Heritage Insurance
Annual Report 2014

Plain-text annual report

Morningstar® Document Research℠ FORM 10-KHeritage Insurance Holdings, Inc. - HRTGFiled: March 18, 2015 (period: December 31, 2014)Annual report with a comprehensive overview of the companyThe information contained herein may not be copied, adapted or distributed and is not warranted to be accurate, complete or timely. The userassumes all risks for any damages or losses arising from any use of this information, except to the extent such damages or losses cannot belimited or excluded by applicable law. Past financial performance is no guarantee of future results.Table of Contents UNITED STATESSECURITIES AND EXCHANGE COMMISSIONWashington, D.C. 20549 FORM 10-K xANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934For the Year Ended December 31, 2014OR ¨TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF1934For the Transition Period From to Commission File Number 001-36462 Heritage Insurance Holdings, Inc. Delaware 45-5338504(STATE OF INCORPORATION) (I.R.S. ID)2600 McCormick Drive, Suite 300, Clearwater, Florida 33759(727)362-7200Securities registered pursuant to Section 12(b) of the Act: Title of Each Class Name of Each Exchange on Which RegisteredCommon Stock, par value $0.0001 per share New York Stock ExchangeSecurities registered pursuant to Section 12(g) of the Act:None Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. Yes ¨ No xIndicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Exchange Act. Yes ¨ No xIndicate 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 1934during 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 filingrequirements for the past 90 days. Yes x No ¨Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required tobe submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period thatthe registrant was required to submit and post such files). Yes x No ¨Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K (§229.405 of this chapter) is not contained herein, and willnot be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K orany amendment to this Form 10-K. ¨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 thedefinitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. Large accelerated filer ¨ Accelerated filer ¨Source: Heritage Insurance Holdings, Inc., 10-K, March 18, 2015Powered by Morningstar® Document Research℠The information contained herein may not be copied, adapted or distributed and is not warranted to be accurate, complete or timely. The user assumes all risks for any damages or losses arising from any use of this information,except to the extent such damages or losses cannot be limited or excluded by applicable law. Past financial performance is no guarantee of future results.Non-accelerated filer x (Do not check if a smaller reporting company) Smaller reporting company ¨Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes ¨ No xThe aggregate market value of the Registrant’s common stock hold by non-affiliates was $361.2 million on June 30, 2014, computed on the basis on theclosing sale price of the Registrant’s common stock on that date.As of March 10, 2015, the total number of common shares outstanding of Registrant’s common stock was 29,794,960.DOCUMENTS INCORPORATED BY REFERENCEPortions of the Registrant’s Proxy Statement for its Annual Meeting of Stockholders are incorporated by reference into Part III of this Annual Report on Form10-K, provided that if such Proxy Statement is not filed with the Securities and Exchange Commission within 120 days after the end of the fiscal year coveredby this Form 10-K, an amendment to this Form 10-K shall be filed no later than the end of such 120-day period. Source: Heritage Insurance Holdings, Inc., 10-K, March 18, 2015Powered by Morningstar® Document Research℠The information contained herein may not be copied, adapted or distributed and is not warranted to be accurate, complete or timely. The user assumes all risks for any damages or losses arising from any use of this information,except to the extent such damages or losses cannot be limited or excluded by applicable law. Past financial performance is no guarantee of future results.Table of ContentsTable of Contents Page PART I Item 1. Business. 1 Item 1A. Risk Factors 15 Item 1B. Unresolved Staff Comments 31 Item 2. Properties 31 Item 3. Legal Proceedings 31 Item 4. Mine Safety Disclosure 31 PART II Item 5. Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities 31 Item 6. Selected Financial Data 32 Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations 33 Item 7A. Quantitative and Qualitative Disclosures about Market Risk 46 Item 8. Financial Statements and Supplementary Data 48 Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure 79 Item 9A. Controls and Procedures 79 Item 9B. Other Information 80 PART III Item 10. Directors, Executive Officers and Corporate Governance 80 Item 11. Executive Compensation 80 Item 12. Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters 80 Item 13. Certain Relationships and Related Transactions, and Director Independence 80 Item 14. Principal Accountant Fees and Services. 80 PART IV Item 15. Exhibits, Financial Statements Schedules 81 Signatures 84 Source: Heritage Insurance Holdings, Inc., 10-K, March 18, 2015Powered by Morningstar® Document Research℠The information contained herein may not be copied, adapted or distributed and is not warranted to be accurate, complete or timely. The user assumes all risks for any damages or losses arising from any use of this information,except to the extent such damages or losses cannot be limited or excluded by applicable law. Past financial performance is no guarantee of future results.Table of ContentsSpecial Note Regarding Forward-Looking StatementsThis Annual Report on Form 10-K (this “Annual Report”) contains forward-looking statements that involve risks and uncertainties, such as statementsabout our plans, objectives, expectations, assumptions, or future events. In some cases, you can identify forward-looking statements by terminology such as“anticipate,” “estimate,” “plan,” “project,” “continuing,” “ongoing,” “expect,” “believe,” “intend,” “may,” “will,” “should,” “could,” and similarexpressions. Examples of forward-looking statements include, without limitation: • statements regarding our growth and other strategies, results of operations or liquidity; • statements concerning projections, predictions, expectations, estimates or forecasts as to our business, financial and operational results and futureeconomic performance; • statements of management’s goals and objectives; • projections of revenue, earnings, capital structure and other financial items; • assumptions underlying statements regarding us or our business; and • other similar expressions concerning matters that are not historical facts.Forward-looking statements should not be read as a guarantee of future performance or results, and will not necessarily be accurate indications of thetimes at, or by, which such performance or results will be achieved. Forward-looking statements are based on information available at the time thosestatements are made or management’s good faith belief as of that time with respect to future events, and are subject to risks and uncertainties that could causeactual performance or results to differ materially from those expressed in or suggested by the forward-looking statements. Important factors that could causesuch differences include, but are not limited to, factors discussed in Part I, Item 1 “Business,” Part I, Item 1A “Risk Factors” and Item 7 “Management’sDiscussion and Analysis of Financial Condition and Results of Operations.Forward-looking statements involve estimates, assumptions, known and unknown risks, uncertainties and other factors that could cause actual resultsto differ materially from any future results, performances, or achievements expressed or implied by the forward-looking statements. These risks include, butare not limited to, those listed below and those discussed in greater detail in Part I, Item 1A“Risk Factors”: • our limited operating history; • the possibility that actual losses may exceed reserves; • the concentration of our business in Florida; • our exposure to catastrophic events; • the fluctuation in our results of operations; • the potential for discontinuation of the Citizens depopulation program and our inability to select favorable Citizens policies to assume; • increased costs of reinsurance, non-availability of reinsurance, and non-collectability of reinsurance; • increased competition, competitive pressures and market conditions; • our failure to accurately price the risks we underwrite; • inherent uncertainty of our models and our reliance on such model as a tool to evaluate risk; • the failure of our claims department to effectively manage or remediate claims; • low renewal rates and failure of such renewals to meet our expectations; • our failure to execute our growth strategy; • failure of our information technology systems and unsuccessful development and implementation of new technologies;Source: Heritage Insurance Holdings, Inc., 10-K, March 18, 2015Powered by Morningstar® Document Research℠The information contained herein may not be copied, adapted or distributed and is not warranted to be accurate, complete or timely. The user assumes all risks for any damages or losses arising from any use of this information,except to the extent such damages or losses cannot be limited or excluded by applicable law. Past financial performance is no guarantee of future results.Table of Contents • a lack of significant redundancy in our operations; • our failure to attract and retain qualified employees and independent agents or our loss of key personnel; • our inability to generate investment income; • our inability to maintain our financial stability rating; • effects of emerging claim and coverage issues relating to legal, judicial, environmental and social conditions; • the failure of our risk mitigation strategies or loss limitation methods; and • changes in regulations and our failure to meet increased regulatory requirements.Additional risks and uncertainties not currently known to us or that we currently deem to be immaterial also may materially adversely affect ourbusiness, financial condition or operating results.The forward-looking statements speak only as of the date on which they are made, and, except as required by law, we undertake no obligation toupdate any forward-looking statement to reflect events or circumstances after the date on which the statement is made or to reflect the occurrence ofunanticipated events. In addition, we cannot assess the impact of each factor on our business or the extent to which any factor, or combination of factors, maycause actual results to differ materially from those contained in any forward-looking statements. Consequently, you should not place undue reliance onforward-looking statements.INDUSTRY AND MARKET DATAThis Annual Report includes industry data, forecasts and information that we have prepared based, in part, upon data, forecasts and informationobtained from independent industry publications and surveys and other information available to us. Some data is also based on our good faith estimates,which are derived from management’s knowledge of the industry and independent sources. Industry publications and surveys and forecasts generally statethat the information contained therein has been obtained from sources believed to be reliable, but there can be no assurance as to the accuracy orcompleteness of included information. We have not independently verified any of the data from third-party sources nor have we ascertained the underlyingeconomic assumptions relied upon therein. Statements as to our market position are based on market data currently available to us. While we are not aware ofany misstatements regarding the industry data presented herein, our estimates involve risks and uncertainties and are subject to change based on variousfactors, including those discussed in Part I, Item 1A “Risk Factors” in this Annual Report. Similarly, we believe our internal research is reliable, even thoughsuch research has not been verified by any independent sources.Source: Heritage Insurance Holdings, Inc., 10-K, March 18, 2015Powered by Morningstar® Document Research℠The information contained herein may not be copied, adapted or distributed and is not warranted to be accurate, complete or timely. The user assumes all risks for any damages or losses arising from any use of this information,except to the extent such damages or losses cannot be limited or excluded by applicable law. Past financial performance is no guarantee of future results.Table of ContentsPART IItem 1. BusinessOur BusinessHeritage Insurance Holdings, Inc., (referred to in this document as we, our, us and Heritage Insurance) is a property and casualty insurance holdingcompany that provides personal and commercial residential insurance. We are headquartered in Clearwater, Florida and, through our subsidiary, HeritageProperty & Casualty Insurance Company (“Heritage P&C”), we provide personal residential insurance for single-family homeowners and condominiumowners, rental property insurance and commercial residential insurance in the state of Florida. We are vertically integrated and control or managesubstantially all aspects of insurance underwriting, actuarial analysis, distribution and claims processing and adjusting. We are led by an experienced seniormanagement team with an average of 28 years of insurance industry experience. We began operations in August 2012, and in December 2012 we beganselectively assuming policies from Citizens Property Insurance Corporation (“Citizens”), a Florida state-supported insurer, through participation in alegislatively established “depopulation program” designed to reduce the state’s risk exposure by encouraging private companies to assume insurancepolicies from Citizens. We also write policies outside the Citizens depopulation program, which we refer to as voluntary policies. Heritage P&C is currentlyrated “A” (“Exceptional”) by Demotech, Inc. (“Demotech”), a rating agency specializing in evaluating the financial stability of insurers.In addition to Heritage P&C, our other subsidiaries include: Heritage MGA, LLC, the managing general agent that manages substantially all aspects ofour insurance subsidiary’s business; Contractors’ Alliance Network, LLC, our vendor network manager; Skye Lane Properties, LLC, our propertymanagement subsidiary; First Access Insurance Group, LLC, our retail agency; Osprey Re LTD; our reinsurance subsidiary that provides a portion of thereinsurance protection purchased by our insurance subsidiary; and Heritage Insurance Claims, LLC an inactive subsidiary reserved for future development. Our CompanyOur company was initially formed as a Florida limited liability company in 2012. On January 1, 2014, we formed a Delaware limited liability company,also named Heritage Insurance Holdings, LLC and merged with it in order to domicile the Company in Delaware. Effective May 22, 2014, Heritage InsuranceHoldings, LLC converted into a Delaware corporation named Heritage Insurance Holdings, Inc.Our primary products are personal and commercial residential insurance, which we currently offer only in Florida under authorization from the FloridaOffice of Insurance Regulation (“FLOIR”). We conduct our operations under one business segment.As of December 31, 2014, we had approximately 207,000 personal residential policies in force representing $400 million of annualized premium andapproximately 2,400 commercial residential policies in force representing $95 million of annualized premium. Approximately 74% of our personal policiesand 92% of our commercial policies as of December 31, 2014 were assumed from Citizens. For the years ended December 31, 2014 and 2013, we had grosspremiums written of $436.4 million and $218.5 million, respectively, and net income of $47.1 million and $34.2 million, respectively. At December 31,2014, we had total assets of $615.0 million and total stockholders’ equity of $255.1 million. 1Source: Heritage Insurance Holdings, Inc., 10-K, March 18, 2015Powered by Morningstar® Document Research℠The information contained herein may not be copied, adapted or distributed and is not warranted to be accurate, complete or timely. The user assumes all risks for any damages or losses arising from any use of this information,except to the extent such damages or losses cannot be limited or excluded by applicable law. Past financial performance is no guarantee of future results.Table of ContentsAs of December 31, 2014, Citizens had approximately 661,000 insurance policies, of which approximately 631,000 were personal residential policiesand approximately 30,000 were commercial policies. We selectively assumed personal residential policies from Citizens in 13 separate assumptiontransactions between December 2012 and December 2014. In October 2014 we completed our first commercial residential assumption transaction withsubsequent assumptions in November and December 2014. A substantial portion of our revenue since our inception has come from these policies. We intendto continue assuming policies from Citizens that meet our assumption strategy and underwriting criteria.In order to assume a policy from Citizens, we must obtain the prior approval of the insurance agent that wrote the policy. With respect to policieswritten by agents that are affiliated with an insurance company or agency, we must also obtain the approval of the insurance company or agency. Currently,four large national insurance companies or agencies permit us to assume policies from Citizens that have been written by their agents—State Farm, Allstate,Brown & Brown and AAA (formerly the American Automobile Association). In an effort to increase the pool of Citizens policies that we may assume, we areseeking similar advance approvals from other insurance companies and agencies. We currently have advance approvals covering more than 5,100 agents.These agents were responsible for writing more than 85% of the eligible personal residential insurance policies held by Citizens as of December 31, 2014.Recent DevelopmentsInitial Public Offering and Concurrent Private PlacementOn May 29, 2014, we completed our initial public offering (“IPO”) in which we sold an aggregate of 6,900,000 shares of our common stock at $11.00per share, including 900,000 shares sold pursuant to the underwriters’ over-allotment option. We received net proceeds of $69.0 million from the IPO, afterdeducting the underwriters offering expenses.In connection with the IPO, Ananke Ltd, an affiliate of Nephila Capital Ltd, agreed to purchase $10.0 million of our common stock in a concurrentprivate placement (the “Private Placement”) at a price per share equal to the IPO price. Poseidon Re Ltd., another affiliate of Nephila Capital Ltd, is currentlya participating reinsurer in our reinsurance program. We received net proceeds of $9.6 million in connection with the Private Placement after deductingdiscounts and expenses.In addition, in connection with the Private Placement, we granted a reinsurer affiliated with or designated by Nephila Capital Ltd a right of first refusalto participate in our future reinsurance programs, subject to certain exceptions. The right of first refusal terminates on May 31, 2019, subject to certainconditions.In connection with the IPO, warrants to purchase an aggregate of 7,685,700 shares were exercised by existing stockholders. We issued 3,827,550shares in exchange for $22.5 million pursuant to cash exercises and 1,794,969 shares in connection with cashless exercises.Sunshine State Insurance Company Policy AcquisitionOn June 13, 2014, Heritage P&C entered into an agreement with the Florida Insurance Guaranty Association (“FIGA”) and the Florida Department ofFinancial Services (“DFS”), the Receiver of Sunshine State Insurance Company (“SSIC”), giving Heritage P&C the right to offer a new policy of insurance toall Florida SSIC policyholders without the need to file a new application with Heritage P&C or pay premium that has already been paid to SSIC. Upontermination of the original policies, Heritage P&C will renew such policies at the lesser of SSIC’s and Heritage P&C’s rates. In connection with thistransaction, Heritage P&C paid $10 million to the DFS, which is being amortized as acquisition costs in relation to the earning of the approximately $29.3million of unearned premium from the assumed SSIC policies. During 2014 we amortized approximately $7.6 million of the $10 million acquisition cost. Asof December 31, 2014, approximately 29,700 SSIC policies were still active, representing approximately $53.3 million of in force premiums. The SSICpolicies represented approximately 14% of our total policies in force at December 31, 2014.Commercial ResidentialAs part of the Company’s strategy to expand its commercial residential insurance business, on October 14, 2014, Heritage P&C entered into anassumption transaction with Citizens to assume approximately 1,900 commercial residential policies. The assumed policies represent approximately $70.0million in gross premiums written. This transaction was followed by subsequent assumptions on November 18, 2014 and December 16, 2014 in which weassumed an additional 300 policies and $15.4 million of in force premium.In October 2014 we issued our first voluntary commercial residential policy. As of December 31, 2014, we had issued approximately 100voluntary commercial residential policies with in force premium of $5.8 million. Additionally, as part of the SSIC transaction, we assumed approximately100 commercial residential policies with $3.5 million of in force premium. In total, at December 31, 2014 we had approximately $94.7 million of commercialresidential in force premiums. 2Source: Heritage Insurance Holdings, Inc., 10-K, March 18, 2015Powered by Morningstar® Document Research℠The information contained herein may not be copied, adapted or distributed and is not warranted to be accurate, complete or timely. The user assumes all risks for any damages or losses arising from any use of this information,except to the extent such damages or losses cannot be limited or excluded by applicable law. Past financial performance is no guarantee of future results.Table of ContentsFirst Quarter 2015 Citizen AssumptionIn the first quarter of 2015, we participated in 3 personal residential and 3 commercial residential assumptions transactions. Following the opt-outs process, we expect to assume in excess of 18,000 personal residential policies and 300 commercial residential policies.Our StrategySince our inception, a substantial portion of our revenue has come from policies we assumed from Citizens and SSIC, with the balance of our revenuegenerated from renewal of these assumed policies and from voluntary policies. Building on these successful transactions, we intend to continue to growprofitably by undertaking the following:Increase Our Policies in Force in Florida Through Strategic Policy Assumptions and Expansion of Our Voluntary Market ShareWe intend to continue assuming policies from Citizens that meet our assumption strategy and underwriting criteria. We may also pursue opportunitiesto acquire policies from private insurers, as we did in the SSIC transaction. We will also pursue opportunities to increase the number of our voluntary policiesby expanding our independent agent distribution network, as well as obtaining approval from national insurance companies to allow their agents to offer ourpersonal residential policies in Florida. We recently entered into a marketing agreement with National General Insurance Company and expect to beginwriting homeowners insurance through their distribution network in early 2015. We also intend to increase our marketing efforts, which we believe will allowus to more effectively penetrate areas of the state where we are not currently writing significant new business.Opportunistically Diversify Product OfferingsWe will continue to grow our commercial residential business, which we launched in the fourth quarter of 2014 with assumption transactions fromCitizens, as well as through voluntary sales. As of December 31, 2014, our commercial residential policies represented approximately $94.7 million of in-force premium, which included $85 million from Citizens assumptions. We anticipate most of our future growth in commercial residential will come fromvoluntary sales, as we have already selected most of the commercial policies that meet our underwriting criteria from Citizens. In the fourth quarter, we alsoentered into the manufactured housing line of business by assuming approximately 7,400 policies from Citizens. Additional new product lines may includenon-residential coverage, such as general liability insurance.Optimize Our Reinsurance ProgramWe will continue to obtain what we believe to be the most appropriate levels and sources of reinsurance. We believe that the significant additionalcapital entering portions of the reinsurance market provides us with the opportunity to obtain favorable pricing and contract terms and conditions, includingmulti-year commitments, which comprises a significant portion of our 2014–2015 reinsurance program. In April 2014, we entered into two fullycollateralized catastrophe reinsurance agreements funded through the issuance of $200.0 million principal amount of catastrophe bonds, and we willcontinue evaluating such cost-efficient alternatives to traditional reinsurance. Additionally, we will continue to meet certain of our reinsurance needsthrough the use of our reinsurance subsidiary, Osprey, which mitigates our reinsurance expense and reduces our reliance on third party reinsurance.Efficiently Manage Losses and Loss Adjustment ExpensesWe are committed to proactively managing our losses and loss adjustment expenses through prudent underwriting and the use of internal claimsadjustment and repair services. In March 2014, we acquired the largest vendor in the Contractors’ Alliance network, which we believe will allow us to expandour in-house mitigation and restoration services. We are licensing our Contractors’ Alliance employees as adjusters, which we believe will reduce our lossadjustment expenses and shorten the length of time required to resolve claims.Expand to New Geographic MarketsWe intend to explore opportunities to enter other coastal states where we believe the market opportunity is most similar to Florida and where we canutilize our underwriting and claims expertise to attract and manage profitable business. We believe further increasing our geographic diversification is animportant factor in reducing our potential risk of loss from any catastrophic event, reducing our per policy reinsurance costs and providing an additional areafor future growth beyond our expansion in Florida. We anticipate beginning the licensing process in several states by mid-2015. 3Source: Heritage Insurance Holdings, Inc., 10-K, March 18, 2015Powered by Morningstar® Document Research℠The information contained herein may not be copied, adapted or distributed and is not warranted to be accurate, complete or timely. The user assumes all risks for any damages or losses arising from any use of this information,except to the extent such damages or losses cannot be limited or excluded by applicable law. Past financial performance is no guarantee of future results.Table of ContentsOur Competitive StrengthsWe believe that our rapid growth to date and our ability to capitalize on our future growth prospects are a result of the following competitive strengthsof our business:Experienced Management Team With a Long History in the Florida Personal Residential Insurance MarketWe have a deep and experienced management team led by Bruce Lucas, Chairman and Chief Executive Officer, Richard Widdicombe, President,Stephen Rohde, Chief Financial Officer, Melvin Russell, Chief Underwriting Officer, Ernesto Garateix, Chief Operating Officer, Sharon Binnun, ExecutiveVice President Finance, Paul Nielsen, Vice President of Claims, Joseph Peiso, Vice President of Compliance, Randy Jones, President Commercial Divisionand Arlene Luis, Executive Vice President Commercial. Our management team, which averages 28 years of insurance industry experience, has extensiveexperience in the Florida personal and commercial residential insurance market, has built longstanding relationships with key participants in the insuranceindustry and is supported by a group of highly qualified individuals with industry expertise, including a Chief Actuary with more than 35 years of industryexperience.Strong, Conservative Capital StructureAs of December 31, 2014, we had stockholders’ equity of $255.1 million. As of December 31, 2014, Heritage P&C had policyholder surplus, as definedby statutory accounting principles, of $172.7 million. We believe that this level of surplus places us among the best capitalized insurance companiesfocusing primarily on the Florida personal residential insurance market and is significantly in excess of the minimum capital levels required by Florida Officeof Insurance Regulation (“FLOIR”) and Demotech for similarly rated in-state insurance companies. In addition, unlike many of our in-state competitors, wehave relied exclusively upon common equity to provide our capital.Selective Underwriting and Policy Acquisition CriteriaWe believe our proprietary data analytics capabilities and underwriting processes allow us to better select the insurance policies we are willing toassume from the Citizens depopulation program, leading to strong profitability and reduced risk. In addition, we choose to minimize our exposure to or avoidcertain types of coverage if we believe there is significant risk of loss, including coverage for sink-hole related losses in high-risk areas. As a result of ourefforts, our gross loss ratio was 28.7% and 27.5% for the years ended December 31, 2014 and December 31, 2013, respectively.Unique Claims Servicing Model and Superior Customer ServiceWe believe that the vertical integration of our claims adjustment and repair services provides us with a competitive advantage. Because we manageboth claims adjusting and repair services, we are generally able to begin the adjustment and mitigation process much earlier than our competitors, thusreducing our loss adjustment expenses and ultimate loss payouts. A significant number of our repair technicians are participating in training and certificationprograms to become licensed claims adjusters, allowing us to capture additional efficiencies. We also believe our unique model provides a superior level ofcustomer service for our policyholders, enhancing our reputation and increasing the likelihood that our policyholders will renew their policies with us.Relationships with Highly Rated ReinsurersWe manage our exposure to catastrophic events through, among other things, the purchase of reinsurance. Our relationships with highly ratedreinsurers have been developed as a result of our management team’s industry experience and reputation for selective underwriting. Our financial strength,underwriting results and the long-term relationships between our management team and our reinsurance partners help improve the cost-effectiveness of ourreinsurance program.Relationships with Independent Agents and National UnderwritersWe have developed relationships with a network of approximately 1,500 independent insurance agents. We believe we have been able to build thisnetwork due to our reputation for financial stability, commitment to the Florida market and integrity in the underwriting and claims process. We are alsoexploring relationships with additional large national insurers and agencies that no longer write substantial personal residential insurance in Florida, whichwould give us access to their network of Florida agents.Our CompetitionThe market for residential property insurance is highly competitive. In our market, Florida, there are over 80 licensed insurance companies that areactively writing homeowners’ policies. The table below shows year-to-date in-force premium volume and market share for the top 20 companies in Florida asof September 30, 2014, which is the most recent date that the information is publicly available. We compete to varying degrees with all of these companiesand others, including large national carriers, the state-sponsored homeowners’ insurance entity, and single state or regional carriers. 4Source: Heritage Insurance Holdings, Inc., 10-K, March 18, 2015Powered by Morningstar® Document Research℠The information contained herein may not be copied, adapted or distributed and is not warranted to be accurate, complete or timely. The user assumes all risks for any damages or losses arising from any use of this information,except to the extent such damages or losses cannot be limited or excluded by applicable law. Past financial performance is no guarantee of future results.Table of ContentsFlorida Property Insurance Market - Personal Residential and Commercial Residential - Ranked by Total Premiums Written.* Company Name (1) Policies in-Force Total PremiumsWritten PercentageDistribution Citizens Property Insurance Corporation 910,154 2,046,715,921 19.10% Universal Property & Casualty Insurance Company 500,503 747,956,321 6.98% Homeowners Choice Property & Casualty Insurance Company, Inc. 147,737 349,465,686 3.26% Florida Peninsula Insurance Company 134,584 316,874,765 2.96% American Coastal Insurance Company 4,294 311,891,289 2.91% Federated National Insurance Company 167,597 311,667,424 2.91% Heritage Property & Casualty Insurance Company 173,512 302,065,300 2.82% United Property & Casualty Insurance Company 156,696 301,014,655 2.81% United Services Automobile Association 124,834 296,723,824 2.77% St. Johns Insurance Company, Inc. 173,166 284,299,305 2.65% People’s Trust Insurance Company 132,790 266,234,441 2.48% American Integrity Insurance Company of Florida 192,131 236,957,614 2.21% Security First Insurance Company 192,058 236,901,968 2.21% Tower Hill Prime Insurance Company 139,242 228,924,696 2.14% First Community Insurance Company 33,800 212,328,708 1.98% Federal Insurance Company 31,977 176,966,457 1.65% Tower Hill Signature Insurance Company 98,566 168,709,549 1.57% USAA Casualty Insurance Company 53,942 147,942,765 1.38% Tower Hill Preferred Insurance Company 67,530 139,070,016 1.30% AIG Property Casualty Company 13,764 139,027,727 1.30% Total - Top 20 Insurers 3,448,877 7,221,738,431 67.39% Total - All Insurers 5,797,120 $10,714,561,913 100.0% (1)This exhibits excludes State Farm Florida Insurance Company, whose data was not publicly available on September 30, 2014. State Farm’s lastpublicly reported data was 389,109 policies and $655,530,740 at December 31, 2013.*The information displayed in the table above is compiled and published by the Florida Office of Insurance Regulation based on information filingssubmitted quarterly by all Florida licensed insurance companies. The information above is presented for each individual company and is notconsolidated or aggregated.Products and DistributionWe market and write personal lines voluntary policies through a network of approximately 1,300 independent agents. Of these agents, approximately55% are affiliated with eight large agency networks with which we have entered into master agency agreements. We intend to pursue additional voluntarybusiness from agents in our existing independent agent network, expand our independent agent network and seek additional opportunities to use insurer-affiliated agents to offer our personal residential policies in Florida. We had 24,400 voluntary policies (12% of our total policies in force) as of December 31,2014, and for the year ended December 31, 2014, we wrote an average of 1,550 new voluntary policies per month. We recently entered into a marketingagreement with National General Insurance Company and expect to begin writing homeowners insurance through their distribution network in early 2015.The voluntary market is a significant component of our growth strategy.We market and write commercial residential voluntary policies through a network of approximately 200 independent agents. We intend to pursueadditional voluntary business from these agents in our existing independent agent network, expand our independent agent network and seek additionalopportunities to increase our commercial residential policies in Florida. We started writing voluntary policies in October 2014. For the year endedDecember 31, 2014, we wrote 92 policies with an average premium of $62,905, totaling $5.8 million in new voluntary policies. The commercial voluntarymarket is the primary component of our growth strategy. 5Source: Heritage Insurance Holdings, Inc., 10-K, March 18, 2015Powered by Morningstar® Document Research℠The information contained herein may not be copied, adapted or distributed and is not warranted to be accurate, complete or timely. The user assumes all risks for any damages or losses arising from any use of this information,except to the extent such damages or losses cannot be limited or excluded by applicable law. Past financial performance is no guarantee of future results.Table of ContentsWe seek to underwrite a diverse mix of geographic risks within Florida to manage the potential impact of a catastrophic event and reduce our perpolicy reinsurance costs. As of December 31, 2014, the geographic distribution of our policies in force and total insured values were as follows (figures maynot sum to totals due to rounding): As of December 31, 2014 (Total Insured Value in Millions) Total All Lines Policy Count Total Insured Value(TIV) % TIV South Florida Counties Miami-Dade 23,082 10,708 14.0% Broward 23,105 12,297 16.1% Palm Beach 18,170 6,632 8.7% South Florida Exposure 64,357 29,638 38.7% Other Significant Counties(1)Pinellas 27,582 8,873 11.6% Hillsborough 20,657 6,402 8.4% Pasco 13,700 3,706 4.8% Lee 9,357 3,152 4.1% Manatee 6,206 2,293 3.0% Collier 4,975 2,010 2.6% Sarasota 6,486 1,926 2.5% Saint Johns 2,985 1,570 2.0% Total Other Significant Counties 91,948 29,932 39.1% Summary for all of FloridaSouth Florida Exposure 64,357 29,638 38.7% Total Other Significant Counties 91,948 29,932 39.1% Other Florida Counties 53,086 17,047 22.2% TOTAL 209,391 76,617 100.0% 1.Other significant counties are defined as those counties with a total insured value greater than 2.0% of the $76.42 billion of total insured value as ofDecember 31, 2014.In order to limit our potential exposure to individual risks and catastrophic events, we purchase significant reinsurance from third party reinsurers.Purchasing reinsurance is an important part of our risk strategy, and premiums paid (or ceded) to reinsurers is our single largest cost. We have strongrelationships with reinsurers which we believe are a result of our management’s industry experience and reputation for selective underwriting. For the twelvemonths ending May 31, 2015, we purchased catastrophe reinsurance from the following sources: (i) the Florida Hurricane Catastrophe Fund, a state-mandatedcatastrophe fund (“FHCF”), (ii) private reinsurers, all of which were rated “A-” or higher by A.M. Best Company, Inc. (“A.M. Best”) or Standard & Poor’sFinancial Services LLC (“S&P”), (iii) sponsored two catastrophe bonds in two issuances of catastrophe bonds that provide $200 million of principal limit thatcan be drawn upon over a three year period, and (iv) our wholly-owned reinsurance subsidiary, Osprey Re Ltd (“Osprey”). In addition to purchasingcatastrophe reinsurance for the twelve months ending May 31, 2015, we also purchased property risk reinsurance which limits our net exposure in the eventof a severe non-catastrophe loss impacting a single location or risk to $1.0 million. We also utilize facultative reinsurance to supplement our per riskreinsurance program where our capacity needs dictate. See “-Reinsurance – 2014 – 2015 Catastrophe Reinsurance Program”.The FLOIR requires all insurance companies, like us, to have a certain amount of capital reserves and reinsurance coverage in order to cover lossesupon the occurrence of a catastrophic event. Our reinsurance program for the twelve months ending May 31, 2015 provides reinsurance in excess of FLOIR’srequirements, which are based on the probable maximum loss that we would incur from an individual catastrophic event estimated to occur once every 100years based on our portfolio of insured risks. We also purchase reinsurance coverage to protect against the potential for multiple catastrophic eventsoccurring in the same year.In placing our 2014-2015 reinsurance program, we sought to obtain multiple years of coverage for certain layers of the program through multi-yearcommitments. We believe these arrangements allow us to capitalize on favorable pricing and contract terms and conditions and allow us to mitigateuncertainty surrounding the price of our future reinsurance coverage. In the aggregate, multi-year coverage accounts for approximately 72% of our purchasesof private reinsurance for the 2014 hurricane season.We test the sufficiency of our reinsurance program by subjecting our personal residential exposures to statistical testing using the AIR U.S. HurricaneModel, which replicates the most severe hurricanes to have occurred historically in Florida, individual storms of severity in excess of such historical levels,and the historical calendar years in which the most severe multiple catastrophic events occurred in Florida. In this regard, the 2004 calendar year, in whichfour large catastrophic hurricanes made landfall in Florida, is considered to be the worst catastrophic year in Florida’s recorded history. Assuming thereoccurrence of the 2004 calendar year events, the probable maximum net loss to us in 2014, based on the coverage for our 2014-2015 reinsurance program,would be $21.4 million (after tax, net of all reinsurance recoveries and including our retention through Osprey). This loss would have represented 8.4% of ourstockholders’ equity at December 31, 2014. 6Source: Heritage Insurance Holdings, Inc., 10-K, March 18, 2015Powered by Morningstar® Document Research℠The information contained herein may not be copied, adapted or distributed and is not warranted to be accurate, complete or timely. The user assumes all risks for any damages or losses arising from any use of this information,except to the extent such damages or losses cannot be limited or excluded by applicable law. Past financial performance is no guarantee of future results.Table of ContentsWe closely manage all aspects of our claims adjustment process. Claims are initially reviewed by our managers and staff adjusters, who determine theextent of the loss and the resources needed to adjust each claim. In the case of a catastrophic event, we have contracted with four large national claimsadjusting firms to assist our adjusters with the increased volume of claims and ensure timely responses to our policyholders. We utilize our wholly-ownedsubsidiary, Contractors’ Alliance Network, LLC (“Contractors’ Alliance”), to manage mitigation and restoration services for our customers. Contractors’Alliance primarily handles water damage-related claims, which comprised approximately 69% of our losses and loss adjustment expenses throughDecember 31, 2014. In March 2014, we completed the acquisition of the assets and personnel of our main water mitigation services vendor. This acquisitionhas allowed us to better service our customers and expand our mitigation and restoration services. In addition, all of our voluntary policies and renewedCitizens policies are enrolled in our Platinum Preferred Savings Program (the “Platinum Program”). Under the Platinum Program, customers receive a 10%discount on their claim deductible, and we obtain control over inspection, claims adjusting and repair services. We believe our approach to claims handlingresults in a higher level of customer service and reduces our losses and loss adjustment expenses. As a result of our efforts, our gross loss ratio, whichexpresses our losses and loss adjustment expenses as a percentage of gross earned premiums, was 28.7% and 27.5% for the years ended December 30, 2014and December 31, 2013, respectively.Our MarketAccording to the U.S. Census Bureau, at December 23, 2014, Florida was the third largest U.S. state with an estimated population of approximately20 million people. The University of Florida Bureau of Economic and Business Research estimates that Florida is expected to reach a population ofapproximately 26 million people by 2040, an increase of 36% from 2010. Property ownership and development represent key drivers of the Florida economy.Because of its location, Florida is exposed to an increased risk of hurricanes during the entire six months of the Atlantic hurricane season, which spansfrom June 1 through November 30. While a significant hurricane has not made landfall in Florida since 2005, eight hurricanes in 2004 and 2005, includingHurricanes Charley, Katrina, Rita and Wilma, caused a combined estimated property damage of over $110 billion, a significant portion of which occurred inFlorida. As a result, personal residential insurance and claims servicing are vitally important to Florida residents.The Florida residential insurance market is highly fragmented and dominated by in-state insurance companies, including Citizens. Significantdislocation in the Florida property insurance market began following Hurricane Andrew in 1992 and accelerated following the 2004 and 2005 hurricaneseasons. In total, national and regional insurers reduced their share of the market in Florida from 84% in 1999 to 26% in 2012. As national and regionalinsurance companies reduced their exposure in Florida, Citizens increased efforts to provide affordable residential insurance to those residents unable toobtain coverage in the private market. As a result, Citizens’ policy count grew from roughly 726,000 policies in 2005 to a peak level of approximately1.5 million policies in late 2011. To reduce Citizens’ risk exposure, beginning in 2010, Florida elected officials encouraged Citizens to focus on reducing thesize of its portfolio by returning policies to the private market. In response, Citizens instituted a number of measures to incentivize the private sector toparticipate in the depopulation program. Some of these initiatives include increased inspections, improved underwriting, reductions in coverage and annualrate increases. Depopulation efforts have been successful, as Citizens’ policy count at December 31, 2014 was approximately 661,000. As of December 31,2014, approximately 153,000 of Heritage’s in force policies were a result of the depopulation program.In May 2013, Florida passed legislation to facilitate the reduction of Citizens’ policy count and establish the Property Insurance Clearinghouse (the“Clearinghouse”), which launched in January 2014. The Clearinghouse makes new and renewal business ineligible for Citizens if a participating insurancecompany is willing to extend comparable coverage at prescribed rates. On March 31, 2014, Heritage P&C was approved to participate in the Clearinghouse.According to data compiled by FLOIR, which excludes State Farm Florida Insurance Company, Citizens was the largest residential insurance carrier inFlorida as of September 30, 2014, with a market share of approximately 19.1% based on total in force direct premiums written for personal and commercialresidential insurance. As of the same date, we ranked 7th in Florida within this market, with a market share of approximately 2.8%, and through ourdepopulation efforts, we have grown substantially in the fourth quarter. Based on our growth in the fourth quarter from our depopulation efforts in bothpersonal and commercial policies our total premiums written were $436.4 million, we would rank as the third largest. Assuming further access to capital andreinsurance support, we believe we have the opportunity to significantly expand the size of our personal and commercial residential insurance business inFlorida and explore the expansion of our business into other complementary business lines and states. 7Source: Heritage Insurance Holdings, Inc., 10-K, March 18, 2015Powered by Morningstar® Document Research℠The information contained herein may not be copied, adapted or distributed and is not warranted to be accurate, complete or timely. The user assumes all risks for any damages or losses arising from any use of this information,except to the extent such damages or losses cannot be limited or excluded by applicable law. Past financial performance is no guarantee of future results.Table of ContentsIn recent years, the property and casualty insurance market has experienced a substantial increase in the availability of property catastrophereinsurance resulting from the increased supply of capital from non-traditional insurance providers, including private capital and hedge funds. This increasedcapital supply, coupled with a lack of recent significant catastrophic storm activity in Florida, has reduced the cost of property catastrophe reinsurance,directly benefitting purchasers of this reinsurance, including us. We believe this market trend will continue for the foreseeable future.UnderwritingOur underwriters evaluate and select only those risks that they believe will enable us to achieve an underwriting profit. In order to achieveunderwriting profitability on a consistent basis, we focus on (1) the suitability of the risk to be assumed or written, (2) the adequacy of the premium withregard to the risk to be assumed or written and (3) the geographic distribution of existing policies within Florida.All of our personal lines underwriting is done internally under the supervision of our Chief Underwriting Officer with input from our Chief Actuary andour Director of Risk Management. Our commercial lines underwriting is done internally under the supervision of our Executive Vice President CommercialDivision. Our underwriters use our proprietary data analytics capabilities, which include a number of automated processes, to analyze a number of riskevaluation factors, including the age, construction, location and value of the residence and the premiums to be received from insuring the residence. Newtechnological advances in computer generated geographical mapping afford us an enhanced perspective as to geographic concentrations ofpolicyholders. When considering the geographic distribution of existing policies, our underwriters may consider the number of other residences we insurewithin the same region, county, city and zip code. We also consider the cost of reinsurance when assessing the adequacy of the premium with regard to therisk to be assumed or written. In particular, because we assume policies from Citizens in large quantities, we must evaluate the aggregate impact of theassumed policies on our reinsurance program. The underwriting criteria that we consider will continue to evolve as our business grows and expands.We also review our expiring policies to determine whether those risks continue to meet our underwriting guidelines. If a given policy no longer meetsour underwriting guidelines, we will take appropriate action regarding that policy, including raising premium rates or, to the extent permitted by applicablelaw and our assumption agreements with Citizens, not offering to renew the policy.Policy AdministrationWe have engaged West Point Underwriters, Inc., and Majesco Mastec providers of web-based software solutions and insurance personnel, to provide uswith policy administration services for our business, including processing, billing and policy maintenance. The software is able to adapt to a variety of formsand rates, handle the administration of an increasing number of policies as our Company grows and expands, and provide detailed information about ourbook of business to our internal underwriters so that they can adjust our underwriting criteria as necessary. The software provides us with daily updatesregarding the insurance policies that we have issued. The systems also allow us to provide renewal notices, late payment notices, cancellation notices,endorsements and policies to our policyholders in a timely fashion.Claims AdministrationWe closely manage all aspects of the claims process, from processing the initial filing to providing remediation services through our wholly-ownedsubsidiary, Contractors’ Alliance. When a policyholder contacts us to report a claim, members of our claims department create a claim file and aggregate theappropriate supporting documentation. Claims are then reviewed by our managers and staff adjusters, who assess the extent of the loss, including through on-site investigations, and determine the resources needed to adjust each claim. Our claims are generally adjusted by our staff claims professionals, except in thecase of a catastrophic event for which we have contracted with four large national claims adjusting firms to assist our adjusters with the increased volume ofclaims and ensure timely responses to our policyholders. In the final stage of the claims process, we leverage Contractors’ Alliance’s vendor network toprovide repair and remediation services to the policyholder.We perform or supervise the services rendered to our policyholders at all stages of the claims process, which we believe allows us to reduce cost andprovide a high level of customer service to our policyholders. To encourage our policyholders to allow us to manage their claims from beginning to end, wedeveloped our Platinum Program. Under the Platinum Program, participating customers receive a 10% discount on their claim deductible, and we obtaincontrol over inspection, claims adjusting and repair services, with the repair services being managed by either Contractors’ Alliance or one of our contractedvendors. If the policyholder elects to use a different vendor to provide repair services, we will resolve the claim for the amount we would have paid hadContractors’ Alliance or one of our contracted vendors performed the work. In March 2014, we acquired the largest vendor in the Contractors’ Alliancenetwork, which has allowed us to expand our in-house mitigation and restoration services. 8Source: Heritage Insurance Holdings, Inc., 10-K, March 18, 2015Powered by Morningstar® Document Research℠The information contained herein may not be copied, adapted or distributed and is not warranted to be accurate, complete or timely. The user assumes all risks for any damages or losses arising from any use of this information,except to the extent such damages or losses cannot be limited or excluded by applicable law. Past financial performance is no guarantee of future results.Table of ContentsCitizens Assumption TransactionsAs of December 31, 2014, we have assumed, net of cancellations, an aggregate of approximately 155,000 policies through participation in the Citizensdepopulation program. Citizens generally offers depopulations on a monthly basis. From December 2012 through December 2014, we participated in 13depopulations. Additionally, during the first quarter of 2015 we have participated in 3 depopulations. After the opt-outs process we expect to next in excessof 18,000 personal residential and 300 commercial residential policies. We have also been approved for depopulation in April 2015.In order to be eligible to participate in an assumption transaction, we first apply to FLOIR for approval to assume a specified number of policies. Weprepare and submit a report showing the cumulative pro forma financial impact of assuming all policies for which we have applied and all policies we havebeen previously approved to assume. Once we have received FLOIR approval indicating the maximum number of policies we may assume, Citizens providesus with a list of policies eligible for assumption and the relevant policy data. We evaluate these policies using our proprietary data analytics capabilities andsubmit to Citizens a list of policies we would like to assume. Citizens then compares our list of preferred policies with those of other private insurancecompanies participating in the depopulation and informs us which policies will be assigned to us.Once Citizens informs us which policies we may assume, we notify each policyholder of our offer to assume their policy, the amount of their estimatedpremium upon renewal and their right to opt-out of the assumption transaction. On the effective date of such transaction, Citizens transfers to us the unearnedpremiums for the policies that have not opted out of the assumption transaction. A policyholder may also opt-out during the 30-day period following theeffective date of the assumption transaction. If a policyholder opts-out during such period, we return the applicable unearned premiums to Citizens.Under the terms of our typical assumption agreement with Citizens, we assume all liability and obligation for losses under the assumed policies arisingon or after the effective date of the assumption transaction, and we directly service all policyholder claims related to such losses. All terms and conditions ofthe assumed policies, including coverage and rates, remain unchanged for the remainder of the policy term. Citizens remains liable for all losses under theassumed policies arising prior to the effective date of the assumption transaction and is solely responsible for servicing all policyholder claims related to suchlosses.We strive to retain these policies by offering competitive rates and efficient claims handling to our policyholders. Through December 31, 2014, werenewed approximately 86% of the policies we assumed from Citizens upon their initial expiration.Loss DevelopmentOur losses and loss adjustment expenses (“LAE”) represent estimated costs ultimately required to settle all claims for a given period. The followingtable illustrates, as of December 31, 2014, development of the estimated liability for losses and loss adjustment expenses as of December 31, 2014: 2012 2013 2014 (In thousands) Original liability for losses and LAE1 $1,393 $19,344 $51,469 Re-estimated losses and LAE2 as of: 1 year later 926 19,121 — 2 years later 996 — — 3 years later — — — Cumulative redundancy (deficiency)3 397 223 — Cumulative amount of liability paid as of: 1 year later 828 12,052 — 2 years later 907 — — 3 years later — — — Gross premiums earned $5,719 $139,959 $311,514 (1)Represents management’s original best estimated liability of (i) unpaid claims, (ii) IBNR and (iii) loss adjustment expenses.(2)Represents the re-estimated liabilities in later years of unpaid claims, IBNR and loss adjustment expenses in the respective years.(3)Represents the difference between the latest re-estimate and the original estimate. A redundancy means the original estimate is higher than the currentestimate whereas a deficiency means that the original estimate is lower than the current estimate. 9Source: Heritage Insurance Holdings, Inc., 10-K, March 18, 2015Powered by Morningstar® Document Research℠The information contained herein may not be copied, adapted or distributed and is not warranted to be accurate, complete or timely. The user assumes all risks for any damages or losses arising from any use of this information,except to the extent such damages or losses cannot be limited or excluded by applicable law. Past financial performance is no guarantee of future results.Table of ContentsTechnologyOur business depends upon the use, development and implementation of integrated technology systems. These systems enable us to provide a highlevel of service to agents and policyholders by processing business efficiently, communicating and sharing data with agents, providing a variety of methodsfor the payment of premiums and allowing for the accumulation and analysis of information for our management. We believe the availability and use of thesetechnology systems has resulted in improved service to agents and customers, increased efficiencies in processing Heritage P&C’s business and loweroperating costs.We also license software from third parties, including West Point, Majesco Mastec and AIR Worldwide, Inc. (“AIR”). AIR’s catastrophe modelingsoftware enables us to optimize our insurance portfolio to reduce our reinsurance costs. We also own or license other technology systems used by HeritageP&C. These technology systems consist primarily of an integrated central processing computer, a series of server-based computer networks, a back-up serverand various Internet-based communications systems.ReinsuranceIn order to limit our potential exposure to catastrophic events, we purchase significant reinsurance from third party reinsurers. We also purchaseproperty per risk reinsurance coverage for non-catastrophe related to losses in excess of $1.0 million. Purchasing reinsurance is an important part of our riskstrategy, and premiums paid (or ceded) to reinsurers is our single largest cost. Reinsurance involves transferring, or “ceding”, a portion of the risk exposure onpolicies we write to another insurer, known as a reinsurer. To the extent that our reinsurers are unable to meet the obligations they assume under ourreinsurance agreements, we remain liable for the entire insured loss. See in Part I, Item 1A “Risk Factors”. We may not be able to collect reinsurance amountsdue to us from the reinsurers with which we have contracted.Our reinsurance agreements are short-term, prospective contracts. We record an asset, prepaid reinsurance premiums, and a liability, reinsurancepayable, for the entire contract amount upon commencement of our new reinsurance agreements. We amortize our reinsurance premiums over the 12-monthcontract period, which is June 1 through May 31.In the event that we incur losses and loss adjustment expenses recoverable under our reinsurance program, we record amounts recoverable from ourreinsurers on paid losses plus an estimate of amounts recoverable on unpaid losses. The estimate of amounts recoverable on unpaid losses is a function of ourliability for unpaid losses associated with the reinsured policies; therefore, the amount changes in conjunction with any changes to our estimate of unpaidlosses. As a result, a reasonable possibility exists that an estimated recovery may change significantly in the near term from the amounts included in ourconsolidated financial statements.FLOIR requires all insurance companies, like us, to have a certain amount of capital and reinsurance coverage in order to cover losses and lossadjustment expenses upon the occurrence of a catastrophic event. Our 2014-2015 reinsurance program provides reinsurance in excess of FLOIR’srequirements, which are based on the probable maximum loss that we would incur from an individual catastrophic event estimated to occur once in every 100years based on our portfolio of insured risks. The nature, severity and location of the event giving rise to such a probable maximum loss differs for eachinsurer depending on the insurer’s portfolio of insured risks, including, among other things, the geographic concentration of insured value within suchportfolio. As a result, a particular catastrophic event could be a one-in-100 year loss event for one insurance company while having a greater or lesserprobability of occurrence for another insurance company. We also purchase reinsurance coverage to protect against the potential for multiple catastrophicevents occurring in the same year.2014-2015 Catastrophe Reinsurance ProgramOur annual reinsurance program, which is segmented into layers of coverage, protects us for excess property catastrophe losses and loss adjustmentexpenses. Our 2014-2015 reinsurance program incorporates the mandatory coverage required by law to be placed with the FHCF, as well as privatereinsurance below, alongside and above the FHCF layer and aggregate reinsurance coverage.In placing our 2014-2015 reinsurance program, we sought to obtain multiple years of coverage for certain layers of the program through multi-yearcommitments. We believe these arrangements allow us to capitalize on favorable pricing and contract terms and conditions and allow us to mitigateuncertainty surrounding the price of our future reinsurance coverage, our single largest cost.For example, on April 17, 2014, Heritage P&C entered into a catastrophe reinsurance agreement with Citrus Re Ltd., a newly-formed Bermuda specialpurpose insurer, which provides for three years of coverage from catastrophe losses caused 10Source: Heritage Insurance Holdings, Inc., 10-K, March 18, 2015Powered by Morningstar® Document Research℠The information contained herein may not be copied, adapted or distributed and is not warranted to be accurate, complete or timely. The user assumes all risks for any damages or losses arising from any use of this information,except to the extent such damages or losses cannot be limited or excluded by applicable law. Past financial performance is no guarantee of future results.Table of Contentsby certain named storms, including hurricanes, beginning on June 1, 2014. The limit of coverage of $150.0 million is fully collateralized by a reinsurancetrust account for the benefit of Heritage P&C. Heritage P&C pays a periodic premium to Citrus Re Ltd. during this three-year risk period. Citrus Re Ltd. issued$150.0 million of principal-at-risk variable notes due April 18, 2017 (the “Citrus Re-1 Bonds”) to fund the reinsurance trust account and its obligations toHeritage P&C under the reinsurance agreement. The maturity date of the notes may be extended up to two additional years to satisfy claims for catastrophicevents occurring during the three-year term of the reinsurance agreement. By accessing catastrophe reinsurance coverage through capital markets vehicleslike Citrus Re Ltd., we aim to diversify our sources of reinsurance capacity in a cost-effective manner given current market conditions.On April 24, 2014, Heritage P&C entered into a second catastrophe reinsurance agreement with Citrus Re Ltd. providing for $50 million of coverageon substantially similar terms as the agreement described above. Citrus Re Ltd. issued an additional $50 million of principal-at-risk variable notes dueApril 24, 2017 (the “Citrus Re-2 Bonds”) to fund its obligations under the reinsurance agreement.The following describes the layers of our 2014-2015 reinsurance program. • Our Retention. For the first catastrophic event, we have a primary retention on the first $15.0 million of losses and loss adjustment expenses, ofwhich our reinsurance subsidiary, Osprey, is responsible for $6.0 million. For a second catastrophic event, have a primary retention on the first$6.0 million of losses and loss adjustment expenses, of which Osprey is responsible for $4.0 million. For subsequent catastrophic events,Heritage P&C’s primary retention decreases to $2.0 million per event. Osprey has no primary retention beyond the second catastrophic event. • Layer Below FHCF. Immediately above our retention, we have purchased $185.0 million of reinsurance from third party reinsurers. Through thepayment of a reinstatement premium, we are able to reinstate the full amount of this reinsurance one time. To the extent that $185.0 million or aportion thereof is exhausted in a first catastrophic event, we have purchased reinstatement premium protection insurance to pay the requiredpremium necessary for the reinstatement of this coverage. A portion of this coverage wraps around the FHCF layer and provides coveragealongside such layer. • FHCF Layer. Our FHCF coverage includes an estimated maximum provisional limit of 90% of $484.0 million, or $436.0 million, in excess of ourretention and private reinsurance of $181.0 million. The limit and retention of the FHCF coverage is subject to upward or downward adjustmentbased on, among other things, submitted exposures to FHCF by all participants. We have purchased coverage alongside from third partyreinsurers. The layer alongside is in the amount of $48.0 million. The private reinsurance will adjust to fill in gaps in the FHCF coverage. TheFHCF coverage cannot be reinstated once exhausted, but it does provide coverage for multiple events. • Citrus Re Layer. Immediately above the FHCF layer is the coverage provided by the reinsurance agreement with Citrus Re Ltd., which providescoverage for $150.0 million of losses and loss adjustment expenses in excess of $621.0 million, collateralized by the proceeds of the Citrus Re-1Bonds. However, to the extent our FHCF coverage is partially or entirely exhausted by a first catastrophic event, Citrus Re Ltd. providescoverage of $150.0 million of losses and loss adjustment expenses in excess of our private reinsurance coverage of $200.0 million. The coveragefunded by the Citrus Re-1 Bonds cannot be reinstated once exhausted, but it does provide coverage for multiple events. • Layer Above Citrus Re. The layer immediately above the Citrus Re Ltd. layer provides, in the aggregate, coverage for $100.0 million of lossesand loss adjustment expenses in excess of $812.0 million. In this layer, 50% of the layer, or $50.0 million of coverage, is provided by the CitrusRe-2 Bonds, and, through Osprey, we retain a participation of $25.0 million. The remaining $25.0 million of coverage in this layer is providedby the aggregate coverage layer described below commencing upon the exhaustion of Osprey’s retention. To the extent our FHCF coverage isexhausted, this layer provides coverage in excess of our private reinsurance, coverage provided by Citrus Re Ltd. and our retention, each asdescribed above. • Aggregate Coverage. In addition to the layers described above, we have purchased $105.0 million of aggregate reinsurance coverage for lossesand loss adjustment expenses in excess of $825.0 million for a first catastrophic event. Of the $105.0 million of total aggregate coverage, $25.0million covers losses and loss adjustment expenses in the immediately preceding layer. To the extent that this coverage is not fully exhausted inthe first catastrophic event, it provides coverage commencing at our reduced retention levels for second and subsequent events and whereunderlying coverage has been previously exhausted. There is no reinstatement of the aggregate reinsurance coverage once exhausted, but it doesprovide coverage for multiple events. Osprey has a $20.0 million participation in the second aggregate layer. 11Source: Heritage Insurance Holdings, Inc., 10-K, March 18, 2015Powered by Morningstar® Document Research℠The information contained herein may not be copied, adapted or distributed and is not warranted to be accurate, complete or timely. The user assumes all risks for any damages or losses arising from any use of this information,except to the extent such damages or losses cannot be limited or excluded by applicable law. Past financial performance is no guarantee of future results.Table of ContentsFor a first catastrophic event, our reinsurance program provides coverage for $990.0 million of losses and loss adjustment expenses, including ourretention, and we are responsible for all losses and loss adjustment expenses in excess of such amount. For subsequent catastrophic events, our total availablecoverage depends on the magnitude of the first event, as we may have coverage remaining from layers that were not previously fully exhausted. We have alsopurchased reinstatement premium protection insurance to provide an additional $185.0 million of coverage. Our aggregate reinsurance layer also providescoverage for second and subsequent events to the extent not exhausted in prior events. In total, we have purchased $1.175 billion of potential reinsurancecoverage, including our retention, for multiple catastrophic events. Our ability to access this coverage, however, will be subject to the severity and frequencyof such events. As of August 31, 2014, the peak of the hurricane season, our total insured value was $50.1 billion, and we may experience significant lossesand loss adjustment expenses in excess of our retention. The chart below provides a graphic illustration of the structure and operations of our 2014-2015catastrophe reinsurance program. As discussed above, in placing our 2014-2015 reinsurance program, we sought to capitalize on favorable reinsurance pricing and mitigate uncertaintysurrounding the future cost of our reinsurance by negotiating multi-year arrangements. The $200.0 million of aggregate coverage we have purchased fromCitrus Re Ltd., which includes both the Citrus Re-1 Bonds and Citrus Re-2 Bonds, extends for a three-year period. To the extent it is all or partially exhaustedbefore the end of three years, it cannot be reinstated. We also have also received commitments from our private reinsurers to extend the $185.0 million ofcoverage for an additional year, regardless of whether such coverage is exhausted or reinstated during the 2014 hurricane season. In the aggregate, multi-yearcoverage accounts for approximately 72% of our purchases of private reinsurance for the 2014 hurricane season. The terms of each of the multi-year coveragearrangements described above are subject to adjustment depending on, among other things, the size and composition of our portfolio of insured risks infuture periods.We test the sufficiency of our reinsurance program by subjecting our personal residential exposures to statistical testing using the AIR U.S. HurricaneModel, which replicates the most severe hurricanes to have occurred historically in Florida, individual storms of severity in excess of such historical levels,and the calendar years in which the most severe multiple catastrophic events occurred in Florida. In this regard, the 2004 calendar year, in which four largecatastrophic hurricanes made landfall in Florida, is considered to be the worst catastrophic year in Florida’s recorded history. Assuming the reoccurrence ofthe 2004 calendar year events, the probable maximum net loss to us in 2014, assuming the reinsurance coverage described above, would be $21.4 million(after tax, net of all reinsurance recoveries and including our retention through Osprey). This loss would have represented 8.4% of our stockholders’ equity atDecember 31, 2014. We estimate that, based on our portfolio of insured risks as of August 31, 2014, the 2004 calendar year events would have represented, inthe aggregate, a catastrophic event likely to occur approximately once every 181 years and would have exhausted approximately 18.7% of our total expectedreinsurance coverage. 12Source: Heritage Insurance Holdings, Inc., 10-K, March 18, 2015Powered by Morningstar® Document Research℠The information contained herein may not be copied, adapted or distributed and is not warranted to be accurate, complete or timely. The user assumes all risks for any damages or losses arising from any use of this information,except to the extent such damages or losses cannot be limited or excluded by applicable law. Past financial performance is no guarantee of future results.Table of ContentsAssuming the reoccurrence of Hurricane Andrew, which is considered to be the most catastrophic single event in Florida’s recorded history, theprobable maximum net loss to us in 2014, assuming the reinsurance coverage described above, would be $9.3 million (after tax, net of all reinsurancerecoveries and including our retention through Osprey). This loss would have represented 3.7% of our stockholders’ equity at December 31, 2014. Weestimate that, based on our portfolio of insured risks as of August 31, 2014, Hurricane Andrew would have represented a catastrophic event likely to occurapproximately once every 30 years and would have exhausted approximately 26.2% of our total expected reinsurance coverage.For the twelve months ending May 31, 2014, we purchased reinsurance from the following sources: (i) FHCF, (ii) Citrus Re Ltd., (iii) 15 third-partyprivate reinsurers, all of which were rated “A-” or higher by A.M. Best or S&P and (iv) our wholly-owned reinsurance subsidiary, Osprey. Allianz GlobalCorporate & Specialty SE provides approximately 81% of our third-party reinsurance coverage. The chart below lists our third-party reinsurers withA.M. Best and S&P ratings: Reinsurer A.M. Best Rating S&P RatingACE Tempest Reinsurance Ltd A++ AAAllianz Global Corporate & Specialty SE A+ AAAmlin AG A AAxis Specialty Limited A+ A+Everest Reinsurance Company A+ A+Hamilton Re, Ltd A- NALloyd’s Underwriter Syndicate No. 1955 A A+Lloyd’s Underwriter Syndicate No. 2001 A+ A+Lloyd’s Underwriter Syndicate No. 2010 A A+Lloyd’s Underwriter Syndicate No. 2791 A A+Markel Bermuda Limited A AMontpelier Reinsurance Limited A A-Odyssey Reinsurance Company A A-Partner Reinsurance Co Ltd A+ A+Tokio Millennium Re AG A++ AA-InvestmentsOur investments are managed by seven third-party asset managers. We have designed our investment policy to provide a balance between currentyield, conservation of capital and the liquidity requirements of our operations. As such, our investable assets are primarily held in cash and bonds withrelatively short durations. Our investment policy sets guidelines that provide for a well-diversified investment portfolio that is compliant with Floridastatutes that emphasizes quality and preservation of capital. The policy limits investments in common and preferred stocks to 15% of Heritage P&C’sadmitted assets, with no more than 10% in either class. Our bond portfolio must have a minimum weighted average portfolio quality of A, with only $1million invested in below investment grade bonds. No more than 2% of admitted assets can be invested in any one issuer, excluding government-relatedsecurities. Investments in commercial mortgages cannot exceed 10% of admitted assets. Prohibited investments include short sales and margin purchases, oil,gas, mineral or other types of leases, speculative uses of futures and options, unrated corporate securities, non-US denominated securities, convertiblesecurities high risk CMO instruments, repurchase agreements, securities lending transactions and speculative foreign currency valuation transactions. Ourinvestment policy, which may change from time to time, is approved by our Investment Committee and is reviewed on a regular basis in order to ensure thatour investment policy evolves in response to changes in the financial market. See Note 3 to our consolidated financial statements for the year endedDecember 31, 2014 included elsewhere in this Annual Report.As of December 31, 2014, we held $160.5 million in cash and cash equivalents and $331.2 million in securities, which were comprised of $289.5million in bonds, $15.3 million in preferred stocks, $19.5 million in common stock and $6.9 million in a mortgage loan.Government RegulationThe insurance industry is extensively regulated. Heritage P&C is subject to the laws and regulations of Florida and any other state where we may seekto do business. Florida’s insurance regulatory regime provides for regulation of virtually all 13Source: Heritage Insurance Holdings, Inc., 10-K, March 18, 2015Powered by Morningstar® Document Research℠The information contained herein may not be copied, adapted or distributed and is not warranted to be accurate, complete or timely. The user assumes all risks for any damages or losses arising from any use of this information,except to the extent such damages or losses cannot be limited or excluded by applicable law. Past financial performance is no guarantee of future results.Table of Contentsaspects of Heritage P&C’s business. Florida, like many states, has adopted several model laws and regulations as promulgated by the NAIC. State statutes andadministrative rules generally require each insurance company that is part of a holding company group to register with the department of insurance in its stateof domicile and to furnish information concerning the operations of the companies within the holding company system which may materially affect theoperations, management or financial condition of the insurers within the group. As part of its registration, each insurance company must identify materialagreements, relationships and transactions with affiliates, including without limitation loans, investments, asset transfers, transactions outside of the ordinarycourse of business, certain management, service, and cost sharing agreements, reinsurance transactions, dividends and consolidated tax allocationagreements. In many instances, Florida’s insurance laws and regulations are even more stringent that those promulgated by the NAIC or other states.As an initial matter, Florida routinely places additional restrictions on new insurers as a condition of receiving a certificate of authority. Theserestrictions are typically memorialized in a consent order entered into between FLOIR and the insurer applying for a certificate of authority. We are subject tosuch a consent order in which we have agreed to higher or more stringent restrictions than are otherwise required under Florida law. The material restrictionswe have agreed to include: • Florida law requires a residential property writer to maintain surplus of the greater of $15.0 million or 10% of its liabilities. Pursuant to theconsent order, we agreed to establish a minimum capital and surplus of $18.0 million. As of December 31, 2014, our insurance subsidiary heldsurplus of $172.7 million, in full compliance with Florida law and the consent order. • Florida law restricts the ratio of premiums written to policyholder surplus to 10 to 1 on a gross basis and 4 to 1 on a net of reinsurance basis. As ofDecember 31, 2014, Heritage P&C’s gross and net writing ratios were 2.5 to 1 and 1.9 to 1, respectively. Pursuant to the consent order, we alsoagreed to not exceed the projected premiums in the plan of operation submitted with our original application for licensure without the priorwritten approval of FLOIR during 2012, 2013 and 2014. As part of the FLOIR approval process for the various Citizens assumption transactionsin which we have participated, we have received approval to exceed these projected premiums. We are in full compliance with these provisionsof the consent order. • Florida law places no restrictions on the parent of an insurer, or other upstream entities, with regard to the payment of dividends. Pursuant to theconsent order, we agreed to not make any distributions to stockholders prior to July 31, 2015, except such distributions as are required to offsetstockholders’ tax obligations resulting from the ownership of our equity or such distributions as may be approved by FLOIR in advance and inwriting. We are in full compliance with this provision of the consent order. • Florida law allows an insurer to pay certain dividends to stockholders without approval of FLOIR. Pursuant to the consent order, we agreed that,until July 31, 2017, Heritage P&C would pay only those dividends that have been approved in advance and in writing by FLOIR. Our insurancesubsidiary has paid no stockholder dividends since its inception and is in full compliance with this provision of the consent order.We are also subject to consent orders setting conditions for FLOIR’s approval of the Citizens assumption transactions in which we have participated.We are required by consent order to comply with the assumption agreements entered into with Citizens at the time of each assumption transaction, whichrequires that for the assumed policies, we must offer to renew each policy for a minimum of three years. In addition, the June 2013 assumption and the twosubsequent assumptions in 2013 limit rate increases to the higher of those approved by FLOIR for Citizens for comparable risks or 10%. We are in fullcompliance with all consent orders issued with regard to Citizens’ depopulation program.Additionally, we are subject to regulations administered by a department of insurance in each state in which we do business (currently, only Florida).These regulations relate to, among other things: • the content and timing of required notices and other policyholder information; • the amount of premiums the insurer may assume or write in relation to its surplus; • the amount and nature of reinsurance a company is required to purchase; • participation in guaranty funds and other statutorily created markets or organizations; • business operations and claims practices; • approval of policy forms and premium rates; • standards of solvency, including risk-based capital measurements; 14Source: Heritage Insurance Holdings, Inc., 10-K, March 18, 2015Powered by Morningstar® Document Research℠The information contained herein may not be copied, adapted or distributed and is not warranted to be accurate, complete or timely. The user assumes all risks for any damages or losses arising from any use of this information,except to the extent such damages or losses cannot be limited or excluded by applicable law. Past financial performance is no guarantee of future results.Table of Contents • licensing of insurers and their products; • restrictions on the nature, quality and concentration of investments; • restrictions on the ability of insurance company subsidiaries to pay dividends to insurance holding companies; • restrictions on transactions between insurance companies and their affiliates; • restrictions on the size of risks insurable under a single policy; • requiring deposits for the benefit of policyholders; • requiring certain methods of accounting; • periodic examinations of our operations and finances; • the form and content of records of financial condition required to be filed; and • requiring reserves.FLOIR and regulators in other jurisdictions where we may become licensed and offer insurance products conduct periodic examinations of the affairs ofinsurance companies and require the filing of annual and other reports relating to financial condition, holding company issues and other matters. Theseregulatory authorities also conduct periodic examinations into insurers’ business practices. Additionally, as an insurance company operating in Florida,Heritage P&C is subject to assessments levied by Citizens, the Florida Insurance Guaranty Association and the FHCF.EmployeesAs of December 31, 2014, we had 133 employees, all of whom are full time employees. We are not a party to any collective bargaining agreement andhave not experienced any work stoppages or strikes as a result of labor disputes. We consider relations with our employees to be satisfactory.Available InformationHeritage Insurance Holdings Inc.’s, Annual Reports on Form 10-K, Quarterly Reports on Form 10-Q, Current Reports on Form 8-K and amendments toreports filed pursuant to Sections 13(a) and 15(d) of the Securities Exchange Act of 1934, as amended (the “Exchange Act”) are made available, free ofcharge, on or through the “Investor Relations” portion of our Internet website https://heritagepci.com. The public may read and copy any materials that theCompany has filed with the Securities and Exchange Commission (“SEC”) at the SEC’s Public Reference Room located at 100 F Street, NE, Washington, DC20549. The public may obtain information on the operation of the Public Reference Room by calling the SEC at 800-SEC-0330. Reports filed with orfurnished to the SEC will also be available as soon as reasonably practicable after they are filed with or furnished to the SEC and are available over theinternet at the SEC’s website at http://www.sec.gov.Item 1A. Risk FactorsSet forth below are certain risk factors that could harm our business, results of operations and financial condition. You should carefully read thefollowing risk factors, together with the financial statements, related notes and other information contained in this Annual Report on Form 10-K. Ourbusiness, financial condition and operating results may suffer if any of the following risks are realized. If any of these risks or uncertainties occur, thetrading price of our common stock could decline and you might lose all or part of your investment. This Annual Report on Form 10-K contains forward-looking statements that contain risks and uncertainties. Please refer to the discussion of “Special Note Regarding Forward-Looking Statements” on thesecond page of this Annual Report in connection with your consideration of the risk factors and other important factors that may affect future resultsdescribed herein.Risks Related to Our BusinessWe have a limited operating history, and our business and future prospects are difficult to evaluate.We began operations in August 2012 and wrote our first policy in November 2012. Due to our limited operating history, our ability to execute ourbusiness strategy is materially uncertain and our operations and prospects are subject to all risks inherent in a developing business enterprise. Our limitedoperating history also makes it difficult to evaluate our long 15Source: Heritage Insurance Holdings, Inc., 10-K, March 18, 2015Powered by Morningstar® Document Research℠The information contained herein may not be copied, adapted or distributed and is not warranted to be accurate, complete or timely. The user assumes all risks for any damages or losses arising from any use of this information,except to the extent such damages or losses cannot be limited or excluded by applicable law. Past financial performance is no guarantee of future results.Table of Contentsterm commercial viability. As a new business, we must work to establish and develop successful operating procedures, hire staff, tailor and fine-tune ourinformation management and other systems, maintain adequate control of our expenses, develop business relationships, implement our marketing strategies(and adapt and modify them as needed), establish a positive image and reputation in the community, and take any other steps necessary to conduct ourbusiness. As a result of these challenges, it is possible that we may not be successful in implementing our business strategy or completing the development ofthe infrastructure necessary to expand our business.Our loss reserves are estimates and may be inadequate to cover our actual liability for losses, causing our results of operations to be adversely affected.We maintain reserves to cover our estimated ultimate liabilities for losses and loss adjustment expenses, also referred to as loss reserves. As a newcompany, we have a limited operating history and a limited loss history which may negatively impact our ability to accurately establish loss reserves. Ourcurrent loss reserves are based primarily on industry historical data and statistical projections of what we believe the resolution and administration of claimswill cost based on facts and circumstances then known to us. As a company with limited operating history our claims experience and our experience with therisks related to certain claims is inherently limited, and we must rely heavily on industry historical data, which may not be indicative of future periods. As aresult, our projections and our estimates may be inaccurate, which in turn may cause our actual losses to exceed our loss reserves. If our actual losses exceedour loss reserves, our financial results, our ability to expand our business and to compete in the property and casualty insurance industry may be negativelyaffected.Factors that affect unpaid losses and loss adjustment expenses include the estimates made on a claim-by-claim basis known as “case reserves” coupledwith bulk estimates known as “incurred but not yet reported” (or “IBNR”). Periodic estimates by management of the ultimate costs required to resolve allclaims are based on our analysis of historical data and estimations of the impact of numerous factors such as (i) per claim information, (ii) industry andcompany historical loss experience and development patterns, (iii) legislative enactments, judicial decisions, legal developments in the awarding of damagesand changes in political attitudes, and (iv) trends in general economic conditions, including the effects of inflation. Management revises its estimates basedon the results of its analysis. This process assumes that past experience, adjusted for the effects of current developments and anticipated trends, is anappropriate basis for estimating the ultimate resolution of all claims. There is no precise method for subsequently evaluating the impact of any specific factoron the adequacy of the reserves because the eventual redundancy or deficiency is affected by multiple factors.Because of the inherent uncertainties in the reserving process, we cannot be certain that our reserves will be adequate to cover our actual losses and lossadjustment expenses. If our reserves for unpaid losses and loss adjustment expenses are less than actual losses and loss adjustment expenses, we will berequired to increase our reserves with a corresponding reduction in our net income in the period in which the deficiency is identified. Future loss experiencesubstantially in excess of our reserves for unpaid losses and loss adjustment expenses could substantially harm our results of operations and financialcondition.Because we conduct our business in Florida only, any single catastrophic event, or a series of such events, or other condition affecting losses in Floridacould adversely affect our financial condition and results of operations.We currently conduct our insurance business in Florida only. The distribution of our policies is generally consistent with that of Florida’s populationand is therefore more concentrated in densely-populated coastal areas. A single catastrophic event, or a series of such events, destructive weather pattern,general economic trend, regulatory development or other condition specifically affecting Florida, particularly the more densely populated areas of the state,could have a disproportionately adverse impact on our business, financial condition and results of operations. While we actively manage our exposure tocatastrophic events through our underwriting process and the purchase of reinsurance, the fact that our business is concentrated in Florida subjects us toincreased exposure to certain catastrophic events and destructive weather patterns such as hurricanes, tropical storms and tornadoes. Changes in theprevailing regulatory, legal, economic, political, demographic and competitive environment, and other conditions in Florida could also make it lessattractive for us to do business in Florida and would have a more pronounced effect on our business than it would on other insurance companies that are moregeographically diversified than we are. Since our business is concentrated in this manner, the occurrence of one or more catastrophic events or otherconditions affecting losses in Florida could have an adverse effect on our business, financial condition and results of operations.We have exposure to unpredictable catastrophes, which can materially and adversely affect our financial results.We write insurance policies that cover homeowners, condominium owners and commercial residential buildings for losses that result from, among otherthings, catastrophes. We are therefore subject to losses, including claims under policies we have assumed or written, arising out of catastrophes that may havea significant effect on our business, results of 16Source: Heritage Insurance Holdings, Inc., 10-K, March 18, 2015Powered by Morningstar® Document Research℠The information contained herein may not be copied, adapted or distributed and is not warranted to be accurate, complete or timely. The user assumes all risks for any damages or losses arising from any use of this information,except to the extent such damages or losses cannot be limited or excluded by applicable law. Past financial performance is no guarantee of future results.Table of Contentsoperations and financial condition. A significant catastrophe, or a series of catastrophes, could also have an adverse effect on our reinsurers. Catastrophes canbe caused by various events, including hurricanes, tropical storms, tornadoes, earthquakes, hailstorms, explosions, power outages, fires and by man-madeevents, such as terrorist attacks. The incidence and severity of catastrophes are inherently unpredictable. The extent of losses from a catastrophe is a functionof both the total amount of insured exposure in the area affected and the severity of the event. Our policyholders are currently concentrated in Florida, whichis especially subject to adverse weather conditions such as hurricanes and tropical storms. Therefore, although we attempt to manage our exposure tocatastrophes through our underwriting process and the purchase of reinsurance protection, an especially severe catastrophe or series of catastrophes couldexceed our reinsurance protection and may have a material adverse impact on our results of operations and financial condition. In total, for the period fromJune 1, 2014 through May 31, 2015, we have purchased $1.175 billion of reinsurance coverage, including our retention, for multiple catastrophic events. Ourability to access this coverage, however, is subject to the severity and frequency of such events. As of August 31, 2014, the peak of hurricane season, our totalinsured value was $50.1 billion and we may experience significant losses and loss adjustment expenses in excess of our retention.Our results of operations may fluctuate significantly based on industry factors as well as our participation in the Citizens depopulation program.The insurance business historically has been a cyclical industry characterized by periods of intense price competition due to excess underwritingcapacity, as well as periods when shortages of capacity permitted an increase in pricing. As premium levels increase, there may be new entrants to the market,which could then lead to increased competition, a significant reduction in premium rates, less favorable policy terms and fewer opportunities to underwriteinsurance risks, which could have a material adverse effect on our results of operations and cash flows. In addition to these considerations, changes in thefrequency and severity of losses suffered by insureds and insurers, including changes resulting from multiple and/or catastrophic hurricanes, may affect thecycles of the insurance business significantly. We cannot predict whether market conditions will improve, remain constant or deteriorate. Negative marketconditions may impair our ability to write insurance at rates that we consider appropriate relative to the risk assumed. If we cannot write insurance atappropriate rates, our business would be materially and adversely affected.In addition, the uncertainties inherent in the reserving process, together with the potential for unforeseen developments, including changes in laws andthe prevailing interpretation of policy terms, may result in losses and loss adjustment expenses materially different from the reserves initially established.Changes to prior year reserves will affect current underwriting results by increasing net income if the prior year reserves prove to be redundant or bydecreasing net income if the prior year reserves prove to be insufficient. We are not allowed to record contingency reserves to account for expected futurelosses. As a result, we expect volatility in operating results in periods in which significant loss events occur because generally accepted accounting principlesdo not permit insurers or reinsurers to reserve for loss events until they have occurred and are expected to give rise to a claim. We anticipate that claimsarising from future events may require the establishment of substantial reserves from time to time.Our results of operations may also vary based on our continued participation in the Citizens depopulation program. As part of a typical assumptiontransaction with Citizens, we acquire the unearned premium associated with the assumed policies, which, depending on the size of the transaction, may causesignificant variability in our financial results from period to period. In June 2013, we entered into a retroactive quota share reinsurance agreement withCitizens that resulted in our recognition of $26.0 million of retroactive insurance income for the year ended December 31, 2013, as we realized income equalto the earned premiums, net of associated losses and loss adjustment expenses, from such policies for the period from January 1, 2013 through May 31, 2013with no corresponding reinsurance cost. We do not expect to enter into similar retroactive arrangements in connection with future policy assumptions fromCitizens. See Item 7 “Management’s Discussion and Analysis of Financial Condition and Results of Operations—Key Components of Our Results ofOperations—Retroactive reinsurance income.”Our successful participation in the Citizens depopulation program depends on the continuation of such program and our ability to select favorablepolicies to assume.An important element of our growth strategy involves continued participation in the Citizens depopulation program. As of December 31, 2014,approximately 74% of our 209,400 policies in force were assumed from Citizens. Our ability to participate in this program is subject to a variety of factors,including continuation of the program. There can be no assurance that Citizens will decide to continue the depopulation program for a significant period oftime, or at all. In addition, the establishment of the Clearinghouse, which launched in January 2014 and makes certain new or renewed business ineligible tobe underwritten by Citizens, may substantially reduce Citizens’ policy count and, in particular, the number of policies we would like to assume. Any effortsby the Florida legislature or Citizens to curtail the depopulation program, materially modify the terms of the program as it relates to personal residentialpolicies, or restrict our participation in the program would 17Source: Heritage Insurance Holdings, Inc., 10-K, March 18, 2015Powered by Morningstar® Document Research℠The information contained herein may not be copied, adapted or distributed and is not warranted to be accurate, complete or timely. The user assumes all risks for any damages or losses arising from any use of this information,except to the extent such damages or losses cannot be limited or excluded by applicable law. Past financial performance is no guarantee of future results.Table of Contentshurt our growth prospects and will adversely impair our financial condition and results of operations. When we enter into an assumption transaction withCitizens, we have the opportunity to review information about the policies available for assumption. We undertake a robust selection process in which weanalyze various aspects of each policy’s risk profile and, based on the results, select the policies we would like to assume. Our successful participation in thedepopulation program depends on our ability to select policies that will be accretive to our financial results. However, our selection process involves manydifferent considerations, and there can be no assurances that we will appropriately assess the risks associated with each policy. As a result, we may selectunfavorable policies that could result in substantial losses, which may in turn adversely impact our financial condition and results of operations.We may not be able to collect reinsurance amounts due to us from the reinsurers with which we have contracted.Reinsurance is a method of transferring part of an insurance company’s risk under an insurance policy to another insurance company. To the extent thatour reinsurers are unable to meet the obligations they assume under our reinsurance agreements, we remain liable for the entire insured loss. We usereinsurance arrangements to limit and manage the amount of risk we retain, to stabilize our underwriting results and to increase our underwriting capacity.Our ability to recover amounts due from reinsurers under the reinsurance treaties we currently have in effect is subject to the reinsurance company’s abilityand willingness to pay and to meet its obligations to us. We attempt to select financially strong reinsurers with an A.M. Best or S&P rating of “A-” or better orwe require the reinsurer to fully collateralize its exposure. While we monitor from time to time their financial condition, we also rely on our reinsurancebroker and rating agencies in evaluating our reinsurers’ ability to meet their obligations to us.Our reinsurance coverage in any given year may be concentrated with one or a limited group of reinsurers. For the twelve months ending May 31,2015, Allianz Global Corporate & Specialty SE provides approximately 81% of our third-party reinsurance coverage. Any failure on the part of any onereinsurance company to meet its obligations to us could have a material adverse effect on our financial condition or results of operations.All residential and commercial insurance companies that write business in Florida, including us, are required to obtain reinsurance through FHCF, andthis coverage comprises a substantial portion of our reinsurance program. The limit and retention of the FHCF coverage is subject to upward or downwardadjustment based on, among other things, submitted exposures to FHCF by all participants. We have purchased private reinsurance alongside our FHCF layerto fill in gaps in coverage that may result from the adjustment of the limit or retention of our FHCF coverage; however, such reinsurance would not cover anylosses we may incur as a result of FHCF’s inability to pay the full amount of our claims. If a catastrophic event occurs in Florida, FHCF may not havesufficient funds to pay all of its claims from insurance companies in full or in a timely manner. This could result in significant financial, legal and operationalchallenges to our Company. In the event of a catastrophic loss, FHCF’s ability to pay may be dependent upon its ability to issue bonds in amounts that wouldbe required to meet its reinsurance obligations. There can be no assurance that FHCF will be able to do this. While we believe FHCF currently has adequatecapital and financing capacity to meet its reinsurance obligations, there can be no assurance that it will be able to meet its obligations in the future, and anyfailure to do so could have a material adverse effect on our liquidity, financial condition and results of operations.Reinsurance coverage may not be available to us in the future at commercially reasonable rates or at all.The cost of reinsurance is subject to prevailing market conditions beyond our control such as the amount of capital in the reinsurance market, as well asthe frequency and magnitude of natural and man-made catastrophes. We cannot be assured that reinsurance will remain continuously available to us in theamounts we consider sufficient and at prices acceptable to us. As a result, we may determine to increase the amount of risk we retain or look for otheralternatives to reinsurance, which could in turn have a material adverse effect on our financial position, results of operations and cash flows.Increased competition, competitive pressures, industry developments and market conditions could affect the growth of our business and adverselyimpact our financial results.The property and casualty insurance industry in Florida is cyclical and, during times of increased capacity, highly competitive. We compete not onlywith other stock companies, but also with Citizens, mutual companies, other underwriting organizations and alternative risk sharing mechanisms. Ourprincipal lines of business are written by numerous other insurance companies. Competition for any one account may come from very large, well-establishednational companies, smaller regional companies, other specialty insurers in our field and other companies that write insurance only in Florida. Some of thesecompetitors have greater financial resources, larger agency networks and greater name recognition than we do. We compete for business not only on the basisof price, but also on the basis of financial strength, types of coverages offered, and availability of coverage desired by customers, commission structure andquality of service. We may have difficulty continuing to compete successfully on any of these bases in the future. Competitive pressures coupled with marketconditions may affect our rate of premium growth and financial results. 18Source: Heritage Insurance Holdings, Inc., 10-K, March 18, 2015Powered by Morningstar® Document Research℠The information contained herein may not be copied, adapted or distributed and is not warranted to be accurate, complete or timely. The user assumes all risks for any damages or losses arising from any use of this information,except to the extent such damages or losses cannot be limited or excluded by applicable law. Past financial performance is no guarantee of future results.Table of ContentsIn addition, industry developments could further increase competition in our industry. These developments could include: • an influx of new capital in the marketplace as existing companies attempt to expand their businesses and new companies attempt to enter theinsurance business as a result of better premium pricing and/or policy terms; • an increase in programs in which state-sponsored entities provide property insurance in catastrophe-prone areas; • changes in Florida’s regulatory climate; and • the passage of federal proposals for an optional federal charter that would allow some competing insurers to operate under regulations different orless stringent than those applicable to Heritage P&C.These developments and others could make the property and casualty insurance marketplace more competitive by increasing the supply of insuranceavailable. If competition limits our ability to write new business at adequate rates, our future results of operations would be adversely affected.Our success depends on our ability to accurately price the risks we underwrite.Our results of operations and financial condition depend on our ability to underwrite and set premium rates accurately for a wide variety of risks. Rateadequacy is necessary to generate sufficient premiums to pay losses, loss adjustment expenses, reinsurance costs and underwriting expenses and to earn aprofit. In order to price our products accurately, we must collect and properly analyze a substantial amount of data; develop, test and apply appropriate ratingformulas; closely monitor and timely recognize changes in trends; and project both severity and frequency of losses with reasonable accuracy. Our ability tosuccessfully perform these tasks, and as a result price our products accurately, is subject to a number of risks and uncertainties, some of which are outside ourcontrol, including: • the availability of sufficient reliable data and our ability to properly analyze available data; • regulatory delays in approving filed rate changes; • the uncertainties that inherently characterize estimates and assumptions; • our selection and application of appropriate rating and pricing techniques; • changes in legal standards, claim resolution practices, and restoration costs; and • legislatively imposed consumer initiatives.In addition, we could underprice risks, which would negatively affect our profit margins. We could also overprice risks, which could reduce the numberof policies we write and our competitiveness. In either event, our profitability could be materially and adversely affected.The inherent uncertainty of models and our reliance on such models as a tool to evaluate risk may have an adverse effect on our financial results.We license analytic and modeling software from third parties to facilitate our pricing, assess our risk exposure and determine our reinsurance needs.Given the inherent uncertainty of modeling techniques and the application of such techniques, these models and databases may not accurately address theemergence of a variety of matters which might impact our exposure to losses. Accordingly, these models may understate the exposures we are assuming andour financial results may be adversely impacted, perhaps significantly.The failure of our claims department to effectively manage or remediate claims could adversely affect our insurance business, financial results andcapital requirements.We rely on our claims department to facilitate and oversee the claims adjustment process for our policyholders. Many factors could affect the ability ofour claims department to effectively manage claims by our policyholders, including: • the accuracy of our adjusters as they make their assessments and submit their estimates of damages; • the training, background and experience of our claims representatives; 19Source: Heritage Insurance Holdings, Inc., 10-K, March 18, 2015Powered by Morningstar® Document Research℠The information contained herein may not be copied, adapted or distributed and is not warranted to be accurate, complete or timely. The user assumes all risks for any damages or losses arising from any use of this information,except to the extent such damages or losses cannot be limited or excluded by applicable law. Past financial performance is no guarantee of future results.Table of Contents • the ability of our claims department to ensure consistent claims handling; • the ability of our claims department to translate the information provided by adjusters into acceptable claims resolutions; and • the ability of our claims department to maintain and update its claims handling procedures and systems as they evolve over time based on claimsand geographical trends in claims reporting.Any failure to effectively manage the claims adjustment process, including failure to pay claims accurately, could lead to material litigation,undermine our reputation in the marketplace, impair our corporate image and negatively affect our financial results.Additionally, in the final stage of the claims process, we leverage Contractors’ Alliance’s vendor network to provide repair and remediation services tothe policyholder. If such services are not performed properly, we may face liability. Although we maintain professional liability insurance to cover lossesarising from our repair and remediation services, there can be no assurances that such coverage is adequate. In addition, our failure to timely and properlyremediate claims, or the perception of such failure, may damage our reputation and adversely affect our ability to renew existing policies or write newpolicies.If actual renewals of our existing contracts do not meet expectations, our premiums written in future years and our future results of operations could bematerially adversely affected.Our insurance policies are written for a one-year term. We make assumptions about the renewal of our prior year’s contracts, including for purposes ofdetermining the amount of reinsurance we purchase. If actual renewals do not meet expectations or if we choose not to write on a renewal basis because ofpricing conditions, our premiums written in future years and our future operations would be materially adversely affected, and we may purchase reinsurancebeyond what we believe is the most appropriate level.Our participation in the new Clearinghouse may not result in an increase in our premium revenue.Part of our growth strategy includes participating in the Clearinghouse. On March 31, 2014, we were approved to participate in the Clearinghouse, butthere can be no assurance that our policy count or gross premiums will increase as a result of our participation in the Clearinghouse because our premiumsmay not be below the threshold required by Citizens, other carriers participating in the Clearinghouse may be willing to offer similar policies for lowerpremiums, or we may decide to not provide a quote on these policies if they do not meet our underwriting guidelines. To date, our participation in theclearinghouse has not resulted in a significant number of new policies.We may not be able to effectively execute our growth strategy.We may invest significant time and resources to develop and market new lines of business and/or products and services and we may not achieve thereturn on our investment that we expect. Initial timetables for the introduction and development of new lines of business and/or new products or services maynot be achieved and price and profitability targets may not prove feasible. External factors, such as compliance with regulations, competitive alternatives,and shifting customer preferences may also impact the successful implementation of a new line of business or a new product or service. Such external factorsand requirements may increase our costs and potentially affect the speed with which we will be able to pursue new market opportunities. There can be noassurance that we will be successful bringing new insurance products to our marketplace. Additionally, any new line of business and/or new product orservice could have a significant impact on the effectiveness of our system of internal controls. Failure to successfully manage these risks could have amaterial adverse effect on our business, results of operations and financial condition.Our growth strategy may also involve expansion of our business to states outside of Florida. Geographic diversification may be hindered by the factthat we have a limited operating history, and we may be unable to satisfy requirements imposed by state regulators and other third parties.If we are unable to expand our business because our capital must be used to pay greater than anticipated claims, our financial results may suffer.Further, we may require additional capital in the future which may not be available or may only be available on unfavorable terms.Our future growth and future capital requirements will depend on our ability to expand the number of insurance policies we assume or write in Florida,to expand the kinds of insurance products we offer and to expand the geographic 20Source: Heritage Insurance Holdings, Inc., 10-K, March 18, 2015Powered by Morningstar® Document Research℠The information contained herein may not be copied, adapted or distributed and is not warranted to be accurate, complete or timely. The user assumes all risks for any damages or losses arising from any use of this information,except to the extent such damages or losses cannot be limited or excluded by applicable law. Past financial performance is no guarantee of future results.Table of Contentsmarkets in which we do business, all balanced by the business risks we choose to assume and cede. All of these growth initiatives require capital. Our existingsources of funds include possible sales of common or preferred stock, incurring debt and our earnings from operations and investments. Unexpectedcatastrophic events in our coverage areas, such as the hurricanes experienced in Florida in the past decade, may result in greater claims losses thananticipated, which could require us to limit or halt our growth while we redeploy our capital to pay these unanticipated claims unless we are able to raiseadditional capital.To the extent that our present capital is insufficient to meet future operating requirements or to cover losses, we may need to raise additional fundsthrough financings or curtail our growth. Based on our current operating plan, we believe that our current capital together with our anticipated retainedincome will support our operations. However, we cannot provide any assurance in that regard, since many factors will affect the amount and timing of ourcapital needs, including our growth and profitability, the availability and cost of reinsurance, as well as possible acquisition opportunities, marketdisruptions and other unforeseeable developments. If we require additional capital, it is possible that equity or debt financing may not be available onacceptable terms or at all. In the case of equity financings, dilution to our stockholders could result, and in any case such securities may have rights,preferences and privileges that are senior to those of existing stockholders. If we cannot obtain adequate capital on favorable terms or at all, our business,financial condition or results of operations could be materially adversely affected.Our information technology systems, or those of our key service providers, may fail or suffer a loss of security which could adversely affect our business.Our insurance business is highly dependent upon the successful and uninterrupted functioning of our computer and data processing systems. We relyon these systems to perform actuarial and other modeling functions necessary for writing business, as well as to handle our policy administration process (i.e.,handling and adjusting claims, the printing and mailing of our policies, endorsements, renewal notices, etc.). The successful operation of our systems dependson a continuous supply of electricity. The failure of these systems or disruption in the supply of electricity could interrupt our operations and result in amaterial adverse effect on our business.The development and expansion of our insurance business is dependent upon the successful development and implementation of advancedtechnology, including modeling, underwriting and information technology systems. Because we intend to expand our business by writing additionalvoluntary policies and entering into new lines of business, we are enhancing our information technology systems to handle and process an increased volumeof policies. Additionally, we have engaged service providers to provide us with policy and other administration services for certain of our policies and weintend to continue to utilize third party systems as our policy count grows. The failure of any of these systems to function as planned could slow our growthand adversely affect our future business volume and results of operations. In addition, we have licensed certain systems and data from third parties. We cannotbe certain that we will have access to these, or comparable systems, or that our technology or applications will continue to operate as intended. Moreover, wecannot be certain that we would be able to replace these systems without slowing our underwriting response time. A major defect or failure in our internalcontrols or information technology systems could result in management distraction, harm to our reputation, a loss or delay of revenues or increased expense.In addition, a security breach of our computer systems could damage our reputation or result in liability. We retain confidential business andpolicyholder information in our computer systems. We may be required to spend significant capital and other resources to protect against security breaches orto alleviate problems caused by such breaches. It is critical that our facilities and infrastructure remain secure. Despite the implementation of securitymeasures, our infrastructure may be vulnerable to physical break-ins, computer viruses, programming errors, attacks by third parties or similar disruptiveproblems. In addition, we could be subject to liability if hackers were able to penetrate our network security or otherwise misappropriate confidentialinformation.The development and implementation of new technologies will require an additional investment of our capital resources in the future.Frequent technological changes, new products and services and evolving industry standards are all influencing the insurance business. We believe thatthe development and implementation of new technologies will require additional investment of our capital resources in the future. We have not determined,however, the amount of resources and the time that this development and implementation may require, which may result in short-term, unexpectedinterruptions to our business, or may result in a competitive disadvantage in price and/or efficiency, as we endeavor to develop or implement newtechnologies. 21Source: Heritage Insurance Holdings, Inc., 10-K, March 18, 2015Powered by Morningstar® Document Research℠The information contained herein may not be copied, adapted or distributed and is not warranted to be accurate, complete or timely. The user assumes all risks for any damages or losses arising from any use of this information,except to the extent such damages or losses cannot be limited or excluded by applicable law. Past financial performance is no guarantee of future results.Table of ContentsWe do not have significant redundancy in our operations.We conduct our business primarily from offices located on the west coast of Florida where hurricanes could damage our facilities or interrupt our powersupply. The loss or significant impairment of functionality in these facilities for any reason could have a material adverse effect on our business, as we do nothave significant redundancies to replace our facilities if functionality is impaired. We contract with a third party vendor to maintain complete daily backupsof our systems, however, we have not fully tested our plan to recover data in the event of a disaster.We may be unable to attract and retain qualified employees.We depend on our ability to attract and retain experienced underwriting talent and other skilled employees who are knowledgeable about our business.If the quality of our underwriters and other personnel decreases, we may be unable to maintain our current competitive position in the specialized markets inwhich we operate and be unable to expand our operations, which could adversely affect our results.Because we began operations in August 2012 and have relatively few employees, the loss of, or failure to attract, key personnel could have a moresignificant impact on our business as compared to some of our competitors that are larger or have longer operating histories. We believe that our ability togrow and fully execute our business plan will depend in large part on our ability to attract and retain additional skilled and qualified personnel and toexpand, train and manage our employees. We may not be successful in doing so, because the competition for experienced personnel in the insurance industryis intense.We are dependent on key executives, the loss of whom could adversely affect our business.Our future success depends to a significant extent on the efforts of our senior management. We believe there are only a limited number of available andqualified executives with substantial experience in our industry. Accordingly, the loss of the services of one or more of the members of our seniormanagement could delay or prevent us from fully implementing our business strategy and, consequently, significantly and negatively affect our business.Currently, we only maintain key man life insurance with respect to Bruce Lucas, our Chairman and Chief Executive Officer. If any other member ofsenior management dies or becomes incapacitated, or leaves the company to pursue employment opportunities elsewhere, we would be solely responsible forlocating an adequate replacement for such senior management and for bearing any related cost. To the extent that we are unable to locate an adequatereplacement or are unable to do so within a reasonable period of time, our business may be significantly and negatively affected.Our financial results may be negatively affected by the fact that a portion of our income is generated by the investment of our company’s capital,premiums and loss reserves.A portion of our income is, and likely will continue to be, generated by the investment of our capital, premiums and loss reserves. The amount ofincome so generated is a function of our investment policy, available investment opportunities and the amount of available cash invested. We are alsoconstrained by investment limitations contained in the Florida Insurance Code. At December 31, 2014, approximately 66% of our total investments, cash andcash equivalents was invested in fixed-maturity and equity securities and mortgage loans with the balance in cash and cash equivalents. We may, undercertain circumstances, be required to liquidate our investments in securities at prices below book value, which may adversely affect our financial results. Wecurrently hold all of our cash in accounts with three financial institutions and, as a result of this concentration, a portion of the balances in such accountsexceeds the FDIC insurance limits. While we monitor and adjust the balances in our accounts as appropriate, these balances could be impacted if any of thesefinancial institutions fail and could be subject to other adverse conditions in the financial markets.We may alter our investment policy to accept higher levels of risk with the expectation of higher returns. Fluctuating interest rates and other economicfactors make it impossible to estimate accurately the amount of investment income that will be realized. In fact, we may realize losses on our investments.Our inability to maintain our financial stability rating may have a material adverse effect on our competitive position, the marketability of our productofferings, and our liquidity, operating results and financial condition.Financial stability ratings are important factors in establishing the competitive position of insurance companies and can have a significant effect on aninsurance company’s business. Many insurance buyers, agents, brokers and secured lenders use the ratings assigned by rating agencies to assist them inassessing the financial stability and overall quality of the companies from which they are considering purchasing insurance or in determining the financialstability of the company that provides insurance. We currently have a Demotech rating of “A” (“Exceptional”). This is the third highest financial stability 22Source: Heritage Insurance Holdings, Inc., 10-K, March 18, 2015Powered by Morningstar® Document Research℠The information contained herein may not be copied, adapted or distributed and is not warranted to be accurate, complete or timely. The user assumes all risks for any damages or losses arising from any use of this information,except to the extent such damages or losses cannot be limited or excluded by applicable law. Past financial performance is no guarantee of future results.Table of Contentsrating of the six financial stability ratings utilized by Demotech. These financial stability ratings provide an objective baseline for assessing solvency andshould not be interpreted as (and are not intended to serve as) an assessment of, a recommendation to buy, sell, or hold, any securities of an insurancecompany or its parent holding company, including the shares of our common stock being offered by this prospectus.On an ongoing basis, rating agencies review the financial performance and condition of insurers and can downgrade or change the outlook on aninsurer’s ratings due to, for example, a change in an insurer’s statutory capital, a reduced confidence in management or a host of other considerations that mayor may not be under the insurer’s control. All ratings are subject to continuous review; therefore, the retention of these ratings cannot be assured. Adowngrade in any of these ratings could have a material adverse effect on our competitive position, the marketability of our product offerings and our abilityto grow in the marketplace.The effects of emerging claim and coverage issues on our business are uncertain.Loss severity in the property and casualty insurance industry has continued to increase in recent years, principally driven by larger court judgments. Inaddition, many legal actions and proceedings have been brought on behalf of classes of complainants, which can increase the size of judgments. Thepropensity of policyholders and third party claimants to litigate and the willingness of courts to expand causes of loss and the size of awards may render theloss reserves of our insurance subsidiary inadequate for current and future losses. In addition, as industry practices and social and other environmentalconditions change, unexpected and unintended issues related to claims and coverage may emerge. These issues may adversely affect our business by eitherextending coverage beyond our underwriting intent or by increasing the number or size of claims. In some instances, these changes may not become apparentuntil sometime after we have issued insurance policies that are affected by the changes. As a result, the full extent of liability under our insurance policiesmay not be known at the time such policies are issued or renewed, and our financial position and results of operations may be adversely affected.The failure of the risk mitigation strategies we utilize could have a material adverse effect on our financial condition or results of operations.We utilize a number of strategies to mitigate our risk exposure including: • employing proper underwriting procedures; • carefully evaluating the terms and conditions of our policies; • geographic diversification; and • ceding insurance risk to reinsurance companies.However, there are inherent limitations in all of these tactics. No assurance can be given that an event or series of unanticipated events will not result inloss levels which could have a material adverse effect on our financial condition or results of operations.Lack of effectiveness of exclusions and other loss limitation methods in the insurance policies we assume or write could have a material adverse effecton our financial condition or our results of operations.Various provisions of our policies, such as limitations or exclusions from coverage which are designed to limit our risks, may not be enforceable in themanner we intend. In addition, the policies we issue contain conditions requiring the prompt reporting of claims to us and our right to decline coverage in theevent of a violation of that condition. While our insurance product exclusions and limitations reduce the loss exposure to us and help eliminate knownexposures to certain risks, it is possible that a court or regulatory authority could nullify or void an exclusion or limitation, or legislation could be enactedmodifying or barring the use of such endorsements and limitations in a way that would adversely affect our loss experience, which could have a materialadverse effect on our financial condition or results of operations.We rely on independent agents to write voluntary insurance policies for us, and if we are not able to attract and retain independent agents, our revenueswould be negatively affected.We write voluntary personal and commercial insurance policies through a network of independent agents including those policies acquired from SSIC.Of our network of approximately 1,300 independent agents, approximately 55% are affiliated with eight large agency networks with which we have enteredinto master agency agreements. As of December 31, 2014, voluntary policies written through independent agents including the policies we acquired fromSSIC, constituted 23Source: Heritage Insurance Holdings, Inc., 10-K, March 18, 2015Powered by Morningstar® Document Research℠The information contained herein may not be copied, adapted or distributed and is not warranted to be accurate, complete or timely. The user assumes all risks for any damages or losses arising from any use of this information,except to the extent such damages or losses cannot be limited or excluded by applicable law. Past financial performance is no guarantee of future results.Table of Contentsapproximately 25.9% of our total policies in force and represented approximately $95.9 million in annualized premiums. We expect to increase the numberof voluntary policies we write as our business expands, which will further increase our reliance on our network of independent agents. In fact, in the future, wemay rely on independent agents to be the primary source for our property insurance policies. If any of our independent agents cease writing policies for us, orif any of our master agency agreements are terminated, we may suffer a reduction in the amount of products we are able to sell, which would negativelyimpact our results.Many of our competitors also rely on independent agents. As a result, we must compete with other insurers for independent agents’ business. Ourcompetitors may offer a greater variety of insurance products, lower premiums for insurance coverage, or higher commissions to their agents. If our products,pricing and commissions do not remain competitive, we may find it more difficult to attract business from independent agents to sell our products.Changing climate conditions may adversely affect our financial condition, profitability or cash flows.Climate change, to the extent it produces extreme changes in temperatures and changes in weather patterns, could affect the frequency or severity ofweather events. Further, it could reduce the affordability and availability of personal residential insurance, which could have an effect on pricing. Changes inweather patterns could also affect the frequency and severity of other natural catastrophe events to which we may be exposed.We identified material weaknesses in our internal controls over financial reporting. If we are unable to implement and maintain effective internalcontrols over financial reporting in the future, investors may lose confidence in the accuracy and completeness of our financial reports and the marketprice of our common stock may be negatively affected.As a public company, we are required to maintain internal controls over financial reporting and to report any material weaknesses in such internalcontrols. A material weakness is a deficiency, or a combination of deficiencies, in internal control over financial reporting, such that there is a reasonablepossibility that a material misstatement of a company’s annual or interim financial statements will not be prevented or detected on a timely basis. Section 404of the Sarbanes-Oxley Act of 2002 (the “Sarbanes-Oxley Act”) requires that we evaluate and determine the effectiveness of our internal controls overfinancial reporting and, beginning with our Annual Report for the year ending December 31, 2015, provide a management report on the internal controls overfinancial reporting. If we have a material weakness in our internal controls over financial reporting, we may not detect errors on a timely basis and ourfinancial statements may be materially misstated. We are in the process of designing and implementing the internal controls over financial reporting requiredto comply with this obligation, which process will be time consuming, costly, and complicated.As previously reported on our Form S-1 effective May 22, 2014 and quarter’s reports on Forms 10-Q issued during 2014, we have material weaknessesin our internal control over financial reporting related to, among other things, accounting for stock based compensation, equity transactions and incometaxes. With the oversight of senior management, we have taken steps to remediate the underlying causes of these material weaknesses, primarily through thedevelopment and implementation of formal policies, improved processes, as well as the hiring additional finance personnel, and the outsourcing of morecomplex accounting matters to third party consultants. We will continue to monitor the effectiveness of these remediation efforts as we consider in futurereporting periods whether such control deficiencies have been fully remediated.The occurrence of any of the following may cause investors to lose confidence in the accuracy and completeness of our financial reports and couldnegatively impact the price of our common stock: • our inability to remediate the material weaknesses discussed above; • identification of additional material weaknesses in our internal controls over financial reporting; • our inability to comply with the requirements of Section 404 of the Sarbanes-Oxley Act in a timely manner; • our inability to assert that our internal controls over financial reporting are effective; or • our independent registered public accounting firm’s inability to express an opinion as to the effectiveness of our internal controls over financialreporting.If any of the foregoing occur, we may also become subject to investigations by the stock exchange on which our common stock is listed, the Securitiesand Exchange Commission (“SEC”) or other regulatory authorities, as well as lawsuits by private plaintiffs. 24Source: Heritage Insurance Holdings, Inc., 10-K, March 18, 2015Powered by Morningstar® Document Research℠The information contained herein may not be copied, adapted or distributed and is not warranted to be accurate, complete or timely. The user assumes all risks for any damages or losses arising from any use of this information,except to the extent such damages or losses cannot be limited or excluded by applicable law. Past financial performance is no guarantee of future results.Table of ContentsThe requirements of being a public company have increased certain of our costs and require significant management focus.As a public company, our legal, accounting and other expenses associated with compliance related and other activities have increased. For example, inconnection with our initial public offering, we created new board committees and appointed independent directors to comply with the corporate governancerequirements of the NYSE. In addition, our management team and board of directors have limited experience implementing public company compliancerequirements, and therefore, since our initial public offering, our management and other personnel have diverted attention from operational and otherbusiness matters to devote substantial time to such efforts. In particular, we have incurred significant expenses and devoted substantial management efforttoward ensuring compliance with the requirements of Section 404 of the Sarbanes-Oxley Act, which will increase when we are no longer an emerging growthcompany, as defined in The Jumpstart Our Business Act of 2012 (the “JOBS Act”). We have hired additional accounting and financial staff with appropriatepublic company experience and technical accounting knowledge and have established an internal audit function. Costs to obtain director and officerliability insurance also contribute to our increased costs. As a result of the associated liability, it may be more difficult for us to attract and retain qualifiedpersons to serve on our board of directors or as executive officers. Advocacy efforts by stockholders and third parties may also prompt even more changes ingovernance and reporting requirements, which could further increase our compliance costs.We are an “emerging growth company” and we cannot be certain if the reduced disclosure and other requirements applicable to emerging growthcompanies will make our common stock less attractive to investors.We are an “emerging growth company,” as defined in the JOBS Act, and we currently and may in the future take advantage of certain exemptions fromvarious reporting requirements that are applicable to other public companies that are not “emerging growth companies” including, but not limited to, notbeing required to comply with the auditor attestation requirements of Section 404 of the Sarbanes-Oxley Act with respect to our internal control overfinancial reporting, reduced disclosure obligations regarding executive compensation in our periodic reports and proxy statements, and exemptions from therequirements of holding a nonbinding advisory vote on executive compensation and stockholder approval of any golden parachute payments not previouslyapproved. We may take advantage of these provisions for up to five years from our initial public offering or such earlier time that we are no longer an“emerging growth company.” We would cease to be an “emerging growth company” upon the earliest to occur of: (i) the last day of the year in which wehave more than $1.0 billion in annual revenues; (ii) the date we qualify as a “large accelerated filer,” with at least $700 million of equity securities; (iii) theissuance, in any three-year period, by our company of more than $1.0 billion in non-convertible debt securities held by non-affiliates; and (iv) the last day ofthe year ending after the fifth anniversary of our initial public offering. We may choose to take advantage of some but not all of these reduced reporting andother burdens. To the extent we take advantage of any of the reduced reporting burdens in this prospectus or in future filings, the information that we provideour security holders may be different than you might get from other public companies in which you hold equity interests. We cannot predict if investors willfind our common stock less attractive because we may rely on these exemptions. If some investors find our common stock less attractive as a result, there maybe a less active trading market for our common stock and our stock price may be more volatile.In addition, Section 107 of the JOBS Act provides that an “emerging growth company” can take advantage of the extended transition period providedin Section 7(a)(2)(B) of the Securities Act for complying with new or revised accounting standards. In other words, an “emerging growth company” can delaythe adoption of certain accounting standards until those standards would otherwise apply to private companies. We have chosen to “opt- out” of suchextended transition period, however, and, as a result, we will comply with new or revised accounting standards on the relevant dates on which adoption ofsuch standards is required for non-emerging growth companies. Section 107 of the JOBS Act provides that our decision to opt-out of the extended transitionperiod for complying with new or revised accounting standards is irrevocable.Risks Related to Regulation of our Insurance OperationsWe are subject to extensive regulation which may reduce our profitability or limit our growth. Moreover, if we fail to comply with these regulations, wemay be subject to penalties, including fines and suspensions, which may adversely affect our financial condition and results of operations.We are subject to extensive state regulation. Heritage P&C is subject to supervision and regulation that is primarily designed to protect ourpolicyholders rather than our stockholders, and such regulation is imposed by both the state in which it is domiciled (Florida) and the states in which it doesbusiness (currently only Florida). These regulations relate to, among other things, the approval of policy forms and premium rates, our conduct in themarketplace, our compliance with solvency and financial reporting requirements, transactions with our affiliates, and limitations on the amount of businesswe can write, 25Source: Heritage Insurance Holdings, Inc., 10-K, March 18, 2015Powered by Morningstar® Document Research℠The information contained herein may not be copied, adapted or distributed and is not warranted to be accurate, complete or timely. The user assumes all risks for any damages or losses arising from any use of this information,except to the extent such damages or losses cannot be limited or excluded by applicable law. Past financial performance is no guarantee of future results.Table of Contentsthe amount of dividends we can pay to stockholders, and the types of investments we can make. Insurance holding company regulations generally providethat transactions between an insurance company and its affiliates must be fair and reasonable, and must be clearly and accurately disclosed in the records ofthe respective parties, with expenses and payments allocated between the parties in accordance with customary accounting practices. Many types oftransactions between an insurance company and its affiliates, such as transfers of assets, loans, reinsurance agreements, service agreements, certain dividendpayments by the insurance company and certain other material transactions, may be subject to prior approval by, or prior notice to, state regulatoryauthorities. If we are unable to obtain the requisite prior approval for a specific transaction, we would be precluded from taking the action, which couldadversely affect our operations. These regulatory requirements may adversely affect or inhibit our ability to achieve some or all of our business objectives. Inaddition, regulatory authorities also may conduct periodic examinations into insurers’ business practices. These reviews may reveal deficiencies in ourinsurance operations or differences between our interpretations of regulatory requirements and those of the regulators.State insurance regulations also frequently impose notice or approval requirements for the acquisition of specified levels of ownership in the insurancecompany or insurance holding company. For example, Florida law requires that a person may not, individually or in conjunction with any affiliated person ofsuch person, acquire directly or indirectly, conclude a tender offer or exchange offer for, enter into any agreement to exchange securities for, or otherwisefinally acquire 5% or more of the outstanding voting securities of a Florida domiciled stock insurer or of a controlling company, unless it is in compliancewith certain notice and approval requirements. Such restriction may inhibit our ability to grow our business or achieve our business objectives.Further, regulatory authorities have relatively broad discretion to deny or revoke licenses for various reasons, including the violation of regulations. Insome instances, we follow practices based on our interpretations of regulations or practices that we believe may be generally followed by the industry. Thesepractices may turn out to be different from the interpretations of regulatory authorities. If we do not have the requisite licenses and approvals or do notcomply with applicable regulatory requirements, insurance regulatory authorities could preclude or temporarily suspend us from carrying on some or all ofour activities or otherwise penalize us. This could adversely affect our ability to operate our business.Heritage P&C is subject to additional regulation imposed by consent orders entered into with FLOIR in connection with our formation.In addition to compliance with statutes and regulations, Florida routinely places additional restrictions on new insurers as a condition of receivingtheir certificate of authority. These restrictions are typically memorialized in a consent order entered into between FLOIR and the insurer applying for acertificate of authority. We are subject to such a consent order. We have, in certain cases, agreed to higher or more stringent restrictions than are otherwiserequired under Florida law. The material restrictions we have agreed to include: • Florida law requires a residential property writer to maintain surplus of the greater of $15.0 million or 10% of its liabilities. Pursuant the consentorder, we agreed to establish a minimum capital and surplus of $18.0 million. • Florida law restricts the ratio of premiums written to policyholder surplus to 10 to 1 on a gross basis and 4 to 1 on a net of reinsurance basis.Pursuant to the consent order, we agreed to not exceed the projected premiums in the plan of operation submitted with our original applicationfor licensure without the prior written approval of FLOIR during 2012, 2013 and 2014. As part of the FLOIR approval process for the variousCitizens assumption transactions in which we have participated, we have received approval to exceed these projected premiums. • Florida law places no restrictions on the parent of an insurer, or other upstream entities, with regard to the payment of dividends. Pursuant to theconsent order, we agreed to not make any distributions to stockholders prior to July 31, 2015, except such distributions as are required to offsetstockholders’ tax obligations resulting from the ownership of our equity or such distributions as may be approved by FLOIR in advance and inwriting. • Florida law allows an insurer to pay certain dividends to stockholders without approval of FLOIR. Pursuant to the consent order, we agreed that,until July 31, 2017, Heritage P&C would pay only those dividends that have been approved in advance and in writing by FLOIR.In addition, we are subject to several consent orders setting conditions upon FLOIR’s approval of the various Citizens assumption transactions inwhich we have participated. For example, beginning with our June 2013 assumption transaction, we are required to offer to renew each assumed policy for aminimum of three years and limit rate increases to the higher of those offered by Citizens for comparable risks or 10%. 26Source: Heritage Insurance Holdings, Inc., 10-K, March 18, 2015Powered by Morningstar® Document Research℠The information contained herein may not be copied, adapted or distributed and is not warranted to be accurate, complete or timely. The user assumes all risks for any damages or losses arising from any use of this information,except to the extent such damages or losses cannot be limited or excluded by applicable law. Past financial performance is no guarantee of future results.Table of ContentsIn the event we are unable to comply with the additional regulation imposed by these consent orders, it may adversely affect our ability to operate ourbusiness.Changes in regulation may reduce our profitability and limit our growth.We are subject to extensive regulation in Florida, the only state in which we currently conduct business. The National Association of InsuranceCommissioners (“NAIC”) and state insurance regulators are constantly reexamining existing laws and regulations, generally focusing on modifications toholding company regulations, interpretations of existing laws and the development of new laws. For example, in 2013 FLOIR asked the Florida legislature toamend the Florida Insurance Code in conformity with the latest amendments to the NAIC Model Holding Company System Regulatory Act. Among otherthings, such amendments would require the ultimate controlling person of any Florida insurance company to file an Annual Report identifying the materialrisks within the insurance holding company system that could pose enterprise risk to the insurance company. The proposed legislation was not enacted in2013, but is expected to be reintroduced and eventually enacted into law.From time to time, states consider and/or enact laws that may alter or increase state authority to regulate insurance companies and insurance holdingcompanies. States also consider and/or enact laws that impact the competitive environment and marketplace for property and casualty insurance. Ourinsurance company subsidiary currently transacts insurance only in Florida, where the recent political environment has led to aggressive regulation ofproperty and casualty insurance companies. We expect this to continue for the foreseeable future. For example, in 2007, Florida enacted legislation that ledto rate levels in the private insurance market that we believe, in many instances in the past, were inadequate to cover the related underwriting risk. This samelegislation required Citizens to reduce its premium rates and begin competing against private insurers in the Florida residential property insurance market.Florida lawmakers may continue to enact or retain legislation that suppresses the rates of Citizens, further adversely impacting the private insurance marketand increasing the likelihood that it must levy assessments on private insurance companies and ultimately on Florida consumers. These and other aspects ofthe political environment in jurisdictions where we operate may reduce our profitability, limit our growth, or otherwise adversely affect our operations.During the past several years, various regulatory and legislative bodies have adopted or proposed new laws or regulations to address the cyclical natureof the insurance industry, catastrophic events and insurance capacity and pricing. These regulations include (i) the creation of “market assistance plans”under which insurers are induced to provide certain coverages, (ii) restrictions on the ability of insurers to rescind or otherwise cancel certain policies in mid-term or to nonrenew policies at their scheduled expirations, (iii) advance notice requirements or limitations imposed for certain policy non-renewals,(iv) limitations upon or decreases in rates permitted to be charged, (v) expansion of governmental involvement in the insurance market and (vi) increasedregulation of insurers’ policy administration and claims handling practices.Currently, the federal government does not directly regulate the insurance business. However, in recent years the state insurance regulatory frameworkhas come under increased federal scrutiny. Congress and some federal agencies from time to time investigate the current condition of insurance regulation inthe United States to determine whether to impose federal regulation or to allow an optional federal charter, similar to banks. In addition, changes in federallegislation and administrative policies in several areas, including changes in the Gramm-Leach-Bliley Act, financial services regulation and federal taxation,can significantly impact the insurance industry and us.We cannot predict with certainty the effect any enacted, proposed or future state or federal legislation or NAIC initiatives may have on the conduct ofour business. Furthermore, there can be no assurance that the regulatory requirements applicable to our business will not become more stringent in the futureor result in materially higher costs than current requirements, or that creation of a federal insurance regulatory system will not adversely affect our business ordisproportionately benefit our competitors. Changes in the regulation of our business may reduce our profitability, limit our growth or otherwise adverselyaffect our operations.Our insurance subsidiary is subject to minimum capital and surplus requirements, and our failure to meet these requirements could subject us toregulatory action.Our insurance subsidiary is subject to risk-based capital standards and other minimum capital and surplus requirements imposed under applicable statelaws, currently the laws of Florida. The risk-based capital standards, based upon the Risk-Based Capital Model Act adopted by the NAIC, require ourinsurance subsidiary to report its results of risk-based capital calculations to FLOIR and the NAIC. These risk-based capital standards provide for differentlevels of regulatory attention depending upon the ratio of an insurance company’s total adjusted capital, as calculated in accordance with NAIC guidelines,to its authorized control level risk-based capital. Authorized control level risk-based capital is determined using the NAIC’s risk-based capital formula, whichmeasures the minimum amount of capital that an insurance company needs to support its overall business operations. 27Source: Heritage Insurance Holdings, Inc., 10-K, March 18, 2015Powered by Morningstar® Document Research℠The information contained herein may not be copied, adapted or distributed and is not warranted to be accurate, complete or timely. The user assumes all risks for any damages or losses arising from any use of this information,except to the extent such damages or losses cannot be limited or excluded by applicable law. Past financial performance is no guarantee of future results.Table of ContentsAn insurance company with total adjusted capital that is less than 200% of its authorized control level risk-based capital is at a company action level,which would require the insurance company to file a risk-based capital plan that, among other things, contains proposals of corrective actions the companyintends to take that are reasonably expected to result in the elimination of the company action level event. Additional action level events occur when theinsurer’s total adjusted capital falls below 150%, 100%, and 70% of its authorized control level risk-based capital. The lower the percentage, the more severethe regulatory response, including, in the event of a mandatory control level event (total adjusted capital falls below 70% of the insurer’s authorized controllevel risk-based capital), placing the insurance company into receivership. As of December 31, 2014, Heritage P&C’s risk-based capital ratio was 459%In addition, our insurance subsidiary is required to maintain certain minimum capital and surplus and to limit its written premiums to specifiedmultiples of its capital and surplus. The insurance subsidiary could exceed these ratios if its volume increases faster than anticipated or if its surplus declinesdue to catastrophe or non-catastrophe losses or excessive underwriting and operational expenses.Florida law requires a residential property writer to maintain surplus of the greater of $15.0 million or 10% of its liabilities. Pursuant to the consentorder we entered into in connection with receiving our certificate of authority, we agreed to establish a minimum capital and surplus of $18.0 million. As ofDecember 31, 2014, our insurance subsidiary held surplus of $172.7 million. Florida law also restricts the ratio of premiums written to policyholder surplus to10 to 1 on a gross basis and 4 to 1 on a net of reinsurance basis. As of December 31, 2014, our insurance subsidiary’s gross and net writing ratios were 2.5 to 1and 1.9 to 1, respectively. Pursuant to the consent order, we agreed to not exceed the projected premiums in the plan of operation submitted with our originalapplication for licensure without the prior written approval of FLOIR during 2012, 2013, and 2014. As part of the FLOIR approval process for the variousCitizens assumption transactions in which we have participated, we have received approval to exceed these projected premiums.Any failure by our insurance subsidiary to meet the applicable risk-based capital or minimum statutory capital requirements or the writings ratiolimitations imposed by the laws of Florida (or other states where we may eventually conduct business) could subject it to further examination or correctiveaction imposed by state regulators, including limitations on our writing of additional business, state supervision or liquidation.Any changes in existing risk-based capital requirements, minimum statutory capital requirements, or applicable writings ratios may require us toincrease our statutory capital levels, which we may be unable to do.Regulation limiting rate increases and requiring us to participate in loss sharing may decrease our profitability.From time to time, political dispositions affect the insurance market, including efforts to effectively suppress rates at a level that may not allow us toreach targeted levels of profitability. Despite efforts to remove politics from insurance regulation, facts and history demonstrate that public policymakers,when faced with untoward events and adverse public sentiment, can act in ways that impede a satisfactory correlation between rates and risk. Such acts mayaffect our ability to obtain approval for rate changes that may be required to attain rate adequacy along with targeted levels of profitability and returns onequity. Our ability to afford reinsurance required to reduce our catastrophe risk may be dependent upon the ability to adjust rates for our cost.Additionally, we are required to participate in guaranty funds for insolvent insurance companies. The funds periodically assess losses against allinsurance companies doing business in the state. Our operating results and financial condition could be adversely affected by any of these factors.Risks Relating to Ownership of Our Common StockThe price of our common stock may fluctuate significantly, and you could lose all or part of your investment.Volatility in the market price of our common stock may prevent you from being able to sell your shares at or above the price you paid for them. Themarket price for our common stock could fluctuate significantly for various reasons, including: • our operating and financial performance and prospects; • our quarterly or annual earnings or those of other companies in our industry; • the public’s reaction to our press releases, our other public announcements and our filings with the SEC; • changes in, or failure to meet, earnings estimates or recommendations by research analysts who track our common stock or the stock of othercompanies in our industry; 28Source: Heritage Insurance Holdings, Inc., 10-K, March 18, 2015Powered by Morningstar® Document Research℠The information contained herein may not be copied, adapted or distributed and is not warranted to be accurate, complete or timely. The user assumes all risks for any damages or losses arising from any use of this information,except to the extent such damages or losses cannot be limited or excluded by applicable law. Past financial performance is no guarantee of future results.Table of Contents • the failure of research analysts to cover our common stock; • general economic, industry and market conditions; • strategic actions by us, our customers or our competitors, such as acquisitions or restructurings; • new laws or regulations or new interpretations of existing laws or regulations applicable to our business; • changes in accounting standards, policies, guidance, interpretations or principles; • material litigation or government investigations; • changes in general conditions in the U.S. and global economies or financial markets, including those resulting from war, incidents of terrorism orresponses to such events; • changes in key personnel; • sales of common stock by us, our principal stockholders or members of our management team; • the granting or exercise of employee stock options; • volume of trading in our common stock; and • impact of the facts described elsewhere in “Risk Factors.”In addition, in recent years, the stock market has regularly experienced significant price and volume fluctuations. This volatility has had a significantimpact on the market price of securities issued by many companies, including companies in our industry. The changes frequently appear to occur withoutregard to the operating performance of the affected companies. Hence, the price of our common stock could fluctuate based upon factors that have little ornothing to do with us and these fluctuations could materially reduce our share price.We do not currently intend to pay dividends on our common stock.We do not anticipate paying any cash dividends on our common stock for the foreseeable future. Instead, we intend to retain future earnings to fundour growth. In addition, as a holding company, our ability to pay dividends will depend on amounts that our subsidiaries are able to pay us. We have agreedto refrain from making distributions to our equity holders through July 31, 2015, except for such distributions as are required to offset holders’ taxobligations or as may be approved by FLOIR in advance and in writing. Further, for a five-year period beginning on July 31, 2012, Heritage P&C, as a newlylicensed insurer in Florida, is precluded from paying dividends unless approved by FLOIR. There is no guarantee that we or Heritage P&C will elect to paydividends when permitted to do so. Finally, business and regulatory considerations may impact the amount of dividends actually paid, and prior approval ofdividend payments may be required. Therefore, you may not receive a return on your investment in our common stock by receiving a payment of dividends.Heritage Insurance Holdings, Inc. is a holding company and does not conduct any substantive operations. As a result, its ability to pay dividends willbe dependent upon the financial results and cash flows of its operating subsidiaries and the distribution or other payment of cash to it in the form ofdividends or otherwise. The direct and indirect subsidiaries of the issuer are separate and distinct legal entities and have no obligation to make any fundsavailable to the issuer.In addition, the declaration and payment of dividends will be at the discretion of our board of directors and will be dependent upon the profits andfinancial requirements of our company and other factors, including legal and regulatory restrictions on the payment of dividends, general business conditionsand such other factors as our board of directors deems relevant. 29Source: Heritage Insurance Holdings, Inc., 10-K, March 18, 2015Powered by Morningstar® Document Research℠The information contained herein may not be copied, adapted or distributed and is not warranted to be accurate, complete or timely. The user assumes all risks for any damages or losses arising from any use of this information,except to the extent such damages or losses cannot be limited or excluded by applicable law. Past financial performance is no guarantee of future results.Table of ContentsCertain provisions of our certificate of incorporation and our bylaws may make it difficult for stockholders to change the composition of our board ofdirectors and may discourage hostile takeover attempts that some of our stockholders may consider to be beneficial.Certain provisions of our certificate of incorporation and bylaws may have the effect of delaying or preventing changes in control if our board ofdirectors determines that such changes in control are not in the best interests of us and our stockholders. The provisions in such certificate of incorporationand bylaws will include, among other things, the following: • the ability of our board of directors to issue shares of preferred stock and to determine the price and other terms, including preferences and votingrights, of those shares without stockholder approval; • stockholder action can only be taken at a special or regular meeting and not by written consent; • advance notice procedures for nominating candidates to our board of directors or presenting matters at stockholder meetings; • removal of directors only for cause; and • allowing only our board of directors to fill vacancies on our board of directors.We have elected in our certificate of incorporation not to be subject to Section 203 of the DGCL, an anti-takeover law. In general, Section 203prohibits a publicly held Delaware corporation from engaging in a business combination, such as a merger, with a person or group owning 15% or more of thecorporation’s voting stock for a period of three years following the date the person became an interested stockholder, unless (with certain exceptions) thebusiness combination or the transaction in which the person became an interested stockholder is approved in a prescribed manner. Accordingly, we will notbe subject to any anti-takeover effects of Section 203.While these provisions have the effect of encouraging persons seeking to acquire control of our company to negotiate with our board of directors, theycould enable the board of directors to hinder or frustrate a transaction that some, or a majority, of the stockholders might believe to be in their best interests,including an acquisition that would result in a price per share at a premium over the market price, and, in that case, may prevent or discourage attempts toremove and replace incumbent directors.These provisions may frustrate or prevent any attempts by our stockholders to replace or remove our current management by making it more difficultfor stockholders to replace members of our board of directors, which is responsible for appointing the members of our management.Applicable insurance laws may make it difficult to effect a change of control of our company.State insurance holding company laws require prior approval by the state insurance department of any change of control of an insurer that is domiciledin that respective state. “Control” is generally defined as the possession, direct or indirect, of the power to direct or cause the direction of the managementand policies of a company, whether through the ownership of voting securities, by contract or otherwise. Control is generally presumed to exist through thedirect or indirect ownership of 10% or more of the voting securities of a domestic insurance company or any entity that controls adomestic insurance company. Because Heritage P&C is domiciled in Florida, we are subject to Florida law, which prohibits any person from acquiring 5% ormore of our outstanding voting securities without the prior approval of FLOIR. However, a party acquiring more than 5% but less than 10% of our votingsecurities that does not otherwise exercise control may make such acquisition without prior approval by filing a disclaimer of affiliation and control withFLOIR. These laws may discourage potential acquisition proposals and may delay, deter or prevent a change of control of us, including through transactions,and in particular unsolicited transactions, that some or all of our stockholders might consider to be desirable.Any issuance of preferred stock could make it difficult for another company to acquire us or could otherwise adversely affect holders of our commonstock, which could depress the price of our common stock.Our board of directors has the authority to issue preferred stock and to determine the preferences, limitations and relative rights of shares of preferredstock and to fix the number of shares constituting any series and the designation of such series, without any further vote or action by our stockholders. Ourpreferred stock could be issued with voting, liquidation, dividend and other rights superior to the rights of our common stock. The potential issuance ofpreferred stock may delay or prevent a change in control of us, discouraging bids for our common stock at a premium over the market price, and adverselyaffect the market price and the voting and other rights of the holders of our common stock. 30Source: Heritage Insurance Holdings, Inc., 10-K, March 18, 2015Powered by Morningstar® Document Research℠The information contained herein may not be copied, adapted or distributed and is not warranted to be accurate, complete or timely. The user assumes all risks for any damages or losses arising from any use of this information,except to the extent such damages or losses cannot be limited or excluded by applicable law. Past financial performance is no guarantee of future results.Table of ContentsOur business and stock price may suffer as a result of our limited public company operating experience. In addition, if securities or industry analysts donot publish research or publish inaccurate or unfavorable research about our business, our stock price and trading volume could decline.We completed our initial public offering in May 2014. Our limited public company operating experience may make it difficult to forecast and evaluateour future prospects. If we are unable to execute our business strategy, either as a result of our inability to effectively manage our business in a publiccompany environment or for any other reason, our business, prospects, financial condition and results of operations may be harmed. In addition, no or veryfew securities or industry analysts cover of our company, the trading price for our stock would be negatively impacted. If one or more of the analysts whocovers us downgrades our stock or publishes inaccurate or unfavorable research about our business, our stock price would likely decline. If one or more ofthese analysts ceases coverage of us or fails to publish reports on us regularly, demand for our stock could decrease, which could cause our stock price andtrading volume to decline.Item 1B. Unresolved Staff CommentsNoneItem 2. PropertiesIn April 2013, we purchased a two-building 13-acre campus located in Clearwater, Florida for aggregate consideration of $9.8 million and contributedthe property to our wholly-owned subsidiary, Skye Lane. We established our operating headquarters on this site in March 2014. Approximately 88% of theproperty is occupied by unaffiliated tenants. In 2014, we built a parking garage on the property to better accommodate the parking needs of the tenants.Item 3. Legal ProceedingsWe are subject to routine legal proceedings in the ordinary course of business. We believe that the ultimate resolution of these matters will not have amaterial adverse effect on our business, financial condition or results of operations.Item 4. Mine Safety DisclosuresNot applicableItem 5. Market For Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity SecuritiesOur common stock trades on the New York Stock Exchange (“NYSE”) under the symbol “HRTG”. The following table sets forth the high and low saleprices as reported on the NYSE. These reported prices reflect inter-dealer prices without adjustments for retail markups, markdowns or commissions. Year Quarter High Low Dividends Paid PerShare 2014 First $— $— $— Second $15.38 $11.29 $— Third $15.70 $13.60 $— Fourth $19.84 $14.03 $— The closing sale price of our common stock as reported on the NYSE on March 9, 2015 was $22.36 per share. As of such date there were 108 holders ofrecord of our common stock based on information provided by our transfer agent.DividendsWe do not plan to pay a regular dividend on our common stock for the foreseeable future. The declaration and payment of all future dividends, if any,will be at the discretion of our board of directors and will depend upon, among other things, 31Source: Heritage Insurance Holdings, Inc., 10-K, March 18, 2015Powered by Morningstar® Document Research℠The information contained herein may not be copied, adapted or distributed and is not warranted to be accurate, complete or timely. The user assumes all risks for any damages or losses arising from any use of this information,except to the extent such damages or losses cannot be limited or excluded by applicable law. Past financial performance is no guarantee of future results.Table of Contentsour financial condition, earnings and contractual obligations. Moreover, our ability to pay dividends if and when our board of directors determines to do so,may be restricted by regulatory limits on the amount of dividends Heritage P&C is permitted to pay to us. We have agreed to refrain from makingdistributions to our equity holders through July 31, 2015, except for such distributions as are required to offset members’ tax obligations or as may beapproved by FLOIR in advance and in writing. Further, until July 31, 2017, Heritage P&C has agreed to pay only those dividends that have been approved inadvance and in writing by FLOIR. Heritage P&C has not paid, and has not sought approval from FLOIR to pay, any dividends to date.Item 6. Selected Financial DataThe following selected consolidated financial data should be read in conjunction with Item 7 – Management’s Discussion and Analysis of FinancialCondition Results of Operations and our consolidated financial statements and the related notes appearing in Item 8 – Financial Statements andSupplementary Data of this Annual Report. The consolidated statements of operations data for the years ended December 31, 2014, 2013 and for the period ofAugust 7, 2012 (inception) to December 31, 2012 and the consolidated balance sheet data at December 31, 2014 and 2013 are derived from our consolidatedfinancial statements appearing in Item 8 of this Annual Report. The historical results shown below are not necessarily indicative of the results to be expectedin any future period. Statements of Operations Data: For the YearEndedDecember 31, 2014 For the YearEndedDecember 31, 2013 August 7, 2012(inception) toDecember 31, 2012 (In thousands, except per share data) Revenue: Gross premiums written $436,407 $218,537 $43,384 Gross premiums earned $311,514 $139,959 $5,719 Net premiums earned $223,612 $95,159 $5,599 Net investment income and realized gains(losses) $4,153 $726 $27 Other revenue $6,055 $2,901 $4 Total revenue $233,820 $124,832 $5,630 Expenses: Loss and loss adjustment expenses $89,560 $38,501 $1,402 Other operating expenses $70,008 $30,854 $8,006 Total expenses $159,568 $69,371 $10,237 Income (loss) before income taxes $74,252 $55,461 $(4,607) Provision for income taxes $27,155 $21,248 $859 Net income (loss) $47,097 $34,213 $(5,466) Earnings (loss) per share: Basic $1.92 $2.39 $(0.87) Diluted $1.82 $2.36 $(0.87) Ratios to net premiums earned: Net loss ratio 40.1% 40.5% 25.0% Net expense ratio 31.3% 32.4% 143.0% Combined ratio 71.4% 72.9% 168.0% Balance Sheet Data: As of December 31, 2014 As ofDecember 31, 2013 (In thousands) Cash and invested assets $491,640 $201,236 Prepaid reinsurance premiums $43,148 $31,252 Deferred policy acquisition costs $24,370 $9,765 Total Assets $615,031 $281,978 Unpaid loss and loss adjustment expense $51,469 $19,344 Unearned premiums $241,136 $116,243 Reinsurance payable $17,113 $29,591 Total Liabilities $359,942 $181,073 Total Stockholders’ Equity $255,089 $100,905 32Source: Heritage Insurance Holdings, Inc., 10-K, March 18, 2015Powered by Morningstar® Document Research℠The information contained herein may not be copied, adapted or distributed and is not warranted to be accurate, complete or timely. The user assumes all risks for any damages or losses arising from any use of this information,except to the extent such damages or losses cannot be limited or excluded by applicable law. Past financial performance is no guarantee of future results.Table of ContentsPART IIItem 7. Management’s Discussion and Analysis of Financial Condition and Results of OperationsThe following discussion and analysis of our financial condition and results of operations should be read in conjunction with our consolidated financialstatements and related notes appearing elsewhere in this Form 10-K. This discussion and analysis contains forward-looking statements that involve risks,uncertainties and assumptions. The actual results may differ materially from those anticipated in these forward-looking statements as a result of certainfactors, including, but not limited to, those which are not within our control.Overview: Discussion of our business and overall financial results, and other highlights related to our results of operations for the periods presented.Financial Results Highlights for the Year Ended December 31, 2014 • Approximately 209,400 policies in-force at December 31, 2014, of which approximately 74.1% were assumed from Citizens, 14.2% wereassumed from SSIC and 11.7% were from voluntary sales • Gross premiums written of $436.4 million and total revenue of $233.8 million • Net premiums earned of $223.6 million • Net income of $47.1 million • Combined ratio of 79.4% on a gross basis and 71.4% on a net basis • Cash, cash equivalents and investments of $491.6 million, with total assets of $615.0 millionConsolidated Results of Operations: An analysis and discussion of our financial results comparing our consolidated results of operations for the yearended December 31, 2014 to the year ended December 31, 2013, is discussed below. Our Company was formed in August 2012 and we did not generaterevenue until December 2012 when we commenced our first assumption transaction with Citizens, and wrote our first voluntary policies. Due to the limitedoperating activities in 2012, we are not presenting a comparative analysis between the year ended December 31, 2013 and the period August 7, 2012(inception) to December 31, 2012.Consolidated Results of OperationsThe following table summarizes our results of operations for the periods indicated (in thousands, except per share amounts): Year EndedDecember 31,2014 Year EndedDecember 31,2013 August 7, 2012(inception) toDecember 31,2012 Revenue Gross premiums written $436,407 $218,537 $43,384 Increase in gross unearned premiums (124,893) (78,578) (37,665) Gross premiums earned 311,514 139,959 5,719 Ceded premiums (87,902) (44,800) (120) Net premiums earned 223,612 95,159 5,599 Net investment income 3,849 1,049 27 Retroactive reinsurance (1) — 26,046 — Net realized investment (losses) gains 304 (323) — Other revenue 6,055 2,901 4 Total revenue$233,820 $124,832 $5,630 ExpensesLosses and loss adjustment expenses 89,560 38,501 1,402 Policy acquisition costs 36,510 6,150 84 General and administrative expenses(2) 33,498 24,704 7,922 Interest expense — 16 829 Total expenses 159,568 69,371 10,237 Income (Loss) before income taxes 74,252 55,461 (4,607) Income taxes 27,155 21,248 859 Net income (loss)$47,097 $34,213 $(5,466) Income (loss) available (attributable) to common stockholders$47,097 $34,213 $(5,466) 33Source: Heritage Insurance Holdings, Inc., 10-K, March 18, 2015Powered by Morningstar® Document Research℠The information contained herein may not be copied, adapted or distributed and is not warranted to be accurate, complete or timely. The user assumes all risks for any damages or losses arising from any use of this information,except to the extent such damages or losses cannot be limited or excluded by applicable law. Past financial performance is no guarantee of future results.Table of ContentsPer Share Data:Basic earnings per common share (3)$1.92 $2.39 $(0.87) Diluted earnings per common share (3)$1.82 $2.36 $(0.87) Selected Other DataBook value per share (3)(4)$8.56 $7.20 $3.38 Growth in book value per share (4) 18.9% 113.0% (14)% Return on average equity (4) 26.5% 45.0% 335.0% Ratios to Gross Premiums Earned:Ceded premium ratio 28.2% 32.0% 2.1% Loss Ratio 28.7% 27.5% 24.5% Expense Ratio 22.5% 22.0% 140.0% Combined Ratio 79.4% 81.6% 166.6% Ratios to Net Premiums Earned: (5)Loss Ratio 40.1% 40.5% 25.0% Expense Ratio 31.3% 32.4% 143.0% Combined Ratio 71.4% 72.9% 168.0% 1.Retroactive reinsurance income of $26.0 million during the year ended December 31, 2013 represents premiums earned, net of losses, for the periodfrom January 1, 2013 through May 31, 2013 from a retroactive reinsurance quota share agreement entered into in connection with our assumption ofapproximately 39,000 policies from Citizens in June 2013. See Note 2 to our consolidated financial statements included elsewhere in this AnnualReport.2.General and administrative expenses for the years ended December 31, 2014, December 31, 2013 and for the period August 7, 2012 (inception) toDecember 31, 2012 includes $3.3 million, $5.7 million and $5.5 million of stock-based compensation expense, respectively.3.Share and per share data for the periods presented gives retroactive effect to the 2,550-for-1 stock split effected on May 7, 2014, but does not giveretroactive effect to the “Warrant Exercise” and, together with the Conversion, the “Reorganization Transactions”.4.Includes the value, as of the end of each period, of the redeemable equity.5.The ratios presented do not reflect the impact of the retroactive reinsurance income described in footnote 1 above. For a definition of each of the ratiospresented, see “Key Components of Our Results of Operations—Ratios.”Critical Accounting Policies and Estimates: Our discussion and analysis of operating results and financial condition are based upon our financialstatements. The preparation of our financial statements in accordance with GAAP requires us to make estimates and assumptions that affect the reportedamounts of assets, liabilities, revenues, expenses and related disclosures of contingent assets and liabilities. We base our estimates on past experience andother assumptions that we believe are reasonable under the circumstances, and we evaluate these estimates on an ongoing basis. Our critical accountingpolicies are those that materially affect our financial statements and involve difficult, subjective or complex judgments by management. Although theseestimates are based on management’s best knowledge of current events and actions that may impact us in the future, actual results may be materially differentfrom the estimates.We intend the discussion of our financial condition and results of operations that follows to provide information that will assist the reader inunderstanding our consolidated financial statements, the changes in certain key items in those financial statements from year to year, and the primary factorsthat accounted for those changes, as well as how certain accounting principles, policies and estimates affect our consolidated financial statements. Thisdiscussion should be read in conjunction with our consolidated financial statements and the related notes that appear elsewhere in this document.Key Components of our Results of OperationsRevenueGross premiums written. Gross premiums written represent, with respect to a period, the sum of assumed premiums written (premiums from policies that weassumed from Citizens, net of opt-outs, as well as policies acquired from SSIC) plus direct premiums written (premiums from subsequent renewals of Citizens’policies and voluntary policies written during the period, net of any midterm cancellations), in each case prior to ceding premiums to reinsurers.Gross premiums earned. Gross premiums earned represent the total premiums earned during a period from policies assumed from Citizens, net of opt-outs, aswell as policies acquired from SSIC, subsequent renewals of such policies and voluntary policies. Premiums associated with assumed policies are earnedratably over the remaining term of the policy and premiums associated with voluntary and renewed policies are earned ratably over the twelve-month term ofthe policy.Ceded premiums. Ceded premiums represent the cost of our reinsurance during a period. We recognize the cost, excluding premiums ceded to Osprey, of ourreinsurance program ratably over the twelve month term of the arrangement. In most cases, our reinsurance contracts are effective June 1 and run throughMay 31 of the following year.Net premiums earned. Net premiums earned reflect gross premiums earned less ceded premiums during the period. 34Source: Heritage Insurance Holdings, Inc., 10-K, March 18, 2015Powered by Morningstar® Document Research℠The information contained herein may not be copied, adapted or distributed and is not warranted to be accurate, complete or timely. The user assumes all risks for any damages or losses arising from any use of this information,except to the extent such damages or losses cannot be limited or excluded by applicable law. Past financial performance is no guarantee of future results.Table of ContentsRetroactive reinsurance income. Retroactive reinsurance income represents the income, net of associated losses and loss adjustment expenses, arising fromthe retroactive reinsurance agreement we entered in connection with our assumption of approximately 39,000 policies from Citizens in June 2013. Under thisretroactive reinsurance agreement, we realized income equal to the earned premiums, net of associated losses and loss adjustment expenses, from such policesfor the period from January 1, 2013 through May 31, 2013 with no corresponding reinsurance costs. The earned premiums for the period from June 1, 2013through June 27, 2013 (the date the assumption agreement) are effective) are included in gross premiums written for the year ended December 31, 2013. Theretroactive reinsurance agreement, which was a key element of our decision to enter into an assumption transaction at the outset of hurricane season, is nottypical of our assumption transactions with Citizens. The typical assumption transaction with Citizens provides for the assumption of unearned premiums asof the effective date of the transaction, and does not result in the transfer of earned premiums and losses and loss adjustment expenses for prior periods. We donot expect to enter into similar retroactive arrangements with Citizens in connection with future policy assumptions.Net investment income. Net investment income represents interest earned from fixed maturity securities, short term securities and other investments, dividendson equity securities, and the gains or losses from the sale of investments.Other revenue. Other revenue represents rental income due under non-cancelable leases for space at our commercial property in Clearwater, Florida that weacquired in April 2013, and all policy and pay-plan fees. Florida law allows insurers to charge policyholders a $25 policy fee on each policy written; thesefees are not subject to refund, and we recognize the income immediately when collected. We also charge pay-plan fees to policyholders that pay theirpremium in more than one installment and record the fees as income when collected.ExpensesLosses and loss adjustment expenses. Losses and loss adjustment expenses reflect losses paid, expenses paid to resolve claims, such as fees paid to adjusters,attorneys and investigators, and changes in our reserves for unpaid losses and loss adjustment expenses during the period, in each case net of losses ceded toreinsurers. Our reserves for unpaid losses and loss adjustment expenses represent the estimated ultimate cost of resolving all reported claims plus all losses weincurred related to insured events that we assume have occurred as of the reporting date, but that policyholders have not yet reported to us (which arecommonly referred to as incurred but not reported, or “IBNR”). We estimate our reserves for unpaid losses using individual case-based estimates for reportedclaims and actuarial estimates for IBNR losses. We continually review and adjust our estimated losses as necessary based on industry development trends, ourevolving claims experience and new information obtained. If our unpaid losses and loss adjustment expenses are considered deficient or redundant, weincrease or decrease the liability in the period in which we identify the difference and reflect the change in our current period results of operations.Policy acquisition costs. Policy acquisition costs consist of the following items: (i) commissions paid to outside agents at the time of policy issuance,(ii) policy administration fees paid to a third-party administrator at the time of policy issuance, (iii) premium taxes and (iv) inspection fees. We recognizepolicy acquisition costs ratably over the term of the underlying policy. Until renewed, policies assumed from Citizens have no associated policy acquisitioncosts. Policy acquisition costs also include the costs to acquire the SSIC policies. We recognize these costs ratably over the term of the unearned premiumacquired in the transaction.General and administrative expenses. General and administrative expenses include compensation and related benefits, professional fees, office lease andrelated expenses, information system expenses, corporate insurance, and other general and administrative costs.Provision for income taxes. Provision for income taxes historically consisted of income taxes associated with our subsidiaries that are taxed as corporations.On May 22, 2014, we converted from a limited liability company to a corporation. As a corporation, we are subject to typical corporate U.S. federal and stateincome tax rates which we expect to result in a statutory tax rate of approximately 38.575% under current tax law.RatiosCeded premium ratio. Our ceded premium ratio represents ceded premiums as a percentage of gross premiums earned.Gross loss ratio. Our gross loss ratio represents losses and loss adjustment expenses as a percentage of gross premiums earned. 35Source: Heritage Insurance Holdings, Inc., 10-K, March 18, 2015Powered by Morningstar® Document Research℠The information contained herein may not be copied, adapted or distributed and is not warranted to be accurate, complete or timely. The user assumes all risks for any damages or losses arising from any use of this information,except to the extent such damages or losses cannot be limited or excluded by applicable law. Past financial performance is no guarantee of future results.Table of ContentsNet loss ratio. Our net loss ratio represents losses and loss adjustment expenses as a percentage of net premiums earned.Gross expense ratio. Our gross expense ratio represents policy acquisition costs and general and administrative expenses as a percentage of gross premiumsearned.Net expense ratio. Our net expense ratio represents policy acquisition costs and general and administrative expenses as a percentage of net premiums earned.Combined ratios. Our combined ratio on a gross basis represents the sum of ceded premiums, losses and loss adjustment expenses, policy acquisition costsand general and administrative expenses as a percentage of gross premiums earned. Our combined ratio on a net basis represents the sum of losses and lossadjustment expenses, policy acquisition costs and general and administrative expenses as a percentage of net premiums earned.The combined ratio is the key measure of underwriting performance traditionally used in the property and casualty industry. A combined ratio under100% generally reflects profitable underwriting results.Due to the impact our reinsurance costs have on net premiums earned from period to period, our management believes the combined ratio on a grossbasis is more relevant in assessing overall performance.Results of Operations – Year Ended December 31, 2014 Compared to December 31, 2013RevenueGross premiums writtenGross premiums written increased from $218.5 million for the year ended December 31, 2013 to $436.4 million for the year December 31, 2014. Theincrease in gross premiums written was due to the renewal of a significant number of policies previously assumed from Citizens and SSIC, the growingnumber of new voluntary policies written and the assumption of approximately 55,000 personal residential policies from Citizens and 32,000 from SSIC, aswell as approximately 2,200 commercial residential policies from Citizens in 2014. Of our gross premiums written for the year December 31, 2014, $283.3million represents direct premiums written and $153.1 million represents assumed premiums written. Of the $283.3 million of direct premiums written,renewals of policies previously assumed from Citizens accounted for $217.1 million and renewals of policies previously assumed from SSIC accounted for$23.9 million, while voluntary business accounted for $42.2 million. The assumed premiums written of $153.1 million were comprised of $124.5 millionfrom policies assumed from Citizens and $28.6 million from policies assumed from SSIC.Gross premiums earnedGross premiums earned increased from $140.0 million for the year ended December 31, 2013 to $311.5 million for the year ended December 31, 2014.Our policies in force as of December 31, 2013 and 2014 were approximately 85,100, and 209,400 respectively, and this increase had a favorable impact onour gross premiums earned. Approximately $28.5 million of gross premiums earned during the year ended December 31, 2014 was attributable to the SSICpolicies acquired on June 27, 2014, and $17.0 million from our entrance into the commercial residential line of business during the fourth quarter of 2014,via assumptions from Citizens and new voluntary writings.Ceded premiumsCeded premiums increased from $44.8 million for the year ended December 31, 2013 to $87.9 million for the year ended December 31, 2014. Theincrease in ceded premiums is primarily a result of the significant increase in the policies in force noted above, partially offset by lower reinsurance costs dueto favorable reinsurance market conditions and the availability of lower cost reinsurance related to $200 million of catastrophe bonds issued by a third party,and improved geographic spread of risk. Additionally prior to June 1, 2013, our reinsurance costs were significantly lower because we purchased reinsurancelimited to non-hurricane losses through May 31, 2013.Net premiums earnedNet premiums earned increased from $95.2 million for the year ended December 31, 2013 to $223.6 million for the year ended December 31, 2014. Theincrease in net premiums earned in the comparable periods is primarily attributable to the increase in the number of policies in force during the year endedDecember 31, 2014 as compared to the year ended December 31, 2013, partially offset by increased ceded earned premiums. 36Source: Heritage Insurance Holdings, Inc., 10-K, March 18, 2015Powered by Morningstar® Document Research℠The information contained herein may not be copied, adapted or distributed and is not warranted to be accurate, complete or timely. The user assumes all risks for any damages or losses arising from any use of this information,except to the extent such damages or losses cannot be limited or excluded by applicable law. Past financial performance is no guarantee of future results.Table of ContentsNet investment incomeNet investment income, inclusive of net realized investment gains and losses, increased from $0.7 million for the year ended December 31, 2013 to$4.2 million for the year ended December 31, 2014. The increase in net investment income is due to the significant increase in invested assets from $136.2million at December 31, 2013 to $331.2 million at December 31, 2014. The increase resulted primarily from policy growth.Retroactive reinsurance incomeRetroactive reinsurance income of $26.0 million for the year ended December 31, 2013 was a non-recurring event. In connection with our assumptionof 39,000 policies in June 2013, we entered into a retroactive quota share reinsurance agreement with Citizens that resulted in our recognition of $26.0million of retroactive reinsurance income, representing the earned premium, net of associated losses and loss adjustment expenses, from such policies for theperiod from January 1, 2013 through May 31, 2013.Other revenueOther revenue increased from $2.9 million for the year ended December 31, 2013 to $6.1 million for the year ended December 31, 2014. The increase inother revenue between the comparable periods is primarily attributable to the policy fees generated by our growing portfolio of new and renewed policies.Also, the rental income received pursuant to non-cancelable leases for our commercial property in Clearwater, Florida that we purchased in April 2013,contributed to the increase in other revenue.Total revenueTotal revenue increased from $124.8 million for the year ended December 31, 2013 to $233.8 million for the year ended December 31, 2014. Theincrease in total revenue was due primarily from the growth in net premiums earned resulting from the significant increase in the number of policies in forcethroughout the year ended December 31, 2014 as compared to the prior year.ExpensesLosses and loss adjustment expensesLosses and loss adjustment expenses increased from $38.5 million for the year ended December 31, 2013 to $89.6 million for the year endedDecember 31, 2014. The increase in losses and loss adjustment expenses resulted primarily from an increase in the number of policies in force between therespective periods as well as a modest increase in the loss ratio. Losses and loss adjustment expenses for the year ended December 31, 2014 include lossespaid of $57.4 million and a $32.1 million increase in unpaid losses and loss adjustment expenses, including the addition of $19.1 million of IBNR reserves.As of December 31, 2014, we reported $51.5 million in unpaid losses and loss adjustment expenses which included $30.1 million attributable to IBNR, or58.4% of total reserves for unpaid losses and loss adjustment expenses.Policy acquisition costsPolicy acquisition costs increased from $6.2 million for the year ended December 31, 2013 to $36.5 million for the year ended December 31, 2014. Theincrease is primarily attributable to the significant increase in new and renewed policies, which have associated commissions and administration fees paid tooutside agents and administrators at the time of policy issuance, premium taxes and inspection fees, none of which are associated with policies assumed fromCitizens prior to their renewal. In addition, $7.6 million of the $10 million SSIC policy acquisition fee was amortized during the year ended December 31,2014.General and administrative expensesGeneral and administrative expenses increased from $24.7 million for the year ended December 31, 2013 to $33.5 million for the year endedDecember 31, 2014. The increase in 2014 was due primarily to the growth in our infrastructure resulting in greater costs associated with our personnel,facilities and overall business activity. 37Source: Heritage Insurance Holdings, Inc., 10-K, March 18, 2015Powered by Morningstar® Document Research℠The information contained herein may not be copied, adapted or distributed and is not warranted to be accurate, complete or timely. The user assumes all risks for any damages or losses arising from any use of this information,except to the extent such damages or losses cannot be limited or excluded by applicable law. Past financial performance is no guarantee of future results.Table of ContentsProvision for income taxesProvision for income taxes was $21.2 million and $27.2 million for the years ended December 31, 2013 and 2014, respectively. Our effective tax ratesfor the years ended December 31, 2013 and 2014 was 38.3% and 36.6%, respectively. The decrease in the effective tax rate is a result of limited liabilitycompany status income in 2014, prior to the conversion of the parent to a corporation in May 2014 compared to a loss recognized by the limited liabilitycompany status of the parent company in 2013.Net IncomeOur results of operations for the year ended December 31, 2014 reflect net income of $47.1 million, or $1.82 earnings per diluted common share,compared to net income of $34.2 million, or $2.36 earnings per diluted common share, for the year ended December 31, 2013. The weighted average sharesoutstanding on a diluted basis increased from 14.5 million shares to 25.8 million shares as of December 31, 2014, primarily due to the Company’s IPO onMay 22, 2014 and related warrants exercise. This caused the reduced earnings per diluted share in 2014, despite the increase in net income.Ratios – Year Ended December 31, 2014 Compared to December 31, 2013Due to the impact our reinsurance costs have on net premiums earned from period to period, our management believes the ratios discussed below are moremeaningful when viewed on a gross basis.Ceded premium ratioOur ceded premium ratio decreased from 32.0% for the year ended December 31, 2013 to 28.2% for the year ended December 31, 2014. This decrease isprimarily due to lower reinsurance costs due to favorable reinsurance market conditions, the availability of lower cost reinsurance related to $200 million ofcatastrophe bonds issued by a third party and improved geographic spread of risk.Gross loss ratioOur gross loss ratio increased from 27.5% for the year ended December 31, 2013 to 28.7% for the year ended December 31, 2014, primarily due to anincrease in IBNR.Net loss ratioOur net loss ratio decreased from 40.5% for the year ended December 31, 2013 to 40.1% for the year ended December 31, 2014, primarily as a result inthe improvement of the ceded premium ratio to gross earned premiums.Gross expense ratioOur gross expense ratio increased modestly from 22.0% for the year ended December 31, 2013 to 22.5% for the year ended December 31, 2014,primarily as a result of the acquisition costs associated with the SSIC book of business that was acquired on June 27, 2014.Net expense ratioOur net expense ratio decreased from 32.4% for the year ended December 31, 2013 to 31.3% for the year ended December 31, 2014, primarily as aresult of the improvement of the ceded premium ratio to gross earned premiums.Combined ratioOur combined ratio on a gross basis decreased from 81.5% for the year ended December 31, 2013 to 79.4% for the year ended December 31, 2014. Ourcombined ratio on a net basis decreased from 72.9% for the year ended December 31, 2013 to 71.4% for the year ended December 31, 2014. The changes inour combined ratio, on both a gross and net basis, are primarily as a result of the improvement of the ceded premium ratio to gross earned premiums. 38Source: Heritage Insurance Holdings, Inc., 10-K, March 18, 2015Powered by Morningstar® Document Research℠The information contained herein may not be copied, adapted or distributed and is not warranted to be accurate, complete or timely. The user assumes all risks for any damages or losses arising from any use of this information,except to the extent such damages or losses cannot be limited or excluded by applicable law. Past financial performance is no guarantee of future results.Table of ContentsPeriod from August 7, 2012 (inception) to December 31, 2012Our Company was formed in August 2012. We did not generate revenue until December 2012 when we commenced our first assumption transaction withCitizens, and wrote our first voluntary policies. Due to the limited operating activities in 2012, we are not presenting a comparative analysis between theyear ended December 31, 2013 and the period August 7, 2012 (inception) to December 31, 2012.RevenueGross premiums writtenGross premiums written for the period ended December 31, 2012 were $43.4 million and primarily related to our assumption of approximately 37,000policies from Citizens in December 2012.Gross premiums earnedGross premiums earned for the period ended December 31, 2012 were $5.7 million and primarily related to our December 2012 assumption transactionwith Citizens.Ceded premiumsCeded premiums during the period ended December 31, 2012 were $0.1 million. The Company was only required purchase reinsurance in 2012 toprotect the Company against non-hurricane catastrophes. This resulted in low ceded premiums in relation to gross premiums earned.Net premiums earnedNet premiums earned for the period ended December 31, 2012 were $5.6 million.Net investment incomeNet investment income was $27,000 for the period ended December 31, 2012.Total revenueTotal revenue for the period ended December 31, 2012 was $5.6 million.ExpensesLosses and loss adjustment expensesLosses and loss adjustment expenses for the period ended December 31, 2012 were $1.4 million and reflect our brief period of operations. Nomeaningful conclusions relating to trends or variance from expectations can be drawn from the very few reported losses during the period. Consequently, weestablished IBNR reserves consistent with the risk characteristics related to the exposures drawn from our assumption of policies from Citizens in December2012.Policy acquisition costsPolicy acquisition costs were $84,000 for the period ended December 31, 2012 and related to an insignificant number of voluntary polices written in2012.General and administrative expensesGeneral and administrative expenses were $7.9 million for the period ended December 31, 2012 and primarily related to stock-based compensation of$5.5 million and start-up expenses.Interest expenseInterest expense was $0.8 million for the period ended December 31, 2012 and related to the payment of a 20% fee payable upon the exchange of $3.9million aggregate principal amount of notes for equity. 39Source: Heritage Insurance Holdings, Inc., 10-K, March 18, 2015Powered by Morningstar® Document Research℠The information contained herein may not be copied, adapted or distributed and is not warranted to be accurate, complete or timely. The user assumes all risks for any damages or losses arising from any use of this information,except to the extent such damages or losses cannot be limited or excluded by applicable law. Past financial performance is no guarantee of future results.Table of ContentsProvision for income taxesProvision for income taxes was $0.9 million for the period ended December 31, 2012. Heritage P&C had taxable income for the period endedDecember 31, 2012, while our limited liability company subsidiaries sustained losses. Such losses were passed through to our equity holders and were notavailable to offset Heritage P&C’s taxable income.Liquidity and Capital ResourcesAs of December 31, 2014, we had $160.5 million of cash and cash equivalents, which primarily consisted of cash and money market accounts. Weintend to hold substantial cash balances during hurricane season to meet seasonal liquidity needs and the collateral requirements of Osprey Re Ltd, ourcaptive reinsurance company described below. We also had $4.3 million in restricted cash to meet our contractual obligations related to the CAT bondsissued by Citrus Re.Osprey is required to maintain a collateral trust account equal to the risk that it assumes from Heritage P&C, less amounts collateralized through a letterof credit. In December, the FLOIR approved the removal of $45 million from the collateral trust account following the end of the 2014 hurricane season. As ofDecember 31, 2014, $5.0 million was held in Osprey’s trust account and an additional $5 million was collateralized with a letter of credit. At December 31,2014, the Company and the FLOIR deemed $10 million to be sufficient to satisfy Osprey’s reinsurance obligations from non-hurricane catastrophic events.Further, $35.0 million of the $45.0 million that was removed from the collateral trust accounts was contributed as paid in surplus, to Heritage Property &Casualty.Although we can provide no assurances, we believe that we maintain sufficient liquidity to pay Heritage P&C’s claims and expenses, as well as tosatisfy commitments in the event of unforeseen events such, inadequate premium rates, or reserve deficiencies. We maintain a comprehensive reinsuranceprogram at levels management considers adequate to diversify risk and safeguard our financial position.As of December 31, 2014, we had 29,794,960 shares of common stock outstanding, and warrants and options to purchase 1,685,923 shares of commonstock, reflecting total paid-in capital of $188.3 million as of such date.We believe our current capital resources, together with cash provided from our operations, will be sufficient to meet currently anticipated workingcapital requirements. We cannot provide assurance, however, that such will be the case in the future.Statement of Cash FlowsThe net increases (decreases) in cash and cash equivalents are summarized in the following table (in thousands): Periods Ended December 31, 2014 Change 2013 Change 2012 Net cash provided by (used in): Operating activities $194,196 $89,145 $105,051 $55,576 $49,475 Investing activities (200,047) (63,553) (136,494) (122,606) (13,888) Financing activities 101,273 68,643 32,630 4,345 28,285 Net increase (decrease) in cash and cash equivalents$95,422 $94,235 $1,187 $(62,685) $63,872 Operating ActivitiesNet cash provided by operating activities for December 31, 2013 was $105.1 million as compared to $194.2 million cash provided during the yearended December 31, 2014. The increase was primarily due to the significant policy growth experienced in 2014. 40Source: Heritage Insurance Holdings, Inc., 10-K, March 18, 2015Powered by Morningstar® Document Research℠The information contained herein may not be copied, adapted or distributed and is not warranted to be accurate, complete or timely. The user assumes all risks for any damages or losses arising from any use of this information,except to the extent such damages or losses cannot be limited or excluded by applicable law. Past financial performance is no guarantee of future results.Table of ContentsInvesting ActivitiesNet cash used in investing activities for the year ended December 31, 2013 was $136.5 million as compared to $200.0 million for the year ended December31, 2014, reflecting the investment of funds provided by operating activities.Financing ActivitiesNet cash provided by financing activities for the year ended December 31, 2013 was $32.6 million, as compared to $101.3 million for the yearended December 31, 2014. On May 29, 2014 we completed our IPO, which along with the concurrent private placement, raised $78.6 million. In addition,and in connection with the IPO, $22.5 million was raised from the exercise of warrants from existing stockholders.TaxationDeferred Tax Asset and Current Tax LiabilityWe report a deferred tax asset arising from the portion (20%) of unearned premiums that are otherwise recognized as taxable income in advance ofbeing earned for financial reporting purposes. Accordingly, our income taxes currently paid and payable also reflect this temporary difference betweentaxable income and earned income reported in our financial statements. The increases in our deferred tax asset from December 31, 2013 throughDecember 31, 2014 reflect the significant unearned premiums arising from our assumption transactions and the additional resulting temporary differences dueto certain amounts being taxable in advance of being recognized as earned for financial reporting purposes.Conversion to a CorporationOn May 22, 2014, Heritage Insurance Holdings, Inc. was converted from a limited liability company to a corporation. As a limited liability company,Heritage Insurance was treated as a partnership for tax purposes, and accordingly was not subject to entity-level federal or state income taxation. Our incometax provision generally consists of income taxes payable by our separate subsidiaries that are taxed as corporations and which have been taxed as such sinceour inception. As such, our effective tax rate as a limited liability company has historically been driven primarily by the taxable income recognized by oursubsidiaries. As a corporation, we are subject to typical corporate U.S. federal and state income tax rates which we expect to result in a statutory tax rate ofapproximately 38.575% under current tax law.Critical Accounting Policies and EstimatesThe preparation of our consolidated financial statements requires us to make judgments and estimates that may have a significant impact upon ourfinancial results. Note 1, under Item 8, Financial Statements and Supplementary Data — Notes to Consolidated Financial Statements, of this Form 10-KAnnual Report contains a summary of our significant accounting policies, many of which require the use of estimates and assumptions. We believe that thefollowing areas are particularly subject to management’s judgments and estimates and could materially affect our results of operations and financial position.Premiums. We recognize direct and assumed premiums written as revenue, net of ceded amounts, on a daily pro rata basis over the contract period ofthe related policies that are in force. For any portion of premiums not earned at the end of the reporting period, we record an unearned premium liability.Premiums receivable represents amounts due from our policyholders for billed premiums and related policy fees. We perform a policy-level evaluationto determine the extent to which the balance of the premium receivable exceeds the balance of the unearned premium. We then age any resulting exposurebased on the last date the policy was billed to the policyholder, and we establish an allowance account for credit losses for any amounts outstanding for morethan 90 days. When we receive payments on amounts previously charged off, we credit bad debt expense in the period we receive the payment. Balances inpremiums receivable and the associated allowance account are removed upon cancellation of the policy due to non-payment. We recorded an allowance of$250,000 and $0 for uncollectible premiums at December 31, 2014 and 2013 respectively.When we receive premium payments from policyholders prior to the effective date of the related policy, we record an advance premium liability. Onthe policy effective date, we reduce the advance premium liability and record the premiums as described above. 41Source: Heritage Insurance Holdings, Inc., 10-K, March 18, 2015Powered by Morningstar® Document Research℠The information contained herein may not be copied, adapted or distributed and is not warranted to be accurate, complete or timely. The user assumes all risks for any damages or losses arising from any use of this information,except to the extent such damages or losses cannot be limited or excluded by applicable law. Past financial performance is no guarantee of future results.Table of ContentsReserves for Unpaid Losses and Loss Adjustment Expenses. Reserves for unpaid losses and loss adjustment expenses, also referred to as loss reserves,represent the most significant accounting estimate inherent in the preparation of our financial statements. These reserves represent management’s bestestimate of the amount we will ultimately pay for losses and loss adjustment expenses and we base the amount upon the application of various actuarialreserve estimation techniques as well as considering other material facts and circumstances known at the balance sheet date.We establish two categories of loss reserves as follows: • Case reserves—When a claim is reported, we establish an initial estimate of the losses that will ultimately be paid on the reported claim. Ourinitial estimate for each claim is based upon the judgment of our claims professionals who are familiar with property and liability lossesassociated with the coverage offered by our policies. Then, our claims personnel perform an evaluation of the type of claim involved, thecircumstances surrounding each claim and the policy provisions relating to the loss and adjust the reserve as necessary. As claims mature, weincrease or decrease the reserve estimates as deemed necessary by our claims department based upon additional information we receive regardingthe loss, the results of on-site reviews and any other information we gather while reviewing the claims. • IBNR reserves—Our IBNR reserves include true IBNR reserves plus “bulk” reserves. True IBNR reserves represent amounts related to claims forwhich a loss occurred on or before the date of the financial statements but which have not yet been reported to us. Bulk reserves representadditional amounts that cannot be allocated to particular claims, but which are necessary to estimate ultimate losses on known claims. Weestimate our IBNR reserves by projecting our ultimate losses using industry accepted actuarial methods and then deducting actual loss paymentsand case reserves from the projected ultimate losses. We review and adjust our IBNR reserves on a quarterly basis based on information availableto us at the balance sheet date.When we establish our reserves, we analyze various factors such as the evolving historical loss experience of the insurance industry as well as ourexperience, claims frequency and severity, our business mix, our claims processing procedures, legislative enactments, judicial decisions and legaldevelopments in imposition of damages, and general economic conditions, including inflation. A change in any of these factors from the assumptionsimplicit in our estimates will cause our ultimate loss experience to be better or worse than indicated by our reserves, and the difference could be material. Dueto the interaction of the foregoing factors, there is no precise method for evaluating the impact of any one specific factor in isolation, and an element ofjudgment is ultimately required. Due to the uncertain nature of any projection of the future, the ultimate amount we will pay for losses will be different fromthe reserves we record.We determine our ultimate loss reserves by selecting a point estimate within a relevant range of indications that we calculate using generally acceptedactuarial techniques. Our selection of the point estimate is influenced by the analysis of our paid losses and incurred losses since inception, as well asindustry information relevant to the population of exposures drawn from Citizens. At our current level of experience, industry information stronglyinfluences the basis for estimates of claims related factors. We expect that our loss experience will be of growing significance in future periods.Our independent actuary evaluated the adequacy of our reserves as of December 31, 2014 and concluded that total reserves ranging from a low of $45.3million to a high of $51.9 million would meet the requirements of the insurance laws of Florida, be consistent with reserves computed in accordance withaccepted loss reserving standards and principles, and make a reasonable provision for all unpaid loss and loss adjustment expense obligations under the termsof our contracts and agreements. In addition to $21.4 million of recorded case reserves, we recorded $30.1 million of IBNR reserves as of December 31, 2014to achieve overall reserves of $51.5 million.The process of establishing our reserves is complex and inherently imprecise, as it involves using judgment that is affected by many variables. Webelieve a reasonably likely change in almost any of the factors we evaluate as part of our loss reserve analysis could have an impact on our reported results,financial position and liquidity.The following table quantifies the Pro-forma impact of hypothetical changes in our loss reserves on our net income, stockholders’ equity and liquidityas of and for the year ended December 31, 2014 (in thousands).Source: Heritage Insurance Holdings, Inc., 10-K, March 18, 2015Powered by Morningstar® Document Research℠The information contained herein may not be copied, adapted or distributed and is not warranted to be accurate, complete or timely. The user assumes all risks for any damages or losses arising from any use of this information,except to the extent such damages or losses cannot be limited or excluded by applicable law. Past financial performance is no guarantee of future results. Actual Low Estimate % Change fromActual High Estimate % Change fromActual Loss Reserves $51,469 $45,357 $51,943 Impact on: Net income $47,097 $50,851 8.0% $46,806 (0.6)% Stockholders’ equity $255,089 $258,843 1.5% $254,798 (0.1)% Cash, cash equivalents and investments $491,640 $491,640 0.0% $491,640 — Adjusted cash, cash equivalents and investments(1) $460,025 $463,779 0.8% $459,734 (0.1)% (1)Adjusted cash, cash equivalents and investments is intended to present a measure of future liquidity and consists of cash, cash equivalents andinvestments, less loss reserves, net of taxes, assuming a 38.575% tax rate. 42Source: Heritage Insurance Holdings, Inc., 10-K, March 18, 2015Powered by Morningstar® Document Research℠The information contained herein may not be copied, adapted or distributed and is not warranted to be accurate, complete or timely. The user assumes all risks for any damages or losses arising from any use of this information,except to the extent such damages or losses cannot be limited or excluded by applicable law. Past financial performance is no guarantee of future results.Table of ContentsPolicy Acquisition Costs. We incur policy acquisition costs that vary with, and are directly related to, the production of new business. Policyacquisition costs consist of the following four items: (i) commissions paid to outside agents at the time of policy issuance, (ii) policy administration fees paidto a third-party administrator at the time of policy issuance, (iii) premium taxes and (iv) inspection fees. We capitalize policy acquisition costs to the extentrecoverable, then we amortize those costs over the contract period of the related policy.At each reporting date, we determine whether we have a premium deficiency. A premium deficiency would result if the sum of our expected losses,deferred policy acquisition costs and policy maintenance costs (such as costs to store records and costs incurred to collect premiums and pay commissions)exceeded our related unearned premiums plus investment income. Should we determine that a premium deficiency exists, we would write off theunrecoverable portion of deferred policy acquisition costs.Reinsurance. We follow industry practice of reinsuring a portion of our risks. Reinsurance involves transferring, or “ceding”, all or a portion of the riskexposure on policies we write to another insurer, known as a reinsurer. To the extent that our reinsurers are unable to meet the obligations they assume underour reinsurance agreements, we remain liable for the entire insured loss.Our reinsurance agreements are short-term, prospective contracts. We record an asset, prepaid reinsurance premiums, and a liability, reinsurancepayable, for the entire contract amount upon commencement of our new reinsurance agreements. We amortize our prepaid reinsurance premiums over the 12-month contract period.In the event that we incur losses recoverable under our reinsurance program, we record amounts recoverable from our reinsurers on paid losses plus anestimate of amounts recoverable on unpaid losses. The estimate of amounts recoverable on unpaid losses is a function of our liability for unpaid lossesassociated with the reinsured policies; therefore, the amount changes in conjunction with any changes to our estimate of unpaid losses. In the event that weincur losses recoverable under the reinsurance program, the estimate of amounts recoverable from reinsurers on unpaid losses may change at any point in thefuture because of its relation to our reserves for unpaid losses.We estimate uncollectible amounts receivable from reinsurers based on an assessment of factors including the creditworthiness of the reinsurers and theadequacy of collateral obtained, where applicable. We recorded no uncollectible amounts under our reinsurance program or bad debt expense related toreinsurance for the years ended December 31, 2014 and December 31, 2013, respectively.Investments. We currently classify all of our investments in fixed maturity securities and equity securities as available-for-sale, and report them at fairvalue. We classify our investment in a mortgage loan as held to maturity and report it at amortized cost. Subsequent to our acquisition of available-for-salesecurities, we record changes in value through the date of disposition as unrealized holding gains and losses, net of tax effects, and include them as acomponent of other comprehensive income. We include realized gains and losses, which we calculate using the specific-identification method fordetermining the cost of securities sold, in net income. We amortize any premium or discount on investments over the remaining maturity period of the relatedinvestments using the effective interest method, and we report the amortization in net investment income. We recognize dividends and interest income whenearned.Quarterly, we perform an assessment of our investments to determine if any are “other-than-temporarily” impaired. An investment is impaired when thefair value of the investment declines to an amount less than the cost or amortized cost of that investment. As part of our assessment process, we determinewhether the impairment is temporary or “other-than-temporary”. We base our assessment on both quantitative criteria and qualitative information,considering a number of factors including, but not limited to: how long the security has been impaired; the amount of the impairment; whether, in the case ofequity securities, we intend to hold, and have the ability to hold, the security for a period sufficient for us to recover our cost basis, or whether, in the case ofdebt securities or mortgage loans, we intend to sell the investment or it is more likely than not that we will have to sell the investment before we recover theamortized cost; the financial condition and near-term prospects of the issuer; whether the issuer is current on contractually-obligated interest and principalpayments; key corporate events pertaining to the issuer and whether the market decline was affected by macroeconomic conditions. 43Source: Heritage Insurance Holdings, Inc., 10-K, March 18, 2015Powered by Morningstar® Document Research℠The information contained herein may not be copied, adapted or distributed and is not warranted to be accurate, complete or timely. The user assumes all risks for any damages or losses arising from any use of this information,except to the extent such damages or losses cannot be limited or excluded by applicable law. Past financial performance is no guarantee of future results.Table of ContentsIf we were to determine that an equity security has incurred an “other-than-temporary” impairment, we would permanently reduce the cost of thesecurity to fair value and recognize an impairment charge. If a debt security or mortgage loan is impaired and we either intend to sell the security or mortgageloan or it is more likely than not that we will have to sell the security or mortgage loan before we are able to recover the amortized cost, then we would recordthe full amount of the impairment in our net income.A large portion of our investment portfolio consists of fixed maturity securities and a mortgage loan, which may be adversely affected by changes ininterest rates as a result of governmental monetary policies, domestic and international economic and political conditions and other factors beyond ourcontrol. A rise in interest rates would decrease the net unrealized holding gains of our investment portfolio, offset by our ability to earn higher rates of returnon funds reinvested. Conversely, a decline in interest rates would increase the net unrealized holding gains of our investment portfolio, offset by lower ratesof return on funds reinvested.Fair Value. Fair value is the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between marketparticipants (an exit price). When reporting the fair values of the Company’s financial instruments, the Company prioritizes those fair value measurementsinto one of three levels based on the nature of the inputs, as follows: • Level 1—Assets and liabilities with values based on unadjusted quoted prices for identical assets or liabilities in an active market that the Company isable to access; • Level 2—Asset and liabilities with values based on quoted prices for similar assets or liabilities in active markets; quoted prices for identical or similarassets in markets that are not active; or valuation models with inputs that are observable, directly or indirectly for substantially the term of the asset orliability. • Level 3—Assets and liabilities with values that are based on prices or valuation techniques that require inputs that are both unobservable andsignificant to the overall fair value measurement. Unobservable inputs reflect the Company’s estimates of the assumptions that market participantswould use in valuing the assets and liabilities.We estimate the fair value of our investments using the closing prices on the last business day of the reporting period, obtained from active markets.For securities for which quoted prices in active markets are unavailable, we use observable inputs such as quoted prices in inactive markets, quoted prices inactive markets for similar instruments, benchmark interest rates, broker quotes and other relevant inputs. We do not have any investments in our portfoliowhich require us to use unobservable inputs. Our estimates of fair value reflect the interest rate environment that existed as of the close of business onDecember 31, 2014 and December 31, 2013. Changes in interest rates subsequent to December 31, 2014 may affect the fair value of our investments.The carrying amounts for the following financial instruments approximate their fair values at December 31, 2014 and December 31, 2013 because oftheir short-term nature: cash and cash equivalents, accrued investment income, premiums receivable, reinsurance payable, and accounts payable and accruedexpenses.Our non-financial assets, such as goodwill, purchased intangible assets, and property and equipment are carried at cost until there are indicators ofimpairment, and are recorded at fair value only when an impairment charge is recognized.Stock-Based Compensation. We recognize compensation expense under ASC 718 for its stock-based payments based on the fair value of the awards.The Company grants stock options at exercise prices equal to the fair market value of the Company’s stock on the dates the options are granted. The optionshave a maximum term of ten years from the date of grant and vest primarily in equal annual installments over a range of one to five year periods following thedate of grant for employee options. If a participant’s employment relationship ends, the participant’s vested awards will remain exercisable for the shorter of aperiod of 30 days or the period ending on the latest date on which such award could have been exercisable. The fair value of each option grant is separatelyestimated for each grant date. The fair value of each option is amortized into compensation expense on a straight-line basis between the grant date for theaward and each vesting date. The Company estimates the fair value of all stock option awards as of the date of the grant by applying the Black-Scholes-Merton multiple-option pricing valuation model. The application of this valuation model involves assumptions that are judgmental and highly sensitive inthe determination of compensation expense. We recorded $3.3 million, $5.7 million and $5.5 of stock-based compensation in 2014, 2013 and 2012,respectively.Income taxes. On May 22, 2014, the Company converted from a limited liability company to a corporation. As a limited liability company, theCompany was treated as a partnership for tax purposes, and accordingly was not subject to 44Source: Heritage Insurance Holdings, Inc., 10-K, March 18, 2015Powered by Morningstar® Document Research℠The information contained herein may not be copied, adapted or distributed and is not warranted to be accurate, complete or timely. The user assumes all risks for any damages or losses arising from any use of this information,except to the extent such damages or losses cannot be limited or excluded by applicable law. Past financial performance is no guarantee of future results.Table of Contentsentity-level federal or state income taxation. The Company’s income tax provision generally consisted of income taxes payable by its separate subsidiariesthat are taxed as corporations. As such, the Company’s effective tax rate as a limited liability company has historically been driven primarily by the taxableincome recognized with respect to gross premiums written. As a corporation, the Company is subject to typical corporate U.S. federal and state income taxrates on a consolidated basis which it expects to result in a statutory tax rate of approximately 38.575% under current tax law.We recognize deferred tax assets and liabilities for the future tax consequences attributable to differences between the financial statement carryingamounts of existing assets and liabilities and their respective tax bases. We measure deferred tax assets and liabilities using enacted tax rates expected toapply to taxable income in the years in which we expect to recover or settle those temporary differences. Should a change in tax rates occur, we recognize theeffect on deferred tax assets and liabilities in operations in the period that includes the enactment date. Realization of our deferred income tax assets dependsupon our generation of sufficient future taxable income.We recognize the financial statement benefit of a tax position only after determining that the relevant tax authority would more likely than not sustainthe position following an audit. For tax positions meeting the more likely than not threshold, the amount recognized in the consolidated financial statementsis the largest benefit that has a greater than 50% likelihood of being realized upon ultimate settlement with the relevant taxing authority.We record any income tax penalties and income tax-related interest as income tax expense in the period incurred. We did not incur any material taxpenalties or income tax-related interest during the year ended December 31, 2014 or the years ended December 31, 2013 and 2012.Recent Accounting PronouncementsThe Company describes below recent pronouncements that have had or may have a significant effect on its financial statements or on its disclosures.The Company does not discuss recent pronouncements that a) are not anticipated to have an impact on, or b) are unrelated to its financial condition, results ofoperations, or related disclosures.In May 2014, the FASB issued ASU No. 2014-09, “Revenue from Contracts with Customers (Topic 606),” (“ASU 2014-09”) which supersedes currentrevenue recognition guidance, including most industry-specific guidance. ASU 2014-09 requires a company to recognize revenue when it transfers promisedgoods or services to customers in an amount that reflects the consideration to which the company expects to be entitled in exchange for those goods andservices. The guidance also requires additional disclosures regarding the nature, amount, timing and uncertainty of revenue that is recognized. ASU 2014-09is effective for annual and interim periods beginning after December 15, 2016. Early adoption is not permitted. The Company is evaluating the impact of thenew guidance on its consolidated financial statements.Seasonality of our BusinessOur insurance business is seasonal as hurricanes typically occur during the period from June 1 through November 30 each year. With our reinsuranceprogram effective on June 1 each year, any variation in the cost of our reinsurance, whether due to changes to reinsurance rates or changes in the total insuredvalue of our policy base will occur and be reflected in our financial results beginning June 1 of each year, subject to certain adjustments.Off-Balance Sheet ArrangementsWe obtained a $5 million irrevocable letter of credit from a financial institution to secure Osprey’s obligations arising from our reinsurance program.We collateralized this letter of credit facility with otherwise unencumbered real estate. The letter of credit terminates on May 31, 2015.JOBS ActWe qualify as an “emerging growth company” under the JOBS Act. Section 107 of the JOBS Act provides that an emerging growth company can takeadvantage of the extended transition period provided in Section 7(a)(2)(B) of the Securities Act for complying with new or revised accounting standards. Inother words, an emerging growth company can delay the adoption of certain accounting standards until those standards would otherwise apply to privatecompanies. We have irrevocably elected not to avail ourselves of this extended transition period and, as a result, we will adopt new or revised accountingstandards on the relevant dates on which adoption of such standards is required for other public companies. 45Source: Heritage Insurance Holdings, Inc., 10-K, March 18, 2015Powered by Morningstar® Document Research℠The information contained herein may not be copied, adapted or distributed and is not warranted to be accurate, complete or timely. The user assumes all risks for any damages or losses arising from any use of this information,except to the extent such damages or losses cannot be limited or excluded by applicable law. Past financial performance is no guarantee of future results.Table of ContentsWe are in the process of evaluating the benefits of relying on other exemptions and reduced reporting requirements provided by the JOBS Act. Subjectto certain conditions set forth in the JOBS Act, if as an emerging growth company we choose to rely on such exemptions, we may not be required to, amongother things, (i) provide an auditor’s attestation report on our systems of internal controls over financial reporting pursuant to Section 404 of the Sarbanes-Oxley Act of 2002, (ii) provide all of the compensation disclosure that may be required of non-emerging growth public companies under the Dodd-FrankWall Street Reform and Consumer Protection Act, (iii) comply with any requirement that may be adopted by the Public Company Accounting OversightBoard regarding mandatory audit firm rotation or a supplement to the auditor’s report providing additional information about the audit and the financialstatements (auditor discussion and analysis), and (iv) disclose certain executive compensation-related items such as the correlation between executivecompensation and performance and comparisons of the Chief Executive Officer’s compensation to median employee compensation. These exemptions willapply until we no longer meet the requirements of being an emerging growth company. We will remain an emerging growth company until the earlier of(1) the last day of the year (a) following the fifth anniversary of the completion of our initial public offering, (b) in which we have total annual gross revenueof at least $1 billion or (c) in which we are deemed to be a large accelerated filer, which means the market value of our common stock that is held by non-affiliates exceeds $700 million as of the last business day of our prior second quarter, and (2) the date on which we have issued more than $1 billion in non-convertible debt during the prior three-year period.Impact of Inflation and Changing PricesThe consolidated financial statements and related data presented herein have been prepared in accordance with generally accepted accountingprinciples which require the measurement of financial position and operating results in terms of historical dollars without considering changes in the relativepurchasing power of money over time due to inflation. Our primary assets are monetary in nature. As a result, interest rates have a more significant impact onour performance than the effects of the general levels of inflation. Interest rates do not necessarily move in the same direction or with the same magnitude asthe cost of paying losses and LAE.Insurance premiums are established before we know the amount of loss and LAE and the extent to which inflation may affect such expenses.Consequently, we attempt to anticipate the future impact of inflation when establishing rate levels. While we attempt to charge adequate rates, we may belimited in raising our premium levels for competitive and regulatory reasons. Inflation also affects the market value of our investment portfolio and theinvestment rate of return. Any future economic changes which result in prolonged and increasing levels of inflation could cause increases in the dollaramount of incurred loss and LAE and thereby materially adversely affect future liability requirements.Item 7A. Quantitative and Qualitative Disclosures About Market Risk.Our investment portfolios at December 31, 2014 included fixed-maturity and equity securities, the purposes of which are not for trading or speculation.Our main objective is to maximize after-tax investment income and maintain sufficient liquidity to meet policyholder obligations while minimizing marketrisk which is the potential economic loss from adverse fluctuations in securities’ prices. We consider many factors including credit ratings, investmentconcentrations, regulatory requirements, anticipated fluctuation of interest rates, durations and market conditions in developing investment strategies.Investment securities are managed by a group of nationally recognized asset managers and are overseen by the investment committee appointed by our boardof directors. Our investment portfolios are primarily exposed to interest rate risk, credit risk and equity price risk. We classify our fixed-maturity and equitysecurities as available-for-sale and report any unrealized gains or losses, net of deferred income taxes, as a component of other comprehensive income withinour stockholders’ equity. As such, any material temporary changes in their fair value can adversely impact the carrying value of our stockholders’ equity.Interest Rate RiskOur fixed-maturity securities are sensitive to potential losses resulting from unfavorable changes in interest rates. We manage the risk by analyzinganticipated movement in interest rates and considering our future capital needs. 46Source: Heritage Insurance Holdings, Inc., 10-K, March 18, 2015Powered by Morningstar® Document Research℠The information contained herein may not be copied, adapted or distributed and is not warranted to be accurate, complete or timely. The user assumes all risks for any damages or losses arising from any use of this information,except to the extent such damages or losses cannot be limited or excluded by applicable law. Past financial performance is no guarantee of future results.Table of ContentsThe following table illustrates the impact of hypothetical changes in interest rates to the fair value of our fixed-maturity securities at December 31,2014 (in thousands): Hypothetical Change in Interest rates Estimated Fair ValueAfter Change Change In Estimated FairValue Percentage Increase(Decrease) in EstimatedFair Value 300 basis point increase $257,418 $(35,667) (12)% 200 basis point increase $269,307 $(23,778) (8)% 100 basis point increase $281,196 $(11,889) (4)% 100 basis point decrease $304,708 $11,623 4% 200 basis point decrease $314,030 $20,945 7% 300 basis point decrease $318,947 $25,862 9% Credit risk can expose us to potential losses arising principally from adverse changes in the financial condition of the issuer of our fixed maturities. Wemitigate this risk by investing in fixed-maturities that are generally investment grade and by diversifying our investment portfolio to avoid concentrations inany single issuer or market sector.The following table presents the composition of our fixed-maturity portfolio by rating at December 31, 2014 (in thousands): Comparable Rating Amortized Cost % of Total Amortized Cost Estimated Fair Value % of Total Estimated FairValue AAA $62,416 21% $62,448 21% AA+ $25,381 9% $25,632 9% AA- $23,786 8% $24,145 8% AA $43,923 15% $44,405 15% A+ $28,060 10% $28,434 10% A- $32,613 11% $32,920 11% A $36,869 13% $37,064 13% BBB+ $26,806 9% $26,903 9% BBB- $1,951 1% $1,956 1% BBB $8,067 3% $8,094 3% BB+ $698 0% $703 0% BB $302 0% $305 0% B+ $78 0% $76 0% Total$290,950 100% $293,085 100% Our equity investment portfolio at December 31, 2014 consists of common stocks and redeemable and non-redeemable preferred stocks. We may incurpotential losses due to adverse changes in equity security prices. We manage this risk primarily through industry and issuer diversification and assetallocation techniques.The following table illustrates the composition of our equity portfolio at December 31, 2014 (in thousands): Estimated Fair Value % of TotalEstimated Fair Value Stocks by sector: Financial $4,333 14% Energy 15,661 50% Other 8,411 27% Subtotal$28,405 91% Mutual Funds and ETF By type:Equity 2,820 9% Subtotal 2,820 9% Total$31,225 100% Foreign Currency Exchange RiskAt December 31, 2014, we did not have any material exposure to foreign currency related risk. 47Source: Heritage Insurance Holdings, Inc., 10-K, March 18, 2015Powered by Morningstar® Document Research℠The information contained herein may not be copied, adapted or distributed and is not warranted to be accurate, complete or timely. The user assumes all risks for any damages or losses arising from any use of this information,except to the extent such damages or losses cannot be limited or excluded by applicable law. Past financial performance is no guarantee of future results.Table of ContentsItem 8. Financial Statements and Supplementary DataHERITAGE INSURANCE HOLDINGS, INC.INDEX OF CONSOLIDATED FINANCIAL STATEMENTS Page Report of Independent Registered Public Accounting Firm 49 Consolidated Balance Sheets as of December 31, 2014 and December 31, 2013 50 Consolidated Statements of Operations and Comprehensive Income (Loss) for the Years Ended December 31, 2014 and 2013 and the period fromAugust 7, 2012 (inception) to December 31, 2012 51 Consolidated Statements of Changes in Stockholders’ Equity for the Years Ended December 31, 2014 and 2013 and the period from August 7,2012 (inception) to December 31, 2012 52 Consolidated Statements of Cash Flows for the Years Ended December 31, 2014 and 2013 and the period from August 7, 2012 (inception) toDecember 31, 2012 53 Notes to Consolidated Financial Statements 54 48Source: Heritage Insurance Holdings, Inc., 10-K, March 18, 2015Powered by Morningstar® Document Research℠The information contained herein may not be copied, adapted or distributed and is not warranted to be accurate, complete or timely. The user assumes all risks for any damages or losses arising from any use of this information,except to the extent such damages or losses cannot be limited or excluded by applicable law. Past financial performance is no guarantee of future results.Table of ContentsREPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRMBoard of DirectorsHeritage Insurance Holdings Inc., a Delaware CorporationWe have audited the accompanying consolidated balance sheets of Heritage Insurance Holdings, Inc. (a Delaware Corporation) and subsidiaries (the“Company”) as of December 31, 2014 and 2013, and the related consolidated statements of operations and comprehensive income (loss), changes instockholders’ equity, and cash flows for the years ended December 31, 2014 and 2013 and the period from August 7, 2012 (inception) to December 31, 2012.These financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these financial statementsbased on our audits.We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require thatwe plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. We were not engagedto perform an audit of the Company’s internal control over financial reporting. Our audits included consideration of internal control over financial reportingas a basis for designing audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of theCompany’s internal control over financial reporting. Accordingly, we express no such opinion. An audit also includes examining, on a test basis, evidencesupporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management,as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of Heritage InsuranceHoldings, Inc. and subsidiaries as of December 31, 2014 and 2013, and the results of their operations and their cash flows for the years ended December 31,2014 and 2013 and the period from August 7, 2012 (inception) to December 31, 2012 in conformity with accounting principles generally accepted in theUnited States of America./s/ GRANT THORNTON LLPTampa, FloridaMarch 18, 2015 49Source: Heritage Insurance Holdings, Inc., 10-K, March 18, 2015Powered by Morningstar® Document Research℠The information contained herein may not be copied, adapted or distributed and is not warranted to be accurate, complete or timely. The user assumes all risks for any damages or losses arising from any use of this information,except to the extent such damages or losses cannot be limited or excluded by applicable law. Past financial performance is no guarantee of future results.Table of ContentsHERITAGE INSURANCE HOLDINGS, INC. AND SUBSIDIARIESCONSOLIDATED BALANCE SHEETS(In thousands, except share data) December 31, 2014 December 31, 2013 ASSETS Fixed maturity securities, available for sale, at fair value (amortized cost of $290,951 and$105,955 in 2014 and 2013, respectively) $293,085 $104,668 Equity securities, available for sale, at fair value (cost of $30,555 and $25,446 in 2014 and 2013,respectively) 31,225 25,446 Mortgage loan, held to maturity, at amortized cost 6,849 6,063 Total investments 331,159 136,177 Cash and cash equivalents 160,481 65,059 Restricted cash 4,339 — Accrued investment income 2,617 971 Premiums receivable, net 20,028 10,347 Prepaid reinsurance premiums 43,148 31,252 Reinsurance premiums receivable — 5,337 Income taxes receivable — 5,073 Deferred income taxes 6,622 4,436 Deferred policy acquisition costs, net 24,370 9,765 Property and equipment, net 17,087 10,935 Other assets 5,180 2,626 Total Assets$615,031 $281,978 LIABILITIES AND STOCKHOLDERS’ EQUITYUnpaid losses and loss adjustment expenses$51,469 $19,344 Unearned premiums 241,136 116,243 Reinsurance payable 17,113 29,591 Income taxes payable 12,808 2,805 Advance premiums 5,143 3,829 Accrued compensation 442 505 Other liabilities 31,831 8,756 Total Liabilities$359,942 $181,073 Commitments and contingencies (Note 12)Redeemable shares — 20,921 Stockholders’ Equity:Common stock, $0.0001 par value, 50,000,000 shares authorized, 29,794,960 and 14,007,150shares issued and outstanding at December 31, 2014 and December 31, 2013, respectively 3 1 Additional paid-in capital 188,342 62,849 Accumulated other comprehensive income (loss) 1,723 (790) Retained earnings 65,021 17,924 Total Stockholders’ Equity 255,089 79,984 Total Liabilities and Stockholders’ Equity$615,031 $281,978 The accompanying notes are an integral part of these consolidated financial statements. 50Source: Heritage Insurance Holdings, Inc., 10-K, March 18, 2015Powered by Morningstar® Document Research℠The information contained herein may not be copied, adapted or distributed and is not warranted to be accurate, complete or timely. The user assumes all risks for any damages or losses arising from any use of this information,except to the extent such damages or losses cannot be limited or excluded by applicable law. Past financial performance is no guarantee of future results.Table of ContentsHERITAGE INSURANCE HOLDINGS, INC AND SUBSIDIARIESCONSOLIDATED STATEMENTS OF OPERATIONS AND COMPREHENSIVE INCOME (LOSS)(In thousands, except share and per share data) For the YearEnded December 31,2014 For the YearEnded December 31,2013 August 7, 2012(inception) toDecember 31, 2012 REVENUE: Gross premiums written $436,407 $218,537 $43,384 Increase in gross unearned premiums (124,893) (78,578) (37,665) Gross premiums earned 311,514 139,959 5,719 Ceded premiums (87,902) (44,800) (120) Net premiums earned 223,612 95,159 5,599 Retroactive reinsurance — 26,046 — Net investment income 3,849 1,049 27 Net realized gains (losses) 304 (323) — Other revenue 6,055 2,901 4 Total revenue 233,820 124,832 5,630 EXPENSES:Losses and loss adjustment expenses 89,560 38,501 1,402 Policy acquisition costs 36,510 6,150 84 General and administrative expenses 33,498 24,704 7,922 Interest expense — 16 829 Total expenses 159,568 69,371 10,237 Income (Loss) before income taxes 74,252 55,461 (4,607) Provision for income taxes 27,155 21,248 859 Net income (loss)$47,097 $34,213 $(5,466) OTHER COMPREHENSIVE INCOME(LOSS):Change in net unrealized gains (losses) on investments 4,395 (1,610) — Reclassification adjustment for net realized investment (gains)losses (304) 323 — Income tax (expense) benefit related to items of othercomprehensive income (loss) (1,578) 497 — Total comprehensive income (loss)$49,610 $33,423 $(5,466) Weighted average shares outstandingBasic 24,568,876 14,313,150 6,280,650 Diluted 25,816,590 14,473,800 6,280,650 Earnings (loss) per shareBasic$1.92 $2.39 $(0.87) Diluted$1.82 $2.36 $(0.87) The accompanying notes are an integral part of these consolidated financial statements. 51Source: Heritage Insurance Holdings, Inc., 10-K, March 18, 2015Powered by Morningstar® Document Research℠The information contained herein may not be copied, adapted or distributed and is not warranted to be accurate, complete or timely. The user assumes all risks for any damages or losses arising from any use of this information,except to the extent such damages or losses cannot be limited or excluded by applicable law. Past financial performance is no guarantee of future results.Table of ContentsHERITAGE INSURANCE HOLDINGS, INC AND SUBSIDIARIESCONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS’ EQUITY(In thousands, except share and per share data) Common Stock Additional Paid-In Capital Retained Earnings(Deficit) Accumulated OtherComprehensive Income(Loss) TotalStockholders’Equity Shares Amount August 7, 2012 (Inception) — $— $— $— $— $— Issuance of equity 5,938,950 1 23,289 — — 23,290 Equity based compensation 1,356,600 — 5,320 — — 5,320 Notes payable exchanged for equity 1,014,900 — 4,975 — — 4,975 Net loss — — — (5,466) — (5,466) Balance at December 31, 2012 8,310,450 $1 $33,584 $(5,466) $— $28,119 Equity reclassified to temporary equity (1,058,250) — (4,150) — — (4,150) Issuance of equity 6,459,150 — 31,939 — — 31,939 Equity based compensation 247,350 — 1,273 — — 1,273 Executive stock grant 38,250 — 150 — — 150 Issuance of equity for services 10,200 — 53 — — 53 Net unrealized change in investments, net of tax — — — — (790) (790) Change in fair value of redeemable shares — — — (10,823) — (10,823) Net income — — — 34,213 — 34,213 Balance at December 31, 2013 14,007,150 1 62,849 17,924 (790) 79,984 Temporary equity reclassified to equity 2,338,350 — 20,921 — — 20,921 Issuance of equity 17,850 — 88 — — 88 Net unrealized change in investments, net of tax — — — — 2,513 2,513 Issuance of common stock equity in initial publicoffering and private placement, net of discount feeand direct costs of issuance of $6,530 6,909,091 1 69,469 — — 69,470 Issuance of common stock to underwriters for overallotment, net of discount fee and direct costs ofissuance of $700 900,000 — 9,200 — — 9,200 Exercise of warrants 5,622,519 1 22,514 — — 22,515 Stock based compensation — — 3,301 — — 3,301 Net income — — — 47,097 — 47,097 Balance at December 31, 2014 29,794,960 $3 $188,342 $65,021 $1,723 $255,089 The accompanying notes are an integral part of these consolidated financial statements. 52Source: Heritage Insurance Holdings, Inc., 10-K, March 18, 2015Powered by Morningstar® Document Research℠The information contained herein may not be copied, adapted or distributed and is not warranted to be accurate, complete or timely. The user assumes all risks for any damages or losses arising from any use of this information,except to the extent such damages or losses cannot be limited or excluded by applicable law. Past financial performance is no guarantee of future results.Table of ContentsHERITAGE INSURANCE HOLDINGS, INC AND SUBSIDIARIESCONSOLIDATED STATEMENTS OF CASH FLOWS(In thousands) For the YearEndedDecember 31,2014 For the YearEndedDecember 31,2013 August 7, 2012(inception) toDecember 31,2012 OPERATING ACTIVITIES Net income (loss) $47,097 $34,213 $(5,466) Adjustments to reconcile net income (loss) to net cash provided by operating activities: Stock-based compensation 3,301 5,733 5,520 Non-cash interest expense — — 780 Amortization of bond discount 2,531 891 16 Depreciation and amortization 777 150 — Bad debt expense 250 — — Net realized (gains) losses (304) 323 — Deferred income taxes (3,764) (893) (3,046) Changes in operating assets and liabilities: Accrued investment income (1,646) (856) (115) Premiums receivable, net (9,931) (10,227) (120) Restricted cash (4,339) — — Prepaid reinsurance premiums (11,896) (30,658) (594) Reinsurance premiums receivable 5,337 (5,337) — Income taxes receivable 5,073 (5,073) — Deferred policy acquisition costs, net (14,605) (9,733) (32) Other assets (2,554) (1,810) (213) Unpaid losses and loss adjustment expenses 32,125 17,951 1,393 Unearned premiums 124,893 78,578 37,665 Reinsurance payable (12,478) 20,604 8,987 Income taxes payable 10,003 (1,100) 3,312 Accrued compensation (63) 504 1 Advance premiums 1,314 3,824 5 Other liabilities 23,075 7,967 1,382 Net cash provided by operating activities 194,196 105,051 49,475 INVESTING ACTIVITIESProceeds from sales and maturities of investments available for sale 38,738 7,424 — Purchases of investments available for sale (231,070) (126,971) (13,084) Purchase of mortgage loan participation (786) (6,063) (201) Purchase of other invested assets — — (603) Cost of property and equipment acquired (6,929) (10,884) — Net cash used in investing activities (200,047) (136,494) (13,888) FINANCING ACTIVITIESProceeds from issuance of equity and redeemable shares 88 33,630 23,385 Proceeds from issuance of equity from initial public offering, net of discount fee and costs 78,670 — — Proceeds from issuance of equity from exercise of warrants, net 22,515 — — Proceeds from notes payable - members — — 3,900 Repayment on note payable to bank — (1,000) 1,000 Net cash provided by financing activities 101,273 32,630 28,285 Increase in cash and cash equivalents 95,422 1,187 63,872 Cash and cash equivalents at beginning of period 65,059 63,872 — Cash and cash equivalents at end of period$160,481 $65,059 $63,872 Supplemental Cash Flows Information:Interest paid$— $16 $48 Income taxes paid, net$13,038 $28,314 $— Notes payable, $3.9 million and accrued interest, $780,000, converted to equity$— $— $4,680 Temporary equity reclassified to equity$20,921 $— $— The accompanying notes are an integral part of these consolidated financial statements. 53Source: Heritage Insurance Holdings, Inc., 10-K, March 18, 2015Powered by Morningstar® Document Research℠The information contained herein may not be copied, adapted or distributed and is not warranted to be accurate, complete or timely. The user assumes all risks for any damages or losses arising from any use of this information,except to the extent such damages or losses cannot be limited or excluded by applicable law. Past financial performance is no guarantee of future results.Table of ContentsHERITAGE INSURANCE HOLDINGS, INC. AND SUBSIDIARIESNOTES TO CONSOLIDATED FINANCIAL STATEMENTS Note 1.Basis of Presentation and Nature of BusinessBusiness DescriptionHeritage Insurance Holdings, Inc. (the “Company”, “we”, “our”, “us”) was initially formed as a Florida limited liability company in 2012. OnJanuary 1, 2014, the Company formed a Delaware limited liability company, also named Heritage Insurance Holdings, LLC and merged with it in order todomicile the Company in Delaware. Effective May 22, 2014, Heritage Insurance Holdings, LLC converted into a Delaware corporation named HeritageInsurance Holdings, Inc. As used in these consolidated financial statements, the terms “the Company”, “we”, “our” and “us” also refer to Heritage InsuranceHoldings, LLC and its consolidated subsidiaries prior to our conversion to a Delaware corporation.Our insurance subsidiary is Heritage Property & Casualty Insurance Company (“Heritage P&C). Our other subsidiaries include: Heritage MGA, LLC,the managing general agent that manages substantially all aspects of our insurance subsidiary’s business; Contractors’ Alliance Network, LLC, our vendornetwork manager; Skye Lane Properties, LLC, our property management subsidiary; First Access Insurance Group, LLC, our retail agency; Osprey Re LTD;our reinsurance subsidiary that provides a portion of the reinsurance protection purchased by our insurance subsidiary; and Heritage Insurance Claims, LLC,an inactive subsidiary reserved for future development.The Company’s primary products are personal and commercial residential insurance, which the Company currently offers only in Florida underauthorization from the Florida Office of Insurance Regulation (“FLOIR”). The Company conducts its operations under one business segment.On May 22, 2014, the Company’s registration statement on Form S-1 was declared effective, pursuant to which it sold 6,900,000 shares of commonstock to the public at a price of $11.00 per share, including 900,000 shares sold pursuant to the underwriters’ over-allotment option (the “IPO”). Concurrentwith the IPO, the Company completed a private placement (the “Private Placement”) with Ananke Ltd., an affiliate of Nephila Capital Ltd., to purchase $10million of the Company’s common stock at a price per share equal to the IPO price. The Company’s total net proceeds from the IPO and the Private Placementwere $78.6 million, after deducting underwriting discounts and other costs.On June 13, 2014, Heritage P&C, entered into an Insurance Policy Acquisition and Transition Agreement (the “Agreement”) with the Florida InsuranceGuaranty Association (“FIGA”) and the Florida Department of Financial Services (“DFS”), the Receiver of Sunshine State Insurance Company (“SSIC”).Pursuant to the Agreement, Heritage P&C had the right to offer a new policy of insurance, effective June 27, 2014 to all (subject to limited exceptions)Florida SSIC policyholders having in-force policies (“Transition Policies”), without the need for SSIC policyholders to file a new application with HeritageP&C or pay premium that has already been paid to SSIC (“Transition Coverage”). As of June 27, 2014, SSIC had approximately 33,000 policies in force,representing approximately $58.9 million of in force premium and unearned premium of approximately $29.3 million. The Transition Coverage willterminate at the end of the original SSIC policy period. Upon termination of each Transition Policy, Heritage P&C will renew such policies at the lesser ofSSIC’s and Heritage P&C’s rates on either SSIC’s or Heritage P&C’s forms, respectively. As consideration, Heritage P&C paid $10 million to the DFS, whichwill be amortized as acquisition costs in relation to the earning of the approximate $29.3 million of unearned premium. Heritage P&C was assigned theentirety of the unearned premium. At December 31, 2014, approximately 29,800 policies were in force representing approximately $53.3 million ofannualized premium. The SSIC policies represented approximately 14% of the Company’s total policies in force at December 31, 2014.Basis of PresentationThe consolidated financial statements include the accounts of Heritage Insurance Holdings, Inc. and its wholly-owned subsidiaries. The accompanyingconsolidated financial statements include the accounts of the Company and all other entities in which the Company has a controlling financial interest (noneof which are variable interest entities). All intercompany accounts and transactions have been eliminated in consolidation.The Company qualifies as an “emerging growth company” as defined in Section 2(a)(19) of the Securities Act, as modified by the Jumpstart OurBusiness Startups Act of 2012 (the “JOBS Act”). As a result, the Company is eligible for certain exemptions from various reporting requirements applicable toother public companies that are not emerging growth companies. The Company intends to continue to take advantage of some, but not all, of the exemptionsavailable to emerging growth companies until such time that it is no longer an emerging growth company. The Company has, however, irrevocably 54Source: Heritage Insurance Holdings, Inc., 10-K, March 18, 2015Powered by Morningstar® Document Research℠The information contained herein may not be copied, adapted or distributed and is not warranted to be accurate, complete or timely. The user assumes all risks for any damages or losses arising from any use of this information,except to the extent such damages or losses cannot be limited or excluded by applicable law. Past financial performance is no guarantee of future results.Table of Contentselected not to take advantage of the extended transition period afforded by the JOBS Act for the implementation of new or revised accounting standards. As aresult, the Company will comply with new or revised accounting standards on the relevant dates on which adoption of such standards is required for non-emerging growth companies.Use of EstimatesThe preparation of consolidated financial statements in conformity with United States Generally Accepted Accounting Principles (“U.S. GAAP”)requires us to make estimates and assumptions about future events that affect the amounts reported in our consolidated financial statements andaccompanying notes. We evaluate our estimates on an ongoing basis when updated information related to such estimates becomes available. We base ourestimates on historical experience and information available to us at the time these estimates are made. Actual results could differ materially from theseestimates. Note 2.Significant Accounting Policies and PracticesCash and Cash EquivalentsThe Company’s cash and cash equivalents include demand deposits with financial institutions and short-term, highly-liquid instruments with originalmaturities of three months or less when purchased.Restricted CashThe carrying amounts reported in the consolidated balance sheets for interest bearing deposits approximate their fair value because of the shortmaturity of these investments. As of December 31, 2014, restricted cash was $4.3 million. Heritage P&C holds approximately $4.3 million relating to areinsurance agreement with an entity that issued catastrophe (“CAT”) bonds, as Heritage P&C is contractually required to deposit two installments ofreinsurance premiums into a trust account.Offering costsOffering costs incurred in connection with the Company’s IPO and concurrent Private Placement, which included underwriters’ fees, legal andaccounting fees, printing and other fees, were deducted from the gross proceeds of the IPO and Private Placement. The proceeds from the issuance of shares,net of offering costs, is included in additional paid in capital in the consolidated statements of stockholders’ equity. The Company incurred an aggregate$7.2 million in offering costs related to the IPO and Private Placement.InvestmentsThe Company classifies all of its investments in fixed maturity securities and equity securities as available-for-sale, and reports them at fair value. TheCompany’s mortgage loan is classified as held to maturity and reported at amortized cost. Subsequent to its acquisition of available-for-sale securities, theCompany records changes in value through the date of disposition as unrealized holding gains and losses, net of tax effects, and includes them as acomponent of other comprehensive income (loss). The Company includes realized gains and losses, which it calculates using the specific-identificationmethod for determining the cost of securities sold, in net income. The Company amortizes any premium or discount on fixed maturities over the remainingmaturity period of the related securities using the effective interest method, and the Company reports the amortization in net investment income. TheCompany recognizes dividends and interest income when earned.Quarterly, the Company performs an assessment of its investments to determine if any are “other-than-temporarily” impaired. An investment isimpaired when the fair value of the investment declines to an amount less than the cost or amortized cost of that investment. As part of the assessmentprocess, the Company determines whether the impairment is temporary or “other-than-temporary”. The Company bases its assessment on both quantitativecriteria and qualitative information, considering a number of factors including, but not limited to: how long the security has been impaired; the amount of theimpairment; whether, in the case of equity securities, the Company intends to hold, and have the ability to hold, the security for a period sufficient for us torecover our cost basis, or whether, in the case of debt securities and participations in mortgage loans, the Company intends to sell the investment or it is morelikely than not that the Company will have to sell the investment before it recovers the amortized cost or cost; the financial condition and near-termprospects of the issuer; whether the issuer is current on contractually-obligated interest and principal payments; key corporate events pertaining to the issuerand whether the market decline was affected by macroeconomic conditions. 55Source: Heritage Insurance Holdings, Inc., 10-K, March 18, 2015Powered by Morningstar® Document Research℠The information contained herein may not be copied, adapted or distributed and is not warranted to be accurate, complete or timely. The user assumes all risks for any damages or losses arising from any use of this information,except to the extent such damages or losses cannot be limited or excluded by applicable law. Past financial performance is no guarantee of future results.Table of ContentsIf the Company were to determine that an equity security has incurred an “other-than-temporary” impairment, the Company would permanently reducethe cost of the security to fair value and recognize an impairment charge in its consolidated statements of operations and comprehensive income (loss). If adebt security or participation in a commercial mortgage loan is impaired and the Company either intends to sell the investment or it is more likely than notthat the Company will have to sell the investment before it is able to recover the amortized cost or cost, then the Company would record the full amount ofthe impairment in its net income.A large portion of the Company’s investment portfolio consists of fixed maturity securities, which may be adversely affected by changes in interestrates as a result of governmental monetary policies, domestic and international economic and political conditions and other factors beyond its control. A risein interest rates would decrease the net unrealized holding gains of our investment portfolio, offset by the Company’s ability to earn higher rates of return onfunds reinvested. Conversely, a decline in interest rates would increase the net unrealized holding gains of our investment portfolio, offset by lower rates ofreturn on funds reinvested.Fair ValueFair value is the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants (an exitprice). When reporting the fair values of the Company’s financial instruments, the Company prioritizes those fair value measurements into one of three levelsbased on the nature of the inputs, as follows: • Level 1—Assets and liabilities with values based on unadjusted quoted prices for identical assets or liabilities in an active market that the Company isable to access; • Level 2—Asset and liabilities with values based on quoted prices for similar assets or liabilities in active markets; quoted prices for identical or similarassets in markets that are not active; or valuation models with inputs that are observable, directly or indirectly for substantially the term of the asset orliability. • Level 3—Certain inputs are unobservable (supported by little or no market activity) and significant to the fair value measurement. Unobservable inputsreflect the Company’s best estimate of what hypothetical market participants would use to determine a transaction price for the asset or liability at thereporting date based on the best information available in the circumstances.The Company estimates the fair value of its investments using the closing prices on the last business day of the reporting period, obtained from activemarkets such as the NYSE, NASDAQ and NYSE MKT. For securities for which quoted prices in active markets are unavailable, the Company uses observableinputs such as quoted prices in inactive markets, quoted prices in active markets for similar instruments, benchmark interest rates, broker quotes and otherrelevant inputs. The Company does not have any investments in its portfolio which require the use of unobservable inputs. The Company’s estimate of fairvalue reflect the interest rate environment that existed as of the close of business on December 31, 2014. Changes in interest rates subsequent toDecember 31, 2014 may affect the fair value of the Company’s investments.The carrying amounts for the following financial instruments approximate their fair values at December 31, 2014 because of their short-term nature:cash and cash equivalents, accrued investment income, premiums receivable, reinsurance payable, and accounts payable and accrued expenses.The Company’s non-financial assets, such as goodwill (reported in other assets), and property, plant and equipment are carried at cost until there areindicators of impairment, and are recorded at fair value only when an impairment charge is recognized.PremiumsThe Company records assumed premiums written (premiums from policies that the Company assumed from SSIC and from Citizens Property InsuranceCorporation (“Citizens”), net of opt-outs) and direct premiums written (premiums from subsequent renewals of Citizens’ and SSIC policies and voluntarypolicies written during the period) as revenue, net of ceded amounts, on a daily pro rata basis over the contract period of the related policies that are in force.For any portion of premiums not earned at the end of the reporting period, the Company records an unearned premium liability.Premiums receivable represents amounts due from our policyholders for billed premiums and related policy fees. We perform a policy-level evaluationto determine the extent to which the balance of premiums receivable exceeds the balance of unearned premiums. We then age any resulting exposure basedon the last date the policy was billed to the policyholder, and 56Source: Heritage Insurance Holdings, Inc., 10-K, March 18, 2015Powered by Morningstar® Document Research℠The information contained herein may not be copied, adapted or distributed and is not warranted to be accurate, complete or timely. The user assumes all risks for any damages or losses arising from any use of this information,except to the extent such damages or losses cannot be limited or excluded by applicable law. Past financial performance is no guarantee of future results.Table of Contentswe establish an allowance for credit losses for any amounts outstanding for more than 90 days. When we receive payments on amounts previously chargedoff, we reduce bad debt expense in the period we receive the payment. Balances in premiums receivable and the associated allowance account are removedupon cancellation of the policy due to non-payment. We recorded an allowance of $250,000 and $0 for uncollectible premiums at December 31, 2014 and2013, respectively. Bad debt expense related to uncollectible premiums was $250,000, $0 and $0 for the years ended December 31, 2014 and 2013 and theperiod from August 7, 2012 (inception) to December 31, 2012, respectively. The Company has no direct write offs to date.When the Company receives premium payments from policyholders prior to the effective date of the related policy, the Company records an advancepremiums liability. On the policy effective date, the Company reduces the advance premium liability and records the premiums as described above.During June 2013, we received authorization from FLOIR to enter into a quota share reinsurance agreement with Citizens that was retroactive toJanuary 1, 2013. All of the terms and conditions of the policies assumed pursuant to that agreement, including coverage and rates, remained unchanged forthe remainder of the policy term. The assumed Citizens policies that do not opt-out or cancel will remain in effect until their respective expiration date andwill be renewed by us on our own policy forms thereafter. Effective June 28, 2013, we assumed the premiums and losses associated with approximately39,000 policies pursuant to a retroactive reinsurance agreement for the period January 1, 2013 through June 27, 2013. The transaction involved a period inthe past, where known loss activity had already been determined (January 1, 2013 to May 31, 2013) as well as a period after which our policy selection hadbeen made and the loss activity undetermined. The transaction exhibited both retroactive and prospective characteristics; the pending transaction’s termswere substantially set by May 31, 2013 and the reinsurance consequences of the pending transaction would begin on June 1, 2013, at the placement of our2013—2014 catastrophe excess of loss reinsurance program. Based on these factors, we concluded that consideration received relating to the period fromJanuary 1 through May 31, 2013 was retroactive reinsurance and the effects of this portion of the transaction were excluded from our underwriting results. In2013, we incurred no reinsurance cost associated with the retroactive component of this transaction and we recognized retroactive reinsurance income of$26.0 million, net of associated losses and loss adjustment expenses of $1.1 million, for the period January 1, 2013 through May 31, 2013. We do notcurrently expect to enter into similar transactions in future periods.Policy Acquisition CostsThe Company incurs policy acquisition costs that vary with, and are directly related to, the production of new business. Policy acquisition costsconsist of the following four items: (i) commissions paid to outside agents at the time of policy issuance; (ii) policy administration fees paid to a third-partyadministrator at the time of policy issuance; (iii) premium taxes; and (iv) inspection fees. The Company capitalizes policy acquisition costs to the extentrecoverable, then the Company amortizes those costs over the contract period of the related policy.At each reporting date, the Company determines whether it has a premium deficiency. A premium deficiency would result if the sum of the Company’sexpected losses, deferred policy acquisition costs, and policy maintenance costs (such as costs to store records and costs incurred to collect premiums and paycommissions) exceeded the Company’s related unearned premiums plus investment income. Should the Company determine that a premium deficiencyexists, the Company would write off the unrecoverable portion of deferred policy acquisition cost.Long-Lived Assets—Property and EquipmentProperty and equipment is stated at cost less accumulated depreciation and amortization. Depreciation is calculated on a straight-line basis over theestimated useful lives as follows: building—40 years; computer hardware and software 3—years; office and furniture equipment—3 to 7 years. Leaseholdimprovements are amortized over the shorter of the lease term or the asset’s useful life. Expenditures for improvements are capitalized to the propertyaccounts. Replacements and maintenance and repairs that do not improve or extend the life of the respective assets are expensed as incurred.Impairment of Long-Lived AssetsThe Company assesses the recoverability of long-lived assets when events or circumstances indicate that the assets might have become impaired. TheCompany determines whether the assets can be recovered from undiscounted future cash flows and, if not recoverable, the Company recognizes impairmentto reduce the carrying value to fair value. Recoverability of long lived assets is dependent upon, among other things, the Company’s ability to maintainprofitability, so as to be able to meet its obligations when they become due. In the opinion of management, based upon current information and projections,long-lived assets will be recovered over the period of benefit. 57Source: Heritage Insurance Holdings, Inc., 10-K, March 18, 2015Powered by Morningstar® Document Research℠The information contained herein may not be copied, adapted or distributed and is not warranted to be accurate, complete or timely. The user assumes all risks for any damages or losses arising from any use of this information,except to the extent such damages or losses cannot be limited or excluded by applicable law. Past financial performance is no guarantee of future results.Table of ContentsUnpaid Losses and Loss Adjustment ExpensesThe Company’s reserves for unpaid losses and loss adjustment expenses represent the estimated ultimate cost of settling all reported claims plus allclaims we incurred related to insured events that have occurred as of the reporting date, but that policyholders have not yet reported to the Company(incurred but not reported, or IBNR).The Company estimates its reserves for unpaid losses and loss adjustment expenses using individual case-based estimates for reported claims andactuarial estimates for IBNR losses. The Company continually reviews and adjusts its estimated losses as necessary based on industry development trends,the Company’s evolving claims experience and new information obtained. If the Company’s unpaid losses and loss adjustment expenses are considered to bedeficient or redundant, the Company increases or decreases the liability in the period in which it identifies the difference and reflects the change in its currentperiod results of operations. Though the Company’s estimate of the ultimate cost of settling all reported and unreported claims may change at any point inthe future, a reasonable possibility exists that its estimate may vary significantly in the near term from the estimated amounts included in the Company’sconsolidated financial statements.The Company reports its reserves for unpaid losses and loss adjustment expenses gross of the amounts related to unpaid losses recoverable fromreinsurers and reports losses net of amounts ceded to reinsurers. The Company does not discount its loss reserves for financial statement purposes.Other RevenueOther revenue represents rental income due under non-cancelable leases for space at the Company’s commercial property in Clearwater, Florida that weacquired in April 2013, and all policy and pay-plan fees. Florida law allows insurers to charge policyholders a $25 policy fee on each policy written; thesefees are not subject to refund, and the Company recognizes the income immediately when collected. The Company also charges pay-plan fees topolicyholders that pay its premiums in more than one installment and record the fees as income when collected.ReinsuranceThe Company follows industry practice of reinsuring a portion of our risks. Reinsurance involves transferring, or “ceding”, all or a portion of the riskexposure on policies the Company writes to another insurer, known as a reinsurer. To the extent that the Company’s reinsurers are unable to meet theobligations they assume under the Company’s reinsurance agreements, the Company remains liable for the entire insured loss.The Company’s reinsurance agreements are short-term, prospective contracts. The Company records an asset, prepaid reinsurance premiums, and aliability, reinsurance payable, for the entire contract amount upon commencement of new reinsurance agreements. The Company amortizes its prepaidreinsurance premiums over the 12-month contract period.In the event that the Company incurs losses recoverable under its reinsurance program, the Company records amounts recoverable from its reinsurers onpaid losses plus an estimate of amounts recoverable on unpaid losses. The estimate of amounts recoverable on unpaid losses is a function of the Company’sliability for unpaid losses associated with the reinsured policies; therefore, the amount changes in conjunction with any changes to the estimate of unpaidlosses. Though an estimate of amounts recoverable from reinsurers on unpaid losses may change at any point in the future because of its relation to theCompany’s reserves for unpaid losses, a reasonable possibility exists that an estimated recovery may change significantly from initial estimates.The Company estimates uncollectible amounts receivable from reinsurers based on an assessment of factors including the creditworthiness of thereinsurers and the adequacy of collateral obtained, where applicable. The Company recorded no uncollectible amounts under its reinsurance program or baddebt expense related to reinsurance for the years ended December 31, 2014 and 2013 and the period from August 7, 2012 (inception) to December 31, 2012.AssessmentsGuaranty fund and other insurance-related assessments imposed upon the Company are recorded as policy acquisition costs in the period theregulatory agency imposes the assessment. To recover Florida Insurance Guaranty Association (FIGA) assessments, the Company in turn calculates andbegins collecting a policy surcharge that will allow us to collect the entire assessment over a 12-month period, based on an estimate of the number of policiesthe Company expects to write. The Company then submits an information only filing, pursuant to Florida Statute 631.57(3)(h), to the insurance regulatoryauthority requesting formal approval of the policy FIGA surcharge. The process may be repeated in successive 12-month periods until the Company collectsthe entire assessment. The Company records the recoveries as revenue in the period that it collects the cash. While current regulations allow the Company torecover from policyholders the amount of assessments imposed upon the Company, the Company’s payment of the assessments and recoveries may not offseteach other in the same year. There were no such assessments during the periods presented. 58Source: Heritage Insurance Holdings, Inc., 10-K, March 18, 2015Powered by Morningstar® Document Research℠The information contained herein may not be copied, adapted or distributed and is not warranted to be accurate, complete or timely. The user assumes all risks for any damages or losses arising from any use of this information,except to the extent such damages or losses cannot be limited or excluded by applicable law. Past financial performance is no guarantee of future results.Table of ContentsThe Company collects other assessments imposed upon policyholders as a policy surcharge and records the amounts collected as a liability until theCompany remits the amounts to the regulatory agency that imposed the assessment.Accrued Bonus CompensationFor the year ended December 31, 2014, the Company accrued employee’s bonus compensation totaling $7.7 million, which the Company paid out incash as of December 31, 2014. During the third quarter of 2013, the Company accrued bonuses of $5.3 million based on 8.5% of targeted earnings beforeinterest, taxes, depreciation and amortization. For the year ended December 31, 2013, the Company awarded its directors, executive officers and selectemployees’ bonus compensation in aggregate of $11.5 million for 2013, comprised of $6.4 million in cash and $5.1 million in ownership equity, inclusive of$5.3 million recognized through September 30, 2013. The equity component was issued in the form of 389 ownership shares at a value of $13,125 per share.The per share value was determined based on an independent valuation, and the Company evaluated the assumptions, methodologies and conclusionsassociated with that valuation.Income TaxesOn May 22, 2014, the Company converted from a limited liability company to a corporation. As a limited liability company, the Company was treatedas a partnership for tax purposes, and accordingly was not subject to entity-level federal or state income taxation. The Company’s income tax provisiongenerally consisted of income taxes payable by its separate subsidiaries that are taxed as corporations. As such, the Company’s effective tax rate as a limitedliability company was historically driven primarily by the taxable income recognized by its taxable subsidiaries. As a corporation, the Company is subject totypical corporate U.S. federal and state income tax rates on a consolidated basis which it expects to result in a combined federal and state statutory tax rate ofapproximately 38.575% under current tax law.The Company recognizes deferred tax assets and liabilities for the future tax consequences attributable to differences between the financial statementcarrying amounts of existing assets and liabilities and their respective tax bases. The Company measures deferred tax assets and liabilities using enacted taxrates expected to apply to taxable income in the years in which it expects to recover or settle those temporary differences. Should a change in tax rates occur,the Company recognizes the effect on deferred tax assets and liabilities in operations in the period that includes the enactment date. Realization of theCompany’s deferred income tax assets depends upon our generation of sufficient future taxable income.The Company recognizes the financial statement benefit of a tax position only after determining that the relevant tax authority would more likely thannot sustain the position following an audit. For tax positions meeting the more likely than not threshold, the amount recognized in the consolidated financialstatements is the largest benefit that has a greater than 50% likelihood of being realized upon ultimate settlement with the relevant taxing authority.The Company records any income tax penalties and income-tax-related interest as income tax expense in the period incurred. The Company did notincur any material tax penalties or income-tax-related interest for the years ended December 31, 2014, 2013, and the period from August 7, 2012 (inception)to December 31, 2012, respectively.Advertising CostsThe Company expenses all advertising costs when it incurs those costs. For the years and period ended December 31, 2014, 2013 and 2012, theCompany incurred advertising costs of $14,200, $393,000, and $77,000, respectively.Stock-Based CompensationASC Topic 718, Compensation–Stock Compensation (“ASC 718”), requires that a company measure at fair value any new or modified share-basedcompensation arrangements with employees, such as stock options and restricted stock units, and recognize as compensation expense that fair value over therequisite service period.The Company estimates the fair value of options on the date of grant using the Black-Scholes-Merton option-pricing model. Key assumptions used inestimating the grant-date fair value of these options are as follows: the fair value of the ordinary shares, expected term, expected volatility, risk-free interestrate, and expected dividend yield.The Company uses the closing price of our ordinary shares on the New York Stock Exchange on the date of the grant as the fair value of ordinary sharesin the Black-Scholes-Merton option-pricing model.The expected term, which is a key factor in measuring the fair value and related compensation cost of share-based payments, has historically beenbased on the “simplified” methodology originally prescribed by Staff Accounting Bulletin (“SAB”) No. 107, in which the expected term is determined bycomputing the mathematical mean of the average vesting period and the contractual life of the options. While the widespread use of the simplified methodunder SAB No. 107 expired on December 31, 2007, the U.S. Securities and Exchange Commission (the “SEC”) issued SAB No. 110 in December 2007, whichallowed the simplified method to continue to be used in certain circumstances. These circumstances include when a company does not have sufficienthistorical data surrounding option exercises to provide a reasonable basis upon which to estimate expected term and during periods prior to its equity sharesbeing publicly traded.During 2014, with additional historical data available, the Company considered its own historical volatility, as well as the historical and impliedvolatilities of publicly-traded companies within the Company’s industry, in estimating expected volatility for options granted in 2014.The risk-free interest rate is based on the yield for a U.S. Treasury security having a maturity similar to the expected term of the related option grant. 59Source: Heritage Insurance Holdings, Inc., 10-K, March 18, 2015Powered by Morningstar® Document Research℠The information contained herein may not be copied, adapted or distributed and is not warranted to be accurate, complete or timely. The user assumes all risks for any damages or losses arising from any use of this information,except to the extent such damages or losses cannot be limited or excluded by applicable law. Past financial performance is no guarantee of future results.Table of ContentsAs of December 31, 2014, the Company has not granted any restricted stock.Under the fair value recognition provisions of ASC 718, the Company recognizes share-based compensation net of estimated forfeitures and, therefore,only recognizes compensation cost for those awards expected to vest over the requisite service period. The forfeiture rate is based on our estimate offorfeitures by plan participants based on historical forfeiture rates. Compensation expense recognized for each award ultimately reflects the number of awardsthat actually vest.Share-based compensation expense is generally recognized as a component of general and administrative expense, which is consistent with where therelated employee costs are recorded.Earnings Per ShareThe Company reports both basic earnings per share and diluted earnings per share. To calculate basic earnings per share, the Company divides netincome attributable to common shareholders by the weighted-average number of shares outstanding during the period, including redeemable shares. TheCompany calculates diluted earnings per share by dividing net income attributable to common shareholders by the weighted-average number of shares,redeemable shares, share equivalents, and restricted shares outstanding during the period. The Company uses the treasury stock method to calculate commonstock equivalents.Concentrations of RiskThe Company’s current operations subject us to the following concentrations of risk: • Revenue—The Company writes residential property and liability policies exclusively • Geographic—The Company writes 100% of its premium in Florida • Group concentration of credit risk—all of the Company’s reinsurers engage in similar activities and have similar economic characteristics thatcould cause their ability to repay us to be similarly affected by changes in economic or other conditions • Credit risk—The Company chooses to deposit all its cash at four financial institutionsThe Company mitigates its geographic and group concentrations of risk by entering into reinsurance contracts with highly rated, financially-stablereinsurers, and by securing irrevocable letters of credit from reinsurers when necessary.With regard to cash, the Company had $154.4 million and $65.9 million in excess of Federal Deposit Insurance Corporation (FDIC) insurance limits atDecember 31, 2014 and December 31, 2013, respectively. Deposits held in non- interest-bearing transaction accounts are combined with interest-bearingaccounts and are insured up to $250,000.Accounting PronouncementsThe Company describes below recent pronouncements that have had or may have a significant effect on its financial statements or on its disclosures.The Company does not discuss recent pronouncements that a) are not anticipated to have an impact on, or b) are unrelated to its financial condition, results ofoperations, or related disclosures.In May 2014, the FASB issued ASU No. 2014-09, “Revenue from Contracts with Customers (Topic 606),” (“ASU 2014-09”) which supersedes currentrevenue recognition guidance, including most industry-specific guidance. ASU 2014-09 requires a company to recognize revenue when it transfers promisedgoods or services to customers in an amount that reflects the consideration to which the company expects to be entitled in exchange for those goods andservices. The guidance also requires additional disclosures regarding the nature, amount, timing and uncertainty of revenue that is recognized. ASU 2014-09is effective for annual and interim periods beginning after December 15, 2016. Early adoption is not permitted. The Company is evaluating the impact of thenew guidance on its consolidated financial statements.In June 2014, FASB issued ASU 2014-12, Compensation - Stock Compensation, which clarifies accounting for share-based payments for which theterms of an award provide that a performance target could be achieved after the requisite service period. That is the case when an employee is eligible to retireor otherwise terminate employment before the end of the period in which a performance target could be achieved and still be eligible to vest in the award ifand when the 60Source: Heritage Insurance Holdings, Inc., 10-K, March 18, 2015Powered by Morningstar® Document Research℠The information contained herein may not be copied, adapted or distributed and is not warranted to be accurate, complete or timely. The user assumes all risks for any damages or losses arising from any use of this information,except to the extent such damages or losses cannot be limited or excluded by applicable law. Past financial performance is no guarantee of future results.Table of Contentsperformance target is achieved. The updated guidance clarifies that such a term should be treated as a performance condition that affects vesting. As such, theperformance target should not be reflected in estimating the grant-date fair value of the award. Compensation cost should be recognized in the period inwhich it becomes probable that the performance target will be achieved and should represent the compensation cost attributable to the periods for which therequisite service has already been rendered. The guidance will be effective for the Company beginning with year 2016, and may be applied eitherprospectively or retrospectively. The Company does not anticipate that this guidance will materially impact its consolidated financial statements and relateddisclosures.Subsequent EventsThe Company follows the provisions of ASC Topic 855-10, “Subsequent Events,” relating to subsequent events. This guidance defines the period afterthe balance sheet date during which events or transactions that may occur would be required to be recognized or disclosed in the Company’s consolidatedfinancial statements. The Company has evaluated subsequent events up to the date of issuance of this report (see Note 21). Note 3.InvestmentsThe following table details the difference between cost or adjusted/amortized cost and estimated fair value, by major investment category, atDecember 31, 2014 and December 31, 2013: Cost or Adjusted /Amortized Cost Gross Unrealized Gains Gross UnrealizedLosses Fair Value (In thousands) December 31, 2014 U.S. government and agency securities $7,002 $22 $16 $7,008 States, municipalities and politicalsubdivisions 41,578 560 18 42,120 Special revenue 133,269 1,349 237 134,381 Industrial and miscellaneous 105,591 668 254 106,005 Redeemable preferred stocks 3,511 84 24 3,571 Total fixed maturities 290,951 2,683 549 293,085 Nonredeemable preferred stocks 11,494 237 53 11,678 Equity securities 19,061 1,525 1,039 19,547 Total equity securities 30,555 1,762 1,092 31,225 Mortgage loan participation 6,849 — — 6,849 Total investments$328,355 $4,445 $1,641 $331,159 Cost or Adjusted /Amortized Cost Gross Unrealized Gains Gross UnrealizedLosses Fair Value (In thousands) December 31, 2013 U.S. government and agency securities $1,486 $— $44 $1,442 States, municipalities and political subdivisions 14,255 42 136 14,161 Special revenue 41,114 89 608 40,595 Industrial and miscellaneous 46,726 69 480 46,315 Redeemable preferred stocks 2,374 4 223 2,155 Total fixed maturities 105,955 204 1,491 104,668 Nonredeemable preferred stocks 5,283 6 331 4,958 Equity securities 20,163 370 45 20,488 Total equity securities 25,446 376 376 25,446 Mortgage loan participation 6,063 — — 6,063 Total investments$137,464 $580 $1,867 $136,177 Source: Heritage Insurance Holdings, Inc., 10-K, March 18, 2015Powered by Morningstar® Document Research℠The information contained herein may not be copied, adapted or distributed and is not warranted to be accurate, complete or timely. The user assumes all risks for any damages or losses arising from any use of this information,except to the extent such damages or losses cannot be limited or excluded by applicable law. Past financial performance is no guarantee of future results.The Company calculates the gain or loss realized on the sale of investments by comparing the sales price (fair value) to the cost or adjusted/amortizedcost of the security sold. The Company determines the cost or adjusted/ amortized cost of the security sold using the specific-identification method. Thefollowing tables detail the Company’s realized gains (losses) by major investment category as of December 31, 2014 and 2013, respectively: 2014 2013 Gains (Losses) Fair Value at Sale Gains (Losses) Fair Value at Sale (In thousands) Year Ended December 31, Fixed maturities $429 $8,632 $7 $1,764 Equity securities — — 8 507 Total realized gains 429 8,632 15 2,271 Fixed maturities (114) 4,164 (44) 1,331 Equity securities (11) 19,680 (294) 3,603 Total realized losses (125) 23,844 (338) 4,934 Net realized gain (losses)$304 $32,476 $(323) $7,205 61Source: Heritage Insurance Holdings, Inc., 10-K, March 18, 2015Powered by Morningstar® Document Research℠The information contained herein may not be copied, adapted or distributed and is not warranted to be accurate, complete or timely. The user assumes all risks for any damages or losses arising from any use of this information,except to the extent such damages or losses cannot be limited or excluded by applicable law. Past financial performance is no guarantee of future results.Table of ContentsThe table below summarizes the Company’s fixed maturities at December 31, 2014 by contractual maturity periods. Actual results may differ as issuersmay have the right to call or prepay obligations, with or without penalties, prior to the contractual maturity of those obligations. Cost or Amortized Cost Percent of Total Fair Value Percent of Total (In thousands) (In thousands) December 31, 2014 Due in one year or less $13,709 5% $13,712 5% Due after one year through five years 171,091 59% 171,382 59% Due after five years through ten years 61,114 21% 62,091 21% Due after ten years 45,037 15% 45,900 15% Total$290,951 100% $293,085 100% December 31, 2013Due in one year or less$1,518 1% $1,523 1% Due after one year through five years 62,242 59% 62,059 59% Due after five years through ten years 33,620 32% 32,921 32% Due after ten years 8,575 8% 8,165 8% Total$105,955 100% $104,668 100% The following table summarizes the Company’s net investment income by major investment category for the years ended December 31, 2014 and2013, and the period from August 7, 2012 (inception) to December 31, 2012 respectively: Year EndedDecember 31, 2014 Year EndedDecember 31, 2013 Period From August 7,2012 (inception)to December 31,2012 (In thousands) Fixed maturities $3,100 $914 $12 Equity securities 1,159 456 — Cash, cash equivalents and short-terminvestments 181 83 15 Other investments 243 93 5 Net investment income 4,683 1,546 32 Investment expenses 834 497 5 Net investment income, less investmentexpenses$3,849 $1,049 $27 During the Company’s quarterly evaluations of its securities for impairment, the Company determined that none of its investments in debt and equitysecurities that reflected an unrealized loss position were other-than-temporarily impaired. The issuers of the debt securities in which the Company investscontinue to make interest payments on a timely basis and have not suffered any credit rating reductions. The Company does not intend to sell, nor is it likelythat it would be required to sell, the debt securities before the Company recovers its amortized cost basis. All the issuers of the equity securities it owns hadnear-term prospects that indicated the Company could recover its cost basis, and the Company also has the ability and the intent to hold these securities untilthe value equals or exceeds its cost. 62Source: Heritage Insurance Holdings, Inc., 10-K, March 18, 2015Powered by Morningstar® Document Research℠The information contained herein may not be copied, adapted or distributed and is not warranted to be accurate, complete or timely. The user assumes all risks for any damages or losses arising from any use of this information,except to the extent such damages or losses cannot be limited or excluded by applicable law. Past financial performance is no guarantee of future results.Table of ContentsThe following table presents an aging of the Company’s unrealized investment losses by investment class as of December 31, 2014 and December 31,2013: Less Than Twelve Months Twelve Months or More Number ofSecurities GrossUnrealizedLosses FairValue Number ofSecurities GrossUnrealizedLosses FairValue (In thousands) December 31, 2014 U.S. government and agency securities 11 $15 $2,451 1 $1 $109 States, municipalities and political subdivisions 14 15 7,661 1 3 177 Industrial and miscellaneous 98 204 51,156 10 50 1,975 Special revenue 71 214 36,643 6 23 1,592 Redeemable preferred stocks 18 9 854 8 15 355 Total fixed maturities 212 $457 $98,765 26 $92 $4,208 Nonredeemable preferred stocks 1 31 2,552 1 22 490 Equity securities 1 1,039 9,792 — — — Total equity securities 2 1,070 12,344 1 22 490 Total 214 $1,527 $111,109 27 $114 $4,698 December 31, 2013U.S. government and agency securities 6 $44 $1,335 — $— $— States, municipalities and political subdivisions 17 116 8,294 2 20 341 Industrial and miscellaneous 89 413 30,962 6 67 888 Special revenue 59 582 27,256 3 26 502 Redeemable preferred stocks 27 223 1,844 — — — Total fixed maturities 198 $1,378 $69,691 11 $113 $1,731 Nonredeemable preferred stocks 58 331 4,349 — — — Equity securities 4 45 689 — — — Total equity securities 62 376 5,038 — — — Total 260 $1,754 $74,729 11 $113 $1,731 Note 4.Earnings (Loss) Per ShareBasic earnings per weighted average common share (“EPS”) is calculated by dividing net income by the weighted average number of basic commonshares outstanding during the period. Diluted earnings per share amounts are based on the weighted average number of common shares including outstandingwarrants, vested stock options and the net effect of potentially dilutive common shares outstanding.The following table sets forth the computation of basic and diluted EPS for the periods indicated. Year EndedDecember 31, 2014 Year EndedDecember 31, 2013 Period From August 7,2012(inception) toDecember 31, 2012 Basic earnings per share: Net income (loss) attributable to common stockholders(000’s) $47,097 $34,213 $(5,466) Weighted average shares outstanding 24,568,876 14,313,150 6,280,650 Basic earnings (loss) per share:$1.92 $2.39 $(0.87) Diluted earnings per share:Net income (loss) attributable to common stockholders(000’s)$47,097 $34,213 $(5,466) Weighted average shares outstanding 24,568,876 14,313,150 6,280,650 Weighted average dilutive shares 1,247,714 160,650 — Total weighted average dilutive shares 25,816,590 14,473,800 6,280,650 Diluted earnings (loss) per share:$1.82 $2.36 $(0.87) Note 5.Fair Value Financial InstrumentsFor the Company’s investments in U.S. government securities that do not have prices in active markets, agency securities, state and municipalgovernments, and corporate bonds, the Company obtains the fair values from its custodian, which uses a third-party valuation service and we evaluate therelevant inputs, assumptions, methodologies and conclusions associated with such valuations. The valuation service calculates prices for the Company’sinvestments in the aforementioned security types on a month-end basis by using several matrix-pricing methodologies that incorporate inputs from varioussources. The model the valuation service uses to price U.S. government securities and securities of states and municipalities incorporates inputs from activemarket makers and inter-dealer brokers. To price corporate bonds and agency securities, the valuation service calculates non-call yield spreads on all issuers,uses option-adjusted yield spreads to account for any early redemption features, then adds final spreads to the U.S. Treasury curve as of quarter end. Theinputs the valuation service uses in their calculations are not quoted prices in active markets, but are observable inputs, and therefore represent Level 2inputs.Source: Heritage Insurance Holdings, Inc., 10-K, March 18, 2015Powered by Morningstar® Document Research℠The information contained herein may not be copied, adapted or distributed and is not warranted to be accurate, complete or timely. The user assumes all risks for any damages or losses arising from any use of this information,except to the extent such damages or losses cannot be limited or excluded by applicable law. Past financial performance is no guarantee of future results. 63Source: Heritage Insurance Holdings, Inc., 10-K, March 18, 2015Powered by Morningstar® Document Research℠The information contained herein may not be copied, adapted or distributed and is not warranted to be accurate, complete or timely. The user assumes all risks for any damages or losses arising from any use of this information,except to the extent such damages or losses cannot be limited or excluded by applicable law. Past financial performance is no guarantee of future results.Table of ContentsThe following table presents information about the Company’s assets measured at fair value on a recurring basis. The Company assesses the levels forthe investments at each measurement date, and transfers between levels are recognized on the actual date of the event or change in circumstances that causedthe transfer in accordance with the Company’s accounting policy regarding the recognitions of transfers between levels of the fair value hierarchy. For theyears ended December 31, 2014 and 2013, there were no transfers in or out of Level 1, 2, and 3. December 31, 2014 Total Level 1 Level 2 Level 3 (In thousands) Fixed maturity investments: U.S. Government and Government agencies $7,008 $3,211 $3,797 $— States, municipalities and political subdivisions 42,120 — 42,120 — Special Revenue 134,381 — 134,381 — Industrial and miscellaneous 106,005 — 106,005 — Redeemable preferred stocks 3,571 3,571 — — Total fixed maturity investments$293,085 $6,782 $286,303 $— Non-redeemable preferred stocks$11,678 $11,678 $— $— Equity securities 19,547 19,547 — — Total equity securities$31,225 $31,225 $— $— Total investments$324,310 $38,007 $286,303 $— December 31, 2013 Total Level 1 Level 2 Level 3 (In thousands) Fixed maturity investments: U.S. Government and Government agencies $1,442 $— $1,442 $— States, municipalities and political subdivisions 14,161 — 14,161 — Special Revenue 40,595 — 40,595 — Industrial and miscellaneous 46,315 — 46,315 — Redeemable preferred stocks 2,155 2,155 — — Total fixed maturity investments$104,668 $2,155 $102,513 $— Equity securities$20,488 $20,488 $— $— Non-redeemable preferred stocks 4,958 4,958 — — Total equity securities$25,446 $25,446 $— $— Total investments$130,114 $27,601 $102,513 $— 64Source: Heritage Insurance Holdings, Inc., 10-K, March 18, 2015Powered by Morningstar® Document Research℠The information contained herein may not be copied, adapted or distributed and is not warranted to be accurate, complete or timely. The user assumes all risks for any damages or losses arising from any use of this information,except to the extent such damages or losses cannot be limited or excluded by applicable law. Past financial performance is no guarantee of future results.Table of ContentsThe Company acquired a 55% participation in a commercial real estate mortgage loan for $6.1 million in 2013. The underlying $11.5 million loan wasoriginated by unaffiliated lenders, and collateralized by commercial real estate located in Polk County, Florida. The Company records an asset in the amountof our pro rata share of the outstanding principal and carry the investment at amortized cost. The Company receives monthly principal and interest paymentsand recognizes income when collectible. The Company increased its participation in this commercial real estate mortgage loan by $0.8 million to $6.8million in 2014. Note 6.Property and EquipmentProperty and equipment, net consists of the following at December 31, 2014 and 2013 (in thousands): December 31, 2014 December 31, 2013 Land $2,582 $2,582 Building 9,599 7,090 Computer hardware and software 2,155 364 Office furniture and equipment 445 176 Tenant and leasehold improvements 2,812 873 Vehicles 421 — Total, at cost 18,014 11,085 Less: accumulated depreciation and amortization 927 150 Property and equipment, net$17,087 $10,935 Depreciation expense for the years ended December 31, 2014 and 2013 and the period from August 7, 2012 (inception) to December 31, 2012 was $0.8million, $0.2 million and $0, respectively. The Company’s real estate consists of 13 acres of land, two buildings with a gross area of 148,000 square feet and aparking garage. The Company relocated to these facilities during March 2014. These facilities and the related existing tenant lease agreements were acquiredin April 2013 for a total purchase price of $9.8 million paid in cash.The Company currently leases space to non-affiliates and occupies space in one of the buildings.Expected annual rental income due under non-cancellable operating leases for our real estate properties is as follows (in thousands): Year Amount January 1 to December 31, 2015 $2,100 January 1 to December 31, 2016 $2,066 January 1 to December 31, 2017 $2,115 January 1 to December 31, 2018 $2,167 January 1 to December 31, 2019 $1,982 Thereafter $7,189 Note 7.Deferred Policy Acquisition CostsThe Company defers certain costs in connection with written policies, called Deferred Policy Acquisition Costs (“DPAC”), net of correspondingamounts of ceded reinsurance commissions, called Deferred Reinsurance Ceding Commissions (“DRCC”). Net DPAC is amortized over the effective period ofthe related insurance policies.The Company anticipates that its DPAC costs will be fully recoverable in the near term. The table below depicts the activity with regard to DPAC forthe years ended December 31, 2014 and 2013: 2014 2013 (In thousands) Beginning balance $9,765 $32 Policy acquisition costs deferred 51,115 15,883 Amortization (36,510) (6,150) Ending balance$24,370 $9,765 The DPAC at December 31, 2014 includes the unamortized portion of $10 million of deferred costs paid during June 2014 in connection with theCompany’s assumption of policies from SSIC. Likewise, $7.6 million amortization has been recorded related to the SSIC policy acquisition costs for the yearended December 31, 2014. Therefore, the DPAC cost is $2.5 million related to SSIC at December 31, 2014. 65Source: Heritage Insurance Holdings, Inc., 10-K, March 18, 2015Powered by Morningstar® Document Research℠The information contained herein may not be copied, adapted or distributed and is not warranted to be accurate, complete or timely. The user assumes all risks for any damages or losses arising from any use of this information,except to the extent such damages or losses cannot be limited or excluded by applicable law. Past financial performance is no guarantee of future results.Table of ContentsNote 8. ReinsuranceThe Company’s reinsurance program is designed, utilizing the Company’s risk management methodology, to address its exposure to catastrophes. TheCompany’s program provides reinsurance protection for catastrophes including hurricanes, tropical storms, and tornadoes. These reinsurance agreements arepart of the Company’s catastrophe management strategy, which is intended to provide its stockholders an acceptable return on the risks assumed in itsproperty business, and to reduce variability of earnings, while providing protection to the Company’s policyholders.Effective December 4, 2012, concurrent with the effective date of the Company’s initial assumption transaction with Citizens, the Company securedcatastrophe excess of loss reinsurance providing $9.5 million of protection in excess of its $2 million primary retention through May 31, 2013. Losspayments under this contract reduce the limits of coverage afforded by the amounts paid, but the limit of coverage would be reinstated from the time of theoccurrence of the loss. The Company would pay an additional premium calculated at pro rata of 100% of the reinsurer’s premium for the term of this contract,being pro rata only as to the fraction of the reinsurer’s limit of liability and reinstated simultaneously with the reinsurer’s loss payment. Under nocircumstances would the reinsurer’s liability exceed $9.5 million for any one loss occurrence, and $19 million for all loss occurrences during the contractterm.During the second quarter of 2013, the Company placed its reinsurance program for the period from June 1, 2013 through May 31, 2014. TheCompany’s reinsurance program, which was segmented into layers of coverage, protected it for excess property catastrophe losses and loss adjustmentexpenses. The Company’s previous year’s reinsurance program incorporated the mandatory coverage required by law to be placed with the Florida HurricaneCatastrophe Fund, a state-mandated catastrophe reinsurance fund (“FHCF”). The Company also purchased private reinsurance below, alongside and abovethe FHCF layer, as well as aggregate reinsurance coverage. The following describes the various layers of the Company’s June 1, 2013 to May 31, 2014reinsurance program. • The Company’s Retention. For the first catastrophic event, the Company had a primary retention of the first $9 million of losses and lossadjustment expenses, of which the Company’s reinsurance subsidiary, Osprey Re Ltd (“Osprey”), was responsible for $3 million. For a secondand third catastrophic event, Heritage P&C’s primary retention decreased to $3 million per event. To the extent that there was reinsurancecoverage remaining, Heritage P&C had no primary retention for events beyond the third catastrophic event. Osprey had no primary retentionbeyond the first catastrophic event. • Layers Below FHCF. Immediately above the Company’s retention, the Company purchased $94 million of reinsurance from third party reinsurersand Osprey. Through Osprey, the Company retained an aggregate participation in this coverage of $3.5 million, comprised of a 3% participationof $31 million of losses and loss adjustment expenses in excess of $9 million, or $0.9 million, and a 4% participation of $63 million of lossesand loss adjustment expenses in excess of $40 million, or $2.5 million. Through the payment of a reinstatement premium, the Company was ableto reinstate the full amount of this reinsurance one time. To the extent that $94.0 million or a portion thereof was exhausted in a first catastrophicevent, the Company purchased reinstatement premium protection insurance to pay the required premium necessary for the reinstatement of thiscoverage. • FHCF Layer. The Company’s FHCF coverage included an estimated maximum provisional limit of 90% of $270 million, or $243 million, inexcess of the Company’s retention and private reinsurance of $103 million. The limit and retention of the FHCF coverage was subject to upwardor downward adjustment based on, among other things, submitted exposures to FHCF by all participants. The Company purchased coveragealongside and above the FHCF layer from third party reinsurers. The layer alongside was in the amount of $27 million and the layer immediatelyabove was in the amount of $28.5 million. To the extent the FHCF coverage was adjusted, this private reinsurance would adjust to fill in anygaps in coverage up to the reinsurers’ aggregate limits for this layer. Through the payment of a reinstatement premium, the Company was able toreinstate the full amount of this private reinsurance one time. To the extent that all or a portion of either of these private layers was exhausted in afirst catastrophic event, the Company purchased reinstatement premium protection insurance to pay the required premium necessary for thereinstatement of this coverage. The FHCF coverage could not be reinstated once exhausted, but it did provide coverage for multiple events. • Aggregate Coverage. In addition to the layers described above, the Company also purchased $170 million of aggregate reinsurance coverage forlosses and loss adjustment expenses in excess of $401.5 million for a first catastrophic event. To the extent that this coverage was not fullyexhausted in the first catastrophic event, it provided coverage commencing at its reduced retention levels for second and subsequent events andwhere underlying coverage has been previously exhausted. There is no reinstatement of the aggregate reinsurance coverage once exhausted, butit did provide coverage for multiple events. 66Source: Heritage Insurance Holdings, Inc., 10-K, March 18, 2015Powered by Morningstar® Document Research℠The information contained herein may not be copied, adapted or distributed and is not warranted to be accurate, complete or timely. The user assumes all risks for any damages or losses arising from any use of this information,except to the extent such damages or losses cannot be limited or excluded by applicable law. Past financial performance is no guarantee of future results.Table of ContentsFor a first catastrophic event, the Company’s 2013 reinsurance program provided coverage for $571.5 million of losses and loss adjustment expenses,including its retention, and the Company was responsible for all losses and loss adjustment expenses in excess of such amount. For subsequent catastrophicevents, the Company’s total available coverage depended on the magnitude of the first event, as the Company may had coverage remaining from layers thatwere not previously fully exhausted. The Company also purchased reinstatement premium protection insurance to provide an additional $149.5 million ofcoverage. The Company aggregate reinsurance layer also provides coverage for second and subsequent events to the extent not exhausted in prior events.During April 2014, Heritage P&C entered into two catastrophe reinsurance agreements with Citrus Re Ltd., a newly-formed Bermuda special purposeinsurer. The agreements provide for three years of coverage from catastrophe losses caused by certain named storms, including hurricanes, beginning onJune 1, 2014. The limit of coverage of $200 million is fully collateralized by a reinsurance trust account for the benefit of Heritage P&C. Heritage P&C pays aperiodic premium to Citrus Re Ltd. during this three-year risk period. Citrus Re Ltd. issued $200 million of principal-at-risk variable notes due April 2017 tofund the reinsurance trust account and its obligations to Heritage P&C under the reinsurance agreements. The maturity date of the notes may be extended upto two additional years to satisfy claims for catastrophic events occurring during the three-year term of the reinsurance agreements. The Company hasdetermined that, while Citrus Re Ltd. is a variable interest entity, the Company does not have any variable interests in Citrus Re Ltd. Accordingly,consolidation of or disclosures associated with Citrus Re Ltd. are not applicable.During the second quarter of 2014, the Company placed its reinsurance program for the period from June 1, 2014 through May 31, 2015. TheCompany’s reinsurance program, which is segmented into layers of coverage, protects it for excess property catastrophe losses and loss adjustment expenses.The Company’s current reinsurance program incorporates the mandatory coverage required by law to be placed with FHCF. The Company also purchasedprivate reinsurance below, alongside and above the FHCF layer, as well as aggregate reinsurance coverage. The following describes the various layers of theCompany’s June 1, 2014 to May 31, 2015 reinsurance program. • The Company’s Retention. For the first catastrophic event, the Company has a primary retention of the first $15 million of losses and lossadjustment expenses, of which Osprey is responsible for $6 million. For a second event, Heritage P&C’s primary retention decreases to $2 millionand Osprey is responsible for $4 million. To the extent that there is reinsurance coverage remaining, Heritage P&C has a $2 million primaryretention for events beyond the third catastrophic event. Osprey has no primary retention beyond the second catastrophic event. • Layers Below FHCF. Immediately above the Company’s retention, the Company has purchased $185 million of reinsurance from third partyreinsurers. Through the payment of a reinstatement premium, the Company is able to reinstate the full amount of this reinsurance one time. Tothe extent that $185 million or a portion thereof is exhausted in a first catastrophic event, the Company has purchased reinstatement premiumprotection insurance to pay the required premium necessary for the reinstatement of this coverage. A portion of this coverage wraps around theFHCF and provides coverage alongside the FHCF. • FHCF Layer. The Company’s FHCF coverage includes an estimated maximum provisional limit of 90% of $484 million, or $436 million, inexcess of its retention and private reinsurance of $181 million. The limit and retention of the FHCF coverage is subject to upward or downwardadjustment based on, among other things, submitted exposures to FHCF by all participants. The Company has purchased coverage alongsidefrom third party reinsurers. The layer alongside is in the amount of $48 million. To the extent the FHCF coverage is adjusted, this privatereinsurance will adjust to fill in any gaps in coverage up to the reinsurers’ aggregate limits for this layer. The FHCF coverage cannot be reinstatedonce exhausted, but it does provide coverage for multiple events. • CAT Bond Layer. Immediately above the FHCF layer is the coverage provided by the reinsurance agreements entered into with Citrus Re Ltd., asdescribed above in this footnote. The first contract with Citrus Re Ltd. provides $150 million of coverage and the second contract provides anadditional $50 million of coverage. Osprey provides $25 million of coverage alongside the second contract. • Aggregate Coverage. In addition to the layers described above, the Company has also purchased $105 million of aggregate reinsurance coveragefor losses and loss adjustment expenses in excess of $825.0 million for a first catastrophic event. To the extent that this coverage is not fullyexhausted in the first catastrophic event, it provides coverage commencing at its reduced retention levels for second and subsequent events andwhere underlying coverage has been previously exhausted. There is no reinstatement of the aggregate reinsurance coverage once exhausted, butit does provide coverage for multiple events. Osprey Re Ltd. provides $20 million of protection in the layer above $940 million. 67Source: Heritage Insurance Holdings, Inc., 10-K, March 18, 2015Powered by Morningstar® Document Research℠The information contained herein may not be copied, adapted or distributed and is not warranted to be accurate, complete or timely. The user assumes all risks for any damages or losses arising from any use of this information,except to the extent such damages or losses cannot be limited or excluded by applicable law. Past financial performance is no guarantee of future results.Table of ContentsFor a first catastrophic event, the Company’s reinsurance program provides coverage for $990 million of losses and loss adjustment expenses,including its retention, and the Company is responsible for all losses and loss adjustment expenses in excess of such amount. For subsequent catastrophicevents, the Company’s total available coverage depends on the magnitude of the first event, as the Company may have coverage remaining from layers thatwere not previously fully exhausted. The Company has also purchased reinstatement premium protection insurance to provide an additional $185 million ofcoverage. The Company aggregate reinsurance layer also provides coverage for second and subsequent events to the extent not exhausted in prior events.Property Per Risk CoverageThe Company also purchased property per risk coverage for losses and loss adjustment expenses in excess of $1 million per claim. The limit recoveredfor an individual loss is $9 million and total limit for all losses is $27 million. There are two reinstatements available with additional premium due based onthe amount of the layer exhausted. In addition, the Company purchased facultative reinsurance in excess of $10 million for any commercial properties itinsured that the total insured value exceeded $10 million.Assumption Transactions and Assumed Premiums WrittenOn June 27, 2014, the Company assumed approximately $58.9 million (representing 33,000 policies in force) of annualized premiums from SunshineState Insurance Company (“SSIC”). At December 31, 2014, approximately 29,800 SSIC policies were in force representing approximately $53.3 million ofannualized premium. The SSIC policies account for approximately 14% of the Company’s total policies in force as of December 31, 2014.Prior to June 27, 2014, substantially all of the Company’s policies have been obtained in connection with assumption transactions with Citizens,pursuant to which the Company recorded the assumed premiums written in the amount of the unearned premiums transferred to the Company. In connectionwith each assumption transaction, the Company assumes the responsibility of the primary writer of the risk through the expiration of the term of the policy.The following table depicts written premiums, earned premiums and losses, showing the effects that the Company’s assumption transactions have onthese components of the Company’s consolidated statements of operations and comprehensive income (loss): Year EndedDecember 31, 2014 Year EndedDecember 31, 2013 Period From August 7, 2012(inception) toDecember 31, 2012 (In thousands) Premium written: Direct $283,295 $120,893 $215 Assumed 153,112 97,644 43,169 Ceded (99,798) (75,459) (714) Net premium written$336,609 $143,078 $42,670 Change in unearned premiums:Direct$(80,617) $(74,797) $(203) Assumed (44,276) (3,781) (37,462) Ceded 11,896 30,659 594 Net decrease (increase)$(112,997) $(47,919) $(37,071) Premiums earned:Direct$202,678 $46,096 $12 Assumed 108,836 93,863 5,707 Ceded (87,902) (44,800) (120) Net premiums earned$223,612 $95,159 $5,599 Losses and LAE incurred:Direct$64,686 $14,674 $5 Assumed 24,874 23,827 1,397 Net losses and LAE incurred$89,560 $38,501 $1,402 68Source: Heritage Insurance Holdings, Inc., 10-K, March 18, 2015Powered by Morningstar® Document Research℠The information contained herein may not be copied, adapted or distributed and is not warranted to be accurate, complete or timely. The user assumes all risks for any damages or losses arising from any use of this information,except to the extent such damages or losses cannot be limited or excluded by applicable law. Past financial performance is no guarantee of future results.Table of ContentsThe following table highlights the effects that the Company’s assumption transactions have on unpaid losses and loss adjustment expenses andunearned premiums: Year EndedDecember 31, 2014 Year EndedDecember 31, 2013 Period fromAugust 7, 2012(inception) toDecember 31, 2012 (In thousands) Unpaid losses and loss adjustment expenses: Direct $34,420 $10,037 $— Assumed 17,049 9,307 1,393 Gross unpaid losses and LAE 51,469 19,344 1,393 Net unpaid losses and LAE$51,469 $19,344 $1,393 Unearned premiums:Direct$155,617 $75,000 $203 Assumed 85,519 41,243 37,462 Gross unearned premiums 241,136 116,243 37,665 Ceded (43,148) (31,252) (594) Net unearned premiums$197,988 $84,991 $37,071 Prepaid reinsurance premiums related to twenty-one and sixteen reinsurers at December 31, 2014 and December 31, 2013, respectively. There were noamounts receivable with respect to reinsurers at December 31, 2014, 2013 or 2012. Thus, there were no concentrations of credit risk associated withreinsurance receivables as of December 31, 2014, 2013 and 2012. The percentages of assumed premiums earned to net premiums earned for the periods endedDecember 31, 2014, 2013 and 2012 were 46.8%, 98.6% and 102%, respectively. Note 9.Reserve For Unpaid LossesThe Company determines the reserve for unpaid losses on an individual-case basis for all incidents reported. The liability also includes amounts forwhich are commonly referred to as incurred but not reported, or “IBNR”, claims as of the balance sheet date.The table below summarizes the activity related to the Company’s reserve for unpaid losses: Years Ended December 31, PeriodAugust 7, 2012(inception) toDecember 31,2012 2014 2013 (In thousands) Balance, beginning of period $19,344 $1,393 $— Less: reinsurance recoverable on unpaid losses — — — Net balance, beginning of period 19,344 1,393 — Incurred related to:Current year 89,783 38,968 1,402 Prior years (223) (467) — Total incurred 89,560 38,501 1,402 Paid related to:Current year 45,618 20,010 9 Prior years 11,817 540 — Total paid 57,435 20,550 9 Net balance, end of period 51,469 19,344 1,393 Plus: reinsurance recoverable on unpaid losses — — — Balance, end of period$51,469 $19,344 $1,393 69Source: Heritage Insurance Holdings, Inc., 10-K, March 18, 2015Powered by Morningstar® Document Research℠The information contained herein may not be copied, adapted or distributed and is not warranted to be accurate, complete or timely. The user assumes all risks for any damages or losses arising from any use of this information,except to the extent such damages or losses cannot be limited or excluded by applicable law. Past financial performance is no guarantee of future results.Table of ContentsThe significant increase in the Company’s reserves for unpaid losses in 2014 from 2013 is primarily due to the increase in policy count.The Company writes insurance in the state of Florida, which could be exposed to hurricanes or other natural catastrophes. Although the occurrence of amajor catastrophe could have a significant effect on its monthly or quarterly results, such an event is unlikely to be so material as to disrupt its overall normaloperations. However, the Company is unable to predict the frequency or severity of any such events that may occur in the near term or thereafter. TheCompany believes that the reserve for unpaid losses reasonably represents the amount necessary to pay all claims and related expenses which may arise fromincidents that have occurred as of the balance sheet date.The Company’s losses incurred in 2014 and 2013 reflect prior year redundancies of $223,000 and $467,000, respectively, due to changes in theCompany’s estimate of ultimate losses on claims incurred in prior years not attributable to any specific trend or claims handling dynamic. Note 10.Income TaxesThe following table summarizes the provision for income taxes: Year EndedDecember 31,2014 Year EndedDecember 31,2013 Period FromAugust 7, 2012(inception) toDecember 31,2012 (In thousands) Federal: Current $26,440 $19,066 $3,312 Deferred (3,219) (769) (2,583) Provision for Federal income tax expense 23,221 18,297 729 State:Current 4,479 3,075 593 Deferred (545) (124) (463) Provision for State income tax expense 3,934 2,951 130 Provision for income taxes$27,155 $21,248 $859 The following table sets forth the components of income (loss) before income taxes for the years ended December 31, 2014 and 2013 and the periodfrom August 7, 2012 (inception) to December 31, 2012 (in thousands): Year EndedDecember 31, 2014 Year EndedDecember 31, 2013 Period From August 7,2012 (inception) toDecember 31, 2012 Pass-through entities (through May 22, 2014) $2,668 $1,888 $(7,165) Non-pass through entities 71,584 53,573 2,558 Income (loss) before income taxes$74,252 $55,461 $(4,607) The actual income tax expense differs from the expected income tax expense computed by applying the combined applicable effective federal andstate tax rates to income before the provision for income taxes as follows: Year EndedDecember 31, 2014 Year EndedDecember 31, 2013 Period From August 7,2012 (inception) toDecember 31, 2012 Expected income tax expense at federal rate 35.0% 35.0% 34.0% State tax expense, net of federal tax benefits 3.6% 3.6% 3.6% Operating losses (income) from pass-through entities (seeNote 2) (1.4%) (1.2%) (55.7%) Rate change and other (0.6%) 0.9% (0.6%) Reported income tax expense 36.6% 38.3% (18.7%) The effective income tax rate differs from the statutory income tax rate in 2014, 2013 and 2012 primarily due to state incomes taxes and the fact that aportion of the Company’s consolidated pre-tax income through May 22, 2014 was earned at our limited liability companies that had elected to be taxedunder the Partnership provisions of the Internal Revenue Code. Accordingly, all income or losses and applicable tax credits generated by these entitiesthrough that date are reported on the common shareholders’ individual tax returns, and no federal income taxes are recorded by the Company. 70Source: Heritage Insurance Holdings, Inc., 10-K, March 18, 2015Powered by Morningstar® Document Research℠The information contained herein may not be copied, adapted or distributed and is not warranted to be accurate, complete or timely. The user assumes all risks for any damages or losses arising from any use of this information,except to the extent such damages or losses cannot be limited or excluded by applicable law. Past financial performance is no guarantee of future results.Table of ContentsDeferred income taxes reflect the net tax effects of temporary differences between the carrying amounts of assets and liabilities for financial reportingpurposes and the amounts used for income tax purposes.The table below summarizes the significant components of our net deferred tax assets: December 31, 2014 December 31, 2013 (In thousands) Deferred tax assets: Unearned premiums $15,567 $6,843 Tax-related discount on loss reserve 1,022 385 Unrealized loss — 497 Stock based compensation 1,258 — Other 545 484 Total deferred tax assets 18,392 8,209 Deferred tax liabilities:Deferred acquisition costs 9,401 3,767 Unrealized gain 1,081 — Property and equipment 633 — Other 655 6 Total deferred tax liabilities 11,770 3,773 Less: valuation allowance — — Net deferred tax assets$6,622 $4,436 In assessing the net carrying amount of deferred tax assets, we consider whether it is more likely than not that we will not realize some portion or all ofthe deferred tax assets. The ultimate realization of deferred tax assets depends upon the generation of future taxable income during the periods in which thosetemporary differences become deductible. We consider the scheduled reversal of deferred tax liabilities, projected future taxable income and tax planningstrategies in making this assessment.The statue of limitations related to our federal and state income tax returns remains open from our first filings for 2012 through 2014. No taxingauthorities are currently examining any of our federal or state income tax returns.The reinsurance affiliate, which is based in Bermuda, made an irrevocable election under section 953(d) of the U.S. Internal Revenue Code of 1986, asamended, to be treated as a domestic insurance company for U.S. Federal income tax purposes. As a result of this election, our reinsurance subsidiary issubject to United States income tax as if it were a U.S. corporation.As of December 31, 2014, the Company had no uncertain tax positions or unrecognized tax benefits that, if recognized, would impact the effectiveincome tax rate. Note 11.Statutory Accounting and RegulationsState laws and regulations, as well as national regulatory agency requirements, govern the operations of all insurers such as our insurance subsidiary.The various laws and regulations require that insurers maintain minimum amounts of statutory surplus and risk-based capital, restrict insurers’ ability to paydividends, specify allowable investment types and investment mixes, and subject insurers to assessments.The Company’s insurance subsidiary, Heritage P&C, must file with the insurance regulatory authorities an “Annual Statement” which reports, amongother items, net income (loss) and surplus as regards policyholders, which is called stockholder’s equity under GAAP. For the years ended December 31, 2014and 2013, the Company’s insurance subsidiary recorded statutory net income of $9.8 million and $20.9 million, respectively. The Company’s insurancesubsidiary is domiciled in Florida, and the laws of that state require that the Company’s insurance subsidiary maintain capital and surplus equal to the greaterof $15 million or 10% of its liabilities. The Company’s statutory capital surplus was $172.7 million and $63.1 million at December 31, 2014 and 2013,respectively. State law also requires the Company’s insurance subsidiary to adhere to prescribed premium-to-capital surplus ratios, with which the subsidiaryis in compliance.In 2014, the Florida legislature passed Senate Bill 1308, which was signed into law by the Governor. Among other things, this bill incorporates theNational Association of Insurance Commissioners (“NAIC”) recommendations with regard to expansion of the regulation of insurers to include non-insuranceentity affiliates. Specifically, the new law permits the 71Source: Heritage Insurance Holdings, Inc., 10-K, March 18, 2015Powered by Morningstar® Document Research℠The information contained herein may not be copied, adapted or distributed and is not warranted to be accurate, complete or timely. The user assumes all risks for any damages or losses arising from any use of this information,except to the extent such damages or losses cannot be limited or excluded by applicable law. Past financial performance is no guarantee of future results.Table of ContentsOffice of Insurance Regulation to examine affiliated entities within an insurance holding company system in order to ascertain the financial condition of theinsurer. The law also provides for certain disclosures with regard to enterprise risk, which are satisfied by the provision of related information filed with theSEC. This legislation was designed to bolster regulation for insurer solvency and governance and became effective January 1, 2015.The National Association of Insurance Commissioners (“NAIC”) published risk-based capital guidelines for insurance companies that are designed toassess capital adequacy and to raise the level of protection that statutory surplus provides for policy holders. Most states, including Florida, have enacted theNAIC guidelines as statutory requirements, and insurers having less statutory surplus than required will be subject to varying degrees of regulatory action,depending on the level of capital inadequacy. State insurance regulatory authorities could require an insurer to cease operations in the event the insurer failsto maintain the required statutory capital.The level of required risk-based capital (RBC) is calculated and reported annually. There are five outcomes to the RBC calculation set forth by theNAIC which are as follows: 1.No Action Level—If RBC is greater than 200%, no further action is required. 2.Company Action Level—If RBC is between 150%-200%, the insurer must prepare a report to the regulator outlining a comprehensive financial planthat identifies conditions that contributed to the insurer’s financial condition and proposes corrective actions. 3.Regulatory Action Level—If RBC is between 100%-150%, the state insurance commissioner is required to perform any examinations or analyses to theinsurer’s business and operations that he or she deems necessary as well as issuing appropriate corrective orders. 4.Authorized Control Level—If RBC is between 70%-100%, this is the first point that the regulator may take control of the insurer even if the insurer isstill technically solvent and is in addition to all the remedies available at the higher action levels. 5.Mandatory Control Level—If RBC is less than 70%, the regulator is required to take steps to place the insurer under its control regardless of the levelof capital and surplus.At December 31, 2014, the ratio of adjusted capital to authorized control level risk based capital was 459%.Florida law permits an insurer to pay dividends or make distributions out of that part of statutory surplus derived from net operating profit and netrealized capital gains. The law further provides calculations to determine the amount of dividends or distributions that can be made without the priorapproval of the insurance regulatory authority and the amount of dividends or distributions that would require prior approval of the insurance regulatoryauthority. Statutory risk-based capital requirements may further restrict our insurance subsidiary’s ability to pay dividends or make distributions if theamount of the intended dividend or distribution would cause statutory surplus to fall below minimum risk-based capital requirements. However, the consentorder authorizing our commencement of operations precludes us from paying dividends without the prior approval of FLOIR until July 31, 2017.Florida law limits an insurer’s investment in equity instruments and also restricts investments in medium to low quality debt instruments. TheCompany was in compliance with all investment restrictions at December 31, 2014 and 2013.Governmental agencies or certain quasi-governmental entities can levy assessments upon the Company in the states in which the Company writespolicies. See Note 2 for a description of how the Company recovers assessments imposed upon it.Governmental agencies or certain quasi-governmental entities can also levy assessments upon policyholders, and the Company collects the amount ofthe assessments from policyholders as surcharges for the benefit of the assessing agency. We currently collect assessments levied upon policyholders onbehalf of Citizens in the amount of 1.0%, and on behalf of FHCF in the amount of 1.3%. The Company multiplies the premium written on each policy bythese assessment percentages to determine the additional amount that it will collect from the policyholder and remit to the assessing agencies. 72Source: Heritage Insurance Holdings, Inc., 10-K, March 18, 2015Powered by Morningstar® Document Research℠The information contained herein may not be copied, adapted or distributed and is not warranted to be accurate, complete or timely. The user assumes all risks for any damages or losses arising from any use of this information,except to the extent such damages or losses cannot be limited or excluded by applicable law. Past financial performance is no guarantee of future results.Table of ContentsThe Company reported its insurance subsidiary’s assets, liabilities and results of operations in accordance with GAAP, which varies from statutoryaccounting principles prescribed or permitted by state laws and regulations, as well as by general industry practices. The following items are principaldifferences between statutory accounting and GAAP: • Statutory accounting requires that the Company excluded certain assets, called non-admitted assets, from the balance sheet. • Statutory accounting requires the Company to expense policy acquisition costs when incurred, while GAAP allows the Company to defer and amortizepolicy acquisition costs over the estimated life of the policies. • Statutory accounting dictates how much of a deferred income tax asset the Company can admit on a statutory balance sheet. • Statutory accounting requires that the Company record certain investments at cost or amortized cost, while the Company records other investments atfair value; however, GAAP requires that we record all available for sale investments at fair value. • Statutory accounting requires that surplus notes, also known as surplus debentures, be recorded in statutory surplus, while GAAP requires the Companyto record surplus notes as a liability. • Statutory accounting allows bonds to be carried at amortized cost or fair value based on the rating received from the Securities Valuation Office of theNAIC, while they are recorded at fair value for GAAP if designated as available for sale. • Statutory accounting allows ceding commission income to be recognized when written if the cost of acquiring and renewing the associated businessexceeds the ceding commissions, but under GAAP such income is deferred and recognized over the coverage period. • Statutory accounting requires that unearned premiums and loss reserves be presented net of related reinsurance rather than on a gross basis underGAAP. • Statutory accounting requires a provision for reinsurance liability be established for reinsurance recoverable on paid losses aged over ninety days andfor unsecured amounts recoverable from unauthorized reinsurers. Under GAAP there is no charge for uncollateralized amounts ceded to a company notlicensed in the insurance affiliate’s domiciliary state and a reserve for uncollectable reinsurance is charged through earnings rather than surplus orequity. • Statutory accounting requires an additional admissibility test outlined in Statements on Statutory Accounting Principles, No. 101 and the change indeferred income tax is reported directly in capital and surplus, rather than being reported as a component of income tax expense under GAAP.The Company’s insurance subsidiary must file with the insurance regulatory authorities an “Annual Statement” which reports, among other items, netincome (loss) and surplus as regards policyholders, which is called stockholder’s equity under GAAP.The table below reconciles the Company’s consolidated GAAP net income (loss) to statutory net income (loss) of its insurance subsidiary (inthousands): Year EndedDecember 31, 2014 Year EndedDecember 31, 2013 Period FromAugust 7, 2012(inception) toDecember 31, 2012 Consolidated GAAP net income (loss) $47,097 $34,213 $(5,466) Increase (decrease) due to: Deferred income taxes (3,764) (893) (3,046) Deferred policy acquisition costs (14,605) (9,733) (32) Surplus note interest (1,445) (278) — Non-statutory subsidiaries (16,788) (2,191) 7,165 Equity compensation (1,106) — — Allowance for doubtful accounts 250 — — Other 199 (128) 240 Statutory net income (loss) of insurance subsidiary$9,838 $20,990 $(1,139) 73Source: Heritage Insurance Holdings, Inc., 10-K, March 18, 2015Powered by Morningstar® Document Research℠The information contained herein may not be copied, adapted or distributed and is not warranted to be accurate, complete or timely. The user assumes all risks for any damages or losses arising from any use of this information,except to the extent such damages or losses cannot be limited or excluded by applicable law. Past financial performance is no guarantee of future results.Table of ContentsThe table below reconciles our consolidated GAAP stockholders’ equity to the surplus as regards policyholders of our insurance subsidiary (inthousands): Year EndedDecember 31, 2014 Year EndedDecember 31, 2013 Period FromAugust 7, 2012(inception) toDecember 31, 2012 Consolidated GAAP stockholders’ equity $255,089 $79,984 $28,119 Increase (decrease) due to: Ownership shares issued (176,464) (72,948) (33,585) Redeemable shares classified as temporary equity — 20,921 — Subsidiary capitalization — 20,000 18,000 Surplus debentures and paid in surplus 128,106 17,000 7,000 Deferred policy acquisition costs (24,370) (9,765) (32) Deferred income taxes 8,308 2,891 (257) Non-admitted assets (320) (511) (143) Surplus debenture interest (1,723) (278) — Non-statutory subsidiaries (10,825) 5,355 7,165 Unrealized investment losses/gains (2,227) 746 — Equity compensation (3,106) — — Allowance for doubtful accounts 250 — — Other (7) (341) 239 Statutory surplus as regards policyholders of insurancesubsidiary$172,711 $63,054 $26,506 The Company’s reinsurance subsidiary, Osprey Re Ltd. (“Osprey”), which was incorporated on April 23, 2013, is licensed as a Class 3a Insurer underThe Bermuda Insurance Act 1978 and related regulations. Osprey is required to maintain statutory capital and surplus of at least $1.0 million and maintainliquid resources or have access to liquid resources equal to its maximum obligation for which it is responsible under the terms of any reinsurance arrangementto which it is a party. In May 2013, the Company contributed $1.7 million in cash to Osprey. Osprey secures its reinsurance obligations to our insurancesubsidiary with an irrevocable letter of credit in the amount of $5 million. These resources, in addition to premiums ceded to it by our insurance subsidiaryare sufficient to comply with regulatory requirements as of December 31, 2014. Bermuda’s standard for financial statement reporting is U.S. GAAP. Note 12.Commitment and ContingenciesThe Company is involved in claims-related legal actions arising in the ordinary course of business. The Company accrues amounts resulting fromclaims-related legal actions in unpaid losses and loss adjustment expenses during the period that it determines an unfavorable outcome becomes probableand it can estimate the amounts. Management makes revisions to its estimates based on its analysis of subsequent information that the Company receivesregarding various factors, including: (i) per claim information; (ii) company and industry historical loss experience; (iii) judicial decisions and legaldevelopments in the awarding of damages; and (iv) trends in general economic conditions, including the effects of inflation. When determinable, theCompany discloses the range of possible losses in excess of those accrued and for reasonably possible losses. Note 13.Other LiabilitiesAt December 31, 2014, other liabilities included approximately $21.1 million related to amounts owed to Citizens for policies assumed by theCompany, where the policyholder subsequently opted-out of the assumption program. Note 14.Related Party TransactionsThe Company has been party to various related party transactions involving certain of its officers, directors and significant stockholders as set forthbelow. The Company has entered into these arrangements without obligation to continue its effect in the future and the associated expense was immaterial toits results of operations or financial position as of December 31, 2014 and December 31, 2013. • The Company leased the space that it had occupied through March 2014 at 700 Central Avenue, Ste. 500 St. Petersburg, Florida from a real estatemanagement company controlled by a stockholder. The Company leased the space without obligation to continue doing so in the future. For the yearsended December 31, 2014, 2013 and for the period from August 7, 2012 (inception) to December 31, 2012 the Company incurred rent expense ofapproximately $70,000, $488,000 and $65,000 respectively. • The Company has entered into an agreement with a real estate management company controlled by one of its directors to manage its Clearwater officespace. Management services are provided at a fixed fee, plus ordinary and necessary out of pocket expenses. As of December 31, 2014, the Companyhas made payments of $93,000 under this agreement. Fees for additional services, such as the oversight of construction activity, are provided for on anas needed basis. • The Company entered into an agreement for the construction of a parking facility for its Clearwater property with a relative of one of its directors. As ofDecember 31, 2014, the Company has made payments of approximately $2.6 million for engineering and architectural services. The project wascompleted during September 2014. Note 15.Employee Benefit PlanThe Company provides a 401(k) plan for substantially all of its employees. The Company contributes 3% of employees’ salary, up to the maximumallowable contribution, regardless of the employees’ level of participation in the plan. For the years ended December 31, 2014 and 2013, the Company’scontributions to the plan on behalf of the participating employees were $285,000, and $155,000, respectively.Source: Heritage Insurance Holdings, Inc., 10-K, March 18, 2015Powered by Morningstar® Document Research℠The information contained herein may not be copied, adapted or distributed and is not warranted to be accurate, complete or timely. The user assumes all risks for any damages or losses arising from any use of this information,except to the extent such damages or losses cannot be limited or excluded by applicable law. Past financial performance is no guarantee of future results. 74Source: Heritage Insurance Holdings, Inc., 10-K, March 18, 2015Powered by Morningstar® Document Research℠The information contained herein may not be copied, adapted or distributed and is not warranted to be accurate, complete or timely. The user assumes all risks for any damages or losses arising from any use of this information,except to the extent such damages or losses cannot be limited or excluded by applicable law. Past financial performance is no guarantee of future results.Table of ContentsNote 16.EquityThe total amount of our authorized capital stock consists of 50,000,000 shares of common stock, $0.0001 par value, and 5,000,000 shares of preferredstock, $0.0001 par value. As of December 31, 2014, the Company had 29,794,960 shares of common stock outstanding and no shares of preferred stockoutstanding.Warrants to Purchase Common StockAs of December 31, 2014, the Company had outstanding warrants to purchase an aggregate of 30,600 shares of common stock. The warrants have anexercise price of $5.88 per share and expire on March 31, 2018. The warrants are non-redeemable by the Company and are subject to certain restrictions ontransfer. Number of WarrantsOutstanding Number of CommonShares Issuable /(Issued) UponExercise (In thousands) Warrants outstanding at August 7, 2012 (inception) — — Warrants issued 1,015 1,015 Warrants exercised — — Warrants outstanding at December 31, 2012 1,015 1,015 Warrants issued 6,691 6,691 Warrants exercised (8) (8) Warrants outstanding at December 31, 2013 7,698 7,698 Warrants issued 18 18 Warrants exercised (7,685) (7,685) Warrants outstanding at December 31, 2014 31 31 Common StockHolders of common stock are entitled to one vote for each share held on all matters subject to a vote of stockholders, subject to the rights of holders ofany outstanding preferred stock. Accordingly, holders of a majority of the shares of common stock entitled to vote in any election of directors may elect all ofthe directors standing for election, subject to the rights of holders of any outstanding preferred stock. Holders of common stock will be entitled to receiveratably any dividends that the board of directors may declare out of funds legally available therefor, subject to any preferential dividend rights of outstandingpreferred stock. Upon the Company’s liquidation, dissolution or winding up, the holders of common stock will be entitled to receive ratably its net assetsavailable after the payment of all debts and other liabilities and subject to the prior rights of holders of any outstanding preferred stock. Holders of commonstock have no preemptive, subscription, redemption or conversion rights. There are no redemption or sinking fund provisions applicable to the commonstock. All outstanding shares of the Company’s capital stock are fully paid and nonassessable.Equity IssuancesAs of December 31, 2013, there were 14,007,150 shares of common stock outstanding and 2,338,350 redeemable shares outstanding, representing$62.9 million of additional paid-in capital and $20.9 million of redeemable shares, respectively. The following discloses the changes in the Company’sstockholders’ equity during 2014.First Quarter 2014In the first quarter 2014, the Company raised an additional $0.1 million of capital through the issuance of 17,850 investment units, comprised of17,850 shares of common stock and 17,850 warrants to purchase shares of common stock at an exercise price of $5.88 per share. 75Source: Heritage Insurance Holdings, Inc., 10-K, March 18, 2015Powered by Morningstar® Document Research℠The information contained herein may not be copied, adapted or distributed and is not warranted to be accurate, complete or timely. The user assumes all risks for any damages or losses arising from any use of this information,except to the extent such damages or losses cannot be limited or excluded by applicable law. Past financial performance is no guarantee of future results.Table of ContentsSecond Quarter 2014Prior to the IPO, certain of the Company’s stockholders held warrants to purchase an aggregate of 7,716,300 shares of the Company at an exercise priceof $5.88 per share. On May 22, 2014, warrants to purchase an aggregate of 7,685,700 shares were exercised (the “Warrant Exercise”), including warrants topurchase an aggregate of 3,858,150 shares exercised on a cashless basis. Pursuant to the cashless exercise provisions of the warrants, each warrant holder paidthe exercise price by surrendering to the Company an amount of shares having a value equal to the aggregate exercise price of the warrants being exercised.The terms of the warrants provided that the value ascribed to each share surrendered to the Company as payment for the exercise price was equal to our initialpublic offering price per share of common stock. As a result, an aggregate of 5,622,519 shares were issued in connection with the Warrant Exercise. TheCompany received $22.5 million in proceeds from the cash exercise of 3,827,550 warrants.All remaining 30,600 warrants can be exercised at an exercise price equal to $5.88 per share on or before March 31, 2018. At issuance, equity warrantsare recorded at their relative fair values, using the relative fair value method, in the stockholders’ equity section of the consolidated balance sheets. TheCompany’s equity warrants can only be settled through the issuance of shares and are not subject to anti-dilution provisions. The aggregate intrinsic value ofwarrants was approximately $0.3 million at December 31, 2014.On May 29, 2014, the Company sold as part of the IPO 6,900,000 shares of common stock at $11.00 per share of common stock, including 900,000shares sold pursuant to the underwriters’ over-allotment option for gross cash proceeds in aggregate of $75.9 million. The Company incurred an underwriterdiscount fee of $5.3 million or $0.77 per share of common stock, netting proceeds (before costs) of $70.6 million or $10.23 per share of common stock.Ananke, an affiliate of Nephila Capital Ltd, purchased $10 million of the Company’s common stock (909,090 shares) in the Private Placement at aprice per share equal to the public offering price. Poseidon Re Ltd., another affiliate of Nephila Capital Ltd, is currently a participating reinsurer in theCompany’s reinsurance program. The sale of such shares was not registered under the Securities Act and was conducted in accordance with Section 4(a)(2) ofthe Securities Act.In addition, in connection with the Private Placement, a reinsurer affiliated with or designated by Nephila Capital Ltd was provided with a right of firstrefusal to participate in the Company’s future reinsurance programs, subject to certain exceptions. The right of first refusal terminates on May 31, 2019,subject to certain conditions. Note 17.Stock-Based CompensationThe Company has adopted the Heritage Insurance Holdings, Inc., Omnibus Incentive Plan (the “Plan”) effective on May 22, 2014. The Plan hasauthorized 2,981,737 shares of common stock reserved for issuance under the Plan for future grants.At December 31, 2014, there were 1,295,814 shares available for grant under the Plan, respectively.The Company recognizes compensation expense under ASC 718 for its stock-based payments based on the fair value of the awards. The Companygrants stock options at exercise prices equal to the fair market value of the Company’s stock on the dates the options are granted. The options have amaximum term of ten years from the date of grant and vest primarily in equal annual installments over a range of one to five year periods following the dateof grant for employee options. If a participant’s employment relationship ends, the participant’s vested awards will remain exercisable for the shorter of aperiod of 30 days or the period ending on the latest date on which such award could have been exercisable. The fair value of each option grant is separatelyestimated for each grant date. The fair value of each option is amortized into compensation expense on a straight-line basis between the grant date for theaward and each vesting date. The Company estimates the fair value of all stock option awards as of the date of the grant by applying the Black-Scholes-Merton multiple-option pricing valuation model. The application of this valuation model involves assumptions that are judgmental and highly sensitive inthe determination of compensation expense.Stock OptionsOn September 24, 2014, the Company granted 359,000 options to certain employees and directors. No stock options were granted in 2013 or 2012.These options were awarded with the strike price set at the fair market value at the grant date, and vest on March 15, 2015 with an expiration date ofSeptember 24, 2017. The fair value of each option grant, which was $2.70 per option granted in 2014, is estimated on the date of grant using the Black-Scholes option-pricing model. 76Source: Heritage Insurance Holdings, Inc., 10-K, March 18, 2015Powered by Morningstar® Document Research℠The information contained herein may not be copied, adapted or distributed and is not warranted to be accurate, complete or timely. The user assumes all risks for any damages or losses arising from any use of this information,except to the extent such damages or losses cannot be limited or excluded by applicable law. Past financial performance is no guarantee of future results.Table of ContentsOn December 2, 2014, the Company granted 1,326,923 options to certain employees and directors. The employee options were awarded with the strikeprice set at the fair market value at the grant date, and vest at 50 percent upon grant and 50 percent on April 30, 2015 with an expiration date of December 2,2017. The directors’ options were awarded with the strike price set at the fair market value at the grant date, and vest quarterly commencing on January 1,2015 with an expiration date of December 2, 2017. The fair value of each option grant, which ranged from $3.07 to $3.54 per option granted in 2014, isestimated on the date of grant using the Black-Scholes option-pricing model.The following table provides the assumptions utilized in the Black-Scholes model for options granted during the year ended December 31, 2014. Nooptions were granted during the years ended December 31, 2013 and 2012. Option Grant Dates: December 2,2014 September 24,2014 Weighted-average risk-free interest rate 51% 42% Expected term of option in years 1.6 1.7 Weighted-average volatility 35.56% 36.47% Dividend yield 0% 0% Weighted average grant date fair value per share $3.19 $2.70 A summary of information related to stock options outstanding at December 31, 2014 is as follows: Shares Weighted-Average GrantDate Fair Value (In thousands) Balance at December 31, 2013 — Granted 1,685,923 $3.09 Exercised — Forfeited — Balance at December 31, 2014 1,685,923 $3.09 Options Outstanding Options Exercisable Range ofExercise Price NumberOutstanding AverageRemainingContractualLife (inyears) WeightedAverageExercise Price NumberExercisable AverageRemainingContractualLife (inyears) WeightedAverageExercise Price $14.02 359,000 3.4 $14.02 50,000 3.4 $14.02 $16.89 1,326,923 3 $16.79 715,000 3 $16.73 $15.46 1,685,923 3.2 $15.40 765,000 3.2 $15.38 The Company had approximately $1.9 million of unrecognized stock compensation expense on December 31, 2014 related to non-vestedcompensation, which the Company expects to recognize ratably over the period of 0.5 years. The Company recognized $3.3 million of compensationexpense for the year ended December 31, 2014. The intrinsic value of the Company’s outstanding stock options totaled approximately $5.2 million atDecember 31, 2014.Employment Agreement Redemption ProvisionsOn January 1, 2013 (the modification date), the Company executed employment agreements with three of its key executives each containing aprovision requiring the Company to repurchase the executive’s stock if the executive is terminated for any reason. Because the redemption of the shares issubject to redemption at the option of the holder in an event that is outside of our control, these shares are required to be classified outside of permanentequity on the consolidated balance sheets and recorded at fair value as of the modification date with adjustments to fair value through the settlement date.Accordingly, this temporary equity is recorded as “redeemable shares” on our consolidated balance sheets at December 31, 2013. Upon amendment to theemployment agreements in February 2014, the redemption provision was removed and the shares were reclassified to equity.The following summarizes the activity of the redeemable shares: Shares Amount (In thousands) Redeemable shares, Balance at December 31, 2012 — $— Equity reclassification to temporary equity 1,058,250 4,150 Issuance of temporary equity 1,272,450 5,903 Warrants exercised 7,650 45 Change in fair value of redeemable shares — 10,823 Redeemable shares, Balance at December 31, 2013 2,338,350 $20,921 Equity reclassification (2,338,350) (20,921) Redeemable shares, Balance at December 31, 2014 — $— 77Source: Heritage Insurance Holdings, Inc., 10-K, March 18, 2015Powered by Morningstar® Document Research℠The information contained herein may not be copied, adapted or distributed and is not warranted to be accurate, complete or timely. The user assumes all risks for any damages or losses arising from any use of this information,except to the extent such damages or losses cannot be limited or excluded by applicable law. Past financial performance is no guarantee of future results.Table of ContentsNote 18.Stock SplitIn connection with the IPO in May 2014, the Company’s Board of Directors approved a 2,550 for 1 stock split of the Company’s Shares. The stock splitbecame effective on May 7, 2014. All share and per share amounts in the consolidated financial statements and notes thereto have been retroactively adjustedfor all periods presented to give effect to this stock split and for changes allocated with conversion from a limited liability company to a corporation. Note 19.Condensed Financial Information of RegistrantHeritage Insurance Holdings, Inc. (the parent company) has no long term debt obligations, guarantees or material contingencies as of December 31,2014, 2013 and 2012. The following summarizes the major categories of the parent company’s financial statements (in thousands, except share and per sharedata): Condensed Balance Sheets As of December 31, 2014 2013 ASSETS Cash and cash equivalents $30,927 $10,744 Investment in and advances to subsidiaries 218,600 90,999 Other assets 6,473 132 Total Assets$256,000 $101,875 LIABILITIES AND MEMBERS’ EQUITYOther liabilities$911 $970 Total Liabilities 911 970 Redeemable shares, 2,338,350 shares — 20,921 Paid-in-capital 188,345 62,850 Accumulated other comprehensive income (loss) 1,723 (790) Retained earnings 65,021 17,924 Total Stockholders’ Equity 255,089 79,984 Total Liabilities and Stockholders’ Equity$256,000 $101,875 Condensed Statements of Operations Years Ended December 31, 2014 2013 2012 REVENUE: Other income $1,896 $1,075 $126 Total revenue 1,896 1,075 126 EXPENSES:General and administrative expenses 6,649 4,119 5,971 Interest expenses — 16 828 Total expenses 6,649 4,135 6,799 Loss before income taxes and equity in net income of subsidiaries (4,753) (3,060) (6,673) Benefit from for income taxes (801) — — Loss before equity in net income of subsidiaries (3,952) (3,060) (6,673) Equity in net income of subsidiaries 51,049 37,273 1,207 Net income (loss)$47,097 $34,213 $(5,466) Weighted average shares outstandingBasic 24,568,876 14,313,150 6,280,650 Diluted 25,816,590 14,473,800 6,280,650 Earnings (loss) per shareBasic$1.92 $2.39 $(0.87) Diluted$1.82 $2.36 $(0.87) 78Source: Heritage Insurance Holdings, Inc., 10-K, March 18, 2015Powered by Morningstar® Document Research℠The information contained herein may not be copied, adapted or distributed and is not warranted to be accurate, complete or timely. The user assumes all risks for any damages or losses arising from any use of this information,except to the extent such damages or losses cannot be limited or excluded by applicable law. Past financial performance is no guarantee of future results.Table of ContentsCondensed Statements of Cash Flows Years Ended December 31, 2014 2013 2012 Net cash provided by (used in) operating activities $1,280 $2,925 $(577) Investing Activities Dividends received from subsidiaries 16,099 — — Investments and advances to subsidiaries (98,469) (26,895) (25,624) Net cash used in investing activities (82,370) (26,895) (25,624) Financing ActivitiesProceeds (repayments) note payable—bank — (1,000) 1,000 Proceeds note payable—member — — 3,900 Proceeds from issuance of equity from IPO and private placement, net of discount fee and direct costs ofissuance 78,670 — — Proceeds from exercise of warrants 22,515 — — Proceeds from issuance of equity and redeemable shares 88 33,630 23,385 Net cash provided by financing activities 101,273 32,630 28,285 Increase in cash and cash equivalents 20,183 8,660 2,084 Cash and cash equivalents at beginning of period 10,744 2,084 — Cash and cash equivalents at end of year$30,927 $10,744 $2,084 Note 20.Quarterly Results for 2014 and 2013 (unaudited)The following table provides a summary of quarterly results for the periods presented (in thousands, except per share data): For the year ended December 31, 2014 FirstQuarter SecondQuarter ThirdQuarter FourthQuarter Net premiums earned $42,236 $44,295 $55,527 $81,554 Investment income, including realized gains (losses) on investments $576 $743 $1,206 $1,628 Total revenues $43,878 $46,539 $58,013 $85,390 Total expenses $32,056 $31,429 $41,904 $54,179 Net income $7,888 $9,566 $9,965 $19,678 Basic earnings per share $0.48 $0.43 $0.33 $0.67 Diluted earnings per share $0.42 $0.39 $0.33 $0.67 For the year ended December 31, 2013 Net premiums earned $19,966 $21,624 $21,805 $31,764 Investment income, including realized gains (losses) on investments $210 $79 $179 $258 Total revenues $20,342 $48,601 $22,780 $33,109 Total expenses $9,389 $14,320 $15,113 $30,549 Net income $7,054 $21,018 $5,327 $814 Basic earnings per share $0.66 $1.38 $0.35 $0.05 Diluted earnings per share $0.66 $1.38 $0.35 $0.05 Fourth quarter net income of $19.7 million in 2014 compared to $0.8 million in 2013 can be primarily attributed to growth in our in force premium,which was significantly impacted by the introduction into the commercial residential line of business coupled with successful transition of SSIC policies toour Company, and the lower cost of catastrophe reinsurance. Note 21.Subsequent EventsDuring the first quarter of 2015, the Company participated in three personal residential and three commercial residential assumptions transactions.Following the opt-outs process, the Company expects to assume in excess of 18,000 personal residential policies and 300 commercial residential policies. Item 9.Changes in and Disagreements with Accountants on Accounting and Financial DisclosureNone Item 9A.Controls and ProceduresEvaluation of Disclosure Controls and ProceduresWe maintain disclosure controls and procedures (as defined in Exchange Act Rule 13a-15(e)) that are designed to assure that information required to bedisclosed in our Exchange Act reports is recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and forms, andthat such information is accumulated and communicated to management, including our Chief Executive Officer and Chief Financial Officer, as appropriate,to allow timely decisions regarding required disclosures.As required by Exchange Act Rule 13a-15(b), as of the end of the period covered by this Annual Report, under the supervision and with theparticipation of our Chief Executive Officer and Chief Financial Officer, we evaluated the effectiveness of our disclosure controls and procedures. Based onthis evaluation, our Chief Executive Officer and Chief Financial Officer concluded that our disclosure controls and procedures were ineffective as ofDecember 31, 2014 due to the unremediated material weakness in our internal controls over financial reporting described below. Notwithstanding theidentified material weakness, management believes the consolidated financial statements included in this Annual Report on Form 10-K fairly represent in allmaterial respects our financial condition, results of operations and cash flows at and for the periods presented in accordance with U.S. GAAP.Source: Heritage Insurance Holdings, Inc., 10-K, March 18, 2015Powered by Morningstar® Document Research℠The information contained herein may not be copied, adapted or distributed and is not warranted to be accurate, complete or timely. The user assumes all risks for any damages or losses arising from any use of this information,except to the extent such damages or losses cannot be limited or excluded by applicable law. Past financial performance is no guarantee of future results.Limitations on Effectiveness of ControlsOur management, including our Chief Executive Officer and Chief Financial Officer, do not expect that our disclosure controls and procedures willprevent all errors and fraud. In designing and evaluating the disclosure controls and procedures, management recognized that any controls and procedures, nomatter how well designed and operated, can provide only reasonable, not absolute, assurance of achieving the desired control objectives. Further, the designof a control system must reflect the fact that there are resource constraints, and management necessarily was required to apply its judgment in evaluating thecost-benefit relationship of possible controls and procedures. Because of the inherent limitations in all control systems, no evaluation of controls can provideabsolute assurance that all control issues and instances of fraud, if any, within the Company have been detected. These inherent limitations include therealities that judgments in decision-making can be faulty, and that breakdowns can occur because of simple error or mistake. Additionally, controls can becircumvented by the individual acts of some persons, by collusion of two or more people, or by management’s override of the control.The design of any system of controls also is based in part upon certain assumptions about the likelihood of future events, and there can be no assurancethat any design will succeed in achieving its stated goals under all potential future conditions. Over time, controls may become inadequate because ofchanges in conditions, or the degree of compliance with the policies or procedures may deteriorate. Because of the inherent limitations in a cost-effectivecontrol system, misstatements due to error or fraud may occur and not be detected. 79Source: Heritage Insurance Holdings, Inc., 10-K, March 18, 2015Powered by Morningstar® Document Research℠The information contained herein may not be copied, adapted or distributed and is not warranted to be accurate, complete or timely. The user assumes all risks for any damages or losses arising from any use of this information,except to the extent such damages or losses cannot be limited or excluded by applicable law. Past financial performance is no guarantee of future results.Table of ContentsManagement’s Report on Internal Control Over Financial ReportingThis Annual Report does not include a report of management’s assessment regarding internal control over financial reporting or an attestation report ofour independent registered public accounting firm due to a transition period established by the rules of the SEC for newly public companies.Changes in Internal Control Over Financial ReportingAs previously reported on our Form S-1 effective May 22, 2014 and quarter’s reports on Forms 10-Q issued during 2014, we have material weaknessesin our internal control over financial reporting related to, among other things, accounting for stock based compensation, equity transactions and incometaxes. With the oversight of senior management, we have taken steps to remediate the underlying causes of these material weaknesses, primarily through thedevelopment and implementation of formal policies, improved processes, as well as the hiring additional finance personnel, and the outsourcing of morecomplex accounting matters to third party consultants. We will continue to monitor the effectiveness of these remediation efforts as we consider in futurereporting periods whether such control deficiencies have been fully remediated.Except for the continued remediation efforts described herein, there has been no change in our internal controls over financial reporting during ourmost recent quarter that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting. Item 9B.Other InformationNot applicable.PART III Item 10.Directors, Executive Officers and Corporate GovernanceIn addition to the information set forth under the caption “Executive Officers” in Part I of this Annual Report on Form 10-K, the information requiredby this Item is expected to be in our definitive Proxy Statement for the 2015 Annual Meeting of Stockholders (the “Proxy Statement”), which we expect to befiled within 120 days of the end of our fiscal year ended December 31, 2014 and is incorporated herein by reference. Item 11.Executive CompensationInformation relating to our executive officer and director compensation is incorporated herein by reference to the Proxy Statement. Item 12.Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters Information relating to security ownership of certain beneficial owners of our common stock and information relating to the security ownership of theregistrant’s management is incorporated herein by reference to the Proxy Statement. Item 13.Certain Relationships and Related Transactions, and Director IndependenceInformation relating to certain relationships and related transactions and director independence is incorporated herein by reference to the ProxyStatement. Item 14.Principal Accountant Fees and ServicesInformation regarding principal accountant fees and services is incorporated herein by reference to the Proxy Statement. 80Source: Heritage Insurance Holdings, Inc., 10-K, March 18, 2015Powered by Morningstar® Document Research℠The information contained herein may not be copied, adapted or distributed and is not warranted to be accurate, complete or timely. The user assumes all risks for any damages or losses arising from any use of this information,except to the extent such damages or losses cannot be limited or excluded by applicable law. Past financial performance is no guarantee of future results.Table of ContentsPART IV Item 15.Exhibits, Financial Statements SchedulesThe following documents are filed as part of this Annual Report on Form 10-K: (a)The following documents are filed as part of this report. (1)Financial StatementsThe following consolidated financial statements of the Company and the reports of independent auditors thereon are filed with this report:Report of Independent Registered Public Accounting Firm (Grant Thornton LLP)Consolidated Balance SheetsConsolidated Statements of Operations and Comprehensive Income (Loss)Consolidated Statements of Changes in Stockholders’ EquityConsolidated Statements of Cash FlowsNotes to Consolidated Financial Statements (2)Financial Statement SchedulesAll financial statement schedules have been omitted because the required information is not present or not present in amounts sufficient to require thesubmission of schedules, or because the information required is included in our Consolidated Financial Statements and Notes thereto.(3)List of ExhibitsThe Following is a list of exhibits filed or incorporated by reference as part of this Annual Report on Form 10-K ExhibitNumber Description 3.1 Certificate of Incorporation of Heritage Insurance Holdings, Inc. (incorporated by reference to Exhibit 3.1 to the Company’s Quarterly Report onForm 10-Q filed on August 6, 2014) 3.2 By-laws of Heritage Insurance Holdings, Inc. (incorporated by reference to Exhibit 3.2 to the Company’s Quarterly Report on Form 10-Q filed onAugust 6, 2014) 4.1 Form of Stock Certificate (Incorporated by reference to Exhibit 4.1 to the Company’s Registration Statement on Form S-1 (File No. 333-195409)filed on April 30, 2014) 4.2 Form of Warrant (Incorporated by reference to Exhibit 4.2 to the Company’s Registration Statement on Form S-1 (File No. 333-195409) filed onApril 30, 2014) 10.1 Property Catastrophe Excess of Loss Reinsurance Contract, effective June 1, 2013, issued to Heritage Property & Casualty Insurance Companyby the Subscribing Reinsurers (incorporated by reference to Exhibit 10.1 to the Company’s Quarterly Report on Form 10-Q filed on August 6,2014) 10.2 Catastrophe Excess of Loss and Aggregate Reinsurance Contract, effective June 1, 2013, issued to Heritage Property & Casualty InsuranceCompany by the Subscribing Reinsurers (incorporated by reference to Exhibit 10.2 to the Company’s Quarterly Report on Form 10-Q filed onAugust 6, 2014) 10.3 Second Aggregate Catastrophic Excess of Loss Reinsurance Contract, effective June 1, 2013, issued to Heritage Property & Casualty InsuranceCompany by the Subscribing Reinsurers (incorporated by reference to Exhibit 10.3 to the Company’s Quarterly Report on Form 10-Q filed onAugust 6, 2014) 81Source: Heritage Insurance Holdings, Inc., 10-K, March 18, 2015Powered by Morningstar® Document Research℠The information contained herein may not be copied, adapted or distributed and is not warranted to be accurate, complete or timely. The user assumes all risks for any damages or losses arising from any use of this information,except to the extent such damages or losses cannot be limited or excluded by applicable law. Past financial performance is no guarantee of future results.Table of Contents 10.4Second Catastrophe Excess of Loss and Aggregate Reinsurance Contract, effective June 1, 2013, issued to Heritage Property & CasualtyInsurance Company by the Subscribing Reinsurers (incorporated by reference to Exhibit 10.4 to the Company’s Quarterly Report on Form 10-Q filed on August 6, 2014) 10.5Underlying Property Catastrophe Excess of Loss Reinsurance Contract, effective June 1, 2013, issued to Heritage Property & CasualtyInsurance Company by Osprey Re Ltd. (incorporated by reference to Exhibit 10.5 to the Company’s Quarterly Report on Form 10-Q filed onAugust 6, 2014) 10.6Property Catastrophe Excess of Loss Reinsurance Contract, effective December 4, 2012, issued to Heritage Property & Casualty InsuranceCompany by the Subscribing Reinsurers (incorporated by reference to Exhibit 10.6 to the Company’s Quarterly Report on Form 10-Q filed onAugust 6, 2014) 10.7Property Catastrophe Excess of Loss Reinsurance Contract, effective April 17, 2014, by and among Heritage Property & Casualty InsuranceCompany and Citrus Re Ltd. (incorporated by reference to Exhibit 10.30 to the Company’s Registration Statement on Form S-1 (File No. 333-195409) filed on April 30, 2014) 10.8Property Catastrophe Excess of Loss Reinsurance Contract, effective April 24, 2014, by and among Heritage Property & Casualty InsuranceCompany and Citrus Re Ltd. (incorporated by reference to Exhibit 10.31 to the Company’s Registration Statement on Form S-1 (File No. 333-195409) filed on April 30, 2014) 10.9Common Stock Purchase Agreement, dated May 9, 2014, by and between Heritage Insurance Holdings, LLC and Ananke Ltd. (incorporated byreference to Exhibit 10.32 to the Company’s Registration Statement on Form S-1 (File No. 333-195409) filed on May 16, 2014) 10.10Insurance Policy Acquisition and Transition Agreement, dated as of June 13, 2014, by and among Heritage Property & Casualty InsuranceCompany, the Florida Department of Financial Services, as Receiver for Sunshine State Insurance Company, and the Florida InsuranceGuaranty Association (incorporated by reference to Exhibit 10.1 to the Company’s Current Report on Form 8-K filed on June 19, 2014) 10.11+$4,000,000 XS $2,000,000 XS $4,000,000 Underlying Property Catastrophe Excess of Loss Reinsurance Contract, effective June 1, 2014,between Heritage Property & Casualty Insurance Company and the Subscribing Reinsurers (incorporated by reference to Exhibit 10.11 to theCompany’s Current Report on Form 10-Q filed on August 06, 2014) 10.12+$6,000,000 XS $9,000,000 Underlying Property Catastrophe Excess of Loss Reinsurance Contract, effective June 1, 2014, between HeritageProperty & Casualty Insurance Company and the Subscribing Reinsurers (incorporated by reference to Exhibit 10.12 to the Company’sQuarterly Report on Form 10-Q filed on August 6, 2014) 10.13+Multi-Year First & Second Property Catastrophe Excess of Loss Reinsurance Contract, effective June 1, 2014, between Heritage Property &Casualty Insurance Company and the Subscribing Reinsurers (incorporated by reference to Exhibit 10.13 to the Company’s Quarterly Reporton Form 10-Q filed on August 6, 2014) 10.14+First & Second Property Catastrophe Reinstatement Premium Protection Reinsurance Contract, effective June 1, 2014, between HeritageProperty & Casualty Insurance Company and the Subscribing Reinsurers (incorporated by reference to Exhibit 10.14 to the Company’sQuarterly Report on Form 10-Q filed on August 6, 2014) 10.15+Fourth Property Catastrophe Excess of Loss Reinsurance Contract, effective June 1, 2014, between Heritage Property & Casualty InsuranceCompany and the Subscribing Reinsurers (incorporated by reference to Exhibit 10.15 to the Company’s Quarterly Report on Form 10-Q filedon August 6, 2014) 82Source: Heritage Insurance Holdings, Inc., 10-K, March 18, 2015Powered by Morningstar® Document Research℠The information contained herein may not be copied, adapted or distributed and is not warranted to be accurate, complete or timely. The user assumes all risks for any damages or losses arising from any use of this information,except to the extent such damages or losses cannot be limited or excluded by applicable law. Past financial performance is no guarantee of future results.Table of Contents 10.16+Fifth Property Catastrophe Excess of Loss Reinsurance Contract, effective June 1, 2014, between Heritage Property & Casualty InsuranceCompany and the Subscribing Reinsurers (incorporated by reference to Exhibit 10.16 to the Company’s Quarterly Report on Form 10-Q filedon August 6, 2014) 10.17+Sixth Property Catastrophe Excess of Loss Reinsurance Contract, effective July 1, 2014, between Heritage Property & Casualty InsuranceCompany and the Subscribing Reinsurers (incorporated by reference to Exhibit 3.1 to the Company’s Quarterly Report on Form 10-Q filed onAugust 6, 2014) 10.18+Reimbursement Contract, effective June 1, 2014, between Heritage Property & Casualty Insurance Company and the State Board ofAdministration of the State of Florida (incorporated by reference to Exhibit 10.18 to the Company’s Quarterly Report on Form 10-Q filed onAugust 6, 2014) 10.19+Property Excess Per Risk Reinsurance Contract, effective June 27, 2014, between Heritage Property & Casualty Insurance Company and theSubscribing Reinsurers (incorporated by reference to Exhibit 10.19 to the Company’s Quarterly Report on Form 10-Q filed on August 6,2014) 10.20Separation Agreement and General Release, dated December 22, 2014, by and between Heritage Insurance Holdings, Inc. and Kent Linder.(incorporated by reference to Exhibit 10.1 to the Company’s Current Report on Form 8-K filed on December 22, 2014) 23.1Consent of Grant Thornton LLP** 31.1Rule 13a-14(a)/15d-14(a) Certification of Principal Executive Officer as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002* 31.2Rule 13a-14(a)/15d-14(a) Certification of Principal Financial Officer as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 * 32.1Certification of Chief Executive Officer and Chief Financial Officer pursuant to 18 U.SC. Section 1350, as adopted pursuant to Section 906 ofthe Sarbanes-Oxley Act of 2002**101.INSXBRL Instance Document *101.SCHXBRL Taxonomy Extension Schema. *101.CALXBRL Taxonomy Extension Calculation Linkbase. *101.DEFXBRL Taxonomy Extension Definition Linkbase. *101.LABXBRL Taxonomy Extension Label Linkbase. *101.PREXBRL Taxonomy Extension Presentation Linkbase.* *Filed herewith**Furnished herewith+Portions of this exhibit (indicated by asterisks) have been omitted pursuant to a request for confidential treatment, and this exhibit has been filedseparately with the SEC. 83Source: Heritage Insurance Holdings, Inc., 10-K, March 18, 2015Powered by Morningstar® Document Research℠The information contained herein may not be copied, adapted or distributed and is not warranted to be accurate, complete or timely. The user assumes all risks for any damages or losses arising from any use of this information,except to the extent such damages or losses cannot be limited or excluded by applicable law. Past financial performance is no guarantee of future results.Table of ContentsSIGNATURESPursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on itsbehalf by the undersigned, thereunto duly authorized. HERITAGE INSURANCE HOLDINGS, INC. (Registrant)Date: March 18, 2015 By: /s/ BRUCE LUCAS Chairman and Chief Executive Officer (on behalf of the Registrant and as Principal Executive Officer)POWERS OF ATTORNEYKNOW ALL BY THESE PRESENT, that each person whose signature appears below constitutes and appoints Bruce Lucas as his true and lawfulattorney-in-fact and agent, he with full power of substitution and resubstitution, for him and in his name, place and stead, in any and all capacities, to signany and all amendments to this report, and to file the same, with all exhibits thereto, and other documents in connection therewith, with the Securities andExchange Commission, granting unto said attorneys-in-fact and agents, full power and authority to do and perform each and every act and thing requisite ornecessary to be done in and about the premises, as fully to all intents and purposes as he might or could do in person, hereby ratifying and confirming all thatsaid attorneys-in-fact and agents, or any of them, or their substitute or substitutes, may lawfully do or cause to be done by virtue hereof.Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of theregistrant and in the capacities and on the dates indicated. Signature Title Date/s/ BRUCE LUCAS Bruce Lucas Chairman and Chief Executive Officer(Principal Executive Officer) March 18, 2015/s/ STEPHEN ROHDE Stephen Rohde Chief Financial Officer(Principal Financial Officer and Principal Accounting Officer) March 18, 2015/s/ RICHARD WIDDICOMBE Richard Widdicombe President and Director March 18, 2015/s/ PANAGIOTIS APOSTOLOU Panagiotis Apostolou Director March 18, 2015/s/ TRIFON HOUVARDAS Trifon Houvardas Director March 18, 2015/s/ NICHOLAS PAPPAS Nicholas Pappas Director March 18, 2015/s/ JOSEPH VATTAMATTAM Joseph Vattamattam Director March 18, 2015/s/ IRINI BARLAS Irini Barlas Director March 18, 2015/s/ VIJAY WALVEKAR Vijay Walvekar Director March 18, 2015/s/ JAMES MASIELLO James Masiello Director March 18, 2015 84Source: Heritage Insurance Holdings, Inc., 10-K, March 18, 2015Powered by Morningstar® Document Research℠The information contained herein may not be copied, adapted or distributed and is not warranted to be accurate, complete or timely. The user assumes all risks for any damages or losses arising from any use of this information,except to the extent such damages or losses cannot be limited or excluded by applicable law. Past financial performance is no guarantee of future results.Exhibit 23.1CONSENT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRMWe have issued our report dated March 18, 2015, with respect to the consolidated financial statements included in the Annual Report of Heritage InsuranceHoldings, Inc. on Form 10-K for the year ended December 31, 2014. We hereby consent to the incorporation by reference of said report in the RegistrationStatement of Heritage Insurance Holdings, Inc. on Form S-8 (File No. 333-197906)./s/ GRANT THORNTON LLPTampa, FloridaMarch 18, 2015Source: Heritage Insurance Holdings, Inc., 10-K, March 18, 2015Powered by Morningstar® Document Research℠The information contained herein may not be copied, adapted or distributed and is not warranted to be accurate, complete or timely. The user assumes all risks for any damages or losses arising from any use of this information,except to the extent such damages or losses cannot be limited or excluded by applicable law. Past financial performance is no guarantee of future results.Exhibit 31.1CERTIFICATIONI, Bruce Lucas, certify that:1. I have reviewed this Annual Report on Form 10-K of Heritage Insurance Holdings, Inc.;2. Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make thestatement made, in light of the circumstances under which such statements were made, not misleading, with respect to the periods covered by this report;3. Based on my knowledge, the financial statements, and other financial information included in this report, fairly represent in all material respectsthe financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report;4. The registrant’s other certifying officer and I are responsible for establishing and maintaining disclosure controls and procedures (as defined inExchange Act Rules 13a-15(e) and 15d-15(e)) for the registrant and have:(a) Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, toensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities,particularly during the period in which this report is being prepared;(b) [Omitted pursuant to Exchange Act Rules 13a-14(a) and 15d-15(a).](c) Evaluated the effectiveness of the registrant’s disclosure controls and procedures and presented in this report our conclusions about theeffectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and(d) Disclosed in this report any change in the registrant’s internal control over financial reporting that occurred during the registrant’s mostrecent fiscal quarter (the registrant’s fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonably likely tomaterially affect, the registrant’s internal control over financial reporting; and5. The registrant’s other certifying officer(s) and I have disclosed, based on our most recent evaluation of internal control over financial reporting, tothe registrant’s auditors and the audit committee of the registrant’s board of directors (or persons performing the equivalent functions):(a) All significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which arereasonably likely to adversely affect the registrant’s ability to record, process, summarize and report financial information; and(b) Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant’s internalcontrol over financial reporting. Date: March 18, 2015/s/ BRUCE LUCAS Bruce LucasChief Executive Officer (PrincipalExecutive Officer)Source: Heritage Insurance Holdings, Inc., 10-K, March 18, 2015Powered by Morningstar® Document Research℠The information contained herein may not be copied, adapted or distributed and is not warranted to be accurate, complete or timely. The user assumes all risks for any damages or losses arising from any use of this information,except to the extent such damages or losses cannot be limited or excluded by applicable law. Past financial performance is no guarantee of future results.Exhibit 31.2CERTIFICATIONI, Stephen Rohde, certify that:1. I have reviewed this Annual Report on Form 10-K of Heritage Insurance Holdings, Inc.;2. Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make thestatement made, in light of the circumstances under which such statements were made, not misleading, with respect to the periods covered by this report;3. Based on my knowledge, the financial statements, and other financial information included in this report, fairly represent in all material respectsthe financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report;4. The registrant’s other certifying officer and I are responsible for establishing and maintaining disclosure controls and procedures (as defined inExchange Act Rules 13a-15(e) and 15d-15(e)) for the registrant and have: (a)Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under oursupervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us byothers within those entities, particularly during the period in which this report is being prepared; (b)[Omitted pursuant to Exchange Act Rules 13a-14(a) and 15d-15(a).](c) Evaluated the effectiveness of the registrant’s disclosure controls and procedures and presented in this report our conclusions about theeffectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and(d) Disclosed in this report any change in the registrant’s internal control over financial reporting that occurred during the registrant’s mostrecent fiscal quarter (the registrant’s fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonably likely tomaterially affect, the registrant’s internal control over financial reporting; and5. The registrant’s other certifying officer(s) and I have disclosed, based on our most recent evaluation of internal control over financial reporting, tothe registrant’s auditors and the audit committee of the registrant’s board of directors (or persons performing the equivalent functions):(a) All significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which arereasonably likely to adversely affect the registrant’s ability to record, process, summarize and report financial information; and(b) Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant’s internalcontrol over financial reporting. Date: March 18, 2015/s/ STEPHEN ROHDE Stephen RohdeChief Financial Officer (PrincipalFinancial Officer)Source: Heritage Insurance Holdings, Inc., 10-K, March 18, 2015Powered by Morningstar® Document Research℠The information contained herein may not be copied, adapted or distributed and is not warranted to be accurate, complete or timely. The user assumes all risks for any damages or losses arising from any use of this information,except to the extent such damages or losses cannot be limited or excluded by applicable law. Past financial performance is no guarantee of future results.Exhibit 32.1CERTIFICATIONS PURSUANT TO18 U.S.C. SECTION 1350AS ADOPTED PURSUANT TOSECTION 906 OF THE SARBANES–OXLEY ACT OF 2002In connection with the Annual Report of Heritage Insurance Holdings, Inc. (the “Company”) on Form 10-K for the period ending December 31, 2014,as filed with the Securities and Exchange Commission on the date hereof (the “Report”), we Bruce Lucas, Chief Executive Officer of the Company, andStephen Rohde, Chief Financial Officer of the Company, certify, pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, to our knowledge, that: (1)The Report fully complies with the requirements of Section 13(a) or 15(d) of the Securities Exchange Act of 1934, as amended; and (2)The information contained in the Report fairly presents, in all material respects, the financial condition and results of operations of theCompany. By:/s/ BRUCE LUCAS Bruce LucasChief Executive Officer (Principal Executive Officer) By:/s/ STEPHEN ROHDE Stephen RohdeChief Financial Officer (Principal Financial Officer)Date: March 18, 2015Source: Heritage Insurance Holdings, Inc., 10-K, March 18, 2015Powered by Morningstar® Document Research℠The information contained herein may not be copied, adapted or distributed and is not warranted to be accurate, complete or timely. The user assumes all risks for any damages or losses arising from any use of this information,except to the extent such damages or losses cannot be limited or excluded by applicable law. Past financial performance is no guarantee of future results.Source: Heritage Insurance Holdings, Inc., 10-K, March 18, 2015Powered by Morningstar® Document Research℠The information contained herein may not be copied, adapted or distributed and is not warranted to be accurate, complete or timely. The user assumes all risks for any damages or losses arising from any use of this information,except to the extent such damages or losses cannot be limited or excluded by applicable law. Past financial performance is no guarantee of future results.

Continue reading text version or see original annual report in PDF format above