,219,136

Ceded premiums
(147,336
)
 
(38,040
)
 
711

 
(184,665
)
 
(124,728
)
 
(88,563
)
 
3,590

 
(209,701
)
Net premium written
$
1,442,906

 
$
39,130

 
$

 
$
1,482,036

 
$
960,032

 
$
49,403

 
$

 
$
1,009,435

Change in unearned premium
(111,074
)
 
(3,102
)
 

 
(114,176
)
 
(76,195
)
 
14,741

 

 
(61,454
)
Net earned premium
$
1,331,832

 
$
36,028

 
$

 
$
1,367,860

 
$
883,837

 
$
64,144

 
$

 
$
947,981

Ceding commission income (loss)
(5,100
)
 
14,909

 

 
9,809

 
1,099

 
13,951

 

 
15,050

Service and fee income
196,573

 
1,195

 
(10,807
)
 
186,961

 
129,996

 
1,742

 
(19,310
)
 
112,428

Underwriting expenses:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Loss and loss adjustment expense
863,672

 
17,736

 

 
881,408

 
550,266

 
43,249

 

 
593,515

Acquisition costs and other underwriting expenses
221,286

 
493

 
(6
)
 
221,773

 
175,541

 
10,872

 
(26
)
 
186,387

General and administrative expenses
353,287

 
25,261

 
(10,801
)
 
367,747

 
218,204

 
25,925

 
(19,284
)
 
224,845

Total underwriting expenses
$
1,438,245

 
$
43,490

 
$
(10,807
)
 
$
1,470,928

 
$
944,011

 
$
80,046

 
$
(19,310
)
 
$
1,004,747

Underwriting income (loss)
$
85,060

 
$
8,642

 
$

 
$
93,702

 
$
70,921

 
$
(209
)
 
$

 
$
70,712

Net investment income
49,031

 
2,248

 
(2,081
)
 
49,198

 
30,263

 
4,220

 

 
34,483

Net realized gain on investments
7,858

 
141

 

 
7,999

 
1,429

 
147

 

 
1,576

Other revenue (expense)
314

 

 

 
314

 
(170
)
 

 

 
(170
)
Equity in earnings of unconsolidated subsidiaries
14,038

 

 

 
14,038

 
6,612

 

 

 
6,612

Interest expense
(18,080
)
 
(2,081
)
 
2,081

 
(18,080
)
 
(10,187
)
 
(7,494
)
 

 
(17,681
)
Income (loss) before provision (benefit) for income taxes
$
138,221

 
$
8,950

 
$

 
$
147,171

 
$
98,868

 
$
(3,336
)
 
$

 
$
95,532

Less: Provision (benefit) for income taxes
32,908

 
(274
)
 

 
32,634

 
17,529

 
(1,251
)
 

 
16,278

Net income (loss)
$
105,313

 
$
9,224

 
$

 
$
114,537

 
$
81,339

 
$
(2,085
)
 
$

 
$
79,254

Less: Net (income) loss attributable to non-controlling interest
(16
)
 
(9,224
)
 

 
(9,240
)
 
(44
)
 
2,085

 

 
2,041

Net income attributable NGHC
$
105,297

 
$

 
$

 
$
105,297

 
$
81,295

 
$

 
$

 
$
81,295

Net loss ratio
64.8
%
 
49.2
%
 
 
 
64.4
%
 
62.3
%
 
67.4
%
 
 
 
62.6
%
Net operating expense ratio (non-GAAP)
28.8
%
 
26.8
%
 
 
 
28.7
%
 
29.7
%
 
32.9
%
 
 
 
29.9
%
Net combined ratio (non-GAAP)
93.6
%
 
76.0
%
 
 
 
93.1
%
 
92.0
%
 
100.3
%
 
 
 
92.5
%
 
Six Months Ended June 30,
Reconciliation of net operating expense ratio (non-GAAP):
2016
 
2015
 
NGHC
 
Reciprocal Exchanges
 
Eliminations
 
Total
 
NGHC
 
Reciprocal Exchanges
 
Eliminations
 
Total
 
(Amounts in Thousands)
Total expenses
$
1,456,325

 
$
45,571

 
$
(12,888
)
 
$
1,489,008

 
$
954,198

 
$
87,540

 
$
(19,310
)
 
$
1,022,428

Less: Loss and loss adjustment expense
863,672

 
17,736

 

 
881,408

 
550,266

 
43,249

 

 
593,515

Less: Interest expense
18,080

 
2,081

 
(2,081
)
 
18,080

 
10,187

 
7,494

 

 
17,681

Less: Ceding commission income (loss)
(5,100
)
 
14,909

 

 
9,809

 
1,099

 
13,951

 

 
15,050

Less: Service and fee income
196,573

 
1,195

 
(10,807
)
 
186,961

 
129,996

 
1,742

 
(19,310
)
 
112,428

Net operating expense
$
383,100

 
$
9,650

 
$

 
$
392,750

 
$
262,650

 
$
21,104

 
$

 
$
283,754

Net earned premium
$
1,331,832

 
$
36,028

 
$

 
$
1,367,860

 
$
883,837

 
$
64,144

 
$

 
$
947,981

Net operating expense ratio (non-GAAP)
28.8
%
 
26.8
%
 


 
28.7
%
 
29.7
%
 
32.9
%
 
 
 
29.9
%



67



On June 1, 2016, we closed the acquisition of Century-National, a California based property and casualty insurance company and Western General, a California corporation.

On October 1, 2015, we closed on a master transaction agreement with QBE Investments (North America), Inc. (“QBE Parent”) and its subsidiary, QBE Holdings, Inc. (together with QBE Parent, “QBE”), pursuant to which we acquired QBE’s lender-placed insurance business (“LPI Business”), including certain of QBE’s affiliates engaged in the LPI Business.

On October 1, 2015, we closed our acquisition of certain business lines and assets from Assurant Health, which is a business segment of Assurant, Inc. As part of the transaction, we acquired the small group self-funded and supplemental product lines, as well as North Star Marketing, a proprietary small group sales channel (the "Assurant Transaction").

Since the time of our acquisition of the Attorneys-in-Fact that manage the Reciprocal Exchanges on September 15, 2014, we have been required to consolidate the financial statements of the Reciprocal Exchanges. As noted above in Note 3, "Reciprocal Exchanges" in the notes to our condensed consolidated financial statements, due to the adoption of ASU 2015-02 in January 1, 2016, we were not required to consolidate the Reciprocal Exchanges as variable interest entities for the first quarter of 2016 (the “Deconsolidation of the Reciprocal Exchanges”). Accordingly, comparative information regarding revenues, expenses and cash flows will be affected for the six months ended June 30, 2016 as compared to the six months ended June 30, 2015, as the revenues, expenses and cash flows included the Reciprocal Exchanges in the first quarter of 2015, but such measures exclude the Reciprocal Exchanges for the first quarter of 2016. Effective March 31, 2016, we acquired the surplus notes issued by the Reciprocal Exchanges and in accordance with ASU 2015-02, we consolidated the Reciprocal Exchanges.

As a result of the Century-National and LPI Business acquisitions, the Assurant Transaction and the Deconsolidation of the Reciprocal Exchanges, comparisons between our 2016 and 2015 results will be less meaningful.

Consolidated Results of Operations for the Three Months Ended June 30, 2016 Compared with the Three Months Ended June 30, 2015 (Unaudited)

Gross premium written. Gross premium written increased by $274.8 million from $575.7 million for the three months ended June 30, 2015 to $850.5 million for the three months ended June 30, 2016, due to an increase of $206.4 million in premiums received from the P&C segment as a result of the acquisitions of Century-National ($20.0 million) and LPI Business ($108.2 million), and organic growth ($78.2 million). Premiums received from the A&H segment increased by $68.4 million as a result of premium from the Assurant Transaction ($47.3 million) and organic growth ($21.1 million).

Net premium written. Net premium written increased by $258.0 million from $479.4 million for the three months ended June 30, 2015 to $737.4 million for the three months ended June 30, 2016. Net premium written for the P&C segment increased by $193.5 million for the three months ended June 30, 2016 compared to the same period in 2015 as a result of the acquisitions of Century-National ($17.8 million) and LPI Business ($105.4 million), and organic growth ($70.3 million). Net premium written for the A&H segment increased by $64.6 million as a result of premium from the Assurant Transaction ($47.3 million) and organic growth ($17.3 million).

Net earned premium. Net earned premium increased by $244.1 million, or 52.1%, from $468.8 million for the three months ended June 30, 2015 to $712.9 million for the three months ended June 30, 2016. The increase by segment was: P&C $178.5 million and A&H $65.6 million. The increase in the P&C segment was attributable to the acquisitions of Century-National ($15.9 million) and LPI Business ($108.5 million), and organic growth ($54.0 million). The increase in the A&H segment was due to premium from the Assurant Transaction ($47.4 million) and organic growth ($18.2 million).

Ceding commission income. Ceding commission income increased from $10.0 million for the three months ended June 30, 2015 to $11.7 million for the three months ended June 30, 2016. The increase was attributable to the Reciprocal Exchanges partially offset by a decrease to the sliding scale adjustment on our terminated third party quota share agreement both under the P&C segment.

Service and fee income. Service and fee income increased by $32.5 million, or 56.4%, from $57.6 million for the three months ended June 30, 2015 to $90.0 million for the three months ended June 30, 2016. The increase was primarily attributable to our service and fee income related to the A&H segment ($21.2 million), resulting primarily from the Assurant Transaction and the increase related to the P&C segment ($11.3 million), resulting from the LPI Business acquisition and organic growth.



68



The components of service and fee income are as follows:
 
 
Three Months Ended June 30,
 
 
(amounts in thousands)
 
2016
 
2015
 
Change
Installment fees
 
$
9,454

 
$
8,307

 
$
1,147

Commission revenue
 
32,978

 
15,035

 
17,943

General agent fees
 
18,822

 
19,305

 
(483
)
Late payment fees
 
3,599

 
2,987

 
612

Group health administrative fees
 
17,846

 
3,148

 
14,698

Finance and processing fees
 
1,281

 
7,330

 
(6,049
)
Lender service fees
 
3,832

 

 
3,832

Other
 
2,205

 
1,446

 
759

Total
 
$
90,017

 
$
57,558

 
$
32,459



Loss and loss adjustment expense; net loss ratio. Loss and LAE increased by $185.5 million, or 64.7%, from $286.8 million for the three months ended June 30, 2015 to $472.4 million for the three months ended June 30, 2016, primarily reflecting the Century-National and LPI Business acquisitions, the Assurant Transaction and loss experience in our legacy domestic stop loss programs. The changes by segment were: P&C increased by $132.9 million and A&H increased by $52.6 million. Loss and LAE for the three months ended June 30, 2016 included $10.2 million of favorable development on prior accident year loss and LAE reserves. The $14.6 million of favorable development in the P&C segment was driven by favorable development in our LPI Business and the Reciprocal Exchanges, while $4.4 million of unfavorable development in the A&H segment was primarily driven by unfavorable development in our domestic A&H businesses. Loss and LAE for the three months ended June 30, 2015 included $1.0 million of unfavorable development on prior accident year loss and LAE reserves primarily attributable to loss emergence in the A&H segment, related to legacy domestic medical stop loss programs and to European A&H policies produced by our Euro Accident Health & Care Insurance Aktiebolag ("EHC") business. Our consolidated net loss ratio, which includes the Reciprocal Exchanges, increased from 61.2% for the three months ended June 30, 2015 to 66.3% for the three months ended June 30, 2016 with a higher P&C segment net loss ratio driven by product mix changes, losses related to hail storms that occurred in Texas and a higher A&H segment net loss ratio primarily driven by greater loss experience in our legacy domestic stop loss programs.

Acquisition costs and other underwriting expenses. Acquisition costs and other underwriting expenses increased by $12.4 million, or 12.8%, from $96.5 million for the three months ended June 30, 2015 to $108.9 million for the three months ended June 30, 2016, as a result of the LPI Business acquisition and the Assurant Transaction and organic growth.

General and administrative expenses. General and administrative expenses increased by $72.0 million, or 60.4%, from $119.2 million for the three months ended June 30, 2015 to $191.1 million for the three months ended June 30, 2016, primarily as a result of the LPI Business acquisition, the Assurant Transaction and higher amortization of intangible assets in the Reciprocal Exchanges.

Net operating expense; net operating expense ratio (non-GAAP). Net operating expense increased by $50.1 million, or 33.8%, from $148.1 million for the three months ended June 30, 2015 to $198.3 million for the three months ended June 30, 2016. The consolidated net operating expense ratio, which includes the Reciprocal Exchanges, decreased to 27.8% in the three months ended June 30, 2016 from 31.6% in the three months ended June 30, 2015 with a lower P&C segment net operating expense ratio driven by product mix changes and a lower A&H segment net operating expense ratio resulting from the maturation of the A&H business and increased service and fee income. Excluding the Reciprocal Exchanges, the net operating expense ratio was 27.9% and 31.3% for the three months ended June 30, 2016 and 2015, respectively. The Reciprocal Exchanges' net operating expense ratio was 26.8% and 37.2% for the three months ended June 30, 2016 and 2015, respectively.

Net investment income. Net investment income increased by $9.2 million, or 50.1% from $18.3 million for the three months ended June 30, 2015 to $27.5 million for the three months ended June 30, 2016, primarily due to an increase in average invested assets as a result of our issuances of debt, preferred stock and common stock capital raising activities in 2015.



69



Net realized gain on investments. Net realized gains on investments increased by $4.0 million from a gain of $0.4 million for the three months ended June 30, 2015 to a $4.4 million gain for the three months ended June 30, 2016, primarily due to the increase of gains from our corporate debt securities in the six months ended June 30, 2016 and the recognition of a $1.5 million OTTI charge in the three months ended June 30, 2015.

Equity in earnings of unconsolidated subsidiaries. Equity in earnings of unconsolidated subsidiaries, which primarily relates to our 50% interest in life settlement entities, increased by $5.7 million from $1.7 million in earnings for the three months ended June 30, 2015 to $7.4 million in earnings for the three months ended June 30, 2016, due to the change in fair market value of the life settlement contracts and income from our real estate investments.

Interest expense. Interest expense for the three months ended June 30, 2016 and 2015 was $8.9 million and $8.6 million, respectively.

Provision for income taxes. Income tax expense increased by $6.7 million, or 84.4%, from $7.9 million for the three months ended June 30, 2015, reflecting an effective tax rate of 18.5%, to $14.6 million for the three months ended June 30, 2016, reflecting an effective tax rate of 22.4%. The primary driver of the increase in income tax expense was the increase in pre-tax income period over period. Income tax expense included a tax benefit of $7.5 million and $2.4 million for the three months ended June 30, 2016 and 2015, respectively, attributable to the reduction of the deferred tax liability associated with the equalization reserves of our Luxembourg reinsurers. The effect of this tax benefit reduced the effective tax rate for the three months ended June 30, 2016 and 2015 by 11.5% and 5.5%, respectively.

Excluding the Reciprocal Exchanges, income tax expense was $14.8 million and $9.1 million for the three months ended June 30, 2016 and 2015, respectively, reflecting effective tax rates of 26.5% and 19.8%, respectively.

The Reciprocal Exchanges had pre-tax income of $9.0 million and a pre-tax loss of $3.4 million for the three months ended June 30, 2016 and 2015, respectively. A full valuation allowance was recorded in the Reciprocal Exchanges.

Consolidated Results of Operations for the Six Months Ended June 30, 2016 Compared with the Six Months Ended June 30, 2015 (Unaudited)

Gross premium written. Gross premium written increased by $447.6 million from $1,219.1 million for the six months ended June 30, 2015 to $1,666.7 million for the six months ended June 30, 2016, due to an increase of $299.6 million in premiums received from the P&C segment as a result of the acquisitions of Century-National ($20.0 million) and LPI Business ($220.2 million), and organic growth ($120.3 million), partially offset by the Deconsolidation of the Reciprocal Exchanges ($60.8 million). Premiums received from the A&H segment increased by $147.9 million as a result of premium from the Assurant Transaction ($98.2 million) and organic growth ($49.8 million).

Net premium written. Net premium written increased by $472.6 million from $1,009.4 million for the six months ended June 30, 2015 to $1,482.0 million for the six months ended June 30, 2016. Net premium written for the P&C segment increased by $331.3 million for the six months ended June 30, 2016 compared to the same period in 2015 as a result of the acquisitions of Century-National ($17.8 million) and LPI Business ($217.4 million), and organic growth ($106.4 million), partially offset by the Deconsolidation of the Reciprocal Exchanges ($10.3 million). Net premium written for the A&H segment increased by $141.3 million as a result of premium from the Assurant Transaction ($98.2 million) and organic growth ($43.1 million).

Net earned premium. Net earned premium increased by $419.9 million, or 44.3%, from $948.0 million for the six months ended June 30, 2015 to $1,367.9 million for the six months ended June 30, 2016. The increase by segment was: P&C $284.5 million and A&H $135.3 million. The increase in the P&C segment was attributable to the acquisitions of Century-National ($15.9 million) and LPI Business ($231.3 million), and organic growth ($65.4 million), partially offset by the Deconsolidation of the Reciprocal Exchanges ($28.1 million ). The increase in the A&H segment was due to premium from the Assurant Transaction ($98.4 million) and organic growth ($36.9 million).

Ceding commission income. Ceding commission income decreased from $15.1 million for the six months ended June 30, 2015 to $9.8 million for the six months ended June 30, 2016, primarily driven by a decrease to the sliding scale adjustment on our terminated third party quota share agreement under the P&C segment.

Service and fee income. Service and fee income increased by $74.5 million, or 66.3%, from $112.4 million for the six months ended June 30, 2015 to $187.0 million for the six months ended June 30, 2016. The increase was primarily attributable to our service and fee income related to the A&H segment ($37.2 million), resulting primarily from the Assurant Transaction and the increase related to the P&C segment ($37.3 million), resulting from the LPI Business acquisition and organic growth.


70




The components of service and fee income are as follows:
 
 
Six Months Ended June 30,
 
 
(Amounts in Thousands)
 
2016
 
2015
 
Change
Installment fees
 
$
17,922

 
$
16,432

 
$
1,490

Commission revenue
 
56,835

 
29,277

 
27,558

General agent fees
 
36,783

 
35,432

 
1,351

Late payment fees
 
6,779

 
5,933

 
846

Group health administrative fees
 
36,706

 
5,937

 
30,769

Finance and processing fees
 
19,865

 
16,811

 
3,054

Lender service fees
 
7,912

 

 
7,912

Other
 
4,159

 
2,606

 
1,553

Total
 
$
186,961

 
$
112,428

 
$
74,533


Loss and loss adjustment expense; net loss ratio. Loss and LAE increased by $287.9 million, or 48.5%, from $593.5 million for the six months ended June 30, 2015 to $881.4 million for the six months ended June 30, 2016, primarily reflecting the Century-National and LPI Business acquisitions, the Assurant Transaction and loss experience in our legacy domestic stop loss programs, partially offset by the Deconsolidation of the Reciprocal Exchanges. The changes by segment were: P&C increased by $179.0 million and A&H increased by $108.9 million. Loss and LAE for the six months ended June 30, 2016 included $11.5 million of favorable development on prior accident year loss and LAE reserves. The $15.1 million of favorable development in the P&C segment was driven by favorable development in our LPI Business and the Reciprocal Exchanges, while $3.6 million of unfavorable development in the A&H segment was primarily driven by unfavorable development in our domestic A&H businesses. Loss and LAE for the six months ended June 30, 2015 included $2.1 million of unfavorable development on prior accident year loss and LAE reserves primarily attributable to loss emergence in the A&H segment, of which $1.3 million related to legacy domestic medical stop loss programs and $0.7 million related to European A&H policies produced by our EHC business. Our consolidated net loss ratio, which includes the Reciprocal Exchanges, increased from 62.6% for the six months ended June 30, 2015 to 64.4% for the six months ended June 30, 2016 with a slightly higher P&C segment net loss ratio and a higher A&H segment net loss ratio primarily driven by greater loss experience in our legacy domestic stop loss programs.

Acquisition costs and other underwriting expenses. Acquisition costs and other underwriting expenses increased by $35.4 million, or 19.0%, from $186.4 million for the six months ended June 30, 2015 to $221.8 million for the six months ended June 30, 2016, as a result of the LPI Business acquisition, the Assurant Transaction and organic growth, partially offset by the Deconsolidation of the Reciprocal Exchanges.

General and administrative expenses. General and administrative expenses increased by $142.9 million, or 63.6%, from $224.8 million for the six months ended June 30, 2015 to $367.7 million for the six months ended June 30, 2016, primarily as a result of the LPI Business acquisition, the Assurant Transaction and organic growth.

Net operating expense; net operating expense ratio (non-GAAP). Net operating expense increased by $109.0 million, or 38.4%, from $283.8 million for the six months ended June 30, 2015 to $392.8 million for the six months ended June 30, 2016. The consolidated net operating expense ratio decreased to 28.7% in the six months ended June 30, 2016 from 29.9% in the six months ended June 30, 2015 with a slightly higher P&C segment net operating expense ratio driven by product mix changes, partially offset by a lower A&H segment net operating expense ratio resulting from the maturation of the A&H business and increased service and fee income. Excluding the Reciprocal Exchanges, the net operating expense ratio was 28.8% and 29.7% for the six months ended June 30, 2016 and 2015, respectively. The Reciprocal Exchanges' net operating expense ratio was 26.8% and 32.9% for the six months ended June 30, 2016 and 2015, respectively.

Net investment income. Net investment income increased by $14.7 million, or 42.7%, from $34.5 million for the six months ended June 30, 2015 to $49.2 million for the six months ended June 30, 2016, primarily due to an increase in average invested assets as a result of our issuances of debt, preferred stock and common stock capital raising activities in 2015.

Net realized gain on investments. Net realized gains on investments increased by $6.4 million from a gain of $1.6 million for the six months ended June 30, 2015 to a $8.0 million gain for the six months ended June 30, 2016, primarily due to the increase of gains from our corporate debt securities in the six months ended June 30, 2016 and the recognition of a $2.5 million OTTI charge in the six months ended June 30, 2015.


71




Equity in earnings of unconsolidated subsidiaries. Equity in earnings of unconsolidated subsidiaries, which primarily relates to our 50% interest in life settlement entities, increased by $7.4 million from $6.6 million in earnings for the six months ended June 30, 2015 to $14.0 million in earnings for the six months ended June 30, 2016, due to the change in fair market value of the life settlement contracts and income from our real estate investments.

Interest expense. Interest expense for the six months ended June 30, 2016 and 2015 was $18.1 million and $17.7 million, respectively.

Provision for income taxes. Income tax expense increased by $16.4 million, or 100.5%, from $16.3 million for the six months ended June 30, 2015, reflecting an effective tax rate of 18.3%, to $32.6 million for the six months ended June 30, 2016, reflecting an effective tax rate of 24.5%. The primary driver of the increase in consolidated income tax expense was the increase in pre-tax income period over period. Income tax expense included a tax benefit of $9.3 million and $12.3 million for the six months ended June 30, 2016 and 2015, respectively, attributable to the reduction of the deferred tax liability associated with the equalization reserves of our Luxembourg reinsurers. The effect of this tax benefit reduced the effective tax rate for the six months ended June 30, 2016 and 2015 by 7.0% and 13.8%, respectively.

Excluding the Reciprocal Exchanges, income tax expense was $32.9 million and $17.5 million for the six months ended June 30, 2016 and 2015, respectively, reflecting effective tax rates of 26.5% and 19.0%, respectively.

The Reciprocal Exchanges had pre-tax income of $9.0 million and a pre-tax loss of $3.3 million for the six months ended June 30, 2016 and 2015, respectively. A full valuation allowance was recorded in the Reciprocal Exchanges.



72



P&C Segment - Results of Operations for the Three Months Ended June 30, 2016 and 2015 (Unaudited)

 
Three Months Ended June 30,
 
2016
 
2015
 
NGHC
 
Reciprocal Exchanges
 
Eliminations
 
Total
 
NGHC
 
Reciprocal Exchanges
 
Eliminations
 
Total
 
(Amounts in Thousands)
Gross premium written
$
671,157

 
$
77,170

 
$
(711
)
 
$
747,616

 
$
464,494

 
$
76,729

 
$

 
$
541,223

Ceded premiums
(63,215
)
 
(38,040
)
 
711

 
(100,544
)
 
(41,656
)
 
(45,963
)
 

 
(87,619
)
Net premium written
$
607,942

 
$
39,130

 
$

 
$
647,072

 
$
422,838

 
$
30,766

 
$

 
$
453,604

Change in unearned premium
(32,940
)
 
(3,102
)
 

 
(36,042
)
 
(12,537
)
 
(8,518
)
 

 
(21,055
)
Net earned premium
$
575,002

 
$
36,028

 
$

 
$
611,030

 
$
410,301

 
$
22,248

 
$

 
$
432,549

Ceding commission income (loss)
(3,564
)
 
14,909

 

 
11,345

 
(225
)
 
9,924

 

 
9,699

Service and fee income
60,773

 
1,195

 
(10,807
)
 
51,161

 
49,671

 
947

 
(10,732
)
 
39,886

Underwriting expenses:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Loss and loss adjustment expense
375,893

 
17,736

 

 
393,629

 
245,454

 
15,245

 

 
260,699

Acquisition costs and other underwriting expenses
81,291

 
493

 
(6
)
 
81,778

 
77,293

 
7,611

 
(21
)
 
84,883

General and administrative expenses
147,113

 
25,261

 
(10,801
)
 
161,573

 
104,297

 
11,541

 
(10,711
)
 
105,127

Total underwriting expenses
$
604,297

 
$
43,490

 
$
(10,807
)
 
$
636,980

 
$
427,044

 
$
34,397

 
$
(10,732
)
 
$
450,709

Underwriting income (loss)
$
27,914

 
$
8,642

 
$

 
$
36,556

 
$
32,703

 
$
(1,278
)
 
$

 
$
31,425

Net loss ratio
65.4
%
 
49.2
%
 
 
 
64.4
%
 
59.8
%
 
68.5
%
 
 
 
60.3
%
Net operating expense ratio (non-GAAP)
29.8
%
 
26.8
%
 
 
 
29.6
%
 
32.2
%
 
37.2
%
 
 
 
32.5
%
Net combined ratio (non-GAAP)
95.2
%
 
76.0
%
 
 
 
94.0
%
 
92.0
%
 
105.7
%
 
 
 
92.8
%
 
Three Months Ended June 30,
Reconciliation of net operating expense ratio (non-GAAP):
2016
 
2015
 
NGHC
 
Reciprocal Exchanges
 
Eliminations
 
Total
 
NGHC
 
Reciprocal Exchanges
 
Eliminations
 
Total
 
(Amounts in Thousands)
Total underwriting expenses
$
604,297

 
$
43,490

 
$
(10,807
)
 
$
636,980

 
$
427,044

 
$
34,397

 
$
(10,732
)
 
$
450,709

Less: Loss and loss adjustment expense
375,893

 
17,736

 

 
393,629

 
245,454

 
15,245

 

 
260,699

Less: Ceding commission income (loss)
(3,564
)
 
14,909

 

 
11,345

 
(225
)
 
9,924

 

 
9,699

Less: Service and fee income
60,773

 
1,195

 
(10,807
)
 
51,161

 
49,671

 
947

 
(10,732
)
 
39,886

Net operating expense
$
171,195

 
$
9,650

 
$

 
$
180,845

 
$
132,144

 
$
8,281

 
$

 
$
140,425

Net earned premium
$
575,002

 
$
36,028

 
$

 
$
611,030

 
$
410,301

 
$
22,248

 
$

 
$
432,549

Net operating expense ratio (non-GAAP)
29.8
%
 
26.8
%
 
 
 
29.6
%
 
32.2
%
 
37.2
%
 
 
 
32.5
%



73



P&C Segment - Results of Operations for the Six Months Ended June 30, 2016 and 2015 (Unaudited)

 
Six Months Ended June 30,
 
2016
 
2015
 
NGHC
 
Reciprocal Exchanges
 
Eliminations
 
Total
 
NGHC
 
Reciprocal Exchanges
 
Eliminations
 
Total
 
(Amounts in Thousands)
Gross premium written
$
1,332,494

 
$
77,170

 
$
(711
)
 
$
1,408,953

 
$
974,945

 
$
137,966

 
$
(3,590
)
 
$
1,109,321

Ceded premiums
(123,778
)
 
(38,040
)
 
711

 
(161,107
)
 
(107,847
)
 
(88,563
)
 
3,590

 
(192,820
)
Net premium written
$
1,208,716

 
$
39,130

 
$

 
$
1,247,846

 
$
867,098

 
$
49,403

 
$

 
$
916,501

Change in unearned premium
(79,666
)
 
(3,102
)
 

 
(82,768
)
 
(50,703
)
 
14,741

 

 
(35,962
)
Net earned premium
$
1,129,050

 
$
36,028

 
$

 
$
1,165,078

 
$
816,395

 
$
64,144

 
$

 
$
880,539

Ceding commission income (loss)
(5,828
)
 
14,909

 

 
9,081

 
546

 
13,951

 

 
14,497

Service and fee income
124,261

 
1,195

 
(10,807
)
 
114,649

 
94,905

 
1,742

 
(19,310
)
 
77,337

Underwriting expenses:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Loss and loss adjustment expense
708,552

 
17,736

 

 
726,288

 
504,033

 
43,249

 

 
547,282

Acquisition costs and other underwriting expenses
172,950

 
493

 
(6
)
 
173,437

 
152,630

 
10,872

 
(26
)
 
163,476

General and administrative expenses
291,807

 
25,261

 
(10,801
)
 
306,267

 
190,026

 
25,925

 
(19,284
)
 
196,667

Total underwriting expenses
$
1,173,309

 
$
43,490

 
$
(10,807
)
 
$
1,205,992

 
$
846,689

 
$
80,046

 
$
(19,310
)
 
$
907,425

Underwriting income (loss)
$
74,174

 
$
8,642

 
$

 
$
82,816

 
$
65,157

 
$
(209
)
 
$

 
$
64,948

Net loss ratio
62.8
%
 
49.2
%
 
 
 
62.3
%
 
61.7
%
 
67.4
%
 
 
 
62.2
%
Net operating expense ratio (non-GAAP)
30.7
%
 
26.8
%
 
 
 
30.6
%
 
30.3
%
 
32.9
%
 
 
 
30.5
%
Net combined ratio (non-GAAP)
93.5
%
 
76.0
%
 
 
 
92.9
%
 
92.0
%
 
100.3
%
 
 
 
92.7
%
 
Six Months Ended June 30,
Reconciliation of net operating expense ratio (non-GAAP):
2016
 
2015
 
NGHC
 
Reciprocal Exchanges
 
Eliminations
 
Total
 
NGHC
 
Reciprocal Exchanges
 
Eliminations
 
Total
 
(Amounts in Thousands)
Total underwriting expenses
$
1,173,309

 
$
43,490

 
$
(10,807
)
 
$
1,205,992

 
$
846,689

 
$
80,046

 
$
(19,310
)
 
$
907,425

Less: Loss and loss adjustment expense
708,552

 
17,736

 

 
726,288

 
504,033

 
43,249

 

 
547,282

Less: Ceding commission income (loss)
(5,828
)
 
14,909

 

 
9,081

 
546

 
13,951

 

 
14,497

Less: Service and fee income
124,261

 
1,195

 
(10,807
)
 
114,649

 
94,905

 
1,742

 
(19,310
)
 
77,337

Net operating expense
$
346,324

 
$
9,650

 
$

 
$
355,974

 
$
247,205

 
$
21,104

 
$

 
$
268,309

Net earned premium
$
1,129,050

 
$
36,028

 
$

 
$
1,165,078

 
$
816,395

 
$
64,144

 
$

 
$
880,539

Net operating expense ratio (non-GAAP)
30.7
%
 
26.8
%
 
 
 
30.6
%
 
30.3
%
 
32.9
%
 
 
 
30.5
%


P&C Segment Results of Operations for the Three Months Ended June 30, 2016 Compared with the Three Months Ended June 30, 2015 (Unaudited)

Gross premium written. Gross premium written increased by $206.4 million, or 38.1%, from $541.2 million for the three months ended June 30, 2015 to $747.6 million for the three months ended June 30, 2016, as a result of the acquisitions of Century-National ($20.0 million) and LPI Business ($108.2 million), and organic growth ($78.2 million).

Net premium written. Net premium written increased by $193.5 million from $453.6 million for the three months ended June 30, 2015 to $647.1 million for the three months ended June 30, 2016, as a result of the acquisitions of Century-National ($17.8 million) and LPI Business ($105.4 million), and organic growth ($70.3 million).

Net earned premium. Net earned premium increased by $178.5 million, or 41.3%, from $432.5 million for the three months ended June 30, 2015 to $611.0 million for the three months ended June 30, 2016, as a result to the acquisitions of Century-National ($15.9 million) and LPI Business ($108.5 million), and organic growth ($54.0 million).

Ceding commission income. Ceding commission income increased by $1.6 million from $9.7 million for the three months ended June 30, 2015 to $11.3 million for the three months ended June 30, 2016. The increase was attributable to the Reciprocal Exchanges partially offset by a decrease to the sliding scale adjustment on our terminated third party quota share agreement.


74



Service and fee income. Service and fee income increased by $11.3 million, or 28.3%, from $39.9 million for the three months ended June 30, 2015 to $51.2 million for the three months ended June 30, 2016, as a result of the LPI Business acquisition and organic growth.

Loss and loss adjustment expense; net loss ratio. Loss and LAE increased by $132.9 million, or 51.0%, from $260.7 million for the three months ended June 30, 2015 to $393.6 million for the three months ended June 30, 2016, primarily reflecting the Century-National and LPI Business acquisitions. Our P&C segment net loss ratio, which includes the Reciprocal Exchanges, increased from 60.3% for the three months ended June 30, 2015 to 64.4% for the three months ended June 30, 2016, primarily due to product mix changes and losses related to hail storms that occurred in Texas. Excluding the Reciprocal Exchanges, the net loss ratio was 65.4% and 59.8% for the three months ended June 30, 2016 and 2015, respectively. The Reciprocal Exchanges' net loss ratio was 49.2% and 68.5% for the three months ended June 30, 2016 and 2015, respectively.

Acquisition costs and other underwriting expenses. Acquisition costs and other underwriting expenses decreased by $3.1 million from $84.9 million for the three months ended June 30, 2015 to $81.8 million for the three months ended June 30, 2016. The decrease was primarily due to lower amortization of deferred acquisition costs in the Reciprocal Exchanges and partially offset by the increase of the LPI Business acquisition.

General and administrative expenses. General and administrative expenses increased by $56.4 million from $105.1 million for the three months ended June 30, 2015 to $161.6 million for the three months ended June 30, 2016, as a result of the acquisitions of Century-National, LPI Business and higher amortization of intangible assets in the Reciprocal Exchanges partially offset by a decrease in our legacy business.

Net operating expense; net operating expense ratio (non-GAAP). Net operating expense increased by $40.4 million, or 28.8%, from $140.4 million for the three months ended June 30, 2015 to $180.8 million for the three months ended June 30, 2016. The P&C segment net operating expense ratio, which includes the Reciprocal Exchanges, decreased from 32.5% for the three months ended June 30, 2015 to 29.6% for the three months ended June 30, 2016 primarily as a result of increased net earned premium. Excluding the Reciprocal Exchanges, the net operating expense ratio was 29.8% and 32.2% for the three months ended June 30, 2016 and 2015, respectively. The Reciprocal Exchanges' net operating expense ratio was 26.8% and 37.2% for the three months ended June 30, 2016 and 2015, respectively.

Underwriting income. Underwriting income increased from $31.4 million for the three months ended June 30, 2015 to $36.6 million for the three months ended June 30, 2016, primarily driven by the Century-National and LPI Business acquisitions. The P&C segment net combined ratio, which includes the Reciprocal Exchanges, for the three months ended June 30, 2016 increased to 94.0% compared to 92.8% for the same period in 2015 primarily as a result of an increase in our net loss and net operating expense ratios related to the LPI Business acquisition offset by a decrease in our net operating expense ratio from our legacy business. Excluding the Reciprocal Exchanges, the net combined ratio was 95.2% and 92.0% for the three months ended June 30, 2016 and 2015, respectively. The Reciprocal Exchanges' net combined ratio was 76.0% and 105.7% for the three months ended June 30, 2016 and 2015, respectively.


P&C Segment Results of Operations for the Six Months Ended June 30, 2016 Compared with the Six Months Ended June 30, 2015 (Unaudited)

Gross premium written. Gross premium written increased by $299.6 million, or 27.0%, from $1,109.3 million for the six months ended June 30, 2015 to $1,409.0 million for the six months ended June 30, 2016, as a result of the acquisitions of Century-National ($20.0 million) and LPI Business ($220.2 million), and organic growth ($120.3 million) partially offset by the Deconsolidation of the Reciprocal Exchanges ($60.8 million).

Net premium written. Net premium written increased by $331.3 million from $916.5 million for the six months ended June 30, 2015 to $1,247.8 million for the six months ended June 30, 2016, as a result of the acquisitions of Century-National ($17.8 million) and LPI Business ($217.4 million), and organic growth ($106.4 million), partially offset by the Deconsolidation of the Reciprocal Exchanges ($10.3 million).

Net earned premium. Net earned premium increased by $284.5 million, or 32.3%, from $880.5 million for the six months ended June 30, 2015 to $1,165.1 million for the six months ended June 30, 2016, as a result of the acquisitions of Century-National ($15.9 million) and LPI Business ($231.3 million), and organic growth ($65.4 million), partially offset by the Deconsolidation of the Reciprocal Exchanges ($28.1 million).



75



Ceding commission income. Ceding commission income decreased by $5.4 million from $14.5 million for the six months ended June 30, 2015 to $9.1 million for the six months ended June 30, 2016, primarily driven by a decrease to the sliding scale adjustment on our terminated third party quota share agreement.

Service and fee income. Service and fee income increased by $37.3 million, or 48.2%, from $77.3 million for the six months ended June 30, 2015 to $114.6 million for the six months ended June 30, 2016, as a result of the LPI Business acquisition and organic growth.

Loss and loss adjustment expense; net loss ratio. Loss and LAE increased by $179.0 million, or 32.7%, from $547.3 million for the six months ended June 30, 2015 to $726.3 million for the six months ended June 30, 2016, primarily reflecting the Century-National and LPI Business acquisitions, an increase in our legacy business, partially offset by the Deconsolidation of the Reciprocal Exchanges. Our P&C segment net loss ratio increased from 62.2% for the six months ended June 30, 2015 to 62.3% for the six months ended June 30, 2016, primarily due to product mix changes and losses related to hail storms that occurred in Texas. Excluding the Reciprocal Exchanges, the net loss ratio was 62.8% and 61.7% for the six months ended June 30, 2016 and 2015, respectively. The Reciprocal Exchanges' net loss ratio was 49.2% and 67.4% for the six months ended June 30, 2016 and 2015, respectively.

Acquisition costs and other underwriting expenses. Acquisition costs and other underwriting expenses increased by $10.0 million from $163.5 million for the six months ended June 30, 2015 to $173.4 million for the six months ended June 30, 2016. The increase was primarily as a result of the LPI Business acquisition partially offset by the Deconsolidation of the Reciprocal Exchanges.

General and administrative expenses. General and administrative expenses increased by $109.6 million from $196.7 million for the six months ended June 30, 2015 to $306.3 million for the six months ended June 30, 2016, primarily as a result of the LPI Business acquisition and the Deconsolidation of the Reciprocal Exchanges.

Net operating expense; net operating expense ratio (non-GAAP). Net operating expense increased by $87.7 million, or 32.7%, from $268.3 million for the six months ended June 30, 2015 to $356.0 million for the six months ended June 30, 2016. The P&C segment net operating expense ratio increased from 30.5% for the six months ended June 30, 2015 to 30.6% for the six months ended June 30, 2016. Excluding the Reciprocal Exchanges, the net operating expense ratio was 30.7% and 30.3% for the six months ended June 30, 2016 and 2015, respectively. The Reciprocal Exchanges' net operating expense ratio was 26.8% and 32.9% for the six months ended June 30, 2016 and 2015, respectively.

Underwriting income. Underwriting income increased from $64.9 million for the six months ended June 30, 2015 to $82.8 million for the six months ended June 30, 2016, primarily driven by the Century-National and LPI Business acquisitions. The P&C segment net combined ratio for the six months ended June 30, 2016 increased to 92.9% compared to 92.7% for the same period in 2015. Excluding the Reciprocal Exchanges, the net combined ratio was 93.5% and 92.0% for the six months ended June 30, 2016 and 2015, respectively. The Reciprocal Exchanges' net combined ratio was 76.0% and 100.3% for the six months ended June 30, 2016 and 2015, respectively.



76



A&H Segment - Results of Operations for the Three and Six Months Ended June 30, 2016 and 2015 (Unaudited)

 
Three Months Ended June 30,
 
Six Months Ended June 30,
 
2016
 
2015
 
2016
 
2015
 
(Amounts in Thousands)
Gross premium written
$
102,891

 
$
34,458

 
$
257,748

 
$
109,815

Ceded premiums
(12,514
)
 
(8,652
)
 
(23,558
)
 
(16,881
)
Net premium written
$
90,377

 
$
25,806

 
$
234,190

 
$
92,934

Change in unearned premium
11,533

 
10,461

 
(31,408
)
 
(25,492
)
Net earned premium
$
101,910

 
$
36,267

 
$
202,782

 
$
67,442

Ceding commission income
359

 
271

 
728

 
553

Service and fee income
38,856

 
17,672

 
72,312

 
35,091

Underwriting expenses:
 
 
 
 
 
 
 
Loss and loss adjustment expense
78,729

 
26,130

 
155,120

 
46,233

Acquisition costs and other underwriting expenses
27,096

 
11,619

 
48,336

 
22,911

General and administrative expenses
29,547

 
14,031

 
61,480

 
28,178

Total underwriting expenses
$
135,372

 
$
51,780

 
$
264,936

 
$
97,322

Underwriting income
$
5,753

 
$
2,430

 
$
10,886

 
$
5,764

Net loss ratio
77.3
%
 
72.0
%
 
76.5
%
 
68.6
%
Net operating expense ratio (non-GAAP)
17.1
%
 
21.3
%
 
18.1
%
 
22.9
%
Net combined ratio (non-GAAP)
94.4
%
 
93.3
%
 
94.6
%
 
91.5
%
 
Three Months Ended June 30,
 
Six Months Ended June 30,
Reconciliation of net operating expense ratio (non-GAAP):
2016
 
2015
 
2016
 
2015
 
(Amounts in Thousands)
Total underwriting expenses
$
135,372

 
$
51,780

 
$
264,936

 
$
97,322

Less: Loss and loss adjustment expense
78,729

 
26,130

 
155,120

 
46,233

Less: Ceding commission income
359

 
271

 
728

 
553

Less: Service and fee income
38,856

 
17,672

 
72,312

 
35,091

Net operating expense
$
17,428

 
$
7,707

 
$
36,776

 
$
15,445

Net earned premium
$
101,910

 
$
36,267

 
$
202,782

 
$
67,442

Net operating expense ratio (non-GAAP)
17.1
%
 
21.3
%
 
18.1
%
 
22.9
%


A&H Segment Results of Operations for the Three Months Ended June 30, 2016 Compared with the Three Months Ended June 30, 2015 (Unaudited)

Gross premium written. Gross premium written increased by $68.4 million from $34.5 million for the three months ended June 30, 2015 to $102.9 million for the three months ended June 30, 2016, as a result of premium from the Assurant Transaction ($47.3 million) and organic growth ($21.1 million).

Net premium written. Net premium written increased by $64.6 million from $25.8 million for the three months ended June 30, 2015 to $90.4 million for the three months ended June 30, 2016, as a result of premium from the Assurant Transaction ($47.3 million) and organic growth ($17.3 million).

Net earned premium. Net earned premium increased by $65.6 million from $36.3 million for the three months ended June 30, 2015 to $101.9 million for the three months ended June 30, 2016, due to earned premium from the Assurant Transaction ($47.4 million) and organic growth ($18.2 million).

Service and fee income. Service and fee income increased by $21.2 million, or 119.9%, from $17.7 million for the three months ended June 30, 2015 to $38.9 million for the three months ended June 30, 2016, primarily as a result of the Assurant Transaction.

Loss and loss adjustment expense; net loss ratio. Loss and LAE increased by $52.6 million from $26.1 million for the three months ended June 30, 2015 to $78.7 million for the three months ended June 30, 2016. Net loss ratio increased from 72.0% for


77



the three months ended June 30, 2015 to 77.3% for the three months ended June 30, 2016. The net loss ratio increase in the three months ended June 30, 2016 was primarily driven by higher loss experience in our legacy domestic stop loss programs.

Acquisition costs and other underwriting expenses. Acquisition costs and other underwriting expenses increased by $15.5 million from $11.6 million for the three months ended June 30, 2015 to $27.1 million for the three months ended June 30, 2016, primarily due to the Assurant Transaction and increase in our written premium volume.

General and administrative expenses. General and administrative expenses increased by $15.5 million from $14.0 million for the three months ended June 30, 2015 to $29.5 million for the three months ended June 30, 2016, primarily as a result of the Assurant Transaction.

Net operating expense; net operating expense ratio (non-GAAP). Net operating expense increased by $9.7 million from $7.7 million for the three months ended June 30, 2015 to $17.4 million for the three months ended June 30, 2016. The net operating expense ratio decreased from 21.3% for the three months ended June 30, 2015 to 17.1% for the three months ended June 30, 2016, primarily as a result of increased net earned premiums and higher service and fee income, partially offset by an increase in general and administrative expenses and acquisition costs and other underwriting expenses.

Underwriting income. Underwriting income increased from $2.4 million for the three months ended June 30, 2015 to $5.8 million for the three months ended June 30, 2016, due to maturation of the A&H business. The net combined ratio for the three months ended June 30, 2016 increased to 94.4% compared to 93.3% for the same period in 2015. The net combined ratio increased due to a higher net loss ratio driven by higher loss experience in our legacy domestic stop loss programs, partially offset by a lower net operating expense ratio reflecting continued maturation of the A&H business and higher service and fee income.


A&H Segment Results of Operations for the Six Months Ended June 30, 2016 Compared with the Six Months Ended June 30, 2015 (Unaudited)

Gross premium written. Gross premium written increased by $147.9 million from $109.8 million for the six months ended June 30, 2015 to $257.7 million for the six months ended June 30, 2016, as a result of premium from the Assurant Transaction ($98.2 million) and organic growth ($49.8 million).

Net premium written. Net premium written increased by $141.3 million from $92.9 million for the six months ended June 30, 2015 to $234.2 million for the six months ended June 30, 2016, as a result of premium from the Assurant Transaction ($98.2 million) and organic growth ($43.1 million).

Net earned premium. Net earned premium increased by $135.3 million from $67.4 million for the six months ended June 30, 2015 to $202.8 million for the six months ended June 30, 2016, due to earned premium from the Assurant Transaction ($98.4 million) and organic growth ($36.9 million).

Service and fee income. Service and fee income increased by $37.2 million, or 106.1%, from $35.1 million for the six months ended June 30, 2015 to $72.3 million for the six months ended June 30, 2016, primarily as a result of the Assurant Transaction.

Loss and loss adjustment expense; net loss ratio. Loss and LAE increased by $108.9 million from $46.2 million for the six months ended June 30, 2015 to $155.1 million for the six months ended June 30, 2016. Net loss ratio increased from 68.6% for the six months ended June 30, 2015 to 76.5% for the six months ended June 30, 2016. The net loss ratio increase in the six months ended June 30, 2016 was primarily driven by higher loss experience in our legacy domestic stop loss programs.

Acquisition costs and other underwriting expenses. Acquisition costs and other underwriting expenses increased by $25.4 million from $22.9 million for the six months ended June 30, 2015 to $48.3 million for the six months ended June 30, 2016, primarily due to the Assurant Transaction and increase in our written premium volume.

General and administrative expenses. General and administrative expenses increased by $33.3 million from $28.2 million for the six months ended June 30, 2015 to $61.5 million for the six months ended June 30, 2016, primarily as a result of the Assurant Transaction.

Net operating expense; net operating expense ratio (non-GAAP). Net operating expense increased by $21.3 million from $15.4 million for the six months ended June 30, 2015 to $36.8 million for the six months ended June 30, 2016. The net operating expense ratio decreased from 22.9% for the six months ended June 30, 2015 to 18.1% for the six months ended June 30, 2016,


78



primarily primarily as a result of increased net earned premiums and higher service and fee income partially offset by an increase in general and administrative expenses and acquisition costs and other underwriting expenses.

Underwriting income. Underwriting income increased from $5.8 million for the six months ended June 30, 2015 to $10.9 million for the six months ended June 30, 2016, due to maturation of the A&H business. The net combined ratio for the six months ended June 30, 2016 increased to 94.6% compared to 91.5% for the same period in 2015. The net combined ratio increased due to a higher net loss ratio driven by higher loss experience in our legacy domestic stop loss programs, partially offset by a lower net operating expense ratio reflecting continued maturation of the A&H business and higher service and fee income.


Investment Portfolio

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

The average yield on our investment portfolio was 3.2% and 3.6% and the average duration of the portfolio was 5.04 and 5.19 years for the six months ended June 30, 2016 and 2015, respectively.

The cost or amortized cost, fair value, and gross unrealized gains and losses on available-for-sale securities were as follows:
June 30, 2016
 
Cost or
Amortized
Cost
 
Gross
Unrealized
Gains
 
Gross
Unrealized
Losses
 
Fair
Value
 
 
(amounts in thousands)
Equity securities:
 
 
 
 
 
 
 
 
   Common stock
 
$
110,752

 
$
7,153

 
$
(23,156
)
 
$
94,749

   Preferred stock
 
16,035

 
296

 
(580
)
 
15,751

Fixed maturities:
 
 
 
 
 
 
 
 
   U.S. Treasury
 
27,174

 
1,851

 

 
29,025

   States and political subdivision bonds
 
399,438

 
14,414

 
(192
)
 
413,660

   Foreign government
 
59,644

 
1,283

 
(340
)
 
60,587

   Corporate bonds
 
1,533,488

 
93,788

 
(17,588
)
 
1,609,688

   Residential mortgage-backed securities
 
336,498

 
13,594

 
(60
)
 
350,032

   Commercial mortgage-backed securities
 
106,290

 
3,281

 
(1,053
)
 
108,518

   Structured securities
 
246,396

 
1,675

 
(6,103
)
 
241,968

Total
 
$
2,835,715

 
$
137,335

 
$
(49,072
)
 
$
2,923,978

Less: Securities pledged
 
132,300

 
5,148

 

 
137,448

Total net of Securities pledged
 
$
2,703,415

 
$
132,187

 
$
(49,072
)
 
$
2,786,530

NGHC
 
$
2,558,242

 
$
123,177

 
$
(48,010
)
 
$
2,633,409

Reciprocal Exchanges
 
277,473

 
14,158

 
(1,062
)
 
290,569

Total
 
$
2,835,715

 
$
137,335

 
$
(49,072
)
 
$
2,923,978



79



December 31, 2015
 
Cost or
Amortized
Cost
 
Gross
Unrealized
Gains
 
Gross
Unrealized
Losses
 
Fair
Value
 
 
(amounts in thousands)
Equity securities:
 
 
 
 
 
 
 
 
   Common stock
 
$
53,356

 
$
569

 
$
(6,960
)
 
$
46,965

   Preferred stock
 
11,448

 
377

 

 
11,825

Fixed maturities:
 
 
 
 
 
 
 
 
   U.S. Treasury
 
19,348

 
1,052

 
(48
)
 
20,352

   Federal agencies
 
1,945

 
7

 

 
1,952

   States and political subdivision bonds
 
193,017

 
4,516

 
(609
)
 
196,924

   Foreign government
 
31,383

 
31

 
(352
)
 
31,062

   Corporate bonds
 
1,375,336

 
22,224

 
(47,902
)
 
1,349,658

   Residential mortgage-backed securities
 
419,293

 
6,254

 
(978
)
 
424,569

   Commercial mortgage-backed securities
 
135,134

 
720

 
(3,649
)
 
132,205

   Structured securities
 
205,024

 
15

 
(4,347
)
 
200,692

Total
 
$
2,445,284

 
$
35,765

 
$
(64,845
)
 
$
2,416,204

Less: Securities pledged
 
54,955

 
439

 

 
55,394

Total net of Securities pledged
 
$
2,390,329

 
$
35,326

 
$
(64,845
)
 
$
2,360,810

NGHC
 
$
2,199,714

 
$
34,773

 
$
(58,826
)
 
$
2,175,661

Reciprocal Exchanges
 
245,570

 
992

 
(6,019
)
 
240,543

Total
 
$
2,445,284

 
$
35,765

 
$
(64,845
)
 
$
2,416,204


The decrease in gross unrealized losses from $64.8 million at December 31, 2015 to $49.1 million at June 30, 2016 resulted from fluctuations in market interest rates, partially offset by decreased performance of our equity securities.

The tables below summarize the credit quality of our fixed maturities, securities pledged and preferred securities as of June 30, 2016 and December 31, 2015, as rated by Standard & Poor’s.

 
 
NGHC
 
Reciprocal Exchanges
June 30, 2016
 
Cost or Amortized Cost
 
Fair Value
 
Percentage of Fixed Maturities and Preferred Securities
 
Cost or Amortized Cost
 
Fair Value
 
Percentage of Fixed Maturities and Preferred Securities
 
 
(amounts in thousands)
U.S. Treasury
 
$
21,241

 
$
23,014

 
1.0
%
 
$
5,933

 
$
6,011

 
2.1
%
AAA
 
428,111

 
444,619

 
17.5
%
 
21,114

 
21,362

 
7.4
%
AA, AA+, AA-
 
460,813

 
475,871

 
18.7
%
 
26,936

 
28,862

 
9.9
%
A, A+, A-
 
611,384

 
637,830

 
25.1
%
 
92,339

 
97,848

 
33.7
%
BBB, BBB+, BBB-
 
729,736

 
748,770

 
29.5
%
 
116,480

 
121,092

 
41.7
%
BB+ and lower
 
196,205

 
208,556

 
8.2
%
 
14,671

 
15,394

 
5.2
%
Total
 
$
2,447,490

 
$
2,538,660

 
100.0
%
 
$
277,473

 
$
290,569

 
100.0
%


80



 
 
NGHC
 
Reciprocal Exchanges
December 31, 2015
 
Cost or Amortized Cost
 
Fair Value
 
Percentage of Fixed Maturities and Preferred Securities
 
Cost or Amortized Cost
 
Fair Value
 
Percentage of Fixed Maturities and Preferred Securities
 
 
(amounts in thousands)
U.S. Treasury
 
$
13,416

 
$
14,448

 
0.7
%
 
$
5,932

 
$
5,904

 
2.5
%
AAA
 
343,128

 
348,073

 
16.4
%
 
39,724

 
38,888

 
16.2
%
AA, AA+, AA-
 
379,560

 
383,888

 
18.0
%
 
36,866

 
36,934

 
15.4
%
A, A+, A-
 
501,409

 
508,884

 
23.9
%
 
50,612

 
50,153

 
20.8
%
BBB, BBB+, BBB-
 
634,250

 
623,742

 
29.3
%
 
82,417

 
80,322

 
33.4
%
BB+ and lower
 
274,594

 
249,660

 
11.7
%
 
30,020

 
28,343

 
11.7
%
Total
 
$
2,146,357

 
$
2,128,695

 
100.0
%
 
$
245,571

 
$
240,544

 
100.0
%

The tables below summarize the investment quality of our corporate bond holdings and industry concentrations as of June 30, 2016 and December 31, 2015.
June 30, 2016
 
AAA
 
AA+,
AA,
AA-
 
A+,A,A-
 
BBB+,
BBB,
BBB-
 
BB+ or
Lower
 
Fair
Value
 
% of
Corporate
Bonds
Portfolio
 
 
 
 
 
 
(amounts in thousands)
 
 
 
 
Corporate Bonds:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Financial institutions
 
1.0
%
 
2.7
%
 
17.7
%
 
12.8
%
 
0.7
%
 
$
563,234

 
34.9
%
Industrials
 
0.2
%
 
3.2
%
 
14.8
%
 
31.8
%
 
9.0
%
 
949,006

 
59.0
%
Utilities/Other
 
0.9
%
 
%
 
1.3
%
 
3.6
%
 
0.3
%
 
97,448

 
6.1
%
Total
 
2.1
%
 
5.9
%
 
33.8
%
 
48.2
%
 
10.0
%
 
$
1,609,688

 
100.0
%
NGHC
 
2.1
%
 
5.3
%
 
28.3
%
 
40.6
%
 
9.2
%
 
$
1,376,376

 
85.5
%
Reciprocal Exchanges
 
%
 
0.6
%
 
5.5
%
 
7.6
%
 
0.8
%
 
233,312

 
14.5
%
Total
 
2.1
%
 
5.9
%
 
33.8
%
 
48.2
%
 
10.0
%
 
$
1,609,688

 
100.0
%
December 31, 2015
 
AAA
 
AA+,
AA,
AA-
 
A+,A,A-
 
BBB+,
BBB,
BBB-
 
BB+ or
Lower
 
Fair
Value
 
% of
Corporate
Bonds
Portfolio
 
 
 
 
 
 
(amounts in thousands)
 
 
 
 
Corporate Bonds:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Financial institutions
 
%
 
2.8
%
 
21.2
%
 
12.7
%
 
2.1
%
 
$
524,250

 
38.8
%
Industrials
 
%
 
3.9
%
 
15.4
%
 
32.3
%
 
4.6
%
 
757,907

 
56.2
%
Utilities/Other
 
0.4
%
 
%
 
0.4
%
 
3.4
%
 
0.8
%
 
67,501

 
5.0
%
Total
 
0.4
%
 
6.7
%
 
37.0
%
 
48.4
%
 
7.5
%
 
$
1,349,658

 
100.0
%
NGHC
 
0.4
%
 
6.1
%
 
33.9
%
 
42.7
%
 
6.3
%
 
$
1,206,442

 
89.4
%
Reciprocal Exchanges
 
%
 
0.6
%
 
3.1
%
 
5.7
%
 
1.2
%
 
143,216

 
10.6
%
Total
 
0.4
%
 
6.7
%
 
37.0
%
 
48.4
%
 
7.5
%
 
$
1,349,658

 
100.0
%

The amortized cost and fair value of available-for-sale fixed maturities and securities pledged, held as of June 30, 2016, 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.



81



 
 
NGHC
 
Reciprocal Exchanges
 
Total
June 30, 2016
 
Amortized
Cost
 
Fair
Value
 
Amortized
Cost
 
Fair
Value
 
Amortized
Cost
 
Fair
Value
 
 
(amounts in thousands)
Due in one year or less
 
$
25,213

 
$
25,338

 
$

 
$

 
$
25,213

 
$
25,338

Due after one year through five years
 
323,244

 
344,450

 
34,416

 
36,626

 
357,660

 
381,076

Due after five years through ten years
 
1,250,796

 
1,303,856

 
181,099

 
190,721

 
1,431,895

 
1,494,577

Due after ten years
 
414,001

 
415,519

 
37,371

 
38,418

 
451,372

 
453,937

Mortgage-backed securities
 
418,201

 
433,746

 
24,587

 
24,804

 
442,788

 
458,550

Total
 
$
2,431,455

 
$
2,522,909

 
$
277,473

 
$
290,569

 
$
2,708,928

 
$
2,813,478


Gross Unrealized Losses. The tables below summarize the gross unrealized losses on equity securities and fixed maturities by the length of time the security had continuously been in an unrealized loss position as of June 30, 2016 and December 31, 2015:

 
 
Less Than 12 Months
 
12 Months or More
 
Total
June 30, 2016
 
Fair
Market
Value
 
Unrealized
Losses
 
No. of
Positions
Held
 
Fair
Market
Value
 
Unrealized
Losses
 
No. of
Positions
Held
 
Fair
Market
Value
 
Unrealized
Losses
 
 
(amounts in thousands)
Common stock
 
$
45,129

 
$
(23,136
)
 
65

 
$
154

 
$
(20
)
 
3

 
$
45,283

 
$
(23,156
)
Preferred stock
 
7,957

 
(580
)
 
4

 

 

 

 
7,957

 
(580
)
States and political subdivision bonds
 
4,254

 
(10
)
 
11

 
5,763

 
(182
)
 
11

 
10,017

 
(192
)
Foreign government
 
1,913

 
(340
)
 
1

 

 

 

 
1,913

 
(340
)
Corporate bonds
 
129,782

 
(6,751
)
 
79

 
60,155

 
(10,837
)
 
29

 
189,937

 
(17,588
)
Residential mortgage-backed securities
 
1,162

 
(10
)
 
3

 
1,209

 
(50
)
 
3

 
2,371

 
(60
)
Commercial mortgage-backed securities
 
20,834

 
(305
)
 
7

 
28,114

 
(748
)
 
12

 
48,948

 
(1,053
)
Structured securities
 
99,167

 
(3,854
)
 
47

 
43,237

 
(2,249
)
 
21

 
142,404

 
(6,103
)
Total
 
$
310,198

 
$
(34,986
)
 
217

 
$
138,632

 
$
(14,086
)
 
79

 
$
448,830

 
$
(49,072
)
NGHC
 
$
291,501

 
$
(34,368
)
 
207

 
$
127,478

 
$
(13,642
)
 
65

 
$
418,979

 
$
(48,010
)
Reciprocal Exchanges
 
18,697

 
(618
)
 
10

 
11,154

 
(444
)
 
14

 
29,851

 
(1,062
)
Total
 
$
310,198

 
$
(34,986
)
 
217

 
$
138,632

 
$
(14,086
)
 
79

 
$
448,830

 
$
(49,072
)



82



 
 
Less Than 12 Months
 
12 Months or More
 
Total
December 31, 2015
 
Fair
Market
Value
 
Unrealized
Losses
 
No. of
Positions
Held
 
Fair
Market
Value
 
Unrealized
Losses
 
No. of
Positions
Held
 
Fair
Market
Value
 
Unrealized
Losses
 
 
(amounts in thousands)
Common stock
 
$
39,490

 
$
(6,932
)
 
5

 
$
130

 
$
(28
)
 
2

 
$
39,620

 
$
(6,960
)
U.S. Treasury
 
7,141

 
(48
)
 
5

 

 

 

 
7,141

 
(48
)
States and political subdivision bonds
 
17,674

 
(501
)
 
22

 
4,878

 
(108
)
 
10

 
22,552

 
(609
)
Foreign government
 
21,322

 
(352
)
 
4

 

 

 

 
21,322

 
(352
)
Corporate bonds
 
684,613

 
(37,919
)
 
229

 
32,121

 
(9,983
)
 
38

 
716,734

 
(47,902
)
Residential mortgage-backed securities
 
102,889

 
(919
)
 
23

 
1,655

 
(59
)
 
9

 
104,544

 
(978
)
Commercial mortgage-backed securities
 
66,222

 
(3,472
)
 
30

 
2,364

 
(177
)
 
2

 
68,586

 
(3,649
)
Structured securities
 
153,042

 
(4,347
)
 
65

 

 

 

 
153,042

 
(4,347
)
Total
 
$
1,092,393

 
$
(54,490
)
 
383

 
$
41,148

 
$
(10,355
)
 
61

 
$
1,133,541

 
$
(64,845
)
NGHC
 
$
988,188

 
$
(50,599
)
 
284

 
$
28,691

 
$
(8,227
)
 
34

 
$
1,016,879

 
$
(58,826
)
Reciprocal Exchanges
 
104,205

 
(3,891
)
 
99

 
12,457

 
(2,128
)
 
27

 
116,662

 
(6,019
)
Total
 
$
1,092,393

 
$
(54,490
)
 
383

 
$
41,148

 
$
(10,355
)
 
61

 
$
1,133,541

 
$
(64,845
)

There were 296 and 444 securities at June 30, 2016 and December 31, 2015, respectively, that account for the gross unrealized loss, none of which we deemed to be an other-than-temporary impairment ("OTTI") loss. At June 30, 2016, we have determined that the unrealized losses on fixed maturities were primarily due to market interest rate and credit quality movements since their date of purchase. At June 30, 2016, we have determined that the unrealized losses on common stock were primarily due to continued weakness in the equities market for the communications, energy, industrial and transportation sectors during the second quarter of 2016, and to a lesser extent the expansion of our investment portfolio to include Century-National. Significant factors influencing our 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 we will not be required to sell these investments before anticipated recovery of fair value to our cost basis.

For the three and six months ended June 30, 2016, we did not recognize any OTTI. For the three and six months ended June 30, 2015, we recognized OTTI of $1.5 million and $2.5 million, respectively, on investments based on our qualitative and quantitative review.

Restricted Cash and Investments. In order to conduct business in certain states, we are required to maintain letters of credit or assets on deposit to support state-mandated regulatory requirements and certain third party agreements. We also utilize trust accounts to collateralize business with our reinsurance counterparties. Assets held on deposit or in trust accounts are primarily in the form of cash or certain high-grade securities. The fair values of our restricted assets as of June 30, 2016 and December 31, 2015 are as follows:

 
 
June 30, 2016
 
December 31, 2015
 
 
(amounts in thousands)
Restricted cash
 
$
10,899

 
$
13,776

Restricted investments - fixed maturities, at fair value
 
42,476

 
40,174

Total
 
$
53,375

 
$
53,950




83



Other investments. The table below summarize the composition of our other investments as of June 30, 2016 and December 31, 2015:
 
 
June 30, 2016
 
December 31, 2015
 
 
(amounts in thousands)
Limited partnerships, equity method
 
$
37,996

 
$
5,691

Investments at cost or amortized cost
 
21,364

 
7,340

Total
 
$
59,360

 
$
13,031


Reverse Repurchase and Repurchase Agreements. We enter into reverse repurchase and repurchase agreements, which are accounted for as either collateralized lending or borrowing transactions and are recorded at contract amounts which approximate fair value. For the collateralized borrowing transactions (i.e., repurchase agreements), we receive cash or securities that we invest or hold in short-term or fixed income securities.

As of June 30, 2016 and December 31, 2015, we had no collateralized lending transaction principal outstanding.

As of June 30, 2016 and December 31, 2015, we had collateralized borrowing transaction principal outstanding of $119.5 million and $52.5 million, respectively, at interest rates of 0.70% and 0.80%, respectively. Interest expense associated with these repurchase borrowing agreements for the three and six months ended June 30, 2016 was $0.2 million and $0.3 million, respectively, and for the three and six months ended June 30, 2015 was $0.0 million and $0.1 million, respectively. We had $137.4 million and $55.4 million of collateral pledged in support for these agreements as of June 30, 2016 and December 31, 2015, respectively.


Investment in Entities Holding Life Settlement Contracts

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. During 2010, we formed Tiger Capital LLC (“Tiger”) with a subsidiary of AmTrust for the purpose of acquiring certain life settlement contracts. In 2011, we formed AMT Capital Alpha, LLC (“AMT Alpha”) with a subsidiary of AmTrust for the purpose of acquiring additional life settlement contracts. In the first quarter of 2013, we acquired a 50% interest in AMT Capital Holdings, S.A. (“AMTCH”), the other 50% of which is owned by AmTrust. Additionally, in December 2013, we formed AMT Capital Holdings II, S.A. ("AMTCH II") with AmTrust for the purpose of acquiring additional life settlement contracts. We have a 50% ownership interest in each of Tiger, AMT Alpha, AMTCH and AMTCH II (collectively, the “LSC Entities”). The LSC Entities may also acquire premium finance loans made in connection with the borrowers’ purchase of life insurance policies that are secured by the policies. The LSC Entities acquire the underlying policies securing the loan through the borrowers’ voluntary surrender of the policy in satisfaction of the loan or foreclosure. A third party serves as the administrator for two of the life settlement contract portfolios, for which it receives an administrative fee. The third-party administrator is eligible to receive a percentage of profits after certain time and performance thresholds have been met.

The LSC Entities account for investments in life settlements in accordance with ASC 325-30, "Investments in Insurance Contracts", which states that an investor shall elect to account for its investments in life settlement contracts by using either the investment method or the fair value method. The election is made on an instrument-by-instrument basis and is irrevocable. The LSC Entities have elected to account for these investments using the fair value method.

As of June 30, 2016, we have a 50% ownership interest in the LSC Entities that hold certain life settlement contracts, and the fair value of these contracts owned by the LSC Entities is $304.4 million, with our proportionate interest being $152.2 million. Total capital contributions of approximately $11.0 million and $1.1 million were made to the LSC Entities during the six months ended June 30, 2016 and 2015, respectively, for which we contributed approximately $5.5 million and $0.6 million, respectively, in those same periods. The LSC Entities used the contributed capital to pay premiums and purchase policies.

As of June 30, 2016, the face value amounts of the 255 life insurance policies disclosed in the table below was approximately $1.6 billion. As of June 30, 2016, the LSC Entities owned no premium finance loans.

The following table describes details of our investment in LSC Entities as of June 30, 2016. This table shows the gross amounts for the portfolio of life insurance policies owned by the LSC Entities, in which we and AmTrust each own a 50% interest.



84



(amounts in thousands, except number of life settlement contracts)
Expected Maturity Term in Years
 
Number of
Life Settlement
Contracts
 
Fair Value(1)
 
Face Value
As of June 30, 2016
 
 
 
 
 
 
0 - 1
 

 
$

 
$

1 - 2
 
1

 
1,868

 
2,500

2 - 3
 
8

 
42,956

 
71,000

3 - 4
 
9

 
35,331

 
64,422

4 - 5
 
9

 
19,542

 
62,000

Thereafter
 
228

 
204,737

 
1,412,313

Total
 
255

 
$
304,434

 
$
1,612,235


(1) 
The LSC Entities determined the fair value as of June 30, 2016 based on 215 policies out of 255 policies, as the LSC Entities assigned no value to 40 of the policies as of June 30, 2016. The LSC Entities estimated the fair value of a life insurance policy using a cash flow model with an appropriate discount rate. In some cases, the cash flow model calculates the value of an individual policy to be negative, and therefore the fair value of the policy is zero as no liability exists when a negative value is calculated. The LSC Entities are not contractually bound to pay the premium on its life settlement contracts and, therefore, would not pay a willing buyer to assume title of these contracts. Additionally, certain of the LSC Entities' acquired policies were structured to have low premium payments at inception of the policy term, which later escalate greatly towards the tail end of the policy term. At the current time, the LSC Entities expense all premiums paid, even on policies with zero fair value. Once the premium payments escalate, the LSC Entities may allow the policies to lapse. In the event that death benefits are realized in the time frame between initial acquisition and premium escalation, it is a benefit to cash flow of the LSC Entities.

For the contracts where the LSC Entities determined the fair value to be negative and therefore assigned a fair value of zero, the table below details the amount of premiums paid and the death benefits received during the twelve months preceding June 30, 2016:

(amounts in thousands, except number of life settlement contracts)
June 30, 2016
Number of policies with a negative value from discounted cash flow model as of period end
40

Premiums paid for the preceding twelve month period for period ended
$
7,163

Death benefit received
$


Premiums to be paid by the LSC Entities, in which we have 50% ownership interests, for each of the five succeeding fiscal years to keep the life insurance policies in force as of June 30, 2016, are as follows:
(amounts in thousands)
 
Premiums
Due on Life
Settlement
Contracts
2016
 
$
64,353

2017
 
42,020

2018
 
43,105

2019
 
41,350

2020
 
37,788

Thereafter
 
443,511

Total
 
$
672,127


For additional information about the fair value of the life settlement contracts, see Note 6, "Equity Investments in Unconsolidated Subsidiaries" in the notes to our condensed consolidated financial statements. For additional information about the risks inherent in determining the fair value of the portfolio of life insurance policies, see Item 1A, “Risk Factors-Risks Relating to Our Business Generally-A portion of our financial assets consists of life settlement contracts that are subject to certain risks” of our Annual Report on Form 10-K for the year ended December 31, 2015.



85



Liquidity and Capital Resources

We are organized as a holding company with fifteen 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 fixed-maturity 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 recently raised substantial capital using a combination of debt and equity, and we may raise additional capital over the next twelve months.

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 $225.0 million credit agreement, under which there was $50.0 million outstanding as of June 30, 2016. The proceeds of borrowings under the credit agreement may be used for working capital, acquisitions and general corporate purposes. See "Revolving Credit Agreements" 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 $362.9 million and $360.1 million as of June 30, 2016 and December 31, 2015, respectively, taking into account dividends paid in the prior twelve month periods. During the six months ended June 30, 2016 and 2015, there were no and $16.6 million, respectively, of dividends or return of capital paid by the insurance subsidiaries to National General Management Corp. ("Management Corp.") or the Company.

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 $824.2 million and $576.7 million in the six months ended June 30, 2016 and 2015, respectively. Historically, we have funded claim payments from cash flow from operations (principally premiums), net of amounts ceded to our third party reinsurers. We 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 and total investments has increased from $2,950.0 million at December 31, 2015 to $3,553.4 million at June 30, 2016. 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 LSC Entities in which we own a 50% interest also purchase life settlement contracts that require the LSC Entities to make premium payments on individual life insurance policies in order to keep the policies in force. We presently expect to maintain sufficient cash flow to make future capital contributions to the LSC Entities to permit them to make future premium payments.



86



The following table is a summary of our statement of cash flows:
(amounts in thousands)
 
Six Months Ended June 30,
 
 
2016
 
2015
Cash and cash equivalents provided by (used in):
 
 
 
 
Operating activities
 
$
155,133

 
$
84,274

Investing activities
 
(269,768
)
 
(217,566
)
Financing activities
 
105,306

 
168,891

Effect of exchange rate changes on cash and cash equivalents
 
(1,254
)
 
(153
)
Net increase (decrease) in Cash and cash equivalents
 
$
(10,583
)
 
$
35,446


Comparison of the Six Months Ended June 30, 2016 and 2015

Net cash provided by operating activities was $155.1 million for the six months ended June 30, 2016, compared to $84.3 million net cash provided by operating activities for the same period in 2015. For the six months ended June 30, 2016, net cash provided by operating activities increased by $70.9 million, primarily as a result of increased net income ($35.3 million) and an increase in unearned premiums, unpaid loss and loss expense reserves and reinsurance premium payable.

Net cash used in investing activities was $269.8 million for the six months ended June 30, 2016, compared to $217.6 million net cash used in investing activities for the same period in 2015. For the six months ended June 30, 2016, net cash used in investing activities increased by $52.2 million, primarily due to an increase of cash used for acquisitions ($54.1 million), an increase in the use of cash in purchases of investments ($69.8 million), partially offset by an increase of distributions from unconsolidated subsidiaries and proceeds received from sale of investments ($77.4 million).

Net cash provided by financing activities was $105.3 million for the six months ended June 30, 2016, compared to $168.9 million net cash provided by financing activities for the same period in 2015. For the six months ended June 30, 2016, net cash provided by financing activities decreased by $63.6 million, primarily due to the issuance of 7.50% Non-Cumulative Series B Preferred Stock in March and April 2015 ($159.6 million), increased payments of dividends in 2016 ($8.8 million), partially offset by an increase of cash from our credit facility borrowings ($50.0 million) and in the securities sold under repurchase agreements ($52.6 million) in 2016.




87



Condensed Consolidating Balance Sheet Information

The following tables present the condensed consolidating balance sheets as of June 30, 2016 and December 31, 2015 (amounts in thousands):
 
June 30, 2016
 
NGHC
 
Reciprocal Exchanges
 
Eliminations
 
Total
ASSETS
 
 
 
 
 
 
 
Investments:
 
 
 
 
 
 
 
Fixed maturities, available-for-sale, at fair value
$
2,385,461

 
$
290,569

 
$

 
$
2,676,030

Equity securities, available-for-sale, at fair value
110,500

 

 

 
110,500

Short-term investments
52,708

 

 

 
52,708

Equity investment in unconsolidated subsidiaries
245,703

 

 

 
245,703

Other investments
148,296

 

 
(88,936
)
 
59,360

Securities pledged
137,448

 

 

 
137,448

Total investments
3,080,116

 
290,569

 
(88,936
)
 
3,281,749

Cash and cash equivalents
258,704

 
12,990

 

 
271,694

Accrued investment income
24,738

 
2,643

 
(2,044
)
 
25,337

Premiums and other receivables, net
835,683

 
58,402

 
(712
)
 
893,373

Deferred acquisition costs
160,298

 
14,362

 

 
174,660

Reinsurance recoverable on unpaid losses
813,942

 
39,617

 

 
853,559

Prepaid reinsurance premiums
84,493

 
61,912

 

 
146,405

Income tax receivable

 
300

 

 
300

Notes receivable from related party
125,000

 

 

 
125,000

Due from affiliate
35,406

 

 
(5,632
)
 
29,774

Premises and equipment, net
76,412

 
2,812

 

 
79,224

Intangible assets, net
358,267

 
25,433

 

 
383,700

Goodwill
208,971

 

 

 
208,971

Prepaid and other assets
39,106

 
89

 

 
39,195

Total assets
$
6,101,136

 
$
509,129

 
$
(97,324
)
 
$
6,512,941

LIABILITIES AND STOCKHOLDERS’ EQUITY
 
 
 
 
 
 
 
Liabilities:
 
 
 
 
 
 
 
Unpaid loss and loss adjustment expense reserves
$
1,833,221

 
$
133,531

 
$

 
$
1,966,752

Unearned premiums
1,276,637

 
148,502

 

 
1,425,139

Unearned service contract and other revenue
22,330

 

 

 
22,330

Reinsurance payable
70,033

 
22,640

 
(712
)
 
91,961

Accounts payable and accrued expenses
274,784

 
6,541

 
(2,044
)
 
279,281

Due to affiliate

 
13,152

 
(5,632
)
 
7,520

Securities sold under agreements to repurchase, at contract value
119,472

 

 

 
119,472

Deferred tax liability
(5,557
)
 
26,993

 

 
21,436

Income tax payable
24,883

 

 

 
24,883

Debt
678,715

 
88,936

 
(88,936
)
 
678,715

Other liabilities
129,640

 
38,246

 

 
167,886

Total liabilities
4,424,158

 
478,541

 
(97,324
)
 
4,805,375

Stockholders’ equity:
 
 
 
 
 
 
 
Common stock
1,059

 

 

 
1,059

Preferred stock
220,000

 

 

 
220,000

Additional paid-in capital
908,276

 

 

 
908,276

Accumulated other comprehensive income
44,724

 

 

 
44,724

Retained earnings
502,741

 

 

 
502,741

Total National General Holdings Corp. Stockholders' Equity
1,676,800

 

 

 
1,676,800

Non-controlling interest
178

 
30,588

 

 
30,766

Total stockholders’ equity
1,676,978

 
30,588

 

 
1,707,566

Total liabilities and stockholders' equity
$
6,101,136

 
$
509,129

 
$
(97,324
)
 
$
6,512,941



88



 
December 31, 2015
 
NGHC
 
Reciprocal Exchanges
 
Total
ASSETS
 
Investments:
 
 
 
 
 
Fixed maturities, available-for-sale, at fair value
$
2,063,051

 
$
238,969

 
$
2,302,020

Equity securities, available-for-sale, at fair value
57,216

 
1,574

 
58,790

Short-term investments
1,528

 
1,999

 
3,527

Equity investment in unconsolidated subsidiaries
234,948

 

 
234,948

Other investments
13,031

 

 
13,031

Securities pledged
55,394

 

 
55,394

Total investments
2,425,168

 
242,542

 
2,667,710

Cash and cash equivalents
273,884

 
8,393

 
282,277

Accrued investment income
18,055

 
2,347

 
20,402

Premiums and other receivables, net
702,439

 
56,194

 
758,633

Deferred acquisition costs
136,728

 
23,803

 
160,531

Reinsurance recoverable on unpaid losses
794,091

 
39,085

 
833,176

Prepaid reinsurance premiums
66,613

 
61,730

 
128,343

Income tax receivable

 
300

 
300

Notes receivable from related party
125,057

 

 
125,057

Due from affiliate
29,476

 
12,060

 
41,536

Premises and equipment, net
42,599

 
332

 
42,931

Intangible assets, net
344,073

 
4,825

 
348,898

Goodwill
112,414

 

 
112,414

Prepaid and other assets
41,091

 
93

 
41,184

Total assets
$
5,111,688

 
$
451,704

 
$
5,563,392

LIABILITIES AND STOCKHOLDERS’ EQUITY


 


 
 
Liabilities:


 


 
 
Unpaid loss and loss adjustment expense reserves
$
1,623,232

 
$
132,392

 
$
1,755,624

Unearned premiums
1,046,313

 
146,186

 
1,192,499

Unearned service contract and other revenue
12,504

 

 
12,504

Reinsurance payable
54,815

 
14,357

 
69,172

Accounts payable and accrued expenses
265,057

 
19,845

 
284,902

Securities sold under agreements to repurchase, at contract value
52,484

 

 
52,484

Deferred tax liability
(20,477
)
 
32,724

 
12,247

Income tax payable
5,593

 

 
5,593

Debt
446,061

 
45,476

 
491,537

Other liabilities
112,085

 
38,105

 
150,190

Total liabilities
3,597,667

 
429,085

 
4,026,752

Stockholders’ equity:
 
 
 
 
 
Common stock
1,056



 
1,056

Preferred stock
220,000



 
220,000

Additional paid-in capital
900,114



 
900,114

Accumulated other comprehensive income (loss)
(19,414
)


 
(19,414
)
Retained earnings
412,044



 
412,044

Total National General Holdings Corp. Stockholders' Equity
1,513,800



 
1,513,800

Non-controlling interest
221


22,619

 
22,840

Total stockholders’ equity
1,514,021


22,619

 
1,536,640

Total liabilities and stockholders' equity
$
5,111,688


$
451,704

 
$
5,563,392





89



Other Material Changes in Financial Position

(amounts in thousands)
 
June 30, 2016
 
December 31, 2015
Selected Assets:
 
 
 
 
Premiums and other receivables, net
 
$
893,373

 
$
758,633

Selected Liabilities:
 
 
 
 
Unpaid loss and loss adjustment expense reserves
 
$
1,966,752

 
$
1,755,624

Unearned premiums
 
$
1,425,139

 
$
1,192,499

Debt
 
$
678,715

 
$
491,537

Other liabilities
 
$
167,886

 
$
150,190


During the six months ended June 30, 2016, Premiums and other receivables, net increased by $134.7 million compared to December 31, 2015, primarily due to the acquisition of Century-National, ARS premium volume which is now written on our paper, and the seasonality of policy renewals in our A&H segment.

During the six months ended June 30, 2016, Unpaid loss and loss adjustment expense reserves increased by $211.1 million compared to December 31, 2015, primarily due to the acquisitions of Century-National and ARS in our P&C segment, and the increase in incurred but not reported claims in our A&H segment. Unearned premiums increased by $232.6 million compared to December 31, 2015, due to the acquisition of Century-National, ARS premium volume which is now written on our paper, and the seasonality of policy renewals in our A&H segment. Debt increased by $187.2 million compared to December 31, 2015, due to borrowings under our credit facility loan and the Century-National promissory note partially offset by our purchase of the Reciprocal Exchanges' surplus notes. Other liabilities increased by $17.7 million compared to December 31, 2015, primarily due to an increase in outstanding in process disbursements.


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 reinsurance companies. 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) at the time we enter into our reinsurance agreements. We also enter 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.

As of July 1, 2016, 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 $355.0 million in coverage in excess of a $20.0 million retention, with one reinstatement.

As of May 1, 2016, our new reinsurance property catastrophe excess of loss program went into effect protecting us against catastrophic events and other large losses. The property catastrophe program provides a total of $475.0 million in coverage in excess of a $50.0 million retention, with one reinstatement. Included in this coverage is drop down coverage to reduce the retention to $35.0 million provided there is a second event. The casualty program provides $45.0 million in coverage in excess of a $5.0 million retention. We pay a premium as consideration for ceding the risk.

For a more detailed description of our reinsurance arrangements, see ‘‘Reinsurance’’ in ‘‘Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations’’ in our Annual Report on Form 10-K for the year ended December 31, 2015.




90



7.625% Subordinated Notes due 2055

On August 18, 2015, we sold $100.0 million aggregate principal amount of our 7.625% subordinated notes due 2055 (the “7.625% Notes”) in a public offering. The net proceeds we received from the issuance was approximately $96.6 million, 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, beginning on December 15, 2015. The 7.625% Notes are our 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 we incur in the future that ranks equally with the 7.625% Notes, and (iii) subordinate in right of payment to any of our existing and future senior debt, including amounts outstanding under our revolving credit facility, our 6.75% Notes and certain of our other obligations. In addition, the 7.625% Notes 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 and six months ended June 30, 2016 was $1.9 million and $3.8 million, 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 our consolidated leverage ratio would exceed 0.35 to 1.00, a limitation on liens, a limitation on the disposition of stock of certain of our subsidiaries and a limitation on transactions with certain of our affiliates. We were in compliance with all covenants contained in the indenture as of June 30, 2016.


6.75% Notes due 2024

On May 23, 2014, we sold $250.0 million aggregate principal amount of our 6.75% Notes due 2024 (the "6.75% Notes") to certain purchasers in a private placement. The net proceeds we received from the issuance was approximately $245.0 million, after deducting the 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, beginning on November 15, 2014. 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 are also effectively subordinated to any of our existing and future secured indebtedness to the extent of the value of the collateral securing such indebtedness and are structurally subordinated to the existing and future indebtedness of our subsidiaries (including trade payables). The 6.75% Notes mature on May 15, 2024, unless earlier redeemed or purchased by us.

On October 8, 2015, we sold an additional $100.0 million aggregate principal amount of our 6.75% Notes to certain purchasers in a private placement. The additional 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, beginning on November 15, 2015. The additional 6.75% Notes mature on May 15, 2024, unless earlier redeemed or purchased by us. The net proceeds we received from the issuance was approximately $98.9 million, after deducting the estimated issuance expenses payable us. We intend to use the net proceeds from the issuance for general corporate purposes, including strategic acquisitions and to support its current and future policy writings. The additional 6.75% Notes were issued under the same indenture as the original 6.75% Notes.

Interest expense on the 6.75% Notes for the three and six months ended June 30, 2016 was $5.9 million and $11.7 million, respectively. Interest expense on the 6.75% Notes for the three and six months ended June 30, 2015 was $4.3 million and $8.5 million, 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 our consolidated leverage ratio would exceed 0.35 to 1.00, a limitation on liens, a limitation on the disposition of stock of certain of our subsidiaries and a limitation on transactions with certain of our affiliates. We were in compliance with all covenants contained in the indenture as of June 30, 2016.




91



Revolving Credit Agreement

On January 25, 2016, we entered into a $225.0 million 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 revolving credit facility with a letter of credit sublimit of $25.0 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.

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 us 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 us and our 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 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 (x) 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 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 June 30, 2016).

On May 31, 2016, we borrowed $50,000 under the Credit Agreement, Eurodollar borrowings was elected for interest rate. Interest payments are due the last day of the interest period in intervals of three months duration, commencing on the date of such borrowing. The borrowing bears interest at the adjusted LIBOR rate which was 3.00% as of June 30, 2016 and will reset in November 30, 2016. Interest expense on the Credit Agreement for the three and six months ended June 30, 2016 was $0.1 million and $0.1 million, respectively. We were in compliance with all of the covenants under the Credit Agreement as of June 30, 2016.


Imperial-related Debt

Our subsidiary, Imperial Fire and Casualty Insurance Company, is the issuer of $5.0 million 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 us at a redemption price equal to 100% of their principal amount. Interest expense on the Imperial Surplus Notes for the three and six months ended June 30, 2016 was $0.1 million and $0.1 million, respectively. Interest expense on the Imperial Surplus Notes for the three and six months ended June 30, 2015 was $0.1 million and $0.1 million, respectively.




92



Reciprocal Exchanges' Surplus Notes

The Reciprocal Exchanges issued surplus notes ("Reciprocal Exchanges' Surplus Notes") when they were originally capitalized. The obligation to repay principal and interest on these surplus notes is subordinated to the Reciprocal Exchanges’ other liabilities, including obligations to policyholders and claimants for benefits under insurance policies. Principal and interest on these surplus notes are payable only with regulatory approval. Interest expense on the Reciprocal Exchanges' Surplus Notes for the three and six months ended June 30, 2015 was $3.8 million and $7.5 million, respectively, which includes amortization of $2.1 million and $4.2 million, respectively. Effective March 31, 2016, we purchased the Reciprocal Exchanges' Surplus Notes from subsidiaries of ACP Re for an aggregate amount of approximately $88.9 million. The purchase price was based on an independent third party valuation of the fair market value of the surplus notes. At June 30, 2016, the surplus notes receivable and surplus notes payable are eliminated upon consolidation. Interest income and interest expense from the purchased date were also eliminated upon consolidation. (See Note 3, "Reciprocal Exchanges" and Note 14, "Related Party Transactions" in the notes to our condensed consolidated financial statements).


Century-National Promissory Note

On June 1, 2016, in connection with the closing of our acquisition of all of the issued and outstanding shares of capital stock of Century-National and Western General, we issued a promissory note ("Century-National Promissory Note") in the approximate amount of $182.3 million to the seller to fund a portion of the purchase price for the acquisition. The Century-National Promissory Note is unsecured and has a two-year term. Principal on the Century-National Promissory Note is payable in two equal installments of approximately $91.1 million on June 1, 2017 and 2018, respectively. Interest on the outstanding principal balance of the Century-National Promissory Note accrues at an annual rate of 4.4% and is payable in arrears on each of the two payment dates. The Century-National Promissory Note may be prepaid at any time, without penalty. The Century-National Promissory Note contains a cross-acceleration provision that is triggered in the event that payment under our $225.0 million Credit Agreement is accelerated and such acceleration is not revoked, rescinded or withdrawn within 30 days of such acceleration. The Century-National Promissory Note also contains customary events of default. Interest expense on the Century-National Promissory Note for the three and six months ended June 30, 2016 was $0.6 million and $0.6 million, respectively.


Securities Sold (Purchased) Under Agreements to Repurchase (Sell), at Contract Value

We enter into reverse repurchase and repurchase agreements, which are accounted for as either collateralized lending or borrowing transactions and are recorded at contract amounts which approximate fair value. For the collateralized borrowing transactions (i.e., repurchase agreements), we receive cash or securities that we invest or hold in short-term or fixed income securities.

As of June 30, 2016 and December 31, 2015, we had no collateralized lending transaction principal outstanding.

As of June 30, 2016 and December 31, 2015, we had collateralized borrowing transaction principal outstanding of $119.5 million and $52.5 million, respectively, at interest rates of 0.70% and 0.80%, respectively. Interest expense associated with these repurchase borrowing agreements for the three and six months ended June 30, 2016 was $0.2 million and $0.3 million, respectively, and for the three and six months ended June 30, 2015 was $0.0 million and $0.1 million, respectively. We had $137.4 million and $55.4 million of collateral pledged in support for these agreements as of June 30, 2016 and December 31, 2015, respectively.




93



ACP Re Credit Agreement

On July 28, 2016, NG Re Ltd., a subsidiary of the Company, AmTrust and its wholly-owned subsidiary AII, entered into a restatement agreement to the ACP Re Credit Agreement, dated September 15, 2014, among AmTrust, as Administrative Agent, ACP Re, ACP Re Holdings, LLC, as guarantor, and AII and NG Re Ltd., as Lenders. The terms of the Restatement Agreement, upon their effectiveness, will alter the original terms of the ACP Re Credit Agreement principally by lengthening the maturity date, reducing the interest rate and improving the credit profile. Such modification of terms is deemed to be a troubled debt restructuring under GAAP. We will possess a collateral interest of at least 115% of the $125.0 million outstanding balance based on the Maintenance Covenant within the Restatement Agreement. As such, management determined no write down or reserve in the carrying value of the loan will be required as a result of the terms of the Restatement Agreement. The need to evaluate the loan for impairment and classification as a TDR will be evaluated quarterly, as will the adequacy of the Company's reserve position based on collateral levels maintained (See Note 14, "Related Party" and Note 17, "Subsequent Events" in the notes to our condensed consolidated financial statements).


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 fixed-maturity securities and the financial condition of our third party reinsurers. Additionally, we have counterparty credit risk with our repurchase agreement counterparties.

We address the credit risk related to the issuers of our fixed-maturity securities by investing primarily in fixed-maturity securities that are rated “BBB-” or higher by Standard & Poor’s. We also independently monitor the financial condition of all issuers of our fixed-maturity 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 third party reinsurers. Although our third party 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 have an A.M. Best rating of “A-” (Excellent) or better 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.”

Counterparty credit risk with our repurchase agreement counterparties is mitigated by obtaining collateral. We obtain collateral in the amount of 105-110% of the value of the securities we have sold with agreement to repurchase. Additionally, repurchase agreements are only transacted with pre-approved counterparties.

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 fixed maturities, securities pledged and preferred stock with a fair value of $2,829.2 million and a cost or amortized cost of $2,725.0 million as of June 30, 2016 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 fixed-maturity 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 fixed-maturity securities as of June 30, 2016 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 fixed-maturity and equity securities as available-for-sale. Temporary changes in the fair value of our fixed-maturity securities impact the carrying


94



value of these securities and are reported in our stockholders’ equity as a component of accumulated other comprehensive income, net of deferred taxes.

The selected scenarios with our fixed maturities (including our securities pledged) and excluding $15.8 million of preferred stock, 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 fixed maturities and on our stockholders’ equity, each as of June 30, 2016.

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
 
$
2,613,721

 
$
(199,757
)
 
(7.1
)%
100 basis point increase
 
2,745,955

 
(67,523
)
 
(2.4
)
No change
 
2,813,478

 

 

100 basis point decrease
 
3,030,116

 
216,638

 
7.7

200 basis point decrease
 
3,187,671

 
374,193

 
13.3


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 $687.3 million principal amount of debt instruments of which $632.3 million are 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 $0.6 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 June 30, 2016 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.


Item 4. Controls and Procedures

Evaluation of Financial Reporting Controls and Procedures

Our management, with the participation and under the supervision of the 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.

Based on its evaluation as of March 31, 2016, the Company incorrectly analyzed certain provisions of ASU 2015-02 Consolidation related to accounting for variable interest entities which became effective for the periods commencing after December 15, 2015. The Company incorrectly consolidated the balance sheet of the Reciprocal Exchanges as of January 1, 2016 and its results of operations for the period ended March 31, 2016 in its Form 8-K filed on May 2, 2016 (the “Form 8-K”). The Company’s Chief Executive Officer and Chief Financial Officer determined that the Company’s financial reporting controls and procedures with respect to review and approvals of significant and unusual transactions were not operating effectively for the first quarter ended March 31, 2016 to ensure that information required to be disclosed by the Company in the reports that it files or submits under the Exchange Act is 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. The Company’s control failure noted above and the consequential understatement in the Company’s shareholders’ equity in the Form 8-K resulted from a material weakness in the Company’s internal control over financial reporting. A material weakness is a deficiency, or combination of deficiencies, in internal control over financial reporting, such that there is a reasonable possibility that a material misstatement of the Company’s annual or interim financial statements will not be prevented or detected on a timely basis.

In the second quarter of 2016, the Company hired a controller with appropriate experience applying GAAP technical accounting guidance, as well as additional accounting personnel. In addition, the Company implemented controls around the


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identification, documentation and application of technical accounting guidance with particular emphasis on events outside the ordinary course of business. These controls include a renewed focus on the timely preparation and review of formal accounting memorandums to support our conclusions on technical accounting matters, formalized inquiry and communication among management, and greater use of research tools to assist in compliance with GAAP in regard to complex accounting transactions. As a result of the remediation activities and controls in place as of June 30, 2016 described above, the material weakness was considered remediated as the applicable controls operated for a sufficient period of time and management has concluded, through testing, that these controls are operating effectively.

Changes in Internal Controls Over Financial Reporting

Except for our remediation efforts related to the material weakness identified as of and for the period ending March 31, 2016, 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 June 30, 2016 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, 2015 as filed with the SEC.


Item 6. Exhibits

INDEX TO EXHIBITS

The following documents are filed as exhibits to this report:
Exhibit No.
 
Description
 
 
 
3.1
 
Certificate of Designations of 7.50% Non-Cumulative Preferred Stock, Series C (incorporated by reference to Exhibit 3.1 to the Company’s Current Report on Form 8-K filed on July 7, 2016)
4.1
 
Deposit Agreement, dated July 7, 2016, among National General Holdings Corp., American Stock Transfer & Trust Company, LLC and the holders from time to time of the depositary receipts described therein (incorporated by reference to Exhibit 4.1 to the Company’s Current Report on Form 8-K filed on July 7, 2016)
4.2
 
Form of depositary receipt (included as Exhibit A to Exhibit 4.1) (incorporated by reference to Exhibit 4.2 to the Company’s Current Report on Form 8-K filed on July 7, 2016)
4.3
 
Form of stock certificate evidencing 7.50% Non-Cumulative Preferred Stock, Series C (incorporated by reference to Exhibit 4.3 to the Company’s Current Report on Form 8-K filed on July 7, 2016)
10.1
 
Promissory Note, dated June 1, 2016, issued by National General Holdings Corp. in favor of Kramer-Wilson Company, Inc. (incorporated by reference to Exhibit 10.1 to the Company’s Current Report on Form 8-K filed on June 1, 2016)
10.2
 
Agreement and Plan of Merger, dated as of June 24, 2016, by and among National General Holdings Corp., Bluebird Acquisition Corp., Elara Holdings, Inc. and Shareholder Representative Services LLC (incorporated by reference to Exhibit 10.1 to the Company’s Current Report on Form 8-K filed on June 24, 2016)
12.1
 
Computation of Ratio of Earnings to Fixed Charges (filed herewith)
31.1
 
Certification of Chief Executive Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 (filed herewith)
31.2
 
Certification of Chief Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 (filed herewith)
32.1
 
Certification of Chief Executive Officer pursuant to 18 U.SC. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 (furnished herewith)
32.2
 
Certification of Chief Financial Officer pursuant to 18 U.SC. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 (furnished herewith)
101.1
 
The following materials from the Company’s Quarterly Report on Form 10-Q for the quarter ended June 30, 2016, formatted in XBRL (Extensible Business Reporting Language): (i) the Condensed Consolidated Balance Sheets at June 30, 2016 and December 31, 2015; (ii) the Condensed Consolidated Statements of Income for the three and six months ended June 30, 2016 and 2015; (iii) the Condensed Consolidated Statements of Comprehensive Income for the three and six months ended June 30, 2016 and 2015; (iv) the Condensed Consolidated Statements of Changes in Stockholders' Equity for the six months ended June 30, 2016 and 2015; (v) the Condensed Consolidated Statements of Cash Flows for the six months ended June 30, 2016 and 2015; 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.
August 5, 2016
 
 
 
By:
/s/ Barry Karfunkel
 
 
Name: Barry Karfunkel
Title: President and Chief Executive Officer
 
 
 
 
By:
/s/ Michael Weiner
 
 
Name: Michael Weiner
Title: Chief Financial Officer




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