National General
National General Holdings Corp. (Form: 10-Q, Received: 05/09/2017 15:18:01)

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

(Mark One)
x
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the Quarterly Period Ended March 31, 2017

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

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

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

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

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

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

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

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

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

As of May 4, 2017 , the number of common shares of the registrant outstanding was 106,542,350 .






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)
 
 
 
 
 
March 31,
 
December 31,
 
2017
 
2016
ASSETS
(unaudited)
 
(audited)
Investments - NGHC
 
 
 
Fixed maturities, available-for-sale, at fair value (amortized cost $2,772,939 and $2,739,045)
$
2,804,092

 
$
2,755,454

Equity securities, available-for-sale, at fair value (cost $5,863 and $22,854)
9,963

 
29,578

Fixed maturities, trading, at fair value (amortized cost $56,734 and $32,698)
54,114

 
38,677

Equity securities, trading, at fair value (cost $58,618 and $28,176)
57,067

 
30,133

Short-term investments
78,222

 
15,674

Other investments (Related parties $405,889 and $390,688)
520,420

 
497,588

Investments - Exchanges
 
 
 
Fixed maturities, available-for-sale, at fair value (amortized cost $305,217 and $301,017)
311,818

 
306,345

Total investments
3,835,696

 
3,673,449

Cash and cash equivalents (Exchanges - $6,985 and $7,405)
209,644

 
220,299

Restricted cash and cash equivalents (Exchanges - $1,085 and $969)
45,351

 
65,601

Accrued investment income (Related parties $1,160 and $1,298)
(Exchanges - $3,361 and $2,957)
29,577

 
28,769

Premiums and other receivables, net (Exchanges - $43,972 and $47,198)
1,394,309

 
1,090,669

Deferred acquisition costs (Exchanges - $33,278 and $31,043)
242,784

 
220,922

Reinsurance recoverable (Related parties - $39,866 and $37,046)
(Exchanges - $71,521 and $55,972)
968,087

 
948,236

Prepaid reinsurance premiums (Exchanges - $71,045 and $69,685)
169,972

 
156,970

Deferred tax asset (Exchanges - $(16,986) and $(19,095))
60,840

 
46,207

Premises and equipment, net (Exchanges - $5,259 and $4,117)
125,809

 
114,504

Intangible assets, net (Exchanges - $3,820 and $11,025)
438,902

 
467,720

Goodwill
173,528

 
155,290

Prepaid and other assets (Exchanges - $240 and $88)
62,979

 
56,345

Total assets
$
7,757,478

 
$
7,244,981

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 

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)
 
 
 
 
 
March 31,
 
December 31,
 
2017
 
2016
LIABILITIES AND STOCKHOLDERS’ EQUITY
(unaudited)
 
(audited)
Liabilities:
 
 
 
Unpaid loss and loss adjustment expense reserves (Exchanges - $139,085 and $137,075)
$
2,268,201

 
$
2,265,072

Unearned premiums (Exchanges - $167,356 and $163,326)
1,854,818

 
1,635,625

Unearned service contract and other revenue
43,088

 
30,263

Reinsurance payable (Related parties - $33,795 and $33,419)
(Exchanges - $36,037 and $19,861)
134,450

 
98,810

Accounts payable and accrued expenses (Related parties - $32,011 and $29,271)
(Exchanges - $5,578 and $6,781)
477,111

 
336,991

Debt
745,962

 
752,001

Other liabilities (Exchanges - $61,726 and $47,057)
274,265

 
200,715

Total liabilities
5,797,895

 
5,319,477

 
 
 
 
Stockholders’ equity:
 
 
 
Common stock, $0.01 par value - authorized 150,000,000 shares, issued and outstanding 106,502,250 shares - 2017; authorized 150,000,000 shares, issued and outstanding 106,428,092 shares - 2016.
1,065

 
1,064

Preferred stock, $0.01 par value - authorized 10,000,000 shares, issued and outstanding 2,565,000 shares - 2017; authorized 10,000,000 shares, issued and outstanding 2,565,000 shares - 2016.
Aggregate liquidation preference $420,000 - 2017, $420,000 - 2016.
420,000

 
420,000

Additional paid-in capital
917,057

 
914,706

Accumulated other comprehensive income:
 
 
 
Unrealized foreign currency translation adjustment
(3,034
)
 
(2,320
)
Unrealized gains on investments
22,914

 
15,030

Total accumulated other comprehensive income
19,880

 
12,710

Retained earnings
574,962

 
545,106

Total National General Holdings Corp. Stockholders’ Equity
1,932,964

 
1,893,586

Non-controlling interest (Exchanges - $26,346 and $31,675)
26,619

 
31,918

Total stockholders’ equity
1,959,583

 
1,925,504

Total liabilities and stockholders’ equity
$
7,757,478

 
$
7,244,981




See accompanying notes to unaudited condensed consolidated financial statements.
2



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

 
 
 
 
 
Three Months Ended March 31,
 
2017
 
2016
Revenues:
 
 
 
Net earned premium
$
920,171

 
$
654,920

Ceding commission income (loss)
19,994

 
(1,895
)
Service and fee income
125,942

 
96,944

Net investment income
26,390

 
21,670

Net gain (loss) on investments
(161
)
 
3,617

Bargain purchase gain and other revenue
10,450

 
701

Total revenues
1,102,786

 
775,957

Expenses:
 
 
 
Loss and loss adjustment expense
616,325

 
409,050

Acquisition costs and other underwriting expenses
175,301

 
112,899

General and administrative expenses
255,185

 
176,627

Interest expense
11,545

 
9,141

Total expenses
1,058,356

 
707,717

Income before provision for income taxes and earnings of equity method investments
44,430

 
68,240

Provision for income taxes
13,518

 
18,083

Income before earnings of equity method investments
30,912

 
50,157

Earnings of equity method investments (Related parties $4,781 and $6,682)
4,954

 
6,682

Net income
35,866

 
56,839

Less: Net (income) loss attributable to non-controlling interest
6,125

 
(12
)
Net income attributable to NGHC
41,991

 
56,827

Dividends on preferred stock
(7,875
)
 
(4,125
)
Net income attributable to NGHC common stockholders
$
34,116

 
$
52,702

 
 
 
 
Earnings per common share:
 
 
 
Basic earnings per share
$
0.32

 
$
0.50

Diluted earnings per share
$
0.31

 
$
0.49

Dividends declared per common share
$
0.04

 
$
0.03

 
 
 
 
Weighted average common shares outstanding:
 
 
 
Basic
106,467,599

 
105,597,594

Diluted
109,166,681

 
108,266,508




See accompanying notes to unaudited condensed consolidated financial statements.
3



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

 
 
Three Months Ended March 31,
 
 
2017
 
2016
Net income
 
$
35,866

 
$
56,839

Other comprehensive income, net of tax:
 
 
 
 
Foreign currency translation adjustment
 
(714
)
 
866

Gross gain on investments, net of tax ($5,951 and $13,695)
 
11,051

 
25,433

Reclassification adjustments for investment gain/loss included in net income:
 
 
 
 
Other gain on investments, net of tax ($(1,260) and $(1,266))
 
(2,341
)
 
(2,351
)
Other comprehensive income, net of tax
 
7,996

 
23,948

Comprehensive income
 
43,862

 
80,787

Less: Comprehensive (income) loss attributable to non-controlling interest
 
5,299

 
(12
)
Comprehensive income attributable to NGHC
 
$
49,161

 
$
80,775




See accompanying notes to unaudited condensed consolidated financial statements.
4



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

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

 
$
1,064

 
2,565,000

 
$
420,000

 
$
914,706

 
$
12,710

 
$
545,106

 
$
31,918

 
$
1,925,504

Net income (loss)

 

 

 

 

 

 
41,991

 
(6,125
)
 
35,866

Foreign currency translation adjustment, net of tax

 

 

 

 

 
(714
)
 

 

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

 

 

 

 

 
7,884

 

 
826

 
8,710

Common stock dividends

 

 

 

 

 

 
(4,260
)
 

 
(4,260
)
Preferred stock dividends

 

 

 

 

 

 
(7,875
)
 

 
(7,875
)
Common stock issued under employee stock plans and exercises of stock options
74,158

 
1

 

 

 
171

 

 

 

 
172

Stock-based compensation

 

 

 

 
2,180

 

 

 

 
2,180

Balance March 31, 2017
106,502,250

 
$
1,065

 
2,565,000

 
$
420,000

 
$
917,057

 
$
19,880

 
$
574,962

 
$
26,619

 
$
1,959,583


 
Three Months Ended March 31, 2016
 
Common Stock
 
Preferred Stock
 
 
 
 
 
 
 
 
 
 
 
Shares
 
$
 
Shares
 
$
 
Additional Paid-in Capital
 
Accumulated Other Comprehensive Income (Loss)
 
Retained Earnings
 
Non-controlling Interest
 
Total
Balance January 1, 2016
105,554,331

 
$
1,056

 
2,365,000

 
$
220,000

 
$
900,114

 
$
(19,414
)
 
$
412,044

 
$
22,840

 
$
1,536,640

Cumulative effect adjustment of change in accounting principle
 
 
 
 
 
 
 
 
 
 
 
 
 
 
(22,619
)
 
(22,619
)
Net income

 

 

 

 

 

 
56,827

 
12

 
56,839

Foreign currency translation adjustment, net of tax

 

 

 

 

 
866

 

 

 
866

Change in unrealized gain on investments, net of tax

 

 

 

 

 
23,082

 

 

 
23,082

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

 

 

 

 

 

 

 
9,575

 
9,575

Return of capital
 
 
 
 
 
 
 
 
(150
)
 
 
 
 
 
 
 
(150
)
Common stock dividends

 

 

 

 

 

 
(3,172
)
 

 
(3,172
)
Preferred stock dividends

 

 

 

 

 

 
(4,125
)
 

 
(4,125
)
Common stock issued under employee stock plans and exercises of stock options
160,585

 
1

 

 

 
1,851

 

 

 

 
1,852

Stock-based compensation

 

 

 

 
2,118

 

 

 

 
2,118

Balance March 31, 2016
105,714,916

 
$
1,057

 
2,365,000

 
$
220,000

 
$
903,933

 
$
4,534

 
$
461,574

 
$
9,808

 
$
1,600,906




See accompanying notes to unaudited condensed consolidated financial statements.
5



NATIONAL GENERAL HOLDINGS CORP.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(In Thousands)
(Unaudited)
 
 
 
 
 
Three Months Ended March 31,
 
2017
 
2016
Cash flows from operating activities:
 
 
 
Net income
$
35,866

 
$
56,839

Reconciliation of net income to net cash provided by (used in) operating activities:
 
 
 
Depreciation and amortization
35,273

 
8,856

Net amortization of premium/discount on fixed maturities and debt, net
3,570

 
1,356

Stock-compensation expense
2,180

 
2,118

Bad debt expense
15,545

 
6,959

Bargain purchase gain and other, net
(9,786
)
 

Net (gain) loss on investments
161

 
(3,617
)
Earnings of equity method investments, net of dividends and distributions
(3,683
)
 
(6,682
)
Foreign currency translation adjustment
(737
)
 
1,547

Changes in assets and liabilities:
 
 
 
Accrued investment income
(1,306
)
 
(2,655
)
Premiums and other receivables
(320,753
)
 
(106,611
)
Deferred acquisition costs
(21,790
)
 
(7,616
)
Reinsurance recoverable
(20,087
)
 
(370
)
Prepaid reinsurance premiums
(13,002
)
 
(5,838
)
Prepaid expenses and other assets
(5,801
)
 
(2,705
)
Unpaid loss and loss adjustment expense reserves
2,090

 
20,896

Unearned premiums
218,413

 
96,892

Unearned service contract and other revenue
12,710

 
15,838

Reinsurance payable
35,661

 
15,337

Accounts payable
118,143

 
(16,885
)
Deferred tax asset / liability
(18,928
)
 
(12,133
)
Other liabilities
73,568

 
(31,761
)
Net cash provided by operating activities
137,307

 
29,765

Cash flows from investing activities:
 
 
 
Purchases of fixed maturities, available-for-sale
(82,163
)
 
(36,533
)
Proceeds from sale and maturity of fixed maturities, available-for-sale
41,469

 
76,487

Purchases of equity securities, available-for-sale
(16,539
)
 
(556
)
Proceeds from sale of equity securities, available-for-sale
5,132

 
8,749

Purchases of trading investments
(85,234
)
 

Proceeds from sale and maturity of trading investments
71,456

 

Purchases of short-term investments
(231,502
)
 
(2,651
)
Proceeds from sale of short-term investments
194,061

 
1,739

Purchases of other investments
(21,203
)
 
(130,322
)
Proceeds from sale of other investments
2,741

 

Purchases of premises and equipment
(17,704
)
 
(4,991
)
Acquisition of consolidated subsidiaries, net of cash
(16,968
)
 

 
 
 
 

See accompanying notes to unaudited condensed consolidated financial statements.
6



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

 
 
 
 
 
Three Months Ended March 31,
 
2017
 
2016
 
 
 
 
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
(156,454
)
 
(93,798
)
Cash flows from financing activities:
 
 
 
Securities sold under agreements to repurchase, net

 
61,712

Repayments of debt and return of capital
(44
)
 
(150
)
Dividends paid to common shareholders
(4,257
)
 
(3,172
)
Dividends paid to preferred shareholders
(7,875
)
 
(4,125
)
Exercises of stock options
172

 
1,407

Net cash (used in) provided by financing activities
(12,004
)
 
55,672

Effect of exchange rate changes on cash and cash equivalents
246

 
833

Net decrease in cash, cash equivalents, and restricted cash
(30,905
)
 
(7,528
)
Cash, cash equivalents, and restricted cash at beginning of the period
285,900

 
282,277

Cash, cash equivalents, and restricted cash at end of the period
$
254,995

 
$
274,749

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

 
$
3,200

Cash paid for interest
3,029

 
1,962

Supplemental disclosures of non-cash investing and financing activities:
 
 
 
Unsettled investment security purchases
$
24,685

 
$
25,010

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

 
9,575

Accrued common stock dividends
4,260

 
3,172

Accrued preferred stock dividends
7,875

 
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, 2016 , previously filed with the SEC on March 23, 2017 . The balance sheet at December 31, 2016 , 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 financial statements as of March 31, 2017 , and the audited condensed consolidated balance sheet as of December 31, 2016 , 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”). From January 1, 2016 to March 31, 2016, the Reciprocal Exchanges did not meet the criteria for consolidation under GAAP and as a result their accounts and operations are excluded from presentation during the period then ended. 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.

All significant inter-company transactions and accounts have been eliminated in the condensed consolidated financial statements. To facilitate period-to-period comparisons, certain reclassifications have been made to amounts in prior period condensed consolidated financial statements to conform to current period presentation.

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, 2016 , filed with the SEC.


2. Recent Accounting Pronouncements

Adopted During 2017

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. ASU 2016-07 eliminates 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. ASU 2016-07 is effective for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2016, and 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. The Company adopted ASU 2016-07 on January 1, 2017. The adoption of this guidance did not have an effect on the Company’s 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.” The areas for simplification in ASU 2016-09 involve several aspects of the

8


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

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. ASU 2016-09 is effective for annual periods beginning after December 15, 2016, and interim periods within those annual periods. The Company adopted ASU 2016-09 on January 1, 2017. The adoption of this guidance did not have a material effect on the Company’s results of operations, financial position or liquidity. The Company will continue to estimate expected forfeitures. Excess tax benefits were reflected in the statement of cash flows prospectively.

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 eight specific cash flow classification issues. ASU 2016-15 is effective for fiscal years beginning after December 15, 2017, and interim periods within those fiscal years, with early adoption permitted. The Company elected to early adopt ASU 2016-15 on January 1, 2017 resulting in the application of its requirements using a retrospective transition method to each period presented. The adoption of this guidance did not have an effect on the Company’s results of operations, financial position or liquidity; other than the required classifications of the eight specific transactions in the statements of cash flows.

Not Yet Adopted

With the exception of those discussed below or as adopted above, there have been no recent accounting pronouncements, changes in accounting pronouncements, or quantitative or qualitative progress made towards implementation of outstanding accounting pronouncements during the three months ended March 31, 2017 , as compared to those described in the Company’s Annual Report on Form 10-K for the year ended December 31, 2016 , that are of significance, or potential significance, to the Company.

In January 2016, the FASB issued ASU 2016-01, “Financial Instruments-Overall (Subtopic 825-10): Recognition and Measurement of Financial Assets and Financial Liabilities” to provide users of financial statements with more useful information on the recognition, measurement, presentation, and disclosure of financial instruments. Specifically, under ASU 2016-01, equity investments (other than those accounted for using the equity method of accounting or those subject to consolidation) will be measured at fair value with changes in fair value recognized in earnings. Also, for those financial liabilities for which the fair value option accounting has been elected, ASU 2016-01 requires changes in fair value due to instrument-specific credit risk to be presented separately in other comprehensive income. ASU 2016-01 requires companies to use the exit price notion when measuring the fair value of financial instruments for disclosure purposes. ASU 2016-01 is effective for fiscal years beginning after December 15, 2017, including interim periods within those fiscal years. Early adoption of certain provisions is permitted. ASU 2016-01 should be applied by means of a cumulative-effect adjustment to the balance sheet as of the beginning of the fiscal year of adoption. As of March 31, 2017 and December 31, 2016 , the Company had $2,665 and $4,371 , respectively, of net unrealized gains, net of tax, for equity securities, available-for-sale, recognized as a component of accumulated other comprehensive income (“AOCI”).



9


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

3. Reciprocal Exchanges

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 as primary beneficiary.

In March 2016, the Company purchased the Reciprocal Exchanges surplus notes that were issued by the Reciprocal Exchanges when they were originally capitalized. 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.

The Company determined that 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 Company is the primary beneficiary as it has both, the power to direct their activities that most significantly impact their economic performance and that the Company would absorb more than an insignificant amount of expected losses or residual returns of the Reciprocal Exchanges. Accordingly, the Company consolidates the Reciprocal Exchanges as of March 31, 2016, and eliminates all intercompany balances and transactions with the Company.

The consolidation of the Reciprocal Exchanges at March 31, 2016 was 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 acquired and liabilities assumed represents the fair value of the non-controlling interest.

For the three months ended March 31, 2017 , the Reciprocal Exchanges recognized total revenues, total expenses and net loss of $61,243 , $67,398 and $(6,155) , respectively.


10


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 31, 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
 
28,909

Debt
 
88,900

Other liabilities
 
37,550

Total liabilities
 
454,600

Stockholders’ equity:
 
 
Non-controlling interest
 
9,575

Total stockholders’ equity
 
9,575

Total liabilities and stockholders’ equity
 
$
464,175




11


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:
March 31, 2017
 
Cost or
Amortized Cost
 
Gross
Unrealized Gains
 
Gross
Unrealized Losses
 
Fair Value
Fixed maturities:
 
 
 
 
 
 
 
 
U.S. Treasury
 
$
44,840

 
$
956

 
$
(95
)
 
$
45,701

Federal agencies
 
4,775

 
1

 
(145
)
 
4,631

States and political subdivision bonds
 
448,237

 
4,060

 
(7,346
)
 
444,951

Foreign government
 
59,965

 

 
(2,575
)
 
57,390

Corporate bonds
 
1,575,004

 
45,983

 
(9,894
)
 
1,611,093

Residential mortgage-backed securities
 
407,669

 
4,622

 
(4,259
)
 
408,032

Commercial mortgage-backed securities
 
128,064

 
1,845

 
(1,655
)
 
128,254

Asset-backed securities
 
438

 

 
(6
)
 
432

Structured securities
 
409,164

 
6,541

 
(279
)
 
415,426

Total fixed maturities
 
3,078,156

 
64,008

 
(26,254
)
 
3,115,910

Equity securities:
 
 
 
 
 
 
 
 
Common stock
 
3,744

 
4,050

 
(19
)
 
7,775

Preferred stock
 
2,119

 
84

 
(15
)
 
2,188

Total equity securities
 
5,863

 
4,134

 
(34
)
 
9,963

Total
 
$
3,084,019

 
$
68,142

 
$
(26,288
)
 
$
3,125,873

NGHC
 
$
2,778,802

 
$
59,963

 
$
(24,710
)
 
$
2,814,055

Reciprocal Exchanges
 
305,217

 
8,179

 
(1,578
)
 
311,818

Total
 
$
3,084,019

 
$
68,142

 
$
(26,288
)
 
$
3,125,873

December 31, 2016
 
Cost or
Amortized Cost
 
Gross
Unrealized Gains
 
Gross
Unrealized Losses
 
Fair Value
Fixed maturities:
 
 
 
 
 
 
 
 
U.S. Treasury
 
$
45,405

 
$
937

 
$
(494
)
 
$
45,848

Federal agencies
 
739

 

 
(26
)
 
713

States and political subdivision bonds
 
460,089

 
3,625

 
(11,403
)
 
452,311

Foreign government
 
60,025

 

 
(3,226
)
 
56,799

Corporate bonds
 
1,580,918

 
43,322

 
(13,338
)
 
1,610,902

Residential mortgage-backed securities
 
450,997

 
4,305

 
(5,982
)
 
449,320

Commercial mortgage-backed securities
 
107,546

 
1,521

 
(1,724
)
 
107,343

Structured securities
 
334,343

 
4,656

 
(436
)
 
338,563

Total fixed maturities
 
3,040,062

 
58,366

 
(36,629
)
 
3,061,799

Equity securities:
 
 
 
 
 
 
 
 
Common stock
 
21,274

 
7,050

 
(308
)
 
28,016

Preferred stock
 
1,580

 
17

 
(35
)
 
1,562

Total equity securities
 
22,854

 
7,067

 
(343
)
 
29,578

Total
 
$
3,062,916

 
$
65,433

 
$
(36,972
)
 
$
3,091,377

NGHC
 
$
2,761,899

 
$
58,180

 
$
(35,047
)
 
$
2,785,032

Reciprocal Exchanges
 
301,017

 
7,253

 
(1,925
)
 
306,345

Total
 
$
3,062,916

 
$
65,433

 
$
(36,972
)
 
$
3,091,377


12


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

As of March 31, 2017 and December 31, 2016 , the Company had no other-than-temporary impairments (“OTTI”) in AOCI related to available-for-sale fixed maturities.

Proceeds from sales of fixed maturities and equity securities classified as available for sale during the three months ended March 31, 2017 and 2016 were $25,744 and $81,805 , respectively.

The amortized cost and fair value of available-for-sale fixed maturities held as of March 31, 2017 , by contractual maturity, are shown in the table below. Actual maturities may differ from contractual maturities because some borrowers may have the right to call or prepay obligations with or without call or prepayment penalties.
 
 
NGHC
 
Reciprocal Exchanges
 
Total
March 31, 2017
 
Amortized
Cost
 
Fair
Value
 
Amortized
Cost
 
Fair
Value
 
Amortized
Cost
 
Fair
Value
Due in one year or less
 
$
28,171

 
$
28,530

 
$
2,386

 
$
2,386

 
$
30,557

 
$
30,916

Due after one year through five years
 
611,045

 
626,607

 
80,578

 
85,301

 
691,623

 
711,908

Due after five years through ten years
 
1,253,548

 
1,263,726

 
157,650

 
159,313

 
1,411,198

 
1,423,039

Due after ten years
 
369,693

 
373,763

 
38,914

 
39,566

 
408,607

 
413,329

Mortgage-backed securities
 
510,482

 
511,466

 
25,689

 
25,252

 
536,171

 
536,718

Total
 
$
2,772,939

 
$
2,804,092

 
$
305,217

 
$
311,818

 
$
3,078,156

 
$
3,115,910


(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 March 31, 2017 and December 31, 2016 .
 
 
Less Than 12 Months
 
12 Months or More
 
Total
March 31, 2017
 
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
 
$
21,546

 
$
(95
)
 
20

 
$

 
$

 

 
$
21,546

 
$
(95
)
Federal agencies
 
4,558

 
(145
)
 
22

 

 

 

 
4,558

 
(145
)
States and political subdivision bonds
 
253,508

 
(7,166
)
 
299

 
2,933

 
(180
)
 
6

 
256,441

 
(7,346
)
Foreign government
 
55,472

 
(2,494
)
 
5

 
1,918

 
(81
)
 
1

 
57,390

 
(2,575
)
Corporate bonds
 
383,862

 
(9,143
)
 
223

 
20,087

 
(751
)
 
15

 
403,949

 
(9,894
)
Residential mortgage-backed securities
 
180,808

 
(4,219
)
 
81

 
2,124

 
(40
)
 
4

 
182,932

 
(4,259
)
Commercial mortgage-backed securities
 
51,039

 
(1,081
)
 
59

 
5,028

 
(574
)
 
3

 
56,067

 
(1,655
)
Asset-backed securities
 
431

 
(6
)
 
2

 

 

 

 
431

 
(6
)
Structured securities
 
68,183

 
(255
)
 
42

 
8,201

 
(24
)
 
4

 
76,384

 
(279
)
Equity securities:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Common stock
 
96

 
(19
)
 
4

 

 

 

 
96

 
(19
)
Preferred stock
 
276

 
(15
)
 
1

 

 

 

 
276

 
(15
)
Total
 
$
1,019,779

 
$
(24,638
)
 
758

 
$
40,291

 
$
(1,650
)
 
33

 
$
1,060,070

 
$
(26,288
)
NGHC
 
$
944,701

 
$
(23,444
)
 
722

 
$
34,922

 
$
(1,266
)
 
22

 
$
979,623

 
$
(24,710
)
Reciprocal Exchanges
 
75,078

 
(1,194
)
 
36

 
5,369

 
(384
)
 
11

 
80,447

 
(1,578
)
Total
 
$
1,019,779

 
$
(24,638
)
 
758

 
$
40,291

 
$
(1,650
)
 
33

 
$
1,060,070

 
$
(26,288
)

13


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, 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:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
U.S. Treasury
 
$
37,436

 
$
(494
)
 
24

 
$

 
$

 

 
$
37,436

 
$
(494
)
Federal agencies
 
419

 
(26
)
 
3

 

 

 

 
419

 
(26
)
States and political subdivision bonds
 
318,946

 
(11,236
)
 
387

 
2,956

 
(167
)
 
6

 
321,902

 
(11,403
)
Foreign government
 
48,156

 
(3,226
)
 
6

 

 

 

 
48,156

 
(3,226
)
Corporate bonds
 
495,443

 
(12,376
)
 
292

 
33,112

 
(962
)
 
21

 
528,555

 
(13,338
)
Residential mortgage-backed securities
 
262,269

 
(5,894
)
 
212

 
2,141

 
(88
)
 
4

 
264,410

 
(5,982
)
Commercial mortgage-backed securities
 
51,120

 
(1,002
)
 
27

 
4,890

 
(722
)
 
3

 
56,010

 
(1,724
)
Structured securities
 
54,361

 
(243
)
 
43

 
17,908

 
(193
)
 
10

 
72,269

 
(436
)
Equity securities:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Common stock
 
3,198

 
(308
)
 
5

 

 

 

 
3,198

 
(308
)
Preferred stock
 
1,298

 
(35
)
 
2

 

 

 

 
1,298

 
(35
)
Total
 
$
1,272,646

 
$
(34,840
)
 
1,001

 
$
61,007

 
$
(2,132
)
 
44

 
$
1,333,653

 
$
(36,972
)
NGHC
 
$
1,190,788

 
$
(33,382
)
 
963

 
$
51,813

 
$
(1,665
)
 
28

 
$
1,242,601

 
$
(35,047
)
Reciprocal Exchanges
 
81,858

 
(1,458
)
 
38

 
9,194

 
(467
)
 
16

 
91,052

 
(1,925
)
Total
 
$
1,272,646

 
$
(34,840
)
 
1,001

 
$
61,007

 
$
(2,132
)
 
44

 
$
1,333,653

 
$
(36,972
)

There were 791 and 1,045 securities at March 31, 2017 and December 31, 2016 , respectively, that account for the gross unrealized loss, none of which are deemed by the Company to be other-than-temporary impairments. Significant factors influencing the Company’s determination that none of these securities were OTTI included the length of time and/or magnitude of unrealized losses in relation to cost, the nature of the investment, the current financial condition of the issuer and its future prospects, the ability to recover to cost in the near term, and management’s intent not to sell these securities and it being more likely than not that the Company will not be required to sell these investments before anticipated recovery of fair value to the Company’s cost basis.

As of March 31, 2017 and December 31, 2016 , of the $1,650 and $2,132 , respectively, of unrealized losses related to securities in unrealized loss positions for a period of twelve or more consecutive months, $9 and $0 , respectively, of those unrealized losses were related to securities in unrealized loss positions greater than or equal to 25% of its 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.

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


14


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

(c) Unrealized Gains and Losses

Unrealized gains (losses) on investments classified as available for sale as of March 31, 2017 and December 31, 2016 , consisted of the following:
 
 
March 31, 2017
 
December 31, 2016
Net unrealized gain on fixed maturities
 
$
37,754

 
$
21,737

Net unrealized gain on common stock
 
4,031

 
6,742

Net unrealized gain (loss) on preferred stock
 
69

 
(18
)
Deferred income tax
 
(14,651
)
 
(9,968
)
Unrealized gains (losses), net of deferred income tax
 
$
27,203

 
$
18,493

NGHC
 
$
22,914

 
$
15,030

Reciprocal Exchanges
 
4,289

 
3,463

Unrealized gains (losses), net of deferred income tax
 
27,203

 
18,493

Non-controlling interest
 
(4,289
)
 
(3,463
)
NGHC unrealized gains (losses), net of deferred income tax
 
$
22,914

 
$
15,030

 
 
 
 
 
 
 
Three Months Ended March 31,
 
 
2017
 
2016
NGHC change in unrealized gains, net of deferred income tax
 
$
7,884

 
$
23,082

Non-controlling interest change in unrealized gains, net of deferred income tax
 
$
826

 
$


(d) Trading Securities

The cost or amortized cost, gross unrealized gains and losses, and fair value on trading securities were as follows:
March 31, 2017
 
Cost or
Amortized
Cost
 
Gross
Unrealized
Gains
 
Gross
Unrealized
Losses
 
Fair
Value
Fixed maturities:
 
 
 
 
 
 
 
 
U.S. Treasury
 
$
27,312

 
$
90

 
$
(21
)
 
$
27,381

Corporate bonds
 
29,422

 
821

 
(3,510
)
 
26,733

Equity securities:
 
 
 
 
 
 
 
 
Common stock
 
58,618

 
4,028

 
(5,579
)
 
57,067

Total
 
$
115,352

 
$
4,939

 
$
(9,110
)
 
$
111,181

NGHC
 
$
115,352

 
$
4,939

 
$
(9,110
)
 
$
111,181

Reciprocal Exchanges
 

 

 

 

Total
 
$
115,352

 
$
4,939

 
$
(9,110
)
 
$
111,181


15


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

December 31, 2016
 
Cost or
Amortized
Cost
 
Gross
Unrealized
Gains
 
Gross
Unrealized
Losses
 
Fair
Value
Fixed maturities:
 
 
 
 
 
 
 
 
Corporate bonds
 
$
32,698

 
$
5,979

 
$

 
$
38,677

Equity securities:
 
 
 
 
 
 
 
 
Common stock
 
28,176

 
5,172

 
(3,215
)
 
30,133

Total
 
$
60,874

 
$
11,151

 
$
(3,215
)
 
$
68,810

NGHC
 
$
60,874

 
$
11,151

 
$
(3,215
)
 
$
68,810

Reciprocal Exchanges
 

 

 

 

Total
 
$
60,874

 
$
11,151

 
$
(3,215
)
 
$
68,810


Proceeds from sales of trading securities were $85,079 during the three months ended March 31, 2017 . The Company reclassified certain available-for-sale securities to trading securities for the purpose of buying and selling them in the near term and benefiting from the change in market prices or spreads.

(e) Investment Income

The components of net investment income consisted of the following:
 
 
Three Months Ended March 31,
 
 
2017
 
2016
Interest income
 
 
 
 
Cash and short-term investments
 
$
34

 
$
684

Fixed maturities
 
26,818

 
19,739

Equity securities
 
75

 
333

Investment income
 
26,927

 
20,756

Investment expenses
 
(1,701
)
 
(1,638
)
Repurchase agreements interest expense
 

 
(144
)
Other income (1)
 
1,164

 
2,696

Net Investment Income
 
$
26,390

 
$
21,670

NGHC
 
$
23,506

 
$
21,670

Reciprocal Exchanges
 
2,884

 

Net Investment Income
 
$