ANNNUAL REPPORT 2013
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-K
ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the fiscal year ended December 31, 2013
OR
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF
1934
Commission File Number 001-15204
Kingsway Financial Services Inc.
(Exact name of registrant as specified in its charter)
Ontario, Canada
(State or other jurisdiction of
incorporation or organization)
Not Applicable
(I.R.S. Employer Identification No.)
45 St. Clair Avenue West, Suite 400
Toronto, Ontario
(Address of principal executive offices)
M4V 1K9
(Zip Code)
1-416-848-1171
(Registrant's telephone number, including area code)
Securities registered pursuant to Section 12(b) of the Act:
Title of Each Class
Common Stock, no par value
Name of Each Exchange on Which Registered
New York Stock Exchange
Securities 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
Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act. Yes
No
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act
of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject
to such filing requirements for the past 90 days. Yes
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 to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that
No
the registrant was required to submit and post such files). Yes
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 will not 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 or any 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 the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange
Act. Large accelerated filer
Smaller reporting company
Non-accelerated filer
Accelerated filer
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes
No
As of June 30, 2013, the aggregate market value of the registrant's voting common stock held by non-affiliates of the registrant was $33,227,916
based upon the closing sale price of the common stock as reported by the New York Stock Exchange. Solely for purposes of this calculation,
all executive officers and directors of the registrant are considered affiliates.
The number of shares of the Registrant's Common Stock outstanding as of March 31, 2014 was 16,429,761.
DOCUMENTS INCORPORATED BY REFERENCE
Part III of this Form 10-K is incorporated by reference to certain sections of the Proxy Statement for the 2014 Annual Meeting of Shareholders,
which will be filed with the Securities and Exchange Commission no later than 120 days after the end of our fiscal year ended December 31,
2013.
KINGSWAY FINANCIAL SERVICES INC.
Table Of Contents
Caution Regarding Forward-Looking Statements
PART I
Item 1. Business
Item 1A. Risk Factors
Item IB. Unresolved Staff Comments
Item 2. Properties
Item 3. Legal Proceedings
Item 4. Mine Safety Disclosures
PART II
Item 5. Market for Registrant's Common Equity, Related Stockholder Matters and Issuer Purchases of
Equity Securities
Item 6. Selected Financial Data
Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations
Item 7A. Quantitative and Qualitative Disclosures About Market Risk
Item 8. Financial Statements and Supplementary Data
Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure
Item 9A. Controls and Procedures
Item 9B. Other Information
PART III
Item 10. Directors, Executive Officers, and Corporate Governance
Item 11. Executive Compensation
Item 12. Security Ownership of Certain Beneficial Owners and Management and Related Stockholder
Matters
Item 13. Certain Relationships and Related Transactions, and Director Independence
Item 14. Principal Accounting Fees and Services
PART IV
Item 15. Exhibits, Financial Statement Schedules
SIGNATURES
EXHIBIT INDEX
3
4
4
18
28
28
28
28
29
29
30
31
47
48
90
90
91
91
91
91
91
91
91
92
92
101
102
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KINGSWAY FINANCIAL SERVICES INC.
Caution Regarding Forward-Looking Statements
This 2013 Annual Report on Form 10-K (the "2013 Annual Report"), including the accompanying consolidated financial statements
of Kingsway Financial Services Inc. ("Kingsway") and its subsidiaries (individually and collectively referred to herein as the
"Company") and the notes thereto appearing in Item 8 herein (the "Consolidated Financial Statements"), Management's Discussion
and Analysis of Financial Condition and Results of Operations appearing in Item 7 herein (the "MD&A"), and the other Exhibits
and Financial Statement Schedules filed as a part hereof or incorporated by reference herein may contain or incorporate by reference
information that includes or is based on forward-looking statements within the meaning of Section 27A of the Securities Act of
1933 and Section 21E of the Securities Exchange Act of 1934.
Forward-looking statements relate to future events or future performance and reflect Kingsway management's current beliefs,
based on information currently available. The words "anticipate," "expect," "believe," "may," "should," "estimate," "project,"
"outlook," "forecast" and variations or similar words and expressions are used to identify such forward looking information, but
these words are not the exclusive means of identifying forward-looking statements. Specifically, statements about (i) the Company's
ability to preserve and use its net operating losses; (ii) the Company's expected liquidity; and (iii) the potential impact of volatile
investment markets and other economic conditions on the Company's investment portfolio and underwriting results, among others,
are forward-looking, and the Company may also make forward-looking statements about, among other things:
•
•
•
•
•
•
•
•
•
•
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its results of operations and financial condition (including, among other things, premium volume, premium rates, net and
operating income, investment income and performance, return on equity, and expected current returns and combined ratios);
changes in facts and circumstances affecting assumptions used in determining the provision for unpaid loss and loss adjustment
expenses;
the number and severity of insurance claims (including those associated with catastrophe losses) and their impact on the
adequacy of the provision for unpaid loss and loss adjustment expenses;
the impact of emerging claims issues as well as other insurance and non-insurance litigation;
orders, interpretations or other actions by regulators that impact the reporting, adjustment and payment of claims;
changes in industry trends and significant industry developments;
uncertainties related to regulatory approval of insurance rates, policy forms, license applications and similar matters;
the impact of certain guarantees made by the Company;
the ability to complete current or future acquisitions successfully;
the ability to successfully implement our restructuring activities; and
strategic initiatives.
For a discussion of some of the factors that could cause actual results to differ, see Item 1A,"Risk Factors," and Item 7, "Management's
Discussion and Analysis of Financial Condition and Results of Operations-Critical Accounting Estimates and Assumptions," in
this 2013 Annual Report.
Except as expressly required by applicable securities laws, the Company disclaims any intention or obligation to update or revise
any forward-looking statements, whether as a result of new information, future events or otherwise, that might arise subsequent
to the date of this 2013 Annual Report.
3
KINGSWAY FINANCIAL SERVICES INC.
Part I
Item 1. BUSINESS
Kingsway Financial Services Inc. was incorporated under the Business Corporations Act (Ontario) on September 19, 1989. In
this report, the terms "Kingsway," the "Company," "we," "us" or "our" mean Kingsway Financial Services Inc. and all entities
included in our consolidated financial statements.
The Company's registered office is located at 45 St. Clair Avenue West, Suite 400, Toronto, Ontario, Canada M4V 1K9. The
common shares of Kingsway are listed on the Toronto Stock Exchange and the New York Stock Exchange under the trading symbol
"KFS."
Kingsway is a holding company and is primarily engaged, through its subsidiaries, in the property and casualty insurance business
and conducts its business through the following two reportable segments: Insurance Underwriting and Insurance Services.
Insurance Underwriting and Insurance Services conduct their business and distribute their products in the United States. Certain
of the business descriptions below, particularly "Investments," "Reinsurance" and "Regulatory Environment," are principally or
exclusively related to Insurance Underwriting. The "Debt" description below is unrelated to either segment.
Financial information about Kingsway's reportable business segments for the years ended December 31, 2013 and 2012 is contained
in the following sections of this 2013 Annual Report: (i) Note 23, "Segmented Information," to the Consolidated Financial
Statements; and (ii) "Results of Continuing Operations" section of MD&A.
REPORTING CURRENCY
The Consolidated Financial Statements have been presented in U.S. dollars because the Company's principal investments and cash
flows are denominated in U.S. dollars. The Company's functional currency is the U.S. dollar since the substantial majority of its
operations is conducted in the U.S. Assets and liabilities of subsidiaries with non-U.S. dollar functional currencies are translated
to U.S. dollars at period-end exchange rates, while revenue and expenses are translated at average monthly rates and shareholders'
equity is translated at the rates in effect at dates of capital transactions. Foreign exchange differences arising from the translations
as described above are included in shareholders' equity under the caption accumulated other comprehensive income.
All of the dollar amounts in this 2013 Annual Report are expressed in U.S. dollars, except where otherwise indicated. References
to "dollars" or "$" are to U.S. dollars, and any references to "C$" are to Canadian dollars.
GENERAL DEVELOPMENT OF BUSINESS
Rights Offering
On May 30, 2013, the Company announced that it had filed a registration statement for a proposed rights offering relating to
transferable subscription rights to purchase up to approximately $13.1 million of its shares of common stock (the "Common
Shares") and warrants to purchase Common Shares. The rights offering was made in the United States pursuant to a registration
statement on Form S-1 that was previously filed with the Securities and Exchange Commission and became effective on July 24,
2013.
Under the rights offering, each shareholder of record as of August 9, 2013 (the "Record Date") received, at no charge, one
subscription right for each Common Share owned on the Record Date (the "Subscription Right"). Four Subscription Rights entitled
the holder to purchase one unit (a "Unit") consisting of one Common Share, one Series A Warrant (a "Series A Warrant") and one
Series B Warrant (a "Series B Warrant", and together with the Series A Warrants, the "Warrants"). Each Warrant entitled the holder
to purchase one Common Share. The subscription price was $4.00 per Unit. The exercise prices per Common Share for each
Series A Warrant is $4.50 and for each Series B Warrant is $5.00. Each Series A Warrant is redeemable by the Company and has
a term of seven years from its date of issuance. Each Series B Warrant is non-redeemable and has a term of ten years from its
date of issuance. The Company may redeem the Series A Warrants at a price of $0.25 per Warrant if, and only if, the closing price
of the Common Shares equals or exceeds $6.00 per Common Share for twenty consecutive trading days on the New York Stock
Exchange ("NYSE") or such other market or exchange as the Common Shares of the Company trade on or are quoted at the time
of redemption; but in any event, no earlier than the first anniversary date of issuance. Subject to applicable securities laws, the
Warrants may be exercised at any time starting on the first day of the thirty-seventh month after the date of issuance until any time
on or before the seventh anniversary after the date of issuance for the Series A Warrants and the tenth anniversary after the date
of issuance for the Series B Warrants. Holders who fully exercise their Subscription Rights will be entitled to subscribe for an
additional amount of Units, if any, that are not purchased by other shareholders or their transferees through the exercise of their
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KINGSWAY FINANCIAL SERVICES INC.
basic subscription privileges, in an amount equal to up to five Units for each Unit for which such holder was otherwise entitled
to subscribe.
On September 16, 2013, the transaction closed. Subscription rights to purchase 3,280,790 units were exercised, resulting in gross
proceeds to the Company of $13.1 million. Net proceeds to the Company were $12.1 million after deducting commissions and
other offering expenses. The Company used the proceeds from the rights offering to partially redeem the senior unsecured
debentures due February 1, 2014. The partial early redemption was completed on October 15, 2013 in the amount of $12.0 million
at par plus accrued interest of $0.2 million.
Acquisition
Effective May 22, 2013, the Company's subsidiary, Trinity Warranty Solutions LLC ("Trinity"), acquired certain intangible assets
of Trinity Warranty Corp. for total consideration consisting of approximately $1.1 million in cash and future contingent payments.
Trinity is a provider of warranty products and maintenance support to consumers and businesses in the heating, ventilation, air
conditioning ("HVAC") and refrigeration industry. Further information is contained in Note 4, "Acquisitions," to the Consolidated
Financial Statements.
Liquidations
During 2013, the Company's subsidiaries, Kingsway Reinsurance (Bermuda) Ltd. ("KRL") and Kingsway 2007 General Partnership
("2007 GP"), were liquidated. As a result of the liquidations of these subsidiaries, the Company realized a net after-tax gain of
$7.2 million for the year ended December 31, 2013. This gain represents the foreign exchange gain previously recorded in
accumulated other comprehensive income and now recognized in the consolidated statements of operations as a result of the
liquidations of KRL and 2007 GP. Further information is contained in Note 5, "Liquidations, Disposition and Reacquisition," to
the Consolidated Financial Statements.
INSURANCE UNDERWRITING SEGMENT
The Company's property and casualty insurance business operations are conducted primarily through the following subsidiaries:
Mendota Insurance Company ("Mendota"), Mendakota Insurance Company ("Mendakota"), Universal Casualty Company
("UCC"), Maison Insurance Company ("Maison"), Kingsway Amigo Insurance Company ("Amigo") and Kingsway Reinsurance
Corporation (collectively, "Insurance Underwriting").
The insurance subsidiaries in Insurance Underwriting issue insurance policies and retain the risk of operating profit or loss related
to the ultimate loss and loss adjustment expenses incurred on the underlying policies. Insurance Underwriting provides non-
standard automobile and homeowners insurance to individuals and actively conducts business in 16 states. In 2013, the following
states accounted for 85.7% of the Company's gross premiums written: Florida (22.2%), Illinois (14.7%), Texas (13.5%), Louisiana
(11.1%), California (9.8%), Colorado (7.7%) and Nevada (6.7%).
Insurance Underwriting principally offers personal automobile insurance to drivers who do not meet the criteria for coverage by
standard automobile insurers. For the year ended December 31, 2013, non-standard automobile accounted for 84.1% of the
Company's gross premiums written.
During the fourth quarter of 2012, the Company began taking steps to place all of Amigo into voluntary run-off. On November
19, 2012, the Florida Office of Insurance Regulation (“OIR”) approved Amigo's plan to withdraw from the business of offering
commercial lines insurance in Florida. On January 30, 2013, the OIR approved Amigo's plan to withdraw from the business of
offering personal lines insurance in Florida. In April 2013, Kingsway filed a comprehensive run-off plan with the OIR, which
outlines plans for Amigo's run-off. Kingsway continues to manage Amigo in a manner consistent with its filed run-off plan.
Insurance Underwriting Products
Insurance Underwriting primarily markets automobile insurance products which provide coverage in three major areas: liability,
accident benefits and physical damage. Liability insurance provides coverage for claims against the Company's insureds legally
responsible for automobile accidents which have injured third-parties or caused property damage to third-parties. Accident benefit
policies or personal injury protection policies provide coverage for loss of income, medical and rehabilitation expenses for insured
persons who are injured in an automobile accident, regardless of fault. Physical damage policies cover damages to an insured
automobile arising from a collision with another object or from other risks such as fire or theft.
Table 1 and Table 2 summarize Insurance Underwriting's gross premiums written by line of business and by state, respectively,
for the years ended December 31, 2013 and 2012.
5
TABLE 1 Gross premiums written by line of business
For the years ended December 31 (in millions of dollars, except for percentages)
KINGSWAY FINANCIAL SERVICES INC.
Private passenger auto liability
Auto physical damage
Total non-standard automobile
Commercial auto liability
Allied lines
Homeowners
Total gross premiums written
2013
82.0
39.7
121.7
—
13.9
9.1
144.7
% of Total
56.7%
27.4%
84.1%
—%
9.6%
6.3%
100.0%
TABLE 2 Gross premiums written by state
For the years ended December 31 (in millions of dollars, except for percentages)
Florida
Illinois
Texas
Louisiana
California
Colorado
Nevada
Other
Total gross premiums written
Non-Standard Automobile
2013
% of Total
32.1
21.2
19.6
16.0
14.2
11.2
9.7
20.7
144.7
22.2%
14.7%
13.5%
11.1%
9.8%
7.7%
6.7%
14.3%
100.0%
2012
92.1
37.5
129.6
6.0
10.3
—
145.9
2012
59.4
24.1
15.5
2.5
10.0
7.2
7.3
19.9
145.9
% of Total
63.1%
25.7%
88.8%
4.1%
7.1%
—%
100.0%
% of Total
40.7%
16.5%
10.6%
1.7%
6.9%
4.9%
5.0%
13.7%
100.0%
Non-standard automobile insurance is principally provided to individuals who do not qualify for standard automobile insurance
coverage because of their payment history, driving record, place of residence, age, vehicle type or other factors. Such drivers
typically represent higher than normal risks and pay higher insurance rates for comparable coverage.
Non-standard automobile insurance loss experience is generally driven by higher frequency and lower severity than the standard
automobile market. The higher frequency, however, is mitigated to some extent by higher premium rates; the tendency of high-
risk individuals to own low-value automobiles; and generally lower limits of insurance coverage as insureds tend to purchase
coverage at the minimum prescribed limits. In the United States, non-standard automobile insurance policies generally have lower
limits of insurance commensurate with the minimum coverage requirements under the statute of the states in which we write the
business. These limits of liability are typically not greater than $50,000 per occurrence.
The insuring of non-standard drivers is often transitory. When their driving records improve, insureds may qualify to obtain
insurance in the standard market at lower premium rates. We often cancel policies for non-payment of premium and, following
a period of lapse in coverage, insureds frequently return to purchase a new policy at a later date. As a result, our non-standard
automobile insurance policies experience a retention rate that is lower than that experienced for standard market risks. This creates
an on-going requirement to replace non-renewing policyholders with new policyholders and to react promptly to issue cancellation
notices for non-payment of premiums to mitigate potential bad debt write-offs. Most of our insureds pay their premiums on a
monthly installment basis, and we typically limit our risk of non-payment of premiums by requiring a deposit for future insurance
premiums and the prepayment of subsequent installments.
In the United States, automobile insurers are generally required to participate in various involuntary residual market pools and
assigned risk plans that provide automobile insurance coverage to individuals or other entities that are unable to purchase such
coverage in the voluntary market. Participation in these pools in most jurisdictions is in proportion to voluntary writings of selected
lines of business in those jurisdictions.
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KINGSWAY FINANCIAL SERVICES INC.
For the year ended December 31, 2013, gross premiums written for non-standard automobile insurance decreased 6.1% to $121.7
million as compared to $129.6 million in 2012. Non-standard automobile insurance accounted for 84.1% and 88.8% of our gross
premiums written for the years ended December 31, 2013 and 2012, respectively. The decrease in gross premiums written is the
result of decreased premium volumes at Amigo, reflecting the actions begun by the Company during the fourth quarter of 2012
to place Amigo into voluntary run-off, partially offset by increased premium volumes at Maison, Mendota and Mendakota.
Commercial Automobile
Commercial automobile policies provide coverage for low-limit, light-weight, individual unit or small fleet commercial vehicles.
For the year ended December 31, 2013, gross premiums written for commercial automobile insurance decreased by 100.0% to
zero compared to $6.0 million in 2012. This decrease reflects the actions begun by the Company during the fourth quarter of 2012
to place Amigo into voluntary run-off.
Allied Lines
Allied lines includes policies that provide coverage for wind and hail-related property losses of residential dwellings and certain
contents as well as premium related to Amigo's participation in the National Flood Insurance Program. The program is a cooperative
undertaking of the insurance industry and the Federal Emergency Management Agency which allows participating property and
casualty insurance companies to write and service the Standard Flood Insurance Policy in their own names. Under the program,
Amigo receives an expense allowance for policies written and claims processed while the federal government retains responsibility
for underwriting all losses. For the year ended December 31, 2013, gross premiums written from allied lines increased by 35.0%
to $13.9 million compared to $10.3 million in 2012. This increase primarily reflects the Company's entry into the wind and hail-
related insurance business in October of 2012 with the new business formation and licensing of Maison and subsequent participation
in a depopulation of in-force wind and hail policies from Louisiana's state-owned insurance facility, Louisiana Citizens Property
Insurance Corporation.
Homeowners
Homeowners premium includes dwelling, homeowner and mobile home/manufactured home policies for multi-peril property
risks. For the year ended December 31, 2013, gross premiums written for homeowners insurance was $9.1 million compared to
zero in 2012. This increase reflects Maison's entry into the homeowners insurance business during 2013.
Marketing and Distribution
Our strategy focuses on developing and maintaining strong relationships with our independent agents. Insurance Underwriting's
products and services are marketed through approximately 4,500 independent agencies. We maintain an "open market" approach
which enables these agents to place business with us without the obligation of minimum production commitments, providing us
with a broad, flexible and scalable distribution network. We continually strive to provide excellent service in the markets in which
we operate, communicating through a variety of channels as we look for opportunities to increase efficiency and reduce operating
costs with our agents. Our independent agents have the ability to bind insurance policies on our behalf, subject to our insurance
guidelines. Our proprietary point-of-sale systems, however, prevent any agent from binding an unacceptable risk. We do not,
though, delegate authority to settle or adjust claims, except as relates to a third-party agreement specific to our homeowners
business, establish underwriting guidelines, develop rates or enter into other transactions or commitments through our independent
agents.
Texas business is originated through an affiliated managing general agent and written through an unaffiliated Texas county mutual
insurance company. This business is then 100% assumed through a quota-share arrangement by one of our insurance subsidiaries.
This represents a common way of originating non-standard automobile business in the state of Texas due to the greater rating and
underwriting flexibility accorded Texas county mutual insurance companies under Texas statutes.
In December of 2012 and 2013, the Company participated in a depopulation of in-force wind and hail policies from Louisiana's
state-owned insurance facility, Louisiana Citizens Property Insurance Corporation.
No material part of the business of Insurance Underwriting is dependent upon a single customer or group of customers, the loss
of any one of which would have a material adverse effect on the Company, and no one customer or group of affiliated customers
accounts for 10% or more of the Company's consolidated revenues.
Competition
Insurance Underwriting operates in a highly competitive environment. Our core non-standard automobile offerings are policies
at the minimum prescribed limits in each state produced entirely through our independent agents. We compete with large national
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KINGSWAY FINANCIAL SERVICES INC.
insurance companies and smaller regional insurance companies which produce through independent agents. We also compete
with insurance companies which sell policies directly to their customers.
Large national insurance companies and direct underwriters typically operate in standard lines of personal automobile and property
insurance in addition to non-standard lines and generally bring with them increased name recognition obtained through extensive
media advertising, loyalty of the customer base to the insurer rather than to an independent agency and, potentially, reduced policy
acquisition costs and increased customer retention.
From time to time, the non-standard automobile market attracts competition from new entrants. In many cases, these entrants are
looking for growth and, as a result, price their insurance below the rates that we believe provide an acceptable return for the related
risk. We firmly believe that it is not in our best interest to compete solely on price; consequently, we are willing to experience a
loss of market share during periods of intense price competition or "soft" market conditions. During the last few years, the Company
carried out a detailed review of its premium adequacy in the territories in which it operates and implemented steps to terminate
business where premium adequacy was unlikely to be achieved within an acceptable period of time.
In order to stay competitive while striving to generate an economic rate of return, we compete on a number of factors such as
distribution strength and breadth, premium adequacy, agency relationships, ease of doing business and market reputation.
Ultimately, we believe that our ability to compete successfully in our industry is based, among other things, on our ability to:
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identify markets that are most likely to produce an underwriting profit;
operate with a disciplined underwriting approach;
practice prudent claims management;
establish an appropriate provision for unpaid loss and loss adjustment expenses;
strive for cost containment and the economics of shared support functions where deemed appropriate; and
provide our independent agents and brokers with competitive commissions, an ease of doing business and additional value-
added products and services for them and their customers.
The Company generally does not compete on the basis of ratings. In October, 2011 the Company had the A.M. Best ratings for
all of its non-standard automobile insurance subsidiaries withdrawn. As a result, the Company's non-standard automobile insurance
subsidiaries are currently unrated. Maison currently conducts business on the basis of a Demotech, Inc. Financial Stability Rating
of A (“Exceptional”).
Underwriting
Our underwriting philosophy stresses receiving an adequate premium and spread of risks for the business we accept. We regularly
monitor premium adequacy by territory, line of business and agency and take actions as necessary. Actions include, but are not
limited to, tightening underwriting requirements, filing for rate increases, terminating underperforming programs and agents, non-
renewing policies (where permitted) and other administrative changes. Typically, we do not reduce our premiums when competitors
underwrite at premium rates that we believe are below acceptable levels. Instead, we focus on maintaining our premium per risk
rather than writing a large number of risks at premiums that we believe would be inadequate and thus unprofitable. As a result,
our premium volumes may be negatively impacted during a soft market.
Claims Management
Claims management is the process by which Insurance Underwriting determines the validity and amount of a claim. We believe
that claims management is fundamental to our operating results. With respect to Insurance Underwriting, proper and efficient
claims management has a direct effect on the operating profit or loss which has been retained related to the ultimate loss and loss
adjustment expenses incurred on the underlying policies.
The individual operating subsidiaries in Insurance Underwriting primarily employ their own claims adjusters who are responsible
for investigating and settling claims. Under certain circumstances, however, our operating subsidiaries will utilize each other's
claims expertise where appropriate. In the case of Maison, we also rely on a third-party arrangement to assist us in settling claims.
Our goal is to settle claims fairly for the benefit of our insureds in a manner that is consistent with the insurance policy language
and our regulatory and legal obligations.
In addition to claims adjusters, our operating subsidiaries also employ appraisers, special investigators and salvage, subrogation
and other personnel who are responsible for helping us reduce the net cost of claim-handling particularly with respect to identifying
instances of fraud. We aggressively combat fraud and have processes in place to investigate suspicious claim activity. We may
also employ independent appraisers, private investigators, various experts and legal counsel to assist us in adjusting claims. When
necessary, we defend litigation against our insureds generally by retaining outside legal counsel.
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INSURANCE SERVICES SEGMENT
KINGSWAY FINANCIAL SERVICES INC.
Insurance Services includes the following subsidiaries of the Company: Assigned Risk Solutions Ltd. ("ARS"), IWS Acquisition
Corporation ("IWS") and Trinity, (collectively, "Insurance Services"). During the first quarter of 2013, Northeast Alliance Insurance
Agency, LLC, formerly included in Insurance Services, was merged into ARS.
ARS is a licensed property and casualty agent, full service managing general agent and third-party administrator focused primarily
on the assigned risk market. ARS is licensed to administer business in 22 states but generates its revenues primarily by operating
in the states of New York and New Jersey.
IWS is a licensed motor vehicle service agreement company and is a provider of after-market vehicle protection services distributed
by credit unions in 26 states to their members.
Trinity is a provider of warranty products and maintenance support to consumers and businesses in the HVAC and refrigeration
industry. Trinity distributes its warranty products through original equipment manufacturers, HVAC distributors and commercial
and residential contractors. Trinity distributes its maintenance support direct through corporate owners of retail spaces throughout
the United States.
Insurance Services Products
ARS generally markets the same type of insurance products as Insurance Underwriting; however, ARS does not retain the risk of
operating profit or loss related to the ultimate loss and loss adjustment expenses incurred on the underlying policies. This risk is
borne by the insurance companies which partner with ARS in their marketing efforts.
IWS markets and administers vehicle service agreements and related products for new and used automobiles throughout the United
States. A vehicle service agreement is an agreement between IWS and the vehicle purchaser under which IWS agrees to replace
or repair, for a specific term, designated vehicle parts in the event of a mechanical breakdown. IWS serves as the administrator
on all contracts it originates. Vehicle service agreements supplement, or are in lieu of, manufacturers' warranties and provide a
variety of extended coverage options. Vehicle service agreements typically range from three months to seven years and/or 3,000
miles to 100,000 miles. The cost of the vehicle service agreement is a function of the contract term, coverage limits and type of
vehicle.
In addition to marketing vehicle service agreements, IWS also brokers a guaranteed asset protection product (“GAP”) through its
distribution channel. GAP generally covers a consumer's out-of-pocket amount, related to an automobile loan or lease, if the
vehicle is stolen or damaged beyond repair. IWS earns a commission when a consumer purchases a GAP certificate but does not
take on any insurance risk.
Trinity is a provider of HVAC and refrigeration warranty products and provider of equipment breakdown and maintenance support
services to companies across the United States. As a provider of warranty products, Trinity markets and administers product
warranty contracts for certain new and used products in the HVAC and refrigeration industries throughout the United States. A
warranty contract is an agreement between Trinity and the purchaser of such HVAC and refrigeration equipment to replace or
repair, for a specific term, designated parts in the event of a mechanical breakdown. As a provider of equipment breakdown and
maintenance support services, Trinity acts as a single point of contact to its clients for both certain equipment breakdowns and
scheduled maintenance of equipment. Trinity will provide such repair and breakdown services by contracting with certain HVAC
providers.
Marketing and Distribution
ARS markets its products through over 5,000 independent agencies. ARS' strategy focuses on developing and maintaining strong
relationships with its assigned risk partners as well as the insurance companies which it represents. ARS' business is highly
dependent upon its ability to provide excellent customer service in all facets of operations and by the market dynamics which
determine the size of the assigned risk auto market pools in the states in which it competes. Many of these market dynamics are
beyond ARS' control to meaningfully influence.
IWS markets its products primarily through credit unions. IWS enters into an exclusive agreement with each credit union whereby
the credit union receives a stipulated access fee for each vehicle service agreement issued to its members. The credit unions are
served by IWS employee representatives located throughout the United States in close geographical proximity to the credit unions
they serve. IWS distributes and markets its products in 26 states.
Trinity directly markets and distributes its warranty products to manufacturers, distributors and installers of HVAC and refrigeration
equipment. As a provider of equipment breakdown and maintenance support, Trinity directly markets and distributes its product
through its clients, which are primarily companies that directly own and operate numerous locations across the United States.
9
KINGSWAY FINANCIAL SERVICES INC.
No material part of the business of Insurance Services is dependent upon a single customer or group of customers, the loss of any
one of which would have a material adverse effect on the Company, and no one customer or group of affiliated customers accounts
for 10% or more of the Company's consolidated revenues.
Competition
ARS operates in an environment with few market competitors but with more limited growth opportunities in the particular markets
in which they compete. As ARS looks for more opportunities to grow beyond their current markets, they may begin to experience
the more highly competitive environment described above for Insurance Underwriting.
IWS focuses exclusively on the automotive finance market with its core vehicle service agreement and related product offerings,
while much of its competition in the credit union channel has a less targeted product approach. IWS' typical competitor takes a
generalist approach to market by providing credit unions with a variety of different product offerings. They are thus unable to
deliver specialty expertise on par with IWS and do not give vehicle service agreement products the attention they require for
healthy profitability and strong risk management.
Trinity operates in an environment with few market competitors. Trinity competes on two important facets: its belief that it provides
superior customer service relative to its competitors and its ability, through the support of its insurance company partners, to
provide warranty solutions to a wider range of HVAC and refrigeration equipment than that of its competitors.
Claims Management
Claims management is the process by which Insurance Services determines the validity and amount of a claim. We believe that
claims management is fundamental to our operating results. With respect to ARS, even though the operating profit or loss related
to the ultimate loss and loss adjustment expenses incurred on the underlying policies is retained by our insurance company partners,
proper and efficient claims management has a direct effect on the operating profit or loss of our partners which consequently has
a bearing on the strength of our continuing relationships and the opportunities for future growth. ARS also has negotiated contingent
commission arrangements which enable it to participate economically in the profitable results of its partners.
The individual operating subsidiaries in Insurance Services primarily employ their own claims adjusters who are responsible for
investigating and settling claims. Our goal is to settle claims fairly for the benefit of our insureds and the insureds of our insurance
company partners in a manner that is consistent with the insurance policy language and our regulatory and legal obligations.
In addition to claims adjusters, ARS also employ appraisers, special investigators and salvage, subrogation and other personnel
who are responsible for helping us reduce the net cost of claim-handling particularly with respect to identifying instances of fraud.
We aggressively combat fraud and have processes in place to investigate suspicious claim activity. We may also employ independent
appraisers, private investigators, various experts and legal counsel to assist us in adjusting claims. When necessary, we defend
litigation against our insureds generally by retaining outside legal counsel.
IWS effectively and efficiently manages claims by utilizing in-house expertise and information systems. IWS employs an
experienced claims staff comprised of Automotive Service Excellence certified mechanics, knowledgeable in all aspects of vehicle
repairs and potential claims. Additionally, IWS owns its own proprietary database of historical claims data dating back over twenty
years. Management analyzes this database to drive real-time pricing adjustments and strategic decision-making.
Trinity claims on warranty products are managed by the insurance companies with which Trinity partners. Trinity may, at times,
act as a third-party administrator of such claims; however at no time does Trinity bear the loss of claims on warranty products.
PRICING AND PRODUCT MANAGEMENT
Responsibility for pricing and product management rests with the Company's individual operating subsidiaries in each of Insurance
Underwriting and Insurance Services. Typically, teams comprised of pricing actuaries, product managers and business development
managers work together by territory to develop policy forms and language, rating structures, regulatory filings and new product
ideas. Data solutions and claims groups track loss performance on a monthly basis so as to alert the operating subsidiaries to the
potential need to adjust forms or rates.
UNPAID LOSS AND LOSS ADJUSTMENT EXPENSES
Kingsway records a provision for its unpaid losses that have occurred as of a given evaluation date as well as for its estimated
liability for loss adjustment expenses. The provision for unpaid losses includes a provision, commonly referred to as case reserves,
for losses related to reported claims as well as a provision for losses related to claims incurred but not reported ("IBNR"). The
provision for loss adjustment expenses represents the cost to investigate and settle claims.
10
KINGSWAY FINANCIAL SERVICES INC.
The provision for unpaid loss and loss adjustment expenses does not represent an exact calculation of the liability but instead
represents management's best estimate at a given accounting date, utilizing actuarial and statistical procedures, of the undiscounted
estimates of the ultimate net cost of all unpaid loss and loss adjustment expenses. Management continually reviews its estimates
and adjusts its provision as new information becomes available. In establishing the provision for unpaid loss and loss adjustment
expenses, the Company also takes into account estimated recoveries, reinsurance, salvage and subrogation.
Any adjustments to the provision for unpaid loss and loss adjustment expenses are reflected in the consolidated statements of
operations in the periods in which they become known, and the adjustments are accounted for as changes in estimates. Even after
such adjustments, ultimate liability or recovery may exceed or be less than the revised provisions. An adjustment that increases
the provision for unpaid loss and loss adjustment expenses is known as an unfavorable development or a deficiency and will reduce
net income while an adjustment that decreases the provision is known as a favorable development or a redundancy and will increase
net income.
Process for Establishing the Provision for Unpaid Loss and Loss Adjustment Expenses
The process for establishing the provision for unpaid loss and loss adjustment expenses reflects the uncertainties and significant
judgmental factors inherent in predicting future results of both reported and IBNR claims. As such, the process is inherently
complex and imprecise and estimates are constantly refined. The process of establishing the provision for unpaid loss and loss
adjustment expenses relies on the judgment and opinions of a large number of individuals, including the opinions of the Company's
actuaries.
Factors affecting the provision for unpaid loss and loss adjustment expenses include the continually evolving and changing
regulatory and legal environment, actuarial studies, professional experience and expertise of the Company's claims departments'
personnel and independent adjusters retained to handle individual claims, the quality of the data used for projection purposes,
existing claims management practices including claims handling and settlement practices, the effect of inflationary trends on future
loss settlement costs, court decisions, economic conditions and public attitudes.
The process for establishing the provision for loss and loss adjustment expenses begins with the collection and analysis of claim
data. Data on individual reported claims, both current and historical, including paid amounts and individual claim adjuster estimates,
are grouped by common characteristics and evaluated by actuaries in their analyses of ultimate claim liabilities by product line.
Such data is occasionally supplemented with external data as available and when appropriate. The process of analyzing the
provision is undertaken on a regular basis, generally quarterly, in light of continually updated information.
Multiple estimation methods are available for the analysis of the provision for loss and loss adjustment expenses. Each estimation
method has its own set of assumption variables and its own advantages and disadvantages, with no single estimation method being
better than the others in all situations and no one set of assumption variables being meaningful for all product line components.
The relative strengths and weaknesses of the particular estimation methods when applied to a particular group of claims can also
change over time; therefore, the actual choice of estimation method can change with each evaluation. The estimation methods
chosen are those that are believed to produce the most reliable indication at that particular evaluation date.
In most cases, multiple estimation methods will be valid for the evaluation of the provision for loss and loss adjustment expenses.
This will result in a range of reasonable estimates for the provision. Reported values found to be closer to the endpoints of a range
of reasonable estimates are subject to further detailed reviews. These reviews may substantiate the validity of management's
recorded provision or lead to a change in the reported provision.
The exact boundary points of these ranges are more qualitative than quantitative in nature, as no clear line of demarcation exists
to determine when the set of underlying assumptions for an estimation method switches from being reasonable to unreasonable.
As a result, the Company does not believe that the endpoints of these ranges are or would be comparable across companies. In
addition, potential interactions among the different estimation assumptions for different product lines make the aggregation of
individual ranges a highly judgmental and inexact process.
A basic premise in most actuarial analyses is that past patterns demonstrated in the data will repeat themselves in the future, absent
a material change in the associated risk factors discussed below. To the extent a material change affecting the ultimate provision
for loss and loss adjustment expenses is known, such change is quantified to the extent possible through an analysis of internal
company data and, if available and when appropriate, external data. Such a measurement is specific to the facts and circumstances
of the particular claim portfolio and the known change being evaluated. Significant structural changes to the available data, product
mix or organization can materially impact the provision for loss and loss adjustment expenses.
Informed judgment is applied throughout the process. This includes the application of various individual experiences and expertise
to multiple sets of data and analyses. In addition to actuaries, experts involved with the reserving process also include underwriting
11
KINGSWAY FINANCIAL SERVICES INC.
and claims personnel and lawyers, as well as other company management. As a result, management may have to consider varying
individual viewpoints when establishing the provision for loss and loss adjustment expenses.
Variables Influencing the Provision for Unpaid Loss and Loss Adjustment Expenses
The variables discussed above have different impacts on estimation uncertainty for a given product line, depending on the length
of the claim tail, the reporting lag, the impact of individual claims and the complexity of the claim process for a given product
line.
Property and casualty insurance policies are either written on a claims-made or occurrence basis. Claims-made policies generally
cover, subject to requirements in individual policies, claims reported during the policy period. Policies that are written on an
occurrence basis require that the insured demonstrate that a loss occurred in the policy period, even if the insured reports the loss
in a later policy period. The Company's insurance policies are generally written on an occurrence basis.
Product lines are generally classifiable as either long-tail or short-tail, based on the average length of time between the event
triggering claims under a policy and the final resolution of those claims. Short-tail claims are reported and settled quickly, resulting
in less estimation variability. The longer the time before final claim resolution, the greater the exposure to estimation risks and
hence the greater the estimation uncertainty.
A major component of the claim tail is the reporting lag. The reporting lag, which is the time between the event triggering a claim
and the reporting of the claim to the insurer, makes estimating IBNR inherently more uncertain. In addition, the greater the
reporting lag, the greater the proportion of IBNR to the total provision for the product line. Writing new products with material
reporting lags can result in adding several years' worth of IBNR claim exposure before the reporting lag exposure becomes clearly
observable, thereby increasing the risk associated with pricing and reserving such products.
For some lines, the impact of large individual claims or loss events, such as catastrophes, can be material to the analysis. These
lines are generally referred to as being "low frequency/high severity," while lines without this "large claim" sensitivity are referred
to as "high frequency/low severity." The provision for low frequency/high severity lines can be sensitive to the impact of a small
number of potentially large claims or a small number of significant loss events, such as catastrophes. As a result, the role of
judgment is much greater for these provisions. In contrast, for high frequency/low severity lines, the impact of individual claims
is relatively minor and the range of reasonable provision estimates is narrower and more stable.
Claim complexity can also greatly affect the estimation process by impacting the number of assumptions needed to produce the
estimate, the potential stability of the underlying data and claim process, and the ability to gain an understanding of the data.
Product lines with greater claim complexity have inherently greater estimation uncertainty.
Actuaries have to exercise a considerable degree of judgment in the evaluation of all these factors in their analysis of the provision
for loss and loss adjustment expenses. The human element in the application of actuarial judgment is unavoidable when faced
with material uncertainty. Different actuaries may choose different assumptions when faced with such uncertainty, based on their
individual backgrounds, professional experiences and areas of focus. Hence, the estimates selected by the various actuaries may
differ materially from each other.
Lastly, significant structural changes to the available data, product mix or organization can also materially impact the process for
establishing the provision for loss and loss adjustment expenses.
Property and Casualty Insurance
For the year ended December 31, 2013, non-standard automobile insurance accounted for 84.1% of the Company's gross premiums
written. Non-standard automobile includes both short and long-tail coverages. The payments that are made quickly typically
pertain to auto physical damage and property damage claims. The payments that take longer to finalize and are more difficult to
estimate relate to bodily injury claims. Reporting lags are relatively short, and the claim settlement process for personal automobile
liability generally is the least complex of the liability products. Given that our core non-standard automobile offerings are policies
at the minimum prescribed limits in each state, our non-standard automobile business is generally viewed as a high frequency,
low severity business.
Examples of common risk factors that could change and, thus, affect the provision for loss and loss adjustment expenses for the
non-standard automobile product line include, but are not limited to:
•
•
•
•
trends in jury awards;
changes in the underlying court system and its philosophy;
changes in case law;
litigation trends;
12
KINGSWAY FINANCIAL SERVICES INC.
•
•
•
•
•
•
•
•
•
•
•
•
•
•
frequency of claims with payment capped by policy limits;
change in average severity of accidents, or proportion of severe accidents;
subrogation opportunities;
degree of patient responsiveness to treatment;
changes in claim handling philosophies;
effectiveness of no-fault laws;
frequency of visits to health providers;
number of medical procedures given during visits to health providers;
types of health providers used;
types of medical treatments received;
changes in cost of medical treatments;
changes in policy provisions (e.g., deductibles, policy limits, endorsements, etc.);
changes in underwriting standards; and
changes in the use of credit data for rating and underwriting.
Historical Development of Property and Casualty Unpaid Loss and Loss Adjustment Expenses
Table 3 summarizes the changes over time in the Company's provision for property and casualty unpaid loss and loss adjustment
expenses.
The first section of the table shows the provision for property and casualty unpaid loss and loss adjustment expenses recorded at
the balance sheet date for each of the indicated years. The original provision for each year is presented on a gross basis as well
as net of estimated reinsurance recoverable on unpaid loss and loss adjustment expenses.
The second section displays the cumulative amount of payments made through the end of each subsequent year with respect to
each original provision. The third section presents the re-estimation over subsequent years of each year's original net liability for
property and casualty unpaid loss and loss adjustment expenses as more information becomes known and trends become more
apparent. For example, as of December 31, 2013, we had paid $188.8 million of the currently re-estimated provision of $192.9
million for property and casualty loss and loss adjustment expenses that had been incurred through the end of 2007 and which
were originally estimated to be $197.7 million at December 31, 2007. As a result, an estimated $4.1 million of property and
casualty loss and loss adjustment expenses incurred through December 31, 2007 remain unpaid as of December 31, 2013. The
final section compares the latest re-estimation to the original estimate for each year presented in the table on both a gross and net
basis.
The development of the provision for property and casualty unpaid loss and loss adjustment expenses is shown by the difference
between the original estimates and the re-estimated liabilities at each subsequent year-end. The re-estimated liabilities at each
year-end are based on actual payments in full or partial settlement of claims plus re-estimates of the payments required for claims
still open or IBNR claims. Favorable development (redundancy) means that the original estimated provision was higher than
subsequently re-estimated. Unfavorable development (deficiency) means that the original estimated provision was lower than
subsequently re-estimated. The cumulative development represents the aggregate change in the estimates over all prior years.
Continuing with the December 31, 2007 example, the final section shows that the re-estimated net liability of $192.9 million
reflected a cumulative $4.8 million redundancy in relation to the $197.7 million originally estimated at December 31, 2007.
13
TABLE 3 Provision for property and casualty unpaid loss and loss adjustment expense, net of recoveries from reinsurers
As of December 31, 2013 (in millions of dollars, except percentages)
KINGSWAY FINANCIAL SERVICES INC.
2013
2012
2011
2010
2009
2008
2007
2006
2005
2004
2003
Property and casualty
unpaid loss and loss
adjustment expenses
originally established - end
of year, gross
Less: reinsurance
recoverable on property and
casualty unpaid loss and
loss adjustment expenses
Property and casualty
unpaid loss and loss
adjustment expenses
originally established - end
of year, net
Cumulative net paid as of:
One year later
Two years later
Three years later
Four years later
Five years later
Six years later
Seven years later
Eight years later
Nine years later
Ten years later
Re-estimated liability as of:
One year later
Two years later
Three years later
Four years later
Five years later
Six years later
Seven years later
Eight years later
Nine years later
Ten years later
As of December 31, 2013:
Cumulative deficiency
(redundancy)
Cumulative deficiency
(redundancy) as a % of
property and casualty
unpaid loss and loss
adjustment expenses
originally established - net
Re-estimated liability - gross
Less: re-established
reinsurance recoverable
Re-estimated provision - net
Cumulative deficiency
(redundancy) - gross
% of property and casualty
unpaid loss and loss
adjustment expenses
originally established - gross
84.5 103.1
120.3
174.7
186.7
183.2
198.0
119.1
106.8
104.9
100.0
7.9
5.5
0.3
8.0
—
0.5
0.3
0.3
0.5
0.3
0.4
76.6
97.6
120.0
166.7
186.7
182.7
197.7
118.8
106.3
104.6
99.6
53.4
70.0
99.4
105.2
141.2
162.2
111.7
155.5
175.3
188.0
96.4
133.8
133.8
174.6
185.0
187.1
201.1
202.0
206.8
209.6
107.1
156.8
180.4
190.8
196.0
108.6
150.5
174.3
183.6
186.9
188.8
184.5
197.6
198.0
201.0
201.2
190.2
186.9
193.3
191.9
192.0
192.9
48.8
75.5
90.9
98.8
101.4
102.7
103.0
109.0
104.9
106.0
106.8
106.0
106.0
105.9
50.0
71.0
83.9
91.3
94.9
96.1
97.4
97.6
105.1
98.2
96.6
97.6
98.0
98.3
99.1
99.3
52.6
73.3
84.2
90.0
94.4
95.9
96.5
97.6
97.8
102.0
99.7
97.1
96.2
97.4
97.5
97.8
98.5
98.6
61.4
83.6
95.2
101.3
104.0
107.7
108.4
108.7
109.5
109.7
102.5
107.7
108.1
106.6
106.6
109.2
109.3
109.4
109.9
110.2
(1.2)
13.8
20.4
22.9
18.5
(4.8)
(12.9)
(7.0)
(6.0)
10.6
(1.2)% 11.5% 12.2% 12.3% 10.1% (2.4)% (10.9)% (6.6)% (5.7)% 10.6%
96.4
110.2
187.1
192.9
133.8
105.9
209.6
201.2
99.3
98.6
—
96.4
—
7.4
—
—
133.8
179.7
209.6
201.2
—
192.9
—
105.9
—
99.3
—
98.6
—
110.2
(6.7)
13.5
12.4
22.9
18.0
(5.1)
(13.2)
(7.5)
(6.3)
10.2
(6.5)% 11.2%
7.1% 12.3%
9.8% (2.6)% (11.1)% (7.0)% (6.0)% 10.2%
14
Rollforward of Property and Casualty Unpaid Loss and Loss Adjustment Expenses
KINGSWAY FINANCIAL SERVICES INC.
Table 4 shows a rollforward of the provision for property and casualty unpaid loss and loss adjustment expenses, net of amounts
recoverable from reinsurers. The effect on the Company's net loss during the past two years due to changes in estimates of prior
year property and casualty unpaid loss and loss adjustment expenses is shown as the "prior years" contribution to incurred losses.
The consolidated financial statements are presented on a calendar year basis for all data. Calendar year results reflect payments
and re-estimation of the provision that have been recorded in the consolidated financial statements during the applicable reporting
period without regard to the periods in which the original losses were incurred. Calendar year results do not change after the end
of the applicable reporting period, even as new information develops.
TABLE 4 Rollforward of property and casualty unpaid loss and loss adjustment expenses
As of December 31, (in millions of dollars)
Balance at beginning of period, gross
Less reinsurance recoverable related to property and casualty unpaid
loss and loss adjustment expenses
Balance at beginning of period, net
Incurred related to:
Current year
Prior years
Paid related to:
Current year
Prior years
Balance at end of period, net
Plus reinsurance recoverable related to property and casualty unpaid
loss and loss adjustment expenses
Balance at end of period, gross
INVESTMENTS
2013
103.1
5.5
97.6
81.9
(1.2)
(48.3)
(53.4)
76.6
7.9
84.5
2012
120.3
0.3
120.0
85.6
13.8
(51.8)
(70.0)
97.6
5.5
103.1
We manage our investments to support the liabilities of our insurance operations, preserve capital, maintain adequate liquidity
and maximize after-tax investment returns within acceptable risks. We invest predominantly in high-quality fixed maturities with
relatively short durations. The fixed maturities portfolios are managed by a third-party firm. The Investment and Capital Committee
of the Board of Directors is responsible for monitoring their performance and compliance with the Company's investment policies
and guidelines.
Our investment guidelines stress preservation of capital, liquidity to support payment of our liabilities and diversification of risk.
The Investment and Capital Committee of the Board of Directors reviews and approves the investment guidelines at least annually.
We are also subject to the applicable state regulations that prescribe the type, quality and concentration of investments that individual
insurance companies can make.
For further descriptions of the Company's investments, see our disclosures under the headings "Net Investment Income," "Net
Realized Gains," "Investments," "Liquidity and Capital Resources" and "Critical Accounting Estimates and Assumptions" in the
MD&A and Note 6, "Investments," and Note 24, "Fair Value of Financial Instruments," to the Consolidated Financial Statements.
REINSURANCE
For most of the non-standard automobile business that we write in the United States, our exposure is generally limited to the
minimum statutory liability limits, which are typically not greater than $50,000 per occurrence, depending on the state. We have
from time to time, though, entered into different types of reinsurance arrangements as part of the management of our non-standard
automobile business. During 2012, we purchased excess of loss clash reinsurance to protect against awards in excess of our policy
limits. During 2012 and 2013, we purchased quota-share reinsurance to increase our capacity to underwrite additional insurance
risks. And, during 2012, we purchased excess of loss reinsurance for part of the year to reduce our exposure to losses related to
certain catastrophic events in Florida. For 2014, we have entered into an excess of loss reinsurance arrangement to reduce our
exposure to losses related to certain catastrophic events which may occur in any of the states in which we write non-standard
15
KINGSWAY FINANCIAL SERVICES INC.
automobile business. Finally, we purchase significant excess of loss reinsurance protection against certain catastrophic events
which may adversely affect Maison.
Reinsurance ceded does not relieve us of our ultimate liability to our insureds in the event that any reinsurer is unable to meet its
obligations under its reinsurance contracts. We therefore enter into reinsurance contracts with only those reinsurers who we believe
have sufficient financial resources to meet their obligations to us. Reinsurance treaties generally have terms of one year and, as
a result, are subject to renegotiation annually.
Because our reinsurance recoverable is generally unsecured, we regularly evaluate the financial condition of our reinsurers and
monitor the concentrations of credit risk to minimize our exposure to significant losses as a result of the insolvency of a reinsurer.
We believe that the amounts we have recorded as reinsurance recoverable are appropriately established. Estimating our reinsurance
recoverable, however, is subject to various uncertainties and the amounts ultimately recoverable may vary from amounts currently
recorded. Estimating amounts of reinsurance recoverable is also impacted by the uncertainties involved in the establishment of
provisions for unpaid loss and loss adjustment expenses. As our underlying provision develops, the amounts ultimately recoverable
may vary from amounts currently recorded.
As of December 31, 2013, we had 10.3 million recoverable from third-party reinsurers. As shown in Table 5 below, at December 31,
2013, 100.0% of the amounts recoverable from third-party reinsurers were due from reinsurers that were rated "A-" or higher by
the A.M. Best rating service. We regularly evaluate our reinsurers and their respective amounts recoverable, and an allowance
for uncollectible reinsurance is provided, if needed.
TABLE 5 Composition of amounts due from reinsurers by A.M. Best rating
As of December 31, 2013
A+
A-
Total
DEBT
85.5%
14.5%
100.0%
Debt includes LROC preferred units, senior unsecured debentures and subordinated debt, all of which are carried at fair value.
Debt consists of the following instruments:
TABLE 6 Debt
As of December 31 (in millions of dollars)
7.5% Senior notes due 2014
LROC preferred units due 2015
Subordinated debt
Total
2013
Principal
14.4
14.9
90.5
119.8
Fair Value
14.4
14.9
28.5
57.8
2012
Principal
27.0
15.9
90.5
133.4
Fair Value
23.7
13.7
23.8
61.2
Further information regarding our debt is discussed within the "Debt" section of MD&A as well as in Note 15, "Debt," and Note
28, "Subsequent Events," to the Consolidated Financial Statements.
REGULATORY ENVIRONMENT
Our insurance subsidiaries are subject to extensive regulation in the states in which they do business. Such regulation pertains to
a variety of matters, including, but not limited to, policy forms, premium rate plans, licensing of agents, licenses to transact business,
trade practices, claims practices, investments, payment of dividends, transactions with affiliates and solvency. The majority of
our insurance is written in states requiring prior approval by regulators before proposed rates for property and casualty policies
may be implemented.
Our U.S. insurance subsidiaries are subject to the insurance holding company laws in the jurisdictions in which they conduct
business. These regulations require that each U.S insurance company in the holding company system register with the insurance
department of its state of domicile and furnish information concerning the operations of companies in the holding company system
which may materially affect the operations, management or financial condition of the insurers in the holding company domiciled
16
KINGSWAY FINANCIAL SERVICES INC.
in that state. We have U.S. insurance subsidiaries that are organized and domiciled under the insurance statutes of Illinois,
Minnesota, Florida and Louisiana. The insurance laws in each of these states similarly provide that all transactions among members
of a holding company system be done at arm’s length and be shown to be fair and reasonable to the regulated insurer. Transactions
between insurance company subsidiaries and their parents and affiliates typically must be disclosed to the state regulators, and
any material or extraordinary transaction requires prior approval of the applicable state insurance regulator. A change of control
of a domestic insurer or of any controlling person requires the prior approval of the state insurance regulator. In general, any person
who acquires 10% or more of the outstanding voting securities of the insurer or its parent company is presumed to have acquired
control of the domestic insurer. To the best of our knowledge, we are in compliance with the regulations discussed above.
We are a holding company with no business operations of our own. Our ability to meet our debt payment obligations and cover
our operating expenses is largely dependent on dividends or other payments from our operating subsidiaries as well as the sale of
assets held by the holding company and the issuance of securities to raise capital. Dividends declared and paid by an insurance
subsidiary are subject to certain restrictions which may require prior approval by the insurance regulators of the state in which
such subsidiary is domiciled. At this time, the U.S. insurance subsidiaries of the Company are restricted from making any dividend
payments without regulatory approval pursuant to the domiciliary state insurance regulations. Other transactions between our
insurance company subsidiaries and their affiliates generally must be disclosed to state regulators, and prior regulatory approval
generally is required before any material or extraordinary transaction may be consummated or any management agreement, services
agreement, expense sharing arrangement or other contract providing for the rendering of services on a regular, systematic basis
is executed.
Insurance companies are required to report their financial condition and results of operation in accordance with statutory accounting
principles prescribed or permitted by state insurance regulators in conjunction with the National Association of Insurance
Commissioners (the "NAIC"). State insurance regulators also prescribe the form and content of statutory financial statements,
perform periodic financial examinations of insurers, establish standards for the types and amounts of investments and require
minimum capital and surplus levels. Such statutory capital and surplus requirements reflect risk-based capital ("RBC") standards
promulgated by the NAIC. These RBC standards are intended to assess the level of risk inherent in an insurance company's
business and consider items such as asset risk, credit risk, underwriting risk and other business risks relevant to its operations. In
accordance with RBC formulas, an insurance company's RBC requirements are calculated and compared to its total adjusted
capital, as defined by the NAIC, to determine whether regulatory intervention is warranted. In general, insurers reporting surplus
as regards policyholders below 200% of the authorized control level, as defined by the NAIC, at December 31 are subject to
varying levels of regulatory action, including discontinuation of operations. As of December 31, 2013, surplus as regards
policyholders reported by each of our insurance subsidiaries exceeded the 200% threshold. During the fourth quarter of 2012,
the Company began taking steps to place all of Amigo into voluntary run-off. Further information regarding Amigo is discussed
within the "Liquidity and Capital Resources" section of MD&A.
Our insurance subsidiaries are required under the guaranty fund laws of most states in which they transact business to pay
assessments up to prescribed limits to fund policyholder losses or liabilities of insolvent insurance companies. Our insurance
subsidiaries also are required to participate in various involuntary pools or assigned risk pools. In most states, the involuntary
pool participation of our insurance subsidiaries is in proportion to their voluntary writings of related lines of business in such
states.
We operate under licenses issued by various state insurance authorities. These licenses govern, among other things, the types of
insurance coverage and agency and claim services that we may offer consumers in these states. Such licenses typically are issued
only after we file an appropriate application and satisfy prescribed criteria. We must apply for and obtain the appropriate new
licenses before we can implement any plan to expand into a new state or offer a new line of insurance or other new product that
requires separate licensing.
The insurance laws of most states in which our insurance subsidiaries operate require insurance companies to file insurance rate
schedules and insurance policy forms for review and approval. State insurance regulators have broad discretion in judging whether
our rates are adequate, not excessive and not unfairly discriminatory and whether our policy forms comply with law. The speed
at which we can change our rates depends, in part, on the method by which the applicable state's rating laws are administered.
Generally, state insurance regulators have the authority to disapprove our rates or request changes in our rates. In addition, certain
states in which we operate have laws and regulations that limit an automobile insurance company's ability to cancel or not renew
policies.
We are subject to state laws and regulations that require diversification of our investment portfolios and that limit the amount of
investments in certain categories. Failure to comply with these laws and regulations would cause non-conforming investments
to be treated as non-admitted assets for purposes of measuring statutory surplus and, in some instances, would require divestiture.
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KINGSWAY FINANCIAL SERVICES INC.
The state insurance departments that have jurisdiction over our insurance company subsidiaries may conduct on-site visits and
examinations of the insurance companies' affairs, especially as to their financial condition, ability to fulfill their obligations to
policyholders, market conduct, claims practices and compliance with other laws and applicable regulations. Typically, these
examinations are conducted every three to five years. In addition, if circumstances dictate, regulators are authorized to conduct
special or target examinations of insurance companies to address particular concerns or issues. The results of these examinations
can give rise to regulatory orders requiring remedial, injunctive or other corrective action on the part of the company that is the
subject of the examination or the assessment of fines or other penalties against that company.
The Gramm-Leach-Bliley Act protects consumers from the unauthorized dissemination of certain personal information. The
majority of states have implemented additional regulations to address privacy issues. These laws and regulations apply to all
financial institutions, including insurance companies, and require us to maintain appropriate procedures for managing and protecting
certain personal information of our customers and to fully disclose our privacy practices to our customers. We may also be exposed
to future privacy laws and regulations, which could impose additional costs and impact our results of operations or financial
condition.
In July 2010, the Dodd-Frank Act (the "DFA”) was enacted into law. Among other things, the DFA forms within the Treasury
Department a Federal Insurance Office that is charged with monitoring all aspects of the insurance industry, gathering data, and
conducting a study on methods to modernize and improve the insurance regulatory system in the United States. A report on this
study that was delivered to Congress in mid-December 2013 concluded that a hybrid approach to regulation, involving a combination
of state and federal government action, could improve the U.S. insurance system by attaining uniformity, efficiency and consistency,
particularly with respect to solvency and market conduct regulation. A hybrid approach was also recommended to address the
perceived need for uniform supervision of insurance companies with national and global activities. It is too early to know whether
or how the report’s recommendations might result in changes to the current state-based system of insurance industry regulation
or ultimately impact Kingsway’s operations.
Vehicle service agreements are regulated in all states in the United States, and IWS is subject to these regulations. Most states
utilize the approach of the Uniform Service Contract Act which was adopted by the NAIC in the early 1990's. Under that scheme,
states regulate vehicle service contract companies by requiring them annually to file documentation, together with a copy of the
contract of insurance covering their liability under the service contracts, which complies with the particular state's regulatory
requirements. IWS is in compliance with the regulations of each state in which it sells vehicle service agreements.
Certain, but not all, states regulate the sale of HVAC and equipment warranty contracts. Trinity is licensed as a service contract
provider in those states where it is required.
EMPLOYEES
At December 31, 2013, we employed 570 personnel supporting our continuing operations, of which 560 are full-time employees.
ACCESS TO REPORTS
Our Annual Report on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K and amendments to those reports
filed or furnished pursuant to Section 13(a) or 15(d) of the Securities Exchange Act of 1934 are made available free of charge
through our website at www.kingsway-financial.com as soon as reasonably practicable after such material is electronically filed
with, or furnished to, the U.S. Securities and Exchange Commission ("SEC").
Item 1A. Risk Factors
Most issuers, including Kingsway, are exposed to numerous risk factors that could cause actual results to differ materially from
recent results or anticipated future results. The risks and uncertainties described below are those specific to the Company which
we currently believe have the potential to be material, but they may not be the only ones we face. If any of the following risks,
or any other risks and uncertainties that we have not yet identified or that we currently consider not to be material, actually occur
or become material risks, our business, prospects, financial condition, results of operations and cash flows could be materially
and adversely affected. Investors are advised to consider these factors along with the other information included in this 2013
Annual Report and to consult any further disclosures Kingsway makes on related subjects in its filings with the SEC.
FINANCIAL RISK
Kingsway is a holding company, and its operating insurance subsidiaries are subject to dividend restrictions and are
required to maintain minimum capital and surplus levels, which could limit our operations and have a material adverse
effect on our financial condition.
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KINGSWAY FINANCIAL SERVICES INC.
Kingsway is a holding company with assets consisting primarily of the capital stock of its subsidiaries. Our operations are and
will continue to be limited by the earnings of our subsidiaries and their ability to pay dividends to us. The payment of dividends
by our operating insurance subsidiaries is subject to various statutory and regulatory restrictions imposed by the insurance laws
of the domiciliary jurisdiction, including Barbados, of each such subsidiary. As a result of operating losses recorded in recent
years, at this time none of our U.S. insurance subsidiaries is able to declare and pay a dividend to the holding company without
prior regulatory approval. The Company expects these restrictions to continue. In the case of other subsidiaries not currently
subject to these restrictions, these subsidiaries may be limited in their ability to make dividend payments or advance funds to
Kingsway in the future because of the need to support their own capital levels. The inability of our subsidiaries to pay dividends
to us could have a material adverse effect on our financial condition.
See the "Liquidity and Capital Resources" section of MD&A for a detailed description of the liquidity requirements of the holding
company and the regulatory capital requirements of the operating insurance subsidiaries. No assurances can be given that the
operating insurance subsidiaries will be able to maintain compliance with these regulatory capital requirements.
We have substantial outstanding debt, which could adversely affect our ability to obtain financing in the future, react to
changes in our business and satisfy our obligations.
As of December 31, 2013, we had $119.8 million principal value of outstanding debt, including $14.4 million principal value of
senior unsecured debentures due February 1, 2014 and $14.9 million (C$15.8 million) principal value of LROC preferred units
due June 30, 2015. Because of our substantial outstanding debt:
•
•
•
our ability to engage in acquisitions without raising additional equity or obtaining additional debt financing could be limited;
our ability to obtain additional financing for working capital, capital expenditures, acquisitions, debt service requirements or
general corporate purposes and our ability to satisfy our obligations with respect to our debt may be impaired in the future;
a large portion of our cash flow must be dedicated to the payment of principal and interest on our debt, thereby reducing the
funds available to us for other purposes;
• we are exposed to the risk of increased interest rates because our outstanding subordinated debt, representing $90.5 million
of principal value, bears interest directly related to the London interbank offered interest rate for three-month U.S. dollar
deposits ("LIBOR");
it may be more difficult for us to satisfy our obligations to our creditors, resulting in possible defaults on, and acceleration
of, such debt;
•
• we may be more vulnerable to general adverse economic and industry conditions;
• we may be at a competitive disadvantage compared to our competitors with proportionately less debt or with comparable debt
on more favorable terms and, as a result, they may be better positioned to withstand economic downturns;
our ability to refinance debt may be limited or the associated costs may increase;
•
•
our flexibility to adjust to changing market conditions and ability to withstand competitive pressures could be limited; and
• we may be prevented from carrying out capital spending that is, among other things, necessary or important to our growth
strategy and efforts to improve the operating results of our businesses.
Even though, subsequent to December 31, 2013, we redeemed our $14.4 million principal value of senior unsecured debentures
due February 1, 2014, there can be no assurance that we will continue to generate the liquidity necessary to redeem our remaining
outstanding debt, including the $14.9 million (C$15.8 million) principal value of LROC preferred units due June 30, 2015.
Increases in interest rates would increase the cost of servicing our debt and could adversely affect our results of operation.
$90.5 million principal value of our outstanding debt bears interest directly related to LIBOR. As a result, increases in LIBOR
would increase the cost of servicing our debt and could adversely affect our results of operation. As of December 31, 2013, each
one percentage point increase in LIBOR would result in an approximately $1.0 million increase in our annual interest expense.
Our operations are restricted by the terms of our debt indentures, which could limit our ability to plan for or react to
market conditions or meet our capital needs.
Our debt indentures contain numerous covenants that limit our ability, among other things, to borrow money, make particular
types of investments or other restricted payments, sell assets, merge or consolidate, pay dividends or redeem common stock, and
incur liens to secure debt. The covenants under our debt agreements could limit our ability to plan for or react to market conditions
or to meet our capital needs. Our ability to comply with the covenants in these agreements may be affected by events beyond our
control, and we may have to curtail some of our operations, restructuring and growth plans to maintain compliance. No assurances
can be given that we will be able to maintain compliance with these covenants.
If we are not able to comply with the covenants and other requirements contained in the debt indentures, an event of default under
the relevant debt instrument could occur. If an event of default does occur, it could trigger a default under our other debt instruments,
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KINGSWAY FINANCIAL SERVICES INC.
we could be prohibited from accessing additional borrowings, and the holders of the defaulted debt instrument could declare
amounts outstanding with respect to such debt to become immediately due and payable. Upon such an event, our assets and cash
flow may not be sufficient to fully repay borrowings under our outstanding debt instruments. In addition, such a repayment under
an event of default could adversely affect our liquidity and force us to sell assets to repay borrowings.
The Investment and Capital Committee of the Board of Directors closely monitors the debt and capital position and, from time to
time, recommends capital initiatives based upon the circumstances of the Company. For capital initiatives undertaken in 2013,
see the "Liquidity and Capital Resources" section of MD&A.
We may not be able to realize our investment objectives, which could significantly reduce our net income.
We depend on income from our investments for a substantial portion of our earnings. A significant decline in investment yields
or an impairment of investments that we own could have a material adverse effect on our business, results of operations and
financial condition. We currently maintain and intend to continue to maintain investments primarily comprised of fixed maturities.
As of December 31, 2013, the fair value of our investments included $54.2 million of fixed maturities. Due to declines in the
yields on fixed maturities, we face reinvestment risk as these investments mature because the funds may be reinvested at rates
lower than those of the maturing investments.
Our ability to achieve our investment objectives is affected by general economic conditions that are beyond our control. General
economic conditions can adversely affect the markets for interest rate-sensitive instruments, including the extent and timing of
investor participation in such markets, the level and volatility of interest rates and, consequently, the value of fixed maturities.
In addition, changing economic conditions can result in increased defaults by the issuers of investments that we own. Interest
rates are highly sensitive to many factors, including monetary policies, domestic and international economic and political conditions
and other factors beyond our control. General economic conditions, stock market conditions and many other factors can also
adversely affect the securities markets and, consequently, the value of the investments we own. We may not be able to realize our
investment objectives, which could reduce our profitability significantly.
A difficult economy generally may materially adversely affect our business, results of operations and financial condition.
An adverse change in market conditions leading to instability in the global credit markets presents additional risks and uncertainties
for our business. In particular, deterioration in the public debt markets could lead to investment losses and an erosion of capital
in our insurance company subsidiaries as a result of a reduction in the fair value of investments.
Depending on market conditions going forward, we could incur substantial realized and unrealized losses in future periods, which
could have an adverse impact on our results of operations and financial condition. We could also experience a reduction in capital
in our insurance subsidiaries below levels required by the regulators in the jurisdictions in which they operate. Certain trust
accounts and letters of credit for the benefit of related companies and third-parties have been established with collateral on deposit
under the terms and conditions of the relevant trust and/or letter of credit agreements. The value of collateral could fall below the
levels required under these agreements putting the subsidiary or subsidiaries in breach of the agreements.
Market volatility may also make it more difficult to value certain of our investments if trading becomes less frequent. Disruptions,
uncertainty and volatility in the global credit markets may also impact our ability to obtain financing for future acquisitions. If
financing is available, it may only be available at an unattractive cost of capital, which would decrease our profitability. There
can be no assurance that market conditions will not deteriorate in the near future.
Financial disruption or a prolonged economic downturn may materially and adversely affect our business.
Worldwide financial markets have recently experienced periods of extraordinary disruption and volatility, resulting in heightened
credit risk, reduced valuation of investments and decreased economic activity. Moreover, many companies have experienced
reduced liquidity and uncertainty as to their ability to raise capital during such periods of market disruption and volatility. In the
event that these conditions recur or result in a prolonged economic downturn, our results of operations, financial position and/or
liquidity could be materially and adversely affected. These market conditions may affect the Company's ability to access debt
and equity capital markets. In addition, as a result of recent financial events, we may face increased regulation. Many of the other
risk factors discussed in this Risk Factors section identify risks that result from, or are exacerbated by, financial economic downturn.
These include risks related to our investments portfolio, the competitive environment, adequacy of unpaid loss and loss adjustment
expenses and regulatory developments.
We have generated net operating loss carryforwards for U.S. income tax purposes, but our ability to use these net operating
losses may be limited by our inability to generate future taxable income.
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KINGSWAY FINANCIAL SERVICES INC.
Our U.S. businesses have generated net operating loss (“NOL”) carryforwards for U.S. federal income tax purposes of
approximately $861.0 million as of December 31, 2013. These losses can be available to reduce income taxes that might otherwise
be incurred on future U.S. taxable income. The utilization of these losses would have a positive effect on our cash flow. Our
operations, however, remain challenged, and there can be no assurance that we will generate the taxable income in the future
necessary to utilize these losses and realize the positive cash flow benefit.
We have generated NOL carryforwards for U.S. income tax purposes, but our ability to preserve and use these NOLs may
be limited or impaired by future ownership changes.
Our ability to utilize the NOL carryforwards after an "ownership change" is subject to the rules of Section 382 of the U.S. Internal
Revenue Code of 1986, as amended ("Section 382"). An ownership change occurs if, among other things, the shareholders (or
specified groups of shareholders) who own or have owned, directly or indirectly, five (5%) percent or more of the value of our
shares or are otherwise treated as five (5%) percent shareholders under Section 382 and the regulations promulgated thereunder
increase their aggregate percentage ownership of the value of our shares by more than 50 percentage points over the lowest
percentage of the value of the shares owned by these shareholders over a three-year rolling period. In the event of an ownership
change, Section 382 would impose an annual limitation on the amount of taxable income we may offset with NOL carryforwards.
This annual limitation is generally equal to the product of the value of our shares on the date of the ownership change multiplied
by the long-term tax-exempt rate in effect on the date of the ownership change. The long-term tax-exempt rate is published monthly
by the Internal Revenue Service. Any unused Section 382 annual limitation may be carried over to later years until the applicable
expiration date for the respective NOL carryforwards. In the event an ownership change as defined under Section 382 were to
occur, our ability to utilize our NOL carryforwards would become substantially limited. The consequence of this limitation would
be the potential loss of a significant future cash flow benefit because we would no longer be able to substantially offset future
taxable income with NOL carryforwards. There can be no assurance that such ownership change will not occur in the future.
Expiration of our tax benefit preservation plan may increase the probability that we will experience an ownership change
as defined under Section 382.
In order to reduce the likelihood that we would experience an ownership change without the approval of our Board of Directors,
our shareholders ratified and approved the tax benefit preservation plan agreement (the "Plan"), dated as of September 28, 2010,
between the Company and Computershare Investor Services Inc., as rights agent, for the sole purpose of protecting the NOLs.
The Plan expired on September 28, 2013. There can be no assurance that our Board of Directors will recommend to our shareholders
that a similar tax benefit preservation plan be approved to replace the expired Plan; furthermore, there can be no assurance that
our shareholders would approve any new tax benefit preservation plan were our Board of Directors to present one for shareholder
approval. The expiration of the Plan, without a new tax benefit preservation plan, exposes us to certain changes in share ownership
which we would not be able to prevent as we would have been able to prevent under the Plan. Such changes in share ownership
could trigger an ownership change as defined under Section 382 resulting in restrictions on the use of NOLs in future periods, as
discussed above.
COMPLIANCE RISK
If we fail to comply with applicable insurance and securities laws or regulatory requirements, our business, results of
operations and financial condition could be adversely affected.
As a publicly traded holding company listed on the Toronto and New York Stock Exchanges and which owns several property
and casualty insurance subsidiaries, we are subject to numerous laws and regulations. These laws and regulations delegate
regulatory, supervisory and administrative powers to federal, provincial or state regulators.
Insurance regulations are generally designed to protect policyholders rather than shareholders and are related to matters including:
rate-setting;
risk-based capital and solvency standards;
restrictions on the amount, type, nature, quality and quantity of investments;
the maintenance of adequate provisions for unearned premiums and unpaid loss and loss adjustment expenses;
restrictions on the types of terms that can be included in insurance policies;
standards for accounting;
•
•
•
•
•
•
• marketing practices;
•
•
claims-settlement practices;
the examination of insurance companies by regulatory authorities, including periodic financial and market conduct
examinations;
the licensing of insurers and their agents;
limitations on dividends and transactions with affiliates;
•
•
21
•
•
approval of certain reinsurance transactions; and
insolvency proceedings.
KINGSWAY FINANCIAL SERVICES INC.
In light of losses incurred in recent years, Kingsway and its regulated subsidiaries have been subject to intense review and supervision
by insurance regulators. Regulators have taken significant steps to protect the policyholders of the companies we own. These
steps have included:
•
•
requesting additional capital contributions from Kingsway to its insurance subsidiaries; and
requiring more frequent reporting, including with respect to capital and liquidity positions.
These and other actions have made it challenging for the Company to continue to maintain focus on the operation and development
of its businesses. The Company does not expect these conditions to change in the foreseeable future.
In light of financial performance and a number of material transactions executed during the year, the Company has been asked to
respond to questions from and provide information to regulatory bodies overseeing insurance and/or securities laws in Canada
and the United States. The Company has cooperated in all respects with these reviews and has responded to information requests
on a timely basis.
Any failure to comply with applicable laws or regulations could result in the imposition of fines or significant restrictions on our
ability to do business, which could adversely affect our results of operations or financial condition. In addition, any changes in
laws or regulations, including the adoption of consumer initiatives regarding rates charged for automobile or other insurance
coverage or claims-handling procedures, could materially adversely affect our business, results of operations and financial
condition. It is not possible to predict the future impact of changing federal, state and provincial regulation on our operations,
and there can be no assurance that laws and regulations enacted in the future will not be more restrictive than existing laws and
regulations.
Our business is subject to risks related to litigation and regulatory actions.
We are a defendant in a number of legal actions relating to our insurance and other business operations. We may from time to
time be subject to a variety of legal and regulatory actions relating to our current and past business operations, including, but not
limited to:
•
•
•
•
•
disputes over coverage or claims adjudication;
disputes regarding sales practices, disclosure, premium refunds, licensing, regulatory compliance and compensation
arrangements;
disputes with our agents, producers or network providers over compensation and termination of contracts and related claims;
disputes with taxing authorities regarding our tax liabilities; and
disputes relating to certain businesses acquired or disposed of by us.
In addition, plaintiffs continue to bring new types of legal actions against insurance and related companies. Current and future
court decisions and legislative activity may increase our exposure to these types of claims. Multiparty or class action claims may
present additional exposure to substantial economic, non-economic or punitive damage awards. The loss of even one of these
claims, if it resulted in a significant award or a judicial ruling that was otherwise detrimental, could create a precedent in our
industry that could have a material adverse effect on our results of operations and financial condition. This risk of potential liability
may make reasonable settlements of claims more difficult to obtain. We cannot determine with any certainty what new theories
of recovery may evolve or what their impact may be on our business.
We may be subject to governmental or administrative investigations and proceedings in the context of our highly regulated
businesses. We cannot predict the outcome of these investigations, proceedings and reviews, and cannot assure that such
investigations, proceedings or reviews or related litigation or changes in operating policies and practices would not materially
adversely affect our results of operations and financial condition. In addition, if we were to experience difficulties with our
relationship with a regulatory body in a given jurisdiction, it could have a material adverse effect on our ability to do business in
that jurisdiction.
STRATEGIC RISK
The achievement of our strategic objectives is highly dependent on effective change management.
We have continued to restructure our operating insurance subsidiaries, including exiting states and lines of business, placing
subsidiaries into voluntary run-off and terminating managing general agent relationships, with the objective of focusing on core
lines of business, creating a more effective and efficient operating structure and focusing on profitability. These actions resulted
in changes to our structure and business processes. While these changes are expected to bring us benefits in the form of a more
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KINGSWAY FINANCIAL SERVICES INC.
agile and focused business, success is dependent on management effectively realizing the intended benefits. Ineffective change
management may result in disruptions to the operations of the business or may cause employees to act in a manner which is
inconsistent with our objectives. Any of these events could negatively impact our performance. We may not always achieve the
expected cost savings and other benefits of our initiatives.
We may experience difficulty continuing to reduce our holding company expenses while at the same time retaining staff
given the significant reduction in size and scale of our businesses.
We have divested a number of subsidiaries during the last few years and significantly reduced our written premium in the insurance
subsidiaries we continue to own. At the same time, we have been downsizing our holding company expense base in an attempt
to compensate for the reduction in scale. There can be no assurance that our remaining businesses will produce enough cash flow
to adequately compensate and retain the staff necessary to continue the restructuring and to service our other holding company
obligations, particularly the interest expense burden of our remaining outstanding debt.
The insurance industry and related businesses in which we operate may be subject to periodic negative publicity which
may negatively impact our financial results.
Our products and services are ultimately distributed to individual consumers. From time to time, consumer advocacy groups or
the media may focus attention on insurance products and services, thereby subjecting our industry to periodic negative publicity.
We also may be negatively impacted if participants in one or more of our markets engage in practices resulting in increased public
attention to our businesses. Negative publicity may also result in increased regulation and legislative scrutiny of practices in the
property and casualty insurance industry as well as increased litigation. These factors may further increase our costs of doing
business and adversely affect our profitability by impeding our ability to market our products and services, requiring us to change
our products or services, or by increasing the regulatory burdens under which we operate.
The highly competitive environment in which we operate could have an adverse effect on our business, results of operations
and financial condition.
The property and casualty markets in which we operate are highly competitive. We compete with major North American and
other insurers, many of which have more financial, marketing and management resources than we do. There may also be other
companies of which we are not aware that may be planning to enter the property and casualty insurance industry. Insurers in our
markets generally compete on the basis of price, consumer recognition, coverages offered, claims handling, financial stability,
customer service and geographic coverage. Although our pricing is influenced to some degree by that of our competitors, we
generally believe that it is not in our best interest to compete solely on price. As a result, we are willing to experience from time
to time a loss of market share during periods of intense price competition. Our business could be adversely impacted by the loss
of business to competitors offering competitive insurance products at lower prices. This competition could affect our ability to
attract and retain profitable business.
In our non-standard automobile business, we compete with both large national underwriters and smaller regional companies. Our
competitors include other companies that, like us, serve the independent agency market, as well as companies that sell insurance
directly to customers. Direct underwriters may have certain competitive advantages over agency underwriters, including increased
name recognition, loyalty of the customer base to the insurer rather than to an independent agency and reduced costs to acquire
policies.
Additionally, in certain states, government-operated risk plans may provide non-standard automobile insurance products at lower
prices than we provide.
From time to time, our markets may also attract competition from new entrants. In some cases, such entrants may, because of
inexperience, the desire for new business or for other reasons, price their insurance below the rates that we believe offer acceptable
premiums for the related risk. Further, a number of our competitors, including new entrants to our markets, are developing e-
business capabilities which may impact the level of business transacted through our more traditional distribution channels or that
may affect pricing in the market as a whole.
The vehicle service agreement market in which we compete is comprised of a few large companies, which market service agreements
to credit unions on a national basis and have significantly more financial, marketing and management resources than we do, as
well as several other companies that are somewhat similar in size to IWS that market service agreements to credit unions either
on a regional basis or a less robust national basis. There may also be other companies of which we are not aware that may be
planning to enter the vehicle service agreement industry. Competitors in our market generally compete on coverages offered,
claims handling, customer service, financial stability and, to a lesser extent, price. Larger competitors of ours benefit from added
advantages such as industry endorsements and preferred vendor status. We do not believe that it is in our best interest to compete
solely on price. Instead, we focus our marketing on the total value experience to the credit union and its member, with an emphasis
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KINGSWAY FINANCIAL SERVICES INC.
on customer service. While we historically have been able to adjust our product offering to remain competitive when competitors
have focused on price, our business could be adversely impacted by the loss of business to competitors offering vehicle service
agreements at lower prices.
Engaging in acquisitions involves risks, and, if we are unable to effectively manage these risks, our business may be
materially harmed.
From time to time we engage in discussions concerning acquisition opportunities and, as a result of such discussions, may enter
into acquisition transactions.
Acquisitions entail numerous risks, including the following:
•
•
•
•
•
difficulties in the integration of the acquired business;
assumption of unknown material liabilities, including deficient provisions for unpaid loss and loss adjustment expenses;
diversion of management's attention from other business concerns;
failure to achieve financial or operating objectives; and
potential loss of policyholders or key employees of acquired companies.
We may not be able to integrate or operate successfully any business, operations, personnel, services or products that we may
acquire in the future.
Engaging in new business start-ups involves risks, and, if we are unable to effectively manage these risks, our business may
be materially harmed.
From time to time we engage in discussions concerning the formation of a new business venture and, as a result of such discussions,
may form and capitalize a new business.
New business start-ups entail numerous risks, including the following:
•
•
•
•
•
identification of appropriate management to run the new business;
understanding the strategic, competitive and marketplace dynamics of the new business and, perhaps, industry;
establishment of proper financial and operational controls;
diversion of management's attention from other business concerns; and
failure to achieve financial or operating objectives.
We may not be able to operate successfully any business, operations, personnel, services or products that we may organize as a
new business start-up in the future.
OPERATIONAL RISK
Our provisions for unpaid loss and loss adjustment expenses may be inadequate, which would result in a reduction in our
net income and might adversely affect our financial condition.
Our provisions for unpaid loss and loss adjustment expenses do not represent an exact calculation of our actual liability but are
estimates involving actuarial and statistical projections at a given point in time of what we expect to be the cost of the ultimate
settlement and administration of reported and IBNR claims. The process for establishing the provision for unpaid loss and loss
adjustment expenses reflects the uncertainties and significant judgmental factors inherent in estimating future results of both
reported and IBNR claims and, as such, the process is inherently complex and imprecise. These estimates are based upon various
factors, including:
•
•
•
•
•
•
•
actuarial projections of the cost of settlement and administration of claims reflecting facts and circumstances then known;
estimates of future trends in claims severity and frequency;
legal theories of liability;
variability in claims-handling procedures;
economic factors such as inflation;
judicial and legislative trends, actions such as class action lawsuits, and judicial interpretation of coverages or
policy exclusions; and
the level of insurance fraud.
Most or all of these factors are not directly quantifiable, particularly on a prospective basis, and the effects of these and unforeseen
factors could negatively impact our ability to accurately assess the risks of the policies that we write. In addition, there may be
24
KINGSWAY FINANCIAL SERVICES INC.
significant reporting lags between the occurrence of insured events and the time they are actually reported to us and additional
lags between the time of reporting and final settlement of claims.
As time passes and more information about the claims becomes known, the estimates are appropriately adjusted upward or
downward to reflect this additional information. Because of the elements of uncertainty encompassed in this estimation process,
and the extended time it can take to settle many of the more substantial claims, several years of experience may be required before
a meaningful comparison can be made between actual losses and the original provision for unpaid loss and loss adjustment expenses.
We cannot assure that we will not have unfavorable development in the future. In addition, we have in the past, and may in the
future, acquire other insurance companies. We cannot assure that the provisions for unpaid loss and loss adjustment expenses of
the companies that we acquire are or will be adequate.
In addition, government regulators for our insurance subsidiaries could require that we increase our provisions for unpaid loss and
loss adjustment expenses if they determine that our provisions are understated. Such an increase to the provision for unpaid loss
and loss adjustment expenses for one of our insurance subsidiaries could cause a reduction in its surplus as regards policyholders,
which could adversely affect our ability to sell insurance policies.
Our insurance services subsidiaries' deferred service fees may be inadequate, which would result in a reduction in our net
income and might adversely affect our financial condition.
Our insurance services subsidiaries' deferred service fees do not represent an exact calculation but are estimates involving actuarial
and statistical projections at a given point in time of what we expect to be the remaining future revenue to be recognized in relation
to our remaining future obligations to provide policy administration and claim-handling services. The process for establishing
deferred service fees reflects the uncertainties and significant judgmental factors inherent in estimating the length of time and the
amount of work related to our future service obligations. If we amortize the deferred service fees too quickly, we could overstate
current revenues which may adversely affect future reported operating results.
As time passes and more information about the remaining service obligations becomes known, the estimates are appropriately
adjusted upward or downward to reflect this additional information. We cannot assure that we will not have unfavorable re-
estimations in the future of our deferred service fees. In addition, we have in the past, and may in the future, acquire companies
which record deferred service fees. We cannot assure that the deferred service fees of the companies that we acquire are or will
be adequate.
Our reliance on independent agents can impact our ability to maintain business, and it exposes us to credit risk.
We market and distribute our automobile and homeowners insurance products through a network of independent agents in the
United States. As a result, we rely heavily on these agents to attract new business. They typically represent more than one insurance
company, which may expose us to competition within the agencies and, therefore, we cannot rely on their commitment to our
insurance products. Loss of all or a substantial portion of the business provided by these intermediaries could have a material
adverse effect on our business, results of operations and financial condition.
In accordance with industry practice, our customers sometimes pay the premiums for their policies to agents for remittance to us.
These premiums are considered paid when received by the agents and thereafter the customer is no longer liable to us for those
amounts, whether or not we have actually received the premiums from the agents. Consequently, we assume a degree of risk
associated with our reliance on independent agents in connection with the settlement of insurance balances.
Our reliance on credit unions can impact our ability to maintain business.
We market and distribute our vehicle service agreements through a network of credit unions in the United States. As a result, we
rely heavily on these credit unions to attract new business. While these distribution arrangements tend to be exclusive between
us and each credit union, we have competitors which offer similar products exclusively through credit unions. Loss of all or a
substantial portion of our existing credit union relationships could have a material adverse effect on our business, results of
operations and financial condition.
Our reliance on a limited number of warranty and maintenance support clients and customers can impact our ability to
maintain business.
We market and distribute our warranty products and equipment breakdown and maintenance support services through a limited
number of customers and clients across the United States. Loss of all or a substantial portion of our existing customers and clients
could have a material adverse effect on our business, results of operations and financial condition.
25
KINGSWAY FINANCIAL SERVICES INC.
The majority of our gross premiums written are derived from the non-standard automobile markets. If the demand for
insurance in this market declines, our results of operations could be adversely affected.
For the year ended December 31, 2013, approximately 84.1% of our gross premiums written were attributable to non-standard
automobile insurance. The size of the non-standard automobile insurance market can be affected significantly by many factors
outside of our control, such as the underwriting capacity and underwriting criteria of standard automobile insurance carriers, and
we may be specifically affected by these factors. Additionally, the non-standard automobile insurance market tends to contract
during periods of high unemployment as was experienced in the United States throughout 2011 and 2012. To the extent that the
non-standard automobile insurance markets are affected adversely for any reason, our gross premiums written will be
disproportionately affected due to our substantial reliance on these insurance markets.
We derive the majority of our non-standard automobile insurance gross premiums from a few geographic areas, which
may cause our business to be affected by catastrophic losses or business conditions in these areas. We derive 100% of our
homeowners insurance premiums from Louisiana, which may cause our business to be affected by catastrophic losses or
business conditions in Louisiana.
Certain jurisdictions, specifically Florida, Illinois, Texas, California, Nevada and Colorado, generated 85.7% of our non-standard
automobile insurance gross written premiums during 2013. Louisiana generated 100% of our homeowners insurance premiums
and 49.7% of our allied lines gross written premiums during 2013.
Our results of operations may, therefore, be adversely affected by any catastrophic losses in these areas. Catastrophic losses can
be caused by a wide variety of events, including earthquakes, hurricanes, tropical storms, tornadoes, wind, ice storms, hail, fires,
terrorism, riots and explosions, and their incidence and severity are inherently unpredictable. Catastrophic losses are characterized
by low frequency but high severity due to aggregation of losses and could result in adverse effects on our results of operations or
financial condition. Our results of operations may also be adversely affected by general economic conditions, competition,
regulatory actions or other business conditions that affect losses or business conditions in the specific areas in which we conduct
most of our business.
If reinsurance rates rise significantly or reinsurance becomes unavailable or reinsurers are unable to pay amounts due to
us, we may be adversely affected.
We purchase reinsurance from third-parties in order to reduce our liability on individual risks. Reinsurance does not relieve us
of our primary liability to our insureds. A third-party reinsurer's insolvency, inability or unwillingness to make payments under
the terms of a reinsurance treaty could have a material adverse effect on our financial condition or results of operations. As of
December 31, 2013, we had $10.3 million recoverable from third-party reinsurers.
The amount and cost of reinsurance available to our insurance companies are subject, in large part, to prevailing market conditions
beyond our control. Our ability to provide insurance at competitive premium rates and coverage limits on a continuing basis
depends in part upon the extent to which we can obtain adequate reinsurance in amounts and at rates that will not adversely affect
our competitive position. We cannot assure that we will be able to maintain our current reinsurance facilities, which generally are
subject to annual renewal. If we are unable to renew any of these facilities upon their expiration or to obtain other reinsurance
facilities in adequate amounts and at favorable rates, we may need to modify our underwriting practices or reduce our underwriting
commitments.
Our start-up homeowners business is heavily dependent on the availability and proper structuring of reinsurance.
As a start-up company with a relatively small capital base, our homeowners insurance business relies significantly on the availability
of reinsurance at economically reasonable terms. If we are unable to secure the reinsurance necessary to execute our business
plan, or reinsurance is only available to us at unattractive terms, we could suffer a material adverse effect on our business or results
of operations. Further, if we inadequately structure our reinsurance, our exposure to severe catastrophes could lead to a material
adverse effect on our financial condition.
Disruptions or security failures in our information technology systems could create liability for us and/or limit our ability
to effectively monitor, operate and control our operations and adversely impact our reputation, business, financial condition,
results of operation and cash flows.
Our information technology systems facilitate our ability to monitor, operate and control our operations. Changes or modifications
to our information technology systems could cause disruption to our operations or cause challenges with respect to our compliance
with laws, regulations or other applicable standards. For example, delays, higher than expected costs or unsuccessful
implementation of new information technology systems could adversely impact our operations. In addition, any disruption in or
failure of our information technology systems to operate as expected could, depending on the magnitude of the problem, adversely
26
KINGSWAY FINANCIAL SERVICES INC.
impact our business, financial condition, results of operation and cash flows, including by limiting our capacity to monitor, operate
and control our operations effectively. Failures of our information technology systems could also lead to violations of privacy
laws, regulations, trade guidelines or practices related to our customers and employees. If our disaster recovery plans do not work
as anticipated, or if the third-party vendors to which we have outsourced certain information technology or other services fail to
fulfill their obligations to us, our operations may be adversely impacted. Any of these circumstances could adversely impact our
reputation, business, financial condition, results of operation and cash flows.
Our success depends on our ability to price accurately the risks we underwrite.
Our results of operation and financial condition depend on our ability to underwrite and set premium rates accurately for a wide
variety of risks. Adequate rates are necessary to generate premiums sufficient to pay loss and loss adjustment expenses and other
expenses and to earn a profit. To price our products accurately, we must collect and properly analyze a substantial amount of data;
develop, test and apply appropriate pricing techniques; closely monitor and timely recognize changes in trends; and project both
severity and frequency of losses with reasonable accuracy. Our ability to undertake these efforts successfully, and as a result price
our products accurately, is subject to a number of risks and uncertainties, some of which are outside our control, including:
•
•
•
•
the availability of reliable data and our ability to properly analyze available data;
the uncertainties that inherently characterize estimates and assumptions;
our selection and application of appropriate pricing techniques; and
changes in applicable legal liability standards and in the civil litigation system generally.
Consequently, we could underprice risks, which would adversely affect our underwriting results, or we could overprice risks,
which would reduce our sales volume and competitiveness. In either case, our results of operation could be materially and adversely
affected.
Our results of operation may fluctuate as a result of cyclical changes in the property and casualty insurance industry.
Our results of operation are primarily attributable to the property and casualty insurance industry, which as an industry is cyclical
in nature and has historically been characterized by soft markets followed by hard markets. A soft market is a period of relatively
high levels of price competition, less restrictive underwriting standards and generally low premium rates. A hard market is a
period of capital shortages resulting in lack of insurance availability, relatively low levels of competition, more selective
underwriting of risks and relatively high premium rates. If we find it necessary to reduce premiums or limit premium increases
due to competitive pressures on pricing in a softening market, we may experience a reduction in our premiums written and,
therefore, in our earned premium revenues, which could adversely affect our results of operation.
Our results of operation and financial condition could be adversely affected by the results of our voluntary run-off of two
of our insurance subsidiaries.
The Company currently has two of its insurance subsidiaries, UCC and Amigo, operating in voluntary run-off. Our success at
managing these run-offs is highly dependent upon proper claim-handling and the availability of the necessary liquidity to pay
claims when due. As a result, we are dependent in part on our ability to retain the services of appropriately trained and supervised
claim-handling personnel. The loss of the services of any of our key claim-handling personnel working in our run-offs, or the
inability to identify, hire and retain other highly qualified claim-handling personnel in the future, could adversely affect our results
of operations. We are also dependent on the continuing availability of the necessary liquidity, from the sale of securities, collection
of reinsurance recoverables and, potentially, capital contributions, to properly settle claims. In particular in the case of the Amigo
run-off, the carrying value of its home office building is significantly in excess of its surplus as regards policyholders. Our inability
to sell securities when needed; to collect outstanding reinsurance recoverables when due; or, in the case of Amigo, to sell the
building at all or to avoid a material loss upon the sale of the building, could have an adverse effect on our results of operation or
financial condition.
See the "Liquidity and Capital Resources" section of MD&A for additional detail regarding the voluntary run-offs of UCC and
Amigo.
HUMAN RESOURCES RISK
Our business depends upon key employees, and if we are unable to retain the services of these key employees or to attract
and retain additional qualified personnel, our business may be adversely affected.
Our success at improving our performance will be dependent in part on our ability to retain the services of our existing key
employees and to attract and retain additional qualified personnel in the future. The loss of the services of any of our key employees,
27
or the inability to identify, hire and retain other highly qualified personnel in the future, could adversely affect our results of
operations.
KINGSWAY FINANCIAL SERVICES INC.
Item 1B. Unresolved Staff Comments
None.
Item 2. Properties
Owned Properties
Insurance Underwriting owns and occupies a building located in Florida consisting of approximately 57,386 square feet, which
is currently held for sale.
Leased Properties
Insurance Underwriting leases facilities with an aggregate square footage of approximately 57,804 at four locations in four states.
The latest expiration date of the existing leases is in January 2018.
Insurance Services leases facilities with an aggregate square footage of approximately 96,678 at six locations in four states. The
latest expiration date of the existing leases is in May 2019.
KAI leases a facility with an aggregate square footage of approximately 23,491 at one location in one state. The expiration date
of the existing lease is in November 2019.
Item 3. Legal Proceedings
In connection with its operations in the ordinary course of business, the Company and its subsidiaries are named as defendants in
various actions for damages and costs allegedly sustained by the plaintiffs. While it is not possible to estimate the loss, or range
of loss, if any, that may be incurred in connection with any of the various proceedings at this time, it is possible that some of the
actions may result in losses having a material adverse effect on the Company's financial condition or results of operations.
Item 4. Mine Safety Disclosures
Not applicable.
28
KINGSWAY FINANCIAL SERVICES INC.
Part II
Item 5. Market for Registrant's Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities
Market Information
Our common shares are listed on the Toronto Stock Exchange ("TSX") and the NYSE under the trading symbol "KFS."
The following table sets forth, for the calendar quarters indicated, the high and low sales price for our common shares as reported
on the TSX and NYSE. The high and low sales price for prior periods has been adjusted to reflect the impact of the Company's
share consolidation, as more fully described in the "Shareholders of Record" section below.
TSX
NYSE
High - C$
Low - C$
High - US$
Low - US$
C$
C$
4.21
4.02
4.17
4.53
4.39
2.75
3.20
3.92
2.87
2.87
3.15
3.61
2.12
1.70
1.80
2.00
$
$
3.96
3.87
4.25
4.42
4.48
2.96
3.24
4.00
2.78
2.76
3.08
3.68
2.15
1.74
1.80
2.00
2013
Quarter 4
Quarter 3
Quarter 2
Quarter 1
2012
Quarter 4
Quarter 3
Quarter 2
Quarter 1
Shareholders of Record
On July 3, 2012, the Company announced that the Board of Directors of the Company authorized the implementation of a share
consolidation at a ratio of one post-consolidation share for every four pre-consolidation shares. The share consolidation, which
was approved by the stockholders at the Company's Annual and Special Meeting held on May 31, 2012, was effective as of July
3, 2012 (the "Effective Date"). As a result of the consolidation, every four of the Company's common shares that were issued and
outstanding on the Effective Date were automatically combined into one issued and outstanding common share, without any
change in the par value of such shares. Any fractional shares resulting from the consolidation were rounded up to the nearest
whole. The consolidation had the effect of reducing the number of common shares of the Company issued and outstanding from
52,595,828 shares pre-consolidation to 13,148,971 shares post-consolidation. The issued and outstanding shares reported in the
consolidated balance sheets and the number of weighted-average shares outstanding included in the loss per share computations,
as reported in the consolidated statements of operations, have been restated for all periods presented to reflect the impact of the
share consolidation.
As of March 28, 2014, the closing sales price of our common shares as reported by the TSX was C$4.43 per share and as reported
by the NYSE was $4.14 per share.
As of March 31, 2014, we had 16,429,761 common shares issued and outstanding, held by approximately 5,100 shareholders of
record.
Dividends
The Company has not declared a dividend since the first quarter of 2009. The declaration and payment of dividends is subject to
the discretion of our Board of Directors after taking into account many factors, including financial condition, results of operations,
anticipated cash needs and other factors deemed relevant by our Board of Directors. For a discussion of our cash resources and
needs, see the "Liquidity and Capital Resources" section of MD&A.
We are a holding company and a legal entity separate and distinct from our operating subsidiaries. As a holding company without
significant operations of our own, our principal sources of funds are dividends and other payments from our operating subsidiaries.
Dividends declared and paid by an insurance subsidiary are subject to certain restrictions which may require prior approval by the
insurance regulators of the state in which such subsidiary is domiciled. At this time, none of our U.S. insurance subsidiaries is
29
KINGSWAY FINANCIAL SERVICES INC.
able to declare and pay a dividend to the holding company without prior regulatory approval. There are no regulatory restrictions
on the payment of dividends from the businesses which compromise Insurance Services.
Securities Authorized for Issuance under Equity Compensation Plans
As of December 31, 2013, we had one equity compensation plan under which our shares of common stock have been authorized
for issuance to key officers of the Company and its subsidiaries, namely our 2013 Equity Incentive Plan (the "2013 Plan") adopted
by the Board of Directors in 2013. The 2013 Plan has been approved by the shareholders of the Company.
The following summary information is presented with respect to shares of our common stock that may be issued under our equity
compensation plans as of December 31, 2013:
Equity Compensation Plan Information
Number of securities to
be issued upon exercise of
outstanding options,
warrants and rights
Weighted-average
exercise price of
outstanding options,
warrants and rights
Plan category
Equity compensation plans approved
by security holders
Equity compensation plans not
approved by security holders
Total
(a)
355,625
N/A
355,625
(b)
$18.35
N/A
$18.35
Recent Sales of Unregistered Securities
During 2013, we did not have any unregistered sales of our equity securities.
Repurchases of Equity Securities
During 2013, we did not have any repurchases of our equity securities.
Item 6. Selected Financial Data
Number of securities
remaining available for
future issuance under
equity compensation
plans (excluding
securities reflected in
column (a))
(c)
2,272,345
N/A
2,272,345
We are a smaller reporting company as defined in Rule 12b-2 of the Exchange Act; therefore, pursuant to Regulation S-K, we are
not required to make disclosures under this Item.
30
KINGSWAY FINANCIAL SERVICES INC.
Management's Discussion and Analysis
Item 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS
OVERVIEW
Kingsway is a holding company and is primarily engaged, through its subsidiaries, in the property and casualty insurance business.
The Company conducts its business through the following two reportable segments: Insurance Underwriting and Insurance Services.
Insurance Underwriting includes the following subsidiaries of the Company: Mendota Insurance Company ("Mendota"),
Mendakota Insurance Company ("Mendakota"), Universal Casualty Company ("UCC"), Maison Insurance Company ("Maison"),
Kingsway Amigo Insurance Company ("Amigo") and Kingsway Reinsurance Corporation. Throughout this 2013 Annual Report,
the term "Insurance Underwriting" is used to refer to this segment.
Insurance Underwriting actively conducts business in 16 states. In 2013, production in the following states represented 85.7% of
the Company's gross premiums written: Florida (22.2%), Illinois (14.7%), Texas (13.5%), Louisiana (11.1%), California (9.8%),
Colorado (7.7%) and Nevada (6.7%).
Insurance Underwriting principally offers personal automobile insurance to drivers who do not meet the criteria for coverage by
standard automobile insurers. For the year ended December 31, 2013, non-standard automobile insurance accounted for 84.1%
of the Company's gross premiums written.
During the fourth quarter of 2012, the Company began taking steps to place all of Amigo into voluntary run-off. On November
19, 2012, the Florida Office of Insurance Regulation (“OIR”) approved Amigo's plan to withdraw from the business of offering
commercial lines insurance in Florida. On January 30, 2013, the OIR approved Amigo's plan to withdraw from the business of
offering personal lines insurance in Florida. In April 2013, Kingsway filed a comprehensive run-off plan with the OIR, which
outlines plans for Amigo's run-off. Kingsway continues to manage Amigo in a manner consistent with its filed run-off plan.
Insurance Services includes the following subsidiaries of the Company: Assigned Risk Solutions Ltd. ("ARS"), IWS Acquisition
Corporation ("IWS") and Trinity Warranty Solutions LLC ("Trinity"). During the first quarter of 2013, Northeast Alliance Insurance
Agency, LLC, formerly included in Insurance Services, was merged into ARS. Throughout this 2013 Annual Report, the term
"Insurance Services" is used to refer to this segment.
ARS is a licensed property and casualty agent, full service managing general agent and third-party administrator focused primarily
on the assigned risk market. ARS is licensed to administer business in 22 states but generates its revenues primarily by operating
in the states of New York and New Jersey.
IWS is a licensed motor vehicle service agreement company and is a provider of after-market vehicle protection services distributed
by credit unions in 26 states to their members.
Trinity is a provider of warranty products and maintenance support to consumers and businesses in the heating, ventilation, air
conditioning ("HVAC") and refrigeration industry. Trinity distributes its warranty products through original equipment
manufacturers, HVAC distributors and commercial and residential contractors. Trinity distributes its maintenance support direct
through corporate owners of retail spaces throughout the United States.
NON U.S.-GAAP FINANCIAL MEASURES
Throughout this 2013 Annual Report, we present our operations in the way we believe will be most meaningful, useful and
transparent to anyone using this financial information to evaluate our performance. In addition to the U.S. GAAP presentation of
net loss, we show certain statutory reporting information and other non-U.S. GAAP financial measures that we believe are relevant
in managing our business and drawing comparisons to our peers. These measures are operating (loss) income, gross premiums
written, net premiums written and underwriting ratios.
Following is a list of non-U.S. GAAP measures found throughout this report with their definitions, relationships to U.S. GAAP
measures and explanations of their importance to our operations.
Operating (Loss) Income
Operating (loss) income represents one measure of the pretax profitability of our segments and is derived by subtracting direct
segment expenses from direct segment revenues. Revenues and expenses are presented in the consolidated statements of operations,
but are not subtotaled by segment. However, this information is available in total and by segment in Note 23, "Segmented
31
KINGSWAY FINANCIAL SERVICES INC.
Management's Discussion and Analysis
Information," to the Consolidated Financial Statements, regarding reportable segment information. The nearest comparable U.S.
GAAP measure is loss from continuing operations before income tax (benefit) expense which, in addition to operating (loss)
income, includes net investment income, net realized gains, other-than-temporary impairment loss, other income, general and
administrative expenses, restructuring expense, interest expense, amortization of intangible assets, contingent consideration
expense, impairment of asset held for sale, loss on change in fair value of debt, (loss) gain on buy-back of debt, and equity in net
income (loss) of investee.
Gross Premiums Written
While net premiums earned is the related U.S. GAAP measure used in the consolidated statements of operations, gross premiums
written is the component of net premiums earned that measures insurance business produced before the impact of ceding reinsurance
premiums, but without respect to when those premiums will be recognized as actual revenue. We use this measure as an overall
gauge of gross business volume in Insurance Underwriting.
Net Premiums Written
While net premiums earned is the related U.S. GAAP measure used in the consolidated statements of operations, net premiums
written is the component of net premiums earned that measures the difference between gross premiums written and the impact of
ceding reinsurance premiums, but without respect to when those premiums will be recognized as actual revenue. We use this
measure as an indication of retained or net business volume in Insurance Underwriting.
Underwriting Ratios
Kingsway, like many insurance companies, analyzes performance based on underwriting ratios such as loss, expense and combined
ratios. The loss ratio is derived by dividing the amount of net loss and loss adjustment expenses incurred by net premiums earned.
The expense ratio is derived by dividing the sum of commissions and premium taxes and general and administrative expenses by
net premiums earned. The combined ratio is the sum of the loss ratio and the expense ratio. A combined ratio below 100%
demonstrates underwriting profit whereas a combined ratio over 100% demonstrates an underwriting loss.
CRITICAL ACCOUNTING ESTIMATES AND ASSUMPTIONS
The preparation of consolidated financial statements in conformity with U.S. GAAP requires management to make estimates and
assumptions that affect application of policies and the reported amounts of assets and liabilities and disclosure of contingent assets
and liabilities at the date of the consolidated financial statements and the reported amounts of revenues and expenses during the
year. Actual results could differ from these estimates. Estimates and their underlying assumptions are reviewed on an ongoing
basis. Changes in estimates are recorded in the accounting period in which they are determined. The critical accounting estimates
and assumptions in the accompanying consolidated financial statements include the provision for unpaid loss and loss adjustment
expenses, valuation of fixed maturities and equity investments, valuation of deferred income taxes, valuation of intangible assets,
goodwill recoverability, deferred acquisition costs, fair value assumptions for debt obligations, and contingent consideration.
Provision for Unpaid Loss and Loss Adjustment Expenses
A significant degree of judgment is required to determine amounts recorded in the consolidated financial statements for the provision
for unpaid loss and loss adjustment expenses. The process for establishing the provision for unpaid loss and loss adjustment
expenses reflects the uncertainties and significant judgmental factors inherent in predicting future results of both known and
unknown loss events. As such, the process is inherently complex and imprecise and estimates are constantly refined. The process
of establishing the provision for unpaid loss and loss adjustment expenses relies on the judgment and opinions of a large number
of individuals, including the opinions of the Company's actuaries. Further information regarding estimates used in determining
our provision for unpaid loss and loss adjustment expenses is discussed in the “Unpaid Loss and Loss Adjustment Expenses”
section of Part I, Item 1 of this Annual Report and Note 14, "Unpaid Loss and Loss Adjustment Expenses," to the Consolidated
Financial Statements.
Factors affecting the provision for unpaid loss and loss adjustment expenses include the continually evolving and changing
regulatory and legal environment, actuarial studies, professional experience and expertise of the Company's claims departments'
personnel and independent adjusters retained to handle individual claims, the quality of the data used for projection purposes,
existing claims management practices including claims handling and settlement practices, the effect of inflationary trends on future
loss settlement costs, court decisions, economic conditions and public attitudes.
During 2012, the Company moved responsibility for evaluating the adequacy of our provision for unpaid loss and loss adjustment
expenses under the terms of our policies and vehicle service agreements to an external process for most of our operating subsidiaries.
32
KINGSWAY FINANCIAL SERVICES INC.
Management's Discussion and Analysis
The provision is evaluated by the Company's actuaries with the results then shared with management, which is responsible for
establishing the provision recorded in the consolidated balance sheets.
In the year-end actuarial review process, an analysis of the provision for unpaid loss and loss adjustment expenses is completed
for each insurance subsidiary and IWS. Unpaid losses, allocated loss adjustment expenses and unallocated loss adjustment expenses
are separately analyzed by line of business or coverage by accident year. A wide range of actuarial methods are utilized in order
to appropriately measure ultimate loss and loss adjustment expense costs. These methods include paid loss development, incurred
loss development and frequency-severity method. Reasonability tests such as ultimate loss ratio trends and ultimate allocated loss
adjustment expense to ultimate loss are also performed prior to selection of the final provision. The provision is indicated by line
of business or coverage and is separated into case reserves, reserves for losses incurred but not reported ("IBNR") and a provision
for unallocated loss adjustment expenses.
Because the establishment of the provision for unpaid loss and loss adjustment expenses is an inherently uncertain process involving
estimates, current provisions may need to be updated. Adjustments to the provision, both favorable and unfavorable, are reflected
in the consolidated statements of operations for the periods in which such estimates are updated. The Company's actuaries develop
a range of reasonable estimates and a point estimate of unpaid loss and loss adjustment expenses. The actuarial point estimate is
intended to represent the actuaries' best estimate and will not necessarily be at the mid-point of the high and low estimates of the
range.
Valuation of Fixed Maturities and Equity Investments
Our equity investments are recorded at fair value using quoted prices from active markets. For fixed maturities, we use observable
inputs such as quoted prices in inactive markets, quoted prices in active markets for similar instruments, benchmark interest rates,
broker quotes and other relevant inputs. We do not have any investments in our portfolio which require us to use unobservable
inputs. Any change in the estimated fair value of our investments could impact the amount of unrealized gain or loss we have
recorded, which could change the amount we have recorded for our investments and other comprehensive (loss) income on our
consolidated balance sheets.
Gains and losses realized on the disposition of investments are determined on the first-in first-out basis and credited or charged
to the consolidated statements of operations. Premium and discount on investments are amortized and accredited using the interest
method and charged or credited to net investment income.
The establishment of an other-than-temporary impairment on an investment requires a number of judgments and estimates. We
perform a quarterly analysis of the individual investments to determine if declines in market value are other-than-temporary. The
analysis includes some or all of the following procedures, as applicable:
•
•
•
•
•
•
•
•
identifying all unrealized loss positions that have existed for at least six months;
identifying other circumstances which management believes may impact the recoverability of the unrealized loss positions;
obtaining a valuation analysis from third-party investment managers regarding the intrinsic value of these investments based
on their knowledge and experience together with market-based valuation techniques;
reviewing the trading range of certain investments over the preceding calendar period;
assessing if declines in market value are other-than-temporary for debt instruments based on the investment grade credit ratings
from third-party rating agencies;
assessing if declines in market value are other-than-temporary for any debt instrument with a non-investment grade credit
rating based on the continuity of its debt service record;
determining the necessary provision for declines in market value that are considered other-than-temporary based on the analyses
performed; and
assessing the company's ability and intent to hold these investments at least until the investment impairment is recovered.
The risks and uncertainties inherent in the assessment methodology used to determine declines in market value that are other-than-
temporary include, but may not be limited to, the following:
•
•
•
•
the opinions of professional investment managers could be incorrect;
the past trading patterns of individual investments may not reflect future valuation trends;
the credit ratings assigned by independent credit rating agencies may be incorrect due to unforeseen or unknown facts related
to a company's financial situation; and
the debt service pattern of non-investment grade instruments may not reflect future debt service capabilities and may not
reflect a company's unknown underlying financial problems.
33
KINGSWAY FINANCIAL SERVICES INC.
Management's Discussion and Analysis
The Company did not recognize any impairment related to its fixed maturities that was considered other-than-temporary for the
years ended December 31, 2013 and 2012. As further discussed in the "Results of Continuing Operations" section below, the
Company recorded a write-down for other-than-temporary impairment related to its investment in Atlas Financial Holdings, Inc.
preferred stock of $1.8 million for the year ended December 31, 2013. The Company recorded write-downs for other-than-
temporary impairment related to investment in investee and other investments of $2.2 million and $0.5 million, respectively, for
the year ended December 31, 2012.
Valuation of Deferred Income Taxes
The provision for income taxes is calculated based on the expected tax treatment of transactions recorded in our consolidated
financial statements. In determining our provision for income taxes, we interpret tax legislation in a variety of jurisdictions and
make assumptions about the expected timing of the reversal of deferred income tax assets and liabilities and the valuation of
deferred income taxes.
The ultimate realization of the deferred income tax asset balance is dependent upon the generation of future taxable income during
the periods in which the Company's temporary differences reverse and become deductible. A valuation allowance is established
when it is more likely than not that all or a portion of the deferred income tax asset balance will not be realized. In determining
whether a valuation allowance is needed, management considers all available positive and negative evidence affecting specific
deferred income tax asset balances, including the Company's past and anticipated future performance, the reversal of deferred
income tax liabilities, and the availability of tax planning strategies.
Objective positive evidence is necessary to support a conclusion that a valuation allowance is not needed for all or a portion of a
company's deferred income tax asset balances when significant negative evidence exists. Cumulative losses are the most compelling
form of negative evidence considered by management in this determination. To the extent a valuation allowance is established in
a period, an expense must be recorded within the income tax provision in the consolidated statements of operations. As of
December 31, 2013, the Company maintains a valuation allowance of $284.3 million, $279.0 million of which relates to its U.S.
deferred income taxes. The largest component of the U.S. deferred income tax asset balance relates to tax loss carryforwards that
have arisen as a result of the continued losses of the Company's U.S. operations. Uncertainty over the Company's ability to utilize
these losses over the short-term has led the Company to record a valuation allowance.
Future events may result in the valuation allowance being adjusted, which could materially impact our financial position and results
of operations. If sufficient positive evidence were to arise in the future indicating that all or a portion of the deferred income tax
assets would meet the more likely than not standard, the valuation allowance would be reversed in the period that such a conclusion
was reached.
Valuation of Intangible Assets
Intangible assets were initially recoded at their estimated fair values at the date of acquisition. Intangible assets with definite useful
lives consist of vehicle service agreements in-force ("VSA in-force"), database, customer-related relationships and non-compete
agreement. A discounted cash flow analysis was used to determine the fair value of the VSA in-force asset. The multi-period
excess earnings method was used to determine the fair value of the customer-related intangible assets. A form of the income
method, known as the "with and without" method, was utilized to determine the fair values of the database and non-compete
agreement intangible assets.
Indefinite-lived intangible assets consist of insurance licenses, renewal rights and trade name. Intangible assets with an indefinite
life are assessed for impairment annually as of December 31, or more frequently if events or circumstances indicate that the carrying
value may not be recoverable. The Company has the option to perform a qualitative assessment to determine whether it is more
likely than not that an indefinite-lived intangible asset is impaired. If facts and circumstances indicate that it is more likely than
not that the intangible asset is impaired, a fair value-based impairment test would be required. Management must make estimates
and assumptions in determining the fair value of indefinite-lived intangible assets that may affect any resulting impairment write-
down. This includes assumptions regarding future cash flows and future revenues from the related intangible assets or their
reporting units. Management then compares the fair value of the indefinite-lived intangible assets to their respective carrying
amounts. If the carrying amount of an intangible asset exceeds the fair value of that intangible asset, an impairment is recorded.
Additional information regarding our intangible assets is included in Note 11, "Intangible Assets," to the Consolidated Financial
Statements.
Goodwill Recoverability
Goodwill is assessed for impairment annually as of December 31, or more frequently if events or circumstances indicate that the
carrying value may not be recoverable. The Company has the option to perform a qualitative assessment to determine whether it
34
KINGSWAY FINANCIAL SERVICES INC.
Management's Discussion and Analysis
is more likely than not that the fair value of a reporting unit is less than its carrying amount. If facts and circumstances indicate
that it is more likely than not that the goodwill is impaired, a fair value-based impairment test would be required. The goodwill
impairment test is a two-step process that requires management to make judgments in determining what assumptions to use in the
calculation. The first step of the process consists of estimating the fair value of each reporting unit based on valuation techniques,
including a discounted cash flow model using revenue and profit forecasts and recent industry transaction and trading multiples
of our peers, and comparing those estimated fair values with the carrying values of the assets and liabilities of the reporting unit,
which includes the allocated goodwill. If the estimated fair value is less than the carrying value, a second step is performed to
compute the amount of the impairment, if any, by determining an implied fair value of goodwill. The determination of the implied
fair value of goodwill of a reporting unit requires management to allocate the estimated fair value of the reporting unit to the assets
and liabilities of the reporting unit. Any unallocated fair value represents the implied fair value of goodwill, which is compared
to its corresponding carrying value. Additional information regarding our goodwill is included in Note 10, "Goodwill," to the
Consolidated Financial Statements.
Deferred Acquisition Costs
Deferred acquisition costs represent the deferral of expenses that we incur related to successful efforts to acquire new business or
renew existing business. Acquisition costs, primarily commissions, premium taxes and underwriting and agency expenses related
to issuing insurance policies and vehicle service agreements, are deferred and charged against income ratably over the terms of
the related insurance policies and vehicle service agreements. Management regularly reviews the categories of acquisition costs
that are deferred and assesses the recoverability of this asset. For Insurance Underwriting, a premium deficiency and a corresponding
charge to income is recognized if the sum of the expected losses and loss adjustment expenses, unamortized acquisition costs and
maintenance costs exceeds related unearned premiums and anticipated net investment income.
Fair Value Assumptions for Debt Obligations
Our Linked Return of Capital ("LROC") preferred units, senior unsecured debentures and subordinated debt are measured and
reported at fair value. The fair value of the LROC preferred units is based on quoted market prices, and the fair value of the
subordinated debt is estimated using an internal model based on significant market observable inputs. The fair value of the senior
unsecured debentures, for which no active market exists, is derived from quoted market prices of similar instruments or other third-
party evidence. Any change in the estimated fair value of our debt is reflected in the gain or loss on change in fair value of debt
we record in the consolidated statements of operations and in the carrying value for our debt on our consolidated balance sheets.
Contingent Consideration
The consideration for certain of the Company's acquisitions includes future payments to the former owners that are contingent
upon the achievement of certain targets over future reporting periods. Liabilities for contingent consideration are measured and
reported at fair value at the date of acquisition with subsequent changes reported in the consolidated statements of operations as
contingent consideration expense. The fair value of contingent consideration liabilities is estimated using valuation models designed
to estimate the probability of such contingent payments based on various assumptions. Estimated payments are discounted using
present value techniques to arrive at estimated fair value at the balance sheet date. Changes in the fair value of contingent
consideration liabilities can result from changes to one or multiple inputs, including adjustments to the discount rates or changes
in the assumed achievement or timing of any targets. These fair value measurements are based on significant inputs not observable
in the market. Management must use judgment in determining the appropriateness of these assumptions as of the acquisition date
and for each subsequent period. Changes in assumptions could have an impact on the payout of contingent consideration liabilities.
35
KINGSWAY FINANCIAL SERVICES INC.
Management's Discussion and Analysis
RESULTS OF CONTINUING OPERATIONS
A reconciliation of total segment operating loss to net loss for the years ended December 31, 2013 and 2012 is presented in Table
1 below:
TABLE 1 Segment (Loss) Income
For the years ended December 31, (in millions of dollars)
Segment operating (loss) income
Insurance Underwriting
Insurance Services
Total segment operating loss
Net investment income
Net realized gains
Other-than-temporary impairment loss
Other income and expenses not allocated to segments, net
Interest expense
Amortization of intangible assets
Contingent consideration expense
Impairment of asset held for sale
Loss on change in fair value of debt
(Loss) gain on buy-back of debt
Equity in net income (loss) of investee
Loss from continuing operations before income tax (benefit) expense
Income tax (benefit) expense
Loss from continuing operations
Gain on liquidation of subsidiaries, net of taxes
Net loss
Loss from Continuing Operations, Net Loss and Diluted Loss Per Share
2013
2012
Change
(17.0)
1.8
(15.2)
2.4
3.5
(1.8)
(10.8)
(7.3)
(2.2)
(0.8)
(2.4)
(9.1)
—
0.3
(43.4)
(0.1)
(43.3)
7.2
(36.1)
(29.1)
4.5
(24.6)
3.2
1.1
(2.7)
(8.9)
(7.6)
(1.0)
(0.1)
—
(9.2)
0.5
(1.0)
(50.3)
3.0
(53.3)
—
(53.3)
12.1
(2.7)
9.4
(0.8)
2.4
0.9
(1.9)
0.3
(1.2)
(0.7)
(2.4)
0.1
(0.5)
1.3
6.9
(3.1)
10.0
7.2
17.2
For the year ended December 31, 2013, we incurred a loss from continuing operations of $43.3 million ($3.07 per diluted share)
compared to $53.3 million ($4.05 per diluted share) for the year ended December 31, 2012. The loss from continuing operations
for the year ended December 31, 2013 is attributable to operating losses in Insurance Underwriting, corporate general expenses,
interest expense, other-than-temporary impairment loss, impairment of asset held for sale and loss on the change in fair value of
debt. The loss from continuing operations for the year ended December 31, 2012 is due to operating losses in Insurance
Underwriting, corporate general expenses, interest expense, other-than-temporary impairment loss, equity in net loss of investee
and loss on the change in fair value of debt.
For the year ended December 31, 2013, we incurred net loss of $36.1 million ($2.56 per diluted share) compared to $53.3 million
($4.05 per diluted share) for the year ended December 31, 2012.
Insurance Underwriting
For the year ended December 31, 2013, Insurance Underwriting gross premiums written were $144.7 million compared to $145.9
million for the year ended December 31, 2012, representing a 0.8% decrease. Net premiums written were $113.6 million for the
year ended December 31, 2013 compared to $115.3 million for the year ended December 31, 2012, representing a 1.5% decrease.
Net premiums earned were $109.6 million for the year ended December 31, 2013 compared to $114.9 million for the year ended
December 31, 2012, representing a 4.6% decrease.
36
KINGSWAY FINANCIAL SERVICES INC.
Management's Discussion and Analysis
The decrease in gross premiums written is the result of a decrease in non-standard and commercial automobile premium volumes
at Amigo reflecting the actions begun by the Company during the fourth quarter of 2012 to place Amigo into voluntary run-off,
partially offset by increased premium volumes at Mendota and Mendakota and business written by Maison, which did not begin
operations until the fourth quarter of 2012. The decrease in net premiums written and earned is the result of quota share reinsurance
agreements entered into by Mendota and Mendakota effective July 1, 2012 and continuing in place through December 31, 2013.
The Insurance Underwriting operating loss decreased to $17.0 million for the year ended December 31, 2013 compared with $29.1
million for the year ended December 31, 2012. The decrease in operating loss is primarily attributed to a decrease in loss and loss
adjustment expenses, as reflected in the loss ratio, against a smaller volume of net premiums earned.
The Insurance Underwriting loss ratio for 2013 was 73.7% compared to 86.5% in 2012. The decrease in the loss ratio is primarily
due to unfavorable development of $13.8 million recorded during 2012 in the provision for property and casualty unpaid loss and
loss adjustment expenses for losses incurred as of December 31, 2011 compared to favorable development of $1.2 million recorded
during 2013 in the provision for property and casualty unpaid loss and loss adjustment expenses for losses incurred as of
December 31, 2012. The unfavorable development recorded in 2012 was primarily due to the increase in property and casualty
unpaid loss and loss adjustment expenses of $11.4 million as a result of the Insurance Underwriting restructuring announced by
the Company on September 17, 2012.
The Insurance Underwriting expense ratio was 50.1% in 2013 compared with 45.5% in 2012. The increase in the expense ratio
for the year ended December 31, 2013 is primarily due to the effect of quota-share arrangements entered into by Mendota during
these periods.
The Insurance Underwriting combined ratio was 123.8% in 2013 compared with 132.0% in 2012, reflecting the dynamics which
affected the loss and expense ratios.
The Insurance Underwriting operating loss includes policy fee income of $9.0 million and $7.8 million for the years ended
December 31, 2013 and 2012, respectively; however, when calculating expense and combined ratios under U.S. GAAP, policy
fee income is excluded.
Insurance Services
The Insurance Services service fee and commission income increased 39.4% to $49.5 million for the year ended December 31,
2013 compared with $35.5 million for the year ended December 31, 2012. This increase was primarily driven by the inclusion of
IWS in 2013 following its acquisition during the fourth quarter of 2012. The Insurance Services operating income was $1.8 million
for the year ended December 31, 2013 compared with $4.5 million for the year ended December 31, 2012. The decrease in
operating income in 2013 is due to reduced premium volumes managed by ARS, increased loss and loss adjustment expenses at
IWS and operating losses at Trinity, which was acquired during the fourth quarter of 2013.
Net Investment Income
Net investment income decreased to $2.4 million in 2013 compared to $3.2 million in 2012. The decrease is primarily a result of
a decline in the Company's fixed maturities, which resulted from reduced volumes of business and acceleration of claim payments
in Insurance Underwriting. Additionally, yields on fixed maturities remain at historically low levels such that reinvestment of
maturing investments occurs at yields lower than the yields on the maturing investments.
Net Realized Gains
The Company generated net realized gains of $3.5 million for the year ended December 31, 2013 compared to $1.1 million for
the year ended December 31, 2012. The net realized gains in 2013 resulted primarily from the sale of Atlas Financial Holdings,
Inc. ("Atlas") common stock. During 2013, the Company realized a net gain of $2.6 million related to the sale of Atlas common
stock. The net realized gains in 2012 resulted from the liquidation of equity investments and fixed maturities in Insurance
Underwriting offset by realized losses of $0.5 million related to the sale of Atlas common stock. See Note 6, "Investments," and
Note 7, "Investment in Investee," to the Consolidated Financial Statements for further details of the Company's Atlas common
stock sales.
Other-Than-Temporary Impairment Loss
On July 8, 2013, the Company announced that it had entered into a non-binding letter of intent with Atlas to sell its holdings of
Atlas preferred stock for 90% of liquidation value, or $16.2 million. On August 1, 2013, the Company announced that the transaction
37
KINGSWAY FINANCIAL SERVICES INC.
Management's Discussion and Analysis
had closed. As a result, the Company recorded a write-down for other-than-temporary impairment related to its investment in
Atlas preferred stock of $1.8 million for the year ended December 31, 2013.
As a result of the analysis performed by the Company to determine declines in market value that are other-than-temporary, the
Company recorded write-downs for other-than-temporary impairment related to investment in investee and other investments of
$2.2 million and $0.5 million, respectively, for the year ended December 31, 2012.
There were no write-downs related to fixed maturities for other-than-temporary impairments for the years ended December 31,
2013 and 2012.
Other Income and Expenses not Allocated to Segments, Net
Other income and expenses not allocated to segments was a net expense of $10.8 million in 2013 compared to $8.9 million in
2012. The increase in net expense is primarily due to $0.6 million more in foreign exchange losses and $2.1 million more of
corporate general and administrative expenses, including professional fees, salaries and benefits, offset by $0.8 million more of
other income recorded in 2013 than 2012.
Interest Expense
Interest expense for 2013 was $7.3 million compared to $7.6 million in 2012.
Amortization of Intangible Assets
The Company's intangible assets related to VSA in-force, acquired database, customer-related relationships and non-compete
agreement have definite useful lives and are amortized over their estimated useful lives. Amortization of intangible assets was
$2.2 million in 2013 compared to $1.0 million in 2012. The increase is due to the inclusion of a full year of amortization expense
related to the IWS intangible assets acquired during the fourth quarter of 2012, as well as the inclusion of amortization expense
related to the Trinity intangible asset acquired during the second quarter of 2013. See Note 4, "Acquisitions," to the Consolidated
Financial Statements for further details.
Contingent Consideration Expense
Contingent consideration expense was $0.8 million in 2013 compared to $0.1 million in 2012. The increase is due to the inclusion
of a full year of expense related to the IWS contingent consideration liability acquired during the fourth quarter of 2012, as well
as the inclusion of expense related to the Trinity contingent consideration liability acquired during the second quarter of 2013.
See Note 4, "Acquisitions," to the Consolidated Financial Statements for further details.
Impairment of Asset Held for Sale
As of December 31, 2013, property consisting of building and land located in Miami, Florida with a carrying value of $6.3 million
was classified as held for sale. For the year ended December 31, 2013, the Company recorded a write-down of $2.4 million related
to the asset held for sale.
Loss on Change in Fair Value of Debt
The loss on change in fair value of debt amounted to $9.1 million in 2013 compared to $9.2 million in 2012. The 2013 loss is due
to increase in the fair values of the Company's senior unsecured debentures, subordinated debt and LROC preferred units, whereas
the 2012 loss is primarily due to an increase in the fair values of the Company's subordinated debt and LROC preferred units.
(Loss) Gain on Buy-Back of Debt
During 2013, the Company purchased for $0.6 million, including accrued interest, $0.6 million of par value of its senior unsecured
debentures due February 1, 2014 with a carrying value of $0.6 million, including accrued interest, recording a loss of $0.0 million.
The Company subsequently canceled the acquired debentures. As more fully described in Note 5, "Liquidations, Disposition and
Reacquisition," to the Consolidated Financial Statements, during 2012, Hamilton Risk Management Company purchased a note
payable from a third-party with a carrying value of $2.2 million for $1.7 million, recording a gain of $0.5 million.
Equity in Net Income (Loss) of Investee
As discussed further in Note 7, "Investment in Investee," to the Consolidated Financial Statements, during the second quarter of
2013, the Company discontinued the use of the equity method of accounting for its former investee, Atlas. Prior to discontinuing
38
KINGSWAY FINANCIAL SERVICES INC.
Management's Discussion and Analysis
the use of the equity method of accounting for Atlas, the Company used a reporting lag of three months to report its proportionate
share of Atlas' results. Accordingly, equity in net income of investee recorded during the first quarter of 2013 of $0.3 million
relates to the Company's proportionate share of Atlas' results reported for the three months ended December 31, 2012. For the
year ended December 31, 2012, the Company recorded a loss of $1.0 million from this investment.
Income Tax (Benefit) Expense
Income tax benefit for 2013 was $0.1 million compared to expense of $3.0 million in 2012. The increase in income tax benefit
for the year ended December 31, 2013 is primarily attributable to a decrease in the change in unrecognized tax benefits recorded
in 2013 compared to 2012.
INVESTMENTS
Portfolio Composition
All of our investments in fixed maturities and equity investments are classified as available-for-sale and are reported at fair value.
At December 31, 2013, we held cash and cash equivalents and investments with a carrying value of $167.8 million. As of
December 31, 2013, we held an investments portfolio comprised primarily of fixed maturities issued by the U.S. Government,
government agencies and high quality corporate issuers. Investments held by our insurance subsidiaries must comply with applicable
domiciliary state regulations that prescribe the type, quality and concentration of investments. Our U.S. operations typically invest
in U.S. dollar-denominated instruments to mitigate their exposure to currency rate fluctuations.
Table 2 below summarizes the carrying value of investments, including cash and cash equivalents, at the dates indicated.
TABLE 2 Carrying value of investments, including cash and cash equivalents
As of December 31 (in millions of dollars, except for percentages)
Type of investment
Fixed maturities:
U.S. government, government agencies
and authorities
Canadian government
States municipalities and political
subdivisions
Mortgage-backed
Asset-backed securities and collateralized
mortgage obligations
Corporate
Total fixed maturities
Common stock
Limited liability investments
Other investments
Short-term investments
Total investments
Cash and cash equivalents
Total
Liquidity and Cash Flow Risk
2013
% of Total
2012
% of Total
18.4
4.1
6.2
2.0
4.0
19.5
54.2
7.1
4.4
3.0
0.5
69.2
98.6
167.8
11.0%
2.4%
3.7%
1.2%
2.4%
11.6%
32.3%
4.2%
2.6%
1.8%
0.3%
41.2%
58.8%
100.0%
24.9
3.8
7.3
5.0
1.1
37.4
79.5
3.6
2.3
2.0
0.6
88.0
80.8
168.8
14.8%
2.2%
4.3%
2.9%
0.6%
22.2%
47.0%
2.1%
1.4%
1.2%
0.4%
52.1%
47.9%
100.0%
Table 3 below summarizes the fair value by contractual maturities of the fixed maturities portfolio, excluding cash and cash
equivalents, at December 31, 2013 and 2012.
39
KINGSWAY FINANCIAL SERVICES INC.
Management's Discussion and Analysis
TABLE 3 Fair value of fixed maturities by contractual maturity date
As of December 31 (in millions of dollars)
Due in less than one year
Due in one through five years
Due after five through ten years
Due after ten years
Total
2013
14.1
36.6
1.5
2.0
54.2
% of Total
26.0%
67.5%
2.8%
3.7%
100.0%
2012
16.3
56.2
2.1
4.9
79.5
% of Total
20.5%
70.7%
2.6%
6.2%
100.0%
At December 31, 2013, 93.5% of fixed maturities, including treasury bills, government bonds and corporate bonds, had contractual
maturities of five years or less. Actual maturities may differ from contractual maturities because certain issuers have the right to
call or prepay obligations with or without call or prepayment penalties. The Company holds cash and high-grade short-term assets
which, along with fixed maturities, management believes are sufficient in amount for the payment of unpaid loss and loss adjustment
expenses and other operating subsidiary obligations on a timely basis. In the event that additional cash is required to meet obligations
to our policyholders and customers, we believe that the high quality, liquid investments in the portfolios provide us with sufficient
liquidity.
Market Risk
Market risk is the risk that we will incur losses due to adverse changes in interest or currency exchange rates and equity prices.
Given our U.S. operations typically invest in U.S. dollar denominated instruments and own a relatively insignificant investment
in equity instruments, our primary market risk exposures in the investments portfolio are to changes in interest rates.
Because the investments portfolio is comprised of primarily fixed maturity instruments that are usually held to maturity, periodic
changes in interest rate levels generally impact our financial results to the extent that the investments are recorded at market value
and reinvestment yields are different than the original yields on maturing instruments. During periods of rising interest rates, the
market value of the existing fixed maturities will generally decrease. The reverse is true during periods of declining interest rates.
Credit Risk
Credit risk is defined as the risk of financial loss due to failure of the other party to a financial instrument to discharge an obligation.
Credit risk arises from our positions in short-term investments, corporate debt instruments and government bonds.
The Investment and Capital Committee of the Board of Directors is responsible for the oversight of key investment policies and
limits. These policies and limits are subject to annual review and approval by the Investment and Capital Committee. The
Investment and Capital Committee is also responsible for ensuring that these policies are implemented and that procedures are in
place to manage and control credit risk.
Table 4 below summarizes the composition of the fair value of fixed maturities, excluding cash and cash equivalents, at December 31,
2013 and 2012, by rating as assigned by Standard and Poor's ("S&P") or Moody's Investors Service ("Moody's"). Fixed maturities
consist of predominantly high-quality instruments in corporate and government bonds with approximately 93.6% of those
investments rated 'A' or better at December 31, 2013. During 2012, the Company reinvested cash into certain fixed maturities
rated BBB/Baa. These investment grade fixed maturities purchased provide a better yield while maintaining compliance with
conservative credit risk guidelines adopted by the Company. The decline in BBB/Baa rated instruments since December 31, 2012
is primarily due to redemption of those prior held instruments either due to maturity or call by the issuer.
40
KINGSWAY FINANCIAL SERVICES INC.
Management's Discussion and Analysis
TABLE 4 Credit ratings of fixed maturities
As of December 31
Rating (S&P/Moody's)
AAA/Aaa
AA/Aa
A/A
Percentage rated A/A2 or better
BBB/Baa
Total
Other-Than-Temporary Impairment
2013
52.6%
11.4
29.6
93.6%
6.4
100.0%
2012
45.2%
15.8
22.8
83.8%
16.2
100.0%
The Company performs a quarterly analysis of its investment portfolio to determine if declines in market value are other-than-
temporary. Further information regarding our detailed analysis and factors considered in establishing an other-than-temporary
impairment on an investment is discussed within the "Critical Accounting Estimates and Assumptions" section of MD&A.
On July 8, 2013, the Company announced that it had entered into a non-binding letter of intent with Atlas to sell its holdings of
Atlas preferred stock for 90.0% of liquidation value, or $16.2 million. On August 1, 2013, the Company announced that the
transaction had closed. As a result, the Company recorded a write-down for other-than-temporary impairment related to its
investment in Atlas preferred stock of $1.8 million for the year ended December 31, 2013.
As a result of the analysis performed by the Company to determine declines in market value that are other-than-temporary, the
Company recorded write-downs for other-than-temporary impairment related to investment in investee and other investments of
$2.2 million and $0.5 million, respectively, for the year ended December 31, 2012.
There were no write-downs related to fixed maturities for other-than-temporary impairments for the years ended December 31,
2013 and 2012.
The length of time an individual investment may be held in an unrealized loss position may vary based on the opinion of the
investment manager and their respective analyses related to valuation and to the various credit risks that may prevent us from
recapturing the principal investment. In the case of an individual investment with a maturity date where the investment manager
determines that there is little or no risk of default prior to the maturity of a holding, we would elect to hold the investment in an
unrealized loss position until the price recovers or the investment matures. In situations where facts emerge that might increase
the risk associated with recapture of principal, the Company may elect to sell investments at a loss.
At December 31, 2013, the gross unrealized losses for fixed maturities and equity investments amounted to $0.2 million, and there
were no unrealized losses attributable to non-investment grade fixed maturities.
At each of December 31, 2013 and December 31, 2012, all unrealized losses on individual investments were considered temporary.
Fixed maturities in unrealized loss positions continued to pay interest and were not subject to material changes in their respective
debt ratings. We concluded that default risk did not exist at the time and, therefore, the declines in value were considered temporary.
As we have the capacity to hold these investments to maturity, no impairment provision was considered necessary.
Limited Liability Investments
The Company owns investments in limited liability companies ("LLCs") and a limited partnership ("LP") that primarily invest in
income-producing real estate. The Company's investments in the LLCs and LP are reported as limited liability investments in the
consolidated balance sheets. The real estate investments are held on a triple net lease basis whereby the lessee agrees to pay all
real estate taxes, building insurance and maintenance. The real estate investments yield between 7.5% - 8% minimum preferred
return on invested capital. Table 5 below presents additional information pertaining to its limited liability investments at
December 31, 2013 and 2012.
41
KINGSWAY FINANCIAL SERVICES INC.
Management's Discussion and Analysis
TABLE 5 Limited liability investments
As of December 31 (in millions of dollars)
Limited liability investments:
Real estate held through LLC
Real estate held through LP
Other
Total
Unfunded
Commitment
2013
—
1.8
—
1.8
Carrying Value
2013
2012
—
4.1
0.3
4.4
1.0
1.2
0.1
2.3
PROPERTY AND CASUALTY UNPAID LOSS AND LOSS ADJUSTMENT EXPENSES
Property and casualty unpaid loss and loss adjustment expenses represent the estimated liabilities for reported loss events, IBNR
loss events and the related estimated loss adjustment expenses.
Tables 6 and 7 present distributions, by line of business, of the provision for property and casualty unpaid loss and loss adjustment
expenses gross and net of external reinsurance, respectively.
TABLE 6 Provision for property and casualty unpaid loss and loss adjustment expenses - gross
As of December 31 (in millions of dollars)
Line of Business
Non-standard automobile
Commercial automobile
Other
Total
2013
75.5
6.7
2.3
84.5
2012
79.3
20.9
2.9
103.1
TABLE 7 Provision for property and casualty unpaid loss and loss adjustment expenses - net of reinsurance recoverable
As of December 31 (in millions of dollars)
Line of Business
Non-standard automobile
Commercial automobile
Other
Total
Non-Standard Automobile
2013
67.8
6.4
2.4
76.6
2012
74.6
20.1
2.9
97.6
At December 31, 2013 and 2012, the gross provisions for property and casualty unpaid loss and loss adjustment expenses for our
non-standard automobile business were $75.5 million and $79.3 million, respectively. The decrease primarily reflects the actions
begun by the Company during the fourth quarter of 2012 to place Amigo into voluntary run-off as well as the payment of claims
related to UCC's continuing voluntary run-off. Further information regarding Amigo and UCC is discussed within "Liquidity and
Capital Resources" below.
Commercial Automobile
At December 31, 2013 and 2012, the gross provisions for property and casualty unpaid loss and loss adjustment expenses for our
commercial automobile business were $6.7 million and $20.9 million, respectively. This decrease primarily reflects the actions
begun by the Company during the fourth quarter of 2012 to place Amigo into voluntary run-off as well as the payment of claims
42
KINGSWAY FINANCIAL SERVICES INC.
Management's Discussion and Analysis
related to UCC's continuing voluntary run-off. Further information regarding Amigo and UCC is discussed within "Liquidity and
Capital Resources" below.
Information with respect to development of our provision for prior years' property and casualty unpaid loss and loss adjustment
expenses is presented in Table 8.
TABLE 8 Increase (decrease) in prior years' provision for property and casualty unpaid loss and loss adjustment expenses
by line of business and accident year
For the year ended December 31, 2013 (in millions of dollars)
Accident Year
2008 & prior
2009
2010
2011
2012
Total
Non-standard
Automobile
1.3
0.6
0.1
(1.4)
0.4
1.0
Commercial
Automobile
(0.5)
2.1
(0.7)
(0.7)
(1.6)
(1.4)
For the year ended December 31, 2012 (in millions of dollars)
Accident Year
2007 & prior
2008
2009
2010
2011
Total
Non-standard
Automobile
Commercial
Automobile
(0.9)
2.2
1.0
5.0
3.0
10.3
1.3
0.6
0.2
1.0
0.5
3.6
Other
(0.6)
(0.1)
(0.1)
—
—
(0.8)
Other
(0.3)
0.1
0.6
(0.4)
(0.1)
(0.1)
Total
0.2
2.6
(0.7)
(2.1)
(1.2)
(1.2)
Total
0.1
2.9
1.8
5.6
3.4
13.8
The net movements in prior years' provisions for property and casualty unpaid loss and loss adjustment expenses, net of reinsurance,
was a decrease of $1.2 million and an increase of $13.8 million, respectively, for the years ended December 31, 2013 and 2012.
Table 8 identifies the relative contribution of the increases / (decreases) in the provisions for property and casualty unpaid loss
and loss adjustment expenses attributable to the respective lines of business and accident years.
The favorable development in 2013 was primarily related to the decrease in property and casualty unpaid loss and loss adjustment
expenses at UCC. In 2012, the majority of the unfavorable development is attributable to an increase in unpaid loss and loss
adjustment expenses of $11.4 million at Amigo and Mendota as part of the Company's September 17, 2012 announcement that it
was restructuring its Insurance Underwriting and Insurance Services segments. The remaining adverse development in 2012 is
generally the result of ongoing analysis of recent loss development trends. Original estimates are increased or decreased as
additional information becomes known regarding individual claims.
LIQUIDITY AND CAPITAL RESOURCES
The purpose of liquidity management is to ensure that there is sufficient cash to meet all financial commitments and obligations
as they fall due. The liquidity requirements of the Company and its subsidiaries have been met primarily by funds generated from
operations, disposal of discontinued operations, investment maturities and income and other returns received on investments. Cash
provided from these sources is used primarily for loss and loss adjustment expense payments, debt servicing and other operating
expenses. The timing and amount of payments for loss and loss adjustment expenses may differ materially from our provisions
for unpaid loss and loss adjustment expenses, which may create increased liquidity requirements.
43
Cash Flows
KINGSWAY FINANCIAL SERVICES INC.
Management's Discussion and Analysis
During 2013, the net cash used in operating activities as reported on the consolidated statements of cash flows was $41.8 million.
This use of cash can be explained primarily by the net loss of $36.1 million and the decrease in the provision for unpaid loss and
loss adjustment expenses of $18.9 million offset by a number of smaller sources of cash.
During 2013, the net cash provided by investing activities as reported on the consolidated statements of cash flows was $60.0
million. This source of cash was driven by net proceeds received from the sale of Atlas common stock of $13.6 million during
the first quarter of 2013 as further discussed in Note 7, "Investment in Investee," to the Consolidated Financial Statements; proceeds
received during the third and fourth quarters from the sales of Atlas common stock of $13.2 million and Atlas preferred stock of
$16.2 million as further discussed in Note 6, "Investments," to the Consolidated Financial Statements; and proceeds from sales
and maturities of fixed maturities in excess of purchase of fixed maturities. As previously explained, the Company's insurance
subsidiaries hold investments portfolios comprised primarily of fixed maturities issued by the U.S. Government, government
agencies and high-quality corporate issuers which are of generally short duration and are highly liquid which enables the insurance
subsidiaries to meet their liquidity needs.
During 2013, the net cash used in financing activities as reported on the consolidated statements of cash flows was $0.4 million.
This use of cash is attributed to the partial, early redemption of $12.0 million of par value and buy-back of $0.6 million of par
value of senior unsecured debentures due February 1, 2014 as further discussed in Note 15, "Debt," to the Consolidated Financial
Statements, offset by the net proceeds received from the Company's rights offering of $12.1 million as further discussed in Note
21, "Shareholders' Equity," to the Consolidated Financial Statements. On September 16, 2013 the Company completed its previously
announced rights offering.
In summary, as reported on the consolidated statements of cash flows, the Company's net increase in cash and cash equivalents
during 2013 was $17.8 million.
The Company's Insurance Underwriting subsidiaries fund their obligations primarily through premium and investment income
and maturities in the investments portfolio. The Company's Insurance Services subsidiaries fund their obligations primarily through
service fee and commission income. As a holding company, Kingsway funds its obligations, which primarily consist of interest
payments on debt as well as holding company operating expenses, primarily through disposal of discontinued operations as well
as from receipt of dividends from its non-insurance subsidiaries. On the other hand, the operating insurance subsidiaries require
regulatory approval for the return of capital and, in certain circumstances, prior to the payment of dividends. At December 31,
2013, the U.S. insurance subsidiaries of the Company were restricted from making any dividend payments without regulatory
approval pursuant to the domiciliary state insurance regulations.
Debt Covenants and Buy-backs
The senior unsecured debentures due February 1, 2014 issued by the Company contain negative covenants in the trust indenture,
placing limitations and restrictions over certain actions without the prior written consent of the indenture trustee. Included in the
negative covenants is the limitation on the incurrence of additional debt in the event that the total debt-to-total capital ratio or the
senior debt-to-total capital ratio exceeds 50% or 35%, respectively. The total debt is calculated on a pro-forma basis taking into
account the issuance of additional debt. The indenture also includes covenants limiting the issuance and sale of voting stock of
restricted subsidiaries, the payment of dividends or any other payment in respect of capital stock of the Company, or the retirement
of debt subordinate to the debentures covered by the trust indenture if, after giving effect to such payments as described in the
trust indenture, the total debt-to-total capital ratio exceeds 50%. Following the Company's redemption of its remaining senior
unsecured debentures due February 1, 2014, these negative covenants no longer apply.
Throughout 2013 and 2012, the Company has continued to experience losses. The reduction in equity as a result of these ongoing
losses can detrimentally impact the Company's capital flexibility by triggering negative covenants in its trust indenture described
above and/or limiting the dividend capacity of the operating subsidiaries. As of December 31, 2013, the Company's total debt-to-
total capital and senior debt-to-total capital ratios were 65.8% and 27.5%, respectively. These ratios have been calculated based
on the consolidated financial statements prepared in accordance with U.S. GAAP, under which the Company's shareholders' equity
has materially improved primarily due to fair valuation of its debt.
The Company launched a debt buy-back initiative during 2009, pursuant to which it has retired a substantial amount of its outstanding
debt. During 2013, the Company purchased for $0.6 million, including accrued interest, $0.6 million of par value of its senior
unsecured debentures due February 1, 2014 with a carrying value of $0.6 million, including accrued interest, recording a loss of
$0.0 million. The Company subsequently canceled the acquired debentures. During 2012, the Company did not buy-back any of
44
KINGSWAY FINANCIAL SERVICES INC.
Management's Discussion and Analysis
its outstanding debt. For further detail related to the Company's debt, see "Debt" below and Note 15, "Debt," to the Consolidated
Financial Statements.
Regulatory Capital
In the United States, a risk based capital (“RBC”) formula is used by the National Association of Insurance Commissioners (the
“NAIC”) to identify property and casualty insurance companies that may not be adequately capitalized. Most states, including
the domiciliary states of our insurance subsidiaries, have adopted the NAIC RBC requirements. In general, insurers reporting
surplus as regards policyholders below 200% of the authorized control level, as defined by the NAIC, at December 31 are subject
to varying levels of regulatory action, including discontinuation of operations. As of December 31, 2013, surplus as regards
policyholders reported by each of our insurance subsidiaries exceeded the 200% threshold.
During the fourth quarter of 2012, the Company began taking steps to place all of Amigo into voluntary run-off. On November
19, 2012, the OIR approved Amigo's plan to withdraw from the business of offering commercial lines insurance in Florida. On
January 30, 2013, the OIR approved Amigo's plan to withdraw from the business of offering personal lines insurance in Florida.
In April 2013, Kingsway filed a comprehensive run-off plan with the OIR, which outlines plans for Amigo's run-off. The successful
achievement of any run-off plan depends on future events and circumstances, the outcome of which cannot be assured. Nevertheless,
the Company and Amigo expect that they will take all necessary steps to comply with the provisions of the run-off plan. As of
December 31, 2013, Amigo's RBC was 203%.
Kingsway previously placed UCC into voluntary run-off in early 2011. At the time it was placed into voluntary run-off, UCC's
RBC was 160%. UCC entered into a comprehensive run-off plan approved by the Illinois Department of Insurance in June 2011.
UCC remains in compliance with that plan. As of December 31, 2013, UCC's RBC was 1,569%.
Our reinsurance subsidiary, which is domiciled in Barbados, is required by the regulator in Barbados to maintain minimum capital
levels. As of December 31, 2013, the capital maintained by Kingsway Reinsurance Corporation was in excess of the regulatory
capital requirements in Barbados.
On June 7, 2013, the Company received notification from the New York Stock Exchange ("NYSE") of the Company's non-
compliance with certain NYSE standards for continued listing of its common shares. Specifically, Kingsway is below the NYSE's
continued listing criteria because its average total market capitalization over a recent 30 consecutive trading day period was less
than $50 million at the same time that reported shareholders' equity was below $50 million. Under the NYSE's continued listing
criteria, a NYSE-listed company must maintain average market capitalization of not less than $50 million over a 30 consecutive
trading day period or reported shareholders' equity of not less than $50 million.
The Company had 90 days from the date of the notice to submit a business plan to the NYSE demonstrating its ability to achieve
compliance with the listing standards within 18 months of receiving the notice. The Company submitted a business plan to the
NYSE on July 17, 2013, intended to demonstrate its ability to achieve compliance with the listing standards within 18 months of
receiving the notice. On October 8, 2013, the NYSE accepted the Company's business plan submission. During such 18-month
period, Kingsway's common shares will continue to be listed and traded on the NYSE, subject to compliance with other NYSE
continued listing standards; however, the consolidated tape now includes a “.BC” indicator, which will be removed at such time
as the Company is deemed compliant with the NYSE's continued listing standards.
The notice from the NYSE does not impact the Company's listing on the Toronto Stock Exchange ("TSX"), and its common shares
will continue to be listed and traded on the TSX, subject to compliance with TSX continued listing standards. There can be no
assurance that the Company will regain compliance with NYSE listing standards.
45
KINGSWAY FINANCIAL SERVICES INC.
Management's Discussion and Analysis
DEBT
Canadian Senior Debenture Offering
On July 10, 2007, a general partnership of the Company, Kingsway 2007 General Partnership, issued C$100.0 million Senior
Unsecured Debentures at 6% due on July 11, 2012. These debentures bore interest at a fixed rate of 6% per annum payable semi-
annually from the date of issuance until July 11, 2012. Interest payments were made on January 10 and July 10 of each year,
commencing January 10, 2008. The net proceeds to the Company amounted to C$99.2 million. The debentures were unconditionally
guaranteed by the Company and its subsidiary, Kingsway America Inc. ("KAI").
Pursuant to the debt buy-back initiative previously mentioned, Kingsway 2007 General Partnership repurchased and retired most
of the originally issued par value. On July 11, 2012, Kingsway 2007 General Partnership redeemed the remaining outstanding
principal balance of C$1.7 million.
U.S. Senior Note Offering
On January 29, 2004, KAI completed the sale of $100.0 million 7.50% senior notes due 2014. In March 2004, an additional $25.0
million of these senior notes were issued. Interest payments are to be made on February 1 and August 1 in each year. The notes
are fully and unconditionally guaranteed by the Company. The notes are redeemable at KAI's option in whole at any time or in
part from time to time on or after February 1, 2009 subject to the conditions stated in the trust indenture.
On October 15, 2013, the Company completed a partial, early redemption of its senior unsecured debentures due February 1, 2014.
The Company used the proceeds from the rights offering to partially redeem the senior unsecured debentures due February 1,
2014. The partial early redemption was completed in the amount of $12.0 million at par plus accrued interest of $0.2 million.
Pursuant to the debt buy-back initiative previously mentioned, KAI has repurchased and retired most of the originally issued par
value, and, as of December 31, 2013 and 2012, only $14.4 million and $27.0 million par value, respectively, of this issue remains
outstanding. In February 2014, the Company repaid the $14.4 million principal value of its senior unsecured debentures due
February 1, 2014.
LROC Preferred Units
On July 14, 2005, Kingsway Linked Return of Capital Trust ("KLROC Trust") completed its public offering of C$78.0 million of
5.00% LROC preferred units due June 30, 2015 of which the Company was a promoter. KLROC Trust's net proceeds of the
public offering was C$74.1 million.
Beginning in 2009, KFS Capital LLC ("KFS Capital"), an affiliate of the Company, began purchasing LROC preferred units. On
June 9, 2010, KFS Capital commenced the take-over bid ("the KLROC Offer") to acquire up to 750,000 LROC preferred units at
a price per unit of C$17.50 in cash. On July 9, 2010, KFS Capital increased the size and price of its previously announced KLROC
Offer to 1,500,000 units at a price per unit of C$20.00 in cash. The KLROC Offer expired on July 23, 2010, and 1,525,150 units
were tendered, of which 1,500,000 were purchased on a pro-rata basis. The tender was paid for using available cash.
As a result of these acquisitions, the Company beneficially owns and controls 2,333,715 units, representing 74.8% of the issued
and outstanding LROC preferred units. At December 31, 2013 and 2012, the Company's outstanding obligation is C$15.8 million.
Subordinated Debt
Between December 4, 2002 and December 16, 2003, six subsidiary trusts of the Company issued $90.5 million of 30-year capital
securities to third-parties in separate private transactions. In each instance, a corresponding floating rate junior subordinated
deferrable interest debenture was then issued by KAI to the trust in exchange for the proceeds from the private sale. The floating
rate debentures bear interest at the rate of the London interbank offered interest rate for three-month U.S. dollar deposits ("LIBOR"),
plus spreads ranging from 3.85% to 4.20%, but until dates ranging from December 4, 2007 to January 8, 2009, the interest rates
will not exceed 12.45% to 12.75%. The Company has the right to call each of these securities at par value any time after five
years from their issuance until their maturity. During the first quarter of 2011, the Company gave notice to its trustees of its
intention to exercise its voluntary right to defer interest payments for up to 20 quarters, pursuant to the contractual terms of its
outstanding indentures, which permit interest deferral. This action does not constitute a default under the Company's indentures
or any of its other debt indentures. At December 31, 2013, deferred interest payable of $12.8 million is included in accrued expenses
and other liabilities in the consolidated balance sheets.
46
CERTAIN PAYMENTS PROJECTED BY PERIOD
KINGSWAY FINANCIAL SERVICES INC.
Management's Discussion and Analysis
Table 9 summarizes certain payments projected by period, including debt maturities, interest payments on outstanding debt, future
minimum payments under operating leases and the provision for unpaid loss and loss adjustment expenses. Interest payments in
Table 9 related to the subordinated debt reflect the interest deferral described in the "Subordinated Debt" section above and assume
LIBOR remains constant throughout the projection period.
Our provision for unpaid loss and loss adjustment expenses does not have contractual payment dates. In Table 9 below, we have
included a projection of when we expect our unpaid loss and loss adjustment expenses to be paid, based on historical payment
patterns. The exact timing of the payment of unpaid loss and loss adjustment expenses cannot be predicted with certainty. We
maintain an investments portfolio with varying maturities and a substantial amount in short-term investments to provide adequate
cash flows for the projected payments in Table 9. The unpaid loss and loss adjustment expenses in Table 9 have not been reduced
by amounts recoverable from reinsurers.
TABLE 9 Certain payments projected by period
As of December 31, 2013 (in millions of dollars)
Senior unsecured debentures
Subordinated debt
LROC preferred units
Total debt
Interest payments on outstanding debt
Unpaid loss and loss adjustment expenses
Future minimum lease payments
Total
OFF-BALANCE SHEET ARRANGEMENTS
2014
14.4
—
—
14.4
2.9
50.9
4.1
72.3
2015
2016
2017
2018 Thereafter
—
—
14.9
14.9
1.2
18.3
2.8
37.2
—
—
—
—
26.4
8.8
2.0
37.2
—
—
—
—
4.0
4.8
1.5
10.3
—
—
—
—
4.0
2.6
0.7
7.3
Total
14.4
90.5
14.9
119.8
95.6
87.7
11.7
—
90.5
—
90.5
57.1
2.3
0.6
150.5
314.8
As of December 31, 2013 and 2012, the Company does not engage in any off-balance sheet financing arrangements.
Item 7A. Quantitative and Qualitative Disclosures About Market Risk
We are a smaller reporting company as defined in Rule 12b-2 of the Exchange Act; therefore, pursuant to Regulation S-K, we are
not required to make disclosures under this Item.
47
KINGSWAY FINANCIAL SERVICES INC.
Item 8. Financial Statements and Supplementary Data.
Index to the Consolidated Financial Statements of
Kingsway Financial Services Inc.
Report of Independent Registered Public Accounting Firm
Consolidated Balance Sheets at December 31, 2013 and 2012
Consolidated Statements of Operations for the Years Ended December 31, 2013 and 2012
Consolidated Statements of Comprehensive Loss for the Years Ended December 31, 2013 and 2012
Consolidated Statements of Shareholders' Equity for the Years Ended December 31, 2013 and 2012
Consolidated Statements of Cash Flows for the Years Ended December 31, 2013 and 2012
Notes to the Consolidated Financial Statements
Note 1-Business
Note 2-Summary of Significant Accounting Policies
Note 3-Recently Issued Accounting Standards
Note 4-Acquisitions
Note 5-Liquidations, Disposition and Reacquisition
Note 6-Investments
Note 7-Investment in Investee
Note 8-Reinsurance
Note 9-Deferred Acquisition Costs
Note 10-Goodwill
Note 11-Intangible Assets
Note 12-Property and Equipment
Note 13-Asset Held for Sale
Note 14-Unpaid Loss and Loss Adjustment Expenses
Note 15-Debt
Note 16-Income Taxes
Note 17-Net Loss per Share
Note 18-Stock-Based Compensation
Note 19-Employee Benefit Plan
Note 20-Restructuring
Note 21-Shareholders' Equity
Note 22-Accumulated Other Comprehensive Income
Note 23-Segmented Information
Note 24-Fair Value of Financial Instruments
Note 25-Commitments and Contingent Liabilities
Note 26-Regulatory Capital Requirements and Ratios
Note 27-Statutory Information and Policies
Note 28-Subsequent Events
48
49
50
51
52
53
54
55
55
55
60
61
63
64
67
68
69
69
70
71
71
71
73
75
77
77
79
79
80
81
83
85
88
88
89
89
KINGSWAY FINANCIAL SERVICES INC.
Consolidated Balance Sheets
(in thousands, except per share data)
December 31, 2013
December 31, 2012
Assets
Investments:
Fixed maturities, at fair value (amortized cost of $53,455 and $77,858, respectively)
$
54,151
$
Equity investments, at fair value (cost of $3,554 and $2,305, respectively)
Limited liability investments
Other investments, at cost which approximates fair value
Short-term investments, at cost which approximates fair value
Total investments
Cash and cash equivalents
Investment in investee
Accrued investment income
Premiums receivable, net of allowance for doubtful accounts of $2,123 and $4,040 respectively
Service fee receivable
Other receivables, net of allowance for doubtful accounts of $1,062 and $1,002, respectively
Reinsurance recoverable
Prepaid reinsurance premiums
Deferred acquisition costs, net
Property and equipment, net of accumulated depreciation of $15,848 and $22,887, respectively
Goodwill
Intangible assets, net of accumulated amortization of $18,583 and $16,397, respectively
Other assets
Asset held for sale
Total Assets
Liabilities and Shareholders' Equity
Liabilities:
Unpaid loss and loss adjustment expenses:
Property and casualty
Vehicle service agreements
Total unpaid loss and loss adjustment expenses
Unearned premiums
Reinsurance payable
LROC preferred units, at fair value
Senior unsecured debentures, at fair value
Subordinated debt, at fair value
Deferred income tax liability
Deferred service fees
Income taxes payable
Accrued expenses and other liabilities
Total Liabilities
Shareholders' Equity:
Class A preferred stock, no par value; unlimited number authorized; zero issued and outstanding at
December 31, 2013
Common stock, no par value; unlimited number authorized; 16,429,761 and 13,148,971 issued and
outstanding at December 31, 2013 and December 31, 2012, respectively
Additional paid-in capital
Accumulated deficit
Accumulated other comprehensive income
Shareholders' equity attributable to common shareholders
Noncontrolling interests in consolidated subsidiaries
Total Shareholders' Equity
Total Liabilities and Shareholders' Equity
7,137
4,406
3,000
501
69,195
98,589
—
614
32,035
19,012
4,097
10,335
6,816
12,392
1,662
10,588
48,918
4,039
6,347
79,534
3,548
2,333
2,000
585
88,000
80,813
41,733
2,263
35,598
15,173
4,750
8,557
7,316
14,102
2,709
8,421
50,583
4,045
8,737
324,639
$
372,800
84,534
$
3,128
87,662
48,577
1,033
14,854
14,356
28,471
4,173
48,788
2,984
36,821
103,116
3,448
106,564
45,047
4,956
13,655
23,730
23,774
3,054
48,987
2,879
34,740
287,719
$
307,386
$
$
$
$
— $
—
324,803
(298,930)
9,601
35,474
1,446
36,920
$
324,639
$
—
—
312,378
(262,069)
14,762
65,071
343
65,414
372,800
See accompanying notes to Consolidated Financial Statements.
50
KINGSWAY FINANCIAL SERVICES INC.
Consolidated Statements of Operations
(in thousands, except per share data)
Revenues:
Net premiums earned
Service fee and commission income
Net investment income
Net realized gains
Other-than-temporary impairment loss
Other income
Total revenues
Expenses:
Loss and loss adjustment expenses
Commissions and premium taxes
Cost of services sold
General and administrative expenses
Restructuring expense
Interest expense
Amortization of intangible assets
Contingent consideration expense
Impairment of asset held for sale
Total expenses
Loss from continuing operations before loss on change in fair value of debt, (loss) gain
on buy-back of debt, equity in net income (loss) of investee and income tax (benefit)
expense
Loss on change in fair value of debt
(Loss) gain on buy-back of debt
Equity in net income (loss) of investee
Loss from continuing operations before income tax (benefit) expense
Income tax (benefit) expense
Loss from continuing operations
Gain on liquidation of subsidiaries, net of taxes
Net loss
Less: net income (loss) attributable to noncontrolling interests in consolidated
subsidiaries
Net loss attributable to common shareholders
Loss per share - continuing operations:
Basic:
Diluted:
Loss per share – net loss:
Basic:
Diluted:
Weighted average shares outstanding (in ‘000s):
Basic:
Diluted:
$
$
$
$
$
$
$
Years ended December 31,
2013
2012
$
109,608
49,543
2,395
3,505
(1,800)
9,027
172,278
87,553
23,134
1,843
79,812
1,861
7,263
2,186
785
2,390
114,937
35,491
3,165
1,084
(2,703)
7,617
159,591
100,184
15,422
—
73,856
1,980
7,638
959
75
—
206,827
200,114
(34,549)
(9,060)
(24)
255
(43,378)
(67)
(43,311)
7,227
(36,084)
777
(36,861)
(3.07)
(3.07)
(2.56)
(2.56)
14,111
14,111
$
$
$
$
$
$
(40,523)
(9,234)
500
(1,004)
(50,261)
3,017
(53,278)
—
(53,278)
(1,195)
(52,083)
(4.05)
(4.05)
(4.05)
(4.05)
13,149
13,149
See accompanying notes to Consolidated Financial Statements.
51
KINGSWAY FINANCIAL SERVICES INC.
Consolidated Statements of Comprehensive Loss
(in thousands)
Net loss
Other comprehensive (loss) income, net of taxes(1):
Unrealized gains (losses) on fixed maturities and equity investments:
Unrealized gains (losses) arising during the period
Reclassification adjustment for amounts included in net loss
Foreign currency translation adjustments
Equity in other comprehensive income of investee
Recognition of currency translation gain on liquidation of subsidiaries
Other comprehensive (loss) income
Comprehensive loss
Less: comprehensive income (loss) attributable to noncontrolling interests in
consolidated subsidiaries
Comprehensive loss attributable to common shareholders
(1) Net of income tax (benefit) expense of $0 in 2013 and 2012
Years ended December 31,
2013
2012
$
(36,084)
$
(53,278)
936
424
10
642
(7,227)
(5,215)
(41,299)
$
723
(42,022)
$
$
$
(656)
997
565
895
—
1,801
(51,477)
(1,159)
(50,318)
See accompanying notes to Consolidated Financial Statements
52
KINGSWAY FINANCIAL SERVICES INC.
Consolidated Statements of Shareholders' Equity
(in thousands, except per share data)
Additional
Paid-in
Capital
Accumulated
Deficit
Accumulated
Other
Comprehensive
Income
Shareholders'
Equity
Attributable
to Common
Shareholders
Noncontrolling
Interests in
Consolidated
Subsidiaries
Total
Shareholders'
Equity
Common Stock
Shares
Amount
13,086,471
$
— $
311,892
$
(201,208) $
12,749
$
123,433
$
(7,028) $
116,405
—
—
—
62,500
—
—
—
—
—
—
—
—
—
—
—
132
(205)
559
(8,778)
(52,083)
248
—
(8,530)
(52,083)
8,530
(1,195)
—
(53,278)
—
—
—
—
1,765
1,765
—
—
—
132
(205)
559
36
—
—
—
1,801
132
(205)
559
13,148,971
$
— $
312,378
$
(262,069) $
14,762
$
65,071
$
343
$
65,414
3,280,790
—
12,100
—
—
12,100
—
12,100
—
—
—
—
—
—
—
—
—
—
—
—
—
(199)
524
—
(36,861)
—
—
—
(36,861)
380
777
380
(36,084)
—
—
—
(5,161)
(5,161)
(54)
(5,215)
—
—
(199)
524
—
—
(199)
524
16,429,761
$
— $
324,803
$
(298,930) $
9,601
$
35,474
$
1,446
$
36,920
See accompanying notes to Consolidated Financial Statements.
Balance,
January 1,
2012
Reacquisition
of subsidiary
from
noncontrolling
interest
Net loss
Other
comprehensive
income
Common stock
issued
Forfeited
options
Stock option
expense
Balance,
December 31,
2012
Common stock
and warrants
issued at $4.00
per unit
Issuance of
IWS common
stock to
minority
shareholder
Net loss
Other
comprehensive
loss
Forfeited
options
Stock option
expense
Balance,
December 31,
2013
53
KINGSWAY FINANCIAL SERVICES INC.
Consolidated Statements of Cash Flows
(in thousands)
Cash provided by (used in):
Operating activities:
Net loss
Adjustments to reconcile net loss to net cash used in operating activities:
Gain on liquidation of subsidiaries, net of taxes
Equity in net (income) loss of investee
Equity in net (income) loss of limited liability investments
Depreciation and amortization
Contingent consideration expense
Stock based compensation expense, net of forfeitures
Net realized gains
Loss on change in fair value of debt
Deferred income taxes
Other than temporary impairment loss
Amortization of fixed maturities premiums and discounts
Impairment of asset held for sale
Realized loss (gain) on buy-back of debt
Changes in operating assets and liabilities:
Premiums and service fee receivable
Reinsurance recoverable
Deferred acquisition costs
Income taxes recoverable
Unpaid loss and loss adjustment expenses
Unearned premiums
Reinsurance payable
Deferred service fees
Other, net
Net cash used in operating activities
Investing activities:
Proceeds from sales and maturities of fixed maturities
Proceeds from sales of equity investments
Proceeds from sales of investment in investee
Purchase of fixed maturities
Purchase of equity investments
Net acquisition of limited liability investments
Net purchases of other investments
Net purchases of short-term investments
Acquisition of business, net of cash acquired
Net purchases of property and equipment and intangible assets
Net cash provided by investing activities
Financing activities:
Proceeds from issuance of common stock and warrants, net
Payment of notes payable
Payment of senior unsecured debentures
Net cash used in financing activities
Net increase (decrease) in cash and cash equivalents
Cash and cash equivalents at beginning of period
Cash and cash equivalents at end of period
Supplemental disclosures of cash flows information:
Cash paid (received) during the year for:
Interest
Income taxes
Years ended December 31,
2013
2012
$
(36,084)
$
(53,278)
(7,227)
(255)
(118)
3,838
785
325
(3,505)
9,060
435
1,800
2,551
2,390
24
(276)
(1,778)
1,710
—
(18,902)
3,530
(3,923)
(199)
4,005
(41,814)
40,211
30,526
13,638
(16,692)
(1,586)
(2,749)
(906)
(237)
(1,052)
(1,126)
60,027
12,100
—
(12,537)
(437)
17,776
80,813
98,589
5,145
(674)
$
$
$
—
1,004
68
2,955
75
354
(1,084)
9,234
1,085
2,703
3,624
—
(500)
(9,092)
(7,860)
(903)
8,134
(17,359)
5,624
3,043
2,098
3,379
(46,696)
78,876
2,459
4,024
(49,430)
—
(2,403)
(2,000)
(250)
14,859
(170)
45,965
132
(2,418)
(1,656)
(3,942)
(4,673)
85,486
80,813
4,487
(7,956)
$
$
$
See accompanying notes to Consolidated Financial Statements.
54
KINGSWAY FINANCIAL SERVICES INC.
Notes to Consolidated Financial Statements
NOTE 1 BUSINESS
Kingsway Financial Services Inc. (the "Company" or "Kingsway") was incorporated under the Business Corporations Act (Ontario)
on September 19, 1989. Kingsway is a holding company and is primarily engaged, through its subsidiaries, in the property and
casualty insurance business.
NOTE 2 SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
(a)
Principles of consolidation:
The accompanying information in the 2013 Annual Report has been prepared in accordance with accounting principles generally
accepted in the United States of America ("U.S. GAAP").
Certain prior year amounts have been reclassified to conform to current year presentation. On the consolidated balance sheets,
the prior year common stock was reclassified to additional paid-in capital to conform with the current year presentation.
Subsidiaries
The Company's consolidated financial statements include the assets, liabilities, shareholders' equity, revenue, expenses and cash
flows of the holding company and its subsidiaries and have been prepared on the basis of U.S. GAAP. A subsidiary is an entity
which is controlled, directly or indirectly, through ownership of more than 50% of the outstanding voting rights, or where the
Company has the power to govern the financial and operating policies so as to obtain benefits from its activities. Assessment of
control is based on the substance of the relationship between the Company and the entity and includes consideration of both existing
voting rights and, if applicable, potential voting rights that are currently exercisable and convertible. The operating results of
subsidiaries that have been disposed of are included up to the date control ceased and any difference between the fair value of the
consideration received and the carrying value of the subsidiary are recognized in the consolidated statements of operations. All
intercompany balances and transactions are eliminated in full.
The consolidated financial statements are prepared as of December 31, 2013 based on individual company financial statements at
the same date. Accounting policies of subsidiaries have been aligned where necessary to ensure consistency with those of Kingsway.
The consolidated financial statements include the following subsidiaries, all of which are owned, directly or indirectly: 1347
Advisors LLC ("1347 Advisors"); 1347 Capital LLC; 1347 Property Insurance Holdings, Inc. (formerly Maison Insurance Holdings,
Inc.); Appco Finance Corporation; American Country Underwriting Agency Inc.; ARM Holdings, Inc.; Assigned Risk Solutions
Ltd. ("ARS"); Boston General Agency, Inc.; Hamilton Risk Management Company ("Hamilton"); Insurance Management Services
Inc.; IWS Acquisition Corporation ("IWS"); KAI Advantage Auto, Inc.; KFS Capital LLC ("KFS Capital"); Kingsway America
II Inc.; Kingsway America Inc. ("KAI"); Kingsway America Agency Inc.; Kingsway Amigo Insurance Company ("Amigo");
Kingsway General Insurance Company; Kingsway LGIC Holdings, LLC; Kingsway Linked Return of Capital Trust ("KLROC
Trust"); Kingsway Reinsurance Corporation; Maison Insurance Company ("Maison"); Maison Managers, Inc.; Market Solutions
Insurance Agency LLC; Mattoni Insurance Brokerage, Inc.; Mendakota Insurance Company ("Mendakota"); Mendota Insurance
Agency, Inc.; Mendota Insurance Company ("Mendota"); MIC Insurance Agency Inc.; Trinity Warranty Solutions LLC ("Trinity");
and Universal Casualty Company ("UCC").
Noncontrolling interests
The Company has noncontrolling interests attributable to its subsidiaries, IWS and KLROC Trust. A noncontrolling interest arises
where the Company owns less than 100% of the voting rights and economic interests in a subsidiary and is initially recognized at
the proportionate share of the identifiable net assets of the subsidiary at the acquisition date and is subsequently adjusted for the
noncontrolling interest's share of the acquiree's net income (losses) and changes in capital. The effects of transactions with
noncontrolling interests are recorded in shareholders' equity where there is no change of control.
(b)
Use of estimates:
The preparation of consolidated financial statements in conformity with U.S. GAAP requires management to make estimates and
assumptions that affect application of policies and the reported amounts of assets and liabilities and disclosure of contingent assets
and liabilities at the date of the consolidated financial statements and the reported amounts of revenues and expenses during the
year. Actual results could differ from these estimates. Estimates and their underlying assumptions are reviewed on an ongoing
basis. Changes in estimates are recorded in the accounting period in which they are determined. The critical accounting estimates
and assumptions in the accompanying consolidated financial statements include the provision for unpaid loss and loss adjustment
55
KINGSWAY FINANCIAL SERVICES INC.
Notes to Consolidated Financial Statements
expenses, valuation of fixed maturities and equity investments, valuation of deferred income taxes, valuation of intangible assets,
goodwill recoverability, deferred acquisition costs, fair value assumptions for debt obligations and contingent consideration.
(c)
Foreign currency translation:
The consolidated financial statements have been presented in U.S. dollars because the Company's principal investments and cash
flows are denominated in U.S. dollars. The Company's functional currency is the U.S. dollar since the substantial majority of its
operations is conducted in the U.S. Assets and liabilities of subsidiaries with non-U.S. dollar functional currencies are translated
to U.S. dollars at period-end exchange rates, while revenue and expenses are translated at average monthly rates and shareholders'
equity is translated at the rates in effect at dates of capital transactions. The net unrealized gains or losses which result from the
translation of non-U.S. subsidiaries financial statements are recognized in accumulated other comprehensive income. Such currency
translation gains or losses are recognized in the consolidated statements of operations upon the sale of a foreign subsidiary.
Transactions settled in foreign currencies are translated to functional currencies at the exchange rate prevailing at the transaction
dates. Monetary assets and liabilities denominated in foreign currencies are translated to functional currency at the closing exchange
rate at the period end date. These foreign exchange gains or losses arising from translation are recognized in the consolidated
statements of operations.
The unrealized foreign currency translation gains and losses arising from available-for-sale financial assets are recognized in other
comprehensive (loss) income until realized, at which date they are reclassified to the consolidated statements of operations.
Unrealized foreign currency translation gains and losses on certain interest bearing debt obligations carried at fair value are included
in the consolidated statements of operations.
(d)
Business combinations:
The purchase method of accounting is used to account for the acquisition of subsidiaries or other businesses. The results of acquired
subsidiaries or other businesses are included in the consolidated statements of operations from the date of acquisition. The cost
of an acquisition is measured as the fair value of the assets received, equity instruments issued and liabilities incurred or assumed
at the date of exchange. Identifiable assets acquired and liabilities and contingent liabilities assumed in a business combination
are measured initially at their fair values at the acquisition date, irrespective of the extent of any noncontrolling interest. The
excess of the cost of an acquisition over the fair value of the Company's share of the identifiable net assets acquired is recorded
as goodwill. If the cost of acquisition is less than the fair value of the net assets of the subsidiary acquired, the difference is
recognized in the consolidated statements of operations. Noncontrolling interest in the net assets of consolidated entities are
reported separately in shareholders' equity.
(e)
Investments:
Investments in fixed maturities and equity investments in common stocks are classified as available-for-sale and reported at fair
value. Unrealized gains and losses are included in accumulated other comprehensive income, net of tax, until sold or until an
other-than-temporary impairment is recognized, at which point cumulative unrealized gains or losses are transferred to the
consolidated statements of operations.
Limited liability investments include investments in limited liability companies and a limited partnership in which the Company's
interests are not deemed minor and, therefore, are accounted for under the equity method of accounting. Other investments include
collateral loans and are reported at their unpaid principal balance. Short-term investments, which consist of investments with
original maturities between three months and one year, are reported at cost which approximates fair value.
Realized gains and losses on sales, determined on a first-in first-out basis, are included in net realized gains.
Dividends and interest income are included in net investment income. Investment income is recorded as it accrues. Income from
limited liability investments is recognized based on the Company's share of the earnings of the limited liability entities and is
included in net investment income.
The Company accounts for all financial instruments using trade date accounting.
The Company conducts a quarterly review to identify and evaluate investments that show objective indications of possible
impairment. Impairment is charged to the consolidated statements of operations if the fair value of an instrument falls below its
cost/amortized cost and the decline is considered other-than-temporary. Factors considered in determining whether a loss is other-
than-temporary include the length of time and extent to which fair value has been below cost; the financial condition and near-
56
KINGSWAY FINANCIAL SERVICES INC.
Notes to Consolidated Financial Statements
term prospects of the issuer; and the Company's ability and intent to hold investments for a period of time sufficient to allow for
any anticipated recovery.
(f)
Cash and cash equivalents:
Cash and cash equivalents include cash and investments with maturities of three months or less that are readily convertible into
cash.
(g)
Investment in investee:
The investment in common stock of the Company's former investee, Atlas Financial Holdings, Inc. ("Atlas") was accounted for
under the equity method of accounting and reported as investment in investee in the consolidated balance sheets at December 31,
2012. Investment in investee is accounted for using the equity method and is comprised of investments in entities where the
Company has the ability to exercise significant influence but not control. Significant influence is presumed to exist when the
Company owns, directly or indirectly, between 20% and 50% of the outstanding voting rights of the investee. Assessment of
significant influence is based on the substance of the relationship between the Company and the investee and includes consideration
of both existing voting rights and, if applicable, potential voting rights that are currently exercisable and convertible. These
investments are reported as investment in investee in the consolidated balance sheets, with the Company's share of income (loss)
and other comprehensive loss of the investee reported in the corresponding line in the consolidated statements of operations and
consolidated statements of comprehensive income (loss), respectively. Under the equity method of accounting, an investment in
investee is initially recognized at cost and adjusted thereafter for the post-acquisition change in the Company's share of net assets
of the investee.
At each reporting date, and more frequently when conditions warrant, management assesses its investment in investee for potential
impairment. If management's assessment indicates that there is objective evidence of impairment, the investee is written down to
its recoverable amount, which is determined as the higher of its fair value less costs to sell and its value in use. Write-downs to
reflect other-than-temporary impairments in value are included in other-than-temporary impairment loss in the consolidated
statements of operations.
The most recently available financial statements of the investee are used in applying the equity method. The difference between
the end of the reporting period of the investee and that of the Company is no more than three months. Adjustments are made for
the effects of significant transactions or events that occur between the date of the investee's financial statements and the date of
the Company's consolidated financial statements.
(h)
Premiums and service fee receivables:
Premiums and service fee receivables include balances due and uncollected and installment premiums not yet due from agents
and insureds. Premiums receivable are reported net of an estimated allowance for doubtful accounts.
(i)
Reinsurance:
Reinsurance premiums, losses, and loss adjustment expenses are accounted for on a basis consistent with those used in accounting
for the original policies issued and the terms of the reinsurance contracts. Premiums and losses ceded to other companies have
been reported as a reduction of premium revenue and incurred loss and loss adjustment expenses. Commissions paid to the
Company by reinsurers on business ceded have been accounted for as a reduction of the related policy acquisition costs. Reinsurance
recoverable is recorded for that portion of paid and unpaid losses and loss adjustment expenses that are ceded to other companies.
Prepaid reinsurance premiums are recorded for unearned premiums that have been ceded to other companies.
(j)
Deferred acquisition costs, net:
The Company defers commissions, premium taxes and other underwriting and agency expenses that are directly related to successful
efforts to acquire new or existing insurance policies and vehicle service agreements to the extent they are considered recoverable.
Costs deferred on property and casualty insurance products are amortized over the period in which premiums are earned. Costs
deferred on vehicle service agreements are amortized as the related revenues are earned. The method followed in determining the
deferred acquisition costs limits the deferral to its realizable value by giving consideration to estimated future loss and loss
adjustment expenses to be incurred as revenues are earned. Changes in estimates, if any, are recorded in the accounting period in
which they are determined. Anticipated investment income is included in determining the realizable value of the deferred acquisition
costs. The Company's deferred acquisition costs are reported net of ceding commissions.
57
(k)
Property and equipment:
KINGSWAY FINANCIAL SERVICES INC.
Notes to Consolidated Financial Statements
Property and equipment are reported in the consolidated financial statements at cost. Depreciation of property and equipment has
been provided using the straight-line method over the estimated useful lives of such assets. Repairs and maintenance are recognized
in operations during the period incurred. Land is not depreciated. The Company estimates useful to be three to six years for
leasehold improvements; three to ten years for furniture and equipment; three to seven years for computer hardware; and two to
five years for automobiles.
(l)
Goodwill and intangible assets:
When the Company acquires a subsidiary or other business where it exerts significant influence, the fair value of the net tangible
and intangible assets acquired is determined and compared to the amount paid for the subsidiary or business acquired. Any excess
of the amount paid over the fair value of those net assets is considered to be goodwill.
Goodwill is tested for impairment annually as of December 31, or more frequently if events or circumstances indicate that the
carrying value may not be recoverable, to ensure that its fair value is greater than or equal to the carrying value. Any excess of
carrying value over fair value is charged to the consolidated statements of operations in the period in which the impairment is
determined.
When the Company acquires a subsidiary or other business where it exerts significant influence or acquires certain assets, intangible
assets may be acquired, which are recorded at their fair value at the time of the acquisition. An intangible asset with a definite
useful life is amortized in the consolidated statements of operations over its estimated useful life. The Company writes down the
value of an intangible asset with a definite useful life when the undiscounted cash flows are not expected to allow for full recovery
of the carrying value.
Intangible assets with indefinite useful lives are not subject to amortization and are tested for impairment annually as of December
31, or more frequently if events or circumstances indicate that the carrying value may not be recoverable, to ensure that fair values
are greater than or equal to carrying values. Any excess of carrying value over fair value is charged to the consolidated statements
of operations in the period in which the impairment is determined.
(m)
Unpaid loss and loss adjustment expenses:
Unpaid loss and loss adjustment expenses represent the estimated liabilities for reported loss events, incurred but not yet reported
loss events and the related estimated loss adjustment expenses, including investigation. Unpaid loss and loss adjustment expenses
are determined using case-basis evaluations and statistical analyses, including industry loss data, and represent estimates of the
ultimate cost of all claims incurred through the balance sheet date. Although considerable variability is inherent in such estimates,
management believes that the liability for unpaid loss and loss adjustment expenses is adequate. The estimates are continually
reviewed and adjusted as necessary, and such adjustments are included in current operations and accounted for as changes in
estimates.
(n)
Debt:
The Company's Linked Return of Capital ("LROC") preferred units, senior unsecured debentures and subordinated debt are
measured and reported at fair value. The fair value of the LROC preferred units is based on quoted market prices, and the fair
value of the subordinated debt is estimated using an internal model based on significant market observable inputs. The fair value
of the senior unsecured debentures, for which no active market exists, are derived from quoted market prices of similar instruments
or other third-party evidence. Changes in fair value are reported in the consolidated statements of operations as loss on change in
fair value of debt.
(o)
Contingent consideration:
The consideration for certain of the Company's acquisitions includes future payments to the former owners that are contingent
upon the achievement of certain targets over future reporting periods. Liabilities for contingent consideration are measured and
reported at fair value and are included in accrued expenses and other liabilities in the consolidated balance sheets. Changes in the
fair value of contingent consideration liabilities can result from changes to one or multiple inputs, including adjustments to the
discount rates or changes in the assumed achievement or timing of any targets. These fair value measurements are based on
significant inputs not observable in the market. Changes in assumptions could have an impact on the payout of contingent
consideration liabilities. Changes in fair value are reported in the consolidated statements of operations as contingent consideration
expense.
58
(p)
Income taxes:
KINGSWAY FINANCIAL SERVICES INC.
Notes to Consolidated Financial Statements
The Company and its non-U.S. subsidiaries file separate foreign income tax returns. Kingsway America II Inc. and its eligible
U.S. subsidiaries file a U.S. consolidated federal income tax return ("KAI Tax Group"). The method of allocating federal income
taxes among the companies in the KAI Tax Group is subject to written agreement, approved by each company's Board of Directors.
The allocation is made primarily on a separate return basis, with current credit for any net operating losses or other items utilized
in the consolidated federal income tax return. The Company's U.S. subsidiaries which are not included in the KAI Tax Group file
separate federal income tax returns.
The Company follows the asset and liability method of accounting for income taxes, whereby deferred income tax assets and
liabilities are recognized for (i) the differences between the financial statement carrying amount of existing assets and liabilities
and their respective tax bases and (ii) loss and tax credit carryforwards. Deferred income tax assets and liabilities are measured
using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be
recovered or settled. The effect on deferred tax assets and liabilities of a change in tax rates is recognized in income in the period
that includes the date of enactment. Future tax benefits are recognized to the extent that realization of such benefits is more likely
than not and a valuation allowance is established for any portion of a deferred tax asset that management believes will not be
realized. Current federal income taxes are charged or credited to operations based upon amounts estimated to be payable or
recoverable as a result of taxable operations for the current year. The Company reports a liability for unrecognized tax benefits
resulting from uncertain tax positions taken, or expected to be taken, in an income tax return. The Company recognizes interest
and penalties, if any, related to unrecognized tax benefits in income tax (benefit) expense.
(q)
Revenue recognition:
Premium revenue and unearned premiums
Premium revenue is recognized on a pro rata basis over the terms of the respective policy contracts. Unearned premiums represent
the portion of premiums written that are applicable to the unexpired terms of policies in force.
Service charges on installment premiums are recognized as income upon receipt of related installment payments and are reflected
in other income. Revenue from policy fees is deferred and recognized over the terms of the respective policy contracts, with
revenue reflected in other income.
The reinsurers' share of unearned premiums is recognized as amounts recoverable using principles consistent with the Company's
method for determining the unearned premium liability.
Service fee and commission income and deferred service fees
Service fee and commission income represents policy and claim service fees, vehicle service agreement fees and warranty product
and maintenance support fees based on terms of various agreements with insurance partners, state agencies, credit unions, consumers
and businesses.
Policy and claim service fees are earned over the period of the administration of the related policies and claims. This earning
pattern is based on actuarial data and historical experience.
Vehicle service agreement fees include the administrative fees from the sale of vehicle service agreements as well as the fees to
administer future claims. The administrative fee component is recognized in proportion to the costs incurred in acquiring and
administering the vehicle service agreements. The claims fee component is earned over the life of the vehicle service agreements
based on the greater of expected claims or actual claims experience.
Warranty product and maintenance support fees include the fees from the sale of warranty contracts for certain new and used
heating, ventilation, air conditioning ("HVAC") and refrigeration equipment as well as the fees collected to administer equipment
breakdown and maintenance support services. Warranty product and maintenance support fees are earned at the time the warranty
product sales and equipment breakdown and maintenance support transactions are completed or services are rendered.
The assumptions and methodologies used are continually reviewed and any adjustments are reflected in the consolidated statements
of operations in the period in which the adjustments are made.
(r)
Cost of services sold:
Cost of services sold is comprised of direct costs incurred to generate maintenance support fee revenue. Cost of services sold
includes payments to third-party contractors who service equipment breakdowns and perform maintenance support.
59
(s)
Stock-based compensation:
KINGSWAY FINANCIAL SERVICES INC.
Notes to Consolidated Financial Statements
The Company has a stock-based compensation plan for key officers of the Company and its subsidiaries. The Company uses the
fair-value method of accounting for stock-based compensation awards granted to employees for options granted on or after January
1, 2003. The Company determines the fair value of the stock options on their grant date using the Black-Scholes option pricing
model and records the fair value as a compensation expense over the period that the stock options vest, with a corresponding
increase to additional paid-in capital. When these stock options are exercised, the amount of proceeds together with the amount
recorded in additional paid-in capital is recorded in shareholders' equity.
No compensation expense is recognized for stock options granted prior to January 1, 2003. The consideration paid by employees
on exercise of these stock options is credited to additional paid-in capital.
(t)
Net loss per share:
Basic net loss per share is computed by dividing net loss by the weighted-average number of common shares outstanding during
the year. Diluted net loss per share is computed by giving effect to the potential dilution that could occur if stock options were
exercised and converted into common shares during the year. Shares issued under restricted stock awards are included in basic
shares upon issuance of the awards even though the vesting of shares will occur over time.
(u)
Fair value of financial instruments:
The fair values of the Company's investments in fixed maturities and equity investments, LROC preferred units, senior unsecured
debentures, subordinated debt and contingent consideration are estimated using a fair value hierarchy to categorize the inputs it
uses in valuation techniques. The fair value of the Company's investment in investee was based on quoted market prices. Fair
values for other investments approximate their unpaid principal balance. The carrying amounts reported in the consolidated balance
sheets approximate fair values for cash, short-term investments and certain other assets and other liabilities because of their short-
term nature.
NOTE 3 RECENTLY ISSUED ACCOUNTING STANDARDS
(a)
Adoption of New Accounting Standards:
In July 2012, the FASB issued ASU 2012-02, Intangibles-Goodwill and Other (Topic 350): Testing Indefinite-Lived Intangible
Assets for Impairment ("ASU 2012-02"). ASU 2012-02 provides entities with an option to first assess qualitative factors to
determine whether events or circumstances indicate that it is more likely than not that the indefinite-lived intangible asset is
impaired. If an entity concludes that it is more than 50% likely that an indefinite-lived intangible asset is not impaired, no further
analysis is required. However, if an entity concludes otherwise, it would be required to determine the fair value of the indefinite-
lived intangible asset to measure the amount of actual impairment, if any, as currently required under US GAAP. Effective January
1, 2013, the Company adopted ASU 2012-02 and the adoption did not have an impact on the consolidated financial statements.
There have been no triggering events that would suggest possible impairment or that it is more-likely-than-not that the fair values
of indefinite-lived intangible assets are less than their carrying amounts.
In February 2013, the FASB issued ASU 2013-02, Reporting of Amounts Reclassified Out of Accumulated Other Comprehensive
Income ("ASU 2013-02"), which is intended to improve the reporting of reclassifications out of accumulated other comprehensive
income. The ASU requires an entity to report, either on the face of the income statement or in the notes to the financial statements,
the effect of significant reclassifications out of accumulated other comprehensive income on the respective line items in the income
statement if the amount being reclassified is required to be reclassified in its entirety to net income. For other amounts that are
not required to be reclassified in their entirety to net income in the same reporting period, an entity is required to cross-reference
other required disclosures that provide additional detail about those amounts. Effective January 1, 2013, the Company adopted
ASU 2013-02. Except for the new disclosure requirements, the adoption of the standard did not have an impact on the consolidated
financial statements. The required disclosures are included in Note 22, "Accumulated Other Comprehensive Income."
(b)
Accounting Standard Not Yet Adopted:
In July 2013, the FASB issued ASU 2013-11, Presentation of an Unrecognized Tax Benefit When a Net Operating Loss
Carryforward, a Similar Tax Loss, or a Tax Credit Carryforward Exists ("ASU 2013-11"). ASU 2013-11 is effective for the first
interim or annual period beginning on or after December 15, 2013 with early adoption permitted. ASU 2013-11 amends ASC
Topic 740, Income Taxes, to provide guidance and reduce diversity in practice on the financial statement presentation of an
unrecognized tax benefit when a net operating loss carryforward, a similar tax loss, or a tax credit carryforward exists. Except
60
KINGSWAY FINANCIAL SERVICES INC.
Notes to Consolidated Financial Statements
for the changes, if any, in the Company's presentation, the initial application of the standard is not expected to have a material
impact on the consolidated financial statements.
NOTE 4 ACQUISITIONS
(a)
IWS Acquisition Corporation:
Effective November 16, 2012, the Company's subsidiary, IWS, acquired certain tangible and intangible assets and liabilities of
Intercontinental Warranty Services, Inc. for total consideration consisting of approximately $4.9 million in cash, future contingent
payments and common equity in a newly formed entity. The consolidated statements of operations include the earnings of IWS
from the date of acquisition. As further discussed in Note 23, "Segmented Information," IWS is included in the Insurance Services
segment. At the time that the Company entered into the transaction, the Company determined that the acquisition did not meet
the definition of a material transaction requiring disclosure on Form 8-K. No supplemental proforma revenue and earnings
information for the year ended December 31, 2012 related to the acquisition has been included in this Note 4, as the impact is
immaterial.
IWS is based in Florida and is a provider of after-market vehicle protection services distributed by credit unions throughout the
United States to their members. The acquisition allows the Company to benefit from the institutional knowledge of the credit
unions' vehicle loan programs and expand into the vehicle protection service business.
This acquisition was accounted for as a business combination using the purchase method of accounting. The purchase price was
allocated to the assets purchased and liabilities assumed based upon their estimated fair values at the date of acquisition. During
the fourth quarter of 2012, the Company began its fair value analysis on the assets acquired and liabilities assumed. In accordance
with U.S. GAAP, fair value accounting effects may be adjusted up to one year from the acquisition date upon finalization of the
valuation process. The Company completed its fair value analysis on the assets acquired and liabilities assumed during the second
quarter of 2013. The Company recorded adjustments related to the acquisition during 2013, which resulted in an increase to
goodwill of $1.1 million from the amount recorded at December 31, 2012.
After allocation of additional purchase price, goodwill of $9.0 million was recognized in addition to $12.4 million of separately
identifiable intangible assets. Of this amount, $8.7 million of separately identifiable intangible assets related to this acquisition
resulted from the valuations of acquired database, customer-related relationships, trade name and non-compete agreement. An
additional $3.7 million of separately identifiable intangible assets resulted from the valuation of vehicle service agreements in-
force ("VSA in-force"). Refer to Note 11, "Intangible Assets," for further disclosure on intangible assets related to this acquisition.
The fair value analysis performed included $3.9 million related to present value of future contingent payments. The maximum
the Company can pay in future contingent payments is $11.1 million, on an undiscounted basis. The contingent payments are
payable annually beginning in 2014 through 2019 and are subject to the achievement of certain targets and may be adjusted in
future periods based on actual performance achieved. As of December 31, 2013, the recorded value of the contingent earn-out
agreement is $4.6 million, which is included in accrued expenses and other liabilities on the consolidated balance sheets.
61
KINGSWAY FINANCIAL SERVICES INC.
Notes to Consolidated Financial Statements
The following table summarizes the estimated fair value of the assets acquired and liabilities assumed at the date of acquisition,
as adjusted.
(in thousands)
Cash and cash equivalents
Other tangible assets
Goodwill
Intangible asset - finite-lived
Intangible asset - indefinite-lived
Total assets
Unpaid loss and loss adjustment expenses
Deferred service fees
Accrued expenses and other liabilities
Noncontrolling interest in IWS
Total liabilities and noncontrolling interest
Purchase price
(b)
Trinity Warranty Solutions LLC:
November 16, 2012
19,799
8,281
8,974
11,758
663
49,475
3,665
35,761
4,729
380
44,535
4,940
$
$
$
$
Effective May 22, 2013, the Company's subsidiary, Trinity, acquired certain intangible assets and liabilities of Trinity Warranty
Corp. for total consideration consisting of approximately $1.1 million in cash and future contingent payments. The consolidated
statements of operations include the earnings of Trinity from the date of acquisition. As further discussed in Note 23, "Segmented
Information," Trinity is included in the Insurance Services segment. At the time that the Company entered into the transaction,
the Company determined that the acquisition did not meet the definition of a material transaction requiring disclosure on Form 8-
K. No supplemental proforma revenue and earnings information for the year ended December 31, 2013 related to the acquisition
has been included in this Note 4, as the impact is immaterial.
Trinity is based in Illinois and is a provider of warranty products and maintenance support to consumers and businesses in the
HVAC and refrigeration industry. The acquisition allows the Company to expand into and benefit from the institutional knowledge
of administering warranty products and providing maintenance support to the HVAC and refrigeration industry.
This acquisition was accounted for as a business combination using the purchase method of accounting. The purchase price was
allocated to the assets purchased and liabilities assumed based upon their estimated fair values at the date of acquisition. During
the fourth quarter of 2013, the Company completed its fair value analysis on the assets acquired and liabilities assumed. Goodwill
of $1.1 million was recognized in addition to $0.5 million of a separately identifiable intangible asset for customer-related
relationships. Refer to Note 11, "Intangible Assets," for further disclosure of the intangible asset related to this acquisition. The
fair value analysis performed includes $0.6 million related to present value of future contingent payments. The maximum the
Company can pay in future contingent payments is $2.4 million, on an undiscounted basis. The contingent payments are payable
annually beginning in 2014 through 2023 and are subject to the achievement of certain targets and may be adjusted in future periods
based on actual performance achieved. As of December 31, 2013, the recorded value of the contingent earn-out agreement is $0.7
million, which is included in accrued expenses and other liabilities on the consolidated balance sheets.
62
The following table summarizes the estimated fair value of the assets acquired and liabilities assumed at the date of acquisition.
KINGSWAY FINANCIAL SERVICES INC.
Notes to Consolidated Financial Statements
(in thousands)
Intangible asset - finite-lived
Goodwill
Total assets
Accrued expenses and other liabilities
Total liabilities
Purchase price
May 22, 2013
520
1,104
1,624
572
572
1,052
$
$
$
$
NOTE 5 LIQUIDATIONS, DISPOSITION AND REACQUISITION
(a)
Liquidations
During 2013, the Company's subsidiaries, Kingsway Reinsurance (Bermuda) Ltd. ("KRL") and Kingsway 2007 General Partnership
("2007 GP"), were liquidated. As a result of the liquidations of these subsidiaries, the Company realized a net after-tax gain of
$7.2 million for the year ended December 31, 2013. This gain represents the foreign exchange gain previously recorded in
accumulated other comprehensive income and now recognized in the statement of operations as a result of the liquidations of KRL
and 2007 GP. Summarized financial information for liquidation of subsidiaries is shown below:
(in thousands)
Liquidations:
Gain on liquidations before income taxes
Income tax benefit
Gain on liquidation of subsidiaries, net of taxes
(b)
Disposition
Year ended December 31,
2013
7,227
—
7,227
2012
—
—
—
On March 30, 2011, the Company's subsidiary, KAI, sold all of the issued and outstanding shares of its wholly owned subsidiary
Hamilton and its subsidiaries, including Amigo, to HRM Acquisition Corp., a wholly owned subsidiary of Acadia Acquisition
Partners, L.P. (“Acadia”), in exchange for a $10.0 million senior promissory note due March 30, 2014, a $5.0 million junior
promissory note due March 30, 2016, and a Class B partnership interest in Acadia representing a 40% economic interest. A
third-party and members of the Hamilton management team held Class A partnership interests in Acadia representing a 60%
economic interest. During the second quarter of 2011, HRM Acquisition Corp. merged into Hamilton. As a result of this
transaction, Hamilton had notes payable balances of $2.2 million maturing in March 2014 with the third-party and $0.2 million
maturing in June 2015 with members of the Hamilton management team. On August 14, 2012, Hamilton repaid the note payable
from the third-party with a carrying value of $2.2 million for $1.7 million, recording a gain of $0.5 million. On August 31,
2012, Hamilton repaid the notes payable from the members of the Hamilton management team with a carrying value of $0.2
million for $0.2 million, recording a gain of zero.
(c)
Reacquisition
On August 14, 2012 and August 31, 2012, respectively, Hamilton repurchased the Class A partnership interests held by the
third-party and members of the Hamilton management team, respectively. The Company recorded no gain or loss related to
the repurchase of the Class A partnership interests. During 2012, KAI contributed the $10.0 million promissory note due March
30, 2014 and the $5.0 million junior promissory note due March 30, 2016 to HRM, thereby extinguishing the notes. As a result
of these transactions, Acadia was dissolved, liquidated and wound down, with all assets being distributed to its sole member,
KAI, thereby resulting in Hamilton becoming a wholly owned subsidiary of KAI.
63
KINGSWAY FINANCIAL SERVICES INC.
Notes to Consolidated Financial Statements
NOTE 6 INVESTMENTS
The amortized cost, gross unrealized gains and losses, and estimated fair value of the Company's investments at December 31,
2013 and December 31, 2012 are summarized in the tables shown below:
Amortized
Cost
Gross
Unrealized
Gains
Gross
Unrealized
Losses
Estimated
Fair Value
December 31, 2013
(in thousands)
Fixed maturities:
U.S. government, government agencies and
authorities
Canadian government
States municipalities and political
subdivisions
Mortgage-backed
Asset-backed securities and collateralized
mortgage obligations
Corporate
Total fixed maturities
Equity investments
Total fixed maturities and equity investments
(in thousands)
Fixed maturities:
$
17,777
$
4,235
6,126
1,993
3,996
19,328
53,455
3,554
57,009
$
$
$
$
591
—
105
15
1
183
895
3,623
4,518
Amortized
Cost
Gross
Unrealized
Gains
U.S. government, government agencies and
authorities
$
23,954
$
Canadian government
States municipalities and political
subdivisions
Mortgage-backed
Asset-backed securities and collateralized
mortgage obligations
Corporate
Total fixed maturities
Equity investments
Total fixed maturities and equity investments
3,822
7,158
4,850
1,084
36,990
77,858
2,305
80,163
$
$
$
$
962
—
187
193
8
391
1,741
1,256
2,997
$
$
$
$
$
$
30
153
—
2
3
11
199
40
239
$
$
$
18,338
4,082
6,231
2,006
3,994
19,500
54,151
7,137
61,288
December 31, 2012
Gross
Unrealized
Losses
Estimated
Fair Value
1
40
—
—
—
24
65
13
78
$
24,915
3,782
7,345
5,043
1,092
37,357
79,534
3,548
83,082
$
$
Amortized cost, gross unrealized gains and estimated fair value for equity investments in the preceding table at December 31,
2013 include $0.4 million, $1.6 million and $2.0 million, respectively, for the Company's investment in the common stock of the
Company's former investee, Atlas. As discussed further in Note 7, "Investment in Investee," the Company's investment in the
common stock of Atlas was accounted for under the equity method of accounting and reported as investment in investee in the
consolidated balance sheets at December 31, 2012.
The table below summarizes the Company's fixed maturities at December 31, 2013 by contractual maturity periods. Actual results
may differ as issuers may have the right to call or prepay obligations, with or without penalties, prior to the contractual maturity
of these obligations.
64
KINGSWAY FINANCIAL SERVICES INC.
Notes to Consolidated Financial Statements
(in thousands)
Due in one year or less
Due after one year through five years
Due after five years through ten years
Due after ten years
Total
Amortized Cost
14,089
$
35,974
1,426
1,966
53,455
$
December 31, 2013
Estimated Fair
Value
14,134
36,532
1,507
1,978
54,151
$
$
The following tables highlight the aggregate unrealized loss position, by investment type, of fixed maturities and equity investments
in unrealized loss positions as of December 31, 2013 and 2012. The tables segregate the holdings based on the period of time the
investments have been continuously held in unrealized loss positions.
(in thousands)
December 31, 2013
Less than 12 Months
Greater than 12 Months
Total
Estimated
Fair Value
Unrealized
Loss
Estimated
Fair Value
Unrealized
Loss
Estimated
Fair Value
Unrealized
Loss
Fixed maturities:
U.S. government,
government agencies
and authorities
Canadian government
Mortgage-backed
Asset-backed securities
and collateralized
mortgage obligations
Corporate
Total fixed maturities
Equity investments
Total
(in thousands)
$
4,008
$
—
919
3,474
408
8,809
969
9,778
$
$
$
$
30
—
2
3
1
36
35
71
$
—
$
4,082
—
—
—
$
$
4,082
1
4,083
$
$
—
153
—
—
10
163
5
168
$
$
$
4,008
4,082
919
3,474
408
12,891
970
13,861
$
$
$
30
153
2
3
11
199
40
239
Less than 12 Months
Greater than 12 Months
Total
Estimated
Fair Value
Unrealized
Loss
Estimated
Fair Value
Unrealized
Loss
Estimated
Fair Value
Unrealized
Loss
December 31, 2012
Fixed maturities:
U.S. government,
government agencies
and authorities
Canadian government
Mortgage-backed
Corporate
$
4,612
$
3,782
—
4,169
Total fixed maturities
$
12,563
Equity investments
Total
8
$
12,571
$
$
—
—
267
—
267
38
305
$
$
$
—
—
—
10
10
12
22
$
4,612
$
3,782
267
4,169
$
12,830
46
$
12,876
$
$
1
40
—
24
65
13
78
1
40
—
14
55
1
56
$
$
$
65
KINGSWAY FINANCIAL SERVICES INC.
Notes to Consolidated Financial Statements
Fixed maturities and equity investments contain approximately 27 and 19 individual investments that were in unrealized loss
positions as of December 31, 2013 and 2012, respectively.
The establishment of an other-than-temporary impairment on an investment requires a number of judgments and estimates. The
Company performs a quarterly analysis of the individual investments to determine if declines in market value are other-than-
temporary. The analysis includes some or all of the following procedures as deemed appropriate by the Company:
•
•
•
•
•
•
•
•
identifying all unrealized loss positions that have existed for at least six months;
identifying other circumstances which management believes may impact the recoverability of the unrealized loss positions;
obtaining a valuation analysis from third-party investment managers regarding the intrinsic value of these investments
based on their knowledge and experience together with market-based valuation techniques;
reviewing the trading range of certain investments over the preceding calendar period;
assessing if declines in market value are other-than-temporary for debt instruments based on the investment grade credit
ratings from third-party rating agencies;
assessing if declines in market value are other-than-temporary for any debt instrument with a non-investment grade credit
rating based on the continuity of its debt service record;
determining the necessary provision for declines in market value that are considered other-than-temporary based on the
analyses performed; and
assessing the company's ability and intent to hold these investments at least until the investment impairment is recovered.
The risks and uncertainties inherent in the assessment methodology used to determine declines in market value that are other-than-
temporary include, but may not be limited to, the following:
•
•
•
•
the opinions of professional investment managers could be incorrect;
the past trading patterns of individual investments may not reflect future valuation trends;
the credit ratings assigned by independent credit rating agencies may be incorrect due to unforeseen or unknown facts
related to a company's financial situation; and
the debt service pattern of non-investment grade instruments may not reflect future debt service capabilities and may not
reflect a company's unknown underlying financial problems.
As a result of the above analysis performed by the Company to determine declines in market value that are other-than-temporary,
the Company recorded write-downs for other-than-temporary impairment related to other investments of zero and $0.5 million
for the years ended December 31, 2013 and 2012, respectively.
On July 8, 2013, the Company announced that it had entered into a non-binding letter of intent with Atlas to sell its holdings of
Atlas preferred stock for 90.0% of liquidation value, or $16.2 million. On August 1, 2013, the Company announced that the
transaction had closed. As a result, the Company recorded a write-down for other-than-temporary impairment related to its
investment in Atlas preferred stock of $1.8 million for the year ended December 31, 2013. There were no write-downs related to
equity investments for other-than-temporary impairment for the year ended December 31, 2012.
There were no write-downs related to fixed maturities for other-than-temporary impairments for the years ended December 31,
2013 and 2012. There were no other-than-temporary losses recognized in other comprehensive (loss) income for the years ended
December 31, 2013 and 2012.
During 2012, the Company recorded a write-down for other-than-temporary impairment related to its investment in investee. Refer
to Note 7, "Investment in Investee," for further discussion.
The Company has reviewed currently available information regarding investments with estimated fair values that are less than
their carrying amounts and believes that these unrealized losses are not other-than-temporary and are primarily due to temporary
market and sector-related factors rather than to issuer-specific factors. The Company does not intend to sell those investments,
and it is not likely that it will be required to sell those investments before recovery of its amortized cost.
The Company does not have any exposure to subprime mortgage-backed investments.
Limited liability investments include investments in limited liability companies and a limited partnership that primarily invest in
income-producing real estate. The Company's interests in these investments are not deemed minor and, therefore, are accounted
for under the equity method of accounting. As of December 31, 2013 and December 31, 2012, the carrying value of limited liability
investments totaled $4.4 million and $2.3 million, respectively. At December 31, 2013, the Company has unfunded commitments
totaling $1.8 million to fund limited liability investments.
66
KINGSWAY FINANCIAL SERVICES INC.
Notes to Consolidated Financial Statements
Other investments include collateral loans and are reported at their unpaid principal balance. As of December 31, 2013 and
December 31, 2012, the carrying value of other investments totaled $3.0 million and $2.0 million, respectively.
Gross realized gains and losses on fixed maturities, equity investments and limited liability investments for the years ended
December 31, 2013 and 2012 were as follows:
(in thousands)
Gross realized gains
Gross realized losses
Total
$
$
Years ended December 31,
2012
1,654
(74)
1,580
2013
5,258
(36)
5,222
$
$
Gross realized losses for the years ended December 31, 2013 and 2012 reported in the preceding table exclude the realized loss
on sales of Atlas common stock recorded during the first quarter of 2013 and fourth quarter of 2012, respectively. Refer to Note
7, "Investment in Investee," for further discussion. During the fourth quarter of 2013, the Company received net proceeds of $13.2
million, and recognized a gain of $4.3 million, related to the sale of 1,129,608 shares of Atlas common stock.
Net investment income for the years ended December 31, 2013 and 2012, respectively, is comprised as follows:
(in thousands)
Investment income
Interest from fixed maturities
Dividends
Income (loss) from limited liability investments
Other
Gross investment income
Investment expenses
Net investment income
NOTE 7 INVESTMENT IN INVESTEE
Years ended December 31,
2012
2013
$
$
$
1,249
621
118
620
2,608
(213)
2,395
$
$
$
2,262
991
(68)
427
3,612
(447)
3,165
At December 31, 2012, investment in investee included the Company's investment in the preferred and restricted voting common
stock of Atlas. On February 12, 2013, the Company executed an underwriting agreement to sell 2,625,000 shares of Atlas common
stock. The shares were being offered as part of Atlas' United States initial public offering at a price per share of $5.85. During
the first quarter of 2013, the Company received net proceeds of $13.6 million and recognized a loss of $1.7 million, which is
included in net realized gains on the consolidated statements of operations, resulting from commissions and other expenses incurred
as part of the sale. As a result of this sale, the Company's approximate voting percentage in Atlas was reduced to 16.5%. As a
result of this change in ownership and other qualitative factors, the Company determined that its investment in the common stock
of Atlas no longer qualified for the equity method of accounting. Accordingly, the Company's investment in Atlas common stock
is included in equity investments and reported at its fair value of $2.0 million in the consolidated balance sheets at December 31,
2013. The Company's share of its investee's equity adjustments for other comprehensive income of $0.7 million was offset against
the carrying value of the Company's investment in Atlas common stock during the second quarter of 2013. Prior to discontinuing
the use of the equity method of accounting for Atlas, the Company used a reporting lag of three months to report its proportionate
share of Atlas' results.
67
KINGSWAY FINANCIAL SERVICES INC.
Notes to Consolidated Financial Statements
The carrying value, estimated fair value and approximate voting and equity percentages for the Company's investment in the
common stock of Atlas, which was accounted for under the equity method of accounting and reported as investment in investee
in the Company's consolidated balance sheets at December 31, 2012, were as follows:
(in thousands, except for percentages)
December 31, 2012
Voting percentage
Equity percentage
Estimated Fair
Value
Carrying value
Atlas
30.0%
63.3% $
38,758
$
41,733
The fair value of the Company's investment in Atlas at December 31, 2012 in the table above is calculated based on the published
closing price of Atlas at September 30, 2012 to be consistent with the three-month lag in reporting its carrying value under the
equity method.
Equity in net income (loss) of investee was income of $0.3 million and loss of $1.0 million for the years ended December 31, 2013
and 2012, respectively. The Company also recognized an increase to shareholders' equity attributable to common shareholders of
$0.6 million and $0.9 million for the years ended December 31, 2013 and 2012, respectively, for the Company's pro rata share of
its investee's accumulated other comprehensive income.
During 2012, the Company performed an impairment review of its investment in Atlas which considered the current valuation and
operating results of Atlas. Based upon this review, the Company recorded a write-down for other-than-temporary impairment
related to investment in investee of $2.2 million for the year ended December 31, 2012.
During the fourth quarter of 2012, the Company sold 2,142,454 shares of Atlas common stock. The Company received proceeds
of $4.0 million and realized losses of $0.5 million from the sales.
NOTE 8 REINSURANCE
As is customary in the insurance industry, the Company reinsures portions of certain insurance policies it writes, thereby providing
a greater diversification of risk and minimizing exposure on larger risks. The Company remains contingently at risk with respect
to any reinsurance ceded and would incur an additional loss if an assuming company were unable to meet its obligation under the
reinsurance treaty.
The Company monitors the financial condition of its reinsurers to minimize its exposure to significant losses from reinsurer
insolvencies. Letters of credit are maintained for any unauthorized reinsurer to cover ceded unearned premium and ceded unpaid
loss and loss adjustment expenses balances.
For most of the non-standard automobile business, the liability is limited to the minimum statutory liability limits, which are
typically not greater than $50,000 per occurrence, depending on the state. The Company's reinsurance includes excess of loss
reinsurance to reduce its exposure to individual losses as well as losses related to catastrophic events which may simultaneously
affect many of our policyholders. During 2012, the Company also purchased excess of loss reinsurance to protect against awards
in excess of our policy limits. During 2013 and 2012, the Company purchased quota-share reinsurance to increase its capacity to
underwrite additional insurance risks.
68
KINGSWAY FINANCIAL SERVICES INC.
Notes to Consolidated Financial Statements
Ceded premiums, loss and loss adjustments expenses, and commissions as of and for the years ended December 31, 2013 and
2012 are summarized as follows:
(in thousands)
Ceded premiums written
Ceded premiums earned
Ceded loss and loss adjustment expenses
Ceded unpaid loss and loss adjustment expenses
Ceded unearned premiums
Ceding commissions
$
$
Years ended December 31,
2012
30,630
25,337
10,923
5,478
7,316
8,621
2013
31,031
33,015
16,275
7,942
5,333
6,350
The maximum amount of return commission, which would have been due to reinsurers if they or the Company had canceled all
of the Company's reinsurance, with the return of the unearned premium, is as follows at December 31, 2013:
Assumed
Ceded
Net
Unearned Premium Reserve
5,680
5,333
347
$
$
$
$
December 31, 2013
Commission Equity
1,226
1,338
(112)
The amounts of assumed premiums written were $19.6 million and $15.5 million for the years ended December 31, 2013 and
2012, respectively. The amounts of assumed premiums earned were $19.4 million and $13.4 million for the years ended
December 31, 2013 and 2012, respectively.
NOTE 9 DEFERRED ACQUISITION COSTS
Policy acquisition costs consist primarily of commissions, premium taxes, and underwriting and agency expenses incurred related
to successful efforts to acquire new or renewal insurance contracts, net of ceding commission income, and vehicle service
agreements. Acquisition costs deferred on both property and casualty insurance products and vehicle service agreements are
amortized over the period in which the related revenues are earned.
The components of deferred acquisition costs and the related amortization expense for the years ended December 31, 2013 and
2012, respectively, is comprised as follows:
(in thousands)
Balance at January 1, net
Acquisition costs acquired during the year related to purchase of IWS
Additions
Amortization
Balance at December 31, net
NOTE 10 GOODWILL
Years ended December 31,
2012
2013
14,102
$
—
29,541
(31,251)
12,392
$
8,116
5,083
23,346
(22,443)
14,102
$
$
Goodwill was $10.6 million and $8.4 million at December 31, 2013 and 2012. The Company's goodwill at December 31, 2013
and 2012 is attributable to the Insurance Services reportable segment.
As further discussed in Note 4, "Acquisitions," the Company recorded goodwill of $1.1 million related to the acquisition of certain
intangible assets and liabilities of Trinity Warranty Corp. on May 22, 2013. Also, during the year ended December 31, 2013, the
Company continued its evaluation of certain tangible and intangible assets and liabilities of Intercontinental Warranty Services,
69
KINGSWAY FINANCIAL SERVICES INC.
Notes to Consolidated Financial Statements
Inc. that were acquired on November 16, 2012, which resulted in an increase to goodwill of $1.1 million from the amount recorded
at December 31, 2012.
Goodwill is assessed for impairment annually as of December 31, or more frequently if events or circumstances indicate that the
carrying value may not be recoverable, by applying a fair value-based test. Any potential impairment is identified by comparing
the fair value of a reporting unit to its carrying value. If the fair value of the reporting segment exceeds its carrying value, goodwill
is considered not to be impaired. If the carrying value of the reporting segment exceeds its fair value, a more detailed goodwill
impairment assessment must be undertaken. A goodwill impairment charge is recognized to the extent that, at the reporting unit
level, the carrying value of goodwill exceeds the implied fair value.
The Company tested goodwill for recoverability at December 31, 2013 and 2012. Based on the assessment performed, the Company
concluded that goodwill was recoverable at December 31, 2013 and 2012.
NOTE 11 INTANGIBLE ASSETS
Intangible assets are comprised as follows:
(in thousands)
December 31, 2013
Intangible assets subject to amortization
Database
VSA in-force
Customer-related relationships
Non-compete agreement
Intangible assets not subject to amortization
Renewal rights
Insurance licenses
Trade name
Total
(in thousands)
Intangible assets subject to amortization
Database
VSA in-force
Customer-related relationships
Non-compete agreement
Intangible assets not subject to amortization
Renewal rights
Insurance licenses
Trade name
Total
Gross Carrying
Value
Accumulated
Amortization
Net Carrying
Value
$
$
$
$
4,918
3,680
3,611
70
46,756
7,803
663
67,501
Gross Carrying
Value
4,918
3,680
3,090
70
46,756
7,803
663
66,980
$
$
$
$
554
2,220
344
27
15,438
—
—
18,583
$
$
4,364
1,460
3,267
43
31,318
7,803
663
48,918
December 31, 2012
Accumulated
Amortization
Net Carrying
Value
11
910
34
4
15,438
—
—
16,397
$
$
4,907
2,770
3,056
66
31,318
7,803
663
50,583
The Company's intangible assets with definite useful lives are amortized over their estimated useful lives. Amortization of intangible
assets was $2.2 million and $1.0 million for the years ended December 31, 2013 and 2012, respectively. The estimated aggregate
future amortization expense of all intangible assets is $1.6 million for 2014, $1.2 million for 2015, $1.2 million for 2016, $1.0
million for 2017 and $1.0 million for 2018.
During 2013, the Company recorded $0.5 million of a separately identifiable intangible asset for acquired customer-related
relationships as part of the acquisition of intangible assets and liabilities of Trinity Warranty Corp. Refer to Note 4, "Acquisitions,"
for further discussion related to the acquisition. The customer-related relationships intangible asset is being amortized over ten
years based on the pattern in which the economic benefits of the intangible asset are expected to be consumed.
70
KINGSWAY FINANCIAL SERVICES INC.
Notes to Consolidated Financial Statements
As further discussed in Note 4, "Acquisitions," during 2012, the Company recorded $12.4 million of separately identifiable
intangible assets, related to acquired VSA in-force, database, customer-related relationships, trade name and non-compete
agreement, as part of the acquisition of certain tangible and intangible assets and liabilities of Intercontinental Warranty Services,
Inc. The VSA in-force asset is amortized over a seven-year term as the corresponding deferred service fees acquired are earned
as revenue. The database and non-compete agreement assets are being amortized on a straight-line basis over ten years and three
years, respectively. The customer-related relationships intangible asset is being amortized over 15 years based on the pattern in
which the economic benefits of the intangible asset are expected to be consumed.
The insurance licenses, renewal rights and trade name intangible assets have indefinite useful lives and are not amortized. The
renewal rights intangible assets, recognized related to the acquisitions of Northeast Alliance Insurance Agency, LLC ("NEA") and
ARS, were originally being amortized on a straight-line basis over 10 to 15 years. As a result of the acquisition of ARS during
2010, the Company determined that it was necessary to re-examine the useful lives assigned to the renewal rights intangible assets
due to the fact that NEA and ARS service the assigned risk business in the states of New York and New Jersey and operate in the
New York voluntary markets where there is limited competition for the renewal rights. As a result of the review performed, the
Company determined that there were no legal, regulatory, contractual, competitive, economic, or other factors limiting the useful
life of the renewal rights intangible assets; therefore, effective January 1, 2011, the renewal rights intangible assets were deemed
to have indefinite useful lives and are no longer being amortized. The renewal rights had accumulated amortization of $15.4
million at December 31, 2010.
All intangible assets with indefinite useful lives are reviewed annually by the Company for impairment. No impairment charges
were taken on intangible assets in 2013 or 2012.
NOTE 12 PROPERTY AND EQUIPMENT
Property and equipment are comprised as follows:
(in thousands)
Leasehold improvements
Furniture and equipment
Computer hardware
Automobiles
Total
(in thousands)
Leasehold improvements
Furniture and equipment
Computer hardware
Automobiles
Total
Cost
482
4,051
12,947
30
17,510
Cost
2,476
4,552
18,482
86
25,596
$
$
Accumulated
Depreciation
266
3,412
12,140
30
15,848
$
Accumulated
Depreciation
2,114
3,713
16,976
84
December 31, 2013
Carrying
Value
216
639
807
—
1,662
$
December 31, 2012
Carrying
Value
362
839
1,506
2
2,709
$
22,887
$
NOTE 13 ASSET HELD FOR SALE
As of December 31, 2013, property consisting of building and land located in Miami, Florida with a carrying value of $6.3 million
was classified as held for sale. For the year ended December 31, 2013, the Company recorded a write-down of $2.4 million related
to the asset held for sale. At December 31, 2013, the carrying value of the property is equal to its fair value net of estimated selling
costs.
NOTE 14 UNPAID LOSS AND LOSS ADJUSTMENT EXPENSES
The establishment of the provision for unpaid loss and loss adjustment expenses is based on known facts and interpretation of
circumstances and is therefore a complex and dynamic process influenced by a variety of factors. These factors include the
71
KINGSWAY FINANCIAL SERVICES INC.
Notes to Consolidated Financial Statements
Company's experience with similar cases and historical trends involving loss payment patterns, pending levels of unpaid loss and
loss adjustment expenses, product mix or concentration, loss severity and loss frequency patterns.
Other factors include the continually evolving and changing regulatory and legal environment; actuarial studies; professional
experience and expertise of the Company's claims departments' personnel and independent adjusters retained to handle individual
claims; the quality of the data used for projection purposes; existing claims management practices including claims-handling and
settlement practices; the effect of inflationary trends on future loss settlement costs; court decisions; economic conditions; and
public attitudes.
Consequently, the process of determining the provision necessarily involves risks that the actual results will deviate, perhaps
materially, from the best estimates made.
The Company's evaluation of the adequacy of unpaid loss and loss adjustment expenses includes a re-estimation of the liability
for unpaid loss and loss adjustment expenses relating to each preceding financial year compared to the liability that was previously
established.
(a)
Property and Casualty
The results of the comparison and the changes in the provision for property and casualty unpaid loss and loss adjustment expenses,
net of amounts recoverable from reinsurers, as of December 31, 2013 and December 31, 2012 were as follows:
(in thousands)
December 31,
Balance at beginning of period, gross
Less reinsurance recoverable related to property and casualty unpaid
loss and loss adjustment expenses
Balance at beginning of period, net
Incurred related to:
Current year
Prior years
Paid related to:
Current year
Prior years
Balance at end of period, net
Plus reinsurance recoverable related to property and casualty unpaid
loss and loss adjustment expenses
Balance at end of period, gross
$
2013
$
103,116
$
5,478
97,638
81,906
(1,180)
(48,346)
(53,426)
76,592
7,942
84,534
$
2012
120,258
298
119,960
85,565
13,829
(51,670)
(70,046)
97,638
5,478
103,116
The Company reported favorable development on property and casualty unpaid loss and loss adjustment expenses of $1.2 million
in 2013 compared to an unfavorable development of $13.8 million in 2012. The favorable development in 2013 was primarily
related to a decrease in property and casualty unpaid loss and loss adjustment expenses at UCC. In 2012, non-standard automobile
business contributed $10.3 million and business other than non-standard automobile contributed $3.5 million of the prior years'
adverse development. The majority of the unfavorable development in 2012 was attributable to an increase in unpaid loss and
loss adjustment expenses of $11.4 million at Amigo and Mendota as part of the Company's September 17, 2012 announcement
that it was restructuring its Insurance Underwriting and Insurance Services segments. The remaining adverse development in 2012
was generally the result of ongoing analysis of recent loss development trends. Original estimates are increased or decreased as
additional information becomes known regarding individual claims.
72
Current year
Prior years
Paid related to:
Current year
Prior years
Balance at end of period
NOTE 15 DEBT
Debt consists of the following instruments:
(in thousands)
7.5% Senior notes due 2014
LROC preferred units due 2015
Subordinated debt
Total
(b)
Vehicle Service Agreements
KINGSWAY FINANCIAL SERVICES INC.
Notes to Consolidated Financial Statements
The results of the comparison and the changes in the provision for vehicle service agreement unpaid loss and loss adjustment
expenses as of December 31, 2013 and December 31, 2012 were as follows:
(in thousands)
December 31,
Balance at beginning of period
Vehicle service agreement unpaid loss and loss adjustment expenses
acquired
Incurred related to:
$
$
2013
3,448
—
6,827
—
(7,066)
(81)
3,128
$
$
2012
—
3,665
790
—
(1,007)
—
3,448
2013
Principal
14,356
14,854
90,500
119,710
Fair Value
14,356
14,854
28,471
57,681
$
$
December 31,
2012
Principal
26,966
15,879
90,500
133,345
Fair Value
23,730
13,655
23,774
61,159
$
$
Subordinated debt mentioned above consists of the following trust preferred debt instruments:
Issuer
Principal
Issue date
Kingsway CT Statutory Trust I
15,000
12/4/2002
Kingsway CT Statutory Trust II
17,500
5/15/2003
Kingsway CT Statutory Trust III
20,000
10/29/2003
Kingsway DE Statutory Trust III
15,000
5/23/2003
Kingsway DE Statutory Trust IV
10,000
9/30/2003
Kingsway DE Statutory Trust VI
13,000
1/8/2004
Interest
annual interest rate equal to LIBOR,
plus 4.00% payable quarterly
annual interest rate equal to LIBOR,
plus 4.10% payable quarterly
annual interest rate equal to LIBOR,
plus 3.95% payable quarterly
annual interest rate equal to LIBOR,
plus 4.20% payable quarterly
annual interest rate equal to LIBOR,
plus 3.85% payable quarterly
annual interest rate equal to LIBOR,
plus 4.00% payable quarterly
Redemption date
12/4/2032
5/15/2033
10/29/2033
5/23/2033
9/30/2033
1/8/2034
(a) Senior unsecured debentures:
On January 29, 2004, KAI completed the sale of $100.0 million 7.50% senior notes due 2014. The notes are fully and unconditionally
guaranteed by the Company. In March 2004, an additional $25.0 million of these senior notes were issued. The notes are
redeemable at KAI's option in whole at any time or in part from time to time on or after February 1, 2009, subject to the conditions
stated in the trust indenture. Interest paid during the years ended December 31, 2013 and 2012 was $2.2 million and $2.0 million,
respectively.
73
KINGSWAY FINANCIAL SERVICES INC.
Notes to Consolidated Financial Statements
During 2013, the Company purchased for $0.6 million, including accrued interest, $0.6 million of par value of its senior unsecured
debentures due February 1, 2014 with a carrying value of $0.6 million, including accrued interest, recording a loss of $0.0 million.
The Company subsequently canceled the acquired debentures. During 2012, the Company did not buy-back any of its senior
unsecured debentures due February 1, 2014. During the fourth quarter of 2013, the Company completed a partial, early redemption
of its senior unsecured debentures due February 1, 2014. The partial early redemption was completed in the amount of $12.0
million at par plus accrued interest of $0.2 million. At December 31, 2013 and 2012, $14.4 million and $27.0 million, respectively,
of par value of this issue remains outstanding. In February 2014, the Company repaid the $14.4 million remaining amount
outstanding on its senior unsecured debentures due February 1, 2014.
On July 10, 2007, a general partnership of the Company, Kingsway 2007 General Partnership, issued C$100.0 million Senior
Unsecured Debentures at 6% due on July 11, 2012. These debentures bore interest at a fixed rate of 6% per annum payable semi-
annually from the date of issuance until July 11, 2012. Interest payments were made on January 10 and July 10 of each year,
commencing January 10, 2008. The net proceeds to the Company amounted to C$99.2 million. The debentures were unconditionally
guaranteed by the Company and KAI. On July 11, 2012, Kingsway 2007 General Partnership redeemed the remaining outstanding
principal balance of C$1.7 million.
The trust indenture for the 7.50% senior notes due 2014 contains negative covenants placing limitations and restrictions over
certain actions without the prior written consent of the indenture trustee. Included in the negative covenants is the limitation on
the incurrence of additional debt in the event that the total debt-to-total capital ratio or the senior debt-to-total capital ratio exceeds
50% or 30%, respectively. The total debt is calculated on a pro-forma basis taking into account the issuance of additional debt.
The indenture also includes covenants limiting the issuance and sale of voting stock of restricted subsidiaries, the payment of
dividends or any other payment in respect of capital stock of the Company, or the retirement of debt subordinate to these notes if,
after giving effect to such payments as described in the trust indenture, the total debt-to-total capital ratio exceeds 50%. As of
December 31, 2013, the Company's total debt-to-capital and senior debt-to-capital ratios were 65.8% and 27.5%, respectively.
Following the Company's redemption of its remaining senior unsecured debentures due February 1, 2014, these negative covenants
no longer apply.
(b) LROC preferred units:
On July 14, 2005, KLROC Trust completed its public offering of C$78.0 million of 5.00% LROC preferred units due June 30,
2015 of which the Company was a promoter. KLROC Trust's net proceeds of the public offering was C$74.1 million.
Beginning in 2009, KFS Capital began purchasing LROC preferred units. On June 9, 2010, KFS Capital commenced the take-
over bid (“the KLROC Offer”) to acquire up to 750,000 LROC preferred units at a price per unit of C$17.50 in cash. On July 9,
2010, KFS Capital increased the size and price of its previously announced KLROC Offer to 1,500,000 units at a price per unit
of C$20.00 in cash. The KLROC Offer expired on July 23, 2010, and 1,525,150 units were tendered, of which 1,500,000 were
purchased on a pro-rata basis. The tender was paid for using available cash.
As a result of these acquisitions, the Company beneficially owns and controls 2,333,715 units, representing 74.8% of the issued
and outstanding LROC preferred units. At December 31, 2013 and 2012, the Company's outstanding obligation is C$15.8 million.
(c) Subordinated debt:
Between December 4, 2002 and December 16, 2003, six subsidiary trusts of the Company issued $90.5 million of 30-year capital
securities to third-parties in separate private transactions. In each instance, a corresponding floating rate junior subordinated
deferrable interest debenture was then issued by KAI to the trust in exchange for the proceeds from the private sale. The floating
rate debentures bear interest at the rate of the London interbank offered interest rate for three-month U.S. dollar deposits ("LIBOR"),
plus spreads ranging from 3.85% to 4.20%, but until dates ranging from December 4, 2007 to January 8, 2009, the interest rates
will not exceed 12.45% to 12.75%. The Company has the right to call each of these securities at par value anytime after five years
from their issuance until their maturity.
During the first quarter of 2011, the Company gave notice to its trustees of its intention to exercise its voluntary right to defer
interest payments for up to 20 quarters, pursuant to the contractual terms of its outstanding indentures, which permit interest
deferral. This action does not constitute a default under the Company's indentures or any of its other debt indentures. At
December 31, 2013, deferred interest payable of $12.8 million is included in accounts payable and accrued liabilities in the
consolidated balance sheets.
74
KINGSWAY FINANCIAL SERVICES INC.
Notes to Consolidated Financial Statements
NOTE 16 INCOME TAXES
Income tax (benefit) expense consists of the following:
(in thousands)
Current income tax (benefit) expense
Deferred income tax expense
Income tax (benefit) expense
Years ended December 31,
2012
2013
$
$
(502)
435
(67)
$
$
1,932
1,085
3,017
Income tax (benefit) expense varies from the amount that would result by applying the applicable United States corporate income
tax rate of 34% to loss from continuing operations before income tax (benefit) expense. The following table summarizes the
differences:
(in thousands)
Income tax benefit at United States statutory income tax rate
Valuation allowance
Non-taxable dividend income
Indefinite life intangibles
Prior year tax
Foreign operations subject to different tax rates
Change in unrecognized tax benefits
Other
Income tax (benefit) expense for continuing operations
$
$
$
Years ended December 31,
2012
(17,088)
20,316
(1,716)
401
(1,347)
(526)
3,026
(49)
3,017
2013
(14,748)
15,884
(2,182)
1,119
(708)
272
175
121
(67)
$
The tax effects of temporary differences that give rise to significant portions of the deferred income tax assets and liabilities are
presented as follows:
(in thousands)
Deferred income tax assets:
Losses carried forward
Unpaid loss and loss adjustment expenses and unearned premiums
Foreign exchange adjustment on note payable
Deferred revenue
Intangible assets
Depreciable assets
Debt issuance costs
Other
Valuation allowance
Deferred income tax assets
Deferred income tax liabilities:
Fair value of debt
Investments
Deferred acquisition costs
Indefinite life intangibles
Other
Deferred income tax liabilities
Net deferred income tax liabilities
75
2013
298,358
6,507
3,421
2,274
1,767
1,194
1,052
2,316
(284,276)
32,613
(21,090)
(7,305)
(4,213)
(4,173)
(5)
(36,786)
(4,173)
$
$
$
$
December 31,
2012
282,780
6,599
5,057
2,438
1,462
987
1,408
2,403
(265,553)
37,581
(24,603)
(8,129)
(4,268)
(3,054)
(581)
(40,635)
(3,054)
$
$
$
$
KINGSWAY FINANCIAL SERVICES INC.
Notes to Consolidated Financial Statements
The Company maintains a valuation allowance for its gross deferred income tax assets of $284.3 million (U.S. operations - $279.0
million; Other - $5.3 million) and $265.6 million (U.S. operations - $262.4 million; Other - $3.2 million) at December 31, 2013
and December 31, 2012, respectively. The Company's businesses have generated substantial operating losses during the last several
years. These losses can be available to reduce income taxes that might otherwise be incurred on future taxable income. The
Company's operations, however, remain challenged, and, as a result, it is uncertain whether the Company will generate the taxable
income necessary to utilize these losses or other reversing temporary differences. This uncertainty has caused management to
place a full valuation allowance on its December 31, 2013 and December 31, 2012 net deferred income tax assets. The Company
carries a deferred income tax liability of $4.2 million and $3.1 million at December 31, 2013 and December 31, 2012, respectively,
all of which relates to intangible assets with indefinite useful lives.
Amounts, originating dates and expiration dates of the U.S. operating loss carryforwards are as follows:
Year of net operating loss
2000
2001
2006
2007
2008
2009
2010
2011
2012
2013
Expiration date
2020
2021
2026
2027
2028
2029
2030
2031
2032
2033
$
Net operating loss
479
186
24,077
62,308
55,917
515,335
92,095
45,311
34,552
30,738
The U.S. operating loss carryforward amounts disclosed above contain consolidated and separate company operating loss
carryforwards, the most significant of which is the KAI Tax Group operating loss carryforward of approximately $854.4 million.
In addition, there are operating loss carryforwards relating to the operations in Barbados in the amount of $83.0 million, which
losses will expire by 2018, and operating loss carry forwards relating to operations in Canada in the amount of $14.5 million,
which losses will expire by 2033.
A reconciliation of the beginning and ending unrecognized tax benefits is as follows:
(in thousands)
Unrecognized tax benefits - beginning of year
Gross additions - current year tax positions
Gross additions - prior year tax positions
Gross reductions - prior year tax positions
Gross reductions - settlements with taxing authorities
Impact due to expiration of statute of limitations
Unrecognized tax benefits - end of year
$
$
2013
3,026
—
175
—
—
—
3,201
December 31,
2012
—
691
2,335
—
—
—
3,026
$
$
The amount of unrecognized tax benefits that, if recognized as of December 31, 2013, would affect the Company's effective tax
rate was $0.2 million.
The Company classifies interest and penalty accruals related to unrecognized tax benefits as income tax (benefit) expense. During
the years ended December 31, 2013 and 2012, the Company recognized $0.2 million and $1.2 million, respectively, in interest
and penalty expense. At December 31, 2013 and December 31, 2012, the Company had an accrual of $1.4 million and $1.2 million,
respectively, for the payment of interest and penalties.
The federal income tax returns of the Company's U.S. operations for the years through 2009 are closed for Internal Revenue Service
("IRS") examination. The Company's U.S. operations federal income tax returns are not currently under examination by the IRS
for any open tax years. The federal income tax returns of the Company's Canadian operations for the years through 2008 are closed
76
KINGSWAY FINANCIAL SERVICES INC.
Notes to Consolidated Financial Statements
for Canada Revenue Agency ("CRA") examination. The Company's Canadian operations federal income tax returns are not
currently under examination by the CRA for any open tax years.
NOTE 17 NET LOSS PER SHARE
The following table sets forth the reconciliation of numerators and denominators for the basic and diluted loss per share computation
for the years ended December 31, 2013 and 2012:
(in thousands)
Numerator:
Loss from continuing operations
Denominator:
Weighted average basic shares
Weighted average common shares outstanding
Weighted average diluted shares
Weighted average common shares outstanding
Effect of dilutive stock options
Total weighted average diluted shares
Years ended December 31,
2013
2012
$
(43,311)
$
(53,278)
14,111
14,111
—
14,111
(3.07)
(3.07)
13,149
13,149
—
13,149
(4.05)
(4.05)
$
$
Basic loss per common share from continuing operations
Diluted loss per common share from continuing operations
$
$
Net loss per share is based on the weighted-average number of shares outstanding. Diluted weighted-average shares is calculated
by adjusting basic weighted-average shares outstanding by all potentially dilutive stock options. Since the Company is reporting
a net loss for the each of the years ended December 31, 2013 and 2012, all stock options outstanding were excluded from the
calculation of both basic and diluted loss per share since their inclusion would have been anti-dilutive.
On July 3, 2012, the Company announced that the Board of Directors of the Company authorized the implementation of a share
consolidation at a ratio of one post-consolidation share for every four pre-consolidation shares. The number of weighted-average
shares outstanding included in the loss per share computations, as reported in the consolidated statements of operations, has been
restated for all periods presented to reflect the impact of the share consolidation. See Note 21, "Shareholders' Equity," for further
discussion of the share consolidation.
NOTE 18 STOCK-BASED COMPENSATION
On May 13, 2013, the Company's shareholders approved the 2013 Equity Incentive Plan ("2013 Plan"). The 2013 Plan replaced
the Company's previous Amended and Restated Stock Option Plan ("Prior Plan"), with respect to the granting of future equity
awards. Under the 2013 Plan, the Company may grant new stock options ("New Stock Options") to purchase up to an additional
300,000 common shares to key employees selected by the Company. No New Stock Options were granted during the year ended
December 31, 2013.
On May 13, 2013, the Company's shareholders also approved the Option Exchange Program whereby the outstanding stock options
under the Prior Plan held by current employees will be canceled and replaced with stock options granted under the 2013 Plan
("Replacement Options"). The maximum number of common shares available to be granted as Replacement Options is 355,625.
Each stock option outstanding under the Prior Plan that is not exchanged for a Replacement Option shall remain outstanding in
accordance with the terms of the Prior Plan and the applicable award agreement. Under the Prior Plan, the options vest evenly
over a three or four-year period and are exercisable for periods not exceeding 10 years. No Replacement Options were granted
during the year ended December 31, 2013.
The exercise price of Replacement Options and New Stock Options (collectively, the "Stock Options") is equal to $4.50 provided
that in no event shall the exercise price be less than the fair market value of the shares as of the date of grant. The Stock Options
will be fully vested and exercisable as of the date such options are granted and are exercisable for a period of four years.
77
KINGSWAY FINANCIAL SERVICES INC.
Notes to Consolidated Financial Statements
Additionally under the 2013 Plan, the Company will make grants of restricted common shares ("Restricted Stock") to certain
officers of the Company equal to three times the aggregate number of common shares held and entitled to be purchased through
the exercise of any warrants held by each such officer as of December 31, 2013. The Restricted Stock vests evenly over a ten-
year period and is subject to the officer's continued employment through the vesting date. The aggregate number of common
shares available for Restricted Stock awards is 1,972,345. No Restricted Stock awards were granted during the year ended
December 31, 2013.
The intrinsic value of a stock option grant is the difference between the current market price for the Company's common shares
and the exercise price of the option. The aggregate intrinsic values for the stock options outstanding at each of December 31, 2013
and 2012 were zero. The aggregate intrinsic values for stock options exercisable at each of December 31, 2013 and 2012 were
zero.
The following tables summarize information about stock options outstanding as of December 31, 2013 and December 31, 2012.
Exercise prices are stated as per the terms of the option. The exercise price, number of shares outstanding and number of shares
exercisable in the tables below have been restated for all periods presented to reflect the impact of the Company's share consolidation.
See Note 21, "Shareholders' Equity," for further discussion of the share consolidation.
(in thousands, except for share data)
Number of
Options
Outstanding
Weighted-
Average
Exercise Price
Weighted-
Average
Remaining
Contractual
Term (in Years)
Aggregate
Intrinsic Value
Outstanding at January 1, 2012
397,875
C$
Expired in year
Forfeited in year
(9,750)
(2,000)
Outstanding at December 31, 2012
386,125
C$
Expired in year
Forfeited in year
Outstanding at December 31, 2013
Exercisable at December 31, 2013
(11,750)
(18,750)
355,625
268,125
C$
C$
21.02
89.60
53.88
19.12
53.88
11.94
18.35
18.46
1.2
1.2
—
—
(1)
There were no options granted or exercised during the years ended December 31, 2013 and 2012.
Exercise
Price
$
$
C$
18.00
18.00
40.12
Date of
Grant
29-Sep-10
6-Jan-10
5-Mar-09
Expiry Date
29-Sep-15
6-Jan-15
5-Mar-14
Total:
Remaining Contractual
Life (Years)
1.7
1.0
0.2
1.2
Number
Outstanding
100,000
250,000
5,625
355,625
Number
Exercisable
75,000
187,500
5,625
268,125
December 31, 2013
78
KINGSWAY FINANCIAL SERVICES INC.
Notes to Consolidated Financial Statements
Exercise
Price
$
$
C$
C$
C$
18.00
18.00
7.60
40.12
53.88
Date of
Grant
29-Sep-10
6-Jan-10
5-Mar-09
5-Mar-09
20-Feb-08
Expiry Date
29-Sep-15
6-Jan-15
5-Mar-14
5-Mar-14
20-Feb-13
Total:
Remaining Contractual
Life (Years)
2.8
2.0
1.2
1.2
0.1
2.1
Number
Outstanding
100,000
250,000
16,250
8,125
11,750
386,125
December 31, 2012
Number
Exercisable
50,000
125,000
16,250
8,125
11,750
211,125
At December 31, 2013 and December 31, 2012, the number of options exercisable was 268,125 and 211,125, respectively, with
weighted average prices of C$18.46 and C$20.05, respectively.
The Company determines the fair values of options granted using the Black-Scholes option pricing model. No stock options were
granted in 2013 or 2012.
NOTE 19 EMPLOYEE BENEFIT PLAN
The Company maintains a defined contribution plan in the United States for all of its qualified employees. Qualifying employees
can choose to voluntarily contribute up to 60% of their annual earnings subject to an overall limitation of $17,500 and $17,000
in 2013 and 2012, respectively. The Company matches an amount equal to 50% of each participant's contribution, limited to
contributions up to 5% of a participant's earnings.
The contributions for the plan vest based on years of service with 100% vesting after five years of service. The Company's
contribution is expensed as paid and for the years ended December 31, 2013 and 2012 totaled $0.6 million and $0.6 million,
respectively. All Company obligations to the plans were fully funded as of December 31, 2013.
NOTE 20 RESTRUCTURING
On September 17, 2012, the Company announced that it was restructuring its Insurance Underwriting and Insurance Services
segments under two separate management teams. As part of the restructuring, the Company intends to streamline its non-standard
property and casualty insurance business operations. Specific to Insurance Underwriting, during the fourth quarter of 2012, the
Company began taking steps to place all of Amigo into voluntary run-off. On November 19, 2012, the Florida Office of Insurance
Regulation (“OIR”) approved Amigo's plan to withdraw from the business of offering commercial lines insurance in Florida. On
January 30, 2013, the OIR approved Amigo's plan to withdraw from the business of offering personal lines insurance in Florida.
In April 2013, Kingsway filed a comprehensive run-off plan with the OIR, which outlines plans for Amigo's run-off. Kingsway
continues to manage Amigo in a manner consistent with its filed run-off plan.
As part of the restructuring, the Company will reduce staffing levels to be consistent with placing Amigo into run-off. The Company
estimated that Insurance Underwriting would incur approximately $2.0 million in cash severance expenses due to reductions-in-
force as part of the restructuring during the period beginning with the announcement through the end of 2013. From the time the
restructuring was announced on September 17, 2012 through December 31, 2013, Insurance Underwriting has incurred severance
expense of $2.1 million, $1.9 million of which has been paid as of December 31, 2013.
79
KINGSWAY FINANCIAL SERVICES INC.
Notes to Consolidated Financial Statements
Changes in the restructuring liability, which is included in accrued expenses and other liabilities in the consolidated balance sheets,
and the related restructuring expense for the years ended December 31, 2013 and December 31, 2012 is as follows:
(in thousands)
Insurance Underwriting:
Severance
Lease abandonment
Total Insurance Underwriting
Insurance Services:
Lease abandonment
Total Insurance Services
Severance expense not allocated to segments
Total
(in thousands)
Insurance Underwriting:
Severance
Lease abandonment
Total Insurance Underwriting
NOTE 21 SHAREHOLDERS' EQUITY
Restructuring
liability, beginning
of period
Restructuring
expense
Cash payments
December 31, 2013
Restructuring
liability, end of
period
214
1,207
1,421
—
—
—
1,421
1,428
187
1,615
100
100
146
1,861
(1,406)
(746)
(2,152)
—
—
—
(2,152)
236
648
884
100
100
146
1,130
Restructuring
liability, beginning
of period
Restructuring
expense
Cash payments
December 31, 2012
Restructuring
liability, end of
period
—
—
—
676
1,304
1,980
(462)
(97)
(559)
214
1,207
1,421
On July 3, 2012, the Company announced that the Board of Directors of the Company authorized the implementation of a share
consolidation at a ratio of one post-consolidation share for every four pre-consolidation shares. The share consolidation, which
was approved by the stockholders at the Company's Annual and Special Meeting held on May 31, 2012, was effective as of July
3, 2012 (the "Effective Date"). As a result of the consolidation, every four of the Company's common shares that were issued and
outstanding on the Effective Date were automatically combined into one issued and outstanding common share, without any change
in the par value of such shares. Any fractional shares resulting from the consolidation were rounded up to the nearest whole. The
consolidation had the effect of reducing the number of common shares of the Company issued and outstanding from 52,595,828
shares pre-consolidation to 13,148,971 shares post-consolidation. The issued and outstanding shares reported in the consolidated
balance sheets; the number of weighted-average shares outstanding included in the loss per share computations, as reported in the
consolidated statements of operations; and the number of stock options outstanding have been restated for all periods presented
to reflect the impact of the share consolidation.
On May 13, 2013, the Company's shareholders approved an amendment to the Company's Articles of Incorporation to create an
unlimited number of zero par value class A preferred shares. The Company's Board of Directors will have the ability to fix the
designation, rights, privileges, restrictions and conditions attaching to the shares of each series of preferred shares. The preferred
shares will have priority over the common shares. No Class A preferred shares were issued or outstanding at December 31, 2013.
The Company is authorized to issue an unlimited number of zero par value common stock. There were 16,429,761 and 13,148,971
shares of common stock outstanding at December 31, 2013 and 2012, respectively.
There were no dividends declared during the years ended December 31, 2013 and 2012.
On May 30, 2013, the Company announced that it had filed a registration statement for a proposed rights offering relating to
transferable subscription rights to purchase up to approximately $13.1 million of its shares of common stock (the "Common
Shares") and warrants to purchase Common Shares. The rights offering was made in the United States pursuant to a registration
80
KINGSWAY FINANCIAL SERVICES INC.
Notes to Consolidated Financial Statements
statement on Form S-1 that was previously filed with the Securities and Exchange Commission and became effective on July 24,
2013.
Under the rights offering, each shareholder of record as of August 9, 2013 (the "Record Date") received, at no charge, one
subscription right for each Common Share owned on the Record Date (the "Subscription Right"). Four Subscription Rights entitled
the holder to purchase one unit (a "Unit") consisting of one Common Share, one Series A Warrant (a "Series A Warrant") and one
Series B Warrant (a "Series B Warrant", and together with the Series A Warrants, the "Warrants"). Each Warrant entitled the holder
to purchase one Common Share. The subscription price was $4.00 per Unit. The exercise prices per Common Share for each
Series A Warrant is $4.50 and for each Series B Warrant is $5.00. Each Series A Warrant is redeemable by the Company and has
a term of seven years from its date of issuance. Each Series B Warrant is non-redeemable and has a term of ten years from its date
of issuance. The Company may redeem the Series A Warrants at a price of $0.25 per Warrant if, and only if, the closing price of
the Common Shares equals or exceeds $6.00 per Common Share for twenty consecutive trading days on the New York Stock
Exchange or such other market or exchange as the Common Shares of the Company trade on or are quoted at the time of redemption;
but in any event, no earlier than the first anniversary date of issuance. Subject to applicable securities laws, the Warrants may be
exercised at any time starting on the first day of the thirty-seventh month after the date of issuance until any time on or before the
seventh anniversary after the date of issuance for the Series A Warrants and the tenth anniversary after the date of issuance for the
Series B Warrants. Holders who fully exercise their Subscription Rights will be entitled to subscribe for an additional amount of
Units, if any, that are not purchased by other shareholders or their transferees through the exercise of their basic subscription
privileges, in an amount equal to up to five Units for each Unit for which such holder was otherwise entitled to subscribe.
On September 16, 2013, the transaction closed. Subscription rights to purchase 3,280,790 units were exercised, resulting in gross
proceeds to the Company of $13.1 million. Net proceeds to the Company were $12.1 million after deducting commissions and
other offering expenses.
The following table summarizes information about warrants outstanding at December 31, 2013:
Exercise Price
4.50
$
5.00
$
Date of Grant
16-Sep-13
16-Sep-13
Expiry Date
15-Sep-20
15-Sep-23
Total:
Remaining Contractual
Life (Years)
6.7
9.7
8.2
December 31, 2013
Number
Outstanding
3,280,790
3,280,790
6,561,580
NOTE 22 ACCUMULATED OTHER COMPREHENSIVE INCOME
The table below details the change in the balance of each component of accumulated other comprehensive income, net of tax, for
the years ended December 31, 2013 and 2012 as relates to shareholders' equity attributable to common shareholders on the
consolidated balance sheets. On the other hand, the consolidated statements of comprehensive loss present the components of
other comprehensive (loss) income, net of tax, only for the years ended December 31, 2013 and 2012 and inclusive of the components
attributable to noncontrolling interests in consolidated subsidiaries.
81
(in thousands)
KINGSWAY FINANCIAL SERVICES INC.
Notes to Consolidated Financial Statements
Unrealized Gains
(Losses) on Fixed
Maturities and
Equity Investments
Foreign
Currency
Translation
Adjustments
Equity in Other
Comprehensive
Income (Loss)
of Investee
Total
Accumulated
Other
Comprehensive
Income
Balance, January 1, 2012
13,592
Other comprehensive income (loss)
before reclassifications
Amounts reclassified from accumulated
other comprehensive income
Net current-period other comprehensive
income
(395)
997
602
694
516
—
516
(1,537)
12,749
895
—
895
1,016
997
2,013
Balance, December 31, 2012
14,194
1,210
(642)
14,762
Other comprehensive income before
reclassifications
Amounts reclassified from accumulated
other comprehensive income
Net current-period other comprehensive
income
965
424
1,389
35
(7,227)
(7,192)
Balance, December 31, 2013
15,583
(5,982)
642
—
642
—
1,642
(6,803)
(5,161)
9,601
Components of accumulated other comprehensive income were reclassified to the following lines of the consolidated statements
of operations for the years ended December 31, 2013 and 2012:
Reclassification of accumulated other comprehensive income from unrealized (losses)
gains on fixed maturities and equity investments to:
Net realized gains (losses)
Other-than-temporary impairment loss
Loss from continuing operations before income tax (benefit) expense
$
Income tax (benefit) expense
Net loss
Reclassification of accumulated other comprehensive income from foreign currency
translation adjustments to:
Gain on liquidation of subsidiaries, net of tax
Net (loss) income
Years ended December 31,
2013
2012
$
(424)
—
(424)
—
(424)
7,227
7,227
(997)
—
(997)
—
(997)
—
—
Total reclassification from accumulated other comprehensive income to net loss
$
6,803
$
(997)
82
NOTE 23 SEGMENTED INFORMATION
KINGSWAY FINANCIAL SERVICES INC.
Notes to Consolidated Financial Statements
The Company is primarily engaged, through its subsidiaries, in the property and casualty insurance business. The Company
conducts its business through the following two reportable segments: Insurance Underwriting and Insurance Services.
Insurance Underwriting Segment
Insurance Underwriting includes the following subsidiaries of the Company: Mendota, Mendakota, UCC, Maison, Amigo, and
Kingsway Reinsurance Corporation (collectively, "Insurance Underwriting"). In October 2012, the Company formed Maison, a
Louisiana-domiciled property and casualty insurance company, which provides homeowners policies for wind and hail-related
property losses of residential dwellings and certain contents. In September 2013, Kingsway Reinsurance (Bermuda) Ltd., formerly
included in Insurance Underwriting, was liquidated. Insurance Underwriting principally offers personal automobile insurance to
drivers who do not meet the criteria for coverage by standard automobile insurers and actively conducts business in 16 states.
During the fourth quarter of 2012, the Company began taking steps to place all of Amigo into voluntary run-off. On November
19, 2012, the OIR approved Amigo's plan to withdraw from the business of offering commercial lines insurance in Florida. On
January 30, 2013, the OIR approved Amigo's plan to withdraw from the business of offering personal lines insurance in Florida.
In April 2013, Kingsway filed a comprehensive run-off plan with the OIR, which outlines plans for Amigo's run-off. Kingsway
continues to manage Amigo in a manner consistent with its filed run-off plan.
Insurance Services Segment
Insurance Services includes the following subsidiaries of the Company: ARS, IWS and Trinity (collectively, "Insurance Services").
During the first quarter of 2013, NEA, formerly included in Insurance Services, was merged into ARS.
ARS is a licensed property and casualty agent, full service managing general agent and third-party administrator focused primarily
on the assigned risk market. ARS is licensed to administer business in 22 states but generates its revenues primarily by operating
in the states of New York and New Jersey.
IWS is a licensed motor vehicle service agreement company and is a provider of after-market vehicle protection services distributed
by credit unions in 26 states to their members.
Trinity is a provider of warranty products and maintenance support to consumers and businesses in the HVAC and refrigeration
industry. Trinity distributes its warranty products through original equipment manufacturers, HVAC distributors and commercial
and residential contractors. Trinity distributes its maintenance support direct through corporate owners of retail spaces throughout
the United States.
Results for the Company's reportable segments are based on the Company's internal financial reporting systems and are consistent
with those followed in the preparation of the consolidated financial statements. The following tables provide financial data used
by management. Segment assets are not allocated for management use and, therefore, are not included in the segment disclosures
below.
83
Revenue by reportable segment reconciled to consolidated revenues for the years ended December 31, 2013 and 2012 were:
KINGSWAY FINANCIAL SERVICES INC.
Notes to Consolidated Financial Statements
(in thousands)
Revenues:
Insurance Underwriting:
Net premiums earned
Other income
Total Insurance Underwriting
Insurance Services:
Service fee and commission income
Total Insurance Services
Total segment revenues
Net investment income
Net realized gains
Other-than-temporary impairment loss
Other income and expenses not allocated to segments
Years ended December 31,
2012
2013
$
109,608
$
9,046
118,654
49,543
49,543
168,197
2,395
3,505
(1,800)
(19)
114,937
7,787
122,724
35,491
35,491
158,215
3,165
1,084
(2,703)
(170)
Total revenues
$
172,278
$
159,591
The operating (loss) income of each segment is before income taxes and includes revenues and direct segment costs.
Segment operating (loss) income reconciled to consolidated loss from continuing operations for the years ended December 31,
2013 and 2012 were:
(in thousands)
Segment operating (loss) income
Insurance Underwriting
Insurance Services
Total segment operating loss
Net investment income
Net realized gains
Other-than-temporary impairment loss
Other income and expenses not allocated to segments, net
Interest expense
Amortization of intangible assets
Contingent consideration expense
Impairment of asset held for sale
Loss on change in fair value of debt
(Loss) gain on buy-back of debt
Equity in net income (loss) of investee
Loss from continuing operations before income tax (benefit) expense
Income tax (benefit) expense
Loss from continuing operations
84
Years ended December 31,
2012
2013
(17,006)
1,836
(15,170)
2,395
3,505
(1,800)
(10,855)
(7,263)
(2,186)
(785)
(2,390)
(9,060)
(24)
255
(43,378)
(67)
(43,311)
$
$
$
(29,094)
4,506
(24,588)
3,165
1,084
(2,703)
(8,809)
(7,638)
(959)
(75)
—
(9,234)
500
(1,004)
(50,261)
3,017
(53,278)
$
$
$
Net premiums earned by line of business for the years ended December 31, 2013 and 2012 were:
KINGSWAY FINANCIAL SERVICES INC.
Notes to Consolidated Financial Statements
(in thousands)
Insurance Underwriting:
Private passenger auto liability
Auto physical damage
Total non-standard automobile
Commercial auto liability
Allied lines
Homeowners
Other
Years ended December 31,
2013
2012
$
$
71,236
32,634
103,870
$
$
755
3,539
1,436
8
75,912
29,247
105,159
9,435
345
—
(2)
114,937
Total net premiums earned
$
109,608
$
NOTE 24 FAIR VALUE OF FINANCIAL INSTRUMENTS
Fair value amounts represent estimates of the consideration that would currently be agreed upon between knowledgeable, willing
parties who are under no compulsion to act. Fair value is best evidenced by quoted bid or ask price, as appropriate, in an active
market. Where bid or ask prices are not available, such as in an illiquid or inactive market, the closing price of the most recent
transaction of that instrument subject to appropriate adjustments as required is used. Where quoted market prices are not available,
the quoted prices of similar financial instruments or valuation models with observable market based inputs are used to estimate
the fair value. These valuation models may use multiple observable market inputs, including observable interest rates, foreign
exchange rates, index levels, credit spreads, equity prices, counterparty credit quality, corresponding market volatility levels and
option volatilities. Minimal management judgment is required for fair values calculated using quoted market prices or observable
market inputs for models. Greater subjectivity is required when making valuation adjustments for financial instruments in inactive
markets or when using models where observable parameters do not exist. Also, the calculation of estimated fair value is based on
market conditions at a specific point in time and may not be reflective of future fair values. For the Company's financial instruments
carried at cost or amortized cost, the book value is not adjusted to reflect increases or decreases in fair value due to market
fluctuations, including those due to interest rate changes, as it is the Company's intention to hold them until there is a recovery of
fair value, which may be to maturity.
The Company classifies its investments in fixed maturities and equity investments as available-for-sale and reports these investments
at fair value. The Company's LROC preferred units, senior unsecured debentures, subordinated debt and contingent consideration
liabilities are measured and reported at fair value.
Fair values of equity investments are considered to approximate quoted market values based on the latest bid prices in active
markets. Fair values of fixed maturities for which no active market exists are derived from quoted market prices of similar
instruments or other third-party evidence.
The fair value of the LROC preferred units is based on quoted market prices, and the fair value of the subordinated debt is estimated
using an internal model based on significant market observable inputs. The fair value of the senior unsecured debentures, for
which no active market exists, is derived from quoted market prices of similar instruments or other third-party evidence.
The fair value of contingent consideration liabilities is estimated using internal models without relevant observable market data
over fair value inputs such as probability weighting of payment outcomes.
85
KINGSWAY FINANCIAL SERVICES INC.
Notes to Consolidated Financial Statements
The Company employs a fair value hierarchy to categorize the inputs it uses in valuation techniques to measure the fair value. The
extent of use of quoted market prices (Level 1), valuation models using observable market information (Level 2) and internal
models without observable market information (Level 3) in the valuation of the Company's financial assets and liabilities measured
at fair value on a recurring basis as of December 31, 2013 and December 31, 2012 was as follows:
(in thousands)
December 31, 2013
Fair Value Measurements at the End of the
Reporting Period Using
Quoted Prices
in Active
Markets for
Identical Assets
(Level 1)
Total
Significant
Other
Observable
Inputs
(Level 2)
Significant
Unobservable
Inputs
(Level 3)
Recurring fair value measurements
Assets:
Fixed maturities:
U.S. government, government agencies and
authorities
Canadian government
States municipalities and political subdivisions
Mortgage-backed
Asset-backed securities and collateralized
mortgage obligations
Corporate
Total fixed maturities
Equity investments
Other investments
Short-term investments
Total assets
Liabilities:
LROC preferred units
Senior unsecured debentures
Subordinated debt
Contingent consideration
$
$
$
$
18,338
4,082
6,231
2,006
3,994
19,500
54,151
7,137
3,000
501
64,789
14,854
14,356
28,471
5,344
— $
—
—
—
—
—
—
7,137
—
—
7,137
14,854
—
—
—
$
$
$
18,338
4,082
6,231
2,006
3,994
19,500
54,151
—
3,000
501
57,652
—
14,356
28,471
—
Total liabilities
$
63,025
$
14,854
$
42,827
$
—
—
—
—
—
—
—
—
—
—
—
—
—
—
5,344
5,344
86
(in thousands)
KINGSWAY FINANCIAL SERVICES INC.
Notes to Consolidated Financial Statements
December 31, 2012
Fair Value Measurements at the End of the
Reporting Period Using
Quoted Prices
in Active
Markets for
Identical Assets
(Level 1)
Significant
Other
Observable
Inputs
(Level 2)
Significant
Unobservable
Inputs
(Level 3)
Total
Recurring fair value measurements
Assets:
Fixed maturities:
U.S. government, government agencies and
authorities
Canadian government
States municipalities and political subdivisions
Mortgage-backed
Asset-backed securities and collateralized
mortgage obligations
Corporate
Total fixed maturities
Equity investments
Other investments
Short-term investments
Total assets
Liabilities:
LROC preferred units
Senior unsecured debentures
Subordinated debt
Contingent consideration
$
24,915
$
— $
24,915
$
3,782
7,345
5,043
1,092
37,357
79,534
3,548
2,000
585
—
—
—
—
—
—
3,548
—
—
3,782
7,345
5,043
1,092
37,357
79,534
—
2,000
585
$
85,667
$
3,548
$
82,119
$
13,655
23,730
23,774
3,987
13,655
—
—
—
—
23,730
23,774
—
Total liabilities
$
65,146
$
13,655
$
47,504
$
—
—
—
—
—
—
—
—
—
—
—
—
—
—
3,987
3,987
The following table provides a reconciliation of the fair value of recurring Level 3 fair value measurements for the years ended
December 31, 2013 and 2012:
(in thousands)
Contingent consideration:
Beginning balance
Issuance of contingent consideration in connection with acquisitions
Settlements of contingent consideration liabilities
Change in fair value of contingent consideration included in net loss
Ending balance
2013
3,987
572
—
785
5,344
December 31,
2012
—
3,912
—
75
3,987
87
KINGSWAY FINANCIAL SERVICES INC.
Notes to Consolidated Financial Statements
NOTE 25 COMMITMENTS AND CONTINGENT LIABILITIES
(a) Legal proceedings:
In connection with its operations in the ordinary course of business, the Company and its subsidiaries are named as defendants in
various actions for damages and costs allegedly sustained by the plaintiffs. While it is not possible to estimate the loss, or range
of loss, if any, that may be incurred in connection with any of the various proceedings at this time, it is possible that individual
actions may result in losses having material adverse effects on the Company's financial condition or results of operations.
(b)
Commitment:
The Company has entered into subscription agreements to commit up to $6.0 million of capital to allow for participation in limited
liability investments which invest principally in income-producing real estate. At December 31, 2013, the unfunded commitment
was $1.8 million.
(c) Collateral pledged:
Fixed maturities and short-term investments with an estimated fair value of $14.2 million and $15.0 million were on deposit with
state and provincial regulatory authorities at December 31, 2013 and 2012, respectively. Also, from time to time, the Company
pledges investments to third-parties to collateralize liabilities incurred under its policies of insurance. The amount of such pledged
investments was $24.4 million and $22.3 million at December 31, 2013 and 2012, respectively. Collateral pledging transactions
are conducted under terms that are common and customary to standard collateral pledging and are subject to the Company's standard
risk management controls.
(d) Future minimum lease payments:
Future minimum annual lease payments under operating leases for premises/equipment for the next five years and thereafter are:
(in thousands)
2014
2015
2016
2017
2018
Thereafter
$
4,071
2,765
1,986
1,492
738
566
NOTE 26 REGULATORY CAPITAL REQUIREMENTS AND RATIOS
In the United States, a risk-based capital ("RBC") formula is used by the National Association of Insurance Commissioners
("NAIC") to identify property and casualty insurance companies that may not be adequately capitalized. Most states, including
the domiciliary states of our insurance subsidiaries, have adopted the NAIC RBC requirements. In general, insurers reporting
surplus as regards policyholders below 200% of the authorized control level, as defined by the NAIC, at December 31 are subject
to varying levels of regulatory action, including discontinuation of operations. As of December 31, 2013, surplus as regards
policyholders reported by each of our insurance subsidiaries exceeded the 200% threshold.
As of December 31, 2012, Amigo's RBC was 157%, which is at the company action level, as defined by the NAIC. During the
fourth quarter of 2012, the Company began taking steps to place all of Amigo into voluntary run-off. On November 19, 2012, the
OIR approved Amigo's plan to withdraw from the business of offering commercial lines insurance in Florida. On January 30,
2013, the OIR approved Amigo's plan to withdraw from the business of offering personal lines insurance in Florida. In April 2013,
Kingsway filed a comprehensive run-off plan with the OIR, which outlines plans for Amigo's run-off. The successful achievement
of any run-off plan depends on future events and circumstances, the outcome of which cannot be assured. Nevertheless, the
Company and Amigo expect that they will take all necessary steps to comply with the provisions of the run-off plan. Amigo
remains in compliance with that plan. As of December 31, 2013, Amigo's RBC was 203%.
88
KINGSWAY FINANCIAL SERVICES INC.
Notes to Consolidated Financial Statements
The Company previously placed UCC into voluntary run-off in early 2011. At the time it was placed into voluntary run-off, UCC's
RBC was 160%. UCC entered into a comprehensive run-off plan approved by the Illinois Department of Insurance in June 2011.
UCC remains in compliance with that plan. As of December 31, 2013, UCC's RBC was 1,569%.
The Company's reinsurance subsidiary, which is domiciled in Barbados, is required by the regulator in Barbados to maintain
minimum capital levels. As of December 31, 2013, the capital maintained by Kingsway Reinsurance Corporation was in excess
of the regulatory capital requirements in Barbados.
NOTE 27 STATUTORY INFORMATION AND POLICIES
The Company's insurance subsidiaries prepare statutory basis financial statements in accordance with accounting practices
prescribed or permitted by the Departments of Insurance in states in which they are domiciled. "Prescribed" statutory accounting
practices include state laws, regulations and general administrative rules, as well as a variety of publications of the NAIC.
"Permitted" statutory accounting practices encompass all accounting practices that are not prescribed. Such practices may differ
from state to state; may differ from company to company within a state; and may change in the future.
The Company's insurance subsidiaries are required to report results of operations and financial position to insurance regulatory
authorities based upon statutory accounting practices. In converting from statutory to U.S. GAAP, typical adjustments include
deferral of acquisition costs, the inclusion of statutory non-admitted assets in the balance sheets, the inclusion of net unrealized
holding gains or losses related to fixed maturities in shareholders’ equity, and the inclusion of changes in deferred tax assets and
liabilities in net loss.
Statutory capital and surplus and statutory net loss for the Company's insurance subsidiaries are:
(in thousands)
Combined net loss, statutory basis
Combined capital and surplus, statutory basis
2013
(3,575)
40,647
$
$
December 31,
2012
(19,284)
38,308
$
$
The Company’s insurance subsidiaries are required to hold minimum levels of statutory capital and surplus to satisfy regulatory
requirements. The minimum statutory capital and surplus, or company action level RBC, necessary to satisfy regulatory
requirements for the Company's insurance subsidiaries collectively was $27.8 million at December 31, 2013. Company action
level RBC is the level at which an insurance company is required to file a corrective action plan with its regulators and is equal
to 200% of the authorized control level RBC.
Dividends paid by insurance subsidiaries are restricted by regulatory requirements of the insurance departments in the subsidiaries'
state of domicile. The maximum amount of dividends that can be paid to shareholders by insurance companies without prior
approval of the domiciliary state insurance commissioner is generally limited to the greater of (i) 10% of a company's statutory
capital and surplus at the end of the previous year or (ii) 100% of the company's net income for the previous year and is generally
required to be paid out of an insurance company's unassigned funds.
At December 31, 2013, the U.S. insurance subsidiaries of the Company were restricted from making any dividend payments
without regulatory approval pursuant to the domiciliary state insurance regulations.
NOTE 28 SUBSEQUENT EVENTS
On February 3, 2014, the Company announced that it had closed on its previously announced private placement totaling $6.6
million. At closing, the Company received gross proceeds of $6.6 million, resulting from the sale and issuance of 262,876 units
for a purchase price of $25.00 per unit. Each unit consists of one class A convertible preferred share, series 1 (the "Preferred
Shares"), and 6.25 common share class C purchase warrants. Each Preferred Share is convertible into 6.25 common shares at a
conversion price of $4.00 per common share any time at the option of the holder prior to April 1, 2021. The maximum number of
common shares issuable upon conversion of the Preferred Shares is 1,642,975 common shares. Each warrant will entitle the
subscriber to purchase one common share of Kingsway at a price of $5.00 per common share at any time after September 16, 2016
and prior to expiry on September 15, 2023.
89
KINGSWAY FINANCIAL SERVICES INC.
Notes to Consolidated Financial Statements
In February 2014, the Company repaid the $14.4 million remaining amount outstanding on its senior unsecured debentures due
February 1, 2014.
On March 27, 2014, the Company's wholly owned subsidiary, 1347 Property Insurance Holdings, Inc., formerly known as Maison
Insurance Holdings, Inc., filed a registration statement on Form S-1 with the Securities and Exchange Commission to conduct an
initial public offering of its common stock.
Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure
None
Item 9A. Controls and Procedures
Evaluation of Disclosure Controls and Procedures
The Company's management performed an evaluation under the supervision and with the participation of the Company's principal
executive officer and the principal financial officer, and completed an evaluation of the effectiveness of the design and operation
of the Company's disclosure controls and procedures (as that term is defined in Rules 13a-15(e) and 15d-15(e), as adopted by the
Securities and Exchange Commission ("SEC") under the Securities Exchange Act of 1934, as amended ("the Exchange Act") as
of the end of the period covered by this Annual Report. Disclosure controls and procedures are the controls and other procedures
that are designed to ensure that information required to be disclosed in the reports that we file or submit under the Exchange Act
is recorded, processed, summarized and reported within the time periods specified in the SEC's rules and forms. Disclosure
controls and procedures include, without limitation, controls and procedures designed to ensure that information required to be
disclosed in the reports that the Company files or submits under the Exchange Act is accumulated and communicated to management,
including the principal executive officer and principal financial officer, as appropriate, to allow timely decisions regarding required
disclosures.
Based on that evaluation, the Company's principal executive officer and principal financial officer concluded that the Company's
disclosure controls and procedures are effective.
Management's Report on Internal Control over Financial Reporting
The Company's management is responsible for establishing and maintaining adequate internal control over financial reporting as
defined in Rules 13a-15(f) and 15d-15(f) under the Exchange Act. Our internal control over financial reporting includes policies
and procedures that provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial
statements for external reporting purposes in accordance with U.S. generally accepted accounting principles. All control systems
contain inherent limitations, no matter how well designed. As a result, the Company's management acknowledges that its internal
controls over financial reporting will not prevent or detect all misstatements due to error or fraud. In addition, management's
evaluation of controls can provide only reasonable, not absolute, assurance that all control issues that may result in material
misstatements, if any, have been detected.
The Company's management, including the Company's principal executive officer and principal financial officer, evaluated the
Company's internal control over financial reporting based on the framework in Internal Control - Integrated Framework (1992
Framework) issued by the Committee of Sponsoring Organizations of the Treadway Commission. Based on that evaluation, which
excluded Trinity due to its recent acquisition, management has concluded that our internal control over financial reporting was
effective as of December 31, 2013.
Changes in Internal Control over Financial Reporting
Effective May 22, 2013, the Company's subsidiary, Trinity, acquired certain intangible assets of Trinity Warranty Corp. Since the
date of acquisition, the Company has been analyzing and evaluating procedures and controls to determine their effectiveness and
to make them consistent with our disclosure controls and procedures. As permitted by the guidance issued by the staff of the SEC,
Trinity has been excluded from the scope of our quarterly discussion of material changes in internal control over financial reporting
below.
There have been no changes in the Company's internal control over financial reporting during the period beginning October 1,
2013, and ending December 31, 2013, that have materially affected, or are reasonably likely to materially affect, its internal control
over financial reporting, except as described above with respect to Trinity. Changes to processes, information technology systems
90
KINGSWAY FINANCIAL SERVICES INC.
and other components of internal control over financial reporting resulting from the acquisition of Trinity are expected as the
integration of these operations proceeds.
Item 9B. Other Information
None
PART III.
Item 10. Directors, Executive Officers, and Corporate Governance
The information required by this Item is incorporated herein by reference to the Proxy Statement for our 2014 Annual Meeting
of Shareholders, which will be filed with the SEC no later than 120 days after the end of our fiscal year ended December 31, 2013.
We have adopted a code of ethics applicable to our directors, principal executive officer, principal financial officer, and other
senior financial personnel ("Code of Ethics for Senior Financial Personnel") which is posted in the “Corporate Governance” section
of our website at www.kingsway-financial.com. Any future amendments to the Code of Ethics for Senior Financial Personnel
and any grant of waiver from a provision of the code requiring disclosure under applicable SEC rules will be disclosed in the
"Corporate Governance" section of our website.
Item 11. Executive Compensation
The information required by this Item is incorporated herein by reference to the Proxy Statement for our 2014 Annual Meeting
of Shareholders, which will be filed with the SEC no later than 120 days after the end of our fiscal year ended December 31, 2013.
Item 12. Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters
Information regarding our equity compensation plans is incorporated herein by reference to Item 5 of Part II of this Form 10-K.
All other information required by this Item is incorporated herein by reference to the Proxy Statement for our 2014 Annual Meeting
of Shareholders, which will be filed with the SEC no later than 120 days after the end of our fiscal year ended December 31, 2013.
Item 13. Certain Relationships and Related Transactions, and Director Independence
The information required by this Item is incorporated herein by reference to the Proxy Statement for our 2014 Annual Meeting of
Shareholders, which will be filed with the SEC no later than 120 days after the end of our fiscal year ended December 31, 2013.
Item 14. Principal Accounting Fees and Services
The information required by this Item is incorporated herein by reference to the Proxy Statement for our 2014 Annual Meeting of
Shareholders, which will be filed with the SEC no later than 120 days after the end of our fiscal year ended December 31, 2013.
91
KINGSWAY FINANCIAL SERVICES INC.
Part IV
Item 15. Exhibits, Financial Statement Schedules
(a) Documents filed as part of this Report
(1) Consolidated Financial Statements. See "Index to Consolidated Financial Statements" in Part II, Item 8 of this Form
10-K.
(2) Financial Statement Schedules. The following financial statement schedules are filed as a part hereof along with the
related reports of the Independent Registered Public Accounting Firm included in Part II, Item 8. Schedules not listed
here have been omitted because they are not applicable or the required information is included in the consolidated financial
statements.
Schedule I
Investments Other Than Investments in Related Parties
Schedule II
Financial Information of Registrant (Parent Company)
Schedule III
Supplementary Insurance Information
Schedule IV
Reinsurance Schedule
Schedule VI
Supplemental Information Concerning Property-Casualty Insurance Operations
(3) Exhibits. The exhibits listed in the accompanying "Index to Exhibits" that follow the signature pages of this report
are filed or incorporated by reference as part of this Form 10-K.
(b) Exhibits. Included in Item 15(a)(3) above
(c) Financial Statement Schedules. Included in Item 15(a)(2) above
92
KINGSWAY FINANCIAL SERVICES INC.
SCHEDULE I. Investments Other Than Investments in Related Parties
(in thousands)
Fixed maturities:
U.S. government, government agencies and authorities
Canadian government
State municipalities and political subdivisions
Mortgage-backed
Asset-backed securities and collateralized mortgage
obligations
Corporate
Total fixed maturities
Equity investments
Limited liability investments
Other investments
Short-term investments
Total investments
Cost or
Amortized
Cost
December 31, 2013
Amount Shown
on Consolidated
Balance Sheet
Fair Value
17,777
4,235
6,126
1,993
3,996
19,328
53,455
3,554
4,406
3,000
501
64,916
18,338
4,082
6,231
2,006
3,994
19,500
54,151
7,137
—
—
—
61,288
18,338
4,082
6,231
2,006
3,994
19,500
54,151
7,137
4,406
3,000
501
69,195
NOTE 1: Cost approximates fair value for limited liability investments, other investments and short-term investments.
See accompanying report of independent registered accounting firm.
93
SCHEDULE II. Financial Information of Registrant (Parent Company)
KINGSWAY FINANCIAL SERVICES INC.
Parent Company Balance Sheets
(in thousands)
December 31, 2013
December 31, 2012
Assets
Investments in subsidiaries
Cash and cash equivalents
Other assets
Total Assets
Liabilities and Shareholders' Equity
Liabilities:
Accrued expenses and other liabilities
Total Liabilities
Shareholders' Equity:
Class A preferred stock
Common stock
Additional paid-in capital
Accumulated deficit
Accumulated other comprehensive income
Shareholders' equity attributable to common shareholders
Noncontrolling interests in consolidated subsidiaries
Total Shareholders' Equity
Total Liabilities and Shareholders' Equity
See accompanying report of independent registered accounting firm.
29,296
4,562
3,409
37,267
347
347
—
—
324,803
(298,930)
9,601
35,474
1,446
36,920
37,267
58,709
1,932
5,004
65,645
231
231
—
—
312,378
(262,069)
14,762
65,071
343
65,414
65,645
94
SCHEDULE II. Financial Information of Registrant (Parent Company)
KINGSWAY FINANCIAL SERVICES INC.
Parent Company Statements of Operations
(in thousands)
Revenues:
Net investment income
Other (expenses) income
Total revenues
Expenses:
General and administrative expenses
Total expenses
Loss from continuing operations before income tax benefit and equity in loss of
subsidiaries
Income tax benefit
Equity in loss of subsidiaries
Net loss
See accompanying report of independent registered accounting firm.
Years ended December 31,
2012
2013
35
(341)
(306)
2,875
2,875
(3,181)
(710)
(33,613)
(36,084)
$
$
183
633
816
3,278
3,278
(2,462)
(1,347)
(52,163)
(53,278)
$
$
95
SCHEDULE II. Financial Information of Registrant (Parent Company)
KINGSWAY FINANCIAL SERVICES INC.
Parent Company Statements of Comprehensive Loss
(in thousands)
Net loss
Other comprehensive (loss) income, net of taxes(1):
Unrealized gains (losses) on fixed maturities and equity investments:
Unrealized gains (losses) arising during the period
Reclassification adjustment for amounts included in net loss
Foreign currency translation adjustments
Other comprehensive income - parent only
Equity in other comprehensive (loss) income of subsidiaries and investee
Other comprehensive (loss) income
Comprehensive loss
(1) Net of income tax (benefit) expense of $0 in 2013 and 2012
See accompanying report of independent registered accounting firm.
Years ended December 31,
2012
2013
$
(36,084)
$
(53,278)
—
—
10
10
(5,225)
(5,215)
(41,299)
$
—
—
565
565
1,236
1,801
(51,477)
$
96
SCHEDULE II. Financial Information of Registrant (Parent Company)
KINGSWAY FINANCIAL SERVICES INC.
Parent Company Statements of Cash Flows
(in thousands)
Cash provided by (used in):
Operating activities:
Net loss
Adjustments to reconcile net loss to net cash used in operating activities:
Equity in net loss of subsidiaries
Stock based compensation expense, net of forfeitures
Other, net
Net cash used in operating activities
Financing activities:
Proceeds from issuance of common stock and warrants, net
Net cash provided by financing activities
Net increase (decrease) in cash and cash equivalents
Cash and cash equivalents at beginning of period
Cash and cash equivalents at end of period
See accompanying report of independent registered accounting firm.
Years ended December 31,
2012
2013
$
(36,084)
$
(53,278)
33,613
325
(7,324)
(9,470)
12,100
12,100
2,630
1,932
4,562
$
52,163
354
(19,828)
(20,589)
132
132
(20,457)
22,389
1,932
$
97
KINGSWAY FINANCIAL SERVICES INC.
SCHEDULE III. Supplementary Insurance Information
(in thousands)
2013
Insurance
Underwriting
Total
2012
Insurance
Underwriting
Total
December 31,
Unpaid
Loss and
Loss
Adjustment
Expenses
Deferred
Acquisition
Costs
Years ended December 31,
Unearned
Premiums
Net
Premiums
Earned
Loss and
Loss
Adjustment
Expenses
Amortization
of Deferred
Acquisition
Costs
Other
Operating
Expenses
Net
Premiums
Written
7,254
7,254
84,534
84,534
48,577
48,577
109,608
109,608
80,726
80,726
28,080
28,080
26,854
26,854
113,631
113,631
9,132
9,132
103,116
103,116
45,047
45,047
114,937
114,937
99,394
99,394
21,912
21,912
30,416
30,416
115,269
115,269
NOTE 1: Net investment income is not allocated to segments, therefore net investment income is not provided in this schedule.
See accompanying report of independent registered accounting firm.
98
KINGSWAY FINANCIAL SERVICES INC.
SCHEDULE IV. Reinsurance
(in thousands)
Years ended December 31,
Direct
Premiums
Written
125,077
128,050
Premiums
Ceded to
Other
Companies
31,031
30,630
Premiums
Assumed
from Other
Companies
19,585
17,849
Net Premiums
Written
113,631
115,269
Percentage of
Premiums
Assumed to
Net
17.2%
15.5%
2013
2012
See accompanying report of independent registered accounting firm.
99
KINGSWAY FINANCIAL SERVICES INC.
SCHEDULE VI. Supplemental Information Concerning Property-Casualty Insurance Operations
(in thousands)
Affiliation with
Registrant (1)
Year ended
December 31, 2013
Year ended
December 31, 2012
Deferred
Acquisition
Costs
Unpaid Loss
and Loss
Adjustment
Expenses
Unearned
Premiums
Net Earned
Premiums
Net
Investment
Income
Current
Year
Prior
Years
Amortization
of Deferred
Acquisition
Costs
Paid Loss
and Loss
Adjustment
Expenses
Net
Premiums
Written
Loss and Loss
Adjustment Expenses
Related to
7,254
84,534
48,577
109,608
1,258
81,906
(1,180)
28,080
101,772
113,631
9,132
103,116
45,047
114,937
1.504
85,565
13,829
21,912
121,716
115,269
(1) Consolidated property-casualty insurance operations
See accompanying report of independent registered accounting firm.
100
KINGSWAY FINANCIAL SERVICES INC.
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this
report to be signed on its behalf by the undersigned, thereunto duly authorized.
KINGSWAY FINANCIAL SERVICES INC.
Date: March 31, 2014
/s/ Larry G. Swets, Jr.
By:
Name: Larry G. Swets, Jr.
Title:
President, Chief Executive Officer and Director
(Principal Executive Officer)
Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons
on behalf of the registrant and in the capacities and on the dates indicated.
/s/ Larry G. Swets, Jr.
Larry G. Swets, Jr.
President, Chief Executive Officer and Director
(principal executive officer)
March 31, 2014
/s/ William A. Hickey, Jr.
William A. Hickey, Jr.
Executive Vice President, Chief Operating Officer and
Chief Financial Officer
(principal financial and accounting officer)
March 31, 2014
/s/ Terence Kavanagh
Terence Kavanagh
/s/ Gregory Hannon
Gregory Hannon
/s/ Gary Schaevitz
Gary Schaevitz
/s/ Joseph Stilwell
Joseph Stilwell
Chairman of the Board and Director
March 31, 2014
Director
Director
Director
March 31, 2014
March 31, 2014
March 31, 2014
101
KINGSWAY FINANCIAL SERVICES INC.
EXHIBIT INDEX
Exhibit Description
3.1
3.2
4.1
4.2
4.3
4.4
4.5
4.6
4.7
4.8
10.1
10.2
10.3
10.4
10.5
10.6
10.7
10.8
Certificate of Amendment to the Articles of Incorporation of Kingsway Financial Services Inc. (included as exhibit 3.1 to the
Form 10-Q, filed November 7, 2013, and incorporated herein by reference).
By-law No. 5 of Kingsway Financial Services Inc. (included as exhibit 3.2 to the Form 10-K, filed March 30, 2012, and
incorporated herein by reference).
Indenture dated January 28, 2004 among Kingsway America Inc., Kingsway Financial Services Inc. and BNY Midwest Trust
Company (included as exhibit 4.1 to the Form F-4, filed May 27, 2004, and incorporated herein by reference).
Trust Indenture dated July 10, 2007 among Kingsway 2007 General Partnership, Kingsway Financial Services Inc., Kingsway
America Inc., and Computershare Trust Company of Canada (included as exhibit 4.2 to the Form 10-K, filed March 30, 2012,
and incorporated herein by reference).
Indenture dated December 4, 2002 between Kingsway America Inc. and State Street Bank and Trust Company of Connecticut,
National Association (included as exhibit 4.3 to the Form 10-K, filed March 30, 2012, and incorporated herein by reference).
Indenture dated May 15, 2003 between Kingsway America Inc. and U.S. Bank National Association (included as exhibit 4.4 to
the Form 10-K, filed March 30, 2012, and incorporated herein by reference).
Indenture dated October 29, 2003 between Kingsway America Inc. and U.S. Bank National Association (included as exhibit 4.5
to the Form 10-K, filed March 30, 2012, and incorporated herein by reference).
Indenture dated May 22, 2003 between Kingsway America Inc., Kingsway Financial Services Inc., and Wilmington Trust
Company (included as exhibit 4.6 to the Form 10-K, filed March 30, 2012, and incorporated herein by reference).
Junior Subordinated Indenture dated September 30, 2003 between Kingsway America Inc. and J.P Morgan Chase Bank (included
as exhibit 4.7 to the Form 10-K, filed March 30, 2012, and incorporated herein by reference).
Indenture dated December 16, 2003 between Kingsway America Inc., Kingsway Financial Services Inc., and Wilmington Trust
Company (included as exhibit 4.8 to the Form 10-K, filed March 30, 2012, and incorporated herein by reference).
Amended and Restated Stock Option Plan of Kingsway Financial Services Inc., dated as of May 2001 and amended most
recently as of May 2007 (included as exhibit 10.1 to the Form 10-K, filed March 30, 2012, and incorporated herein by
reference).
Purchase Agreement, dated January 25, 2010, between The Westaim Corporation and Kingsway Financial Services Inc.
(included as exhibit 10.2 to the Form 10-K, filed March 30, 2012, and incorporated herein by reference).
Second Amendment to and Assignment and Assumption of Purchase Agreement, dated June 21, 2010, by and among FH
Enterprises Inc., JBA Associates Inc., the four individual holders of all of JBA's voting securities, and Kingsway America Inc.
(included as exhibit 10.3 to the Form 10-K, filed March 30, 2012, and incorporated herein by reference).
Tax Benefit Preservation Plan Agreement, dated as of September 28, 2010, between Kingsway Financial Services Inc. and
Computershare Investor Services Inc. (included as exhibit 10.4 to the Form 10-K, filed March 30, 2012, and incorporated herein
by reference).
Agreement and Plan of Merger, dated December 14, 2010, among JJR VI Acquisition Corp., Atlas Acquisition Corp., Kingsway
Financial Services Inc., and American Insurance Acquisition Inc. (included as exhibit 10.5 to the Form 10-K, filed March 30,
2012, and incorporated herein by reference).
Operating Agreement of Acadia GP, LLC dated March 16, 2011 (included as exhibit 10.8 to the March 31, 2011 Form 10-Q,
filed March 27, 2012, and incorporated herein by reference).
Stock Purchase Agreement dated March 30, 2011 between HRM Acquisition Corp. and Kingsway America Inc. (included as
exhibit 10.1 to the March 31, 2011 Form 10-Q, filed March 27, 2012, and incorporated herein by reference).
Senior Promissory Note dated March 30, 2011 issued by HRM Acquisition Corp. to Kingsway America Inc. (included as exhibit
10.2 to the March 31, 2011 Form 10-Q, filed March 27, 2012, and incorporated herein by reference).
102
KINGSWAY FINANCIAL SERVICES INC.
10.9
Junior Promissory Note dated March 30, 2011 issued by HRM Acquisition Corp to Kingsway America Inc. (included as exhibit
10.3 to the March 31, 2011 Form 10-Q, filed March 27, 2012, and incorporated herein by reference).
10.10 Note Purchase Agreement dated March 30, 2011 between HRM Acquisition Corp. and United Property and Casualty Insurance
Company (included as exhibit 10.4 to the March 31, 2011 Form 10-Q, filed March 27, 2012, and incorporated herein by
reference).
10.11
Promissory Note dated March 30, 2011 issued by HRM Acquisition Corp. to United Property and Casualty Insurance Company
(included as exhibit 10.5 to the March 31, 2011 Form 10-Q, filed March 27, 2012, and incorporated herein by reference).
10.12 Agreement of Limited Partnership dated March 30, 2011 between Acadia GP, LLC (in its capacity as a general partner of Acadia
Acquisition Partners, L.P.) and limited partners (including United Property and Casualty Insurance Company) (included as
exhibit 10.6 to the March 31, 2011 Form 10-Q, filed March 27, 2012, and incorporated herein by reference).
10.13
Intercreditor Agreement dated March 30, 2011 between HRM Acquisition Corp. and Kingsway America Inc. (included as exhibit
10.7 to the March 31, 2011 Form 10-Q, filed March 27, 2012, and incorporated herein by reference).
10.14
Subscription and Investment Representation Agreement dated March 30, 2011 (included as exhibit 10.9 to the March 31, 2011
Form 10-Q, filed March 27, 2012, and incorporated herein by reference).
10.15 Management Services Agreement between United Insurance Management, L.C. and 1347 Advisors LLC, effective August 29,
2011 (included as exhibit 10.1 to the September 30, 2011 Form 10-Q, filed March 27, 2012, and incorporated herein by
reference).
10.16 Kingsway Financial Services Inc. 2013 Equity Incentive Plan (included as Schedule B to the Definitive Proxy Statement on
Schedule 14A filed with the SEC on April 11, 2013, and incorporated herein by reference).
14
21
23
Kingsway Financial Services Inc. Code of Business Conduct & Ethics (included as exhibit 14 to the Form 10-K, filed March 30,
2012, and incorporated herein by reference).
Subsidiaries of Kingsway Financial Services Inc.
Consent of BDO USA, LLP
31.1
Certification of Chief Executive Officer pursuant to Rule 13a-14(a) of the Exchange Act
31.2
Certification of Chief Financial Officer pursuant to Rule 13a-14(a) of the Exchange Act
32.1
32.2
Certification of Chief Executive Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-
Oxley Act of 2002
Certification of Chief Financial Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-
Oxley Act of 2002
101.INS XBRL Instance Document
101.SCH XBRL Taxonomy Extension Schema
101.CAL XBRL Taxonomy Extension Calculation Linkbase
101.DEF XBRL Taxonomy Extension Definition Linkbase
101.LAB XBRL Taxonomy Extension Label Linkbase
101.PRE XBRL Taxonomy Extension Presentation Linkbase
103
Subsidiaries of Kingsway Financial Services Inc.
Exhibit 21
Subsidiaries
Kingsway America II Inc.
1347 Advisors LLC
1347 Capital LLC
IWS Acquisition Corporation
Market Solutions Insurance Agency LLC
Trinity Warranty Solutions LLC
Hamilton Risk Management Company
Jurisdiction of Incorporation/Organization
Delaware
Delaware
Delaware
Florida
Delaware
Delaware
Florida
Appco Finance Corporation
Pennsylvania
Insurance Management Services Inc.
Kingsway Amigo Insurance Company
American Country Underwriting Agency Inc.
ARM Holdings, Inc.
Mattoni Insurance Brokerage, Inc.
Assigned Risk Solutions Ltd.
KAI Advantage Auto, Inc.
KFS Capital LLC
Kingsway America Inc.
Kingsway LGIC Holdings, LLC
1347 Property Insurance Holdings, Inc.
Maison Insurance Company
Maison Managers, Inc.
Mendota Insurance Company
Boston General Agency, Inc.
Mendakota Insurance Company
Mendota Insurance Agency, Inc.
MIC Insurance Agency Inc.
Universal Casualty Company
Kingsway America Agency Inc.
Kingsway General Insurance Company
Kingsway Reinsurance Corporation
Kingsway ROC GP
Kingsway ROC LLC
Florida
Florida
Illinois
Illinois
Washington
New Jersey
Illinois
Delaware
Delaware
Delaware
Delaware
Louisiana
Delaware
Minnesota
Texas
Minnesota
Texas
Texas
Illinois
Illinois
Ontario
Barbados
Delaware
Delaware
Exhibit 23
Consent of Independent Registered Public Accounting Firm
Kingsway Financial Services Inc.
Itasca, Illinois
We hereby consent to the incorporation by reference in the Registration Statement on Form S-8 (No. 333-194108) of Kingsway
Financial Services Inc. of our report dated March 31, 2014, relating to the consolidated financial statements and financial statement
schedules, which appear in this Form 10-K.
/s/ BDO USA LLP
Grand Rapids, Michigan
March 31, 2014
EXHIBIT 31.1
I, Larry G. Swets, Jr., certify that:
CERTIFICATION PURSUANT TO SECTION 302
1. I have reviewed this annual report on Form 10-K of Kingsway Financial Services 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 the statements made, in light of the circumstances under which such statements were made, not misleading
with respect to the period covered by this report;
3. Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all
material respects the 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(s) and I are responsible for establishing and maintaining disclosure controls and
procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) and internal control over financial reporting (as
defined in Exchange Act Rules 13a-15 (f) and 15d-15(f)) 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, to ensure 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) Designed such internal control over financial reporting, or caused such internal control over financial reporting to be
designed under our supervision, to provide reasonable assurance regarding the reliability of financial reporting and the
preparation of financial statements for external purposes in accordance with generally accepted accounting principles;
c) Evaluated the effectiveness of the registrant's disclosure controls and procedures and presented in this report our
conclusions about the effectiveness 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 most recent fiscal quarter (the registrant's fourth fiscal quarter in the case of an annual report) that has
materially affected, or is reasonably likely to materially affect, the registrant's internal control over financial reporting;
5. The registrant's other certifying officers(s) and I have disclosed, based on our most recent evaluation of internal control over
financial reporting, to the 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 are reasonably 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 internal control over financial reporting.
Date: March 31, 2014
By /s/ Larry G. Swets, Jr.
Larry G. Swets, Jr., President and Chief Executive Officer
(Principal Executive Officer)
EXHIBIT 31.2
CERTIFICATION
I, William A. Hickey, Jr., certify that:
1. I have reviewed this annual report on Form 10-K of Kingsway Financial Services 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 the statements made, in light of the circumstances under which such statements were made, not misleading
with respect to the period covered by this report;
3. Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all
material respects the 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(s) and I are responsible for establishing and maintaining disclosure controls and
procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) and internal control over financial reporting (as
defined in Exchange Act Rules 13a-15(f) and 15d-15(f)) 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, to ensure 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) Designed such internal control over financial reporting, or caused such internal control over financial reporting to be
designed under our supervision, to provide reasonable assurance regarding the reliability of financial reporting and the
preparation of financial statements for external purposes in accordance with generally accepted accounting principles;
(c) Evaluated the effectiveness of the registrant's disclosure controls and procedures and presented in this report our
conclusions about the effectiveness 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 most recent fiscal quarter (the registrant's fourth fiscal quarter in the case of an annual report) that has
materially affected, or is reasonably likely to materially affect, the registrant's internal control over financial reporting;
5. The registrant's other certifying officer(s) and I have disclosed, based on our most recent evaluation of internal control over
financial reporting, to the 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 are reasonably 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 internal control over financial reporting.
Date: March 31, 2014
By /s/ William A. Hickey, Jr.
William A. Hickey, Jr., Chief Financial Officer and Executive Vice President
(Principal Financial Officer)
EXHIBIT 32.1
CERTIFICATION PURSUANT TO
18 U.S.C. SECTION 1350,
AS ADOPTED PURSUANT TO
SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002
In connection with the Annual Report on Form 10-K (the “Report”) of Kingsway Financial Services Inc. (the “Company”) for
the year ended December 31, 2013 as filed with the Securities and Exchange Commission on the date hereof, I, Larry G. Swets,
Jr., the Chief Executive Officer and Principal Executive Officer of the Company, hereby certify pursuant to 18 U.S.C. Section
1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, that, to the best my knowledge and belief:
(1) the Report fully complies with the requirements of Section 13(a) or 15(d) of the Securities Exchange Act of 1934; and
(2) the information contained in the Report fairly presents, in all material respects, the financial condition and results of
operations of the Company.
Date: March 31, 2014
By /s/ Larry G. Swets, Jr.
Larry G. Swets, Jr., President and Chief Executive Officer
(Principal Executive Officer)
EXHIBIT 32.2
CERTIFICATION PURSUANT TO
18 U.S.C. SECTION 1350,
AS ADOPTED PURSUANT TO
SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002
In connection with the Annual Report on Form 10-K (the “Report”) of Kingsway Financial Services Inc. (the “Company”) for
the year ended December 31, 2013 as filed with the Securities and Exchange Commission on the date hereof, I, William A.
Hickey, Jr., the Chief Financial Officer and Principal Financial Officer of the Company, hereby certify pursuant to 18 U.S.C.
Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, that, to the best of my knowledge and
belief:
(1) the Report fully complies with the requirements of Section 13(a) or 15(d) of the Securities Exchange Act of 1934; and
(2) the information contained in the Report fairly presents, in all material respects, the financial condition and results of
operations of the Company.
Date: March 31, 2014
By /s/ William A. Hickey, Jr.
William A. Hickey, Jr., Chief Financial Officer and Executive Vice President
(Principal Financial Officer)