National General
National General Holdings Corp. (Form: 10-Q, Received: 11/08/2016 16:50:01)

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 September 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 November 7, 2016 , the number of common shares of the registrant outstanding was 106,404,367 .





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)
 
 
 
 
 
September 30,
2016
 
December 31,
2015
ASSETS
(unaudited)
 
(audited)
Investments - NGHC
 
 
 
Fixed maturities, available-for-sale, at fair value (amortized cost $2,570,730 and $2,081,456)
$
2,676,115

 
$
2,063,051

Equity securities, available-for-sale, at fair value (cost $81,676 and $63,303)
83,596

 
57,216

Fixed maturities, trading, at fair value (amortized cost $31,057 and $0)
35,429

 

Equity securities, trading, at fair value (cost $24,133 and $0)
22,286

 

Short-term investments
142,530

 
1,528

Equity investment in unconsolidated subsidiaries
246,781

 
234,948

Other investments
64,788

 
13,031

Securities pledged (amortized cost $0 and $54,955)

 
55,394

Investments - Exchanges
 
 
 
Fixed maturities, available-for-sale, at fair value (amortized cost $279,901 and $244,069)
295,020

 
238,969

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

 
1,574

Short-term investments
3,596

 
1,999

Total investments
3,570,141

 
2,667,710

Cash and cash equivalents (Exchanges - $21,830 and $8,393)
216,374

 
282,277

Accrued investment income (Exchanges - $3,073 and $2,347)
25,876

 
20,402

Premiums and other receivables, net (Related parties $19,481 and $62,306) (Exchanges - $56,443 and $56,194)
923,758

 
758,633

Deferred acquisition costs (Exchanges - $23,282 and $23,803)
206,087

 
160,531

Reinsurance recoverable on unpaid losses (Related parties - $33,173 and $42,774) (Exchanges - $45,445 and $39,085)
917,708

 
833,176

Prepaid reinsurance premiums (Exchanges - $65,892 and $61,730)
154,574

 
128,343

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

 
300

Notes receivable from related party
127,049

 
125,057

Due from affiliate (Exchanges - $0 and $12,060)
10,964

 
41,536

Premises and equipment, net (Exchanges - $3,936 and $332)
83,732

 
42,931

Intangible assets, net (Exchanges - $18,229 and $4,825)
366,202

 
348,898

Goodwill
211,702

 
112,414

Prepaid and other assets (Exchanges - $92 and $93)
42,961

 
41,184

Total assets
$
6,857,428

 
$
5,563,392

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 

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)
 
 
 
 
LIABILITIES AND STOCKHOLDERS’ EQUITY
 
 
 
Liabilities:
 
 
 
Unpaid loss and loss adjustment expense reserves (Exchanges - $140,821 and $132,392)
$
2,086,934

 
$
1,755,624

Unearned premiums (Exchanges - $156,042 and $146,186)
1,469,166

 
1,192,499

Unearned service contract and other revenue
13,644

 
12,504

Reinsurance payable (Related parties - $38,096 and $31,923) (Exchanges - $20,415 and $14,357)
100,708

 
69,172

Accounts payable and accrued expenses (Related parties - $27,285 and $51,755) (Exchanges - $4,956 and $19,845)
323,499

 
284,902

Securities sold under agreements to repurchase, at contract value

 
52,484

Deferred tax liability (Exchanges - $27,416 and $32,724)
26,879

 
12,247

Income tax payable
19,783

 
5,593

Debt (Exchanges owed to related party - $0 and $45,476)
675,507

 
491,537

Other liabilities (Exchanges - $44,952 and $38,105)
193,538

 
150,190

Total liabilities
4,909,658

 
4,026,752

Commitments (Note 17)


 


Stockholders’ equity:
 
 
 
Common stock, $0.01 par value - authorized 150,000,000 shares, issued and outstanding 106,088,008 shares - 2016; authorized 150,000,000 shares, issued and outstanding 105,554,331 shares - 2015
1,061

 
1,056

Preferred stock, $0.01 par value - authorized 10,000,000 shares, issued and outstanding 2,565,000 shares - 2016; authorized 10,000,000 shares, issued and outstanding 2,365,000 shares - 2015. Aggregate liquidation preference $420,000 - 2016, $220,000 - 2015
420,000

 
220,000

Additional paid-in capital
905,772

 
900,114

Accumulated other comprehensive income (loss):
 
 
 
Unrealized foreign currency translation adjustments
(2,323
)
 
(3,780
)
Unrealized gains (losses) on investments
69,753

 
(15,634
)
Total accumulated other comprehensive income (loss)
67,430

 
(19,414
)
Retained earnings
518,418

 
412,044

Total National General Holdings Corp. Stockholders' Equity
1,912,681

 
1,513,800

Non-controlling interest (Exchanges - $34,876 and $22,619)
35,089

 
22,840

Total stockholders’ equity
1,947,770

 
1,536,640

Total liabilities and stockholders' equity
$
6,857,428

 
$
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 September 30,
 
Nine Months Ended September 30,
 
2016
 
2015
 
2016
 
2015
Revenues:
 
 
 
 
 
 
 
Premium income:
 
 
 
 
 
 
 
Gross premium written
$
931,459

 
$
626,685

 
$
2,598,160

 
$
1,845,821

Ceded premiums
(125,074
)
 
(101,046
)
 
(309,739
)
 
(310,747
)
Net premium written
806,385

 
525,639

 
2,288,421

 
1,535,074

Change in unearned premium
(36,535
)
 
(22,378
)
 
(150,711
)
 
(83,832
)
Net earned premium
769,850

 
503,261

 
2,137,710

 
1,451,242

Ceding commission income
14,597

 
12,150

 
24,406

 
27,200

Service and fee income
95,662

 
60,907

 
282,623

 
173,335

Net investment income
27,676

 
18,472

 
76,874

 
52,955

Net realized and unrealized gain (loss) on investments:
 
 
 
 
 
 
 
Other-than-temporary impairment loss
(22,102
)
 
(6,009
)
 
(22,102
)
 
(8,492
)
Portion of loss recognized in other comprehensive income

 

 

 

Other net realized and unrealized gain on investments
11,149

 
1,415

 
19,148

 
5,474

Net realized and unrealized loss on investments
(10,953
)
 
(4,594
)
 
(2,954
)
 
(3,018
)
Other revenue (expense)
(56
)
 
(157
)
 
258

 
(327
)
Total revenues
896,776

 
590,039

 
2,518,917

 
1,701,387

Expenses:
 
 
 
 
 
 
 
Loss and loss adjustment expense
509,853

 
302,259

 
1,391,261

 
895,774

Acquisition costs and other underwriting expenses
140,740

 
108,744

 
362,513

 
295,131

General and administrative expenses
198,737

 
118,581

 
566,484

 
343,426

Interest expense
10,455

 
9,428

 
28,535

 
27,109

Total expenses
859,785

 
539,012

 
2,348,793

 
1,561,440

Income before provision for income taxes and equity in earnings of unconsolidated subsidiaries
36,991

 
51,027

 
170,124

 
139,947

Provision for income taxes
8,805

 
8,614

 
41,439

 
24,892

Income before equity in earnings of unconsolidated subsidiaries
28,186

 
42,413

 
128,685

 
115,055

Equity in earnings of unconsolidated subsidiaries
2,953

 
2,288

 
16,991

 
8,900

Net income
31,139

 
44,701

 
145,676

 
123,955

Less: Net (income) loss attributable to non-controlling interest
(3,009
)
 
(1,588
)
 
(12,249
)
 
453

Net income attributable to National General Holdings Corp. ("NGHC")
$
28,130

 
$
43,113

 
$
133,427

 
$
124,408

Dividends on preferred stock
(8,208
)
 
(4,125
)
 
(16,458
)
 
(9,900
)
Net income attributable to NGHC common stockholders
$
19,922

 
$
38,988

 
$
116,969

 
$
114,508

Earnings per common share:
 
 
 
 
 
 
 
Basic earnings per share
$
0.19

 
$
0.39

 
$
1.11

 
$
1.19

Diluted earnings per share
$
0.18

 
$
0.38

 
$
1.08

 
$
1.16

Dividends declared per common share
$
0.04

 
$
0.02

 
$
0.10

 
$
0.06

Weighted average shares common shares outstanding:
 
 
 
 
 
 
 
Basic
106,002,337

 
100,360,687

 
105,801,817

 
95,877,178

Diluted
108,423,998

 
102,940,728

 
108,053,177

 
98,314,808


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 September 30,
 
Nine Months Ended September 30,
 
2016
 
2015
 
2016
 
2015
Net income
$
31,139

 
$
44,701

 
$
145,676

 
$
123,955

Other comprehensive income (loss), net of tax:
 
 
 
 
 
 
 
Foreign currency translation adjustment
1,812

 
(208
)
 
1,457

 
3,544

Gross unrealized holding gain (loss) on securities, net of tax of $6,413 and $(9,906) for the three months ended September 30, 2016 and 2015, respectively, and $47,459 and $(14,433) for the nine months ended September 30, 2016 and 2015, respectively
11,910

 
(15,681
)
 
88,139

 
(26,746
)
Reclassification adjustments for investment gain/loss included in net income:
 
 
 
 
 
 
 
Other-than-temporary impairment loss, net of tax of $7,736 and $2,103 for the three months ended September 30, 2016 and 2015, respectively, and $7,736 and $2,972 for the nine months ended September 30, 2016 and 2015, respectively
14,366

 
3,906

 
14,366

 
5,520

Other net realized and unrealized gain on investments, net of tax of $(2,190) and $(495) for the three months ended September 30, 2016 and 2015, respectively, and $(4,990) and $(1,916) for the nine months ended September 30, 2016 and 2015, respectively
(4,068
)
 
(920
)
 
(9,267
)
 
(3,558
)
Other comprehensive income (loss), net of tax
24,020

 
(12,903
)
 
94,695

 
(21,240
)
Comprehensive income
55,159

 
31,798

 
240,371

 
102,715

Less: Comprehensive (income) loss attributable to non-controlling interest
(4,323
)
 
(1,232
)
 
(20,100
)
 
3,947

Comprehensive income attributable to NGHC
$
50,836

 
$
30,566

 
$
220,271

 
$
106,662




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)

 
Nine Months Ended September 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

 

 

 

 

 
133,427

 

 
12,249

 
145,676

Foreign currency translation adjustment, net of tax

 

 

 

 

 

 
1,457

 

 
1,457

Change in unrealized gain on investments, net of tax

 

 

 

 

 

 
85,387

 
7,851

 
93,238

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

 

 

 

 

 

 

 
14,768

 
14,768

Return of capital

 

 

 

 
(150
)
 

 

 

 
(150
)
Issuance of preferred stock

 

 
200,000

 
200,000

 
(6,482
)
 

 

 

 
193,518

Common stock dividends

 

 

 

 

 
(10,595
)
 

 

 
(10,595
)
Preferred stock dividends

 

 

 

 

 
(16,458
)
 

 

 
(16,458
)
Common stock issued under employee stock plans and exercises of stock options
533,677

 
5

 

 

 
4,203

 

 

 

 
4,208

Stock-based compensation

 

 

 

 
6,471

 

 

 

 
6,471

Tax benefit from stock-based compensation

 

 

 

 
1,616

 

 

 

 
1,616

Balance September 30, 2016
106,088,008

 
$
1,061

 
2,565,000

 
$
420,000

 
$
905,772

 
$
518,418

 
$
67,430

 
$
35,089

 
$
1,947,770


 
Nine Months Ended September 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 (loss)

 

 

 

 

 
124,408

 

 
(453
)
 
123,955

Foreign currency translation adjustment, net of tax

 

 

 

 

 

 
3,544

 

 
3,544

Change in unrealized loss on investments, net of tax

 

 

 

 

 

 
(21,290
)
 
(3,494
)
 
(24,784
)
Change in non-controlling interest

 

 

 

 

 

 

 
(980
)
 
(980
)
Issuance of common stock
11,500,000

 
115

 

 

 
210,527

 

 

 

 
210,642

Issuance of preferred stock

 

 
165,000

 
165,000

 
(5,448
)
 

 

 

 
159,552

Common stock dividends

 

 

 

 

 
(5,813
)
 

 

 
(5,813
)
Preferred stock dividends

 

 

 

 

 
(9,900
)
 

 

 
(9,900
)
Common stock issued under employee stock plans and exercises of stock options
506,511

 
5

 

 

 
1,667

 

 

 

 
1,672

Stock-based compensation

 

 

 

 
(782
)
 

 

 

 
(782
)
Balance September 30, 2015
105,433,893

 
$
1,054

 
2,365,000

 
$
220,000

 
$
896,700

 
$
401,527

 
$
2,446

 
$
8,829

 
$
1,530,556



See accompanying notes to unaudited condensed consolidated financial statements.
5



NATIONAL GENERAL HOLDINGS CORP.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(In Thousands)
(Unaudited)
 
 
 
 
 
Nine Months Ended September 30,
 
2016
 
2015
Cash flows from operating activities:
 
 
 
Net income
$
145,676

 
$
123,955

Reconciliation of net income to net cash provided by (used in) operating activities:
 
 
 
Depreciation and amortization
49,461

 
22,134

Net amortization of premium (discount) on fixed maturities
(945
)
 
4,179

Net amortization of discount on debt
551

 
6,298

Stock-compensation expense
6,471

 
3,444

Bad debt expense
22,816

 
16,645

Other-than-temporary impairment loss
22,102

 
8,492

Other net realized and unrealized gain on investments
(19,148
)
 
(5,474
)
Equity in earnings of unconsolidated subsidiaries
(16,991
)
 
(8,900
)
Foreign currency translation adjustment
(50
)
 
(1,438
)
Changes in assets and liabilities:
 
 
 
Accrued investment income
(3,593
)
 
(4,208
)
Premiums and other receivables
(121,010
)
 
(92,274
)
Deferred acquisition costs
(68,595
)
 
(26,577
)
Reinsurance recoverable on unpaid losses
(67,317
)
 
18,526

Prepaid reinsurance premiums
(15,532
)
 
(28,707
)
Prepaid expenses and other assets
(215
)
 
7,158

Unpaid loss and loss adjustment expense reserves
185,425

 
3,165

Unearned premiums
166,609

 
110,306

Unearned service contract and other revenue
1,140

 
(1,186
)
Reinsurance payable
27,665

 
(18,829
)
Accounts payable
(26,749
)
 
526

Income tax payable
14,026

 
(30,244
)
Deferred tax liability
(24,504
)
 
2,743

Other liabilities
36,664

 
101,530

Net cash provided by operating activities
313,957

 
211,264

Cash flows from investing activities:
 
 
 
Purchases of fixed maturities, available-for-sale
(532,387
)
 
(642,838
)
Proceeds from sale and maturity of fixed maturities, available-for-sale
421,454

 
276,697

Purchases of equity securities, available-for-sale
(25,176
)
 
(11,085
)
Proceeds from sale of equity securities, available-for-sale
41,225

 
2,339

Purchases of trading investments
(36,519
)
 

Proceeds from sale and maturity of trading investments
7,412

 

Purchases of short-term investments
(162,980
)
 
(82,162
)
Proceeds from sale of short-term investments
17,754

 
83,672

Investment in unconsolidated subsidiaries
(6,568
)
 
(68,859
)
Distributions from unconsolidated subsidiaries
12,033

 
2,059

Purchases of other investments
(141,108
)
 
(3,474
)

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 of other investments
6,630

 

Purchases of premises and equipment
(24,341
)
 
(9,584
)
Acquisition of consolidated subsidiaries, net of cash
(126,008
)
 
(61,413
)
Decrease in cash due to deconsolidation of the Reciprocal Exchanges
(8,393
)
 

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

 

Net cash used in investing activities
(554,299
)
 
(514,648
)
Cash flows from financing activities:
 
 
 
Securities sold under agreements to repurchase, net
(52,484
)
 
(5,363
)
Proceeds from debt
50,000

 
96,550

Repayments of debt

 
(631
)
Return of capital
(150
)
 

Issuance of common stock, net (fees $0 and $7,858, respectively)

 
210,642

Issuance of preferred stock, net (fees $6,482 and $5,448, respectively)
193,518

 
159,552

Dividends paid to common shareholders
(9,528
)
 
(5,610
)
Dividends paid to preferred shareholders
(12,375
)
 
(6,806
)
Exercises of stock options
7,271

 
1,672

Net cash provided by financing activities
176,252

 
450,006

Effect of exchange rate changes on cash and cash equivalents
(1,813
)
 
(341
)
Net increase (decrease) in cash and cash equivalents
(65,903
)
 
146,281

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

 
132,615

Cash and cash equivalents, end of the period
$
216,374

 
$
278,896

 
 
 
 
Supplemental disclosures of cash flow information:
 
 
 
Cash paid for income taxes
$
20,846

 
$
52,700

Cash paid for interest
18,089

 
8,524

Supplemental disclosures of non-cash investing and financing activities:
 
 
 
Promissory note issued for acquisition
$
178,894

 
$

Unsettled investment security purchases
22,059

 

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 common stock dividends
4,245

 
2,070

Accrued preferred stock dividends
8,208

 
4,125


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 September 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 nine months ended September 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 nine months ended September 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

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relevant terms and features-including the embedded derivative feature being evaluated for bifurcation-in evaluating the nature of 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

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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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(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 September 30, 2016 and December 31, 2015 , the Company had $1,248 and $(3,909) , respectively, of net unrealized gains (losses), net of tax, for equity securities, available-for-sale, recognized as a component of accumulated other comprehensive income (loss) ("AOCI").

In February 2016, the FASB issued ASU 2016-02, "Leases (Topic 842)” to increase transparency and comparability among organizations by recognizing lease assets and lease liabilities on the balance sheet and disclosing key information about leasing arrangements. The new standard establishes a right-of-use (ROU) model that requires a lessee to record a ROU asset and a lease liability on the balance sheet for all leases with terms longer than 12 months. Leases will be classified as either finance or operating, with classification affecting the pattern of expense recognition in the income statement. The new standard is effective for fiscal years beginning after December 15, 2018, including interim periods within those fiscal years. A modified retrospective transition approach is required for lessees for capital and operating leases existing at, or entered into after, the beginning of the earliest comparative period presented in the financial statements, with certain practical expedients available. The Company is 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 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

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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 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

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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 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 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

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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 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 August 2016, the FASB issued ASU 2016-15 “Statement of Cash Flows (Topic 230): Classification of Certain Cash Receipts and Cash Payments”. ASU 2016-15 provides guidance on the following eight specific cash flow classification issues: (1) debt prepayment or debt extinguishment costs; (2) settlement of zero-coupon debt instruments or other debt instruments with coupon interest rates that are insignificant in relation to the effective interest rate of the borrowing; (3) contingent consideration payments made after a business combination; (4) proceeds from the settlement of insurance claims; (5) proceeds from the settlement of corporate-owned life insurance policies, including bank-owned life insurance policies; (6) distributions received from equity method investees; (7) beneficial interests in securitization transactions; and (8) separately identifiable cash flows and application of the predominance principle. Current GAAP does not include specific guidance on these eight cash flow classification issues. The amendments of ASU 2016-15 are effective for reporting periods beginning after December 15, 2017, with early adoption permitted. The adoption of this guidance is not expected to have a material effect on the Company's results of operations, financial position or liquidity.

In October 2016, the FASB issued ASU 2016-16 “Income Taxes (Topic 740): Intra-Entity Transfers of Assets Other Than Inventory”, which allows an entity to recognize the income tax consequences of an intra-entity transfer of an asset other than inventory when the transfer occurs. ASU 2016-16 eliminates the exception for an intra-entity transfer of an asset other than inventory. Two common examples of assets included in the scope of ASU 2016-16 are intellectual property and property, plant, and equipment. The amendments in ASU 2016-16 do not include new disclosure requirements; however, existing disclosure requirements might be applicable when accounting for the current and deferred income taxes for an intra-entity transfer of an asset other than inventory. The amendments in ASU 2016-16 are effective for annual reporting periods beginning after December 15, 2017, including interim reporting periods within those annual reporting periods. Early adoption is permitted for all entities as of the beginning of an annual reporting period for which financial statements (interim or annual) have not been issued or made available for issuance. The amendments in ASU 2016-16 should be applied on a modified retrospective basis through a cumulative-effect adjustment directly to retained earnings as of the beginning of the period of adoption. The Company is currently evaluating the impact this guidance will have on its results of operations, financial position or liquidity.



14

NATIONAL GENERAL HOLDINGS CORP.

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

3. Reciprocal Exchanges

As of September 15 , 2014, t hrough 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.


15

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 months ended September 30, 2016 , the Reciprocal Exchanges recognized total revenues, total expenses and net income of $52,829 , $49,856 and $2,973 , respectively. For the nine months ended September 30, 2016 , the Reciprocal Exchanges recognized total revenues, total expenses and net income of $107,350 , $95,153 and $12,197 , respectively. For the three months ended September 30, 2015 , the Reciprocal Exchanges recognized total revenues, total expenses and net income of $52,498 , $50,934 and $1,564 , respectively. For the nine months ended September 30, 2015 , the Reciprocal Exchanges recognized total revenues, total expenses and net loss of $136,702 , $137,223 and $(521) , respectively.

For the three months ended September 30, 2016 and 2015 , the Company earned service and fee income from the Reciprocal Exchanges in the amounts of $11,334 and $11,194 , respectively. For the nine months ended September 30, 2016 and 2015 , the Company earned service and fee income from the Reciprocal Exchanges in the amounts of $31,731 and $30,504 , respectively. Such amounts are eliminated in the Company's consolidated earnings, except for $9,590 of service and fee income included in the nine months ended September 30, 2016 , for the period in which the Company and the Reciprocal Exchanges did not meet requirements for consolidation.


16

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, gross unrealized gains and losses, and fair value on available-for-sale securities were as follows:
September 30, 2016
 
Cost or
Amortized
Cost
 
Gross
Unrealized
Gains
 
Gross
Unrealized
Losses
 
Fair
Value
Fixed maturities and securities pledged:
 
 
 
 
 
 
 
 
U.S. Treasury
 
$
22,397

 
$
1,594

 
$

 
$
23,991

Federal agencies
 
431

 
8

 

 
439

States and political subdivision bonds
 
403,649

 
11,801

 
(374
)
 
415,076

Foreign government
 
60,084

 
978

 
(352
)
 
60,710

Corporate bonds
 
1,574,781

 
92,902

 
(5,400
)
 
1,662,283

Residential mortgage-backed securities
 
401,765

 
12,886

 
(61
)
 
414,590

Commercial mortgage-backed securities
 
106,280

 
3,471

 
(448
)
 
109,303

Structured securities
 
281,244

 
4,512

 
(1,013
)
 
284,743

Total fixed maturities and securities pledged
 
2,850,631

 
128,152

 
(7,648
)
 
2,971,135

Equity securities:
 
 
 
 
 
 
 
 
Common stock
 
65,855

 
5,061

 
(3,141
)
 
67,775

Preferred stock
 
15,821

 
515

 
(515
)
 
15,821

Total equity securities
 
81,676

 
5,576

 
(3,656
)
 
83,596

Total
 
$
2,932,307

 
$
133,728

 
$
(11,304
)
 
$
3,054,731

Less: Securities pledged
 

 

 

 

Total net of securities pledged
 
$
2,932,307

 
$
133,728

 
$
(11,304
)
 
$
3,054,731

NGHC
 
$
2,652,406

 
$
118,161

 
$
(10,856
)
 
$
2,759,711

Reciprocal Exchanges
 
279,901

 
15,567

 
(448
)
 
295,020

Total
 
$
2,932,307

 
$
133,728

 
$
(11,304
)
 
$
3,054,731



17

NATIONAL GENERAL HOLDINGS CORP.

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

December 31, 2015
 
Cost or
Amortized
Cost
 
Gross
Unrealized
Gains
 
Gross
Unrealized
Losses
 
Fair
Value
Fixed maturities and securities pledged:
 
 
 
 
 
 
 
 
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 fixed maturities and securities pledged
 
2,380,480

 
34,819

 
(57,885
)
 
2,357,414

Equity securities:
 
 
 
 
 
 
 
 
Common stock
 
53,356

 
569

 
(6,960
)
 
46,965

Preferred stock
 
11,448

 
377

 

 
11,825

Total equity securities
 
64,804

 
946

 
(6,960
)
 
58,790

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


As of September 30, 2016 and December 31, 2015 , the Company had no other-than-temporary impairments ("OTTI")recognized in AOCI.

Proceeds from sales of fixed maturities and equity securities classified as available for sale were $163,885 and $34,012 during the three months ended September 30, 2016 and 2015 , respectively. Proceeds from sales of fixed maturities and equity securities classified as available for sale were $352,282 and $148,508 during the nine months ended September 30, 2016 and 2015 , respectively.

The amortized cost and fair value of available-for-sale fixed maturities and securities pledged, held as of September 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
September 30, 2016
 
Amortized
Cost
 
Fair
Value
 
Amortized
Cost
 
Fair
Value
 
Amortized
Cost
 
Fair
Value
Due in one year or less
 
$
34,921

 
$
35,088

 
$
75

 
$
76

 
$
34,996

 
$
35,164

Due after one year through five years
 
479,553

 
501,849

 
42,896

 
45,598

 
522,449

 
547,447

Due after five years through ten years
 
1,223,595

 
1,280,579

 
179,652

 
190,135

 
1,403,247

 
1,470,714

Due after ten years
 
347,517

 
357,760

 
34,377

 
36,157

 
381,894

 
393,917

Mortgage-backed securities
 
485,144

 
500,839

 
22,901

 
23,054

 
508,045

 
523,893

Total
 
$
2,570,730

 
$
2,676,115

 
$
279,901

 
$
295,020

 
$
2,850,631

 
$
2,971,135



18

NATIONAL GENERAL HOLDINGS CORP.

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

(b) Gross Unrealized Losses

The tables below summarize the gross unrealized losses on fixed maturities and equity securities classified as available for sale, by length of time the security has continuously been in an unrealized loss position as of September 30, 2016 and December 31, 2015 .
 
 
Less Than 12 Months
 
12 Months or More
 
Total
September 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
Fixed maturities:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
States and political subdivision bonds
 
$
40,021

 
$
(203
)
 
49

 
$
5,457

 
$
(171
)
 
10

 
$
45,478

 
$
(374
)
Foreign government
 
17,742

 
(352
)
 
4

 

 

 

 
17,742

 
(352
)
Corporate bonds
 
141,601

 
(3,950
)
 
51

 
31,439

 
(1,450
)
 
24

 
173,040

 
(5,400
)
Residential mortgage-backed securities
 
6,096

 
(19
)
 
4

 
2,278

 
(42
)
 
5

 
8,374

 
(61
)
Commercial mortgage-backed securities
 
8,015

 
(127
)
 
4

 
5,392

 
(321
)
 
4

 
13,407

 
(448
)
Structured securities
 
28,733

 
(113
)
 
15

 
39,953

 
(900
)
 
20

 
68,686

 
(1,013
)
Equity securities:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Common stock
 
14,882

 
(3,133
)
 
32

 
168

 
(8
)
 
3

 
15,050

 
(3,141
)
Preferred stock
 
10,410

 
(515
)
 
6

 

 

 

 
10,410

 
(515
)
Total
 
$
267,500

 
$
(8,412
)
 
165

 
$
84,687

 
$
(2,892
)
 
66

 
$
352,187

 
$
(11,304
)
NGHC
 
$
255,970

 
$
(8,231
)
 
156

 
$
77,117

 
$
(2,625
)
 
51

 
$
333,087

 
$
(10,856
)
Reciprocal Exchanges
 
11,530

 
(181
)
 
9

 
7,570

 
(267
)
 
15

 
19,100

 
(448
)
Total
 
$
267,500

 
$
(8,412
)
 
165

 
$
84,687

 
$
(2,892
)
 
66

 
$
352,187

 
$
(11,304
)
 
 
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
Fixed maturities:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
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
)
Equity securities: