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, 2018
OR
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF
1934
For the Transition Period from _____ to _____
Commission File Number 001-15204
Kingsway Financial Services Inc.
(Exact name of registrant as specified in its charter)
Delaware
(State or other jurisdiction of
incorporation or organization)
150 E. Pierce Road
Itasca, IL
(Address of principal executive offices)
98-0475673
(I.R.S. Employer Identification No.)
60143
(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 definitions of "large accelerated filer," "accelerated filer," and "smaller reporting company" and "emerging growth company" in
Rule 12b-2 of the Exchange Act.
Large accelerated filer
Accelerated filer
Non-accelerated filer
(Do not check if a
smaller reporting
company)
Smaller Reporting Company
Emerging Growth Company
If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying
with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act.
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, 2018, the aggregate market value of the registrant's voting common stock held by non-affiliates of registrant was $37,291,317
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 February 27, 2020 was 22,843,909.
KINGSWAY FINANCIAL SERVICES INC.
Caution Regarding Forward-Looking Statements
Table Of Contents
PART I
Item 1. Business
Item 1A. Risk Factors
Item 1B. 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
Item 16. Form 10-K Summary
SIGNATURES
EXHIBIT INDEX
3
4
4
10
18
19
19
19
19
19
22
23
45
47
121
121
124
124
124
128
132
134
134
136
136
142
143
144
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KINGSWAY FINANCIAL SERVICES INC.
Caution Regarding Forward-Looking Statements
This 2018 Annual Report on Form 10-K (the "2018 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 ("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, among others, are forward-looking,
and the Company may also make forward-looking statements about, among other things:
•
•
•
•
•
•
•
its results of operations and financial condition (including, among other things, net and operating income, investment income
and performance, return on equity and expected current returns);
changes in facts and circumstances affecting assumptions used in determining its provision for unpaid loss and loss adjustment
expenses;
changes in facts and circumstances affecting assumptions used in evaluating its legal proceedings;
changes in industry trends and significant industry developments;
the impact of certain guarantees and indemnifications made by the Company;
its ability to complete and integrate current or future acquisitions successfully; and
its ability to implement its restructuring activities and execute its strategic initiatives successfully.
For a discussion of some of the factors that could cause actual results to differ, see Item 1A,"Risk Factors" and our disclosures
under the heading "Critical Accounting Estimates and Assumptions" in MD&A in this 2018 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 2018 Annual Report.
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KINGSWAY FINANCIAL SERVICES INC.
Part I
Item 1. BUSINESS
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.
Kingsway Financial Services Inc. was incorporated under the Business Corporations Act (Ontario) on September 19, 1989. Effective
December 31, 2018, the Company changed its jurisdiction of incorporation from the province of Ontario, Canada, to the State of
Delaware (the "Domestication"). The Company discontinued its existence as a corporation under Section 181 of the Ontario
Business Corporations Act and, pursuant to Section 388 of the General Corporation Law of the State of Delaware (the "DGCL"),
continued its existence under the DGCL as a corporation incorporated in the State of Delaware. The Company's registered office
is located at 150 E. Pierce Road, Itasca, Illinois 60143.
In connection with the Domestication, the outstanding common stock and preferred stock of the Company have been converted,
on a one-for-one basis, into shares of common stock and preferred stock of the Company, respectively, as a corporation incorporated
in the State of Delaware. Prior to the Domestication, the common shares of Kingsway were listed on the Toronto Stock Exchange
("TSX") and the New York Stock Exchange ("NYSE"). In connection with the Domestication, the Company delisted from the
TSX. The common shares of Kingsway are listed on the NYSE under the trading symbol "KFS."
Kingsway is a holding company with operating subsidiaries located in the United States. The Company owns or controls subsidiaries
primarily in the extended warranty, asset management and real estate industries. Kingsway conducts its business through the
following two reportable segments: Extended Warranty and Leased Real Estate. Extended Warranty and Leased Real Estate
conduct their business and distribute their products in the United States.
Prior to the second quarter of 2018, the Company conducted its business through a third reportable segment, Insurance Underwriting.
Insurance Underwriting included the following subsidiaries of the Company: Mendota Insurance Company, Mendakota Insurance
Company, Mendakota Casualty Company, Kingsway Amigo Insurance Company ("Amigo") and Kingsway Reinsurance
Corporation ("Kingsway Re"). Mendota Insurance Company, Mendakota Insurance Company and Mendakota Casualty Company
are referred to collectively herein as "Mendota." On July 16, 2018, the Company announced that it had entered into a definitive
agreement to sell Mendota. On October 18, 2018, the Company announced that the sale was completed. As a result, Mendota
has been classified as discontinued operations and the results of their operations are reported separately for all periods presented.
As a consequence of classifying Mendota as discontinued operations, the remaining composition of the Insurance Underwriting
segment no longer meets the criteria of a reportable segment. As such, all segmented information has been restated to exclude the
Insurance Underwriting segment for all periods presented. The operating results of Amigo and Kingsway Re, each of which are
currently in voluntary run-off and were previously included in the Insurance Underwriting segment, are now included in Other
income and expenses not allocated to segments, net.
Financial information about Kingsway's reportable business segments for the years ended December 31, 2018 and December 31,
2017 is contained in the following sections of this 2018 Annual Report: (i) Note 28, "Segmented Information," to the Consolidated
Financial Statements; and (ii) "Results of Continuing Operations" section of MD&A.
RESTATEMENT OF PREVIOUSLY ISSUED FINANCIAL STATEMENTS
The Company has restated its previously reported consolidated financial statements as of and for the year ended December 31,
2017. The restatements reflect corrections of errors identified in connection with the preparation of the consolidated financial
statements for the year ended December 31, 2018, and relate primarily to i) the reclassification of certain investments acquired
from Mendota on October 18, 2018 from assets held for sale to equity investments, limited liability investments, limited liability
investments, at fair value and other investments in the consolidated balance sheet; and the reclassification of investment income,
related to these investments, from loss from discontinued operations, net of taxes to net investment income in the consolidated
statement of operations; ii) the consolidation of certain limited liability investments that had previously been accounted for under
the equity method of accounting; and iii) the reclassification of cash and cash equivalents to restricted cash in the consolidated
balance sheets. The restatements are more fully discussed in Note 3, "Restatement of Previously Issued Financial Statements," to
the Consolidated Financial Statements. All amounts in this 2018 Annual Report affected by the restatements reflect such amounts
as restated.
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
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KINGSWAY FINANCIAL SERVICES INC.
operations is conducted in the United States. 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 currency translation adjustments are
included in shareholders' equity under the caption accumulated other comprehensive loss. Foreign currency gains and losses
resulting from transactions that are denominated in currencies other than the entity's functional currency are reflected in non-
operating other income in the consolidated statements of operations.
All of the dollar amounts in this 2018 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
Sale of Mendota:
As described above, on July 16, 2018, the Company announced it had entered into a definitive agreement to sell Mendota. On
October 18, 2018, the Company completed the previously announced sale of Mendota. The final aggregate purchase price of
$28.6 million was redeployed primarily to acquire equity investments, limited liability investments, limited liability investments,
at fair value and other investments, which were owned by Mendota at the time of the closing, and to fund $5.0 million into an
escrow account to be used to satisfy potential indemnity obligations under the definitive stock purchase agreement. Further
information is contained in Note 6, "Disposal, Discontinued Operations and Liquidation," to the Consolidated Financial Statements.
Acquisition of Geminus:
On March 1, 2019, the Company completed the acquisition of Geminus Holding Company, Inc. ("Geminus"), a specialty, full-
service provider of vehicle service contracts ("VSCs") and other finance and insurance ("F&I") products to used car buyers around
the country, for a purchase price of $8.4 million, comprised of cash paid at closing of $7.7 million and a seller note of $0.8 million.
Geminus, headquartered in Wilkes-Barre, Pennsylvania, has been creating, marketing and administering VSCs and F&I products
on high-mileage used cars through its subsidiaries, The Penn Warranty Corporation ("Penn") and Prime Auto Care, Inc. ("Prime"),
since 1988. Penn and Prime distribute these products via independent used car dealerships and franchised car dealerships,
respectively. Geminus recorded unaudited income before income tax expense of $1.4 million for the year ended December 31,
2018.
Related to the acquisition of Geminus, the Company formed Kingsway Warranty Holdings LLC ("KWH") as its acquisition vehicle
and contributed IWS Acquisition Corporation ("IWS") and Trinity Warranty Solutions LLC ("Trinity") to KWH. The Company
secured $10.0 million of acquisition financing from a third-party lender, with Geminus, IWS and Trinity listed as borrowers. After
accounting for the cash purchase price paid at closing and transaction-related expenses paid in cash at closing, $1.3 million of the
$10.0 million of acquisition financing was made available to the Company to be used for general corporate purposes.
EXTENDED WARRANTY SEGMENT
Extended Warranty includes the following subsidiaries of the Company: IWS, Trinity and Professional Warranty Service
Corporation ("PWSC"), (collectively, "Extended Warranty").
IWS is a licensed motor vehicle service agreement company and is a provider of after-market vehicle protection services distributed
by credit unions in 23 states and the District of Columbia to their members.
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KINGSWAY FINANCIAL SERVICES INC.
Trinity sells heating, ventilation, air conditioning ("HVAC"), standby generator, commercial LED lighting and refrigeration
warranty products and provides equipment breakdown and maintenance support services to companies across the United States.
As a seller of warranty products, Trinity markets and administers product warranty contracts for certain new and used products in
the HVAC, standby generator, commercial LED lighting and refrigeration industries throughout the United States. Trinity acts as
an agent on behalf of the third-party insurance companies that underwrite and guaranty these warranty contracts. Trinity does not
guaranty the performance underlying the warranty contracts it sells. 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.
PWSC sells new home warranty products and provides administration services to homebuilders and homeowners across the United
States. PWSC distributes its products and services through an in-house sales team and through insurance brokers and insurance
carriers throughout all states except Alaska and Louisiana.
Extended Warranty Products
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 range from three months to seven years and/or 3,000 miles to
100,000 miles. The average term of a vehicle service agreement is between four and five years. 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 sells HVAC, standby generator, commercial LED lighting and refrigeration warranty products and provides equipment
breakdown and maintenance support services to companies across the United States. As a seller of warranty products, Trinity
markets and administers product warranty contracts for certain new and used products in the HVAC, standby generator, commercial
LED lighting and refrigeration industries throughout the United States. Trinity acts as an agent on behalf of the third-party insurance
companies that underwrite and guaranty these warranty contracts. Trinity does not guaranty the performance underlying the
warranty contracts it sells. 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.
PWSC administers the insured warranty programs of liability coverage for new home construction companies, and the warranty
is issued to new home buyers. The liability coverage is provided nationwide by a single, A+ rated insurance carrier. The warranty
document is an agreement between the homebuilder and the purchaser of the home and includes specific tolerances related to
covered defects and precise definitions of damages. Each damage category includes materials defect coverage for the first year,
major systems coverage for the second year, and workmanship and structural coverage for years three through ten. The warranty
enables certain damages to be resolved by the homebuilder without admitting fault or negligence, and the warranty offers an
efficient method to resolve buyer complaints and avoid costly litigation through mediation and mandatory binding arbitration.
PWSC also has an uninsured warranty administration services program. The warranty document issued through this program is
an agreement between the homebuilder and the purchaser of the home, and it includes performance standards established by the
homebuilder and warrants conditions in the home that could constitute a construction defect throughout the warranty period. This
program enables construction defects to be efficiently and amicably resolved by the homebuilder through mediation and mandatory
binding arbitration to avoid costly litigation. Claims are covered for the statute of repose, or for an elected time-frame by the
builder, in a specific state or per agreement with a general liability insurance carrier. Constituents' interests are aligned to handle
their claims relative to construction defects promptly and without attorney intervention.
Marketing and Distribution
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 23 states and the District of Columbia.
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KINGSWAY FINANCIAL SERVICES INC.
Trinity directly markets and distributes its warranty products to manufacturers, distributors and installers of HVAC, standby
generator, commercial LED lighting 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.
PWSC markets its insured warranty products through a sales force directly to the homebuilder and its uninsured builder backed
warranty products through a network of construction general liability insurance carriers and domestic insurance brokers.
Homebuilder prospects are developed through membership in local homebuilder associations, attendance at homebuilder
conventions, distribution of promotional products and direct mail efforts. For its uninsured homebuilder backed product, PWSC
dedicates senior personnel to working with the construction general liability insurers and domestic insurance brokers to identify
and assist in developing new opportunities and devotes marketing resources to sell its product.
No customer or group of affiliated customers accounts for 10% or more of Extended Warranty's revenues, and no loss of a customer
or group of affiliated customers would have a material adverse effect on the Company.
Competition
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, standby generator, commercial LED lighting and refrigeration equipment
than that of its competitors.
For its insured warranty product, PWSC operates in an environment with several competitors. PWSC differentiates itself through
its relationship with and backing by an A+ rated global insurance carrier; its over 20 years' experience in the field of new home
warranty administration; its dispute resolution services; and its best in class customer service. For its uninsured builder backed
product, PWSC operates in an environment with very few competitors. The most significant features differentiating the builder
backed product from its competition are an express warranty for all construction defects, the only warranty that is fully integrated
with the general liability policy in its definition and coverage of construction defects, and mutual agreement between the
homebuilder and the home buyer that all claims be resolved through mediation or, if necessary, binding arbitration.
Claims Management
Claims management is the process by which Extended Warranty determines the validity and amount of a claim. We believe that
claims management is fundamental to our operating results. 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.
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.
Under PWSC’s warranty products, disputes typically arise when there is a difference between what the homeowner expects of the
builder and what the builder believes are its legitimate warranty service responsibilities. PWSC employs an experienced claims
staff who responds to all inquiries from homeowners and from requests by builders. Any inquiries or complaints received are
submitted or communicated to the builder. PWSC will not make any determination as to the validity or resolution of any complaint;
however, PWSC will discuss alternatives or resolutions to disputes with all parties and can mediate or negotiate a fair solution to
a dispute. This process ensures that homebuilders can effectively manage new home construction risk and reduce the potential
for substantial legal costs associated with litigation. PWSC may, at times, act as a third-party administrator for claims under the
insured warranty product; however, at no time does PWSC bear the loss of claims on warranty products.
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KINGSWAY FINANCIAL SERVICES INC.
LEASED REAL ESTATE SEGMENT
Leased Real Estate includes the Company's subsidiary, CMC Industries, Inc. ("CMC"). CMC owns, through an indirect wholly
owned subsidiary (the "Property Owner"), a parcel of real property consisting of approximately 192 acres located in the State of
Texas (the "Real Property"), which is subject to a long-term triple net lease agreement with a single customer, BNSF Railway
Company. Revenue from this single customer represents more than 10% of the Company’s consolidated revenues. The Real
Property is also subject to a mortgage, which is recorded as note payable in the consolidated balance sheets (the "Mortgage").
PRICING AND PRODUCT MANAGEMENT
Responsibility for pricing and product management rests with the Company's individual operating subsidiaries in Extended
Warranty. 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
The Company 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. For a detailed description of the Company's process for establishing its provision for unpaid
loss and loss adjustment expenses, see "Critical Accounting Estimates and Assumptions" section of MD&A. For a rollforward of
the provision for unpaid loss and loss adjustment expenses, net of amounts recoverable from reinsurers, see Note 16, "Unpaid Loss
and Loss Adjustment Expenses," to the Consolidated Financial Statements.
INVESTMENTS
We manage our investments to support our liabilities, preserve capital, maintain adequate liquidity and maximize after-tax
investment returns within acceptable risks. The fixed maturities portfolios are managed by a third-party firm and are comprised
predominantly of high-quality fixed maturities with relatively short durations. Equity, limited liability and other investments are
managed by a team of employees and advisors dedicated to the identification of investment opportunities that offer asymmetric
risk/reward potential with a margin of safety supported by private market values. The Investment Committee of the Board of
Directors is responsible for monitoring the performance of our investments and compliance with the Company's investment policies
and guidelines, which it reviews annually. Investments held by our insurance subsidiary, Amigo, must comply with domiciliary
state regulations that prescribe the type, quality and concentration of investments.
For further descriptions of the Company's investments, see our disclosures under the headings "Investments" and "Critical
Accounting Estimates and Assumptions" in MD&A and Note 8, "Investments," and Note 29, "Fair Value of Financial Instruments,"
to the Consolidated Financial Statements.
REGULATORY ENVIRONMENT
U.S. insurance companies are subject to the insurance holding company statutes in the jurisdictions in which they conduct business.
These statutes require that each U.S insurance company in a 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 that may
materially affect the operations, management or financial condition of the insurers in the holding company domiciled in that state.
These statutes also generally 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.
U.S. insurance companies 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. U.S. insurance companies also
are required to participate in various involuntary pools or assigned risk pools. In most states, the involuntary pool participation
is in proportion to the voluntary writings of related lines of business in such states.
U.S. insurance companies 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.
We have one U.S. insurance subsidiary, Amigo, which is organized and domiciled under the insurance statutes of Florida. To the
best of our knowledge, we are in compliance with the regulations discussed above.
U.S. 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 ("NAIC"). State insurance regulators also prescribe the form and content of statutory financial statements, perform
periodic financial examinations of insurers, set minimum reserve and loss ratio requirements, 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,
2018, surplus as regards policyholders reported by Amigo exceeded the 200% threshold. Refer to Note 32, "Regulatory Capital
Requirements and Ratios," to the Consolidated Financial Statements for further discussion.
The state insurance department that has jurisdiction over Amigo may conduct on-site visits and examinations, especially as to
financial condition, ability to fulfill 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 Florida Office of Insurance Regulation completed in 2016 a financial examination of Amigo for the three-year
period ending December 31, 2014 and completed in the first quarter of 2018 a financial examination of Amigo for the two-year
period ending December 31, 2016. No financial statement adjustments were required as a result of either examination.
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 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 adversely affect our results of operations or financial condition.
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.
The insurance carrier providing the contractual liability coverage for the insured warranty product offered by PWSC is designated
as a surplus lines carrier in all states. The offering of surplus lines insurance is regulated in all states. The insurance carrier has
designated an agent within PWSC who is a licensed property and casualty broker and a surplus lines broker in all states where
such a license is required. PWSC is in compliance with the regulations of each state in which it offers its insured warranty products.
In addition, New Jersey, Maryland and the U.S. Department of Housing & Urban Development ("HUD") require PWSC to file its
warranty plan documents and other company information for periodic review and approval to demonstrate compliance with new
home warranty plan regulations promulgated by those jurisdictions. HUD and New Jersey require such a filing every two years.
Maryland requires a filing every year. PWSC is in compliance with the filing requirements of each state and HUD.
EMPLOYEES
At December 31, 2018, we employed 123 personnel supporting our continuing operations, of which 122 were 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
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KINGSWAY FINANCIAL SERVICES INC.
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 that 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 2018 Annual
Report and to consult any further disclosures Kingsway makes on related subjects in its filings with the SEC.
FINANCIAL RISK
We have substantial outstanding recourse 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, 2018, we had $90.5 million principal value of outstanding recourse subordinated debt, in the form of trust
preferred debt instruments, with redemption dates beginning in December 2032. And, related to our acquisition on March 1, 2019
of The Penn Warranty Corporation ("Penn") and Prime Auto Care, Inc. ("Prime"), we have guaranteed $10.0 million of acquisition
financing. Because of our substantial outstanding recourse 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 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, and our acquisition financing of $10.0 million bear interest directly related to the London interbank offered
interest rate for three-month U.S. dollar deposits or any equivalent replacement benchmark as defined in the underlying loan
documents ("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.
Increases in interest rates would increase the cost of servicing our outstanding recourse debt and could adversely affect
our results of operation.
Our outstanding recourse subordinate debt of $90.5 million principal value and our acquisition financing of $10.0 million related
to the acquisition of Penn and Prime bear 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 operations. Each one hundred basis point increase in LIBOR
would result in an approximately $1.0 million increase in our annual interest expense.
The expected discontinuation of LIBOR could adversely affect the cost of servicing our outstanding recourse debt.
Our outstanding recourse subordinate debt of $90.5 million principal value, which has redemption dates ranging from December
4, 2032 through January 8, 2034, and our acquisition financing of $10.0 million related to the acquisition of Penn and Prime,
which has a maturity date of March 1, 2024, bear interest directly related to LIBOR and extend beyond 2021, by which time the
United Kingdom’s Financial Conduct Authority, which regulates LIBOR, has announced it intends to phase out LIBOR. It is
unclear if at that time LIBOR will cease to exist or if new methods of calculating LIBOR will be established such that it continues
to exist after 2021. If LIBOR ceases to exist as defined in the indentures governing the Company’s outstanding recourse debt,
the indentures provide fallback language for the respective agents to calculate an alternative LIBOR to be used in determining the
Company’s interest expense on its outstanding recourse debt. At this time, the Company cannot yet reasonably estimate the
expected impact of a discontinuation of LIBOR.
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KINGSWAY FINANCIAL SERVICES INC.
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 may limit our ability, among other things, to make particular types of restricted
payments and pay dividends or redeem capital stock. The covenants under our debt agreements could limit our ability to plan for
or react to market conditions or to meet our capital needs. 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. A specific covenant under our debt indentures is our obligation to deliver audited financial
statements for certain of our subsidiaries as of and for the year ended December 31, 2018. Due to the delay in filing our 2018
Annual Report, we have been unable to meet these obligations, the failure of which could be declared events of default under the
respective indentures. As of the date of the filing of our 2018 Annual Report, none of the lenders or trustees responsible for
administering any of our outstanding debt has declared an event of default, if required by the applicable indenture, notified us of
an intent to accelerate any portion of the outstanding debt or charge default interest thereon, or pursued any other remedies available
to it. If an event of default does occur, it could trigger a default under our other debt instruments, 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 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.
The Real Property is leased pursuant to a long-term triple net lease and the failure of the tenant to satisfy its obligations
under the lease could adversely affect the condition of the Real Property or the results of the Leased Real Estate segment.
Because the Real Property is leased pursuant to a long-term triple net lease, we depend on the tenant to pay all insurance, taxes,
utilities, common area maintenance charges, maintenance and repair expenses and to indemnify, defend and hold us harmless from
and against various claims, litigation and liabilities arising in connection with its business, including any environmental liabilities.
There can be no assurance that the tenant will have sufficient assets, income and access to financing to enable it to satisfy its
payment obligations to us under the lease. The inability or unwillingness of the tenant to meet its rent obligations to CMC or to
satisfy its other obligations, including indemnification obligations, could materially adversely affect the business, financial position
or results of operations of our Leased Real Estate segment. Furthermore, the inability or unwillingness of the tenant to satisfy its
other obligations under the lease, such as the payment of insurance, taxes and utilities, could materially and adversely affect the
condition of the Real Property.
Our triple net lease agreement requires that the tenant maintain comprehensive liability and hazard insurance; however, there are
certain types of losses (including losses arising from environmental conditions or of a catastrophic nature, such as earthquakes,
hurricanes and floods) that may be uninsurable or not economically insurable. Insurance coverage may not be sufficient to pay
the full current market value or current replacement cost of a loss. Inflation, changes in building codes and ordinances,
environmental considerations, and other factors also might make it infeasible to use insurance proceeds to replace the property
after such property has been damaged or destroyed. In addition, if we experience a loss that is uninsured or that exceeds policy
coverage limits, we could lose the capital invested in the property as well as the anticipated future cash flows from the property.
We may not be able to realize our investment objectives, which could significantly reduce our earnings and liquidity.
We depend on our investments for a substantial portion of our liquidity. As of December 31, 2018, our investments included $12.3
million of fixed maturities, at fair value. 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 fair 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. Given the low interest rate environment that
exists for fixed maturities, a significant increase in investment yields or an impairment of investments that we own could have a
material adverse effect on our business, results of operations or financial condition by reducing the fair value of the investments
we own, particularly if we were forced to liquidate investments at a loss. The low interest rate environment for fixed maturities
that has existed for years also exposes us to reinvestment risk as these investments mature because the funds may be reinvested
at rates lower than those of the maturing investments.
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KINGSWAY FINANCIAL SERVICES INC.
As of December 31, 2018, our investments also included $0.9 million of equity investments, $4.8 million of limited liability
investments, $26.0 million of limited liability investments, at fair value, $3.1 million of investments in private companies, at
adjusted cost, $10.7 million of real estate investments, at fair value and other investments, at cost of $2.1 million. These investments
are less liquid than fixed maturities. We generally make these investments with long-term time horizons in mind. General economic
conditions, stock market conditions and many other factors can adversely affect the fair value of the investments we own. If
circumstances necessitated us disposing of our limited liability investments prematurely in order to generate liquidity for operating
purposes, we would be exposed to realizing less than their carrying value.
Our ability to achieve our investment objectives is affected by general economic conditions that are beyond our control and our
own liquidity needs for operating purposes. We may not be able to realize our investment objectives, which could adversely affect
our results of operations, financial condition and available cash resources.
A difficult economy generally could materially adversely affect our business, results of operations or financial condition.
An adverse change in market conditions leading to instability in the global credit markets presents additional risks and uncertainties
for our business. Depending on market conditions going forward, we could incur substantial realized and unrealized losses in
future periods, which could have an adverse affect on our results of operations or financial condition. 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 adversely affect 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 could 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 and regulatory developments.
We are party to a Settlement Agreement that may require us to make cash payments from time to time, which payments
could materially adversely affect our business, results of operations or financial condition.
In May 2016, Aegis Security Insurance Company ("Aegis") filed a complaint for breach of contract and declaratory relief against
the Company in the Eastern District of Pennsylvania alleging, among other things, that we breached a contractual obligation to
indemnify Aegis for certain customs bond losses incurred by Aegis under the indemnity and hold harmless agreements provided
by us to Aegis for certain customs bonds reinsured by Lincoln General Insurance Company ("Lincoln General") during the period
of time that Lincoln General was a subsidiary of the Company. Lincoln General was placed into liquidation in November 2015
and Aegis subsequently invoked its rights to indemnity under the indemnity and hold harmless agreements. Effective January 20,
2020, we entered into a Settlement Agreement with Aegis with respect to such litigation pursuant to which we agreed to pay Aegis
a one-time settlement amount of $0.9 million and to reimburse Aegis for 60% of future losses that Aegis may sustain in connection
with such customs bonds, up to a maximum reimbursement amount of $4.8 million. The timing and severity of our future payments
pursuant to this Settlement Agreement are not reasonably determinable. No assurances can be given, however, that we will not
be required to perform under this Settlement Agreement in a manner that has a material adverse effect on our business, results of
operations or financial condition.
We provided certain indemnifications to the buyer of our non-standard automobile businesses, which could materially
adversely affect our business, results of operations or financial condition.
On July 16, 2018, we announced we had entered into a definitive agreement to sell our non-standard automobile insurance companies
Mendota, Mendakota and MCC (collectively "Mendota"). On October 18, 2018, we completed the previously announced sale of
Mendota. The final aggregate purchase price of $28.6 million was redeployed primarily to acquire equity investments, limited
liability investments, limited liability investments, at fair value and other investments, which were owned by Mendota at the time
of the closing, and to fund $5.0 million into an escrow account to be used to satisfy potential indemnity obligations under the
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KINGSWAY FINANCIAL SERVICES INC.
definitive stock purchase agreement. As part of the transaction, we will indemnify the buyer for any loss and loss adjustment
expenses with respect to open claims and certain specified claims in excess of Mendota’s carried unpaid loss and loss adjustment
expenses at June 30, 2018. The maximum obligation to the Company with respect to the open claims is $2.5 million. There is
no maximum obligation to the Company with respect to the specified claims. During 2019, Mendota notified us that it had entered
into agreements to settle the specified claims. We estimate we will incur a net loss of approximately $1.8 million related to the
settlements of the specified claims, which we will report in our consolidated statement of operations for the year ended December
31, 2019. Our potential exposure under the indemnity obligation with respect to the open claims is not reasonably determinable,
and no liability has been recorded in our Consolidated Financial Statements. No assurances can be given, however, that we will
not be required to perform under the indemnity obligation for the open claims in a manner that has a material adverse effect on
our business, results of operations or financial condition.
We have generated net operating loss carryforwards for U.S. income tax purposes, but our ability to use these net operating
losses could be limited by our inability to generate future taxable income.
Our U.S. businesses have generated consolidated net operating loss carryforwards ("U.S. NOLs") for U.S. federal income tax
purposes of approximately $845.7 million as of December 31, 2018. These U.S. NOLs can be available to reduce income taxes
that might otherwise be incurred on future U.S. taxable income. The utilization of these U.S. NOLs 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 U.S. NOLs and realize the positive cash flow benefit. Also, our U.S. NOLs have
expiration dates. There can be no assurance that, if and when we generate taxable income in the future from operations or the sale
of assets or businesses, we will generate such taxable income before our U.S. NOLs expire.
We have generated U.S. NOLs, but our ability to preserve and use these U.S. NOLs could be limited or impaired by future
ownership changes.
Our ability to utilize the U.S. NOLs 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. An ownership change could also be triggered
by other activities, including the sale of our shares that are owned by our five (5%) shareholders. In the event of an ownership
change, Section 382 would impose an annual limitation on the amount of taxable income we may offset with U.S. NOLs. 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 U.S. NOLs. In the event an ownership change as defined under Section 382 were to occur, our
ability to utilize our U.S. NOLs 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
U.S. NOLs. There can be no assurance that such ownership change will not occur in the future.
Expiration of our tax benefit preservation plan could 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 U.S. 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
that 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.
We will only be able to utilize our U.S. NOLs against the future taxable income generated by companies we acquire if we
are able to include the acquired companies in our U.S. consolidated tax return group.
We have in the past acquired companies and expect to do so in the future. Our ability to include acquired companies in our U.S.
consolidated tax return group is subject to the rules of Section 1504 of the U.S. Internal Revenue Code of 1986, as amended. If
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KINGSWAY FINANCIAL SERVICES INC.
it were ever determined that an acquired company did not qualify to be included in our U.S. consolidated tax return group, such
acquired company would be required to file a U.S. tax return separate and apart from our U.S. consolidated tax return group. In
that instance, the acquired company would be required to pay U.S. income tax on its taxable income despite the existence of our
U.S. NOLs, which would be a use of cash at the acquired company; furthermore, were the income tax obligation of the acquired
company in such instance to be greater than its available cash, we could be obligated to contribute cash to our subsidiary to meet
its income tax obligation. There can be no assurance that an acquired company will generate taxable income and, if an acquired
company does generate taxable income, there can be no assurance that the acquired company will be allowed to be included in
our U.S. consolidated tax return group.
COMPLIANCE RISK
If we fail to comply with applicable insurance and securities laws or regulatory requirements, our business, results of
operations, financial condition or cash flow could be adversely affected.
As a publicly traded holding company listed on the New York Stock Exchange, we are subject to numerous laws and regulations.
These laws and regulations delegate regulatory, supervisory and administrative powers to federal, provincial or state regulators.
In light of financial performance and a number of material transactions executed over the years, 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 or the mandates of our insurance regulators 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, could materially adversely affect our business, results of operations or
financial condition. It is not possible to predict the future affect 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.
Related to our recent acquisition of Penn and Prime, we acquired a reinsurance company domiciled in Turks and Caicos. This
reinsurance company is subject to the insurance statutes and regulatory requirements of the Turks and Caicos. We are planning
on the payment of dividends by the Turks and Caicos-domiciled reinsurance company in order to facilitate servicing the acquisition
financing we incurred to acquire Penn and Prime. The inability of the Turks and Caicos-domiciled reinsurance company to pay
dividends could materially affect our holding company cash flow and liquidity if we were required to perform under our guarantee
of the $10.0 million of acquisition financing incurred related to the acquisition of Penn and Prime.
Our business is subject to risks related to litigation.
In connection with our operations in the ordinary course of business, we 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 would be
incurred in connection with any of the various proceedings at this time, it is possible an individual action would result in a loss
having a material adverse effect on our business, results of operations or financial condition.
Our business is subject to risks related to regulatory actions.
The Department of Housing and Urban Development recently issued a final rule to eliminate the requirement that borrowers
purchase 10-year protection plans in order to qualify for certain mortgages on newly constructed single-family homes when the
home owner is utilizing an FHA loan. It is unclear what effect this ruling may have on our sale of homebuilder warranties. No
assurances can be given, however, that the effect on us of this ruling will not result in a material adverse effect on our business,
results of operations or financial condition.
Material weaknesses in our internal control over financial reporting could result in material misstatements in our
consolidated financial statements.
We are required to evaluate the effectiveness of the design and operation of our disclosure controls and procedures under the
Securities Exchange Act of 1934. We have in the past concluded that our internal controls over financial reporting related to
income tax accounting for non-routine transactions and the adoption of ASU 2014-09 were not effective. In the 2018 Annual
Report, we have identified the existence of material weaknesses in internal control over financial reporting related to the accounting
for and disclosure of certain complex and nonrecurring transactions; the accounting for and disclosure of certain other items;
monitoring the collectability of accounts receivable balances; other-than-temporary impairment on equity method investments;
and certain account reconciliations.
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KINGSWAY FINANCIAL SERVICES INC.
As discussed in Note 3, "Restatement of Previously Issued Financial Statements," to the Consolidated Financial Statements, we
have restated our consolidated financial statements as of and for the year ended December 31, 2017. Although we previously
remediated the material weakness related to income tax accounting for non-routine transactions and are actively engaged in
developing and implementing remediation plans as described Item 9A, Controls and Procedures, of this 2018 Annual Report, we
can provide no assurance that additional material weaknesses in our internal control over financial reporting will not be identified
in the future and that such material weaknesses, if identified, will not result in material misstatements in our consolidated financial
statements.
STRATEGIC RISK
The achievement of our strategic objectives is highly dependent on effective change management.
We have restructured our operating insurance subsidiaries, including exiting states and lines of business, placing subsidiaries into
voluntary run-off, terminating managing general agent relationships, hiring a new management team and ultimately selling Mendota
on October 18, 2018, with the objective of focusing on our Extended Warranty segment, 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 agile and focused business, success is dependent on management
effectively realizing the intended benefits. Change management may result in disruptions to the operations of the business or may
cause employees to act in a manner that is inconsistent with our objectives. Any of these events could negatively affect 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. 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 staff and to service our other holding company obligations, particularly the interest
expense burden of our remaining outstanding debt.
The highly competitive environment in which we operate could have an adverse effect on our business, results of operations
or financial condition.
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. In addition, the homebuilder warranty market in which we operate is comprised
of several competitors. There may also be other companies of which we are not aware that may be planning to enter the vehicle
service agreement and homebuilder warranty industries.
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, with an emphasis 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 affected by the loss of business
to competitors offering vehicle service agreements and homebuilder warranties at lower prices.
Engaging in acquisitions involves risks, and, if we are unable to effectively manage these risks, our business could 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 potential 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 customers or key employees of acquired companies.
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KINGSWAY FINANCIAL SERVICES INC.
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
could 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 potential 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.
Our company has an executive officer and former executive officers, currently contracted to us under advisory agreements,
who also serve as directors and executive officers for 1347 Property Insurance Holdings, Inc., Atlas Financial Holdings,
Inc., Limbach Holdings, Inc. and Itasca Capital Ltd., entities in which we have held investments, which could lead to
conflicting interests.
As a result of our having previously spun off 1347 Property Insurance Holdings, Inc. ("PIH") and Atlas Financial Holdings, Inc.
("Atlas"); formed 1347 Capital Corp., which later entered into a business combination with Limbach Holdings, Inc. ("Limbach");
and invested in Itasca Capital Ltd. ("ICL"), we have an executive officer and former executive officers, currently contracted to us
under advisory agreements, who also serve as directors for PIH, Atlas, Limbach and ICL and who serve as executive officers for
ICL. Our executive officers, former executive officers currently contracted to us under advisory agreements and members of our
Company's board of directors have fiduciary duties to our stockholders; likewise, persons who serve in similar capacities at PIH,
Atlas, Limbach and ICL have fiduciary duties to those companies’ stockholders. We may find, though, the potential for a conflict
of interest if our Company and one or more of these other companies pursue acquisitions, investments and other business
opportunities that may be suitable for each of us. Our executive officers and former executive officers currently contracted to us
under advisory agreements who find themselves in these multiple roles may, as a result, have conflicts of interest or the appearance
of conflicts of interest with respect to matters involving or affecting more than one of the companies to which they owe fiduciary
duties. Furthermore, our executive officers and former executive officers currently contracted to us under advisory agreements
who find themselves in these multiple roles own stock options, shares of common stock and other securities in some of these
entities. These ownership interests could create, or appear to create, potential conflicts of interest when the applicable individuals
are faced with decisions that could have different implications for our Company and these other entities. Our Audit Committee
reviews potential conflicts that may arise on a case-by-case basis, keeping in mind the applicable fiduciary duties owed by the
executive officers and directors of each entity. From time to time, we may enter into transactions with or participate jointly in
investments with PIH, Atlas, Limbach or ICL. There can be no assurance that we will not create new situations where our directors
or executive officers serve as directors or executive officers in future investment holdings of our Company.
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 could adversely affect our financial condition.
Our provisions for unpaid loss and loss adjustment expenses at Amigo 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;
16
KINGSWAY FINANCIAL SERVICES INC.
•
•
•
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 affect our ability to accurately assess the risks of the policies that we write. In addition, there may be
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 and that such unfavorable development will not
have a material adverse effect on our business, results of operations or financial condition.
Our Extended Warranty subsidiaries' deferred service fees may be inadequate, which would result in a reduction in our
net income and could adversely affect our financial condition.
Our Extended Warranty 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 and that such unfavorable re-estimations will not have a material adverse
effect on our business, results of operations or financial condition. In addition, we have in the past, and may in the future, acquire
companies that 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 credit unions and automobile sales could adversely affect 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 that offer similar products exclusively through credit unions. Loss of all or a
substantial portion of our existing credit union relationships; a significant decline in membership in our existing credit union
relationships; or a significant decline in new and used automobile sales could have a material adverse effect on our business, results
of operations or financial condition.
Our reliance on homebuilders and new home sales could adversely affect our ability to maintain business.
We market and distribute our core home warranty products through homebuilders throughout the United States. As a result, we
rely heavily on these homebuilders to generate new business. The builders are part of the new home construction industry, which
is cyclical and closely correlated with large macro-economic factors, such as interest and unemployment rates, wage growth, and
government regulation. We bill certain builders at the end of the policy period, which could extend over more than one year.
During economic downturns, our customers build fewer homes and also reduce operating expenses by insourcing key functions,
such as warranty administration; in turn, our revenue has the propensity to decline during these times. Loss of all or a substantial
portion of our existing homebuilder relationships; a significant decline in new home sales; or collection risk due to unbilled
accounts receivable could have a material adverse effect on our business, results of operations or financial condition.
Our reliance on a limited number of warranty and maintenance support clients and customers could adversely affect 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 or financial condition.
17
KINGSWAY FINANCIAL SERVICES INC.
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 affect 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 affect 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
affect 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 affected. Any of these circumstances could adversely affect 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 or financial condition depend on our ability to price accurately for a wide variety of risks. Adequate rates
are necessary to generate revenues sufficient to pay 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 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 or financial condition could be adversely affected by the results of our voluntary run-off of our
insurance subsidiary.
The Company currently has Amigo operating in voluntary run-off. Our success at managing this run-off is highly dependent upon
proper claim-handling, the outcomes of the remaining open claims 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-off, 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 upon the outcomes of the remaining open claims, some of which may be volatile. During
2019, Amigo agreed to settle three related open claims for approximately $0.8 million in excess of the provision for unpaid loss
and loss adjustment expenses carried by Amigo for these three open claims. This amount will be reported in our consolidated
statement of operations for the year ended December 31, 2019. We are also dependent on the continuing availability of the
necessary liquidity to settle claims properly. See the "Liquidity and Capital Resources" section of MD&A for additional detail
regarding the voluntary run-off of 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 could 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,
or the inability to identify, hire and retain other highly qualified personnel in the future, could adversely affect our results of
operations.
Item 1B. Unresolved Staff Comments
None.
18
KINGSWAY FINANCIAL SERVICES INC.
Item 2. Properties
Leased Properties
Extended Warranty leases facilities with an aggregate square footage of approximately 25,836 at four locations in three states.
The latest expiration date of the existing leases is in July 2026.
The Company leases a facility for its corporate office with an aggregate square footage of approximately 6,338 at one location in
one state. The expiration date of the existing lease is in January 2023.
The properties described above are in good condition. We consider our office facilities suitable and adequate for our current levels
of operations.
Owned Properties
Leased Real Estate owns the Real Property, which is subject to a long-term triple net lease agreement. The Real Property includes
rail car tracks which provide rail car storage spaces and has 72 miles of double-ended rail track. The Real Property also contains
a 5,760 square foot office building with an attached observation tower comprised of 1,150 square feet.
Investment Properties
The Company owns six investment properties subject to long-term triple net lease agreements. These properties comprise 57,360
square feet leased to tenants in the distribution and retail sectors.
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 reasonably the loss,
or range of loss, if any, that would be incurred in connection with any of the various proceedings at this time, it is possible an
individual action could result in a loss having a material adverse effect on the Company's business, results of operations or financial
condition.
Item 4. Mine Safety Disclosures
Not applicable.
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 New York Stock Exchange ("NYSE") under the trading symbol "KFS."
19
KINGSWAY FINANCIAL SERVICES INC.
The following table sets forth, for the calendar quarters indicated, the high and low sales price for our common shares as reported
on the NYSE.
2018
Quarter 4
Quarter 3
Quarter 2
Quarter 1
2017
Quarter 4
Quarter 3
Quarter 2
Quarter 1
Shareholders of Record
$
NYSE
High - US$
Low - US$
$
2.87
3.30
4.65
5.85
6.05
6.20
6.30
6.50
1.87
2.40
2.75
3.65
4.95
5.45
5.35
5.40
As of February 26, 2020, the closing sales price of our common shares as reported by the NYSE was $1.59 per share.
As of February 27, 2020, we had 21,866,959 common shares issued and outstanding, held by approximately 3,300 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.
Securities Authorized for Issuance under Equity Compensation Plans
The information required related to securities authorized for issuance under equity compensation plans is included in Part III,
Item 12 of this 2018 Annual Report.
Recent Sales of Unregistered Securities
During the year ended December 31, 2018, we did not have any unregistered sales of our equity securities.
Issuer Purchases of Equity Securities
During the year ended December 31, 2018, we did not have any repurchases of our equity securities.
20
KINGSWAY FINANCIAL SERVICES INC.
Performance Graph
The following stock performance graph shows a comparison of cumulative total shareholder return on the Company's common
stock for the period beginning on December 31, 2013 and ending on December 31, 2018 with cumulative total return of the Russell
MicroCap Index and the SNL MicroCap U.S. Financial Services Index. Kingsway is not a constituent of either of these two
indices. The graph shows the change in value of an initial one hundred dollar investment over the period indicated, assuming all
dividends have been reinvested.
Company/Index
Kingsway
Russell MicroCap
SNL Micro Cap U.S. Financial Services
Years ended December 31,
2013
2014
2015
2016
2017
2018
$
$
$
100 $
100 $
100 $
142 $
104 $
99 $
117 $
98 $
73 $
160 $
118 $
72 $
129 $
134 $
97 $
74
116
86
21
KINGSWAY FINANCIAL SERVICES INC.
Item 6. Selected Financial Data
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.
22
KINGSWAY FINANCIAL SERVICES INC.
Management's Discussion and Analysis
Item 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS
The following discussion and analysis of our financial condition and results of operations should be read together with the
Consolidated Financial Statements included in Part II, Item 8 of this 2018 Annual Report and reflects the effects of the error
corrections and previously identified immaterial accounting adjustments discussed in Note 3, "Restatement of Previously Issued
Financial Statements," to the Consolidated Financial Statements.
OVERVIEW
Kingsway is a Delaware holding company with operating subsidiaries located in the United States. The Company owns or controls
subsidiaries primarily in the extended warranty, asset management and real estate industries. Kingsway conducts its business
through the following two reportable segments: Extended Warranty and Leased Real Estate.
The Company previously conducted its business through a third reportable segment, Insurance Underwriting. Insurance
Underwriting included the following subsidiaries of the Company: Mendota Insurance Company, Mendakota Insurance Company,
Mendakota Casualty Company, Kingsway Amigo Insurance Company ("Amigo") and Kingsway Reinsurance Corporation
("Kingsway Re"). Mendota Insurance Company, Mendakota Insurance Company and Mendakota Casualty Company are referred
to collectively herein as "Mendota." On July 16, 2018, the Company announced that it had entered into a definitive agreement to
sell Mendota. On October 18, 2018, the Company announced that the sale was completed. As a result, Mendota has been classified
as discontinued operations and the results of their operations are reported separately for all periods presented. As a consequence
of classifying Mendota as discontinued operations, the remaining composition of the Insurance Underwriting segment no longer
meets the criteria of a reportable segment. As such, all segmented information has been restated to exclude the Insurance
Underwriting segment for all periods presented. The operating results of Amigo and Kingsway Re, previously included in the
Insurance Underwriting segment, are now included in Other income and expenses not allocated to segments, net.
Extended Warranty includes the following subsidiaries of the Company: IWS Acquisition Corporation ("IWS"), Trinity Warranty
Solutions LLC ("Trinity") and Professional Warranty Service Corporation ("PWSC"). Throughout this 2018 Annual Report, the
term "Extended Warranty" is used to refer to this segment.
IWS is a licensed motor vehicle service agreement company and is a provider of after-market vehicle protection services distributed
by credit unions in 23 states and the District of Columbia to their members.
Trinity sells heating, ventilation, air conditioning ("HVAC"), standby generator, commercial LED lighting and refrigeration
warranty products and provides equipment breakdown and maintenance support services to companies across the United States.
As a seller of warranty products, Trinity markets and administers product warranty contracts for certain new and used products in
the HVAC, standby generator, commercial LED lighting and refrigeration industries throughout the United States. Trinity acts as
an agent on behalf of the third-party insurance companies that underwrite and guaranty these warranty contracts. Trinity does not
guaranty the performance underlying the warranty contracts it sells. 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.
PWSC sells new home warranty products and provides administration services to homebuilders and homeowners across the United
States. PWSC distributes its products and services through an in-house sales team and through insurance brokers and insurance
carriers throughout all states except Alaska and Louisiana.
Leased Real Estate includes the Company's subsidiary, CMC Industries, Inc. ("CMC"). CMC owns, through an indirect wholly
owned subsidiary (the "Property Owner"), a parcel of real property consisting of approximately 192 acres located in the State of
Texas (the "Real Property"), which is subject to a long-term triple net lease agreement. The Real Property is also subject to a
mortgage, which is recorded as note payable in the consolidated balance sheets (the "Mortgage"). Throughout this 2018 Annual
Report, the term "Leased Real Estate" is used to refer to this segment.
NON U.S.-GAAP FINANCIAL MEASURE
Throughout this 2018 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 present segment operating income as a non-U.S. GAAP financial measure, which we believe is valuable in managing
our business and drawing comparisons to our peers. Below is a definition of our non-U.S. GAAP measure and its relationship to
U.S. GAAP.
23
KINGSWAY FINANCIAL SERVICES INC.
Management's Discussion and Analysis
Segment Operating Income
Segment operating 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 presented in the consolidated statements of operations
are not subtotaled by segment; however, this information is available in total and by segment in Note 28, "Segmented Information,"
to the Consolidated Financial Statements, regarding reportable segment information. The nearest comparable U.S. GAAP measure
to segment operating income is loss from continuing operations before income tax expense (benefit) that, in addition to segment
operating income, includes net investment income, net realized (losses) gains, gain on change in fair value of equity investments,
loss on change in fair value of limited liability investments, at fair value, net change in unrealized loss on private company
investments, interest expense not allocated to segments, other income and expenses not allocated to segments, net, amortization
of intangible assets, contingent consideration benefit, loss on change in fair value of debt, gain on disposal of subsidiary and equity
in net (loss) income of investee. A reconciliation of segment operating income to loss from continuing operations before income
tax expense (benefit) for the years ended December 31, 2018 and December 31, 2017 is presented in Table 1 of the "Results of
Continuing Operations" section of MD&A.
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 the reported amounts and classification of assets and liabilities, revenues and expenses, and the related
disclosures of contingent assets and liabilities in the consolidated financial statements and accompanying notes. 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; impairment assessment of investments; valuation of limited liability investments, at
fair value; valuation of real estate investments; valuation of deferred income taxes; valuation of mandatorily redeemable preferred
stock; valuation and impairment assessment of intangible assets; goodwill recoverability; deferred acquisition costs; fair value
assumptions for subordinated debt obligations; and revenue recognition.
Provision for Unpaid Loss and Loss Adjustment Expenses
Overview
The Company records a provision for 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.
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 unfavorable development or a deficiency and will reduce
net income while an adjustment that decreases the provision is known as 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
external reserving actuaries.
24
KINGSWAY FINANCIAL SERVICES INC.
Management's Discussion and Analysis
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 department
personnel and independent adjusters retained to handle individual claims; the quality of the data used for projection purposes;
existing claims management practices, including claim-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 the Company’s external reserving actuaries in their analyses to estimate
ultimate claim liabilities. Such data is occasionally supplemented with external data as available and when appropriate.
Our Company’s external reserving actuaries use the following generally accepted actuarial loss and loss adjustment expenses
reserving methods in our analysis, for each coverage or segment that we analyze:
•
•
•
Paid Loss Development - we use historical loss and loss adjustment expense payments over discrete periods of time to
estimate future loss and loss adjustment expense payments. Paid development methods assume that the patterns of paid
loss and loss adjustment expenses that occurred in past periods will be similar to loss and loss adjustment expense payment
patterns that will occur in future periods.
Incurred Loss Development - we use historical case incurred loss and loss adjustment expenses (the sum of cumulative
loss and loss adjustment expense payments plus outstanding unpaid case losses) over discrete periods of time to estimate
future loss and loss adjustment expenses. Incurred development methods assume that the case loss and loss adjustment
expenses reserving practices are consistently applied over time.
Frequency and Severity - we use historical claim count development over discrete periods of time to estimate future claim
counts. We divide projected ultimate claim counts by an exposure base (earned premiums or exposures), select expected
claim frequencies from the results, and adjust them for trends based on internal and external information. Concurrently,
we divide projected ultimate losses by the projected ultimate claim counts to select expected loss severities. We use
internal and external information to trend the severities and combine them with the trended, projected frequencies to
develop ultimate loss projections.
The methods above all calculate an estimate of total ultimate losses. Our provision for loss and loss adjustment expenses is
calculated by subtracting total paid losses from our estimate of total ultimate losses. Our estimate for IBNR is calculated by
subtracting case reserves from our 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 assumptions being meaningful for all coverages or segments.
For example, Paid Loss Development does not make use of case reserves, and can be more stable when there are changes to the
case reserving process. Frequency and Severity, by estimating the frequency separately from severity, can assist in understanding
the underlying dynamics when either frequency or severity is changing substantially.
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 a particular evaluation date.
We monitor the actual emergence of loss and loss adjustment expenses data and compare it to the expected emergence implied by
our booked estimates. Differences in these are part of our considerations for whether it is appropriate to modify our assumptions
for developing the estimated provision for unpaid loss and loss adjustment expenses.
We review the adequacy of the provision for unpaid loss and loss adjustment expenses quarterly. For our year-end analysis, we
re-estimate the ultimate losses for each coverage, by accident year. This involves performing a complete update of the historical
development factors used in our analysis, incorporating the experience of the most recent calendar year. On a quarterly basis, we
perform a more limited review, which can entail, for example, a comparison of the expected losses to be paid during the quarter
versus actual payments, or other similar comparisons to determine the extent to which a given segment is performing as expected.
In some cases, a re-estimation (similar to the year-end analysis) may be determined to be useful as part of a quarterly analysis,
and we may make adjustments to ultimate losses in response to the results of this analysis. We adjust carried unpaid loss and loss
25
KINGSWAY FINANCIAL SERVICES INC.
Management's Discussion and Analysis
adjustment expenses as we learn additional information, and reflect these adjustments in the accounting periods in which they are
determined.
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. Significant structural changes to the available data, product mix or organization
can materially affect 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
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 unpaid loss and loss adjustment expenses.
Our estimate of the provision for unpaid loss and loss adjustment expenses is proposed each quarter by our external reserving
actuaries and approved by management. We begin the process each quarter by responding to detailed information requests submitted
by our external reserving actuaries. Upon completion of their estimation analysis of the provision for unpaid loss and loss adjustment
expenses, the results are discussed with management. As part of this discussion, the analyses supporting the actuarial estimates
of IBNR by line of business are reviewed. The external reserving actuaries also present explanations supporting any changes to
the underlying assumptions used to calculate the indicated estimates. A review of the resulting variance between the indicated
provision for unpaid loss and loss adjustment expenses and the carried provision for unpaid loss and loss adjustment expenses
takes place. Management engages in a discussion with the external reserving actuaries and supplies supplemental information in
support of assumptions it believes should be challenged. The external reserving actuaries review the supplemental information
and return with their recommendation in regards to the provision for unpaid loss and loss adjustment expenses that should be
booked to reflect their analytical assessment and view of estimation risk. After discussion of these analyses and all relevant risk
factors, we determine whether the carried provision for unpaid loss and loss adjustment expenses requires adjustment.
Our external reserving actuaries have also developed as part of their actuarial reports to the Company an estimated range around
the carried provision at December 31, 2018 of $2.1 million for unpaid loss and loss adjustment expenses for our property and
casualty companies. Their reports indicate that a carried provision for unpaid loss and loss adjustment expenses anywhere between
$1.8 million and $2.5 million for the Company at December 31, 2018 would fall within their reasonable range of estimation. This
range does not present a forecast of future redundancy or deficiency since actual development of future paid losses related to the
current provision for unpaid loss and loss adjustment expenses may be affected by many variables. The provision for unpaid loss
and loss adjustment expenses recorded at December 31, 2018 represents our best estimate of the ultimate amounts that will be
paid.
To the extent that the ultimate paid losses are higher or lower than the provision for unpaid loss and loss adjustment expenses
recorded by the Company at December 31, 2018, the differences would be recorded in the Company’s consolidated statements of
operations in the accounting periods in which they are determined. There can be assurance that such differences would not be
material.
Valuation of Fixed Maturities and Equity Investments
Our equity investments, including warrants, are recorded at fair value with changes in fair value recognized in net loss in 2018.
Prior to 2018, changes in fair value of equity investments were recognized in other comprehensive loss. See Note 4, "Recently
Issued Accounting Standards," to the Consolidated Financial Statements, for further details regarding the adoption of ASU 2016-01,
Financial Instruments-Overall (Subtopic 825-10): Recognition and Measurement of Financial Assets and Financial Liabilities
("ASU 2016-01"). Fair value for our equity investments are determined using quoted market values based on latest bid prices,
where active markets exist, or models based on significant market observable inputs, where no active markets exist.
For fixed maturities, we use observable inputs such as quoted prices for similar assets in active markets; quoted prices for identical
or similar assets in markets that are inactive; or valuations based on models where the significant inputs are observable or can be
corroborated by observable market data. We do not have any fixed maturities and equity investments in our portfolio that require
us to use unobservable inputs. The Company engages a third-party vendor who utilizes third-party pricing sources and primarily
employs a market approach to determine the fair values of our fixed maturities. The market approach includes primarily obtaining
prices from independent third-party pricing services as well as, to a lesser extent, quotes from broker-dealers. Our third-party
vendor also monitors market indicators, as well as industry and economic events, to ensure pricing is appropriate. All classes of
our fixed maturities are valued using this technique. We have obtained an understanding of our third-party vendor’s valuation
methodologies and inputs. Fair values obtained from our third-party vendor are not adjusted by the Company.
26
KINGSWAY FINANCIAL SERVICES INC.
Management's Discussion and Analysis
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 using the interest method and
charged or credited to net investment income.
Impairment Assessment of Investments
Prior to the adoption of ASU 2016-01, equity investments were considered available-for-sale and were included in the analysis of
other-than-temporary impairments. Following the adoption of ASU 2016-01 beginning with the first quarter of 2018, the Company
includes only its investments in fixed maturities and investments in private companies in its quarterly impairment analysis.
The establishment of an other-than-temporary impairment on an investment requires a number of judgments and estimates.
We perform a quarterly analysis of our investments classified as available-for-sale and our limited liability investments to determine
if declines in market value are other-than-temporary. The analysis for available-for-sale investments 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 management believes may affect 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 analysis performed by the Company to determine declines in market value that are other-than-temporary, there
were no write downs for other-than-temporary impairment related to available-for-sale investments recorded for the years ended
December 31, 2018 and December 31, 2017. As a result of the analysis performed with respect to limited liability investments,
at fair value, the Company recorded impairments of $0.1 million and $0.1 million, which are included in loss on change in fair
value of limited liability investments, at fair value in the consolidated statements of operations, for the years ended December 31,
2018 and December 31, 2017, respectively.
We perform a quarterly analysis of our investments in private companies. The analysis includes some or all of the following
procedures, as applicable:
•
•
•
•
•
•
the opinions of external investment and portfolio managers;
the financial condition and prospects of the investee;
recent operating trends and forecasted performance of the investee;
current market conditions in the geographic area or industry in which the investee operates;
changes in credit ratings; and
changes in the regulatory environment.
As a result of the analysis performed with respect to investments in private companies, the Company recorded impairments of
$1.0 million and $2.0 million for the years ended December 31, 2018 and December 31, 2017, respectively, which are included
in net change in unrealized loss on private company investments in the consolidated statements of operations.
27
KINGSWAY FINANCIAL SERVICES INC.
Management's Discussion and Analysis
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. As a result of the
analysis performed with respect to investment in investee, the Company recorded impairments of $1.7 million and zero for the
years ended December 31, 2018 and December 31, 2017, respectively, which are included in equity in net (loss) income of investee
in the consolidated statements of operations.
Valuation of Limited Liability Investments, at Fair Value
Limited liability investments, at fair value represent the Company's investment in 1347 Investors LLC ("1347 Investors") as well
as the underlying investments of the Company’s consolidated entities Net Lease Investment Grade Portfolio LLC ("Net Lease")
and Argo Holdings Fund I, LLC ("Argo Holdings"). The Company accounts for these investments at fair value with changes in
fair value reported in the consolidated statements of operations. The Company owns 26.7% of the outstanding units of 1347
Investors. The fair value of this investment is calculated based on a model that distributes the net equity of 1347 Investors to all
classes of membership interests. The model uses quoted market prices and significant market observable inputs. Net Lease owns
investments in limited liability companies that hold investment properties. The fair value of Net Lease's investments is based upon
the net asset values of the underlying investments companies as a practical expedient to estimate fair value. Argo Holdings makes
investments in limited liability companies and limited partnerships that hold investments in search funds and private operating
companies. The fair value of Argo Holdings' limited liability investments that hold investments in search funds is based on the
initial investment in the search funds. The fair value of Argo Holdings' limited liability investments that hold investments in private
operating companies is valued using a market approach. Refer to Note 29, "Fair Value of Financial Instruments," to the Consolidated
Financial Statements for further information.
Valuation of Real Estate Investments
The fair value of real estate investments involves a combination of the market and income valuation techniques. Under this
approach, a market-based capitalization rate is derived from comparable transactions, adjusted for any unique characteristics of
each asset, and applies this rate to the asset under consideration. The cap rates used during underwriting and subsequent valuation
at year-end incorporate the consideration of risks of vacancy and collection loss, administrative costs of owning net leased assets
and possible capital expenditures that could be determined a landlord expense.
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, 2018, the Company maintains a valuation allowance of $171.5 million, all 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 losses generated from 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 affect 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, all or a portion of the valuation allowance would be reversed in the period
that such a conclusion was reached.
28
KINGSWAY FINANCIAL SERVICES INC.
Management's Discussion and Analysis
Valuation of Mandatorily Redeemable Preferred Stock
Mandatorily redeemable preferred stock is recorded at the time of issuance based upon the gross proceeds of the offering less (i)
proceeds of the offering allocated to additional paid-in capital based upon the relative fair values of equity-classified warrants
issued as part of the offering and the preferred stock without the warrants; (ii) proceeds of the offering allocated to additional paid-
in capital based upon the calculation of a beneficial conversion feature; and (iii) costs of the offering allocated to the preferred
stock. The discount to the carrying value of the preferred stock created by the allocation of proceeds to the warrants and a beneficial
conversion feature and the allocation of offering costs to the preferred stock are accreted over time as dividend expense. Additional
information regarding our mandatorily redeemable preferred stock is included in Note 25, "Class A Preferred Stock," to the
Consolidated Financial Statements.
Valuation and Impairment Assessment of Intangible Assets
Intangible assets are recorded at their estimated fair values at the date of acquisition. Intangible assets with definite useful lives
consist of vehicle service agreements in-force, database, customer relationships, in-place lease and non-compete agreement.
Intangible assets with definite useful lives are reviewed for impairment whenever events or changes in circumstances indicate that
the carrying amount of an asset or asset group may not be recoverable. If circumstances require that a definite-lived intangible
asset be tested for possible impairment, we first compare the undiscounted cash flows expected to be generated by that definite-
lived intangible asset to its carrying amount. If the carrying amount of the definite-lived intangible asset is not recoverable on an
undiscounted cash flow basis, an impairment is recognized to the extent that the carrying amount exceeds its fair value.
Indefinite-lived intangible assets consist of a tenant relationship and trade names. 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.
No impairment charges were recorded against intangible assets in 2018 or 2017. Additional information regarding our intangible
assets is included in Note 13, "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
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 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. For reporting units with a
negative book value, qualitative factors are evaluated to determine whether it is necessary to perform the second step of the goodwill
impairment test. No impairment charges were recorded against goodwill in 2018 or 2017. Additional information regarding our
goodwill is included in Note 12, "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 and agency expenses related to issuing vehicle service
agreements, are deferred and charged against income ratably over the terms of the related vehicle service agreements. Management
regularly reviews the categories of acquisition costs that are deferred and assesses the recoverability of this asset.
29
KINGSWAY FINANCIAL SERVICES INC.
Management's Discussion and Analysis
Fair Value Assumptions for Subordinated Debt Obligations
Our subordinated debt is measured and reported at fair value. The fair value of the subordinated debt is calculated using a model
based on significant market observable inputs and inputs developed by a third-party. These inputs include credit spread assumptions
developed by a third-party and market observable swap rates.
Revenue Recognition
Refer to Note 2, "Summary of Significant Accounting Policies," and Note 20, "Revenue from Contracts with Customers," to the
Consolidated Financial Statements for information about our revenue recognition accounting policies.
30
KINGSWAY FINANCIAL SERVICES INC.
Management's Discussion and Analysis
RESULTS OF CONTINUING OPERATIONS
A reconciliation of total segment operating income to net loss for the years ended December 31, 2018 and December 31, 2017 is
presented in Table 1 below:
Table 1 Segment Operating Income for the Years Ended December 31, 2018 and December 31, 2017
For the years ended December 31 (in thousands of dollars)
Segment operating income
Extended Warranty
Leased Real Estate
Total segment operating income
Net investment income
Net realized (losses) gains
Gain on change in fair value of equity investments
Loss on change in fair value of limited liability investments, at fair value
Net change in unrealized loss on private company investments
Interest expense not allocated to segments
Other income and expenses not allocated to segments, net
Amortization of intangible assets
Contingent consideration benefit
Loss on change in fair value of debt
Gain on disposal of subsidiary
Equity in net (loss) income of investee
Loss from continuing operations before income tax expense (benefit)
Income tax expense (benefit)
(Loss) income from continuing operations
Loss on liquidation of subsidiary, net of taxes
Income (loss) from discontinued operations, net of taxes
(Loss) gain on disposal of discontinued operations, net of taxes
Net loss
2018
2017
Change
4,215
2,485
6,700
2,957
(17)
381
(7,393)
(1,629)
(7,407)
(8,963)
(2,376)
—
(1,720)
17
(2,499)
(21,949)
315
(22,264)
—
1,064
(7,136)
(28,336)
3,680
3,099
6,779
7,087
306
—
(1,832)
(758)
(6,348)
(10,503)
(1,085)
212
(8,487)
—
2,115
(12,514)
(16,688)
4,174
(494)
(16,306)
1,017
(11,609)
535
(614)
(79)
(4,130)
(323)
381
(5,561)
(871)
(1,059)
1,540
(1,291)
(212)
6,767
17
(4,614)
(9,435)
17,003
(26,438)
494
17,370
(8,153)
(16,727)
(Loss) Income from Continuing Operations, Net Loss and Diluted Loss per Share
For the year ended December 31, 2018, we incurred a loss from continuing operations of $22.3 million ($1.13 per diluted share)
compared to income from continuing operations of $4.2 million (loss of $0.05 per diluted share) for the year ended December 31,
2017. The loss from continuing operations for the year ended December 31, 2018 is primarily attributable to interest expense not
allocated to segments, other income and expenses not allocated to segments, net, amortization of intangible assets, loss on change
in fair value of limited liability investments, at fair value, loss on change in fair value of debt and equity in net loss of investee,
partially offset by operating income in Extended Warranty and Leased Real Estate. The income from continuing operations for
the year ended December 31, 2017 is primarily attributable to operating income in Extended Warranty and Leased Real Estate,
net investment income, gain on change in fair value of limited liability investments, at fair value, equity in net income of investee
and income tax benefit, partially offset by interest expense not allocated to segments, other income and expenses not allocated to
segments, net, amortization of intangible assets and loss on change in fair value of debt.
For the year ended December 31, 2018, we reported net loss of $28.3 million ($1.41 per diluted share) compared to $11.6 million
($0.79 per diluted share) for the year ended December 31, 2017.
31
KINGSWAY FINANCIAL SERVICES INC.
Management's Discussion and Analysis
Extended Warranty
The Extended Warranty service fee and commission income increased 25.6% to $38.3 million for the year ended December 31,
2018 compared with $30.5 million for the year ended December 31, 2017. The increase in service fee and commission income is
primarily reflective of the inclusion of PWSC for the full year of 2018 following its acquisition effective October 12, 2017. PWSC
service fee and commission income was $7.3 million and $2.5 million for the years ended December 31, 2018 and December 31,
2017, respectively. The increase in service fee and commission income is also partially due to increases at both IWS and Trinity.
IWS experienced increased sales of vehicle service agreements due to higher automobile sales, improved penetration at its existing
partners and the development of new credit union relationships. Trinity experienced increased sales to existing customers of both
its maintenance support and warranty products, in addition to sales to new customers of its warranty products.
The Extended Warranty operating income was $4.2 million for the year ended December 31, 2018 compared with $3.7 million
for the year ended December 31, 2017. The increase in operating income is due to the inclusion of PWSC for the full year of
2018, as noted above, as well as increased operating income at Trinity and IWS. The increased operating income at Trinity and
IWS reflects improved revenues at both Trinity and IWS, partially offset by the related increases in cost of services sold at Trinity,
claims authorized on vehicle service agreements at IWS and commissions and general and administrative expenses at both Trinity
and IWS, for the year ended December 31, 2018 compared to the same period in 2017.
Leased Real Estate
Leased Real Estate rental income was $13.4 million for the year ended December 31, 2018 compared to $13.4 million for the year
ended December 31, 2017. The rental income is derived from CMC's long-term triple net lease. The Leased Real Estate operating
income was $2.5 million for the year ended December 31, 2018 compared to $3.1 million for the year ended December 31, 2017.
The decrease in operating income for the year ended December 31, 2018 is due to increased legal expenses, compared to the same
period in 2017. Leased Real Estate recorded legal expense of $0.7 million for the year ended December 31, 2018 compared with
zero for the year ended December 31, 2017. Leased Real Estate operating income includes interest expense of $6.2 million and
$6.3 million for the years ended December 31, 2018 and 2017, respectively. See "Investments" section below for further discussion.
Net Investment Income
Net investment income was $3.0 million in 2018 compared to $7.1 million in 2017. The decrease in 2018 is primarily due to (i)
the difference between the $0.2 million net investment income recorded during 2018 related to the Company’s limited liability
investments compared to the $1.6 million net investment income recorded during 2017 related to the Company’s limited liability
investments and (ii) the difference between the $1.2 million net investment income recorded during 2018 as a result of distributions
received by Net Lease compared to the $4.0 million net investment income recorded during 2017 as a result of distributions received
by Net Lease.
Net Realized (Losses) Gains
The Company incurred net realized losses of $0.0 million in 2018 compared to net realized gains of $0.3 million in 2017. The net
realized losses in 2018 resulted primarily from the sale of a limited liability investment as one part of a broader set of arrangements
with certain former officers of the Company (refer to Note 30, "Related Parties," to the Consolidated Financial Statements, for
further discussion) offset by net realized gains recorded by Argo Holdings. The net realized gains in 2017 resulted primarily from
the sale of a limited liability investment.
Gain on Change in Fair Value of Equity Investments
Gain on change in fair value of equity investments was $0.4 million in 2018 compared to zero in 2017. As further discussed in
Note 4, "Recently Issued Accounting Standards," to the Consolidated Financial Statements, effective January 1, 2018, the Company
adopted ASU 2016-01. As a result, all changes in the fair value of equity investments are now recognized in net income (loss).
The gain on change in fair value of equity investments for the year ended December 31, 2018 includes realized gains of $1.5
million on equity investments sold during 2018 and unrealized losses of $1.1 million on equity investments held as of December 31,
2018.
Loss on Change in Fair Value of Limited Liability Investments, at Fair Value
Loss on change in fair value of limited liability investments, at fair value was $7.4 million in 2018 compared to $1.8 million in
2017. The change from 2017 to 2018 is primarily explained by the difference between the $10.1 million fair value loss recorded
during 2018 related to 1347 Investors compared to the $0.4 million fair value loss recorded during 2017 related to 1347 Investors.
Limited liability investments, at fair value include the Company's investment in 26.7% of the outstanding units of 1347 Investors,
32
KINGSWAY FINANCIAL SERVICES INC.
Management's Discussion and Analysis
which owns common stock in Limbach Holdings, Inc. ("Limbach"), a publicly traded company. The Company's investment in
1347 Investors is accounted for at fair value and reported as limited liability investments, at fair value in the consolidated balance
sheets, with any changes in fair value to be reported in loss on change in fair value of limited liability investments, at fair value
in the consolidated statements of operations. As of December 31, 2018 and December 31, 2017, the carrying value of the Company's
limited liability investment, at fair value related to 1347 Investors was $0.2 million and $10.3 million, respectively. The fair value
of this investment is calculated based on a model that distributes the net equity of 1347 Investors to all classes of membership
interests. The model uses quoted market prices and significant market observable inputs. The most significant input to the model
is the observed stock price of Limbach common stock, which was $13.83 on December 31, 2017 and $3.68 on December 31, 2018,
with 75% of the decline in the Limbach common stock price occurring during the fourth quarter of 2018. Due to the decline in
Limbach stock price, particularly during the fourth quarter of 2018, and the resulting effect of the model on the Company’s
membership interests in 1347 Investors, the Company recorded a fair value loss of $10.1 million related to its investment in 1347
Investors for the year ended December 31, 2018 compared to a fair value loss of $0.4 million related to this investment for the
year ended December 31, 2017. The change between 2017 and 2018 in loss on change in fair value of limited liability investments,
at fair value was partially offset by fair value gains of $1.5 million and $1.2 million recorded during 2018 by Argo Holdings and
Net Lease, respectively, compared to fair value losses of $0.1 million and $1.3 million recorded during 2017 by Argo Holdings
and Net Lease, respectively.
Net Change in Unrealized Loss on Private Company Investments
Net change in unrealized loss on private company investments was an unrealized loss of $1.6 million in 2018 compared to $0.8
million in 2017. The increased loss in 2018 reflects a net increase in impairments and negative fair value adjustments on private
company investments during the year ended December 31, 2018 compared to the year ended December 31, 2017.
Interest Expense not Allocated to Segments
Interest expense not allocated to segments for 2018 was $7.4 million compared to $6.3 million in 2017. The increase in 2018 is
primarily attributable to generally higher London interbank offered interest rates for three-month U.S. dollar deposits ("LIBOR")
during the year ended December 31, 2018 compared to the year ended December 31, 2017. The Company's subordinated debt
bears interest at the rate of LIBOR, plus spreads ranging from 3.85% to 4.20%. The increase is also reflective of the inclusion of
interest expense on the Company’s bank loan incurred as part of its acquisition of PWSC effective October 12, 2017.
Other Income and Expenses not Allocated to Segments, Net
Other income and expenses not allocated to segments was a net expense of $9.0 million in 2018 compared to $10.5 million in
2017. The following items primarily contributed to Other income and expenses not allocated to segments, net.
Total stock-based compensation, net of forfeitures, was a benefit of $1.7 million and an expense of $1.2 million for the years ended
December 31, 2018 and December 31, 2017, respectively. During the third quarter of 2018, the Company modified the terms of
grants of restricted common stock awards to certain former officers of the Company. Refer to Note 23, "Stock-Based Compensation,"
to the Consolidated Financial Statements, for further discussion of the restricted stock awards. The Company also recorded $0.4
million of payroll tax expense and $0.2 million of other expense during 2018 related to these arrangements with its former officers.
The Company recorded $1.3 million less of general and administrative expense, primarily attributable to less compensation,
employee benefits and professional fees in 2018 compared to 2017.
The Company recorded a $0.7 million gain for the year ended December 31, 2017 related to the termination of a financing lease,
as further discussed in Note 18, "Finance Lease Obligation Liability," to the Consolidated Financial Statements.
Loss and loss adjustment expenses were an expense of $1.6 million and $0.4 million for the years ended December 31, 2018 and
December 31, 2017, respectively, primarily as a result of unfavorable development in 2018 and 2017 due to the continuing voluntary
run-off of Amigo. Amigo was previously included in the Insurance Underwriting segment along with Mendota. As a consequence
of classifying Mendota as discontinued operations, the remaining composition of the Insurance Underwriting segment no longer
meets the criteria of a reportable segment. As such, all segmented information has been restated to exclude the Insurance
Underwriting segment for all periods presented. The operating results of Amigo previously included in the Insurance Underwriting
segment are now included in Other income and expenses not allocated to segments, net.
33
KINGSWAY FINANCIAL SERVICES INC.
Management's Discussion and Analysis
Amortization of Intangible Assets
The Company's intangible assets with definite useful lives are amortized over their estimated useful lives. Amortization of intangible
assets was $2.4 million in 2018 compared to $1.1 million in 2017. The higher amortization expense for the year ended December 31,
2018 is related to amortization of intangible assets recorded in conjunction with the Company's acquisition of PWSC on October
12, 2017. During 2018, the Company finalized its fair value analysis of the assets acquired and liabilities assumed in its acquisition
of PWSC, which resulted in the Company recording $1.4 million of amortization expense during 2018 for the period from the date
of acquisition through December 31, 2018. See Note 5, "Acquisition," to the Consolidated Financial Statements for further details.
Contingent Consideration Benefit
Contingent consideration benefit was zero in 2018 compared to $0.2 million in 2017. The benefit recorded in 2017 is attributable
to the Company having executed an agreement with the former owner of Trinity. The asset purchase agreement executed by the
Company in 2013 related to the acquisition of Trinity provided for additional payments to the former owner of Trinity contingent
upon the achievement of certain targets over future reporting periods.
Loss on Change in Fair Value of Debt
The loss on change in fair value of debt amounted to $1.7 million in 2018 compared to $8.5 million in 2017. The loss for 2018
reflects an increase in the fair value of the subordinated debt resulting from changes in inputs, other than the instrument-specific
credit risk, to the Company’s fair value model. The loss for 2017 reflects an increase in the fair value of the subordinated debt
resulting from changes in all of the inputs to the Company’s fair value model. As further discussed in Note 4, "Recently Issued
Accounting Standards," to the Consolidated Financial Statements, effective January 1, 2018, the Company adopted ASU 2016-01.
As a result, the portion of the change in fair value of subordinated debt related to the instrument-specific credit risk is now recognized
in other comprehensive income (loss), whereas for 2017, the total change in fair value of subordinated debt was recorded in net
income (loss). See "Debt" section below for further information.
Gain on Disposal of Subsidiary
On June 1, 2018, the Company disposed of its subsidiary, Itasca Real Estate Investors, LLC. As a result of the disposal, the
Company recognized a gain of $0.0 million during the year ended December 31, 2018.
Equity in Net (Loss) Income of Investee
Equity in net loss of investee was $2.5 million in 2018 compared to equity in net income of investee of $2.1 million in 2017.
Equity in net (loss) income of investee represents the Company's investment in Itasca Capital Ltd. See Note 9, "Investment in
Investee," to the Consolidated Financial Statements, for further discussion.
Income Tax Expense (Benefit)
Income tax expense for 2018 was $0.3 million compared to income tax benefit of $16.7 million in 2017. The 2018 income tax
expense is primarily related to the change in unrecognized tax benefits and state income taxes.
The 2017 income tax benefit is primarily related to a release of deferred income tax liabilities and an adjustment to the deferred
income tax valuation allowance resulting from the Tax Cuts and Jobs Act (the "Tax Act") enacted on December 22, 2017. The
Tax Act made broad and complex changes to the U.S. tax code, including, but not limited to, a permanent reduction in the U.S.
federal corporate income tax rate to 21%.
The Company is subject to the provisions of Accounting Standards Codification 740-10, Income Taxes, which requires that the
effect on deferred tax income assets and liabilities of a change in tax rates be recognized in the period the tax rate change was
enacted. In December of 2017, the SEC staff issued Staff Accounting Bulletin 118 ("SAB 118"), which provides that companies
that have not completed their accounting for the effects of the Tax Act but can determine a reasonable estimate of those effects
should include a provisional amount based on their reasonable estimate in their financial statements.
Pursuant to SAB 118, the Company recorded provisional amounts for the estimated income tax effects of the Tax Act on deferred
income taxes. The Company recorded a $18.1 million decrease to income tax expense in the consolidated statements of operations
for the year ended December 31, 2017, $18.0 million of which related to a decrease in the Company’s net deferred income tax
liability as of December 31, 2017 because of the reduction in the corporate income tax rate.
Although the $18.1 million tax benefit represented what the Company believed was a reasonable estimate of the income tax effects
of the Tax Act on the Company’s Consolidated Financial Statements as of December 31, 2017, it was considered provisional. In
34
KINGSWAY FINANCIAL SERVICES INC.
Management's Discussion and Analysis
the fourth quarter of 2018, the Company finalized its calculation of the income tax effects of the Tax Act on its deferred income
taxes by recording an additional tax benefit of $0.1 million.
See Note 21, "Income Taxes," to the Consolidated Financial Statements, for additional detail of the income tax expense (benefit)
recorded for the years ended December 31, 2018 and December 31, 2017, respectively.
35
KINGSWAY FINANCIAL SERVICES INC.
Management's Discussion and Analysis
INVESTMENTS
As a result of classifying Mendota as discontinued operations, the results of their operations are reported separately for all periods
presented and their assets are presented as held for sale in the consolidated balance sheets at December 31, 2017. All investment
information in the section below has been restated to exclude Mendota for all periods presented.
Portfolio Composition
All of our investments in fixed maturities are classified as available-for-sale and are reported at fair value. All of our equity
investments are reported at fair value. Prior to the adoption of ASU 2016-01, equity investments were considered available-for-
sale. All of our limited liability investments are accounted for under the equity method of accounting. The most recently available
financial statements of the limited liability investments are used in applying the equity method. The difference between the end
of the reporting period of the limited liability investments and that of the Company is no more than three months. Limited liability
investments, at fair value represent the Company's investment in 1347 Investors LLC as well as the underlying investments of the
Company’s consolidated entities Net Lease and Argo Holdings. Investments in private companies consist of common stock,
preferred stock, notes receivable and derivative contracts in privately owned companies and investments in limited liability
companies in which the Company’s interests are deemed minor. These investments do not have readily determinable fair values
and, therefore, are reported at cost, adjusted for observable price changes and impairments. Real estate investments are reported
at fair value. 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.
At December 31, 2018, we held cash and cash equivalents, restricted cash and investments with a carrying value of $91.5 million.
Investments held by our insurance subsidiary, Amigo, must comply with 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 and restricted cash, at the dates
indicated.
36
KINGSWAY FINANCIAL SERVICES INC.
Management's Discussion and Analysis
TABLE 2 Carrying value of investments, including cash and cash equivalents and restricted cash
As of December 31 (in thousands of dollars, except for percentages)
Type of investment
Fixed maturities:
U.S. government, government agencies
and authorities
States, municipalities and political
subdivisions
Mortgage-backed
Corporate
Total fixed maturities
Equity investments:
Common stock
Warrants
Total equity investments
Limited liability investments
Limited liability investments, at fair
value
Investments in private companies
Real estate investments
Other investments
Short-term investments
Total investments
Cash and cash equivalents
Restricted cash
Total
Other-Than-Temporary Impairment
2018
% of Total
2017
% of Total
5,547
607
3,186
2,920
6.1%
0.6%
3.5%
3.2%
5,612
626
2,876
5,427
5.6%
0.6%
2.9%
5.4%
12,260
13.4%
14,541
14.5%
801
55
856
4,790
26,015
3,090
10,662
2,079
152
59,904
14,619
16,959
91,482
0.9%
—%
0.9%
5.2%
28.4%
3.4%
11.7%
2.3%
0.2%
65.5%
16.0%
18.5%
3,570
1,019
4,589
9,094
32,211
4,870
10,662
3,721
151
79,839
5,377
14,985
3.6%
1.0%
4.6%
9.1%
32.1%
4.9%
10.6%
3.7%
0.2%
79.7%
5.4%
14.9%
100.0%
100,201
100.0%
The Company performs a quarterly impairment analysis of its investments classified as available-for-sale and investments in private
companies. Prior to the adoption of ASU 2016-01, equity investments were considered available-for-sale and were included in
the analysis of other-than-temporary impairments. Following the adoption of ASU 2016-01 beginning with the first quarter of
2018, the Company includes only its investments in fixed maturities and investments in private companies in its quarterly impairment
analysis. Further information regarding our detailed analysis and factors considered in establishing an other-than-temporary
impairment on an available-for-sale investment is discussed within the "Critical Accounting Estimates and Assumptions" section
of MD&A.
As a result of the analysis performed by the Company to determine declines in market value that are other-than-temporary, there
were no write downs for other-than-temporary impairment related to available-for-sale investments recorded for the years ended
December 31, 2018 and December 31, 2017. As a result of the analysis performed with respect to limited liability investments,
at fair value, the Company recorded impairments of $0.1 million and $0.1 million for the years ended December 31, 2018 and
December 31, 2017, respectively, which are included in loss on change in fair value of limited liability investments, at fair value
in the consolidated statements of operations. As a result of the analysis performed with respect to investments in private companies,
the Company recorded impairments of $1.0 million and $2.0 million for the years ended December 31, 2018 and December 31,
2017, respectively, which are included in net change in unrealized loss on private company investments in the consolidated
statements of operations.
The length of time a fixed maturity 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 a fixed maturity investment 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
37
KINGSWAY FINANCIAL SERVICES INC.
Management's Discussion and Analysis
with recapture of principal, the Company may elect to sell a fixed maturity investment at a loss. Prior to the adoption of ASU
2016-01, the Company considered the ability and intent to hold an equity investment for a period of time sufficient to allow for
anticipated recovery.
At December 31, 2018, the gross unrealized losses for fixed maturities amounted to $0.2 million, and there were no unrealized
losses attributable to non-investment grade fixed maturities. At December 31, 2017, the gross unrealized losses for fixed maturities
and equity investments amounted to $0.8 million, and there were no unrealized losses attributable to non-investment grade fixed
maturities. At each of December 31, 2018 and December 31, 2017, all unrealized losses on individual investments were considered
temporary.
38
KINGSWAY FINANCIAL SERVICES INC.
Management's Discussion and Analysis
UNPAID LOSS AND LOSS ADJUSTMENT EXPENSES
As a result of classifying Mendota as discontinued operations, the results of their operations are reported separately for all periods
presented and their liabilities are presented as held for sale in the consolidated balance sheets at December 31, 2017. All unpaid
loss and loss adjustment expenses information in the section below has been restated to exclude Mendota for all periods presented.
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 3 and 4 present distributions, by line of business, of the provision for unpaid loss and loss adjustment expenses gross and
net of external reinsurance, respectively.
TABLE 3 Provision for unpaid loss and loss adjustment expenses - gross
As of December 31 (in thousands of dollars)
Line of Business
Non-standard automobile
Commercial automobile
Other
Total
2018
686
794
593
2,073
TABLE 4 Provision for unpaid loss and loss adjustment expenses - net of reinsurance recoverable
As of December 31 (in thousands of dollars)
Line of Business
Non-standard automobile
Commercial automobile
Other
Total
Non-Standard Automobile
2018
686
794
593
2,073
2017
572
580
177
1,329
2017
508
572
177
1,257
At December 31, 2018 and December 31, 2017, the gross provisions for unpaid loss and loss adjustment expenses for our non-
standard automobile business were $0.7 million and $0.6 million, respectively. The increase is due to an increase in unpaid loss
and loss adjustment expenses at Amigo.
Commercial Automobile
At December 31, 2018 and December 31, 2017, the gross provisions for unpaid loss and loss adjustment expenses for our commercial
automobile business were $0.8 million and $0.6 million, respectively. This increase is due to an increase in unpaid loss and loss
adjustment expenses at Amigo.
Other
At December 31, 2018 and December 31, 2017, the gross provisions for unpaid loss and loss adjustment expenses for our other
business were $0.6 million and $0.2 million, respectively. The increase is due to an increase in unpaid loss adjustment expenses
at Amigo.
Information with respect to development of our provision for prior years' loss and loss adjustment expenses is presented in Table
5.
39
KINGSWAY FINANCIAL SERVICES INC.
Management's Discussion and Analysis
TABLE 5 Increase in prior years' provision for loss and loss adjustment expenses
For the years ended December 31 (in thousands of dollars)
Unfavorable change in provision for loss and loss adjustment expenses for
prior accident years
2018
1,631
2017
401
The net movements in prior years' provisions for loss and loss adjustment expenses, net of reinsurance, was an increase of $1.6
million and $0.4 million, respectively, for the years ended December 31, 2018 and December 31, 2017. The unfavorable
development in 2018 and 2017 was related to an increase in loss and loss adjustment expenses due to the continuing voluntary
run-off of Amigo. Original estimates are increased or decreased as additional information becomes known regarding individual
claims.
DEBT
Bank Loan
On October 12, 2017, the Company borrowed a principal amount of $5.0 million from a bank to partially finance its acquisition
of PWSC. The bank loan matures on October 12, 2022 and has a fixed interest rate of 5.0%. The bank loan is carried in the
consolidated balance sheets at its unpaid principal balance.
Notes Payable
As part of its acquisition of CMC in July 2016, the Company assumed the Mortgage and recorded the Mortgage at its estimated
fair value of $191.7 million, which included the unpaid principal amount of $180.0 million as of the date of acquisition plus a
premium of $11.7 million. The Mortgage matures on May 15, 2034 and has a fixed interest rate of 4.07%. The Mortgage is carried
in the consolidated balance sheets at its amortized cost, which reflects the monthly pay-down of principal as well as the amortization
of the premium using the effective interest rate method.
On January 5, 2015, Flower Portfolio 001, LLC assumed a $9.2 million mortgage in conjunction with the purchase of investment
real estate properties ("the Flower Note"). The Flower Note matures on December 10, 2031 and has a fixed interest rate of 4.81%.
The Flower Note is carried in the consolidated balance sheets at its unpaid principal balance.
On October 15, 2015, Net Lease assumed a $9.0 million mezzanine debt in conjunction with the purchase of investment real estate
properties ("the Net Lease Note"). The Net Lease Note matures on November 1, 2020 and has a fixed interest rate of 10.25%.
The Net Lease Note is carried in the consolidated balance sheets at its unpaid principal balance.
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 Kingsway America Inc. to the trust in exchange for the proceeds from the private
sale. The floating rate debentures bear interest at the rate of LIBOR, plus spreads ranging from 3.85% to 4.20%. 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 third quarter of 2018, the Company gave notice to its Trust Preferred 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 Trust Preferred indentures,
which permit interest deferral. This action does not constitute a default under the Company's Trust Preferred indentures or any of
its other debt indentures. At December 31, 2018, deferred interest payable of $2.5 million is included in accrued expenses and
other liabilities in the consolidated balance sheets.
The Company's subordinated debt is measured and reported at fair value. At December 31, 2018, the carrying value of the
subordinated debt is $50.0 million. The fair value of the subordinated debt is calculated using a model based on significant market
observable inputs and inputs developed by a third-party. For a description of the market observable inputs and inputs developed
by a third-party used in determining fair value of debt, see Note 29, "Fair Value of Financial Instruments," to the Consolidated
Financial Statements.
During the year ended December 31, 2018, the market observable swap rates changed, and the Company experienced an increase
in the credit spread assumption developed by the third-party. Changes in the market observable swap rates affect the fair value
40
KINGSWAY FINANCIAL SERVICES INC.
Management's Discussion and Analysis
model in different ways. An increase in the LIBOR swap rates has the effect of increasing the fair value of the Company's
subordinated debt while an increase in the risk-free swap rates has the effect of decreasing the fair value. The increase in the credit
spread assumption has the effect of decreasing the fair value of the Company's subordinated debt while a decrease in the credit
spread assumption has the effect of increasing the fair value. The other primary variable affecting the fair value of debt calculation
is the passage of time, which will always have the effect of increasing the fair value of debt. The changes to the credit spread and
swap rate variables during 2018, along with the passage of time, contributed to the $2.1 million decrease in fair value of the
Company’s subordinated debt between December 31, 2017 and December 31, 2018.
As further discussed in Note 4, "Recently Issued Accounting Standards," to the Consolidated Financial Statements, effective
January 1, 2018, the Company adopted ASU 2016-01. As a result, the portion of the change in fair value of subordinated debt
related to the instrument-specific credit risk is now recognized in other comprehensive income (loss), whereas for 2017, the total
change in fair value of subordinated debt was recorded in net income (loss). Of the $2.1 million decrease in fair value of the
Company’s subordinated debt between December 31, 2017 and December 31, 2018, $3.8 million is reported as decrease in fair
value of debt attributable to instrument-specific credit risk in the Company's consolidated statements of comprehensive loss and
$1.7 million is reported as loss on change in fair value of debt in the Company’s consolidated statements of operations.
Also as a result of the adoption of ASU 2016-01, a cumulative $40.5 million change in fair value of subordinated debt attributable
to instrument-specific credit risk was reclassified from accumulated deficit to accumulated other comprehensive income (loss) as
of January 1, 2018. As long as the Company repays its subordinated debt at maturity, it can be expected that this $40.5 million
reclassification will reverse without being reported in the Company’s consolidated statements of operations. Though changes in
the market observable swap rates will continue to introduce some volatility each quarter to the Company’s reported gain or loss
on change in fair value of debt, changes in the credit spread assumption developed by the third-party will no longer introduce
volatility to the Company’s consolidated statements of operations. The fair value of the Company’s subordinated debt will eventually
equal the principal value of the subordinated debt by the time of the stated redemption date of each trust, beginning with the trust
maturing on December 4, 2032 and continuing through January 8, 2034, the redemption date of the last of the Company’s outstanding
trusts.
For a description of each of the Company's six subsidiary trusts, see Note 17, "Debt," to the Consolidated Financial Statements.
Pursuant to indentures governing the Company’s outstanding bank loan, subordinated debt and a bank loan associated with the
Company’s acquisition on March 1, 2019, described more fully in Note 34, "Subsequent Event," to the Consolidated Financial
Statements, the Company is obligated to deliver audited financial statements for certain of its subsidiaries as of and for the year
ended December 31, 2018. Due to the delay in filing its 2018 Annual Report, the Company has been unable to meet these obligations,
the failure of which could be declared events of default under the respective indentures. As of the date of the filing of its 2018
Annual Report, none of the lenders or trustees responsible for administering any of our outstanding debt has declared an event of
default, if required by the applicable indenture, notified us of an intent to accelerate any portion of the outstanding debt or charge
default interest thereon, or pursued any other remedies available to it. Were any of these lenders or trustees to declare an event of
default, the Company would have a period of time to cure the default. Now that the Company has filed its 2018 Annual Report,
the Company expects to be in a position to deliver to the trustees the requisite audited financial statements for certain of its
subsidiaries as of and for the year ended December 31, 2018.
LIQUIDITY AND CAPITAL RESOURCES
The purpose of liquidity management is to ensure 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, capital raising, disposal of discontinued operations, investment maturities and income and other returns received on
investments or from the sale of investments. Cash provided from these sources is used primarily for making investments and 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.
41
KINGSWAY FINANCIAL SERVICES INC.
Management's Discussion and Analysis
Cash Flows from Continuing Operations
During 2018, the Company reported on the consolidated statements of cash flows $2.8 million of net cash used in operating
activities from continuing operations. The reconciliation between the Company's reported net loss of $28.3 million and the $2.8
million of net cash used in operating activities from continuing operations can be explained primarily by the $7.1 million loss on
disposal of discontinued operations, the $7.4 million loss on change in fair value of limited liability investments, at fair value, $6.7
million of depreciation and amortization expense, the increase in deferred service fees of $6.0 million and the $2.5 million of
equity in net loss of investee, partially offset by the $2.3 million increase in other receivables.
During 2018, the net cash provided by investing activities from continuing operations as reported on the consolidated statements
of cash flows was $18.1 million. This source of cash was driven primarily by net proceeds from the sale of discontinued operations,
in addition to proceeds from sales and maturities of fixed maturities, equity investments, limited liability investments, other
investments and investee in excess of purchases of fixed maturities, equity investments and limited liability investments, at fair
value.
During 2018, the net cash used in financing activities from continuing operations as reported on the consolidated statements of
cash flows was $4.1 million. This use of cash is primarily attributed to principal repayments of $3.4 million on notes payable and
$1.0 million on the bank loan.
In summary, as reported on the consolidated statements of cash flows, the Company's net increase in cash and cash equivalents
and restricted cash from continuing operations during 2018 was $11.2 million. The absence of cash flows from discontinued
operations, whether positive or negative, is not expected to adversely affect the Company’s future liquidity and capital resources
given that the discontinued operations are comprised of insurance subsidiaries formerly reported as part of the Company’s Insurance
Underwriting segment. Receipt of dividends from the Company's insurance subsidiaries has not generally been considered a
source of liquidity for the holding company. The insurance subsidiaries have required regulatory approval for the return of capital
and, in certain circumstances, prior to the payment of dividends. At December 31, 2018, Amigo was restricted from making any
dividend payments to the holding company without regulatory approval pursuant to domiciliary state insurance regulations.
The Company's Extended Warranty subsidiaries fund their obligations primarily through service fee and commission income. The
Company's Leased Real Estate subsidiary funds its obligations through rental income. The Company's insurance subsidiaries fund
their obligations primarily through investment income and maturities in the investments portfolios.
The liquidity of the holding company is managed separately from its subsidiaries. Actions available to the holding company to
raise liquidity in order to meet its obligations include the sale of passive investments; sale of subsidiaries; issuance of debt or
equity securities; distributions from the Company’s Extended Warranty subsidiaries, as further described below; and giving notice
to its Trust Preferred trustees of its intention to exercise its voluntary right to defer interest payments for up to 20 quarters on the
six subsidiary trusts of the Company’s subordinated debt, which right the Company exercised during the third quarter of 2018.
Subsequent to December 31, 2018, the Company announced it had closed on the acquisition of Geminus Holding Company, Inc.
("Geminus"), a specialty, full-service provider of vehicle service contracts and other finance and insurance products offered through
its subsidiaries, The Penn Warranty Corporation ("Penn") and Prime Auto Care, Inc. ("Prime"). Geminus, Penn and Prime will
be included in Extended Warranty. Related to the Geminus acquisition, the Company secured $10.0 million of acquisition financing
(the "Financing"). IWS, Trinity, Geminus, Penn and Prime are borrowers under the Financing. Pursuant to satisfying the covenants
under the Financing, IWS, Trinity, Geminus, Penn and Prime are permitted to make distributions to the holding company in an
aggregate amount not to exceed $1.5 million in any 12-month period. Separately, pursuant to covenants under the bank loan
secured to partially finance the acquisition of PWSC on October 12, 2017, PWSC is not permitted to make distributions to the
holding company without the consent of the lender.
Dividends from the Leased Real Estate segment are not generally considered a source of liquidity for the holding company. Because
of the Lease Amendment, CMC may be in a position to distribute to the Company some of the cash received from the additional
rental income. Any material cash flow to the Company, however, to help the Company meet its holding company obligations
remains likely to occur only upon the occurrence of one of the three events described in the next paragraph that would trigger
payment of service fees. There can be no assurance as to the timing of the occurrence, or the resulting outcome, from one of these
events.
Pursuant to the terms of the management services agreement entered into at the closing of the acquisition of CMC, an affiliate of
the seller (the "Service Provider") will provide certain services to CMC and its subsidiaries in exchange for service fees. Such
services (collectively, the "Services") will include (i) causing an affiliate of the Service Provider to guaranty certain obligations
of the Property Owner (pursuant to an Indemnity and Guaranty Agreement between such affiliate and the holder of the Mortgage
42
KINGSWAY FINANCIAL SERVICES INC.
Management's Discussion and Analysis
(the "Mortgagor")), (ii) providing certain individuals to serve as members of the board of directors and/or certain executive officers
of CMC and/or its subsidiaries and (iii) providing asset management services with respect to the Real Property. In exchange for
the Services, the Property Owner will pay certain fees to the Service Provider. The payment of such service fees may be triggered
by (i) a sale of the Real Property, (ii) a restructuring of the lease to which the Real Property is subject or (iii) a refinancing or
restructuring of the Mortgage. The amount of the service fees will range from 40%-80% of the net proceeds generated by the
event triggering the payment of the service fees (depending on the nature and timing of the triggering event). The Lease Amendment
has not triggered the payment of service fees to the Service Provider.
The holding company’s liquidity, defined as the amount of cash in the bank accounts of Kingsway Financial Services Inc. and
Kingsway America Inc., was $1.9 million and $0.6 million at December 31, 2018 and December 31, 2017, respectively. These
amounts are reflected in the cash and cash equivalents of $14.6 million and $5.4 million reported at December 31, 2018 and
December 31, 2017, respectively, on the Company’s consolidated balance sheets. The cash and cash equivalents and restricted
cash other than the holding company’s liquidity represent restricted and unrestricted cash held by Amigo, Kingsway Re and the
Company's Extended Warranty and Leased Real Estate subsidiaries and are not considered to be available to meet holding company
obligations, which primarily consist of holding company operating expenses; transaction-related expenses; investments; and any
other extraordinary demands on the holding company.
The holding company’s liquidity of $1.9 million at December 31, 2018 represented approximately four months of regularly recurring
operating expenses before any transaction-related expenses, any new holding company investments or any other extraordinary
demands on the holding company. As of the filing date of the Company’s 2018 Annual Report, the holding company’s liquidity
of $1.5 million represented approximately three months of regularly recurring operating expenses before any transaction-related
expenses, any new holding company investments or any other extraordinary demands on the holding company. During the third
quarter of 2018, the Company gave notice to its Trust Preferred 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 Trust Preferred indentures, which permit
interest deferral. As a result of this action, the projected cash obligations of the holding company over the next 12 months have
been reduced by approximately $6.4 million, calculated by holding constant the most recent coupon for each of the six subsidiary
trusts of the Company’s subordinated debt.
The holding company’s liquidity of $1.9 million at December 31, 2018 and $1.5 million as of the filing date of the Company’s
2018 Annual Report represents only actual cash on hand and does not include cash that would be made available to the holding
company from the sale of investments owned by the holding company or the distribution of cash by the Extended Warranty
subsidiaries as described above. While these sources do not represent cash of the holding company as of the filing date of the
Company’s 2018 Annual Report, they do represent future sources of liquidity that make it probable that the holding company will
be able to meet its obligations as they become due over the next 12 months.
While the Company believes it has sources of liquidity available to allow it to continue to meet its holding company obligations,
there can be no assurance that such sources of liquidity will be available when needed.
Regulatory Capital
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. 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, 2018, surplus as
regards policyholders reported by Amigo exceeded the 200% threshold.
During the fourth quarter of 2012, the Company began taking steps to place all of Amigo into voluntary run-off. As of December
31, 2012, Amigo’s RBC was 157%. In April 2013, Kingsway filed a comprehensive run-off plan with the Florida Office of
Insurance Regulation, which outlines plans for Amigo's run-off. Amigo remains in compliance with that plan. As of December 31,
2018, Amigo's RBC was 1,905%.
Kingsway Re, our reinsurance subsidiary domiciled in Barbados, is required by the regulator in Barbados to maintain minimum
statutory capital of $125,000. Kingsway Re is currently operating with statutory capital near the regulatory minimum, requiring
us to periodically contribute capital to fund operating expenses. Kingsway Re incurs operating expenses of approximately $0.1
million per year. As of December 31, 2018, the capital maintained by Kingsway Re was in excess of the regulatory capital
requirements in Barbados.
43
KINGSWAY FINANCIAL SERVICES INC.
Management's Discussion and Analysis
CONTRACTUAL OBLIGATIONS
Table 6 summarizes cash disbursements related to the Company's contractual obligations projected by period, including debt
maturities, interest payments on outstanding debt, the provision for unpaid loss and loss adjustment expenses and future minimum
payments under operating leases. Interest payments in Table 6 related to the subordinated debt 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 6 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 a substantial amount in short-term investments to provide adequate cash flows for the projected payments in Table 6.
The unpaid loss and loss adjustment expenses in Table 6 have not been reduced by amounts recoverable from reinsurers.
TABLE 6 Cash payments related to contractual obligations projected by period
As of December 31, 2018 (in thousands of dollars)
Bank loan
Notes payable
Subordinated debt
Interest payments on outstanding debt
Unpaid loss and loss adjustment expenses
Future minimum lease payments
2019
1,000
3,768
—
8,449
1,272
976
2020
1,000
13,164
—
8,158
372
380
2021
1,000
4,582
—
7,080
285
390
2022
917
5,023
—
2023 Thereafter
—
—
Total
3,917
5,489
157,897
189,923
—
90,500
90,500
6,831
46,473
110,851
187,842
96
398
38
421
10
883
2,073
3,448
Total
15,465
23,074
13,337
13,265
52,421
360,141
477,703
Table 6 above does not reflect amounts that may be paid for the redemption of the 222,876 shares of Class A preferred stock
("Preferred Shares") outstanding at December 31, 2018. 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 "Redemption Date").
On and after February 3, 2016, the Company may redeem all or any part of the then outstanding Preferred Shares for the price of
$28.75 per Preferred Share, plus accrued but unpaid dividends thereon, whether or not declared, up to and including the Redemption
Date. The total redemption amount of the Preferred Shares as of the Redemption Date if the Preferred Shares are not converted
is expected to be $8.2 million. The timing and amount of cash, if any, to be paid by the Redemption Date will be based upon the
extent, if at all, that the Company exercises its right to redeem any Preferred Shares prior to the Redemption Date or the holders
of the Preferred Shares exercise their option to convert any of the Preferred Shares to common shares.
Refer to Note 25, "Redeemable Class A Preferred Stock," to the Consolidated Financial Statements for further information regarding
the Preferred Shares.
OFF-BALANCE SHEET ARRANGEMENTS
The Company has off-balance sheet arrangements related to guarantees, which are further described in Note 31, "Commitments
and Contingent Liabilities," to the Consolidated Financial Statements.
44
KINGSWAY FINANCIAL SERVICES INC.
Item 7A. Quantitative and Qualitative Disclosures About Market Risk
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.
We have exposure to market risk through our investment activities and our financing activities.
Given our U.S. operations typically invest in U.S. dollar denominated fixed maturity instruments, our primary market risk exposures
in the investments portfolio are to changes in interest rates. Periodic changes in interest rate levels generally affect 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 values of the existing fixed maturities will generally
decrease. The reverse is true during periods of declining interest rates.
We manage our exposure to risks associated with interest rate fluctuations through active review of our investment portfolio by
our management and Board of Directors, consultation with third-party financial advisors and by managing the maturity profile of
our fixed maturity portfolio. Our goal is to maximize the total after-tax return on all of our investments. An important strategy
we employ to achieve this goal is to try to hold enough in cash and short-term investments in order to avoid liquidating longer-
term investments to pay claims authorized on vehicle service agreements and loss and loss adjustment expenses.
Table 7 below summarizes the fair value by contractual maturities of the fixed maturities portfolio, excluding cash and cash
equivalents, at December 31, 2018 and December 31, 2017.
TABLE 7 Fair value of fixed maturities by contractual maturity date
As of December 31 (in thousands of dollars, except for percentages)
Due in less than one year
Due in one through five years
Due after five through ten years
Due after ten years
Total
2018
5,445
5,233
210
1,372
12,260
% of Total
44.4%
42.7%
1.7%
11.2%
100.0%
2017
3,605
9,310
345
1,281
14,541
% of Total
24.8%
64.0%
2.4%
8.8%
100.0%
At December 31, 2018, 87.1% 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
that, along with fixed maturities, management believes are sufficient in amount for the payment of unpaid loss and loss adjustment
expenses and other obligations on a timely basis. In the event additional cash is required to meet obligations to our policyholders
and customers, we believe that the high-quality investments in the portfolios provide us with sufficient liquidity.
Based upon the results of interest rate sensitivity analysis, Table 8 below shows the interest rate risk of our investments in fixed
maturities, measured in terms of fair value (which is equal to the carrying value for all our fixed maturity securities), at December 31,
2018 and December 31, 2017.
TABLE 8 Sensitivity analysis on fixed maturities
As of December 31 (in thousands of dollars)
As of December 31, 2018
Estimated fair value
Estimated increase (decrease) in fair value
As of December 31, 2017
Estimated fair value
Estimated increase (decrease) in fair value
100 Basis Point
Decrease in
Interest Rates
No Change
100 Basis Point
Increase in
Interest Rates
$
$
$
$
12,436
176
14,840
299
$
$
$
$
12,260
$
— $
12,084
(176)
14,541
$
— $
14,242
(299)
45
KINGSWAY FINANCIAL SERVICES INC.
We use both fixed and variable rate debt as sources of financing. Because our subordinated debt is LIBOR-based, our primary
market risk related to financing activities is to changes in LIBOR. As of December 31, 2018, each one hundred basis point increase
in LIBOR would result in an approximately $0.9 million increase in our annual interest expense.
Equity Risk
Equity risk is the risk we will incur economic losses due to adverse changes in equity prices. Our exposure to changes in equity
prices results from our holdings of common stock. We principally manage equity price risk through industry and issuer
diversification and asset allocation techniques and by continuously evaluating market conditions.
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 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 Committee. The Investment Committee is also
responsible for ensuring these policies are implemented and procedures are in place to manage and control credit risk.
Table 9 below summarizes the composition of the fair values of fixed maturities, excluding cash and cash equivalents, at
December 31, 2018 and December 31, 2017 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 99.0% of those investments rated 'A' or better at December 31, 2018. 'Not Rated' in Table 9 below at December
31, 2017 represents $3.0 million of 8% preferred stock of 1347 Property Insurance Holdings, Inc., redeemable on February 24,
2020. During the first quarter of 2018, the preferred stock was redeemed at its par value of $3.0 million.
TABLE 9 Credit ratings of fixed maturities
As of December 31 (ratings as a percentage of total fixed maturities)
Rating (S&P/Moody's)
AAA/Aaa
AA/Aa
A/A
Percentage rated A/A2 or better
BBB/Baa
BB/Ba
Not rated
Total
2018
72.0%
16.1
10.9
99.0%
1.0
—
—
2017
59.6%
8.8
10.9
79.3%
—
—
20.7
100.0%
100.0%
46
KINGSWAY FINANCIAL SERVICES INC.
Item 8. Financial Statements and Supplementary Data.
Index to the Consolidated Financial Statements of
Kingsway Financial Services Inc.
Reports of Independent Registered Public Accounting Firms
Consolidated Balance Sheets at December 31, 2018 and 2017
Consolidated Statements of Operations for the Years Ended December 31, 2018 and 2017
Consolidated Statements of Comprehensive Loss for the Years Ended December 31, 2018 and 2017
Consolidated Statements of Shareholders' Equity for the Years Ended December 31, 2018 and 2017
Consolidated Statements of Cash Flows for the Years Ended December 31, 2018 and 2017
Notes to the Consolidated Financial Statements
Note 1-Business
Note 2-Summary of Significant Accounting Policies
Note 3-Restatement of Previously Issued Financial Statements
Note 4-Recently Issued Accounting Standards
Note 5-Acquisition
Note 6-Disposal, Discontinued Operations and Liquidation
Note 7-Variable Interest Entities
Note 8-Investments
Note 9-Investment in Investee
Note 10-Reinsurance
Note 11-Deferred Acquisition Costs
Note 12-Goodwill
Note 13-Intangible Assets
Note 14-Property and Equipment
Note 15-Vehicle Service Agreement Liability
Note 16-Unpaid Loss and Loss Adjustment Expenses
Note 17-Debt
Note 18-Finance Lease Obligation Liability
Note 19-Leases
Note 20-Revenue from Contracts with Customers
Note 21-Income Taxes
Note 22-Loss from Continuing Operations per Share
Note 23-Stock-Based Compensation
Note 24-Employee Benefit Plan
Note 25-Redeemable Class A Preferred Stock
Note 26-Shareholders' Equity
Note 27-Accumulated Other Comprehensive Income (Loss)
Note 28-Segmented Information
Note 29-Fair Value of Financial Instruments
Note 30-Related Parties
Note 31-Commitments and Contingent Liabilities
Note 32-Regulatory Capital Requirements and Ratios
Note 33-Statutory Information and Policies
Note 34-Subsequent Event
47
48
50
51
52
53
54
56
56
56
62
70
71
72
74
77
82
83
83
83
84
85
85
86
91
93
93
94
96
99
99
102
103
103
104
106
108
114
119
120
120
121
KINGSWAY FINANCIAL SERVICES INC.
Report of Independent Registered Public Accounting Firm
To the Shareholders and the Board of Directors of Kingsway Financial Services Inc.
Opinion on the Financial Statements
We have audited the accompanying consolidated balance sheet of Kingsway Financial Services Inc. and its subsidiaries (the
Company) as of December 31, 2018, the related consolidated statements of operations, comprehensive loss, shareholders’
equity and cash flows for the year then ended, and the related notes to the consolidated financial statements and schedules
(collectively, the financial statements). In our opinion, the financial statements present fairly, in all material respects, the
financial position of the Company as of December 31, 2018, and the results of its operations and its cash flows for the year
then ended, in conformity with accounting principles generally accepted in the United States of America.
Basis for Opinion
These financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion
on the Company’s financial statements based on our audit. We are a public accounting firm registered with the Public Company
Accounting Oversight Board (United States) (PCAOB) and are required to be independent with respect to the Company in
accordance with U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange
Commission and the PCAOB.
We conducted our audit in accordance with the standards of the PCAOB. Those standards require that we plan and perform
the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement, whether due
to error or fraud. The Company is not required to have, nor were we engaged to perform, an audit of its internal control over
financial reporting. As part of our audit we are required to obtain an understanding of internal control over financial reporting
but not for the purpose of expressing an opinion on the effectiveness of the Company’s internal control over financial reporting.
Accordingly, we express no such opinion.
Our audit included performing procedures to assess the risks of material misstatement of the financial statements, whether
due to error or fraud, and performing procedures that respond to those risks. Such procedures included examining, on a test
basis, evidence regarding the amounts and disclosures in the financial statements. Our audit also included evaluating the
accounting principles used and significant estimates made by management, as well as evaluating the overall presentation of
the financial statements. We believe that our audit provides a reasonable basis for our opinion.
/s/ RSM US LLP
We have served as the Company's auditor since 2019.
Chicago, Illinois
February 27, 2020
48
KINGSWAY FINANCIAL SERVICES INC.
Report of Independent Registered Public Accounting Firm
Board of Directors and Shareholders
Kingsway Financial Services Inc.
Itasca, Illinois
Opinion on the Consolidated Financial Statements
We have audited the accompanying consolidated balance sheet of Kingsway Financial Services Inc. and subsidiaries (the
“Company”) as of December 31, 2017 and the related consolidated statements of operations, comprehensive loss, shareholders’
equity, and cash flows for the year then ended, and the related notes and schedules (collectively referred to as the “consolidated
financial statements”). In our opinion, the consolidated financial statements present fairly, in all material respects, the financial
position of the Company at December 31, 2017 and the results of its operations and its cash flows for the year then ended, in
conformity with accounting principles generally accepted in the United States of America.
Restatement
As discussed in Note 3 to the consolidated financial statements, the 2017 financial statements have been restated to correct
misstatements.
Basis for Opinion
These consolidated financial statements are the responsibility of the Company’s management. Our responsibility is to express an
opinion on the Company’s consolidated financial statements based on our audit. We are a public accounting firm registered with
the Public Company Accounting Oversight Board (United States) (“PCAOB”) and are required to be independent with respect
to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and
Exchange Commission and the PCAOB.
We conducted our audit in accordance with the standards of the PCAOB. Those standards require that we plan and perform the
audit to obtain reasonable assurance about whether the consolidated financial statements are free of material misstatement, whether
due to error or fraud.
Our audit included performing procedures to assess the risks of material misstatement of the consolidated financial statements,
whether due to error or fraud, and performing procedures that respond to those risks. Such procedures included examining, on a
test basis, evidence regarding the amounts and disclosures in the consolidated financial statements. Our audit also included
evaluating the accounting principles used and significant estimates made by management, as well as evaluating the overall
presentation of the consolidated financial statements. We believe that our audit provides a reasonable basis for our opinion.
/s/ BDO USA, LLP
We served as the Company's auditor from 2010 to 2018.
Grand Rapids, Michigan
March 16, 2018, except for Notes 3, 6 and 28, as to which the date is February 27, 2020
BDO USA, LLP, a Delaware limited liability partnership, is the U.S. member of BDO International Limited, a UK company limited by guarantee, and forms part of the international BDO network of independent
member firms.
BDO is the brand name for the BDO network and for each of the BDO Member Firms.
49
KINGSWAY FINANCIAL SERVICES INC.
Consolidated Balance Sheets
(in thousands, except share data)
December 31, 2018
December 31, 2017
(restated)
Assets
Investments:
Fixed maturities, at fair value (amortized cost of $12,432 and $14,707, respectively)
$
12,260
$
856
4,790
26,015
3,090
10,662
2,079
152
59,904
14,619
16,959
951
420
3,434
9,523
6,904
103,142
74,659
83,266
4,459
—
378,240
$
14,786
$
2,400
47,130
2,073
3,917
199,316
50,023
28,537
—
348,182
$
$
Equity investments, at fair value (cost of $2,274 and $4,868, respectively)
Limited liability investments
Limited liability investments, at fair value
Investments in private companies, at adjusted cost
Real estate investments, at fair value (cost of $10,225 and 10,225, respectively)
Other investments, at cost which approximates fair value
Short-term investments, at cost which approximates fair value
Total investments
Cash and cash equivalents
Restricted cash
Investment in investee
Accrued investment income
Service fee receivable, net of allowance for doubtful accounts of $191 and $318, respectively
Other receivables, net of allowance for doubtful accounts of $184 and zero, respectively
Deferred acquisition costs, net
Property and equipment, net of accumulated depreciation of $15,958 and $11,683, respectively
Goodwill
Intangible assets, net of accumulated amortization of $10,594 and $8,218, respectively
Other assets
Assets held for sale
Total Assets
Liabilities and Shareholders' Equity
Liabilities:
Accrued expenses and other liabilities
Income taxes payable
Deferred service fees
Unpaid loss and loss adjustment expenses
Bank loan
Notes payable
Subordinated debt, at fair value
Net deferred income tax liabilities
Liabilities held for sale
Total Liabilities
Redeemable Class A preferred stock, no par value; 1,000,000 and unlimited number authorized at
December 31, 2018 and December 31, 2017, respectively; 222,876 and 222,876 issued and outstanding
at December 31, 2018 and December 31, 2017, respectively; redemption amount of $7,278 and $7,182
at December 31, 2018 and December 31, 2017, respectively
Shareholders' Equity:
Common stock, no par value; 50,000,000 and unlimited number authorized at December 31, 2018 and
December 31, 2017, respectively; 21,787,728 and 21,708,190 issued and outstanding at December 31,
2018 and December 31, 2017, respectively
Additional paid-in capital
Accumulated deficit
Accumulated other comprehensive income (loss)
Shareholders' equity attributable to common shareholders
Noncontrolling interests in consolidated subsidiaries
Total Shareholders' Equity
Total Liabilities, Class A preferred stock and Shareholders' Equity
$
378,240
$
See accompanying notes to Consolidated Financial Statements.
50
5,800
5,180
—
353,890
(382,196)
40,768
12,462
11,796
24,258
14,541
4,589
9,094
32,211
4,870
10,662
3,721
151
79,839
5,377
14,985
5,230
507
4,431
7,247
6,325
108,008
80,843
79,446
4,302
110,145
506,685
10,359
2,644
41,113
1,329
4,917
203,648
52,105
28,763
105,900
450,778
—
356,171
(310,953)
(3,852)
41,366
9,361
50,727
506,685
KINGSWAY FINANCIAL SERVICES INC.
Consolidated Statements of Operations
(in thousands, except per share data)
2018
Years ended December 31,
2017
(restated)
Revenues:
Service fee and commission income
Rental income
Other income
Total revenues
Operating expenses:
Claims authorized on vehicle service agreements
Loss and loss adjustment expenses
Commissions
Cost of services sold
General and administrative expenses
Leased real estate segment interest expense
Total operating expenses
Operating loss
Other revenues (expenses), net:
Net investment income
Net realized (losses) gains
Gain on change in fair value of equity investments
Loss on change in fair value of limited liability investments, at fair value
Net change in unrealized loss on private company investments
Non-operating other income
Interest expense not allocated to segments
Amortization of intangible assets
Contingent consideration benefit
Loss on change in fair value of debt
Gain on disposal of subsidiary
Equity in net (loss) income of investee
Total other revenues (expenses), net
Loss from continuing operations before income tax expense (benefit)
Income tax expense (benefit)
(Loss) income from continuing operations
Loss on liquidation of subsidiary, net of taxes
Income (loss) from discontinued operations, net of taxes
(Loss) gain on disposal of discontinued operations, net of taxes
Net loss
Less: net income attributable to noncontrolling interests in consolidated subsidiaries
Less: dividends on preferred stock, net of tax
Net loss attributable to common shareholders
Loss per share - continuing operations:
Basic:
Diluted:
Loss per share - discontinued operations:
Basic:
Diluted:
Loss per share – net loss attributable to common shareholders:
Basic:
Diluted:
Weighted average shares outstanding (in ‘000s):
Basic:
Diluted:
$
$
$
$
$
$
$
$
See accompanying notes to Consolidated Financial Statements.
51
$
$
$
$
$
$
$
$
38,286
13,376
416
52,078
5,711
1,631
3,756
7,370
29,732
6,171
54,371
(2,293)
2,957
(17)
381
(7,393)
(1,629)
30
(7,407)
(2,376)
—
(1,720)
17
(2,499)
(19,656)
(21,949)
315
(22,264)
—
1,064
(7,136)
(28,336)
1,765
620
(30,721)
(1.13)
(1.13)
(0.28)
(0.28)
(1.41)
(1.41)
21,728
21,728
30,530
13,384
684
44,598
5,327
404
3,086
6,535
27,311
6,264
48,927
(4,329)
7,087
306
—
(1,832)
(758)
605
(6,348)
(1,085)
212
(8,487)
—
2,115
(8,185)
(12,514)
(16,688)
4,174
(494)
(16,306)
1,017
(11,609)
4,085
1,248
(16,942)
(0.05)
(0.05)
(0.73)
(0.73)
(0.79)
(0.79)
21,547
21,547
KINGSWAY FINANCIAL SERVICES INC.
Consolidated Statements of Comprehensive Loss
(in thousands)
Net loss
Other comprehensive income (loss), net of taxes(1):
Unrealized gains (losses) on available-for-sale investments:
Unrealized gains (losses) arising during the period
Reclassification adjustment for amounts included in net loss
Unrealized gains removed due to disposal of discontinued operations
Change in fair value of debt attributable to instrument-specific credit risk
Equity in other comprehensive loss of limited liability investment
Recognition of currency translation loss on liquidation of subsidiary
Other comprehensive income (loss)
Comprehensive loss
Less: comprehensive income attributable to noncontrolling interests in consolidated
subsidiaries
Comprehensive loss attributable to common shareholders
(1) Net of income tax expense (benefit) of $0 and $0 in 2018 and 2017, respectively
Years ended December 31,
2018
$
(28,336)
$
12
(18)
371
3,804
(45)
—
4,124
$
$
(24,212)
$
1,764
(25,976)
$
2017
(restated)
(11,609)
(5,213)
1,076
—
—
—
494
(3,643)
(15,252)
4,085
(19,337)
See accompanying notes to Consolidated Financial Statements.
52
KINGSWAY FINANCIAL SERVICES INC.
Consolidated Statements of Shareholders' Equity
(in thousands, except share data)
Additional
Paid-in
Capital
Accumulated
Deficit
Accumulated
Other
Comprehensive
Income (Loss)
Shareholders'
Equity
Attributable to
Common
Shareholders
Noncontrolling
Interests in
Consolidated
Subsidiaries
Total
Shareholders'
Equity
Common Stock
Shares
Amount
21,458,190
$
— $
353,882
$
(297,668) $
(208) $
56,006
$
829
$
56,835
—
21,458,190
—
250,000
—
—
—
—
—
—
—
—
—
—
—
—
—
—
1,398
2,409
—
3,807
4,107
7,914
355,280
(295,259)
(208)
59,813
4,936
64,749
(47)
1,000
—
—
(1,248)
—
1,186
—
—
(15,694)
—
—
—
—
(47)
—
(47)
1,000
(15,694)
—
4,085
1,000
(11,609)
—
339
339
(1,248)
(3,644)
(3,644)
—
1,186
—
1
—
(1,248)
(3,643)
1,186
21,708,190
$
— $
356,171
$
(310,953) $
(3,852) $
41,366
$
9,361
$
50,727
—
—
—
—
—
—
(647)
—
(647)
(40,495)
40,495
—
(7)
—
(654)
—
21,708,190
$
— $
356,171
$
(352,095) $
36,643
$
40,719
$
9,354
$
50,073
79,538
—
—
—
—
—
—
—
—
—
—
—
—
—
—
(620)
—
(1,661)
—
(30,101)
—
—
—
—
—
(30,101)
—
1,765
—
(28,336)
—
678
678
(620)
4,125
4,125
—
(1,661)
—
(1)
—
(620)
4,124
(1,661)
21,787,728
$
— $
353,890
$
(382,196) $
40,768
$
12,462
$
11,796
$
24,258
See accompanying notes to Consolidated Financial Statements.
53
—
—
—
—
—
—
—
—
—
Balance, January
1, 2017, as
reported
Correction of
prior period errors
Balance, January
1, 2017 as
restated
Common stock
issuance expenses
Conversion of
Class A preferred
stock to common
stock
Net (loss) income
Contributions
from
noncontrolling
interest holders
Preferred stock
dividends, net of
tax
Other
comprehensive
(loss) income
Stock-based
compensation
Balance,
December 31,
2017
Cumulative effect
of adoption of
ASU 2014-09
Cumulative effect
of adoption of
ASU 2016-01
Balance at
January 1, 2018,
as adjusted
Vesting of
restricted stock
awards, net of
share settlements
for tax
withholdings
Net (loss) income
Contributions
from
noncontrolling
interest holders
Preferred stock
dividends, net of
tax
Other
comprehensive
income (loss)
Stock-based
compensation, net
of forfeitures
Balance,
December 31,
2018
KINGSWAY FINANCIAL SERVICES INC.
Consolidated Statements of Cash Flows
(in thousands)
2018
Years ended December 31,
2017
(restated)
Cash provided by (used in):
Operating activities:
Net loss
Adjustments to reconcile net loss income to net cash used in operating activities:
(Income) loss from discontinued operations, net of taxes
Loss (gain) on disposal of discontinued operations, net of taxes
Equity in net loss (income) of investee
Dividend received from investee
Equity in net income of limited liability investments
Depreciation and amortization expense
Contingent consideration benefit
Stock-based compensation (benefit) expense, net of forfeitures
Net realized losses (gains)
Gain on change in fair value of equity investments
Loss on change in fair value of limited liability investments, at fair value
Net change in unrealized loss on private company investments
Loss on change in fair value of debt
Deferred income taxes
Amortization of fixed maturities premiums and discounts
Amortization of note payable premium
Gain on disposal of subsidiary
Loss on liquidation of subsidiary
Changes in operating assets and liabilities:
Service fee receivable, net
Other receivables, net
Deferred acquisition costs, net
Unpaid loss and loss adjustment expenses
Deferred service fees
Other, net
Cash used in operating activities - continuing operations
Cash used in operating activities - discontinued operations
Net cash used in operating activities
Investing activities:
Proceeds from sales and maturities of fixed maturities
Proceeds from sales of equity investments
Purchases of fixed maturities
Purchases of equity investments
Net proceeds from (acquisitions of) limited liability investments
Purchases of limited liability investments, at fair value
Purchases of investments in private companies
Net proceeds from other investments
Net (purchases of) proceeds from short-term investments
Proceeds from sale of investee
Proceeds from disposal of subsidiary
Net proceeds from sale of discontinued operations
Acquisition of business, net of cash acquired
Net disposals of property and equipment and intangible assets
Cash provided by (used in) investing activities - continuing operations
Cash provided by investing activities - discontinued operations
Net cash provided by investing activities
Financing activities:
Proceeds from issuance of common stock, net
Contributions from noncontrolling interest holders
Taxes paid related to net share settlements of restricted stock awards
Principal (payments on) proceeds from bank loan
Principal payments on note payable
Cash (used in) provided by financing activities - continuing operations
Cash provided by financing activities - discontinued operations
Net cash (used in) provided by financing activities
Net increase (decrease) in cash and cash equivalents and restricted cash from continuing
54
$
(28,336)
$
(1,064)
7,136
2,499
780
(241)
6,711
—
(1,661)
17
(381)
7,393
1,629
1,720
(226)
57
(939)
(17)
—
997
(2,276)
(579)
744
6,017
(2,745)
(2,765)
(7,378)
(10,143)—
7,019
5,094
(4,790)
(1,211)
3,470
(1,580)
—
1,642
(1)
1,001
565
6,343
—
519
18,071
1,977
20,048
—
678
(376)
(1,000)
(3,392)
(4,090)
—
(4,090)
11,216
(11,609)
16,306
(1,017)
(2,115)
—
(1,551)
5,390
(212)
1,186
(306)
—
1,832
758
8,487
(17,316)
95
(960)
—
494
(1,689)
(3,099)
(498)
(873)
1,830
(5,133)
(10,000)
(4,404)
(14,404)
1,756
3,754
(192)
(338)
(7,789)
(664)
(171)
2,272
250
—
—
1,017
(7,929)
4,743
(3,291)
23,392
20,101
(47)
339
—
4,917
(3,037)
2,172
—
2,172
(11,119)
KINGSWAY FINANCIAL SERVICES INC.
Cash and cash equivalents and restricted cash at beginning of period
Less: cash and cash equivalents and restricted cash of discontinued operations at beginning of
period
Cash and cash equivalents and restricted cash of continuing operations at beginning of period
Cash and cash equivalents and restricted cash of continuing operations at end of period
Supplemental disclosures of cash flows information:
Cash paid during the year for:
Interest
Income taxes
Non-cash investing and financing activities:
Conversion of Class A preferred stock to common stock
Accrued dividends on Class A preferred stock issued
43,874
23,512
20,362
31,578
$
36,005
4,524
31,481
20,362
Years ended December 31,
2018
2017
11,369
381
$
$
— $
620
$
12,134
37
1,000
1,248
$
$
$
$
$
See accompanying notes to Consolidated Financial Statements.
55
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. Effective December 31, 2018, the Company changed its jurisdiction of incorporation from the province
of Ontario, Canada, to the State of Delaware. Kingsway is a holding company with operating subsidiaries located in the United
States. The Company owns or controls subsidiaries primarily in the extended warranty, asset management and real estate industries.
NOTE 2 SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
(a)
Principles of consolidation:
The accompanying information in the 2018 Annual Report has been prepared in accordance with accounting principles generally
accepted in the United States of America ("U.S. GAAP").
The accompanying consolidated financial statements include the accounts of Kingsway and its majority owned and controlled
subsidiaries. All significant intercompany accounts and transactions have been eliminated in consolidation. In addition, the
Company evaluates its relationships or investments for consolidation pursuant to authoritative accounting guidance related to the
consolidation of variable interest entities under the Variable Interest Model prescribed by the Financial Accounting Standards
Board ("FASB"). A variable interest entity ("VIE") is consolidated when the Company has the power to direct activities that most
significantly impact the economic performance of the variable interest entity and has the obligation to absorb losses or the right
to receive benefits from the variable interest entity that could potentially be significant to the variable interest entity. When a
variable interest entity is not consolidated, the Company uses either the equity method or the cost method to account for the
investment. Under the equity method, the carrying value is generally the Company’s share of the net asset value of the unconsolidated
entity, and changes in the Company’s share of the net asset value are recorded in net investment income.
Certain prior year amounts have been reclassified to conform to current year presentation. Such reclassifications had no impact
on previously reported net loss or total shareholders' equity.
Subsidiaries
The Company's consolidated financial statements include the assets, liabilities, shareholders' equity, revenues, 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
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 are included up to the date control ceased, and any difference between the fair value of the consideration
received and the carrying value of a subsidiary that has been disposed is 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, 2018 based on individual company financial statements at
the same date, or in the case of certain limited liability companies that are consolidated, on a three-month lag basis. 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
Capital LLC; 1347 Venture Opportunity LLC; Appco Finance Corporation; American Country Underwriting Agency Inc.; Argo
Holdings Fund I, LLC ("Argo Holdings"); Argo Management Group, LLC ("Argo Management"); ARM Holdings, Inc.; CMC
Industries, Inc. ("CMC"); DPM SPV, LLC ("DPM"); Flower Portfolio 001, LLC ("Flower"); Itasca Capital Corp.; Itasca Investors
LLC; IWS Acquisition Corporation ("IWS"); KAI Management Services Inc.; 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 Reinsurance Corporation ("Kingsway Re"); Kingsway Warranty Holdings
LLC; Mattoni Insurance Brokerage, Inc.; Net Lease Investment Grade Portfolio LLC ("Net Lease"); Professional Warranty Service
Corporation ("PWSC"); Professional Warranty Services LLC; and Trinity Warranty Solutions LLC ("Trinity").
Argo Holdings, Flower and Net Lease meet the definition of an investment company and follow the accounting and reporting
guidance in Financial Accounting Standards Codification Topic 946, Financial Services-Investment Companies.
56
KINGSWAY FINANCIAL SERVICES INC.
Notes to Consolidated Financial Statements
Noncontrolling interests
The Company has noncontrolling interests attributable to Argo Holdings, CMC, DPM, IWS and Net Lease. A noncontrolling
interest arises where the Company owns less than 100% of the voting rights and economic interests in a subsidiary. A noncontrolling
interest 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 the reported amounts and classification of assets and liabilities, revenues and expenses, and the related
disclosures of contingent assets and liabilities in the consolidated financial statements and accompanying notes. 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; impairment assessment of investments; valuation of limited liability investments, at
fair value; valuation of real estate investments; valuation of deferred income taxes; valuation of mandatorily redeemable preferred
stock; valuation and impairment assessment of intangible assets; goodwill recoverability; deferred acquisition costs; fair value
assumptions for subordinated debt obligations; and revenue recognition.
(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 United States. 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
(loss). 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. The unrealized foreign currency translation gains and losses arising from available-for-sale financial assets
are recognized in other comprehensive income (loss) 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.
Foreign currency translation adjustments are included in shareholders' equity under the caption accumulated other comprehensive
income (loss). Foreign currency gains and losses resulting from transactions denominated in currencies other than the entity's
functional currency are reflected in non-operating other income in the consolidated statements of operations.
(d)
Business combinations:
The acquisition method of accounting is used to account for acquisitions 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 interests in the net assets of consolidated entities are
reported separately in shareholders' equity.
(e)
Investments:
Investments in fixed maturities are classified as available-for-sale and reported at fair value. Unrealized gains and losses are
included in accumulated other comprehensive income (loss), 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.
57
KINGSWAY FINANCIAL SERVICES INC.
Notes to Consolidated Financial Statements
Equity investments include common stocks and warrants and are reported at fair value. Effective January 1, 2018, changes in fair
value of equity investments are recognized in net income (loss). Prior to 2018, changes in fair value of equity investments were
recognized in other comprehensive income (loss).
Limited liability investments include investments in limited liability companies and limited partnerships in which the Company's
interests are not deemed minor and, therefore, are accounted for under the equity method of accounting. Income or loss 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.
Limited liability investments, at fair value represent the Company's investment in 1347 Investors LLC ("1347 Investors") as well
as the underlying investments of Net Lease and Argo Holdings. The Company accounts for these investments at fair value with
changes in fair value reported in the consolidated statements of operations. Income from limited liability investments, at fair value
is included in loss on change in fair value of limited liability investments, at fair value.
Investments in private companies consist of common stock, preferred stock, notes receivable and derivative contracts in privately
owned companies and investments in limited liability companies in which the Company’s interests are deemed minor. These
investments do not have readily determinable fair values and, therefore, are reported at cost, adjusted for observable price changes
and impairments. Changes in carrying value are included in net change in unrealized loss on private company investments.
Real estate investments are reported at fair value.
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 (losses) gains.
Dividends and interest income are included in net investment income. Investment income is recorded as it accrues.
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-
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 and restricted cash:
Cash and cash equivalents and restricted cash include cash and investments with original maturities of no more than three months
when purchased that are readily convertible into cash.
(g)
Investment in investee:
Investment in investee is comprised of an investment in an entity 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.
At December 31, 2018 and December 31, 2017, investment in investee includes the Company's investment in the common stock
of Itasca Capital Ltd. ("ICL"). This investment is reported as investment in investee in the consolidated balance sheets and accounted
for under the equity method of accounting, with the Company's share of income (loss) and other comprehensive income (loss) of
the investee reported in the corresponding lines 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. Distributions
received are classified using the cumulative earnings approach.
58
KINGSWAY FINANCIAL SERVICES INC.
Notes to Consolidated Financial Statements
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 equity in net (loss) income of investee 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)
Service fee receivable:
Service fee receivable includes balances due and uncollected from customers. Service fee receivable is reported net of an estimated
allowance for doubtful accounts.
(i)
Reinsurance:
Reinsurance 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. Losses ceded to other companies have been reported as a
reduction of 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.
(j)
Deferred acquisition costs, net:
The Company defers commissions and agency expenses that are directly related to successful efforts to acquire new or existing
vehicle service agreements to the extent they are considered recoverable. Costs deferred on vehicle service agreements are amortized
as the related 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.
(k)
Property and equipment:
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 life to be forty years for buildings;
five to fifty years for site improvements; four to six years for leasehold improvements; three to ten years for furniture and equipment;
and three to five years for computer hardware.
(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.
The Company has the option to assess goodwill for impairment by first performing a qualitative assessment to determine whether
it 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. In the first step, the fair value of the reporting unit is compared to its book value including goodwill. If the fair value
of the reporting unit is in excess of its book value, the related goodwill is not impaired and no further analysis is necessary. If the
fair value of the reporting unit is less than its book value, there is an indication of potential impairment and a second step is
performed. When required, the second step of testing involves calculating the implied fair value of goodwill for the reporting unit.
The implied fair value of goodwill is determined in the same manner as goodwill recognized in a business combination, which is
the excess of the fair value of the reporting unit determined in step one over the fair value of its net assets and identifiable intangible
59
KINGSWAY FINANCIAL SERVICES INC.
Notes to Consolidated Financial Statements
assets as if the reporting unit had been acquired. If the carrying value of the reporting unit's goodwill exceeds the implied fair
value of that goodwill, an impairment loss is recognized in an amount equal to that excess. For reporting units with a negative
book value, qualitative factors are evaluated to determine whether it is necessary to perform the second step of the goodwill
impairment test.
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 bank loan is reported at its unpaid principal balance.
The Company has notes payable at Flower, Net Lease and CMC. The Flower and Net Lease notes payable balances are reported
at their unpaid principal balance. The CMC note payable is reported at amortized cost. The CMC note payable includes a premium
that is being amortized through the maturity date of the note payable using the effective interest rate method.
The Company's subordinated debt is measured and reported at fair value. The fair value of the subordinated debt is calculated
using a model based on significant market observable inputs and inputs developed by a third-party. These inputs include credit
spread assumptions developed by a third-party and market observable swap rates. Effective January 1, 2018, the portion of the
change in fair value of subordinated debt related to the instrument-specific credit risk is recognized in other comprehensive income
(loss), whereas for 2017, the total change in fair value of subordinated debt was recorded in net income (loss).
(o)
Contingent consideration:
The consideration for certain of the Company's acquisitions included future payments to the former owners that were 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 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 (benefit).
(p)
Income taxes:
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
60
KINGSWAY FINANCIAL SERVICES INC.
Notes to Consolidated Financial Statements
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 accounts for uncertain tax positions in accordance
with the income tax accounting guidance. The Company recognizes interest and penalties, if any, related to unrecognized tax
benefits in income tax expense (benefit).
(q)
Leases:
Rental income from operating leases is recognized on a straight-line basis, based on contractual lease terms with fixed and
determinable increases over the non-cancellable term of the related lease when collectability is reasonably assured. Rental income
recognized in excess of amounts contractually due and collected pursuant to the underlying lease is recorded in other receivables
in the consolidated balance sheets. Rental expense for operating leases is recognized on a straight-line basis over the lease term,
net of any applicable lease incentive amortization. Below market lease liabilities recorded in connection with the acquisition
method of accounting are amortized on a straight-line basis over the remaining term of the lease, as determined at the acquisition
date, and are included in accrued expenses and other liabilities in the consolidated balance sheets. Amortization of below market
lease liabilities is included in rental income in the consolidated statements of operations.
(r)
Revenue recognition:
Service fee and commission income and deferred service fees
Service fee and commission income represents vehicle service agreement fees, guaranteed asset protection products ("GAP")
commissions, maintenance support service fees, warranty product commissions, homebuilder warranty service fees and
homebuilder warranty commissions based on terms of various agreements with credit unions, consumers, businesses and
homebuilders.
Vehicle service agreement fees include the fees collected to cover the costs of future automobile mechanical breakdown claims
and the associated administration of those claims. Vehicle service agreement fees are earned over the duration of the vehicle
service agreement contracts as the single performance obligation is satisfied. Vehicle service agreement fees are initially recorded
as deferred service fees. On a quarterly basis, the Company compares the remaining deferred service fees balance to the estimated
amount of expected future claims under the vehicle service agreement contracts and records an additional accrual when the deferred
service fees balance is less than expected future claims costs.
GAP commissions include commissions from the sale of GAP products. The Company acts as an agent on behalf of the third-
party insurance company that underwrites and guaranties these GAP contracts. The Company does not assume any insurance risk
from the sale of GAP contracts. IWS receives a single commission fee as its transaction price at the time it sells a GAP contract
to a customer. Each GAP contract contains two separate performance obligations - sale of a GAP contract and GAP claims
administration. The first performance obligation is related to the sale of a GAP contract and is satisfied upon closing the sale. The
second performance obligation is related to the administration of claims during the GAP contract period, generally four years.
Maintenance support service fees include the service fees collected to administer equipment breakdown and maintenance support
services and are earned as services are rendered.
Warranty product commissions include the commissions from the sale of warranty contracts for certain new and used heating,
ventilation, air conditioning ("HVAC"), standby generator, commercial LED lighting and refrigeration equipment. The Company
acts as an agent on behalf of the third-party insurance companies that underwrite and guaranty these warranty contracts. The
Company does not guaranty the performance underlying the warranty contracts it sells. Warranty product commissions are earned
at the time of the warranty product sales.
Homebuilder warranty service fees include fees collected from the sale of warranties issued by new homebuilders. PWSC receives
a single warranty service fee as its transaction price at the time it enters into a written contract with each of its builder customers.
Each contract contains two separate performance obligations - warranty administrative services and other warranty services.
Warranty administrative services include enrolling each home sold by the builder into the program and the warranty administrative
system and delivering the warranty product. Warranty administrative services are earned at the time the home is enrolled and the
warranty product is delivered. Other warranty services include answering builder or homeowner questions regarding the home
warranty and dispute resolution services. Other warranty services are earned as services are performed over the warranty coverage
period.
61
KINGSWAY FINANCIAL SERVICES INC.
Notes to Consolidated Financial Statements
Homebuilder warranty commissions include commissions from the sale of warranty contracts for those builders who have requested
and receive insurance backing of their warranty obligations. The Company acts as an agent on behalf of the third-party insurance
company that underwrites and guaranties these warranty contracts. Homebuilder warranty commissions are earned on the
certification date, which is typically the date of the closing of the sale of the home to the buyer. The Company also earns fees to
manage remediation or repair services related to claims on insurance-backed warranty obligations, which are earned when the
claims are closed, and a profit-sharing bonus on eligible warranties, which is determined based on expected ultimate loss ratio
targets and is earned at the time the profit-sharing bonus is received.
Contingent revenue
The terms of the sale of one of the Company's subsidiaries includes potential receipt by the Company of future earnout payments.
The gain related to the earnout payments is recorded when the consideration is determined to be realizable and is reported in the
consolidated statements of operations as gain on disposal of discontinued operations, net of taxes.
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.
(s)
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 and is incurred
when the services are performed.
(t)
Stock-based compensation:
The Company uses the fair-value method of accounting for stock-based compensation awards granted to employees. Expense is
recognized on a straight-line basis over the requisite service period during which awards are expected to vest, with a corresponding
increase to additional paid-in capital. For awards with a graded vesting schedule, expense is recognized on a straight-line basis
over the requisite service period for each separately vesting portion of the award. For awards subject to a performance condition,
expense is recognized when the performance condition has been satisfied or is probable of being satisfied. Forfeitures are recognized
in the period that the award is forfeited. When stock options are exercised, the amount of proceeds together with the amount
recorded in additional paid-in capital is recorded in shareholders' equity.
(u)
Fair value of financial instruments:
The fair values of the Company's investments in fixed maturities and equity investments, limited liability investments, at fair value,
real estate investments and subordinated debt 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 is 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 and cash equivalents, restricted cash, short-term investments and certain other assets and other
liabilities because of their short-term nature.
NOTE 3 RESTATEMENT OF PREVIOUSLY ISSUED FINANCIAL STATEMENTS
On June 13, 2019, the Audit Committee of the Board of Directors of the Company concluded, after review and discussion with
management, that the Company's audited consolidated financial statements for the year ended December 31, 2017 should no longer
be relied upon. On February 26, 2020, the Audit Committee of the Board of Directors of the Company concluded, after further
review and discussion with management following the completion of the Company’s audit for the year ended December 31, 2018,
that the Company's consolidated financial statements for the year ended December 31, 2017 should be further restated as a result
of additional error corrections identified subsequent to June 13, 2019.
The Company has restated its previously reported consolidated financial statements as of and for the year ended December 31,
2017. The restatements reflect corrections of errors identified in connection with the preparation of the consolidated financial
statements for the year ended December 31, 2018, and relate primarily to i) the reclassification of certain investments acquired
from Mendota on October 18, 2018 from assets held for sale to equity investments, limited liability investments, limited liability
investments, at fair value and other investments in the consolidated balance sheet; and the reclassification of investment income,
related to these investments, from loss from discontinued operations, net of taxes to net investment income in the consolidated
statement of operations ("Error 1"); ii) the consolidation of certain limited liability investments that had previously been accounted
for under the equity method of accounting ("Error 2"); and iii) the reclassification from cash and cash equivalents to restricted
cash in the consolidated balance sheets ("Error 3"). For the year ended December 31, 2017, correcting these errors increased the
62
KINGSWAY FINANCIAL SERVICES INC.
Notes to Consolidated Financial Statements
Company’s net loss by $0.3 million. The cumulative effect of correcting these errors increased previously reported shareholders'
equity by $4.2 million as a result of recording noncontrolling interests in consolidated subsidiaries.
Along with restating our financial statements as of and for the year ended December 31, 2017 to correct the errors discussed above,
the Company has recorded certain immaterial accounting adjustments related to the periods covered by this 2018 Annual Report.
For the year ended December 31, 2017, recording these certain immaterial accounting adjustments increased the Company’s net
loss by $0.2 million. The cumulative effect of recording these certain immaterial accounting adjustments increased previously
reported shareholders' equity by $2.7 million. Refer to the notes under the tables below for descriptions of these immaterial
accounting adjustments.
In addition to these items, certain other amounts have been reclassified in the consolidated balance sheet to conform to current
year presentation. Such reclassifications had no impact on previously reported total shareholders' equity.
63
KINGSWAY FINANCIAL SERVICES INC.
Notes to Consolidated Financial Statements
The following table presents the effects of the error corrections, immaterial accounting adjustments and reclassifications on the
Company’s consolidated balance sheet at December 31, 2017:
(in thousands)
Assets:
Investments:
As Previously
Reported in
Exhibit 99.2 to
the Form 8-K
filed
November 7,
2018
Correction
of Error 1
Correction
of Error 2
Correction
of Error 3
Immaterial
Accounting
Adjustments and
Reclassifications
Fixed maturities, at fair value
Equity investments, at fair value
Limited liability investments
Limited liability investments, at fair value
$
$
14,541
4,476
4,922
5,771
— $
113
6,113
4,545
— $
—
(1,091)
21,895
— $
—
—
—
Investments in private companies, at
adjusted cost
Real estate investments, at fair value
Other investments, at cost which
approximates fair value
Short-term investments, at cost which
approximates fair value
Total investments
Cash and cash equivalents
Restricted cash
Investment in investee
Accrued investment income
Service fee receivable
Other receivables
Deferred acquisition costs, net
Property and equipment
Goodwill
Intangible assets
Other assets
Assets held for sale
Total Assets
Liabilities and Shareholders' Equity
Liabilities:
Accrued expenses and other liabilities
Income taxes payable
Deferred service fees
Unpaid loss and loss adjustment expenses
Bank loan
Notes payable
Subordinated debt, at fair value
Net deferred income tax liabilities
Liabilities held for sale
Total Liabilities
Redeemable Class A preferred stock
Shareholders' Equity:
Common stock
Additional paid-in capital
Accumulated deficit
Accumulated other comprehensive loss
Shareholders' equity attributable to common
shareholders
—
—
—
—
4,020
10,662
2,321
1,400
151
32,182
20,774
—
5,230
331
4,286
6,536
6,325
108,008
80,112
80,062
4,302
136,452
484,600
—
12,171
—
—
—
—
—
—
—
—
—
—
—
(12,171)
$
— $
—
—
35,486
310
—
—
176
—
(48)
—
—
—
—
—
(14,136)
21,788
$
—
—
—
—
—
(14,985)
14,985
—
—
—
—
—
—
—
—
—
—
— $
10,924
$
— $
432
$
— $
$
$
—
—
—
—
17,179
—
—
—
17,611
—
—
—
(51)
—
(51)
2,644
42,257
1,329
4,917
186,469
52,105
28,745
105,900
435,290
5,461
—
356,021
(313,487)
(3,852)
38,682
—
—
—
—
—
—
—
—
—
—
—
—
—
—
—
64
—
—
—
—
—
—
—
—
—
—
—
—
—
—
—
December 31, 2017
As
Restated
$
14,541
4,589
9,094
32,211
4,870
10,662
3,721
151
79,839
5,377
14,985
5,230
507
4,431
7,247
6,325
108,008
80,843
79,446
4,302
110,145
$ 506,685
(a)
(a)
(b)
(c)
(b)
(d)
(d)
(b), (c),
(e), (f)
$
10,359
—
—
(850)
—
850
—
—
—
—
(722)
—
—
—
145
759
—
—
731
(616)
—
—
297
(997)
—
(1,144) (b), (g)
—
—
—
—
18
—
(2,123)
(d)
2,644
41,113
1,329
4,917
203,648
52,105
28,763
105,900
450,778
(281)
(e)
5,180
—
150
2,585
—
2,735
—
(e)
356,171
(c), (d),
(e), (f),
(g)
(310,953)
(3,852)
41,366
KINGSWAY FINANCIAL SERVICES INC.
Notes to Consolidated Financial Statements
Noncontrolling interests in consolidated
subsidiaries
Total Shareholders' Equity
Total Liabilities, Class A preferred stock and
Shareholders' Equity
5,167
43,849
—
—
4,228
4,177
—
—
$
484,600
$
— $
21,788
$
— $
(34) (c), (g)
2,701
297
9,361
50,727
$ 506,685
65
KINGSWAY FINANCIAL SERVICES INC.
Notes to Consolidated Financial Statements
The following table presents the effects of the error corrections, immaterial accounting adjustments and reclassifications on the
Company’s consolidated statement of operations for the year ended December 31, 2017:
(in thousands)
December 31, 2017
As
Previously
Reported in
Exhibit 99.2
to the Form
8-K filed
November 7,
2018
Correction
of Error 1
Correction
of Error 2
Correction
of Error 3
Immaterial
Accounting
Adjustments and
Reclassifications
As
Restated
Revenues:
Service fee and commission income
$
30,807
$
— $
— $
— $
(277)
(c), (g)
$ 30,530
Rental income
Other income
Total revenues
Operating expenses:
Claims authorized on vehicle service agreements
Loss and loss adjustment expenses
Commissions
Cost of services sold
General and administrative expenses
Leased real estate segment interest expense
Total operating expenses
Operating loss
Other revenues (expenses), net:
Net investment income
Net realized gains
Gain on change in fair value of limited liability
investments, at fair value
Net change in unrealized loss on private
company investments
Non-operating other income
Interest expense not allocated to segments
Amortization of intangible assets
Contingent consideration benefit
Loss on change in fair value of debt
Equity in net income of investee
Total other revenues (expenses), net
(Loss) income from continuing operations before
income tax (benefit) expense
Income tax (benefit) expense
Income (loss) from continuing operations
Loss on liquidation of subsidiary, net of taxes
Loss from discontinued operations, net of taxes
Gain on disposal of discontinued operations, net of
taxes
Net loss
Less: net income (loss) attributable to
noncontrolling interests in consolidated
subsidiaries
Less: dividends on preferred stock, net of tax
Net (loss) income attributable to common
shareholders
(Loss) earnings per share - continuing operations:
Basic:
Diluted:
Loss per share - discontinued operations:
Basic:
Diluted:
Loss per share – net loss attributable to common
shareholders:
Basic:
Diluted:
13,384
684
44,875
5,327
404
3,086
6,535
27,038
6,264
48,654
(3,779)
968
306
—
—
697
(4,977)
(1,152)
212
(8,487)
2,115
—
—
—
—
—
—
—
—
—
—
—
—
—
—
—
—
—
—
305
—
305
(305)
1,249
—
4,529
—
(45)
(1,446)
—
—
—
—
—
—
—
(10,318)
1,204
(14,097)
(16,694)
2,597
(494)
(14,252)
1,017
(11,132)
4,337
350
1,204
—
1,204
—
(1,204)
—
—
—
—
(758)
(69)
(1,371)
—
—
—
—
885
580
—
580
—
(850)
—
(270)
(219)
—
—
—
—
—
—
—
—
—
—
—
—
—
—
—
—
—
—
—
—
—
—
—
—
—
—
—
—
—
—
—
—
—
—
(277)
—
—
—
—
(32)
—
(32)
(245)
341
—
(e)
(a)
13,384
684
44,598
5,327
404
3,086
6,535
27,311
6,264
48,927
(4,329)
7,087
306
(341)
(a)
(1,832)
(f)
(d)
—
(23)
—
67
—
—
—
44
(201)
6
(d)
(207)
—
—
—
(207)
(758)
605
(6,348)
(1,085)
212
(8,487)
2,115
(8,185)
(12,514)
(16,688)
4,174
(494)
(16,306)
1,017
(11,609)
(33)
(c), (g)
898
(e)
4,085
1,248
$
$
$
$
$
$
$
(15,819) $
— $
(51)
— $
(1,072)
$ (16,942)
(0.10) $
(0.10) $
0.06
0.06
$
$
0.04
0.04
$
$
(0.64) $
(0.64) $
(0.09) $
(0.09) $
(0.04) $
(0.04) $
(0.73) $
(0.73) $
(0.01) $
(0.01) $
— $
— $
— $
— $
— $
— $
— $
— $
(0.05)
(0.05)
—
—
(0.05)
(0.05)
$
$
$
$
$
$
(0.05)
(0.05)
(0.77)
(0.77)
(0.79)
(0.79)
66
KINGSWAY FINANCIAL SERVICES INC.
Notes to Consolidated Financial Statements
Weighted average shares outstanding (in ‘000s):
Basic:
Diluted:
21,547
21,547
—
—
—
—
—
—
—
—
21,547
21,547
67
KINGSWAY FINANCIAL SERVICES INC.
Notes to Consolidated Financial Statements
The following table presents the effects of the error corrections, immaterial accounting adjustments and reclassifications on the
Company’s consolidated statement of cash flows for the year ended December 31, 2017:
(in thousands)
Year ended December 31, 2017
As
Previously
Reported in
Exhibit 99.2
to the Form
8-K filed
November 7,
2018
Correction
of Error 1
Correction
of Error 2
Correction
of Error 3
Immaterial
Accounting
Adjustments and
Reclassifications
As
Restated
Cash provided by (used in):
Operating activities:
Net loss
$
(11,132) $
— $
(270) $
— $
(207)
(c), (d), (g),
(f), (g)
$ (11,609)
Adjustments to reconcile net loss income to net
cash (used in) provided by operating activities:
Loss from discontinued operations, net of taxes
Gain on disposal of discontinued operations, net of
taxes
Equity in net income of investee
Equity in net income of limited liability
investments
Loss on change in fair value of limited liability
investment
Depreciation and amortization expense
Contingent consideration benefit
Stock-based compensation expense, net of
forfeitures
Net realized gains
Loss on change in fair value of limited liability
investments, at fair value
Net change in unrealized loss on private company
investments
Loss on change in fair value of debt
Deferred income taxes
Amortization of fixed maturities premiums and
discounts
Amortization of note payable premium
Loss on liquidation of subsidiary
Changes in operating assets and liabilities:
Service fee receivable, net
Other receivables, net
Deferred acquisition costs, net
Unpaid loss and loss adjustment expenses
Deferred service fees
Other, net
Cash (used in) provided by operating activities -
continuing operations
Cash (used in) provided by operating activities -
discontinued operations
Net cash (used in) provided by operating activities
Investing activities:
Proceeds from sales and maturities of fixed
maturities
Proceeds from sales of equity investments
Purchases of fixed maturities
Purchases of equity investments
Net acquisitions of limited liability investments
Purchases of limited liability investments, at fair
value
Purchases of investments in private companies
Net proceeds from other investments
Net proceeds from short-term investments
Net proceeds from sale of discontinued operations
Acquisition of business, net of cash acquired
Net disposals of property and equipment and
—
850
—
—
383
—
—
—
—
—
1,446
758
—
—
—
—
—
—
—
20
—
—
—
(3,434)
(247)
—
(247)
—
—
—
—
1,121
(664)
(171)
—
—
—
—
—
14,252
1,204
(1,017)
(2,115)
—
—
(685)
(1,249)
632
5,457
(212)
1,186
(306)
—
—
8,487
(17,322)
95
(960)
494
(1,544)
(3,187)
(498)
(873)
1,754
(2,331)
(9,825)
45
—
—
—
—
—
—
—
—
—
—
—
—
—
—
—
—
—
—
(9,152)
(18,977)
4,748
4,748
1,756
3,754
(192)
(338)
(8,910)
—
—
2,272
250
1,017
(7,929)
4,743
—
—
—
—
—
—
—
—
—
—
—
—
68
—
—
—
—
—
—
—
—
—
—
—
—
—
—
—
—
—
—
—
—
—
—
—
—
—
—
—
—
—
—
—
—
—
—
—
—
—
—
—
—
—
—
—
(677)
(67)
—
—
—
(a)
(d)
386
(a)
—
—
6
—
—
—
(145)
68
—
—
(d)
(c)
(b)
76
(b), (g)
632
(b), (c), (e),
(f), (a)
72
—
72
—
—
—
—
—
—
—
—
—
—
—
—
16,306
(1,017)
(2,115)
(1,551)
—
5,390
(212)
1,186
(306)
1,832
758
8,487
(17,316)
95
(960)
494
(1,689)
(3,099)
(498)
(873)
1,830
(5,133)
(10,000)
(4,404)
(14,404)
1,756
3,754
(192)
(338)
(7,789)
(664)
(171)
2,272
250
1,017
(7,929)
4,743
KINGSWAY FINANCIAL SERVICES INC.
Notes to Consolidated Financial Statements
Cash (used in) provided by investing activities -
continuing operations
Cash provided by (used in) investing activities -
discontinued operations
Net cash provided by (used in) investing activities
Financing activities:
Proceeds from issuance of common stock, net
Contributions from noncontrolling interest holders
Principal proceeds from bank loan
Principal payments on note payable
Cash provided by (used in) financing activities -
continuing operations
Cash provided by financing activities -
discontinued operations
Net cash provided by (used in) financing activities
Net (decrease) increase in cash and cash
equivalents and restricted stock from continuing
operations
Cash and cash equivalents and restricted stock at
beginning of period
Less: cash and cash equivalents and restricted stock
of discontinued operations at beginning of period
Cash and cash equivalents and restricted stock of
continuing operations at beginning of period
Cash and cash equivalents and restricted stock of
continuing operations at end of period
(3,577)
—
28,140
24,563
(47)
—
4,917
(2,645)
2,225
—
2,225
(11,177)
36,475
4,524
31,951
(4,748)
(4,748)
—
—
—
—
—
—
—
—
—
—
—
286
—
286
—
339
—
(392)
(53)
—
(53)
(14)
325
—
325
—
—
—
—
—
—
—
—
—
—
—
—
—
—
—
—
—
—
—
—
—
—
—
—
72
(3,291)
23,392
20,101
(47)
339
4,917
(3,037)
2,172
—
2,172
(11,119)
(795)
(b)
36,005
—
4,524
(795)
(b)
31,481
$
20,774
$
— $
311
$
— $
(723)
$ 20,362
(a) Reclassifications to conform to current presentation. Such reclassifications have no impact on previously reported net
loss or total shareholders' equity.
(b) Reclassifications as a result of misclassifications of amounts in a previous filing. Such reclassifications have no impact
on previously reported net loss or total shareholders' equity.
(c) Adjustments to Extended Warranty segment service fee receivable and accrued expenses and other liabilities, with
offsetting adjustments to accrued expenses and other liabilities and service fee and commission income.
(d) Adjustment to increase goodwill, with offsetting decreases to intangible assets, amortization of intangible assets and
accumulated deficit, related to the Company's acquisition of Argo Management in 2016. Also includes the related tax
impact of these adjustments, resulting in an increase to net deferred income tax liabilities, with offsetting decreases to
income tax benefit and accumulated deficit.
(e) Adjustment to decrease redeemable Class A preferred stock, with an offsetting increase to additional paid-in capital and
an offsetting decrease to general and administrative expenses related to the Company’s issuance of Class A preferred
stock and Class C Warrants on February 3, 2014. Also includes the related reclassifications of accrued dividends on
equity-classified warrants from accrued expenses and other liabilities to redeemable Class A preferred stock and dividend
expense from accumulated deficit to additional paid-in-capital.
(f) Adjustments to accrued expenses and other liabilities, with offsetting adjustments to non-operating other income and
accumulated deficit, related to escheat liability.
(g) Adjustment to decrease Extended Warranty deferred service fees, with an offsetting increase to service fee and commission
income.
69
KINGSWAY FINANCIAL SERVICES INC.
Notes to Consolidated Financial Statements
NOTE 4 RECENTLY ISSUED ACCOUNTING STANDARDS
(a)
Adoption of New Accounting Standards:
Effective January 1, 2018, the Company adopted Accounting Standards Update ("ASU") 2014-09, Revenue from Contracts with
Customers ("ASU 2014-09"), and the related amendments, utilizing the modified retrospective approach, which created a new
comprehensive revenue recognition standard that serves as the single source of revenue guidance for all contracts with customers
to transfer goods or services or contracts for the transfer of nonfinancial assets, unless those contracts are within the scope of other
standards. The core principle of ASU 2014-09 is that an entity recognizes revenue to depict the transfer of promised goods or
services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those
goods or services. Insurance contracts, lease contracts and investments are not within the scope of ASU 2014-09. ASU 2014-09
is applicable to the Company's service fee and commission income. Service fee and commission income represents vehicle service
agreement fees, GAP commissions, maintenance support service fees, warranty product commissions, homebuilder warranty
service fees and homebuilder warranty commissions based on terms of various agreements with credit unions, consumers,
businesses and homebuilders. With the exception of GAP commissions and homebuilder warranty service fees, the adoption of
ASU 2014-09 did not change the way the Company recognized revenue for the year ended December 31, 2018. The new guidance
affects IWS' GAP commissions and PWSC's homebuilder warranty service fees, which will be recognized more slowly as compared
to the historic revenue recognition pattern prior to the Company’s adoption of ASU 2014-09. As a result of the adoption of ASU
2014-09, the Company also recorded a cumulative effect adjustment to increase accumulated deficit by $0.6 million and increase
deferred service fees by $0.6 million. Prior periods have not been restated to conform to the current presentation. Refer to Note
20, "Revenue from Contracts with Customers," for further details.
Effective January 1, 2018, the Company adopted ASU 2016-01, Financial Instruments-Overall (Subtopic 825-10): Recognition
and Measurement of Financial Assets and Financial Liabilities ("ASU 2016-01"). The amendments in ASU 2016-01 address
certain aspects of recognition, measurement, presentation, and disclosure of financial instruments. Most significantly, ASU 2016-01
requires (1) equity investments (except those accounted for under the equity method of accounting or those that result in
consolidation of an investee) to be measured at fair value with changes in fair value recognized in net income (loss); however, an
entity may choose to measure equity investments that do not have readily determinable fair values at cost, adjusted for observable
price changes and impairments; and (2) an entity to present separately in other comprehensive income (loss) the portion of the
total change in the fair value of a liability resulting from a change in the instrument-specific credit risk when the entity has elected
to measure the liability at fair value in accordance with the fair value option for financial instruments. The Company has elected
to measure its investments in private companies at cost, adjusted for observable price changes and impairments. Previously, the
Company recorded its equity investments at fair value with net unrealized gains or losses reported in accumulated other
comprehensive income (loss) and its subordinated debt at fair value with the total change in fair value reported in net income
(loss). As a result of the adoption of ASU 2016-01, at January 1, 2018 cumulative net unrealized losses on equity investments of
$0.0 million were reclassified from accumulated other comprehensive income (loss) into accumulated deficit and a cumulative
$40.5 million change in fair value of subordinated debt attributable to instrument-specific credit risk was reclassified from
accumulated deficit to accumulated other comprehensive income (loss). Prior periods have not been restated to conform to the
current presentation.
Effective January 1, 2018, the Company adopted ASU 2016-15, Classification of Certain Cash Receipts and Cash Payments ("ASU
2016-15"). The objective of ASU 2016-15 is to reduce diversity in the classification of cash receipts and payments for specific
cash flow issues, including debt prepayment or debt extinguishment costs, contingent consideration payments made after a business
combination and proceeds from the settlement of insurance claims. The adoption of the standard did not affect the Company's
consolidated statements of cash flows.
Effective January 1, 2018, the Company adopted ASU 2016-18, Statement of Cash Flows (Topic 230) Restricted Cash ("ASU
2016-18"). The objective of ASU 2016-18 is to explain the change during the period in the total cash, cash equivalents and amounts
generally described as restricted cash or restricted cash equivalents. Amounts generally described as restricted cash and cash
equivalents should be included with the cash and cash equivalents when reconciling the beginning of period and end of period
total amounts shown on the statement of cash flows. As a result of the adoption of the standard, the change in restricted cash is
included in the consolidated statements of cash flows.
Effective July 1, 2018, the Company adopted ASU 2018-07, Compensation-Stock Compensation (Topic 718): Improvements to
Nonemployee Share-Based Payment Accounting ("ASU 2018-07"). ASU 2018-07 was issued to simplify the accounting for share-
based transactions by expanding the scope of Topic 718 from only being applicable to share-based payments to employees to also
include share-based payment transactions for acquiring goods and services from nonemployees. During the third quarter of 2018,
70
KINGSWAY FINANCIAL SERVICES INC.
Notes to Consolidated Financial Statements
the Company granted restricted common stock awards to a nonemployee. Refer to Note 23, "Stock-Based Compensation," for
further details.
(b)
Accounting Standards Not Yet Adopted:
In February 2016, the FASB issued ASU 2016-02, Leases ("ASU 2016-02"). ASU 2016-02 was issued to improve the financial
reporting of leasing transactions. Under current guidance for lessees, leases are only included on the balance sheet if certain
criteria, classifying the agreement as a capital lease, are met. This update will require the recognition of a right-of-use asset and
a corresponding lease liability, discounted to the present value, for all leases that extend beyond 12 months. For operating leases,
the asset and liability will be amortized over the lease term on a straight-line basis, with all cash flows included within operating
activities in the statement of cash flows. The accounting treatment for lessors will remain relatively unchanged. ASU 2016-02
is effective for annual and interim reporting periods beginning after December 15, 2018. The Company will adopt ASU 2016-02
effective January 1, 2019 using the modified retrospective transition method and will not restate comparative periods. The Company
plans to elect the package of practical expedients permitted under the transition guidance within ASU 2016-02, which will allow
the Company to carry forward prior conclusions about lease identification, classification and initial direct costs for leases entered
into prior to adoption of ASU 2016-02. The adoption of ASU 2016-02 will have no impact on the Company's shareholders' equity
as of January 1, 2019, but the Company estimates it will record a right-of-use asset of approximately $2.7 million; a corresponding
lease liability of approximately $2.9 million; and a reversal of December 31, 2018 accrued rent expense of $0.2 million.
In June 2016, the FASB issued ASU 2016-13, Financial Instruments-Credit Losses (Topic 326): Measurement of Credit Losses
on Financial Instruments ("ASU 2016-13"). ASU 2016-13 replaces the current incurred loss model used to measure impairment
losses with an expected loss model for trade, reinsurance, and other receivables as well as financial instruments measured at
amortized cost. ASU 2016-13 will require a financial asset measured at amortized cost, including reinsurance balances recoverable,
to be presented at the net amount expected to be collected by means of an allowance for credit losses that runs through net loss.
Credit losses relating to available-for-sale debt securities will also be recorded through an allowance for credit losses. However,
the amendments would limit the amount of the allowance to the amount by which fair value is below amortized cost. The
measurement of credit losses on available-for-sale investments is similar under current GAAP, but the update requires the use of
the allowance account through which amounts can be reversed, rather than through irreversible write-downs. ASU 2016-13 is
effective for annual periods beginning after December 15, 2019, and interim periods within those annual periods with early adoption
permitted for fiscal years beginning after December 31, 2018 and interim periods within such year. The Company is currently
evaluating ASU 2016-13 to determine the potential impact that adopting this standard will have on its consolidated financial
statements.
In January 2017, the FASB issued ASU 2017-04, Intangibles - Goodwill and Other (Topic 350): Simplifying the Test for Goodwill
Impairment ("ASU 2017-04"). ASU 2017-04 was issued to simplify the subsequent measurement of goodwill. This update changes
the impairment test by requiring an entity to compare the fair value of a reporting unit with its carrying amount as opposed to
comparing the carrying amount of goodwill with its implied fair value. ASU 2017-04 is effective for annual and interim reporting
periods beginning after December 15, 2019. Early adoption is permitted. The Company does not believe the adoption of ASU
2017-04 will have a material effect on its consolidated financial statements.
NOTE 5 ACQUISITION
On October 12, 2017, the Company acquired 100% of the outstanding shares of PWSC for cash consideration of $10.0 million.
As further discussed in Note 28, "Segmented Information," PWSC is included in the Extended Warranty segment. PWSC is based
in Virginia and is a leading provider of new home warranty products and administration services to the largest tier of domestic
residential construction firms in the United States. This acquisition allows the Company to grow its portfolio of warranty companies
and expand into the home warranty business.
This acquisition was accounted for as a business combination using the acquisition method of accounting. The purchase price
was allocated to the assets acquired and liabilities assumed based upon their estimated fair values at the date of acquisition. During
the third quarter of 2018, the Company completed its fair value analysis of the assets acquired and liabilities assumed. Goodwill
of $2.9 million was recognized, which represented a $6.2 million decrease from the amount recorded at December 31, 2017, and
$6.2 million of separately identifiable intangible assets were recognized resulting from the valuations of acquired customer
relationships, non-compete agreement and trade name. Refer to Note 13, "Intangible Assets," for further disclosure of the intangible
assets related to this acquisition. The goodwill represents the premium paid over the fair value of the net tangible and intangible
assets acquired, which the Company paid to grow its portfolio of warranty companies and acquire an assembled workforce. The
goodwill is not deductible for tax purposes. During the years ended December 31, 2018 and December 31, 2017, the Company
71
KINGSWAY FINANCIAL SERVICES INC.
Notes to Consolidated Financial Statements
incurred acquisition-related expenses of $0.0 million and $0.2 million, respectively, which are included in general and administrative
expenses in the consolidated statement of operations.
The following table summarizes the estimated fair value of the assets acquired and liabilities assumed at the date of acquisition:
(in thousands)
Cash and cash equivalents
Other receivables
Service fee receivable
Deferred tax asset
Property and equipment
Goodwill
Intangible assets - subject to amortization
Intangible asset - not subject to amortization
Other assets
Total assets
Deferred service fees
Accrued expenses and other liabilities
Total liabilities
Purchase price
October 12, 2017
2,071
50
1,422
118
238
2,867
5,569
627
206
13,168
800
2,368
3,168
10,000
$
$
$
$
$
NOTE 6 DISPOSAL, DISCONTINUED OPERATIONS AND LIQUIDATION
(a)
Disposal
On June 1, 2018, the Company disposed of its subsidiary, Itasca Real Estate Investors, LLC ("Itasca Real Estate"). As a result of
the disposal, the Company recognized a gain of $0.0 million during the year ended December 31, 2018. The earnings of Itasca
Real Estate are included in the consolidated statements of operations through the June 1, 2018 disposal date.
(b)
Discontinued Operations
Mendota Insurance Company, Mendakota Insurance Company and Mendakota Casualty Company:
On July 16, 2018, the Company announced it had entered into a definitive agreement to sell its non-standard automobile insurance
companies Mendota Insurance Company, Mendakota Insurance Company and Mendakota Casualty Company (collectively
"Mendota"). On October 18, 2018, the Company completed the previously announced sale of Mendota. The final aggregate
purchase price of $28.6 million was redeployed primarily to acquire equity investments, limited liability investments, limited
liability investment, at fair value and other investments, which were owned by Mendota at the time of the closing, and to fund
$5.0 million into an escrow account to be used to satisfy potential indemnity obligations under the definitive stock purchase
agreement. As part of the transaction, the Company will indemnify the buyer for any loss and loss adjustment expenses with
respect to open claims and certain specified claims in excess of Mendota's carried unpaid loss and loss adjustment expenses at
June 30, 2018. The maximum obligation to the Company with respect to the open claims is $2.5 million. There is no maximum
obligation to the Company with respect to the specified claims. During the first quarter of 2019, Mendota settled one of the two
specified claims for no loss to the Company. During the fourth quarter of 2019, Mendota notified the Company that it had entered
into an agreement to settle the remaining specified claim. The Company estimates it will incur a net loss of approximately $1.8
million related to the settlement of the remaining specified claim, which the Company will report in its consolidated statement of
operations for the year ended December 31, 2019.
72
KINGSWAY FINANCIAL SERVICES INC.
Notes to Consolidated Financial Statements
As a result of this announcement, Mendota, which was previously disclosed as part of the Insurance Underwriting segment, has
been classified as a discontinued operation and the results of their operations are reported separately for all periods presented. The
Company recognized a loss on disposal of Mendota of $8.5 million for the year ended December 31, 2018. The assets and liabilities
of Mendota are presented as held for sale in the consolidated balance sheets at December 31, 2017.
Assigned Risk Solutions Ltd.:
On April 1, 2015, the Company closed on the sale of its subsidiary, Assigned Risk Solutions Ltd. ("ARS"). The terms of the sale
provided for receipt by the Company of future earnout payments equal to 1.25% of ARS' written premium and fee income during
the earnout periods. The earnout payments were payable in three annual installments beginning in April 2016 through April 2018.
During 2018, the Company received cash consideration, before expenses, of $1.7 million for the third annual installment earnout
payment. During 2017, the Company received cash consideration, before expenses, of $1.3 million for the second annual installment
earnout payment. Net of expenses, the Company recorded an additional gain on disposal of ARS of $1.3 million and $1.0 million
for the years ended December 31, 2018 and December 31, 2017, respectively. As a result of the sale, ARS, previously disclosed
as part of the Extended Warranty segment, has been classified as a discontinued operation.
Summary financial information for Mendota and ARS included in (loss) income from discontinued operations, net of taxes in the
statements of operations for the years ended December 31, 2018 and December 31, 2017 is presented below:
(in thousands)
Income (loss) from discontinued operations, net of taxes:
Revenues:
Net premiums earned
Net investment income (loss)
Net realized (losses) gains
Other-than temporary impairment loss
Gain on change in fair value of equity investments
Other income
Total revenues
Expenses:
Loss and loss adjustment expenses
Commissions and premium taxes
General and administrative expenses
Impairment of intangible assets
Total expenses
Income (loss) from discontinued operations before income tax benefit
Income tax benefit
Income (loss) from discontinued operations, net of taxes
(Loss) gain on disposal of discontinued operations before income tax expense
Income tax expense
(Loss) gain on disposal of discontinued operations, net of taxes
Years ended December 31,
2018
2017
$
71,182
$
130,443
733
(5)
—
28
7,486
79,424
58,706
7,172
12,482
—
78,360
1,064
—
1,064
(7,136)
—
(7,136)
(353)
3,465
(316)
—
9,938
143,177
120,387
20,682
19,231
250
160,550
(17,373)
(1,067)
(16,306)
1,017
—
1,017
Total loss from discontinued operations, net of taxes
$
(6,072) $
(15,289)
73
KINGSWAY FINANCIAL SERVICES INC.
Notes to Consolidated Financial Statements
The assets and liabilities of Mendota are presented as held for sale in the consolidated balance sheets at December 31, 2017. The
carrying amounts of the major classes of assets and liabilities of Mendota at December 31, 2017 are as follows:
(in thousands)
Assets
Investments:
Fixed maturities, at fair value
Equity investments, at fair value
Total investments
Cash and cash equivalents
Accrued investment income
Premiums receivable, net
Other receivables
Deferred acquisition costs, net
Property and equipment, net
Intangible assets, net
Other assets
Assets held for sale
Liabilities
Unpaid loss and loss adjustment expenses
Unearned premiums
Net deferred income tax liabilities
Accrued expenses and other liabilities
Liabilities held for sale
(c)
Liquidation
December 31, 2017
$
$
$
$
38,673
4,405
43,078
23,512
195
27,855
603
6,720
222
7,553
407
110,145
62,323
36,686
1,586
5,305
105,900
During 2017, the Company's subsidiary, Kingsway ROC GP ("ROC GP"), was liquidated. As a result of the liquidation of this
subsidiary, the Company realized a net after-tax loss of $0.5 million for the year ended December 31, 2017. This loss represents
the foreign exchange loss previously recorded in accumulated other comprehensive loss and now recognized in the statements of
operations as a result of the liquidation of ROC GP. Summarized financial information for liquidation of subsidiary is shown
below:
(in thousands)
Liquidation:
Loss on liquidation before income taxes
Income tax benefit
Loss on liquidation of subsidiary, net of taxes
NOTE 7 VARIABLE INTEREST ENTITIES
Years ended December 31,
2017
2018
$
$
— $
— $
— $
(494)
—
(494)
The Company’s investments include certain investments, primarily in limited liability companies and limited partnerships in which
the Company holds a variable interest. The Company evaluates these investments for the characteristics of a VIE. The Variable
Interest Model identifies the characteristics of a VIE to include investments (1) lacking sufficient equity to finance activities without
additional subordinated support or (2) in which the holders of equity at risk in the investments lack characteristics of a controlling
financial interest, such as the power to direct activities that most significantly impact the legal entity’s economic performance; the
obligation to absorb the legal entity’s expected losses; or the right to receive the expected residual returns of the legal entity. The
equity investors as a group are considered to lack the power to direct activities that most significantly impact the legal entity’s
economic performance when (1) the voting rights of some investors are not proportional to their obligations to absorb the expected
losses of the legal entity or their rights to receive the expected residual returns of the legal entity and (2) substantially all of the
activities of the legal entity are conducted on behalf of an investor with disproportionately few voting rights. When evaluating
whether an investment lacks characteristics of a controlling financial interest, the Company considers limited liability companies
and limited partnerships to lack the power of a controlling financial interest if neither of the following exists: (1) a simple majority
74
KINGSWAY FINANCIAL SERVICES INC.
Notes to Consolidated Financial Statements
or lower threshold of partners or members with equity at risk are able to exercise substantive kick-out rights through voting interest
over the general partner(s) or managing member(s) or (2) limited partners with equity at risk are able to exercise substantive
participating rights over the general partner(s) or managing member(s).
If the characteristics of a VIE are met, the Company evaluates whether it meets the primary beneficiary criteria. The primary
beneficiary is considered to be the entity holding a variable interest that has the power to direct activities that most significantly
impact the economic performance of the VIE; the obligation to absorb losses of the VIE; or the right to receive benefits from the
VIE that could potentially be significant to the VIE. In instances where the Company is considered to be the primary beneficiary,
the Company consolidates the VIE. When the Company is not considered to be the primary beneficiary of the VIE, the VIE is not
consolidated and the Company uses the equity method to account for the investment. Under this method, the carrying value is
generally the Company’s share of the net asset value of the unconsolidated entity, and changes in the Company’s share of the net
asset value are recorded in net investment income.
(a) Consolidated VIEs
Argo Holdings Fund I, LLC:
The Company held a 43.4% investment in Argo Holdings at December 31, 2018 and December 31, 2017. Argo Holdings makes
investments, primarily in established lower middle market companies based in North America, through investments in search
funds. The managing member of Argo Holdings is Argo Management, a wholly owned subsidiary of the Company. Argo Holdings
is considered to be a VIE as the members holding equity at risk lack characteristics of a controlling financial interest. The Company
holds a variable interest in Argo Holdings due to its right to absorb significant economics in Argo Holdings and through its
controlling interest in Argo Management, through which the Company holds the power to direct the significant activities of Argo
Holdings. As such, the Company was the primary beneficiary of Argo Holdings and consolidated Argo Holdings at December 31,
2018 and December 31, 2017.
Net Lease Investment Grade Portfolio, LLC:
The Company held a 71.0% and 71.8% investment in Net Lease at December 31, 2018 and December 31, 2017, respectively. Net
Lease holds three commercial properties under triple net leases. The properties are encumbered by mortgage loans. Net Lease is
considered to be a VIE as the members holding equity at risk lack characteristics of a controlling financial interest. The Company
holds a variable interest in Net Lease due to its right to absorb significant economics in Net Lease and to control the management
decisions of Net Lease, which allows the Company to hold the power to direct the significant activities of Net Lease. As such,
the Company is the primary beneficiary of Net Lease and consolidated Net Lease at December 31, 2018 and December 31, 2017.
DPM SPV, LLC:
The Company held a 66.7% investment in DPM at December 31, 2018 and December 31, 2017. DPM holds an investment in
Swerve Pay LLC, which is a software development firm for medical imaging software. DPM is considered to be a VIE as the
members holding equity at risk lack characteristics of a controlling financial interest. The Company holds a variable interest in
DPM due to its right to absorb significant economics in DPM and to control the management decisions of DPM, which allows the
Company to hold the power to direct the significant activities of the VIE. As such, the Company is the primary beneficiary of
DPM and consolidated DPM at December 31, 2018 and December 31, 2017.
Insurance Income Strategies Ltd.
Insurance Income Strategies Ltd. ("IIS") is a Bermuda corporation organized to offer collateralized reinsurance in the property
catastrophe market through its wholly owned operating subsidiary IIS Re Ltd. The Company held 100% of the outstanding common
stock of IIS at December 31, 2018 and December 31, 2017. IIS was considered to be a VIE at December 31, 2017 as IIS did not
hold sufficient equity to finance its activities without additional subordinated support. At December 31, 2017, the Company was
deemed to have the power to direct the activities of IIS through its voting rights and had the right to absorb significant economics
in IIS; therefore, the Company was the primary beneficiary of IIS and consolidated IIS at December 31, 2017. The results of
consolidation of IIS at December 31, 2017 were immaterial and are reflected as zero in the following table at December 31, 2017.
Effective August 10, 2018, IIS issued preferred stock to a third-party investor in the amount of $15.0 million. In conjunction with
this transaction, documents were executed prohibiting IIS to enter into any material contract, issue equity or debt securities, incur
any other material obligation or enter into, amend or waive any material term of any agreement between the Company and IIS
without the prior written consent of the third-party investor. As a result, while IIS raised sufficient equity to finance its activities,
the holders of equity at risk of IIS no longer had proportionate voting rights, resulting in IIS continuing to be considered a VIE,
75
KINGSWAY FINANCIAL SERVICES INC.
Notes to Consolidated Financial Statements
including at December 31, 2018. Due to the contractual agreements executed in conjunction with the third-party investment, the
Company no longer holds power over IIS as of August 10, 2018. As such, the Company is no longer considered the primary
beneficiary as of August 10, 2018 and deconsolidated IIS.
The following table summarizes the assets and liabilities related to VIEs consolidated by the Company at December 31, 2018 and
December 31, 2017:
(in thousands)
Assets
Limited liability investments, at fair value
Investments in private companies, at adjusted cost
Cash and cash equivalents
Accrued investment income
Other receivable
Total Assets
Liabilities
Accrued expenses and other liabilities
Notes payable
Total Liabilities
2018
25,809
750
351
217
48
27,175
252
9,000
9,252
$
$
December 31,
2017
21,895
750
220
107
—
22,972
97
9,000
9,097
$
$
No arrangements exist requiring the Company to provide additional funding to the consolidated VIEs in excess of the Company’s
unfunded commitments. At December 31, 2018 and December 31, 2017, the Company had $0.6 million and $1.2 million,
respectively, of unfunded commitments to Argo Holdings. There are no restrictions on assets consolidated by these VIEs. There
are no structured settlements of liabilities consolidated by these VIEs. Creditors have no recourse to the general credit of the
Company as the primary beneficiary of these VIEs.
(b) Non-Consolidated VIEs
The Company’s investments include certain non-consolidated investments, primarily in limited liability companies and limited
partnerships in which the Company holds variable interests, that are considered VIEs due to the legal entities holding insufficient
equity; the holders of equity at risk in the legal entities lacking controlling financial interests; and/or the holders of equity at risk
having non-proportional voting rights.
The Company’s risk of loss associated with its non-consolidated VIEs is limited and depends on the investment. Limited liability
investments accounted for under the equity method are limited to the Company’s initial investments. At December 31, 2018 and
December 31, 2017, the Company had zero and $0.1 million, respectively, of unfunded commitments to its non-consolidated VIEs.
The following table summarizes the carrying value and maximum loss exposure of the Company’s non-consolidated VIEs at
December 31, 2018 and December 31, 2017:
(in thousands)
Investments in non-consolidated VIEs
2018
December 31,
2017
Carrying
Value
$
4,664
Maximum
Loss Exposure
4,664
$
Carrying
Value
$
15,363
Maximum
Loss Exposure
15,363
$
76
KINGSWAY FINANCIAL SERVICES INC.
Notes to Consolidated Financial Statements
The following table summarizes the Company’s non-consolidated VIEs by category at December 31, 2018 and December 31,
2017:
(in thousands)
2018
December 31,
2017
Carrying
Value
Percent of
total
Carrying
Value
Percent of
total
Investments in non-consolidated VIEs:
Real estate related
Non-real estate related
Total investments in non-consolidated VIEs
$
1,710
2,954
4,664
36.7%
63.3%
100.0% $
1,726
13,637
15,363
11.2%
88.8%
100.0%
The following table presents aggregated summarized financial information of the Company’s non-consolidated VIEs at
December 31, 2018 and December 31, 2017. For certain of the non-consolidated VIEs, the financial information is presented on
a lag basis, consistent with how the changes in the Company’s share of the net asset values of these equity method investees are
recorded in net investment income. The difference between the end of the reporting period of an equity method investee and that
of the Company is typically no more than three months.
(in thousands)
Assets
Liabilities
Equity
(in thousands)
Net (loss) income
NOTE 8 INVESTMENTS
2018
363,516
296,521
66,995
2018
(29,619)
December 31,
2017
332,181
238,819
93,362
December 31,
2017
(4,294)
$
$
$
$
As further discussed in Note 4, "Recently Issued Accounting Standards," effective January 1, 2018, the Company adopted ASU
2016-01. As a result of the adoption, equity investments are no longer classified as available-for-sale. Prior periods have not
been restated to conform to the current presentation.
The amortized cost, gross unrealized gains and losses, and estimated fair value of the Company's available-for-sale investments
at December 31, 2018 and December 31, 2017 are summarized in the tables shown below:
(in thousands)
Fixed maturities:
U.S. government, government agencies and
authorities
States, municipalities and political subdivisions
Mortgage-backed
Corporate
Total fixed maturities
Amortized
Cost
Gross
Unrealized
Gains
Gross
Unrealized
Losses
Estimated
Fair Value
December 31, 2018
$
1
—
—
—
1
48
14
70
41
173
$
5,547
607
3,186
2,920
12,260
$
5,594
$
621
3,256
2,961
12,432
77
KINGSWAY FINANCIAL SERVICES INC.
Notes to Consolidated Financial Statements
Amortized
Cost
Gross
Unrealized
Gains
Gross
Unrealized
Losses
Estimated
Fair Value
December 31, 2017
(in thousands)
Fixed maturities:
U.S. government, government agencies and
authorities
$
5,671
$
States, municipalities and political subdivisions
Mortgage-backed
Corporate
Total fixed maturities
Equity investments:
Common stock
Warrants - publicly traded
Warrants - not publicly traded
Total equity investments
639
2,933
5,464
14,707
3,883
25
960
4,868
Total fixed maturities and equity investments
$
19,575
$
—
—
—
—
—
—
146
173
319
319
$
$
59
13
57
37
166
313
—
285
598
764
$
5,612
626
2,876
5,427
14,541
3,570
171
848
4,589
$
19,130
Net unrealized gains and losses in the tables above are reported as other comprehensive income (loss) with the exception of net
unrealized losses of $0.1 million, at December 31, 2017, related to warrants - not publicly traded, which are reported in the
consolidated statements of operations.
The table below summarizes the Company's fixed maturities at December 31, 2018 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.
(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
5,462
5,342
217
1,411
12,432
$
$
$
December 31, 2018
Estimated Fair
Value
5,445
5,233
210
1,372
12,260
$
The following tables highlight the aggregate unrealized loss position, by security type, of available-for-sale investments in
unrealized loss positions as of December 31, 2018 and December 31, 2017. The tables segregate the holdings based on the period
of time the investments have been continuously held in unrealized loss positions.
78
KINGSWAY FINANCIAL SERVICES INC.
Notes to Consolidated Financial Statements
(in thousands)
December 31, 2018
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
States, municipalities and political
subdivisions
Mortgage-backed
Corporate
Total fixed maturities
$
1,497
$
1
$
2,609
$
47
$
4,106
$
—
800
595
2,892
—
1
1
3
606
2,134
2,151
7,500
14
69
40
606
2,934
2,746
170
10,392
173
(in thousands)
December 31, 2017
Less than 12 Months
Greater than 12 Months
Total
Estimated
Fair Value
Unrealized
Loss
Estimated
Fair Value
Unrealized
Loss
Estimated
Fair Value
Unrealized
Loss
$
1,545
$
9
$
5,612
$
Fixed maturities:
U.S. government, government
agencies and authorities
States, municipalities and political
subdivisions
Mortgage-backed
Corporate
Total fixed maturities
Equity investments:
Common stock
Warrants
Total equity investments
Total
$
4,067
$
626
2,876
2,427
9,996
3,570
675
4,245
$
14,241
$
50
13
57
37
—
—
—
157
1,545
313
285
598
755
—
—
—
$
1,545
$
—
—
—
9
—
—
—
9
626
2,876
2,427
11,541
3,570
675
4,245
$
15,786
$
48
14
70
41
59
13
57
37
166
313
285
598
764
There are approximately 64 and 68 individual available-for-sale investments that were in unrealized loss positions as of
December 31, 2018 and December 31, 2017, respectively.
The establishment of an other-than-temporary impairment on an available-for-sale investment or limited liability 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 management believes may affect 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;
79
KINGSWAY FINANCIAL SERVICES INC.
Notes to Consolidated Financial Statements
•
•
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 analysis performed by the Company to determine declines in market value that are other-than-temporary, there
were no write-downs for other-than-temporary impairment related to available-for-sale investments recorded for the years ended
December 31, 2018 and December 31, 2017.
The Company has reviewed currently available information regarding investments with estimated fair values less than their carrying
amounts and believes 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 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 limited partnerships. The Company's interests
in these investments are not deemed minor and, therefore, are accounted for under the equity method of accounting. The most
recently available financial statements are used in applying the equity method. The difference between the end of the reporting
period of the limited liability entities and that of the Company is no more than three months. As of December 31, 2018 and
December 31, 2017, the carrying value of limited liability investments totaled $4.8 million and $9.1 million, respectively. At
December 31, 2018, the Company has no unfunded commitments related to limited liability investments.
Limited liability investments, at fair value represent the Company's investment in 1347 Investors as well as the underlying
investments of Net Lease and Argo Holdings. As of December 31, 2018 and December 31, 2017, the carrying value of the
Company's limited liability investments, at fair value was $26.0 million and $32.2 million, respectively. The Company recorded
impairments related to limited liability investments, at fair value of $0.1 million and $0.1 million for the years ended December 31,
2018 and December 31, 2017, respectively, which are included in loss on change in fair value of limited liability investments, at
fair value in the consolidated statements of operations. At December 31, 2018, the Company has unfunded commitments totaling
$0.6 million to fund limited liability investments, at fair value.
Investments in private companies consist of common stock, preferred stock, notes receivable and derivative contracts in privately
owned companies and investments in limited liability companies in which the Company’s interests are deemed minor. The
Company's investments in private companies do not have readily determinable fair values. As further discussed in Note 4, "Recently
Issued Accounting Standards," effective January 1, 2018, the Company adopted ASU 2016-01. As a result of the adoption, the
Company has elected to record investments in private companies at cost, adjusted for observable price changes and impairments.
For the year ended December 31, 2018, the Company recorded adjustments of $0.6 million to decrease the fair value of certain
investments in private companies for observable price changes, which are included in net change in unrealized loss on private
company investments in the consolidated statements of operations.
The Company performs a quarterly impairment analysis of its investments in private companies. The analysis includes some or
all of the following procedures as deemed appropriate by the Company:
•
•
•
•
•
•
the opinions of external investment and portfolio managers;
the financial condition and prospects of the investee;
recent operating trends and forecasted performance of the investee;
current market conditions in the geographic area or industry in which the investee operates;
changes in credit ratings; and
changes in the regulatory environment.
80
KINGSWAY FINANCIAL SERVICES INC.
Notes to Consolidated Financial Statements
As a result of the analysis performed, the Company recorded impairments related to investments in private companies of $1.0
million and $2.0 million for the years ended December 31, 2018 and December 31, 2017, respectively, which are included in net
change in unrealized loss on private company investments in the consolidated statements of operations.
As of December 31, 2018 and December 31, 2017, the carrying value of the Company's investments in private companies totaled
$3.1 million and $4.9 million, respectively.
Real estate investments are reported at fair value. As of December 31, 2018 and December 31, 2017, the carrying value of the
Company's real estate investments totaled $10.7 million and $10.7 million, respectively.
Other investments include collateral loans and are reported at their unpaid principal balance. As of December 31, 2018 and
December 31, 2017, the carrying value of other investments totaled $2.1 million and $3.7 million, respectively.
The Company had previously entered into two separate performance share grant agreements with 1347 Property Insurance Holdings,
Inc. ("PIH"), whereby the Company will be entitled to receive up to an aggregate of 475,000 shares of PIH common stock upon
achievement of certain milestones for PIH’s stock price. Pursuant to the performance share grant agreements, if at any time the
last sales price of PIH’s common stock equals or exceeds: (i) $10.00 per share (as adjusted for stock splits, stock dividends,
reorganizations, recapitalizations and the like) for any 20 trading days within any 30-trading day period, the Company will receive
100,000 shares of PIH common stock; (ii) $12.00 per share (as adjusted for stock splits, stock dividends, reorganizations,
recapitalizations and the like) for any 20 trading days within any 30-trading day period, the Company will receive 125,000 shares
of PIH common stock (in addition to the 100,000 shares of common stock earned pursuant to clause (i) herein); (iii) $15.00 per
share (as adjusted for stock splits, stock dividends, reorganizations, recapitalizations and the like) for any 20 trading days within
any 30-trading day period, the Company will receive 125,000 shares of PIH common stock (in addition to the 225,000 shares of
common stock earned pursuant to clauses (i) and (ii) herein); and (iv) $18.00 per share (as adjusted for stock splits, stock dividends,
reorganizations, recapitalizations and the like) for any 20 trading days within any 30-trading day period, the Company will receive
125,000 shares of PIH common stock (in addition to the 350,000 shares of common stock earned pursuant to clauses (i), (ii) and
(iii) herein). To the extent shares of PIH common stock are granted to the Company under either of the performance share grant
agreements, they will be recorded at the time the shares are granted and will have a valuation equal to the last sales price of PIH
common stock on the day prior to such grant.
On January 2, 2018, the Company entered into an agreement with PIH to cancel the $10.00 per share performance shares grant
agreement in exchange for cash consideration of $0.3 million. On July 24, 2018, the Company entered into an agreement with
PIH to cancel the $12.00 per share, $15.00 per share and $18.00 per share performance share grant agreement in exchange for
cash consideration of $1.0 million. For the year ended December 31, 2018, the Company recorded gains, included in gain on
change in fair value of equity investments in the consolidated statements of operations, of $1.3 million related to these transactions.
No shares were received by the Company under either of the performance share grant agreements as of December 31, 2018.
Net investment income for the years ended December 31, 2018 and December 31, 2017, respectively, is comprised as follows:
(in thousands)
Investment income
Interest from fixed maturities
Dividends
Income from limited liability investments
Income from limited liability investments, at fair value
Loss on change in fair value of warrants - not publicly traded
Income from real estate investments
Other
Gross investment income
Investment expenses
Net investment income
2018
Years ended December 31,
2017
(restated)
236
359
241
1,174
—
800
230
3,040
(83)
2,957
$
$
190
501
1,551
3,973
(292)
800
386
7,109
(22)
7,087
$
$
81
KINGSWAY FINANCIAL SERVICES INC.
Notes to Consolidated Financial Statements
Gross realized gains and losses on available-for-sale investments, limited liability investments and limited liability investments,
at fair value for the years ended December 31, 2018 and December 31, 2017 is comprised as follows:
(in thousands)
Gross realized gains
Gross realized losses
Net realized (losses) gains
$
$
2018
Years ended December 31,
2017
(restated)
309
(3)
306
398
(415)
(17)
$
$
Gain on change in fair value of equity investments for the years ended December 31, 2018 and December 31, 2017 is comprised
as follows:
(in thousands)
Net gains recognized on equity investments sold during the period
Change in unrealized losses on equity investments held at end of the period
Gain on change in fair value of equity investments
$
$
Years ended December 31,
2018
1,464
(1,083)
381
$
$
2017
—
—
—
NOTE 9 INVESTMENT IN INVESTEE
Investment in investee includes the Company's investment in the common stock of ICL. The carrying value of the Company’s
investment in investee is accounted for under the equity method, calculated using ICL’s reported financial statements on a three-
month lag. The carrying value, estimated fair value and approximate equity percentage for the Company's investment in investee
at December 31, 2018 and December 31, 2017 were as follows:
(in thousands, except for percentages)
December 31, 2018
December 31, 2017
Equity
Percentage
Estimated Fair
Value
Carrying
Value
Equity
Percentage
Estimated Fair
Value
Carrying
Value
ICL
22.9% $
951
$
951
31.2% $
3,816
$
5,230
The carrying value of the Company's investment in investee at December 31, 2017 in the table above is calculated using ICL’s
financial statements reported as of and for the period ended September 30, 2017. The estimated fair value of the Company's
investment in investee at December 31, 2017 in the table above is calculated based on the published closing price of ICL common
stock at September 30, 2017 to be consistent with the three-month lag in calculating its carrying value under the equity method.
The carrying value of the Company's investment in investee at December 31, 2018, using ICL’s financial statements reported as
of and for the period ended September 30, 2018, was calculated to be $2.7 million. The Company performed an analysis to
determine whether its $2.7 million carrying value calculated under the equity method is recoverable. As part of its analysis, the
Company considered that the estimated fair value of the Company's investment in investee at December 31, 2018, as presented in
the table above and as calculated based on the published closing price of ICL common stock at December 31, 2018, was $1.0
million. The Company concluded that the $2.7 million carrying value of its investment in investee, as calculated under the equity
method, had an other than temporary impairment as of December 31, 2018. As a result, the Company wrote down the carrying
value of its investment in investee as of December 31, 2018, as presented in the table above, by $1.7 million such that its carrying
value equals the $1.0 million estimated fair value of the Company's investment in investee as calculated based on the published
closing price of ICL common stock at December 31, 2018.
82
KINGSWAY FINANCIAL SERVICES INC.
Notes to Consolidated Financial Statements
Prior to the third quarter of 2018, the Company owned 6,799,449 shares of ICL common stock. On July 30, 2018, the Company
executed an agreement to sell 1,813,889 shares of ICL common stock, having a carrying value of $1.3 million, for $1.0 million.
As a result, the Company recorded a loss of $0.3 million on the sale and reduced its ownership percentage in ICL to 22.9%. Also
during the year ended December 31, 2018, the Company received a dividend of $0.8 million from ICL.
The Company reported equity in net loss of investee of $2.5 million for the year ended December 31, 2018, which includes the
$1.7 million other than temporary impairment, the $0.3 million loss on sale and $0.5 million of equity in net loss of investee. The
Company reported equity in net income of investee of $2.1 million for the year ended December 31, 2017.
NOTE 10 REINSURANCE
Ceded loss and loss adjustments expenses, unpaid loss and loss adjustment expenses and commissions as of and for the years
ended December 31, 2018 and December 31, 2017 are summarized as follows:
(in thousands)
Ceded loss and loss adjustment expenses
Ceded unpaid loss and loss adjustment expenses
Ceding commissions
NOTE 11 DEFERRED ACQUISITION COSTS
$
Years ended December 31,
2017
(226)
72
226
2018
105
—
(105)
$
Policy acquisition costs consist primarily of commissions and agency expenses incurred related to successful efforts to acquire
vehicle service agreements. Acquisition costs deferred on 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 as of and for the years ended December 31,
2018 and December 31, 2017 are comprised as follows:
(in thousands)
Balance at January 1, net
Additions
Amortization
Balance at December 31, net
NOTE 12 GOODWILL
Years ended December 31,
2018
6,325
3,825
(3,246)
6,904
$
$
2017
5,827
3,484
(2,986)
6,325
$
$
Goodwill was $74.7 million and $80.8 million at December 31, 2018 and December 31, 2017, respectively, and is attributable to
the Extended Warranty and Leased Real Estate reportable segments. As further discussed in Note 5, "Acquisition," during the
third quarter of 2018, the Company completed its fair value analysis of the assets acquired and liabilities assumed related to the
acquisition of PWSC on October 12, 2017. As a result, the Company recorded a decrease to goodwill of $6.2 million related to
the acquisition of PWSC from the amount recorded at December 31, 2017.
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 tested goodwill for recoverability at December 31, 2018 and December 31,
2017. Based on the assessment performed, no goodwill impairments were recognized in 2018 and 2017.
83
KINGSWAY FINANCIAL SERVICES INC.
Notes to Consolidated Financial Statements
NOTE 13 INTANGIBLE ASSETS
Intangible assets are comprised as follows:
(in thousands)
December 31, 2018
Intangible assets subject to amortization
Database
Vehicle service agreements in-force
Customer relationships
In-place lease
Non-compete
Intangible assets not subject to amortization
Tenant relationship
Trade names
Total
(in thousands) (restated)
Intangible assets subject to amortization
Database
Vehicle service agreements in-force
Customer relationships
In-place lease
Intangible assets not subject to amortization
Tenant relationship
Trade name
Total
Gross Carrying
Value
Accumulated
Amortization
Net Carrying
Value
$
$
$
$
4,918
3,680
8,914
1,125
266
73,667
1,290
93,860
Gross Carrying
Value
4,918
3,680
3,611
1,125
73,667
663
87,664
$
$
$
$
3,013
3,671
3,691
155
64
—
—
10,594
$
$
1,905
9
5,223
970
202
73,667
1,290
83,266
December 31, 2017
Accumulated
Amortization
Net Carrying
Value
2,521
3,640
1,965
92
—
—
8,218
$
$
2,397
40
1,646
1,033
73,667
663
79,446
As further discussed in Note 5, "Acquisition," during the third quarter of 2018, the Company recorded $6.2 million of separately
identifiable intangible assets, related to acquired customer relationships, non-compete agreement and trade name, as part of the
acquisition of PWSC. The customer relationships intangible asset of $5.3 million is being amortized over fifteen years based on
the pattern in which the economic benefits of the intangible asset are expected to be consumed. The non-compete agreement
intangible asset of $0.3 million is being amortized on a straight-line basis over five years. The trade name intangible asset of $0.6
million is deemed to have an indefinite useful life and is not amortized.
The Company's other intangible assets with definite useful lives are amortized either based on the patterns in which the economic
benefits of the intangible assets are expected to be consumed or using the straight-line method over their estimated useful lives,
which range from seven to eighteen years. Amortization of intangible assets was $2.4 million and $1.1 million for the years ended
December 31, 2018 and December 31, 2017, respectively. The estimated aggregate future amortization expense of all intangible
assets is $1.8 million for 2019, $1.5 million for 2020, $1.4 million for 2021, $1.1 million for 2022 and $0.5 million for 2023.
The tenant relationship and trade names intangible assets have indefinite useful lives and are not amortized. All intangible assets
with indefinite useful lives are reviewed annually by the Company for impairment. No impairment charges were taken on intangible
assets in 2018 or 2017.
84
KINGSWAY FINANCIAL SERVICES INC.
Notes to Consolidated Financial Statements
NOTE 14 PROPERTY AND EQUIPMENT
Property and equipment are comprised as follows:
(in thousands)
Land
Site improvements
Buildings
Leasehold improvements
Furniture and equipment
Computer hardware
Total
(in thousands)
Land
Site improvements
Buildings
Leasehold improvements
Furniture and equipment
Computer hardware
Total
$
$
$
Cost
21,120
91,308
580
104
993
4,995
119,100
Cost
21,371
91,308
968
190
1,072
4,782
$
119,691
Accumulated
Depreciation
—
$
10,161
36
102
901
4,758
15,958
$
Accumulated
Depreciation
—
$
6,028
53
117
973
4,512
$
11,683
December 31, 2018
Carrying
Value
$
$
21,120
81,147
544
2
92
237
103,142
December 31, 2017
Carrying
Value
$
21,371
85,280
915
73
99
270
$
108,008
For the years ended December 31, 2018 and December 31, 2017, depreciation expense on property and equipment of $4.3 million
and $4.3 million, respectively, is included in general and administrative expenses in the consolidated statements of operations.
NOTE 15 VEHICLE SERVICE AGREEMENT LIABILITY
Vehicle service agreement fees include the fees collected to cover the costs of future automobile mechanical breakdown claims
and the associated administration of those claims. Vehicle service agreement fees are initially recorded as deferred service fees.
On a quarterly basis, the Company compares the remaining deferred service fees balance to the estimated amount of expected
future claims under the vehicle service agreement contracts and records an additional accrual when the deferred service fees balance
is less than expected future claims costs.
A reconciliation of the changes in the vehicle service agreement liability, including deferred service fees related to vehicle service
agreements, as of December 31, 2018 and December 31, 2017, were as follows:
(in thousands)
Balance at January 1, net
Gross service fees for vehicle service agreements sold
Recognition of service fees on vehicle service agreements
Liability for claims authorized on vehicle service agreements
Payments of claims authorized on vehicle service agreements
Re-estimation of deferred service fees
Balance at December 31, net
$
$
2018
40,794
$
22,556
(18,939)
5,711
(5,735)
(653)
43,734
$
2017
38,713
18,921
(16,654)
5,327
(5,377)
(136)
40,794
85
KINGSWAY FINANCIAL SERVICES INC.
Notes to Consolidated Financial Statements
The vehicle service agreement liability is presented as components of deferred services fees and accrued expenses and other
liabilities in the consolidated balance sheets as follows:
(in thousands)
Deferred service fees
Accrued expenses and other liabilities
Balance at December 31, net
2018
43,495
239
43,734
$
$
December 31,
2017
40,531
263
40,794
$
$
NOTE 16 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 large variety of factors. These factors include
the 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 for unpaid loss and loss adjustment expenses necessarily involves risks
that the actual loss and loss adjustment expenses incurred by the Company will deviate, perhaps materially, from the estimates
recorded.
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.
The results of this comparison and the changes in the provision for unpaid loss and loss adjustment expenses, net of amounts
recoverable from reinsurers, as of December 31, 2018 and December 31, 2017, were as follows:
(in thousands)
December 31,
Balance at beginning of period, gross
Less reinsurance recoverable related to 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 unpaid loss and loss adjustment
expenses
Balance at end of period, gross
86
$
$
$
2018
1,329
72
1,257
—
1,631
—
(815)
2,073
—
2,073
$
2017
2,202
354
1,848
3
401
—
(995)
1,257
72
1,329
KINGSWAY FINANCIAL SERVICES INC.
Notes to Consolidated Financial Statements
The Company reported unfavorable development on unpaid loss and loss adjustment expenses of $1.6 million and $0.4 million
in 2018 and 2017, respectively. The unfavorable development in 2018 and 2017 was related to an increase in loss adjustment
expenses due to the continuing voluntary run-off of Amigo. During the second quarter of 2019, the Company agreed to settle three
related open Amigo claims for an amount in excess of the provision for unpaid loss and loss adjustment expenses carried by the
Company for these three open claims. The Company estimates it will incur a net loss of approximately $0.8 million related to
the settlement of these claims, which the Company will report in its consolidated statement of operations for the year ended
December 31, 2019. Original estimates are increased or decreased as additional information becomes known regarding individual
claims.
The following tables contain information about incurred and paid loss and loss adjustment expenses development as of and for
the year December 31, 2018, net of reinsurance, as well as cumulative claim frequency and the total of IBNR liabilities, including
expected development on reported unpaid loss and loss adjustment expenses included within the net incurred losses and allocated
loss adjustment expenses amounts. The information about incurred and paid loss and loss adjustment expenses development for
the years ended December 31, 2009 through 2017, and the average annual percentage payout of incurred claims by age as of
December 31, 2018, is presented as supplementary information.
Non-standard automobile insurance - Private passenger auto liability
(in thousands)
Incurred Loss and Allocated Loss Adjustment Expenses, Net of Reinsurance
For the Years Ended December 31,
Accident
Year
2009
Unaudited
2010
Unaudited
2011
Unaudited
2012
Unaudited
2013
Unaudited
2014
Unaudited
2015
Unaudited
2016
Unaudited
2017
Unaudited
2018
2009
2010
2011
2012
2013
2014
2015
2016
2017
2018
Total
35,209
37,387
38,486
40,219
40,436
40,308
40,211
40,177
40,091
40,085
47,253
51,951
55,120
54,591
54,021
53,993
53,810
53,693
53,689
29,034
29,458
28,744
28,094
27,865
27,613
27,597
27,851
13,736
13,536
13,273
12,926
12,815
12,720
13,037
6,456
6,434
5,474
4,488
4,617
4,654
—
—
—
—
—
—
—
—
—
—
—
—
—
—
—
139,316
As of December 31,
2018
Total of
IBNR Plus
Expected
Development
on Reported
Losses
Cumulative
Number of
Reported
Claims
4
2
15
9
228
29
—
—
—
—
—
—
—
—
—
—
—
—
—
—
87
KINGSWAY FINANCIAL SERVICES INC.
Notes to Consolidated Financial Statements
Non-standard automobile insurance - Private passenger auto liability
(in thousands)
Cumulative Paid Loss and Allocated Loss Adjustment Expenses, Net of Reinsurance
For the Years Ended December 31,
Accident
Year
2009
Unaudited
2010
Unaudited
2011
Unaudited
2012
Unaudited
2013
Unaudited
2014
Unaudited
2015
Unaudited
2016
Unaudited
2017
Unaudited
2018
18,742
32,436
25,659
36,390
46,356
18,456
38,796
50,591
25,296
7,060
2009
2010
2011
2012
2013
2014
2015
2016
2017
2018
39,600
51,944
26,599
11,724
3,575
40,072
52,889
27,023
12,284
4,277
—
40,089
53,451
27,378
12,530
4,437
—
—
40,087
53,484
27,431
12,618
4,496
—
—
—
40,085
53,518
27,479
12,635
4,562
—
—
—
—
40,085
53,570
27,677
12,738
4,571
—
—
—
—
—
Total
138,641
Liabilities for non-standard automobile-private passenger auto liability unpaid loss and allocated loss adjustment expenses prior to 2009, net of
reinsurance
Total liabilities for non-standard automobile-private passenger auto liability unpaid loss and allocated loss adjustment expenses, net of
reinsurance
Non-standard automobile insurance - Auto physical damage
(in thousands)
Incurred Loss and Allocated Loss Adjustment Expenses, Net of Reinsurance
5
680
For the Years Ended December 31,
Accident
Year
2009
Unaudited
2010
Unaudited
2011
Unaudited
2012
Unaudited
2013
Unaudited
2014
Unaudited
2015
Unaudited
2016
Unaudited
2017
Unaudited
2018
9,829
7,343
7,977
6,857
6,192
4,366
6,451
5,499
3,247
1,755
2009
2010
2011
2012
2013
2014
2015
2016
2017
2018
Total
6,458
5,487
3,241
1,920
1,085
6,476
5,518
3,263
1,990
996
—
6,482
5,532
3,262
2,015
1,001
—
—
6,480
5,535
3,260
2,007
999
—
—
—
6,482
5,538
3,269
2,018
1,003
—
—
—
—
6,482
5,538
3,261
1,908
988
—
—
—
—
—
18,177
88
As of December 31,
2018
Total of
IBNR Plus
Expected
Development
on Reported
Losses
Cumulative
Number of
Reported
Claims
—
—
—
—
—
—
—
—
—
—
—
—
—
—
—
—
—
—
—
—
KINGSWAY FINANCIAL SERVICES INC.
Notes to Consolidated Financial Statements
Non-standard automobile insurance - Auto physical damage
(in thousands)
Cumulative Paid Loss and Allocated Loss Adjustment Expenses, Net of Reinsurance
For the Years Ended December 31,
Accident
Year
2009
Unaudited
2010
Unaudited
2011
Unaudited
2012
Unaudited
2013
Unaudited
2014
Unaudited
2015
Unaudited
2016
Unaudited
2017
Unaudited
2009
2010
2011
2012
2013
2014
2015
2016
2017
2018
6,221
6,463
5,155
6,505
5,583
2,971
6,499
5,548
3,268
1,783
6,489
5,526
3,270
1,951
1,050
6,487
5,537
3,270
2,006
1,015
—
6,480
5,537
3,266
2,016
1,001
—
—
6,481
5,537
3,267
2,017
1,002
—
—
—
6,482
5,538
3,269
2,018
1,002
—
—
—
—
2018
6,482
5,538
3,261
1,908
988
—
—
—
—
—
Liabilities for non-standard automobile-auto physical damage unpaid loss and allocated loss adjustment expenses prior to 2009, net of
reinsurance
Total liabilities for non-standard automobile-auto physical damage unpaid loss and allocated loss adjustment expenses, net of reinsurance
—
—
Total
18,177
Commercial automobile
(in thousands)
Incurred Loss and Allocated Loss Adjustment Expenses, Net of Reinsurance
For the Years Ended December 31,
Accident
Year
2009
Unaudited
2010
Unaudited
2011
Unaudited
2012
Unaudited
2013
Unaudited
2014
Unaudited
2015
Unaudited
2016
Unaudited
2017
Unaudited
2018
10,450
6,739
8,205
7,016
8,745
8,521
7,743
9,711
9,784
9,503
2009
2010
2011
2012
2013
2014
2015
2016
2017
2018
Total
7,738
9,351
8,990
7,759
597
7,662
9,214
8,752
7,548
477
—
7,625
9,215
8,791
7,349
489
—
—
7,612
9,197
8,812
7,562
350
—
—
—
7,591
9,185
8,816
7,766
364
—
—
—
—
7,585
9,181
8,901
8,078
316
—
—
—
—
—
34,061
89
As of December 31,
2018
Total of
IBNR Plus
Expected
Development
on Reported
Losses
Cumulative
Number of
Reported
Claims
2
26
2
163
58
26
—
—
—
—
—
—
—
—
—
—
—
—
—
—
KINGSWAY FINANCIAL SERVICES INC.
Notes to Consolidated Financial Statements
Commercial automobile
(in thousands)
Cumulative Paid Loss and Allocated Loss Adjustment Expenses, Net of Reinsurance
For the Years Ended December 31,
Accident
Year
2009
Unaudited
2010
Unaudited
2011
Unaudited
2012
Unaudited
2013
Unaudited
2014
Unaudited
2015
Unaudited
2016
Unaudited
2017
Unaudited
2009
2010
2011
2012
2013
2014
2015
2016
2017
2018
3,297
5,753
4,177
6,604
7,716
5,005
7,418
8,658
7,926
5,034
7,562
8,922
8,326
6,607
299
7,606
9,069
8,533
7,028
352
—
7,595
9,149
8,638
7,150
358
—
—
7,585
9,142
8,747
7,457
358
—
—
—
7,585
9,132
8,765
7,681
358
—
—
—
—
2018
7,585
9,136
8,767
7,943
284
—
—
—
—
—
Liabilities for commercial automobile unpaid loss and allocated loss adjustment expenses prior to 2009, net of reinsurance
Total liabilities for commercial automobile unpaid loss and allocated loss adjustment expenses, net of reinsurance
Total
33,715
410
756
The following table reconciles the unpaid loss and allocated loss adjustment expenses, net of reinsurance presented in the tables
above to the unpaid loss and loss adjustment expenses reported in the consolidated balance sheets at December 31, 2018 and
December 31, 2017:
(in thousands)
December 31, 2018
December 31, 2017
Liabilities for loss and allocated loss adjustment expenses, net of reinsurance
Non-standard automobile - private passenger auto liability
Non-standard automobile - auto physical damage
Commercial automobile
Other short-duration insurance lines
Liabilities for unpaid loss and allocated loss adjustment expenses, net of reinsurance
Reinsurance recoverable on unpaid loss and loss adjustment expenses
Non-standard automobile - private passenger auto liability
Commercial automobile
Total reinsurance recoverable on unpaid loss and loss adjustment expenses
Unallocated loss adjustment expenses
680
—
756
592
2,028
—
—
—
45
479
2
521
176
1,178
64
8
72
79
Total gross liability for unpaid loss and loss adjustment expenses
2,073
1,329
90
KINGSWAY FINANCIAL SERVICES INC.
Notes to Consolidated Financial Statements
The following is supplementary information about average historical incurred loss duration as of December 31, 2018.
Average Annual Percentage Payout of Incurred Losses by Age, Net of Reinsurance
(Unaudited)
Year 1 Year 2 Year 3 Year 4 Year 5 Year 6 Year 7 Year 8 Year 9 Year 10
Non-standard automobile -
private passenger auto liability
59.6% 22.1% 10.7% 5.2% 2.0% 0.4% —% —% —% —%
Commercial automobile
70.3% 9.7% 8.9% 7.4% 3.0% 0.7% —% —% —% —%
NOTE 17 DEBT
Debt consists of the following instruments:
(in thousands)
December 31, 2018
December 31, 2017
$
Bank loan
Notes payable:
Mortgage
Flower Note
Net Lease Note
Total notes
payable
Subordinated debt
Total
$
Principal Carrying Value
3,917
3,917
$
Fair Value
3,829
$
$
Principal Carrying Value
4,917
4,917
$
Fair Value
4,864
$
173,155
7,768
9,000
189,923
90,500
284,340
$
182,548
7,768
9,000
199,316
50,023
253,256
$
174,265
8,565
9,409
192,239
50,023
246,091
$
176,136
8,179
9,000
193,315
90,500
288,732
$
186,469
8,179
9,000
203,648
52,105
260,670
$
168,477
8,825
9,870
187,172
52,105
244,141
Subordinated debt mentioned above consists of the following trust preferred debt instruments:
Issuer
Principal
(in thousands)
Issue date
Kingsway CT Statutory Trust I
Kingsway CT Statutory Trust II
Kingsway CT Statutory Trust III
Kingsway DE Statutory Trust III
Kingsway DE Statutory Trust IV
Kingsway DE Statutory Trust VI
$
$
$
$
$
$
(a) Bank loan:
15,000
12/4/2002
17,500
5/15/2003
20,000
10/29/2003
15,000
5/22/2003
10,000
9/30/2003
13,000
12/16/2003
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
5/22/2033
9/30/2033
1/8/2034
On October 12, 2017, the Company borrowed a principal amount of $5.0 million from a bank at a fixed interest rate of 5.0%. The
bank loan matures on October 12, 2022. The carrying value of the bank loan at December 31, 2018 of $3.9 million represents its
unpaid principal balance. The fair value of the bank loan disclosed in the table above is derived from quoted market prices of B
and B minus rated industrial bonds with similar maturities.
(b) Notes payable:
As part of the acquisition of CMC in July 2016, the Company assumed a mortgage, which is recorded as note payable in the
consolidated balance sheets ("the Mortgage"). The Mortgage is nonrecourse indebtedness with respect to CMC and its subsidiaries,
and the Mortgage is not, nor will it be, guaranteed by Kingsway or its affiliates. The Mortgage, which is recorded as note payable
in the consolidated balance sheets, was recorded at its estimated fair value of $191.7 million, which included the unpaid principal
amount of $180.0 million as of the date of acquisition plus a premium of $11.7 million. The Mortgage matures on May 15, 2034
91
KINGSWAY FINANCIAL SERVICES INC.
Notes to Consolidated Financial Statements
and has a fixed interest rate of 4.07%. The Mortgage is carried in the consolidated balance sheets at its amortized cost, which
reflects the monthly pay-down of principal as well as the amortization of the premium using the effective interest rate method.
The fair value of the Mortgage disclosed in the table above is derived from quoted market prices of A-rated industrial bonds with
similar maturities.
On January 5, 2015, Flower assumed a $9.2 million mortgage in conjunction with the purchase of investment real estate properties,
which is recorded as note payable in the consolidated balance sheets ("the Flower Note"). The Flower Note requires monthly
payments of principal and interest and is secured by certain investments of Flower. The Flower Note matures on December 10,
2031 and has a fixed interest rate of 4.81%. The carrying value of the Flower Note at December 31, 2018 of $7.8 million represents
its unpaid principal balance. The fair value of the Flower Note disclosed in the table above is derived from quoted market prices
of A and B rated industrial bonds with similar maturities.
On October 15, 2015, Net Lease assumed a $9.0 million mezzanine debt in conjunction with the purchase of investment real estate
properties, which is recorded as note payable in the consolidated balance sheets ("the Net Lease Note"). The Net Lease Note
requires monthly payments of interest and is secured by certain investments of Net Lease. The Net Lease Note matures on November
1, 2020 and has a fixed interest rate of 10.25%. The carrying value of the Net Lease Note at December 31, 2018 of $9.0 million
represents its unpaid principal balance. The fair value of the Net Lease Note disclosed in the table above is derived from quoted
market prices of B and B minus rated industrial bonds with similar maturities.
(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%. 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.
The subordinated debt is carried in the consolidated balance sheets at fair value. See Note 29, "Fair Value of Financial Instruments,"
for further discussion of the subordinated debt. As further discussed in Note 4, "Recently Issued Accounting Standards," effective
January 1, 2018, the Company adopted ASU 2016-01. As a result, the portion of the change in fair value of subordinated debt
related to the instrument-specific credit risk is now recognized in other comprehensive income (loss), whereas for 2017, the total
change in fair value of subordinated debt was recorded in net income (loss). Of the $2.1 million decrease in fair value of the
Company’s subordinated debt between December 31, 2017 and December 31, 2018, $3.8 million is reported as decrease in fair
value of debt attributable to instrument-specific credit risk in the Company's consolidated statements of comprehensive loss and
$1.7 million is reported as loss on change in fair value of debt in the Company’s consolidated statements of operations.
During the third quarter of 2018, the Company gave notice to its Trust Preferred 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 Trust Preferred indentures,
which permit interest deferral. This action does not constitute a default under the Company's Trust Preferred indentures or any of
its other debt indentures. At December 31, 2018, deferred interest payable of $2.5 million is included in accrued expenses and
other liabilities in the consolidated balance sheets.
Pursuant to indentures governing the Company’s outstanding bank loan, subordinated debt and a bank loan associated with the
Company’s acquisition on March 1, 2019, described more fully in Note 34, "Subsequent Event," the Company is obligated to
deliver audited financial statements for certain of its subsidiaries as of and for the year ended December 31, 2018. Due to the
delay in filing its 2018 Annual Report, the Company has been unable to meet these obligations, the failure of which could be
declared events of default under the respective indentures. As of the date of the filing of its 2018 Annual Report, none of the
lenders or trustees responsible for administering any of our outstanding debt has declared an event of default, if required by the
applicable indenture, notified us of an intent to accelerate any portion of the outstanding debt or charge default interest thereon,
or pursued any other remedies available to it. Were any of these lenders or trustees to declare an event of default, the Company
would have a period of time to cure the default. Now that the Company has filed its 2018 Annual Report, the Company expects
to be in a position to deliver to the trustees the requisite audited financial statements for certain of its subsidiaries as of and for the
year ended December 31, 2018.
92
KINGSWAY FINANCIAL SERVICES INC.
Notes to Consolidated Financial Statements
NOTE 18 FINANCE LEASE OBLIGATION LIABILITY
On October 2, 2014, the Company completed a sale and leaseback transaction involving building and land located in Miami,
Florida, which was previously recorded as asset held for sale. The transaction did not qualify for sales recognition and was
accounted for as a financing due to the Company's continuing involvement with the property as a result of nonrecourse financing
provided to the buyer in the form of prepaid rent. A finance lease obligation liability equal to the selling price of the property was
established at the date of the transaction. During the lease term, the Company recorded interest expense on the finance lease
obligation at its incremental borrowing rate and increased the finance lease obligation liability by the same amount.
During the second quarter of 2017, the Company was informed of the landlord's intent to terminate the lease agreement effective
October 10, 2017. The Company had the option to vacate the property and effectively terminate the lease earlier than October 10,
2017. As a result of terminating the lease, the Company no longer had continuing involvement with the property and recognized
the sale of the property as well as the related gain of $0.7 million during the year ended December 31, 2017. The gain, which is
included in non-operating other income in the consolidated statements of operations, results primarily from removing the carrying
values of the land, building and finance lease obligation liability from the consolidated balance sheets and from the return of part
of the original prepaid rent.
NOTE 19 LEASES
The Company owns a parcel of real property consisting of approximately 192 acres located in the State of Texas (the "Real
Property") that is subject to a long-term triple net lease agreement with an unrelated third-party. The lease provides for future rent
escalations and renewal options. The initial lease term ends in May 2034. The lessee bears the cost of maintenance and property
taxes. Rental income from operating leases is recognized on a straight-line basis, based on contractual lease terms with fixed and
determinable increases over the non-cancellable term of the related lease when collectability is reasonably assured. Rental income
includes amortization of below market lease liabilities of $0.1 million and $0.1 million for the years ended December 31, 2018
and December 31, 2017. The estimated aggregate future amortization of below market lease liabilities is $0.1 million for 2019,
$0.1 million for 2020, $0.1 million for 2021, $0.1 million for 2022 and $0.1 million for 2023.
Assets, which are included in property and equipment, net on the consolidated balance sheets, leased to a third-party under an
operating lease where the Company is the lessor, are as follows:
(in thousands)
Land
Site improvements
Buildings
Gross property and equipment leased
Accumulation depreciation
Net property and equipment leased
As of December 31,
2018
$
$
21,120
91,308
580
113,008
(10,197)
102,811
The Company also leases certain office space under non-cancelable leases, with initial terms ranging from five to eight years,
along with options that permit renewals for additional periods. The Company also leases certain equipment under non-cancelable
operating leases, with initial terms of five years. Minimum rent is expensed on a straight-line basis over the term of the lease.
Future minimum annual lease payments and lease receipts under operating leases for the next five years and thereafter are:
(in thousands)
2019
2020
2021
2022
2023
Thereafter
$
Lease Commitments
943
$
405
404
401
401
817
Lease Receipts
11,572
11,832
12,099
12,371
12,649
149,896
93
KINGSWAY FINANCIAL SERVICES INC.
Notes to Consolidated Financial Statements
NOTE 20 REVENUE FROM CONTRACTS WITH CUSTOMERS
Revenue from contracts with customers relates to Extended Warranty segment service fee and commission income. Service fee
and commission income represents vehicle service agreement fees, GAP commissions, maintenance support service fees, warranty
product commissions, homebuilder warranty service fees and homebuilder warranty commissions based on terms of various
agreements with credit unions, consumers, businesses and homebuilders.
The following table disaggregates revenues from contracts with customers by revenue type:
(in thousands)
Vehicle service agreement fees - IWS
GAP commissions - IWS
Maintenance support service fees - Trinity
Warranty product commissions - Trinity
Homebuilder warranty service fees - PWSC
Homebuilder warranty commissions - PWSC
Service fee and commission income
Years ended December 31,
2017
2018
17,796
748
9,911
2,526
6,332
973
38,286
$
$
16,791
679
8,763
1,810
2,133
354
30,530
$
$
IWS' vehicle service agreement fees include the fees collected to cover the costs of future automobile mechanical breakdown
claims and the associated administration of those claims. Vehicle service agreement contract fees are earned over the duration of
the vehicle service agreement contracts as the single performance obligation is satisfied.
IWS' GAP commissions include fees collected from the sale of GAP contracts. IWS acts as an agent on behalf of the third-party
insurance company that underwrites and guaranties these GAP contracts. IWS does not assume any insurance risk from the sale
of GAP contracts. IWS receives a single commission fee as its transaction price at the time it sells a GAP contract to a customer.
Each GAP contract contains two separate performance obligations - sale of a GAP contract and GAP claims administration. The
first performance obligation is related to the sale of a GAP contract and is satisfied upon closing the sale. The second performance
obligation is related to the administration of claims during the GAP contract period, generally four years.
Standalone selling prices are not directly observable in the GAP contract for each of the separate performance obligations. As a
result, IWS has applied the expected cost plus a margin approach to develop models to estimate the standalone selling price for
each of its performance obligations in order to allocate the transaction price to the two separate performance obligations identified.
For the model related to the sale of a GAP contract performance obligation, IWS makes judgments about which of its actual costs
are associated with selling activities. For the model related to the GAP claims administration performance obligation, IWS makes
judgments about which of its actual costs are associated with claim-handling activities, which are performed over the life of the
GAP contract period. The relative percentage of expected costs plus a margin associated with the sale of a GAP contract performance
obligation is applied to the transaction price to determine the estimated standalone selling price of the sale of a GAP contract
performance obligation, which IWS recognizes as earned at the time of the GAP contract sale. The relative percentage of expected
costs plus a margin associated with the GAP claims administration performance obligation is applied to the transaction price to
determine the estimated standalone selling price of the GAP claims administration performance obligation, which IWS recognizes
as earned as services are performed over the GAP contract period.
For the GAP claims administration performance obligation, IWS applies an input method of measurement, based on the expected
costs plus a margin of providing services, to determine the transfer of its services over the GAP contract period. IWS uses historical
data regarding the number of claims it receives and activities performed, in addition to the number of GAP contracts sold, to
estimate the number of claims to be received by year until coverage expires, which allows IWS to develop a revenue recognition
pattern that it believes provides a faithful depiction of the transfer of services over time for the GAP claims administration
performance obligation.
Trinity's maintenance support service fees include the service fees collected to administer equipment breakdown and maintenance
support services and are earned as services are rendered.
94
KINGSWAY FINANCIAL SERVICES INC.
Notes to Consolidated Financial Statements
Trinity’s warranty product commissions include the commissions from the sale of warranty contracts for certain new and used
heating, ventilation, air conditioning ("HVAC"), standby generator, commercial LED lighting and refrigeration equipment. Trinity
acts as an agent on behalf of the third-party insurance companies that underwrite and guaranty these warranty contracts. Trinity
does not guaranty the performance underlying the warranty contracts it sells. Warranty product commissions are earned at the
time of the warranty product sales.
PWSC’s homebuilder warranty service fees include fees collected from the sale of warranties issued by new homebuilders. PWSC
receives a single warranty service fee as its transaction price at the time it enters into a written contract with each of its builder
customers. Each contract contains two separate performance obligations - warranty administrative services and other warranty
services. Warranty administrative services include enrolling each home sold by the builder into the program and the warranty
administrative system and delivering the warranty product. Other warranty services include answering builder or homeowner
questions regarding the home warranty and dispute resolution services.
Standalone selling prices are not directly observable in the contract for each of the separate performance obligations. As a result,
PWSC has applied the expected cost plus a margin approach to develop models to estimate the standalone selling price for each
of its performance obligations in order to allocate the transaction price to the two separate performance obligations identified.
For the model related to the warranty administrative services performance obligation, PWSC makes judgments about which of its
actual costs are associated with enrolling each home sold by the builder into the program and the warranty administrative system
and delivering the warranty product. For the model related to the other warranty services performance obligation, PWSC makes
judgments about which of its actual costs are associated with activities, such as answering builder or homeowner questions regarding
the home warranty and dispute resolution services, which are performed over the life of the warranty coverage period. The relative
percentage of expected costs plus a margin associated with the warranty administrative services performance obligation is applied
to the transaction price to determine the estimated standalone selling price of the warranty administrative services performance
obligation, which PWSC recognizes as earned at the time the home is enrolled and the warranty product is delivered. The relative
percentage of expected costs plus a margin associated with the other warranty services performance obligation is applied to the
transaction price to determine the estimated standalone selling price of the other warranty services performance obligation, which
PWSC recognizes as earned as services are performed over the warranty coverage period.
For the other warranty services performance obligation, PWSC applies an input method of measurement, based on the expected
costs plus a margin of providing services, to determine the transfer of its services over the warranty coverage period. PWSC uses
historical data regarding the number of calls it receives and activities performed, in addition to the number of homes enrolled, to
estimate the number of complaints and dispute resolution requests to be received by year until coverage expires, which allows
PWSC to develop a revenue recognition pattern that it believes provides a faithful depiction of the transfer of services over time
for the other warranty services performance obligation.
PWSC’s homebuilder warranty commissions include commissions from the sale of warranty contracts for those builders who have
requested and receive insurance backing of their warranty obligations. PWSC acts as an agent on behalf of the third-party insurance
company that underwrites and guaranties these warranty contracts. Homebuilder warranty commissions are earned on the
certification date, which is typically the date of the closing of the sale of the home to the buyer. The Company also earns fees to
manage remediation or repair services related to claims on insurance-backed warranty obligations, which are earned when the
claims are closed, and a profit-sharing bonus on eligible warranties, which is determined based on expected ultimate loss ratio
targets and is earned at the time the profit-sharing bonus is received.
Receivables from contracts with customers are reported as service fee receivable, net in the consolidated balance sheets and at
December 31, 2018 and December 31, 2017 were $3.4 million and $4.4 million, respectively.
The Company records deferred service fees resulting from contracts with customers when payment is received in advance of
satisfying the performance obligations. The Company expects to recognize within one year as service fee and commission income
approximately 34.3% of the deferred service fees as of December 31, 2018. Approximately $16.0 million of service fee and
commission income recognized during the year ended December 31, 2018 was included in deferred service fees as of December
31, 2017.
95
KINGSWAY FINANCIAL SERVICES INC.
Notes to Consolidated Financial Statements
NOTE 21 INCOME TAXES
The Company and its non-U.S. subsidiaries file separate foreign income tax returns. Kingsway America Agency Inc. files a separate
U.S. federal income tax return. 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 U.S. consolidated federal income tax
return. The Company's U.S. subsidiaries not included in the KAI Tax Group file separate U.S. federal income tax returns. As a
result of its domestication to the U.S. on December 31, 2018, the Company will no longer file foreign income tax returns in 2019
and later years. Starting in 2019, the Company and all of its eligible U.S. subsidiaries will file a U.S. consolidated federal income
tax return.
The Tax Cuts and Jobs Act (the "Tax Act") was enacted on December 22, 2017. The Tax Act made broad and complex changes
to the U.S. tax code, including, but not limited to, (1) a permanent reduction in the U.S. federal corporate income tax rate to 21%
and (2) eliminating the corporate alternative minimum tax ("AMT") and changing how existing AMT credits can be realized.
The Company is subject to the provisions of the ASC 740-10, Income Taxes, which requires that the effect on deferred income tax
assets and liabilities of a change in tax rates be recognized in the period the tax rate change was enacted. In December of 2017,
the SEC staff issued Staff Accounting Bulletin 118 ("SAB 118"), which provides that companies that have not completed their
accounting for the effects of the Tax Act but can determine a reasonable estimate of those effects should include a provisional
amount based on their reasonable estimate in their financial statements.
Pursuant to SAB 118, the Company recorded provisional amounts for the estimated income tax effects of the Tax Act on deferred
income taxes. The Company estimated that (1) the reduction in the corporate income tax rate decreased its net deferred income
tax liability as of December 31, 2017 by $18.0 million and (2) the change in the AMT credit rules allowed the Company to reduce
its valuation allowance against its gross deferred income tax assets by $0.1 million, for a combined Tax Act total of $18.1 million.
The $18.1 million Tax Act amount was recorded as a decrease to income tax expense in the Company’s consolidated statements
of operations for the year ended December 31, 2017. In addition, as result of the reduction in the corporate income tax rate, the
Company provisionally reduced its December 31, 2017 net deferred income tax asset balance and the related net deferred income
tax valuation allowance by $105.6 million, the net effect of which had no impact on the Company’s consolidated statements of
operations for the year ended December 31, 2017.
Although the $18.1 million tax benefit represented what the Company believed was a reasonable estimate of the impact of the
income tax effects of the Tax Act on the Company’s Consolidated Financial Statements as of December 31, 2017, it was considered
provisional. In the fourth quarter of 2018, the Company finalized its calculation of the income tax effects of the Tax Act on its
deferred income taxes by recording an additional tax benefit of $0.1 million.
Income tax expense (benefit) consists of the following:
(in thousands)
Current income tax expense
Deferred income tax benefit
Income tax expense (benefit)
Years ended December 31,
2017
2018
$
$
423
(108)
315
$
$
628
(17,316)
(16,688)
96
KINGSWAY FINANCIAL SERVICES INC.
Notes to Consolidated Financial Statements
Income tax expense (benefit) varies from the amount that would result by applying the applicable U.S. corporate income tax rate
of 21% in 2018 and 34% in 2017 to loss from continuing operations before income tax expense (benefit). The following table
summarizes the differences:
(in thousands)
Income tax benefit at U.S. statutory income tax rate
Tax Act adjustment
Valuation allowance
Indefinite life intangibles
Change in unrecognized tax benefits
Compensation
Investment income
Other
Income tax expense (benefit) for continuing operations
$
$
$
Years ended December 31,
2017
(4,255)
(18,052)
3,169
1,173
490
403
—
384
(16,688)
2018
(4,609)
(82)
4,562
92
233
(470)
747
(158)
315
$
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
Intangible assets
Debt issuance costs
Investments
Deferred rent
Deferred revenue
Other
Valuation allowance
Deferred income tax assets
Deferred income tax liabilities:
Indefinite life intangibles
Depreciation and amortization
Fair value of debt
Land
Investments
Deferred acquisition costs
Other
Deferred income tax liabilities
Net deferred income tax liabilities
$
$
$
$
$
2018
180,012
1,670
2,538
1,017
841
727
783
693
(171,456)
16,825
(16,660)
(16,121)
(6,528)
(4,435)
(168)
(1,450)
—
(45,362)
(28,537)
December 31,
2017
185,574
1,513
2,484
988
758
807
183
21
(173,965)
18,363
(16,436)
(16,971)
(5,894)
(4,435)
(1,853)
(1,328)
(209)
(47,126)
(28,763)
$
$
$
$
$
The Company maintains a valuation allowance for its gross deferred income tax assets of $171.5 million (U.S. operations - $171.5
million; Other - $0.0 million) and $174.0 million (U.S. operations - $167.6 million; Other - $6.4 million) at December 31, 2018
and December 31, 2017, respectively. The Company's businesses have generated substantial operating losses in prior years. These
losses can be available to reduce income taxes that might otherwise be incurred on future taxable income; however, 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, 2018 and December 31, 2017
net deferred income tax assets, excluding the deferred income tax liability, deferred state income tax assets, and deferred income
tax assets relating to AMT credit amounts set forth in the paragraph below. In 2018 and 2017, the Company released into income
zero and $0.4 million, respectively, of its valuation allowance, as a result of its acquisition of CMC, due to net deferred income
tax liabilities that are expected to reverse during the period in which the Company will have deferred income tax assets available.
97
KINGSWAY FINANCIAL SERVICES INC.
Notes to Consolidated Financial Statements
The Company carries net deferred income tax liabilities of $28.5 million at December 31, 2018, $8.0 million of which relates to
deferred income tax liabilities that are scheduled to reverse in periods after the expiration of the KAI Tax Group's consolidated
U.S. net operating loss carryforwards, $21.1 million of which relates to deferred income tax liabilities related to land and indefinite
life intangible assets, $0.5 million of which relates to deferred state income tax assets, and $0.1 million of which relates to deferred
income tax assets relating to AMT credits. The Company carries net deferred income tax liabilities of $28.8 million at December 31,
2017, $8.0 million of which relates to deferred income tax liabilities that are scheduled to reverse in periods after the expiration
of the KAI Tax Group's consolidated U.S. net operating loss carryfowards, $20.9 million of which relates to deferred income tax
liabilities related to land and indefinite life intangible assets, and $0.1 million of which relates to deferred income tax assets relating
to AMT credits. The Company considered a tax planning strategy in arriving at its December 31, 2018 and December 31, 2017
net deferred income tax liabilities.
The Tax Act modified the U.S. net operating loss deduction, effective with respect to losses arising in tax years beginning after
December 31, 2017. The Tax Act, however, did not limit the utilization, in 2018 and later tax years, of U.S. net operating losses
generated in 2017 and prior tax years.
Amounts, originating dates and expiration dates of the KAI Tax Group's consolidated U.S. net operating loss carryforwards, totaling
$845.7 million, are as follows:
Year of net operating loss
2007
2008
2009
2010
2011
2012
2013
2014
2016
2017
Expiration date
2027
2028
2029
2030
2031
2032
2033
2034
2036
2037
Net operating loss
(in thousands)
53,909
53,696
506,552
85,215
42,189
32,152
29,913
6,932
15,517
19,628
In addition, not reflected in the table above, are net operating loss carryforwards of (i) $6.5 million relating to separate U.S. tax
returns, which losses will expire over various years through 2037 and (ii) $1.6 million, relating to operations in Barbados which
losses will expire over various years through 2027.
A reconciliation of the beginning and ending unrecognized tax benefits, exclusive of interest and penalties, 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
2018
1,367
—
14
—
—
—
1,381
$
$
December 31,
2017
1,274
—
93
—
—
—
1,367
$
$
The amount of unrecognized tax benefits that, if recognized as of December 31, 2018 and December 31, 2017 would affect the
Company's effective tax rate, was an expense of $0.2 million and $0.5 million, respectively.
As of December 31, 2018 and December 31, 2017, the Company carried a liability for unrecognized tax benefits of $1.4 million
and $1.4 million, respectively, that is included in income taxes payable in the consolidated balance sheets. The Company classifies
interest and penalty accruals, if any, related to unrecognized tax benefits as income tax expense. During the years ended
December 31, 2018 and December 31, 2017, the Company recognized an expense for interest and penalties of $0.2 million and
98
KINGSWAY FINANCIAL SERVICES INC.
Notes to Consolidated Financial Statements
$0.5 million, respectively. At December 31, 2018 and December 31, 2017, the Company carried an accrual for the payment of
interest and penalties of $1.1 million and $0.9 million, respectively, that is included in income taxes payable in the consolidated
balance sheets.
The federal income tax returns of the Company's U.S. operations for the years through 2014 are closed for Internal Revenue Service
("IRS") examination. The Company's 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 2013 are closed for Canada
Revenue Agency ("CRA") examination. The Company's Canadian federal income tax returns are not currently under examination
by the CRA for any open tax years.
NOTE 22 LOSS FROM CONTINUING OPERATIONS PER SHARE
The following table sets forth the reconciliation of numerators and denominators for the basic and diluted loss from continuing
operations per share computation for the years ended December 31, 2018 and December 31, 2017:
(in thousands, except per share data)
Numerator:
(Loss) income from continuing operations
Less: net income attributable to noncontrolling interests
Less: dividends on preferred stock, net of tax
Loss from continuing operations attributable to common shareholders
Denominator:
Weighted average basic shares
Weighted average common shares outstanding
Weighted average diluted shares
Weighted average common shares outstanding
Effect of potentially dilutive securities
Total weighted average diluted shares
Basic loss from continuing operations per share
Diluted loss from continuing operations per share
Years ended December 31,
2018
2017
(restated)
$
$
$
$
$
(22,264)
(1,765)
(620)
(24,649)
$
21,728
21,728
—
21,728
(1.13)
(1.13)
$
$
4,174
(4,085)
(1,248)
(1,159)
21,547
21,547
—
21,547
(0.05)
(0.05)
Basic loss from continuing operations per share is calculated using weighted-average common shares outstanding. Diluted loss
from continuing operations per share is calculated using weighted-average diluted shares. Weighted-average diluted shares is
calculated by adding the effect of potentially dilutive securities to weighted-average common shares outstanding. Potentially
dilutive securities consist of stock options, unvested restricted stock awards, unvested restricted stock units, warrants and convertible
preferred stock. Because the Company is reporting a loss from continuing operations attributable to common shareholders for
the years ended December 31, 2018 and December 31, 2017, all potentially dilutive securities outstanding were excluded from
the calculation of diluted loss from continuing operations per share since their inclusion would have been anti-dilutive.
NOTE 23 STOCK-BASED COMPENSATION
(a)
Stock Options
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 reserved for issuance to key employees selected by the Company new stock options
("New Stock Options") to purchase up to an additional 300,000 common shares. No New Stock Options were granted during the
year ended December 31, 2018. There are no New Stock Options remaining for future grants.
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
99
KINGSWAY FINANCIAL SERVICES INC.
Notes to Consolidated Financial Statements
("Replacement Options"). The maximum number of common shares available to be granted as Replacement Options is 355,625.
No Replacement Options were granted during the year ended December 31, 2018. There are no Replacement Options remaining
for future grants.
The Replacement Options and New Stock Options (collectively, the "Stock Options") are fully vested and exercisable at the date
of grant and are exercisable for a period of four years.
The following table summarizes the stock option activity during the year ended December 31, 2018:
Number of
Options
Outstanding
Weighted-
Average
Exercise Price
Outstanding at December 31, 2017
651,875
$
Granted
Exercised
Expired
Outstanding at December 31, 2018
Exercisable at December 31, 2018
—
—
(611,875)
40,000
40,000
$
$
4.51
—
—
4.50
4.67
4.67
Weighted-
Average
Remaining
Contractual
Term (in years)
Aggregate
Intrinsic Value
(in thousands)
0.4
$
352
1.3
1.3
$
$
—
—
The aggregate intrinsic value of stock options outstanding and exercisable is the difference between the December 31, 2018 market
price for the Company's common shares and the exercise price of the options, multiplied by the number of options where the fair
value exceeds the exercise price.
At December 31, 2018 and December 31, 2017 the number of options exercisable was 40,000 and 651,875 respectively, with
weighted average prices of $4.67 and $4.51, respectively. No options were exercised during the years ended December 31, 2018
and December 31, 2017.
The Company uses the Black-Scholes option pricing model to estimate the fair value of each option on the date of grant. No
options were granted during the years ended December 31, 2018 and December 31, 2017.
(b)
Restricted Stock Awards of the Company
Under the 2013 Plan, the Company made grants of restricted common stock awards to certain officers of the Company on March
28, 2014 (the "2014 Restricted Stock Awards"). The 2014 Restricted Stock Awards shall become fully vested and the restriction
period shall lapse as of March 28, 2024 subject to the officers' continued employment through the vesting date. The 2014 Restricted
Stock Awards are amortized on a straight-line basis over the ten-year requisite service period. The grant-date fair value of the
2014 Restricted Stock Awards was determined using the closing price of Kingsway common stock on the date of grant. Total
unamortized compensation expense related to unvested 2014 Restricted Stock Awards at December 31, 2018 was $0.7 million.
During the third quarter of 2018, the Company modified the terms of the 2014 Restricted Stock Awards for two of its officers.
On September 5, 2018, the Company executed an Amended and Restated Restricted Stock Award Agreement ("Amended RSA
Agreement") with its former Chief Executive Officer. Under the terms of the Amended RSA Agreement, the former Chief Executive
Officer was deemed to have forfeited 1,382,665 shares of the 2014 Restricted Stock Awards. The Company’s accounting policy
is to account for forfeitures when they occur. As a result, the Company reversed during the third quarter of 2018 $2.4 million of
compensation expense previously recognized from March 28, 2014 through June 30, 2018.
Pursuant to the terms of the Amended RSA Agreement, the Company granted to the former Chief Executive Officer a modified
award of 350,000 shares of restricted common stock (the "2018 Modified Restricted Stock Award"). The Company deemed the
2018 Modified Restricted Stock Award to be taxable to the former Chief Executive Officer on the modification date. Pursuant to
the terms of the 2013 Plan and the Amended RSA Agreement, the former Chief Executive Officer was entitled to satisfy the tax
withholding obligation by authorizing the Company to withhold restricted common shares, which would otherwise be deliverable,
having an aggregate fair market value, determined as of the tax date, equal to the tax withholding obligation. The former Chief
Executive Officer chose to satisfy the tax withholding obligation in this manner. As a result, the Company cancelled 102,550 of
100
KINGSWAY FINANCIAL SERVICES INC.
Notes to Consolidated Financial Statements
the 350,000 shares of the 2018 Modified Restricted Stock Award and recognized payroll tax expense of $0.3 million during the
third quarter of 2018.
The remaining 247,450 shares of the 2018 Modified Restricted Stock Award shall become fully vested after the satisfaction of
certain performance conditions, as defined in the Amended RSA Agreement. There is no defined term under which the performance
conditions must be completed. The unamortized compensation expense for the 2018 Modified Restricted Stock Award will be
recognized at the time the performance condition has been satisfied. The grant-date fair value of the 2018 Modified Restricted
Stock Award was determined using the closing price of Kingsway common stock on the modification date. Total unamortized
compensation expense related to the unvested 2018 Modified Restricted Stock Award at December 31, 2018 was $0.6 million.
On September 15, 2018, the Company executed an Employee Separation Agreement and Release ("Separation Agreement") with
a former officer. Under the terms of the Separation Agreement, the former officer forfeited 112,500 shares of the 2014 Restricted
Stock Awards. The Company’s accounting policy is to account for forfeitures when they occur. As a result, the Company reversed
during the third quarter of 2018 $0.4 million of compensation expense previously recognized from March 28, 2014 through June
30, 2018.
The Separation Agreement modified the vesting terms related to the remaining 112,500 shares of the original 2014 Restricted
Stock Awards ("Modified Restricted Stock Award"), such that they became fully vested on September 22, 2018. The Company
deemed the Modified Restricted Stock Award to be taxable to the former officer on the vesting date. Pursuant to the terms of the
2013 Plan and the Separation Agreement, the former officer was entitled to satisfy the tax withholding obligation by authorizing
the Company to withhold restricted common shares, which would otherwise be deliverable, having an aggregate fair market value,
determined as of the tax date, equal to the tax withholding obligation. The former officer chose to satisfy the tax withholding
obligation in this manner. As a result, the Company cancelled 32,962 of the 112,500 shares of the Modified Restricted Stock
Award and recognized payroll tax expense of $0.1 million during the third quarter of 2018.
The Company also recorded during the third quarter of 2018 $0.2 million of compensation expense equal to the fair value of the
remaining 79,538 fully vested shares of the Modified Restricted Stock Award. The grant-date fair value of the Modified Restricted
Stock Award was determined using the closing price of Kingsway common stock on the modification date. Total unamortized
compensation expense related to the unvested Modified Restricted Stock Award at December 31, 2018 was zero.
The Company granted restricted common stock units ("Restricted Stock Units") to an officer of the Company pursuant to a Restricted
Stock Unit Agreement dated August 24, 2016. On September 5, 2018, the Restricted Stock Unit Agreement was cancelled and
500,000 restricted common stock awards were granted to the officer (the "2018 Restricted Stock Award"). There was no change
to the vesting terms. The 2018 Restricted Stock Award shall become fully vested and the restriction period shall lapse as of March
28, 2024 subject to the officer's continued employment through the vesting date. The 2018 Restricted Stock Award is amortized
on a straight-line basis over the requisite service period. The grant-date fair value of the 2018 Restricted Stock Award was
determined using the closing price of Kingsway common stock on the date of grant. Total unamortized compensation expense
related to unvested 2018 Restricted Stock Award at December 31, 2018 was $2.0 million.
The following table summarizes the activity related to unvested 2014 Restricted Stock Awards, 2018 Modified Restricted Stock
Award, Modified Restricted Stock Award and 2018 Restricted Stock Award (collectively "Restricted Stock Awards") during the
year ended December 31, 2018:
Unvested at December 31, 2017
Granted
Vested
Cancelled for Tax Withholding
Forfeited
Unvested at December 31, 2018
Number of Restricted
Stock Awards
Weighted-Average
Grant Date Fair Value
(per Share)
1,952,665
$
850,000
(79,538)
(135,512)
(1,495,165)
1,092,450
$
4.14
4.42
2.95
2.65
4.14
4.51
101
KINGSWAY FINANCIAL SERVICES INC.
Notes to Consolidated Financial Statements
The unvested balance at December 31, 2018 in the table above is comprised of 345,000 shares of 2014 Restricted Stock Awards,
247,450 shares of 2018 Modified Restricted Stock Award and 500,000 shares of the 2018 Restricted Stock Award.
(c)
Restricted Stock Awards of PWSC
PWSC granted 1,000 restricted common stock awards ("PWSC Restricted Stock Award") to an officer of PWSC pursuant to an
agreement dated September 7, 2018. The PWSC Restricted Stock Award contains both a service and a performance condition that
affects vesting. The service condition vests according to a graded vesting schedule and shall become fully vested on February 20,
2022 subject to the officer's continued employment through the applicable vesting dates. The service condition component of the
PWSC Restricted Stock Award is amortized on a straight-line basis over the requisite service period. The performance condition
vests on February 20, 2022 and is based on the internal rate of return of PWSC. Accruals of compensation expense for the
performance condition component of the PWSC Restricted Stock Award is estimated based on the probable outcome of the
performance condition. The grant-date fair value of the PWSC Restricted Stock Award was estimated using a valuation model.
At December 31, 2018, there were 1,000 unvested shares of the PWSC Restricted Stock Award with a weighted-average grant
date fair value of $824.47 per share. Total unamortized compensation expense related to unvested PWSC Restricted Stock Award
at December 31, 2018 was $0.7 million.
(d)
Restricted Stock Units
The Company granted Restricted Stock Units to an officer of the Company pursuant to a Restricted Stock Unit Agreement dated
August 24, 2016. As discussed above, on September 5, 2018, the Restricted Stock Unit Agreement was cancelled. The following
table summarizes the activity related to unvested Restricted Stock Units for the year ended December 31, 2018:
Unvested at December 31, 2017
Granted
Vested
Cancelled
Unvested at December 31, 2018
Number of Restricted
Stock Units
Weighted-Average
Grant Date Fair Value
(per Share)
500,000
$
—
—
(500,000)
— $
5.73
—
—
5.73
—
Total stock-based compensation, net of forfeitures, was a benefit of $1.7 million and an expense of $1.2 million for the years ended
December 31, 2018 and December 31, 2017, respectively.
(d)
Employee Share Purchase Plan
The Company has an employee share purchase plan ("ESPP Plan") whereby qualifying employees could choose each year to have
up to 5% of their annual base earnings withheld to purchase the Company's common shares. After one year of employment, the
Company matches 100% of the employee contribution amount, and the contributions vest immediately. All contributions are used
by the plan administrator to purchase common shares in the open market. The Company's contribution is expensed as paid and
for the years ended December 31, 2018 and December 31, 2017 totaled $0.1 million and $0.1 million, respectively.
NOTE 24 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 $18,500 and $18,000
in 2018 and 2017, 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, 2018 and December 31, 2017 totaled $0.2 million and $0.1
million, respectively. All Company obligations to the plans were fully funded as of December 31, 2018.
102
KINGSWAY FINANCIAL SERVICES INC.
Notes to Consolidated Financial Statements
NOTE 25 REDEEMABLE CLASS A PREFERRED STOCK
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.
There were 222,876 shares of Class A preferred stock ("Preferred Shares") outstanding at December 31, 2018 and December 31,
2017. 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. As of December 31, 2018, the maximum number of common shares issuable upon
conversion of the Preferred Shares is 1,392,975 common shares.
During 2017, 40,000 Preferred Shares were converted into 250,000 common shares at the conversion price of $4.00 per common
share, or $1.0 million, at the option of the holders. As a result, $1.0 million was reclassified from Class A preferred stock to
Shareholders' Equity on the consolidated balance sheet at December 31, 2017.
The Preferred Shares are not entitled to vote. The holders of the Preferred Shares are entitled to receive fixed, cumulative,
preferential cash dividends at a rate of $1.25 per Preferred Share per year. The cash dividend rate shall be revised to $1.875 per
Preferred Share per year if the dividend accumulates for a period greater than 30 consecutive months from the date of the most
recent dividend payment. On and after February 3, 2016, the Company may redeem all or any part of the then outstanding Preferred
Shares for the price of $28.75 per Preferred Share, plus accrued but unpaid dividends thereon, whether or not declared, up to and
including the date specified for redemption. The Company will redeem any Preferred Shares not previously converted into common
shares, and which remain outstanding on April 1, 2021, for the price of $25.00 per Preferred Share, plus accrued but unpaid
dividends, whether or not declared, up to and including the date specified for redemption. At December 31, 2018 and December 31,
2017, accrued dividends of $1.7 million and $1.6 million were included in Class A preferred stock in the consolidated balance
sheets. The redemption amount of the Preferred Shares as if they were currently redeemable was $7.3 million and $7.2 million
at December 31, 2018 and December 31, 2017, respectively.
In accordance with FASB ASC Topic 480-10-S99-3A, SEC Staff Announcement: Classification and Measurement of Redeemable
Securities, redemption features not solely within the control of the issuer are required to be presented outside of permanent equity
on the consolidated balance sheets. As described above, the holder has the option to convert the Preferred Shares at any time;
however, if not converted, they are required to be redeemed on April 1, 2021. As such, the Preferred Shares are presented in
temporary or mezzanine equity on the consolidated balance sheets and will be accreted, using the interest method, up to the stated
redemption value of $5.6 million, through additional paid-in capital as a deemed dividend, from the date of issuance through the
April 1, 2021 redemption date. The Company also accrues dividends through additional paid-in-capital at the stated coupon,
which the Company expects will total $2.6 million as of the April 1, 2021 redemption date. As a result, the total redemption amount
of the Preferred Shares as of the redemption date if the Preferred Shares are not converted is expected to be $8.2 million.
NOTE 26 SHAREHOLDERS' EQUITY
The Company is authorized to issue an unlimited number of zero par value common stock. There were 21,787,728 and 21,708,190
shares of common stock outstanding at December 31, 2018 and December 31, 2017, respectively.
There were no dividends declared during the years ended December 31, 2018 and December 31, 2017.
As described in Note 25, "Redeemable Class A Preferred Stock", during 2017, 40,000 Preferred Shares were converted into 250,000
common shares. As a result, $1.0 million was reclassified from Class A preferred stock to Shareholders' Equity on the consolidated
balance sheet at December 31, 2017.
103
KINGSWAY FINANCIAL SERVICES INC.
Notes to Consolidated Financial Statements
The Company has warrants outstanding, recorded in shareholders' equity, that will entitle each subscriber to purchase one common
share of Kingsway for each warrant. The following table summarizes information about warrants outstanding at December 31,
2018:
Exercise Price
$
$
5.00
5.00
Date of Issue
16-Sep-13
3-Feb-14
Expiry Date
15-Sep-23
15-Sep-23
Total:
Remaining Contractual
Life (in years)
4.7
4.7
4.7
NOTE 27 ACCUMULATED OTHER COMPREHENSIVE INCOME (LOSS)
December 31, 2018
Number
Outstanding
3,280,790
1,392,975
4,673,765
The table below details the change in the balance of each component of accumulated other comprehensive income (loss), net of
tax, for the years ended December 31, 2018 and December 31, 2017 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 income (loss), net of tax, only for the years ended December 31, 2018 and December 31,
2017 and inclusive of the components attributable to noncontrolling interests in consolidated subsidiaries.
As further discussed in Note 4, "Recently Issued Accounting Standards," effective January 1, 2018, the Company adopted ASU
2016-01. As a result of the adoption, equity investments are no longer classified as available-for-sale with unrealized gains and
losses recognized in other comprehensive income (loss); rather, changes in the fair value of equity investments are now recognized
in net income (loss). Also as a result of the adoption, the portion of the total change in the fair value of our subordinated debt
resulting from the change in instrument-specific credit risk is no longer recognized in net income (loss) and is now presented in
other comprehensive income (loss). Prior periods have not been restated to conform to the current presentation.
104
KINGSWAY FINANCIAL SERVICES INC.
Notes to Consolidated Financial Statements
(in thousands)
Balance, January 1, 2017
Other comprehensive loss arising during
the period
Amounts reclassified from accumulated
other comprehensive loss
Net current-period other comprehensive
(loss) income
Balance, December 31, 2017
Cumulative effect of adoption of ASU
2016-01
Balance at January 1, 2018, as adjusted
Other comprehensive income (loss)
arising during the period
Amounts reclassified from accumulated
other comprehensive income
Amounts removed from accumulated
other comprehensive income due to
disposal of discontinued operations
Net current-period other comprehensive
income (loss)
Balance, December 31, 2018
$
$
$
$
Unrealized
Gains
(Losses) on
Available-
for-Sale
Investments
$
3,572
Foreign
Currency
Translation
Adjustments
(3,780)
$
Change in
Fair Value
of Debt
Attributable
to
Instrument-
Specific
Credit Risk
Equity in Other
Comprehensive
Loss of Limited
Liability
Investment
Total
Accumulated
Other
Comprehensive
Income (Loss)
— $
— $
(208)
(5,214)
1,076
(4,138)
—
494
494
—
—
—
—
—
—
(5,214)
1,570
(3,644)
(566) $
(3,286) $
— $
— $
(3,852)
40
(526) $
—
(3,286) $
40,455
40,455
$
—
— $
40,495
36,643
13
(18)
371
—
—
—
3,804
(45)
3,772
—
—
—
—
(18)
371
366
$
— $
3,804
(160) $
(3,286)
44,259
$
$
(45) $
4,125
(45) $
40,768
105
KINGSWAY FINANCIAL SERVICES INC.
Notes to Consolidated Financial Statements
Components of accumulated other comprehensive income (loss) were reclassified to the following lines of the consolidated
statements of operations for the years ended December 31, 2018 and December 31, 2017:
(in thousands)
Reclassification of accumulated other comprehensive income (loss) from
unrealized gains (losses) on available-for-sale investments to:
Net realized (losses) gains
Other-than-temporary impairment loss
$
Loss from continuing operations before income tax expense (benefit)
Income tax expense (benefit)
Income (loss) from discontinued operations, net of taxes
Net income (loss)
Reclassification of accumulated other comprehensive income (loss) from foreign
currency translation adjustments to:
Loss on liquidation of subsidiary, net of taxes
Income tax expense (benefit)
Net loss
Total reclassification from accumulated other comprehensive income (loss) to net
loss
NOTE 28 SEGMENTED INFORMATION
Years ended December 31,
2018
2017
$
18
—
18
—
—
18
—
—
—
(2)
—
(2)
—
(1,074)
(1,076)
(494)
—
(494)
$
18
$
(1,570)
The Company conducts its business through the following two reportable segments: Extended Warranty and Leased Real Estate.
Prior to the second quarter of 2018, the Company conducted its business through a third reportable segment, Insurance Underwriting.
Insurance Underwriting included the following subsidiaries of the Company: Mendota, Amigo and Kingsway Re. As further
discussed in Note 6, "Disposal, Discontinued Operations and Liquidation," on October 18, 2018, the Company announced that it
had completed the sale of Mendota. As a result, Mendota has been classified as discontinued operations and the results of their
operations are reported separately for all periods presented. As a result of classifying Mendota as discontinued operations, the
composition of the Insurance Underwriting segment has changed such that it no longer meets the criteria of a reportable segment.
As such, all segmented information has been restated to exclude the Insurance Underwriting segment for all periods presented.
Extended Warranty Segment
Extended Warranty includes the following subsidiaries of the Company: IWS, Trinity and PWSC (collectively, "Extended
Warranty").
IWS is a licensed motor vehicle service agreement company and is a provider of after-market vehicle protection services distributed
by credit unions in 23 states and the District of Columbia to their members.
Trinity sells HVAC, standby generator, commercial LED lighting and refrigeration warranty products and provides equipment
breakdown and maintenance support services to companies across the United States. As a seller of warranty products, Trinity
markets and administers product warranty contracts for certain new and used products in the HVAC, standby generator, commercial
LED lighting and refrigeration industries throughout the United States. Trinity acts as an agent on behalf of the third-party insurance
companies that underwrite and guaranty these warranty contracts. Trinity does not guaranty the performance underlying the
warranty contracts it sells. 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.
106
KINGSWAY FINANCIAL SERVICES INC.
Notes to Consolidated Financial Statements
PWSC sells new home warranty products and provides administration services to homebuilders and homeowners across the United
States. PWSC distributes its products and services through an in house sales team and through insurance brokers and insurance
carriers throughout all states except Alaska and Louisiana.
Leased Real Estate Segment
Leased Real Estate includes the Company's subsidiary, CMC. CMC owns the Real Property that is leased to a third-party pursuant
to a long-term triple net lease with a single customer. For the year ended December 31, 2018, revenue of $13.4 million from this
single customer represents more than 10% of the Company’s consolidated revenues. The Real Property is also subject to the
Mortgage. When assessing and measuring the operational and financial performance of the Leased Real Estate segment, interest
expense related to the Mortgage is included in Leased Real Estate's segment operating income.
Revenues and Operating Income by Reportable Segment
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.
Revenues by reportable segment reconciled to consolidated revenues for the years ended December 31, 2018 and December 31,
2017 were:
(in thousands)
Revenues:
Extended Warranty:
Years ended December 31,
2017
2018
(restated)
Service fee and commission income
$
38,286
$
Other income
Total Extended Warranty
Leased Real Estate:
Rental income
Other income
Total Leased Real Estate
Total segment revenues
Rental income not allocated to segments
Total revenues
171
38,457
13,366
245
13,611
52,068
10
$
52,078
$
30,530
191
30,721
13,364
493
13,857
44,578
20
44,598
107
KINGSWAY FINANCIAL SERVICES INC.
Notes to Consolidated Financial Statements
The operating income by reportable segment in the following table is before income taxes and includes revenues and direct segment
costs. Total segment operating income reconciled to the consolidated (loss) income from continuing operations for the years ended
December 31, 2018 and December 31, 2017 were:
(in thousands)
Segment operating income
Extended Warranty
Leased Real Estate
Total segment operating income
Net investment income
Net realized (losses) gains
Gain on change in fair value of equity investments
Loss on change in fair value of limited liability investments, at fair value
Net change in unrealized loss on private company investments
Interest expense not allocated to segments
Other income and expenses not allocated to segments, net
Amortization of intangible assets
Contingent consideration benefit
Loss on change in fair value of debt
Gain on disposal of subsidiary
Equity in net (loss) income of investee
Loss from continuing operations before income tax expense (benefit)
Income tax expense (benefit)
(Loss) income from continuing operations
Years ended December 31,
2017
2018
(restated)
4,215
2,485
6,700
2,957
(17)
381
(7,393)
(1,629)
(7,407)
(8,963)
(2,376)
—
(1,720)
17
(2,499)
(21,949)
315
(22,264)
$
$
3,680
3,099
6,779
7,087
306
—
(1,832)
(758)
(6,348)
(10,503)
(1,085)
212
(8,487)
—
2,115
(12,514)
(16,688)
4,174
$
$
NOTE 29 FAIR VALUE OF FINANCIAL INSTRUMENTS
Fair value is the price that would be received upon sale of an asset or paid to transfer a liability in an orderly transaction between
market participants at the measurement date. 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 employs a fair value hierarchy to categorize the inputs it uses in valuation techniques to measure the fair value. The
following fair value hierarchy is used in selecting inputs, with the highest priority given to Level 1:
• Level 1 – Quoted prices for identical instruments in active markets.
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KINGSWAY FINANCIAL SERVICES INC.
Notes to Consolidated Financial Statements
• Level 2 – Quoted prices for similar instruments in active markets; quoted prices for identical or similar instruments in
markets that are not active; and model-derived valuations in which all significant inputs are observable in active markets.
• Level 3 – Valuations derived from valuation techniques in which one or more significant inputs are not observable.
The Company classifies its investments in fixed maturities as available-for-sale and reports these investments at fair value. The
Company's equity investments, limited liability investments, at fair value, real estate investments and subordinated debt are
measured and reported at fair value.
Fixed maturities - 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. All classes of the Company’s fixed maturities, primarily consisting of investments in
US. Treasury bills and government bonds; obligations of states, municipalities and political subdivisions; mortgage-backed
securities; and corporate securities, are classified as Level 2. Level 2 is applied to valuations based upon quoted prices for similar
assets in active markets; quoted prices for identical or similar assets in markets that are inactive; or valuations based on models
where the significant inputs are observable or can be corroborated by observable market data.
The Company engages a third-party vendor who utilizes third-party pricing sources and primarily employs a market approach to
determine the fair values of our fixed maturities. The market approach includes primarily obtaining prices from independent third-
party pricing services as well as, to a lesser extent, quotes from broker-dealers. Our third-party vendor also monitors market
indicators, as well as industry and economic events, to ensure pricing is appropriate. All classes of our fixed maturities are valued
using this technique. The Company has obtained an understanding of our third-party vendor’s valuation methodologies and inputs.
Fair values obtained from our third-party vendor are not adjusted by the Company.
The following is a description of the significant inputs, by asset class, used by the third-party pricing services to determine the fair
values of our fixed maturities included in Level 2:
• U.S. government, government agencies and authorities are generally priced using the market approach. Inputs generally
consist of trades of identical or similar securities, quoted prices in inactive markets and maturity.
•
States, municipalities and political subdivisions are generally priced using the market approach. Inputs generally consist
of trades of identical or similar securities, quoted prices in inactive markets, new issuances and credit spreads.
• Mortgage-backed securities are generally priced using the market approach. Inputs generally consist of trades of identical
or similar securities, quoted prices in inactive markets, expected prepayments, expected credit default rates, delinquencies
and issue specific information including, but not limited to, collateral type, seniority and vintage.
• Corporate securities are generally priced using the market approach using pricing vendors. Inputs generally consist of
trades of identical or similar securities, quoted prices in inactive markets, issuer rating, benchmark yields, maturity and
credit spreads.
Equity investments - Fair values of equity investments, including warrants, reflect quoted market values based on latest bid prices,
where active markets exist, or models based on significant market observable inputs, where no active markets exist.
Limited liability investments, at fair value - Limited liability investments, at fair value include the Company's investment in 1347
Investors as well as the underlying investments of Net Lease and Argo Holdings. 1347 Investors owns common stock in Limbach
Holdings, Inc., a publicly traded company. Net Lease owns investments in limited liability companies that hold investment
properties. Argo Holdings makes investments in limited liability companies and limited partnerships that hold investments in
search funds and private operating companies.
• The fair value of the Company's investment in 1347 Investors is calculated based on a model that distributes the net equity
of 1347 Investors to all classes of membership interests. The model uses quoted market prices and significant market
observable inputs. This investment is categorized in Level 2 of the fair value hierarchy.
• The fair value of Net Lease's investments in limited liability companies is based upon the net asset values of the underlying
investments companies as a practical expedient to estimate fair value. The Company applies the net asset value practical
expedient to Net Lease's limited liability investments on an investment-by-investment basis unless it is probable that the
Company will sell a portion of an investment at an amount different from the net asset value of the investment. Investments
that are measured at fair value using the net asset value practical expedient are not required to be classified using the fair
value hierarchy.
109
KINGSWAY FINANCIAL SERVICES INC.
Notes to Consolidated Financial Statements
• The fair value of Argo Holdings' limited liability investments that hold investments in search funds is based on the initial
investment in the search funds. The fair value of Argo Holdings' limited liability investments that hold investments in
private operating companies is valued using a market approach including valuation multiples applied to corresponding
performance metrics, such as earnings before interest, tax, depreciation and amortization; revenue; or net earnings. The
selected valuation multiples were estimated using multiples provided by the investees and review of those multiples in
light of investor updates, performance reports, financial statements and other relevant information. These investments
are categorized in Level 3 of the fair value hierarchy.
Real estate investments - The fair value of real estate investments involves a combination of the market and income valuation
techniques. Under this approach, a market-based capitalization rate is derived from comparable transactions, adjusted for any
unique characteristics of each asset, and applied to the asset under consideration. The cap rates used during underwriting and
subsequent valuation incorporate the consideration of risks of vacancy and collection loss, administrative costs of owning net
leased assets and possible capital expenditures that could be determined a landlord expense. These investments are categorized in
Level 3 of the fair value hierarchy.
Subordinated debt - The fair value of the subordinated debt is calculated using a model based on significant market observable
inputs and inputs developed by a third-party. These inputs include credit spread assumptions developed by a third-party and market
observable swap rates. The subordinated debt is categorized in Level 2 of the fair value hierarchy.
Contingent consideration - The consideration for certain of the Company's acquisitions included future payments to the former
owners that were contingent upon the achievement of certain targets over future reporting periods. Liabilities for contingent
consideration were measured and reported at fair value and were included in accrued expenses and other liabilities in the consolidated
balance sheets. The fair value of contingent consideration liabilities was estimated using internal models without relevant observable
market inputs. Estimated payments were discounted using present value techniques to arrive at estimated fair value. Contingent
consideration liabilities were revalued each reporting period. 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. Any changes in fair value were reported in the consolidated statements of operations as contingent
consideration benefit. During the second quarter of 2017, the Company settled its remaining contingent consideration liability;
therefore, no contingent consideration liability remains on the consolidated balance sheets as of as of December 31, 2018 and
December 31, 2017.
110
KINGSWAY FINANCIAL SERVICES INC.
Notes to Consolidated Financial Statements
Assets and Liabilities Measured at Fair Value on a Recurring Basis
The balances of the Company's financial assets and liabilities measured at fair value on a recurring basis by level within the fair
value hierarchy as of December 31, 2018 and December 31, 2017 was as follows. Certain investments in limited liability companies
that are measured at fair value using the net asset value practical expedient are not required to be classified using the fair value
hierarchy, but are presented in the following tables to permit reconciliation of the fair value hierarchy to the amounts presented in
the consolidated balance sheets:
(in thousands)
December 31, 2018
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)
Total
Significant
Unobservable
Inputs (Level 3)
Measured at
Net Asset
Value
Recurring fair value
Assets:
Fixed maturities:
U.S. government,
government agencies and
authorities
States, municipalities and
political subdivisions
Mortgage-backed
Corporate
Total fixed maturities
Equity investments:
Common stock
Warrants
Total equity investments
Limited liability investments, at
fair value
Real estate investments
Other investments
Short-term investments
Total assets
Liabilities:
Subordinated debt
Total liabilities
—
—
—
—
—
—
—
—
21,685
—
—
—
—
—
—
—
4,124
10,662
—
—
14,786
$
21,685
— $
— $
—
—
$
5,547
$
— $
5,547
$
— $
607
3,186
2,920
12,260
801
55
856
26,015
10,662
2,079
152
52,024
50,023
50,023
$
$
$
$
$
$
—
—
—
—
801
19
820
—
—
—
—
820
$
— $
— $
607
3,186
2,920
12,260
—
36
36
206
—
2,079
152
14,733
50,023
50,023
$
$
$
111
KINGSWAY FINANCIAL SERVICES INC.
Notes to Consolidated Financial Statements
(in thousands) (restated)
December 31, 2017
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)
Total
Significant
Unobservable
Inputs(Level 3)
Measured at
Net Asset
Value
Recurring fair value
measurements
Assets:
Fixed maturities:
U.S. government,
government agencies and
authorities
States, municipalities and
political subdivisions
Mortgage-backed
Corporate
Total fixed maturities
Equity investments:
Common stock
Warrants
Total equity investments
Limited liability investments, at
fair value
Real estate investments
Other investments
Short-term investments
Total assets
Liabilities:
Subordinated debt
Total liabilities
$
5,612
$
— $
5,612
$
— $
626
2,876
5,427
14,541
3,570
1,019
4,589
32,211
10,662
3,721
151
—
—
—
—
3,570
171
3,741
—
—
—
—
626
2,876
5,427
14,541
—
848
848
10,314
—
3,721
151
—
—
—
—
—
—
—
—
—
—
—
—
—
—
—
1,397
10,662
—
—
20,500
—
—
—
$
$
$
65,875
$
3,741
$
29,575
$
12,059
$
20,500
52,105
52,105
$
$
— $
— $
52,105
52,105
$
$
— $
— $
—
—
112
KINGSWAY FINANCIAL SERVICES INC.
Notes to Consolidated Financial Statements
The following table provides a reconciliation of the fair value of recurring Level 3 fair value measurements for the years ended
December 31, 2018 and December 31, 2017:
(in thousands)
Assets:
Limited liability investments, at fair value:
Beginning balance
Purchases
Distributions received
Change in fair value of limited liability investments, at fair value included
in net loss
Ending balance
Real estate investments:
Beginning balance
Change in fair value of real estate investments included in net loss
Ending balance
Ending balance - assets
Liabilities:
Contingent consideration:
Beginning balance
Settlements of contingent consideration liabilities
Change in fair value of contingent consideration included in net loss
Ending balance - liabilities
Total
$
$
$
$
Years ended December 31,
2018
2017
$
1,397
$
1,580
(386)
1,533
4,124
10,662
—
10,662
14,786
$
— $
—
—
— $
939
664
(86)
(120)
1,397
10,662
—
10,662
12,059
325
(113)
(212)
—
14,786
$
12,059
The following table summarizes the valuation techniques and significant unobservable inputs utilized in determining fair values
for the Company's investments that are categorized as Level 3 at December 31, 2018:
Categories
Limited liability
investments, at fair value
Real estate investments
$
$
Fair Value
(in thousands)
Valuation Techniques
Unobservable
Inputs
Input
Value(s)
4,124
Market approach
Valuation multiples
5.0x - 8.8x
10,662 Market and income approach
Cap rates
7.5%
The following table summarizes the valuation techniques and significant unobservable inputs utilized in determining fair values
for the Company's investments that are categorized as Level 3 at December 31, 2017:
Categories
Limited liability
investments, at fair value
Real estate investments
$
$
Fair Value
(in thousands)
Valuation Techniques
Unobservable
Inputs
Input
Value(s)
1,397
Market approach
Valuation multiples
5.0x - 7.0x
10,662 Market and income approach
Cap rates
7.5%
All transfers are recognized by the Company at the beginning of each reporting period. Transfers between Levels 2 and 3 generally
relate to whether significant unobservable inputs are used for the fair value measurements. There were no transfers between levels
in 2018 or 2017.
113
KINGSWAY FINANCIAL SERVICES INC.
Notes to Consolidated Financial Statements
Investments Measured Using the Net Asset Value per Share Practical Expedient
The following table summarizes investments for which fair value is measured using the net asset value per share practical expedient
at December 31, 2018:
December 31, 2018
Limited liability
investments, at fair value
$
Fair Value
(in thousands)
Unfunded Commitments
(in thousands)
Redemption
Frequency
Redemption
Notice Period
21,685
n/a
n/a
n/a
The following table summarizes investments for which fair value is measured using the net asset value per share practical expedient
at December 31, 2017:
December 31, 2017
Limited liability
investments, at fair value
$
Fair Value
(in thousands)
Unfunded Commitments
(in thousands)
Redemption
Frequency
Redemption
Notice Period
20,500
n/a
n/a
n/a
Assets and Liabilities Measured at Fair Value on a Nonrecurring Basis
Certain assets and liabilities are measured at fair value on a nonrecurring basis, including assets that are adjusted for observable
price changes or written down to fair value as a result of an impairment. For the year ended December 31, 2018, the Company
recorded adjustments to decrease the fair value of certain investments in private companies for observable price changes of $0.6
million and impairments of $1.0 million, respectively, which are included in net change in unrealized loss on private company
investments in the consolidated statements of operations. To determine the fair value of investments in these private companies,
the Company considered rounds of financing and third-party transactions, discounted cash flow analyses and market-based
information, including comparable transactions, trading multiples and changes in market outlook, among other factors. The
Company has classified the fair value measurements of these investments in private companies as Level 3 because they involve
significant unobservable inputs.
NOTE 30 RELATED PARTIES
Related party transactions, including services provided to or received by the Company's subsidiaries, are measured in part by the
amount of consideration paid or received as established and agreed by the parties. Except where disclosed elsewhere in these
consolidated financial statements, the following is a summary of related party relationships and transactions.
(a)
Argo Management Group, LLC
The Company acquired Argo Management in April 2016. Argo Management's primary business is to act as Managing Member
of Argo Holdings. At December 31, 2018 and December 31, 2017, each of the Company, John T. Fitzgerald ("Fitzgerald"), the
Company's Chief Executive Officer and President, and certain of Fitzgerald’s immediate family members owns equity interests
in Argo Holdings, all of which interests were acquired prior to the Company’s acquisition of Argo Management. Subject to certain
limitations, Argo Holdings' governing documents require all individuals and entities owning an equity interest in Argo Holdings
to fund upon request his/her/its pro rata share of any funding requirements of Argo Holdings up to an aggregate maximum amount
equal to his/her/its total capital commitment (each request for funds being referred to as a "Capital Call"). During 2018 and 2017,
the Company funded approximately $0.5 million and $0.3 million, respectively, in response to Capital Calls. During 2018 and
2017, Fitzgerald and Fitzgerald’s immediate family members funded their respective Capital Calls. Argo Holdings used the
proceeds of the Capital Calls to make investments, cover general operating expenses and pay the management fee owed to Argo
Management.
(b)
1347 Property Insurance Holdings, Inc.
In November 2012, the Company formed Maison Insurance Company ("Maison"), a Louisiana domiciled property and casualty
insurance company. In preparation for a transaction to take Maison public, the Company formed 1347 Property Insurance Holdings,
Inc. (“PIH”). Maison was a wholly owned subsidiary of PIH, which completed an initial public offering effective March 31, 2014,
114
KINGSWAY FINANCIAL SERVICES INC.
Notes to Consolidated Financial Statements
pursuant to which the Company disposed of a majority interest in PIH. The Company owned zero and 8% of the common shares
of PIH at December 31, 2018 and December 31, 2017, respectively.
D. Kyle Cerminara ("Cerminara") was appointed to the PIH Board of Directors on December 27, 2016 and became Chairman of
the Board of Directors of PIH on May 11, 2018. Since April 2012, Cerminara has also served as the Chief Executive Officer of
Fundamental Global Investors, LLC ("FGI"). During 2018 and 2017, FGI was a shareholder known by the Company to be a
beneficial owner of more than 5% of the Company’s outstanding common shares. Larry G. Swets, Jr. ("Swets") has served as a
member of the PIH Board of Directors since November 21, 2013 and served as the Chairman of the Board of Directors of PIH
from March 5, 2017 to May 11, 2018. Swets also served as the Company’s Chief Executive Officer from July 1, 2010 until
September 5, 2018 and served on the Company’s Board of Directors from September 16, 2013 through December 21, 2018.
On February 11, 2014, the Company's subsidiary, 1347 Advisors, entered into a management services agreement with PIH which
provides for certain services, including forecasting, analysis of capital structure and reinsurance programs, consultation in future
restructuring or capital raising transactions, and consultation in corporate development initiatives, that 1347 Advisors will provide
to PIH unless and until 1347 Advisors and PIH agree to terminate the services. On February 24, 2015, the Company announced
that it had entered into a definitive agreement with PIH to terminate the management services agreement. Pursuant to the transaction,
1347 Advisors received the following consideration: $2.0 million in cash; $3.0 million of 8% preferred stock of PIH, mandatorily
redeemable on February 24, 2020; a Performance Shares Grant Agreement with PIH, whereby 1347 Advisors will be entitled to
receive 100,000 shares of PIH common stock if at any time the last sales price of PIH's common stock equals or exceeds $10.00
per share for any 20 trading days within any 30-trading day period; and warrants to purchase 1,500,000 shares of common stock
of PIH with a strike price of $15.00, expiring on February 24, 2022. For the year ended December 31, 2018, the Company recognized
$0.7 million of loss on change in fair value of equity investments in its consolidated statement of operations related to the change
in fair value of the warrants to purchase 1,500,000 shares of common stock of PIH.
On March 26, 2014, the Company entered into a Performance Share Grant Agreement with PIH, whereby the Company will be
entitled to receive up to an aggregate of 375,000 shares of PIH common stock upon achievement of certain milestones for PIH’s
stock price. Pursuant to the terms of the Performance Share Grant Agreement, if at any time the last sales price of PIH’s common
stock equals or exceeds: (i) $12.00 per share (as adjusted for stock splits, stock dividends, reorganizations, recapitalizations and
the like) for any 20 trading days within any 30-trading day period, the Company will receive 125,000 shares of PIH common stock;
(ii) $15.00 per share (as adjusted for stock splits, stock dividends, reorganizations, recapitalizations and the like) for any 20 trading
days within any 30-trading day period, the Company will receive 125,000 shares of PIH common stock (in addition to the 125,000
shares of common stock earned pursuant to clause (i) herein); and (iii) $18.00 per share (as adjusted for stock splits, stock dividends,
reorganizations, recapitalizations and the like) for any 20 trading days within any 30-trading day period, the Company will receive
125,000 shares of PIH common stock (in addition to the 250,000 shares of common stock earned pursuant to clauses (i) and (ii)
herein).
On January 2, 2018, the Company entered into an agreement with PIH to cancel the $10.00 per share Performance Share Grant
Agreement in exchange for cash consideration of $0.3 million and to sell the $3.0 million of 8% preferred stock of PIH, mandatorily
redeemable on February 24, 2020, for $3.0 million plus accrued but unpaid dividends. On July 24, 2018, the Company entered
into an agreement with PIH to cancel the $12.00 per share, $15.00 per share and $18.00 per share Performance Share Grant
Agreement in exchange for cash consideration of $1.0 million. For the year ended December 31, 2018, the Company recorded
gains, included in gain on change in fair value of equity investments in the consolidated statements of operations, of $1.3 million
related to these transactions. No shares were received by the Company under either of the performance share grant agreements
as of December 31, 2018.
(c)
Itasca Capital Ltd.
Investment in investee includes the Company's investment in the common stock of ICL, a publicly traded Canadian corporation,
and is accounted for under the equity method. The Company owned 22.9% and 31.2% of the common shares of ICL at December
31, 2018 and December 31, 2017, respectively.
Ballantyne Strong Inc. ("Ballantyne") owned 40.6% and 32.3% of the common shares of ICL at December 31, 2018 and December
31, 2017, respectively. Cerminara has served as the Chief Executive Officer of Ballantyne since November 2015 and as Chairman
of the Board of Ballantyne since May 2015. Cerminara was appointed to the ICL Board of Directors on June 13, 2016 and became
Chairman of the Board of Directors of ICL on June 4, 2018. Since April 2012, Cerminara has also served as the Chief Executive
Officer of FGI. During 2018 and 2017, FGI was a shareholder known by the Company to be a beneficial owner of more than 5%
of the Company’s outstanding common shares. Swets has served as the ICL Chief Executive Officer and a member of the ICL
115
KINGSWAY FINANCIAL SERVICES INC.
Notes to Consolidated Financial Statements
Board of Directors since June 9, 2016. Swets also served as the Company’s Chief Executive Officer from July 1, 2010 until
September 5, 2018 and served on the Company’s Board of Directors from September 16, 2013 through December 21, 2018.
Fitzgerald has served as a member of the ICL Board of Directors since June 9, 2016. Fitzgerald joined the Company as an Executive
Vice President in April 2016 following the Company’s acquisition of Argo. Fitzgerald has served as the Company’s Chief Executive
Officer since September 5, 2018 and has served on the Company’s Board of Directors since April 21, 2016.
ICL and the Company executed a management service agreement effective June 10, 2016 pursuant to which the Company provided
management services to ICL, including the non-exclusive use and services of appropriately qualified individuals to serve as ICL’s
Chief Executive Officer and Chief Financial Officer, for an annual service fee of $0.0 million. This agreement was later amended
on November 17, 2017 to provide an annual service fee of $0.0 million, beginning with full year 2017. The agreement was
ultimately terminated effective January 31, 2019.
On October 30, 2019, the Company executed an agreement to sell 1,974,113 shares of ICL common stock, at a price of C$0.35
per share, to FGI for cash proceeds totaling C$0.7 million. On October 31, 2019, the Company executed an agreement to sell
3,011,447 shares of ICL common stock, at a price of C$0.35 per share, to Swets for consideration totaling C$1.1 million, comprised
of cash proceeds of C$0.2 million and 247,450 shares of the Company’s common stock. The 247,450 shares of the Company’s
common stock were awarded to Swets pursuant to an Amended and Restated Restricted Stock Agreement (the "Swets Restricted
Stock Agreement") executed on September 5, 2018 related to Swets’ departure from the Company. Pursuant to the Swets Restricted
Stock Agreement, Swets retained 350,000 shares of restricted Company common stock that were to vest upon (i) the completion
of the sale by 1347 Investors of its entire interest in the shares of Limbach common stock and (ii) the subsequent completion of
the liquidation of 1347 Investors and the distribution of its assets to its members. Pursuant to a Distribution and Redemption
Agreement, dated as of September 30, 2019, by and among 1347 Investors and its members, the Company received distributions
of cash proceeds of $0.6 million and 0.6 million shares of Limbach common stock, which the Company deemed as having satisfied
the performance obligations described in the Swets Restricted Stock Agreement. Also, pursuant to the Swets Restricted Stock
Agreement, Swets exercised his right to authorize the Company to withhold 102,550 shares of restricted Company common stock,
which would otherwise have been delivered or available for vesting, in order to satisfy all federal, state, local or other taxes required
to be withheld or paid in connection with such award, leaving Swets with 247,450 shares of the Company’s common stock.
(d)
Fundamental Global Investors, LLC
During 2018 and 2017, FGI was a shareholder known by the Company to be a beneficial owner of more than 5% of the Company’s
outstanding common shares.
On October 25, 2017, the Company executed an agreement to sell 900,000 shares of PIH common stock, at a price of $7.85 per
share, to FGI in two separate transactions for cash proceeds totaling $7.1 million. On November 1, 2017, the Company sold
475,428 of the 900,000 shares of PIH common stock to FGI for cash proceeds totaling $3.7 million. The second transaction, for
the sale of the remaining 424,572 shares of PIH common stock for cash proceeds totaling $3.4 million, closed on March 15, 2018
following FGI having obtained the necessary regulatory approvals.
On July 30, 2018, the Company executed an agreement to sell its remaining 75,000 shares of PIH common stock, at a price of
$7.13 per share, to FGI for cash proceeds totaling $0.5 million.
On July 30, 2018, the Company executed an agreement to sell 1,813,889 shares of ICL common stock, at a price of C$0.72 per
share, to FGI for cash proceeds totaling C$1.3 million.
For the year ended December 31, 2018, the Company recorded losses, included in gain on change in fair value of equity investments
in the consolidated statements of operations, of $0.1 million related to these transactions. For the year ended December 31, 2017,
the Company recorded gain, included in net realized (losses) gain in the consolidated statements of operations, of $0.1 million
related to this transaction.
(e)
Insurance Income Strategies Ltd.
IIS is a Bermuda corporation, formed in October 2017, organized to offer collateralized reinsurance in the property catastrophe
market through its wholly owned operating subsidiary IIS Re Ltd. The Company held 100% of the outstanding common stock of
IIS at December 31, 2018 and December 31, 2017. The Company did not invest any capital against the common shares and has
not invested any capital in IIS via any other security of IIS. The Company also does not have any commitment to provide capital
to IIS. See Note 7, "Variable Interest Entities," for further discussion of IIS. Swets has served as the Chairman of the Board of
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KINGSWAY FINANCIAL SERVICES INC.
Notes to Consolidated Financial Statements
Directors of IIS since its formation. Swets also served as the Company’s Chief Executive Officer from July 1, 2010 until September
5, 2018 and served on the Company’s Board of Directors from September 16, 2013 through December 21, 2018.
Effective August 10, 2018, simultaneous with IIS issuing preferred stock to a third-party investor, the Company and IIS entered
into a management service agreement, which describes the Company’s duties and rights to remuneration. The management service
agreement describes the Company’s duties to include (a) identification and due diligence of potential transaction counterparties
for consideration by IIS management; (b) advice on capital structure and corporate development opportunities; (c) support for
compliance with the rules and regulations of the SEC; and (d) other periodic and special requests deemed within the scope of the
management service agreement. The management service agreement provides for a fee 0.9% of the assets of IIS and 9% of the
annual net profits.
Pursuant to other agreements executed August 10, 2018 simultaneous with IIS issuing preferred stock to a third-party investor,
the Company (a) is obligated to share with the IIS third-party investor 50% of any future fees generated under the management
service agreement and (b) waives its right to receive any fees until such time that the IIS third-party investor is either redeemed
or exchanged into publicly traded equity shares of IIS, in either case for consideration not less than the IIS third-party investor’s
original $15.0 million investment. As of December 31, 2018, neither of these scenarios had occurred, so the Company is not
entitled to any fees under the management service agreement and has not recorded any such fees.
(f)
Limited liability investments
The Company’s investments include investments in limited liability companies in which an officer of the Company is named as
a Manager or is authorized to act on behalf of the Manager under the respective operating agreement.
Itasca Golf Investors, LLC:
Itasca Golf Investors, LLC ("IGI") was formed on April 8, 2014 for the general purpose of real estate investment. The members
entered into an operating agreement under which the Company acquired a 42.9% membership interest in IGI. 1347 Capital LLC,
a wholly owned subsidiary of the Company, was named the Manager of IGI in the operating agreement. Swets was authorized to
act on behalf of the Manager. Swets also served as the Company’s Chief Executive Officer from July 1, 2010 until September 5,
2018 and served on the Company’s Board of Directors from September 16, 2013 through December 21, 2018. On September 5,
2018, the Company sold its investment in IGI to IGI Partners LLC for $1.5 million. Swets is a member of IGI Partners LLC. For
the year ended December 31, 2018, the Company recorded loss, included in net realized (losses) gain in the consolidated statements
of operations, of $0.4 million related to this transaction.
AK Realty I LLC:
AK Realty I LLC ("AKR") was formed on September 21, 2015 for the purpose of becoming a member of AKA Opportunity
Investments I LLC, a limited liability company formed for the purpose of investing, directly or indirectly, in real estate projects.
The members of AKR entered into an operating agreement under which the Company acquired a 33.3% membership interest in
AKR. Management of AKR is vested in a two-member Executive Committee. The Company designates one of the two members
of the Executive Committee. Decisions of the Executive Committee require the unanimous approval of the members of the
Executive Committee. The Company designated Swets as its representative on the Executive Committee. Swets also served as
the Company’s Chief Executive Officer from July 1, 2010 until September 5, 2018 and served on the Company’s Board of Directors
from September 16, 2013 through December 21, 2018.
Logistics Leasing, LLC:
Logistics Leasing ("Logistics") was formed on July 26, 2017 for the purpose of acquiring and leasing small vehicles. The members
of Logistics entered into an operating agreement under which the Company acquired a 50% membership interest in Logistics. The
Company designates one of the two managers of Logistics. Major Decisions, as defined in the operating agreement, require the
approval of members holding at least 51% of the membership interest. The Company designated Swets as a manager. Swets also
served as the Company’s Chief Executive Officer from July 1, 2010 until September 5, 2018 and served on the Company’s Board
of Directors from September 16, 2013 through December 21, 2018.
1347 Energy Holdings LLC:
1347 Energy Holdings LLC ("Energy") was formed on April 20, 2016 for the purpose of making investments in hydrocarbon assets
as described in the operating agreement. At December 31, 2018 and December 31, 2017, the Company owned 45.6% of the
membership interests. The Company also held collateralized notes in principal amount of $0.6 million and $1.8 million and a
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KINGSWAY FINANCIAL SERVICES INC.
Notes to Consolidated Financial Statements
surety deposit of zero and $0.7 million at December 31, 2018 and December 31, 2017, respectively. Fitzgerald owned 0.8% of the
membership interests at December 31, 2018 and December 31, 2017. Energy was managed through a Board of Managers comprised
of five managers, two of whom, Swets and Fitzgerald, were appointed by 1347 Capital LLC, a wholly owned subsidiary of the
Company. With respect to any matter before the Board of Managers, the act of a majority of the managers constituting a quorum
constituted the act of the Board. Swets also served as the Company’s Chief Executive Officer from July 1, 2010 until September
5, 2018 and served on the Company’s Board of Directors from September 16, 2013 through December 21, 2018. Fitzgerald joined
the Company as an Executive Vice President in April 2016 following the Company’s acquisition of Argo. Fitzgerald has served
as the Company’s Chief Executive Officer since September 5, 2018 and has served on the Company’s Board of Directors since
April 21, 2016. During 2018, Energy entered into a purchase and sale agreement dated, February 12, 2018, for the sale of Energy
to an unrelated third party, pursuant to which the Company’s $1.8 million collateralized loan to Energy and $0.7 million surety
deposit were repaid in full and the Company’s equity investment, previously written down to zero under the equity method of
accounting, was purchased. The transaction closed in a series of installments during the fourth quarter of 2018 and the first quarter
of 2019. For the year ended December 31, 2018, the Company recorded gain, included in net realized (losses) gain in the
consolidated statements of operations, of $0.0 million related to this transaction.
1347 Investors LLC:
1347 Investors was formed on April 15, 2014 for the purpose of investing in and holding securities of 1347 Capital Corp., which
subsequently merged with Limbach Holdings, Inc., a publicly traded company. The Company owned 26.7% of the membership
units at December 31, 2018 and December 31, 2017. The Company's investment in 1347 Investors is accounted for at fair value
and reported as limited liability investments, at fair value in the consolidated balance sheets, with any changes in fair value to be
reported in (loss) gain on change in fair value of limited liability investment, at fair value in the consolidated statements of operations.
The fair value of this investment is calculated based on a model that distributes the net equity of 1347 Investors to all classes of
membership interests. The model uses quoted market prices and significant market observable inputs. The most significant input
to the model is the observed stock price of Limbach common stock.
ICL owned 47.6% of the membership units at December 31, 2018 and December 31, 2017. Ballantyne owned 40.6% and 32.3%
of the common shares of ICL at December 31, 2018 and December 31, 2017, respectively.
Swets and Cerminara are the named managers of 1347 Investors. All acts of the managers must be unanimous. Cerminara has
served as the Chief Executive Officer of Ballantyne since November 2015 and as Chairman of the Board of Ballantyne since May
2015. Cerminara was appointed to the ICL Board of Directors on June 13, 2016 and became Chairman of the Board of Directors
of ICL on June 4, 2018. Since April 2012, Cerminara has also served as the Chief Executive Officer of FGI. During 2017 and
2018, FGI was a shareholder known by the Company to be a beneficial owner of more than 5% of the Company’s outstanding
common shares. Swets has served as the ICL Chief Executive Officer and a member of the ICL Board of Directors since June 9,
2016. Swets also served as the Company’s Chief Executive Officer from July 1, 2010 until September 5, 2018 and served on the
Company’s Board of Directors from September 16, 2013 through December 21, 2018. Fitzgerald has served as a member of the
ICL Board of Directors since June 9, 2016. Fitzgerald joined the Company as an Executive Vice President in April 2016 following
the Company’s acquisition of Argo. Fitzgerald has served as the Company’s Chief Executive Officer since September 5, 2018
and has served on the Company’s Board of Directors since April 21, 2016.
Pursuant to a Distribution and Redemption Agreement, dated as of September 30, 2019, by and among 1347 Investors and its
members, the Company received distributions on November 19, 2019 of cash proceeds of $0.6 million, 594,750 shares of Limbach
common stock and 400,000 warrants, exercisable at $15 and expiring July 20, 2023, on Limbach common shares. As a result of
this distribution, the Company no longer owns membership units in 1347 Investors.
(g)
Atlas Financial Holdings, Inc.
In November 2010, the Company issued promissory notes (the "Notes") to five employees (each a "Debtor" and collectively the
"Debtors") for a total of $1.1 million, each Note bearing an interest rate of 3% (not compounding). The Debtors used the proceeds
to purchase shares of common stock in Atlas Financial Holdings, Inc. ("Atlas"). Atlas was created via a triangular merger and
spun-off from the Company in December 2010, at which time the Debtors became employees of Atlas and were no longer employees
of the Company. The Notes required annual payments of interest on the anniversary date of the Notes, with the principal and any
unpaid interest due in full on or before January 1, 2017, in the case of one of the Debtors, and November 1, 2017, in the case of
the other four Debtors. Each Debtor was required to pledge to the Company the shares purchased utilizing the Notes proceeds,
and such pledge was to be released once the note was paid in full. The current market value of the pledged shares is $0.1 million.
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KINGSWAY FINANCIAL SERVICES INC.
Notes to Consolidated Financial Statements
The Notes have been amended three times since their issuance, generally to extend payments of principal while also requiring
progress payments that were not part of the original Notes. No principal has been waived, and interest continues to accrue on
unpaid principal. The remaining principal amount outstanding on the Notes was $0.7 million as of December 31, 2018. The
Company has concluded there are no indications the Debtors were experiencing financial difficulties at the time of the amendments,
and the Company expects to collect all amounts due. The Debtors are current with the amended terms of the Notes. As a result,
the Company has concluded the Notes are not impaired.
(h)
Other related party transactions
On July 16, 2018, the Company entered into a definitive agreement to sell Mendota to Premier Holdings LLC. Steve Harrison,
President of Mendota, is a minority investor in Premier Holdings LLC.
On September 5, 2018, the Company entered into a Senior Advisor Agreement with Swets, its former Chief Executive Officer.
The Senior Advisor Agreement was for a one-year term with an annual consulting fee of $0.3 million. After September 5, 2019,
Swets will continue to provide certain consulting services for an hourly fee on an as-needed basis.
NOTE 31 COMMITMENTS AND CONTINGENT LIABILITIES
(a) Legal proceedings:
In April 2018, TRT LeaseCo, LLC ("TRT LeaseCo"), an indirect subsidiary of Kingsway, was named as a defendant in a lawsuit
filed in the United States District Court for the Southern District of New York relating to CMC and its subsidiaries. Kingsway
indirectly owns 81% of CMC. TRT LeaseCo (an indirect wholly owned subsidiary of CMC) entered into a Management Services
Agreement (the "MSA") with DGI-BNSF Corp. ("DGI") (an affiliate of the entity that owns the remaining 19% of CMC) in July
2016 pursuant to which, among other things, DGI agreed to provide services to TRT LeaseCo in exchange for the fees specified
in the MSA. The complaint filed by DGI alleges that DGI is owed certain fees under the MSA that have not been paid. If the case
is decided against TRT LeaseCo, CMC and its subsidiaries (including TRT LeaseCo) would be unable to fulfill certain payment
obligations to Kingsway under the transaction documents such that Kingsway may no longer be able to realize a material portion
of the economic benefits originally anticipated to result from the CMC transaction, which could have a material adverse effect on
Kingsway’s financial position, results of operations and cash flows. Kingsway disagrees with DGI’s allegations and is vigorously
defending these claims; however, there can be no assurance that Kingsway will ultimately prevail. The Company’s potential
exposure under these agreements is not reasonably determinable, and no liability has been recorded in the audited consolidated
financial statements at December 31, 2018. No assurances can be given, however, that the Company will not be required to perform
under these agreements in a manner that would have a material adverse effect on the Company’s financial position, results of
operations and cash flow.
In May 2016, Aegis Security Insurance Company ("Aegis") filed a complaint for breach of contract and declaratory relief against
the Company in the Eastern District of Pennsylvania alleging, among other things, that the Company breached a contractual
obligation to indemnify Aegis for certain customs bond losses incurred by Aegis under the indemnity and hold harmless agreements
provided by the Company to Aegis for certain customs bonds reinsured by Lincoln General Insurance Company ("Lincoln General")
during the period of time that Lincoln General was a subsidiary of the Company. Lincoln General was placed into liquidation in
November 2015 and Aegis subsequently invoked its rights to indemnity under the indemnity and hold harmless agreements.
Effective January 20, 2020, Aegis and the Company entered into a Settlement Agreement with respect to such litigation pursuant
to which the Company agreed to pay Aegis a one-time settlement amount of $0.9 million and to reimburse Aegis for 60% of future
losses that Aegis may sustain in connection with such customs bonds, up to a maximum reimbursement amount of $4.8 million.
The Company’s potential exposure under these agreements was not reasonably determinable at December 31, 2018, and no liability
has been recorded in the audited consolidated financial statements at December 31, 2018.
(b) Guarantee:
As further discussed in Note 6, "Disposal, Discontinued Operations and Liquidation," as part of the transaction to sell Mendota,
the Company will indemnify the buyer for loss and loss adjustment expenses with respect to open claims and certain specified
claims in excess of Mendota's carried unpaid loss and loss adjustment expenses at June 30, 2018 related to the open claims and
specified claims. The Company's potential exposure under these agreements was not reasonably determinable at December 31,
2018, and no liability has been recorded in the consolidated financial statements at December 31, 2018.
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KINGSWAY FINANCIAL SERVICES INC.
Notes to Consolidated Financial Statements
(c)
Commitments:
The Company has entered into subscription agreements to commit up to $2.6 million of capital to allow for participation in limited
liability investments. At December 31, 2018, the unfunded commitment was $0.6 million.
(d) Collateral pledged and restricted cash:
Short-term investments with an estimated fair value of $0.2 million and $0.2 million at December 31, 2018 and December 31,
2017, respectively, were on deposit with state and provincial regulatory authorities. The Company also has restricted cash of $17.0
million and $15.0 million at December 31, 2018 and December 31, 2017, respectively. Included in restricted cash are (i) $5.0
million and zero at December 31, 2018 and December 31, 2017, respectively, held in escrow as part of the transaction to sell
Mendota; (ii) $10.0 million and $12.2 million at December 31, 2018 and December 31, 2017, respectively, held as deposits by
IWS and PWSC; (iii) $1.9 million and $1.9 million at December 31, 2018 and December 31, 2017, respectively, on deposit with
state and provincial regulatory authorities; and (iv) $0.1 million and $0.9 million at December 31, 2018 and December 31, 2017,
respectively, pledged to third-parties as deposits or to collateralize liabilities. 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.
NOTE 32 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. 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, 2018, surplus as
regards policyholders reported by Amigo exceeded the 200% threshold.
During the fourth quarter of 2012, the Company began taking steps to place all of Amigo into voluntary run-off. As of December
31, 2012, Amigo’s RBC was 157%. In April 2013, Kingsway filed a comprehensive run-off plan with the Florida Office of
Insurance Regulation, which outlines plans for Amigo's run-off. Amigo remains in compliance with that plan. As of December 31,
2018, Amigo's RBC was 1,905%.
Kingsway Re, which is domiciled in Barbados, is required by the regulator in Barbados to maintain minimum capital levels. As
of December 31, 2018, the capital maintained by Kingsway Re was in excess of the regulatory capital requirements in Barbados.
NOTE 33 STATUTORY INFORMATION AND POLICIES
The Company's insurance subsidiary, Amigo, prepares statutory basis financial statements in accordance with accounting practices
prescribed or permitted by the Florida Office of Insurance Regulation. "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.
Amigo is 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 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) income.
Statutory capital and surplus and statutory net loss for Amigo are:
(in thousands)
Net loss, statutory basis
Capital and surplus, statutory basis
2018
(1,506)
2,662
$
$
December 31,
2017
(1,357)
4,168
$
$
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KINGSWAY FINANCIAL SERVICES INC.
Notes to Consolidated Financial Statements
Amigo is 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 Amigo was $0.3
million at December 31, 2018. 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 Amigo are restricted by regulatory requirements of the Florida Office of Insurance Regulation. The maximum
amount of dividends that can be paid to shareholders by insurance companies domiciled in the state of Florida without prior
regulatory approval 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, 2018, Amigo was restricted from making any dividend payments to the holding company without regulatory
approval.
NOTE 34 SUBSEQUENT EVENT
On March 1, 2019, the Company acquired 100% of the outstanding shares of Geminus Holding Company, Inc. ("Geminus") for
approximately $8.4 million. Geminus is a specialty, full-service provider of vehicle service contracts ("VSCs") and other finance
and insurance ("F&I") products to used car buyers around the country. Geminus, headquartered in Wilkes-Barre, Pennsylvania,
has been creating, marketing and administering VSCs and F&I products on high-mileage used cars through its subsidiaries, The
Penn Warranty Corporation ("Penn") and Prime Auto Care, Inc. ("Prime"), since 1988. Penn and Prime distribute these products
via independent used car dealerships and franchised car dealerships, respectively. Geminus' balance sheet and results of operations
will be included in the consolidated financial statements of the Company, beginning with the first quarter of 2019.
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, with the participation of our Chief Executive Officer and Chief Financial Officer, has conducted
an evaluation of the effectiveness of the Company’s disclosure controls and procedures (as defined in Rule 13a-15(e) and 15d-15(e)
under the Securities Exchange Act of 1934, as amended (the "Exchange Act") as of December 31, 2018. The Company’s disclosure
controls and procedures are designed to ensure that information required to be disclosed in the reports the Company files under
the Exchange Act is recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and forms
and that such information is accumulated and communicated to the Company’s management, including the Company’s Chief
Executive Officer and Chief Financial Officer, to allow for timely decisions regarding required disclosures. In designing and
evaluating our disclosure controls and procedures, the Company’s management recognizes that disclosure controls and procedures,
no matter how well conceived and operated, can provide only reasonable, not absolute, assurance that the objectives of the disclosure
controls and procedures are met. Our disclosure controls and procedures have been designed to meet reasonable assurance
standards. In addition, the design of disclosure controls and procedures must reflect the fact that there are resource constraints
that require the Company’s management to apply its judgment in evaluating the benefits of possible controls and procedures
relative to their costs. The design of any disclosure controls and procedures also is based in part upon certain assumptions about
the likelihood of future events, and there can be no assurance that any design will succeed in achieving its stated goals under all
potential future conditions.
Based on this evaluation, the Company's Chief Executive Officer and Chief Financial Officer have concluded that, as
of December 31, 2018, the Company's disclosure controls and procedures were not effective as a result of material weaknesses in
the Company's internal control over financial reporting related to the accounting for and disclosure of certain complex and
nonrecurring transactions; the accounting for and disclosure of certain other items; monitoring the collectability of accounts
receivable balances; other-than-temporary impairment on equity method investments; and certain account reconciliations.
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. The Company's management evaluated the effectiveness of
its internal control over financial reporting based on the framework in Internal Control-Integrated Framework issued by the
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KINGSWAY FINANCIAL SERVICES INC.
Committee of Sponsoring Organizations of the Treadway Commission (2013 framework). Based on that evaluation, the Company’s
management has concluded that, as of December 31, 2018, our internal controls over financial reporting were not effective because
of the existence of material weaknesses in internal control over financial reporting related to the accounting for and disclosure of
certain complex and nonrecurring transactions; the accounting for and disclosure of certain other items; monitoring the collectability
of accounts receivable balances; other-than-temporary impairment on equity method investments; and certain account
reconciliations.
Material Weaknesses in Internal Control Over Financial Reporting
A material weakness is defined as a deficiency or combination of deficiencies in internal control over financial reporting such that
there is a reasonable possibility that a material misstatement of annual or interim consolidated financial statements will not be
prevented or detected on a timely basis.
With respect to the accounting for and disclosure of certain complex and nonrecurring transactions, the execution of the controls
over the application of accounting literature did not operate effectively with respect to:
•
•
•
•
•
the reclassification of investment income, related to equity method investments, from loss from discontinued operations,
net of taxes to net investment income in the consolidated statement of operations;
the identification, accounting and disclosure of investments demonstrating characteristics of variable interest entities,
including the consolidation of certain investments;
the adoption and application of ASU 2014-09;
identification, disclosure and accounting for equity-classified warrants; and
purchase accounting, as it relates to the identification and valuation of intangible assets and goodwill.
Concerning the accounting for and disclosure of certain other items, the execution of the controls over the application of accounting
literature did not operate effectively with respect to separating restricted cash from cash and cash equivalents on the face of the
consolidated balance sheet. Additionally, the Company did not have adequate controls in place pertaining to disclosure of related
parties.
Regarding the collectability of accounts receivable balances, the Company did not have adequate controls and procedures with
respect to evaluating balances for collectability, including the lack of a formal policy governing the review of accounts, as well
as calculating and documenting necessary reserves.
With respect to other-than-temporary impairment on equity method investments, the Company did not properly apply the accounting
literature when performing its analysis in determining whether its investment in investee was other-than-temporarily impaired as
of December 31, 2018.
Finally, with respect to the lack of adequate procedures regarding certain account reconciliations, there were errors in the
reconciliation of account balances as they were not performed timely and/or at a level of precision to identify errors and incorrect
balance sheet and income statement classification for certain cash, receivable, deposit, accounts payable, deferred revenue, escheat
liability and investment income accounts.
The matters were discovered during the course of the 2018 external audit of the accounts and were reviewed with the Company's
Audit Committee. As explained in Note 3 to the consolidated financial statements, certain of these material weaknesses resulted
in the restatement of our consolidated financial statements for the year ended December 31, 2017 and our unaudited consolidated
financial statements for each of the quarters ended March 31, 2018, June 30, 2018 and September 30, 2018. The misstatements
in the consolidated financial statements were corrected prior to the issuance of the Company's consolidated financial statements
as of and for the year ended December 31, 2018.
As a result of the identified material weaknesses, the Company’s management directed a comprehensive review of its consolidated
financial statements to assess the possibility of further material misstatements that may remain unidentified. As a result of such
review, and notwithstanding the material weaknesses described above, the Company’s management, including the Company’s
Chief Executive Officer and Chief Financial Officer, believes that the audited consolidated financial statements contained in this
2018 Annual Report on Form 10-K fairly present, in all material respects, our financial condition, results of operations and cash
flows for the fiscal years presented in conformity with U.S. GAAP.
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KINGSWAY FINANCIAL SERVICES INC.
Remediation Process
The Company is evaluating the material weaknesses and developing a plan of remediation to strengthen the effectiveness of the
design and operation of its internal control environment. The remediation plan will include the following actions:
•
Perform a comprehensive assessment of all existing accounting policies and revise existing policies and/or introduce new
policies, as needed;
• Enhance the formality of its review procedures with respect to its accounting for any new investments, as well as the
•
•
periodic evaluation of existing investments;
Implement additional review procedures with respect to its accounting under ASU 2014-09 to ensure the Company’s
accounting will continue to be in accordance with that standard on a go-forward basis;
Implement additional identification, accounting and review controls with respect to complex and nonrecurring
transactions, as well as augment existing staff with outside skilled accounting resources, as appropriate, and strengthen
the review process to improve the operation of financial reporting and corresponding internal controls;
• Enhance the formality and rigor with respect to identifying and tracking all material related party transactions, as well
updating its disclosures controls to enhance the focus on related party disclosure requirements; and
• Enhance the formality and rigor of review with respect to the collectability of accounts receivable balances, other-than-
temporary impairment reviews on equity method investments and the account reconciliation procedures.
The actions that the Company is taking are subject to ongoing senior management review as well as Audit Committee oversight.
The Company is committed to maintaining a strong internal control environment and believes that these remediation efforts will
represent significant improvements in its controls. The Company has started to implement these steps; however, some of these
steps will take time to be fully integrated and confirmed to be effective and sustainable. Additional controls may also be required
over time. Until the remediation steps set forth above are fully implemented and tested, the material weakness described above
will continue to exist.
Changes in Internal Control over Financial Reporting
There have been no changes in the Company's internal control over financial reporting during the period beginning October 1,
2018, and ending December 31, 2018, that have materially affected, or are reasonably likely to materially affect, its internal control
over financial reporting.
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KINGSWAY FINANCIAL SERVICES INC.
Item 9B. Other Information
None
PART III.
Item 10. Directors, Executive Officers, and Corporate Governance
Board of Directors(1)
John T.
Fitzgerald
Age: 48
Residence:
Illinois,
United States
of America
Director
Since: April
21, 2016
Not
independent
Gregory P.
Hannon
Age: 65
Residence:
Ontario, Canada
Director Since:
September 16,
2009
Independent(2)
John T. Fitzgerald has served as Chief Executive Officer of Kingsway since September 2018. Mr. Fitzgerald
joined Kingsway as Executive Vice President on April 21, 2016 following Kingsway’s acquisition of Argo
Management Group, a private equity investment partnership co-founded by Mr. Fitzgerald in 2002. Effective
March 8, 2017, Mr. Fitzgerald was appointed President and Chief Operating Officer of Kingsway. Prior to co-
founding Argo Management Group, Mr. Fitzgerald was managing director of Adirondack Capital, LLC, a
financial futures and derivatives trading firm, and he was a seat-owner on the Chicago Board of Trade. Mr.
Fitzgerald was previously the CEO of Hunter MFG, LLP and, from 2006 to 2016, Mr. Fitzgerald served as its
Chairman. Mr. Fitzgerald received a Bachelor of Science degree from DePaul University and is an MBA graduate
of the Kellogg School of Management, Northwestern University. Mr. Fitzgerald’s education, background and
experience qualify him for his role with Kingsway.
Board Committee
Membership:
Board
Director, Atlas Financial Holdings, Inc. since May 2013
Public Board Membership:
Director, Itasca Capital, Ltd., since June 2016
Gregory P. Hannon has been a Vice-President and Director of Oakmont Capital Inc., a Toronto-based private
investment company, since 1997. He previously was a founding partner of Lonrisk, a Toronto-based specialty
insurer and subsidiary of the London Insurance Group, where he was the Chief Financial Officer. Prior to that,
Mr. Hannon worked for the Continental Bank of Canada in commercial credit and as auditor for Arthur Andersen
and Company, Chartered Accountants. Mr. Hannon received a Bachelor of Commerce degree from Queen’s
University in 1978 and an M.B.A. from The Harvard Business School in 1987. Mr. Hannon brings to the Board
entrepreneurial experience, as well as expertise in accounting, auditing and financial reporting.
Board Committee
Membership:
Board
Public Board Membership:
None
Audit Committee
Nominating and Corporate
Governance Committee
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KINGSWAY FINANCIAL SERVICES INC.
Terence M.
Kavanagh
Age: 65
Residence:
Ontario, Canada
Director Since:
April 23, 2009
Independent(2)
Terence M. Kavanagh has, since 1997, served as President and a Director of Oakmont Capital Inc., a Toronto-
based private investment company. Prior to co-founding Oakmont Capital, Mr. Kavanagh’s previous
experience includes managing the Brentwood Pooled Investment Fund, a North American based investment
fund, and managing a number of family-owned operating businesses in the real estate, property management
and building services industries. Mr. Kavanagh was previously an investment banker in New York and Toronto
with The First Boston Corporation and Lehman Brothers. Mr. Kavanagh received a Bachelor of Law degree
from Western University in 1978, and an M.B.A. from the Tuck School of Business at Dartmouth College in
1982. Mr. Kavanagh brings extensive knowledge of the financial services industry to the Board.
Board Committee Membership:
Public Board Membership:
Board
None
Compensation & Management Resources
Committee
Audit Committee
Investment Committee (prior to May 30,
2018)
Plan Committee
Doug Levine
Age: 61
Doug Levine has been the President of Levine Management, a real estate developer, since January 2013. He
graduated in 1980 from Tufts University with a Bachelor’s Degree in Economics.
Board Committee Membership:
Public Board Membership:
Residence:
Florida, United
States of
America
Director Since:
May 30, 2018
Joseph D.
Stilwell
Age: 58
Residence:
New York,
United States of
America
Director Since:
April 23, 2009
Independent(2)
Notes:
Board (since May 30, 2018)
None
Audit Committee (since May 30, 2018)
Investment Committee (since May 30, 2018)
Joseph D. Stilwell is the owner and managing member of Stilwell Value LLC, the General Partner of a group
of funds known as The Stilwell Group. Mr. Stilwell started his first fund in 1993 and has been reviewing and
analyzing financial statements and managing investment funds for well over 20 years. He graduated in 1983
from the Wharton School at the University of Pennsylvania with a Bachelor of Science in Economics.
Board Committee Membership:
Public Board Membership:
Board
None
Audit Committee (prior to May 30, 2018)
Investment Committee (since May 30, 2018)
Nominating and Corporate Governance
Committee (since May 30, 2018)
Compensation & Management Resources
Committee
Plan Committee
(1) All of the directors attended the 2018 annual meeting of shareholders.
(2)
“Independent” refers to the standards of independence established under section 301 of the Sarbanes-Oxley Act of 2002 (“SOX”) and the criteria for
independence established by the NYSE and SEC.
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Executive Officers Who Are Not Directors
Name (Age)
Executive Officer Since Current Position
Previous Business Experience
William A. Hickey, Jr. (61) August 30, 2010
EVP and CFO
Paul R. Hogan (35)
May 2019
Secretary and General
Counsel
Mr. Hickey has served as Executive Vice
President of the Company since August 2010, as
CFO since April 2011, and as Chief Operating
Officer from August 2010 to March 2017.
Before joining the Corporation, Mr. Hickey was
a Managing Director at the Chicago office of
Macquarie Capital, a corporate finance and
investment firm, from 2009 to 2010. Mr. Hickey
earned his Bachelor of Business Administration
degree in accountancy from the University of
Notre Dame
in 1981 and a Master of
Management degree in finance and management
policy from
the J.L. Kellogg School of
Management at Northwestern University in
1986. He was awarded the Chartered Financial
Analyst designation in 1989 and the Certified
Public Accountant designation in 1981.
Mr. Hogan joined the Company as General
Counsel on May 1, 2019 and was elected
Secretary later that month. Prior to joining the
Corporation, Mr. Hogan was a Senior Corporate
Attorney for KapStone Paper and Packaging
Corporation. Mr. Hogan joined KapStone after
working in private legal practice, most recently
with Greenberg Traurig LLP. Mr. Hogan holds
an undergraduate degree
Indiana
University, with majors
in mathematics,
economics and political science, and a Juris
Doctorate from the Indiana University Maurer
School of Law - Bloomington.
from
Involvement in Certain Legal Proceedings
Mr. Hannon was a director of Delhi Solac Inc., which was placed into bankruptcy on June 6, 2014.
Mr. Fitzgerald was a director of Hunter Licensed Sports Distributing Corporation, which was the subject of a receivership order
from the Superior Court of Quebec dated March 3, 2017. The receivership ended on September 27, 2017 following a Court order.
Hunter was subsequently placed into bankruptcy on August 20, 2018.
In March of 2015, Mr. Stilwell and his affiliate, Stilwell Value LLC, an SEC-registered investment adviser (“Value”), consented
to the entry of an administrative SEC order (the “Order”) that alleged civil violations of certain securities regulations for, among
other things, failing to adequately disclose conflicts of interest presented by inter-fund loans between certain private investment
partnerships managed by Value or Mr. Stilwell, which loans were repaid in full without monetary loss to investors from the alleged
conduct. Under the Order, among other things, (1) Mr. Stilwell was suspended from March 2015 to March 2016 from association
with Value or any other SEC-regulated investment business and paid a civil money penalty of $100,000, and (2) Value paid a civil
money penalty of $250,000 and repaid certain management fees. All obligations under the Order have been satisfied.
The Audit Committee
The Board has a standing Audit Committee which operates pursuant to a written charter adopted by the Board. The Audit Committee
consists of three or more directors, each of whom is an outside director who is unrelated to the Corporation, free from any
relationship that would interfere with the exercise of his or her independent judgment and each of whom is "independent" under
the listing rules of the NYSE. Audit Committee members meet the requirements of all applicable securities laws and the NYSE.
All members of the Audit Committee are financially literate, being defined as able to read and understand basic financial statements,
and the Chair of the Audit Committee has accounting or related financial management expertise. At least one member of the Audit
Committee is an "audit committee financial expert" as defined in the rules and regulations of the SEC. Pursuant to the Audit
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KINGSWAY FINANCIAL SERVICES INC.
Committee Charter, members of the Audit Committee may not simultaneously serve on the audit committees of more than two
other public companies without the approval of the Audit Committee.
The primary purpose of the Audit Committee is to:
(i)
Identify and monitor the management of the principal risks that could impact the financial reporting of the Corporation;
(ii)
reporting and accounting appropriateness and compliance;
Monitor the integrity of the Corporation’s financial reporting process and system of internal controls regarding financial
(iii)
Appoint, replace and monitor the independence and performance of the Corporation’s external auditors;
(iv)
Provide an avenue of communication among the external auditors, management and the Board; and
(v)
Review the annual audited and quarterly unaudited financial statements with management and the external auditors.
As of February 27, 2020, the Audit Committee was comprised of Gregory P. Hannon (Chair), Terence M. Kavanagh and Doug
Levine. The Board has determined that each member of the Audit Committee is "independent" and meets the financial literacy
requirements of the NYSE listing standards, and that each member of the Audit Committee meets the enhanced independence
standards established by the SEC (including Section 10A(m)(3) of and Rule 10A-3 under the Exchange Act). The following is a
description of the education and experience of each member of the Audit Committee that is relevant to the performance of his
responsibilities as a member of the Audit Committee:
Gregory P. Hannon has been a Vice-President and Director of Oakmont Capital Inc. since 1997. He previously was a founding
partner of Lonrisk, a Toronto-based specialty insurer and subsidiary of the London Insurance Group, where he was the Chief
Financial Officer. Prior to that, Mr. Hannon worked for the Continental Bank of Canada in commercial credit and as an auditor
for Arthur Andersen and Company, Chartered Accountants. Mr. Hannon received a Bachelor of Commerce degree from Queen’s
University in 1978 and a Master of Business Administration from The Harvard Business School in 1987. The Board has determined
that Mr. Hannon qualifies as an "audit committee financial expert" as that term is defined in the rules and regulations established
by the SEC.
Terence M. Kavanagh has served as President and a Director of Oakmont Capital Inc. since 1997. Prior to his cofounding of
Oakmont Capital Inc., he managed the Brentwood Pooled Investment Fund and worked as an investment banker in New York and
Toronto. Mr. Kavanagh earned a Bachelor of Law degree from Western University and a Master of Business Administration from
the Tuck School of Business at Dartmouth College.
Doug Levine has been the President of Levine Management, a real estate developer, since January 2013. He graduated in 1980
from Tufts University with a Bachelor’s Degree in Economics.
The Audit Committee held fourteen (14) meetings in the fiscal year ended December 31, 2018. The responsibilities and duties of
the Audit Committee are set out in the Audit Committee’s charter, which was amended and adopted by the Board on May 23, 2019
and is available on the Corporation’s website at www.kingsway-financial.com.
Report of the Audit Committee
The Audit Committee has met and held discussions with management and the independent auditors. Management represented to
the Audit Committee that the Corporation’s consolidated financial statements were prepared in accordance with accounting
principles generally accepted in the United States of America, and the Audit Committee has reviewed and discussed the audited
consolidated financial statements with management and the independent auditors. The Audit Committee discussed with the
independent auditors the matters required to be discussed by the applicable requirements of the Public Company Accounting
Oversight Board ("PCAOB") and the SEC.
The Corporation’s independent auditors also provided to the Audit Committee the written disclosures required by applicable
requirements of the PCAOB regarding the independent auditors’ communications with the Audit Committee concerning
independence, and the Audit Committee discussed with the independent auditors that firm’s independence. The Audit Committee
also considered whether the provision of non-audit services by the independent auditors is compatible with their independence.
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KINGSWAY FINANCIAL SERVICES INC.
Based upon the Audit Committee’s discussion with management and the Corporation’s independent auditors and the Audit
Committee’s review of the representation of management and the report of the independent auditors to the Audit Committee, the
Audit Committee recommended that the Board include the audited consolidated financial statements in the Corporation’s Annual
Report on Form 10-K for the fiscal year ended December 31, 2018 filed with the SEC.
Members of the Audit Committee
Gregory P. Hannon (Chair)
Terence M. Kavanagh
Doug Levine
Code of Ethics
We have adopted a Code of Business Conduct and Ethics that is applicable to all employees, including our chief executive officer,
chief financial officer and other senior financial personnel, as well as our directors. A copy of the Code of Business Conduct and
Ethics is posted in the "Corporate Governance" section of our website at www.kingsway-financial.com. Any future amendments
to the Code of Business Conduct and Ethics 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
Named Executive Officers for 2018
The following individuals are the named executive officers for 2018. Each of the following individuals, except for Mr. Swets,
held the position(s) set forth opposite his name as of December 31, 2018. Mr. Swets held the position of Chief Executive Officer
until his resignation on September 5, 2018.
Name
Title
John T. Fitzgerald
William A. Hickey, Jr.
Larry G. Swets, Jr.
Hassan R. Baqar
Notes:
President & Chief Executive Officer(1)
Executive Vice President & Chief Financial Officer
Former Chief Executive Officer(2)
Vice President(3)
(1) Mr. Fitzgerald has served as Chief Executive Officer of the Company since September 2018.
(2) Mr. Swets served as Chief Executive Officer of the Company from July 2010 until September 2018.
(3) Mr. Baqar served as Vice President of the Company from January 2014 until his resignation in January 2019.
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KINGSWAY FINANCIAL SERVICES INC.
2018 Summary Compensation Table
The following table provides information regarding the compensation of our named executive officers for the last three completed
fiscal years.
Name and Principal
Position
Year
Salary ($)
Bonus
($)
Stock Awards
($)
Option
Awards ($)
All Other
Compensation(1)
($)
Total
($)
John T. Fitzgerald,
President & Chief
Executive Officer
William A. Hickey, Jr.,
Executive Vice President
& Chief Financial Officer
Larry G. Swets, Jr.,
Former Chief Executive
Officer
Hassan R. Baqar, Vice
President
2018
2017
2016
2018
2017
2016
2018
2017
2016
2018
2017
2016
432,564
350,000
209,231
360,000
360,000
360,000
364,101
500,000
500,000
240,000
205,000
170,000
250,000 (2)
—
185,000 (3)
50,000 (2)
—
30,000 (2)
—
—
340,000 (3)
—
—
200,000 (3)
—
—
2,865,000 (4)
—
—
71,764 (5)
—
—
—
—
—
—
—
—
—
—
—
—
—
—
—
—
—
—
28,876
20,235
1,772
25,907
25,782
26,340
28,513
39,359
32,296
12,240
12,177
16,783
461,440
370,235
3,332,767
385,907
385,782
416,340
392,614
539,359
872,296
252,240
217,177
386,783
Notes:
(1)
(2)
(3)
(4)
(5)
For each named executive officer, amounts reported in this column include employer-paid life insurance premiums and contributions to the Company’s
401(k) retirement plan and Employee Stock Purchase Plan. The Company also paid for executive wellness physicals for certain of our named executive
officers.
This amount represents a discretionary cash bonus paid to Messrs. Fitzgerald and Hickey in 2019 for work performed in 2018.
This amount represents a discretionary cash bonus paid to Messrs. Swets, Hickey and Baqar in 2017 for work performed in 2016.
Amount reflects the aggregate grant date fair value of Restricted Stock Units. The amount was determined by multiplying the grant date fair value of
the award by the number of Restricted Stock Units granted. This amount represents Restricted Stock Units awarded August 24, 2016, which become
fully vested on March 28, 2024 if Mr. Fitzgerald remains in continuous employment with the Company through such date. The actual value that Mr.
Fitzgerald may receive depends on market prices, and there can be no assurance that the amounts reflected will actually be realized.
Amount represents the aggregate grant date fair value of options. The amount does not represent the realized or unrealized earnings or value earned in
the year. The actual value that the named executive officer may receive depends on market prices, and there can be no assurance that the amounts
reflected will actually be realized.
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KINGSWAY FINANCIAL SERVICES INC.
2018 Outstanding Equity Awards at Fiscal Year-End
Option Awards
Stock Awards
Number of
Securities
Underlying
Unexercised
Options
Exercisable (#)
40,000 (2)
—
—
—
Number of
Securities
Underlying
Unexercised
Options
Unexercisable
(#)
n/a
n/a
n/a
n/a
Option Exercise
Price ($)
Option
Expiration Date
4.67
April 20, 2020
Number of
Unearned Shares
or Units That
Have Not Vested
(#)
500,000 (3)
Market Value of
Shares or Units
That Have Not
Vested
($)(1)
$1,435,000
n/a
n/a
n/a
n/a
n/a
n/a
229,500 (4)
$658,665
247,450 (5)
$710,182
115,500 (6)
$331,485
Name
John T. Fitzgerald
William A. Hickey, Jr.
Larry G. Swets, Jr.
Hassan R. Baqar
Notes:
(1)
(2)
(3)
(4)
(5)
The value of the Common Shares is based on the closing price of the Common Shares on the NYSE of $2.87 as of December 31, 2018, the last trading
day of the fiscal year.
This amount represents 40,000 options granted April 20, 2016, which were immediately vested and exercisable as of that date.
This amount represents Restricted Common Shares awarded September 5, 2018, which become fully vested on March 28, 2024 if Mr. Fitzgerald
remains in continuous employment with the Company through such date.
This amount represents Restricted Common Shares awarded March 28, 2014, which become fully vested as of the tenth anniversary of the date of grant
if the participant remains in continuous employment with the Company through such anniversary.
This amount represents Restricted Common Shares awarded September 5, 2018, which become fully vested after the satisfaction of certain performance
conditions, as defined in the Amended and Restated Restricted Stock Award Agreement, dated September 5, 2018.
Potential Payments Upon Termination or Change in Control
The Company maintains a severance policy for the payment of certain benefits to certain eligible employees of the Company,
including the named executive officers. Benefits are paid under this policy following a termination of employment in connection
with a reduction in work force. Under the policy, upon a qualifying termination of employment, the named executive officers are
entitled to two weeks of severance pay for each full year of service with the Company, with a minimum of twelve weeks of
severance pay and a maximum of 39 weeks of severance pay. Participants are also entitled to receive subsidized benefits as
provided under the Consolidated Omnibus Budget Reconciliation Act ("COBRA") during the severance period.
Mr. Fitzgerald, Mr. Hickey and Mr. Baqar are (or were, as of December 31, 2018, in the case of Mr. Baqar) entitled to receive
severance benefits consisting of twelve months of base salary for a termination of employment by the Company, other than for
“cause” or by such executive officer for "good reason" or "Constructive Termination," pursuant to the terms of their respective
severance and employment arrangements. As defined in each of Messrs. Hickey and Baqar’s respective severance agreements,
(A) "cause" means the executive’s involuntary termination due to commission of fraud, embezzlement, theft or other illegal or
unethical act likely to materially damage the Company; commission of a terminable offense under the Company’s policies and
procedures; conviction of certain crimes; breach of the executive’s confidentiality obligations or duty of loyalty; or the executive’s
willful failure to follow the lawful directions of the Company and (B) "good reason" means the executive’s voluntary termination
of employment due to a material reduction in the executive’s salary or authority or the Company’s breach of the severance agreement.
As defined in Mr. Fitzgerald’s severance agreements, (A) "Cause" means the executive’s involuntary termination due to: (i) an
intentional act of fraud, embezzlement, theft, or any other illegal act against the Company, any of which would constitute a felony;
(ii) the executive’s improper disclosure or use of the Company’s confidential information but only where the Company has
established that such disclosure or use has financially and materially injured the Company; or (iii) a material breach of the executive’s
duty of loyalty to the Company but only where the Company has established that such breach has financially and materially injured
the Company and (B) "Constructive Termination" means the voluntary termination of the executive’s employment within forty-
five (45) days following written notice to each independent member of the Board setting forth in reasonable detail the occurrence
of any of the following events without the executive’s written consent that is not cured by the Company within thirty (30) days
after such notice: (i) any material diminution in job duties and responsibilities or the imposition of job requirements materially
inconsistent with the executive’s position with the Company; (ii) a reduction in the executive’s then-current base salary, other than
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KINGSWAY FINANCIAL SERVICES INC.
an across-the-board reduction of no more than ten percent (10%) in the base salary of all executive level employees, (iii) a material
reduction in the executive’s annual incentive compensation opportunities; or (iv) the executive has established that he has been
subject to a hostile work environment.
The named executive officers have accelerated vesting of their restricted stock under certain scenarios.
Director Compensation – Narrative Description
The Company’s director compensation program is designed to provide nominal compensation for the risks and responsibilities of
being a director. Only non-employee directors of the Board are remunerated for serving as directors of the Company. Non-
employee directors received a single retainer fee, payable quarterly, in the amount of CAD$100,000 for 2018. The Company also
paid an additional fee of CAD$50,000 to each of the Chairman of the Board and the Chair of the Audit Committee. In 2018, the
exchange rate fluctuated between $1.00 = CAD$1.2512 and CAD$1.3133. The retainers were paid in the currency of each director’s
country of residence.
2018 Director Compensation
The following table provides information regarding the compensation of our non-employee directors for 2018.
Name
Gregory P. Hannon
Terence M. Kavanagh
Doug Levine(2)
Gary R. Schaevitz(3)
Joseph D. Stilwell
Notes:
Fees Earned or Paid in
Cash
All Other
Compensation
($)(1)
116,647
116,647
44,889
32,759
77,765
($)
n/a
n/a
n/a
n/a
n/a
Total
($)
116,647
116,647
44,889
32,759
77,765
(1) Amounts reported in this column include the annual retainer paid to each non-employee director, plus an additional fee of CAD$50,000 paid to each of
Messrs. Kavanagh and Hannon for serving as Chairman of the Board and Chair of the Audit Committee, respectively. The annual retainer and the additional
fees paid to Messrs. Kavanagh and Hannon were paid in the currency of each director’s country of residence and converted to U.S. dollars based on the
exchange rates in effect at the time the payments were made. Messrs. Hannon and Kavanagh were paid in Canadian dollars, and Messrs. Levine, Schaevitz
and Stilwell were paid in U.S. dollars.
(2) Mr. Levine was elected to the Board on May 30, 2018. He received three payments at the CAD$100,000 annualized rate.
(3) Mr. Schaevitz was a member of the Board through May 30, 2018. He received two payments at the CAD$100,000 annualized rate.
Compensation Committee Interlocks and Insider Participation
The Board has a standing Compensation & Management Resources Committee (the "Compensation Committee") which operates
pursuant to a written charter adopted by the Board. The Compensation Committee shall consist of two or more directors, each of
whom must satisfy the applicable independence requirements of the New York Stock Exchange and any other regulatory authorities.
At least two members of the Committee also must qualify as “outside” directors within the meaning of Internal Revenue Code of
1986, as amended (the "Code") Section 162(m) and as "non-employee" directors within the meaning of Rule 16b-3 under the
Securities Exchange Act of 1934, as amended. The Board has determined that each member of the Compensation Committee in
the fiscal year ended December 31, 2018 was independent under the criteria established by the applicable regulatory authorities.
The Compensation Committee held three (3) meetings in the fiscal year ended December 31, 2018. The responsibilities and duties
of the Compensation Committee are set out in the Compensation Committee’s charter, which was amended and adopted by the
Board on March 17, 2017 and is available on the Company’s website at www.kingsway-financial.com.
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KINGSWAY FINANCIAL SERVICES INC.
The primary purpose of the Compensation Committee is to:
(i)
(ii)
(iii)
(iv)
Assist the Board in discharging its responsibilities in respect of compensation of the Company’s executive
officers and subsidiary Presidents;
Provide recommendations to the Board in connection with directors' compensation;
Provide recommendations to the Board in connection with succession planning for senior management of the
Company; and
Produce an annual report for inclusion in the Proxy Statement and Annual Report on Form 10-K.
In making its compensation decisions and recommendations, the Compensation Committee may take into account the
recommendations of the Chief Executive Officer with respect to the other senior officers of the Company and the President of
each of the Company’s subsidiaries. Other than giving such recommendations, however, the Chief Executive Officer has no formal
role and no authority to determine the amount or form of executive and director compensation.
The Compensation Committee shall have the sole authority to retain and terminate (or obtain the advice of) any adviser to assist
it in the performance of its duties, but only after taking into consideration all factors relevant to the adviser’s independence from
management, including those specified in Section 303A.05(c) of the New York Stock Exchange Listed Company Manual. The
Compensation Committee shall evaluate and determine whether any compensation consultant retained or to be retained by it has
any conflict of interest in accordance with Item 407(e)(3)(iv) of Regulation S-K under the rules and regulations of the SEC. As
currently constituted, the Compensation Committee has never engaged a compensation consultant nor does it have any plans to
ever do so.
As of February 27, 2020, the Compensation Committee was comprised of Joseph D. Stilwell (Chair) and Terence M. Kavanagh.
Item 12. Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters
Securities Authorized For Issuance Under Equity Compensation Plans
Equity Compensation Plan Information
Plan Category
Equity compensation plans approved by
security holders
Equity compensation plans not approved
by security holders
Total
Number of securities to be issued
upon exercise of outstanding
options, warrants and rights
Weighted-average exercise price
of outstanding options, warrants
and rights
Number of securities remaining
available for future issuance
under equity compensation plans
(excluding securities reflected in
column (a))
(a)
40,000
—
40,000
(b)
$4.67
n/a
$4.67
(c)
—
—
—
Security Ownership of Certain Beneficial Owners and Management
In accordance with U.S. securities laws, the following table sets forth certain information regarding beneficial ownership or control
or direction, directly or indirectly, of the Common Shares as of February 27, 2020, by: (i) each shareholder known by the Company
to be a beneficial owner of more than 5% of the Company’s outstanding Common Shares; (ii) each director and director nominee
of the Company; (iii) the Chief Executive Officer and each additional executive officer named under the heading "2018 Summary
Compensation Table" in the Proxy Statement; and (iv) all directors, director nominees and executive officers of the Company as
a group. The Company believes that, except as otherwise noted, each individual named has sole investment and voting power
with respect to the Common Shares indicated as beneficially owned by such individual. Unless otherwise indicated, the business
address of each named person is: 150 Pierce Road, 6th Floor, Itasca, IL, 60143.
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KINGSWAY FINANCIAL SERVICES INC.
Number of Common Shares, Including
Restricted Common Shares
Percent of Common Shares, Including
Restricted Common Shares, Outstanding (1)
1,017,834(2)
3,096,074(3)(4)
3,096,074(3)(5)
3,096,074(3)(6)
1,270,786(7)
5,679,539(8)
1,145,809 (9)
358,677 (10)
136,743 (11)
11,422,910
4.45%
13.24%
13.24%
13.24%
5.56%
24.77%
4.98%
1.57%
*
48.13%
Beneficial Owner
John T. Fitzgerald
Gregory P. Hannon
Terence M. Kavanagh
Oakmont Capital
Doug Levine
Joseph D. Stilwell
Larry G. Swets, Jr.
William A. Hickey, Jr.
Hassan R. Baqar
All Directors, Director Nominees and
Executive Officers as a Group (6
persons)
* Indicates less than 1%.
(1) All percentages in this column are calculated based upon: (i) the total number of Common Shares, including Restricted Common Shares, held by the beneficial
owner (or all directors and executive officers as a group); plus the number of options, Series B Warrants and Preferred Shares, held by the beneficial owner
(or all directors and executive officers as a group), exercisable or convertible within sixty (60) days; divided by (ii) 22,843,909, being the total number of
Common Shares, including Restricted Common Shares, outstanding as of February 27, 2020; plus the number of options, Series B Warrants and Preferred
Shares, held by the beneficial owner (or all directors and executive officers as a group), exercisable or convertible within sixty (60) days. Accordingly, this
calculation is not based upon maximum dilution and instead assumes that only the beneficial owner (or all directors and executive officers as a group)
exercises or converts all options, Series B Warrants and Preferred Shares exercisable or convertible within sixty (60) days.
(2) Mr. Fitzgerald owns 977,834 Common Shares, including 500,000 Restricted Common Shares, plus 40,000 options that are currently exercisable.
(3) Number of Common Shares is reported as described in a Schedule 13D filed with the SEC on March 21, 2019 jointly on behalf of Oakmont Capital Inc., an
Ontario corporation ("Oakmont"), E.J.K. Holdings Inc., an Ontario corporation ("EJK"), 1272562 Ontario Inc., an Ontario corporation ("1272562"), Gregory
P. Hannon and Terence M. Kavanagh (collectively, the "Oakmont Group"). The business address of these shareholders is 45 St. Clair Avenue West, Suite
400, Toronto, Ontario, M4V 1K9 Canada.
(4) Mr. Hannon has sole voting power and sole dispositive power with respect to 22,500 Common Shares owned directly by him or through a self-directed
Retirement Savings Plan and 4,500 Common Shares owned directly by two trusts for Mr. Hannon’s children (Mr. Hannon is the sole trustee of both of these
trusts). In addition, Mr. Hannon has shared voting power and shared dispositive power with respect to (i) 3,000 Common Shares owned directly by 1272562,
by virtue of his ownership of all of the outstanding voting stock of 1272562; (ii) 4,000 Common Shares owned directly by Gilter Inc., an Ontario corporation
of which all of the outstanding voting stock is owned by the Gregory Hannon Family Trust (Mr. Hannon is one of two trustees of this trust); (iii) 2,468,037
Common Shares owned directly by Oakmont, by virtue of his ownership of all of the capital stock of 1272562, and 1272562’s ownership of 50% of the
outstanding voting stock of Oakmont and its right to nominate one of the two members of the Board of Directors of Oakmont; (iv) 82,143 Common Shares
issuable upon the conversion of 13,143 shares of Preferred Shares owned by Oakmont; (v) 463,394 Common Shares currently issuable upon exercise of
Series B Warrants owned by Oakmont; and (vi) 13,750 Common Shares owned directly by Mr. Hannon’s spouse. Mr. Hannon may be deemed to be a
beneficial owner of the balance of the 3,096,074 Common Shares beneficially owned by the Oakmont Group, by virtue of his participation in the Oakmont
Group.
(5) Mr. Kavanagh has sole voting power and sole dispositive power with respect to 26,875 Common Shares owned through a self-directed Retirement Savings
Plan, 1,750 Common Shares owned directly and 125 Common Shares owned directly by a trust for his nephew (Mr. Kavanagh is the sole trustee). Mr.
Kavanagh has shared voting power and shared dispositive power with respect to (i) the 6,000 Common Shares owned directly by EJK, by virtue of Mr.
Kavanagh’s ownership of all of the outstanding voting stock of EJK; (ii) the 2,468,037 Common Shares owned directly by Oakmont, by virtue of Mr.
Kavanagh’s ownership of all the outstanding voting stock of EJK, and EJK’s ownership of 50% of the outstanding voting stock of Oakmont and its right to
nominate one of the two members of the Board of Directors of Oakmont; (iii) 82,143 Common Shares issuable upon the conversion of 13,143 shares of
Preferred Shares owned by Oakmont; and (iv) 463,394 Common Shares currently issuable upon exercise of Series B Warrants owned by Oakmont. Mr.
Kavanagh may be deemed to be a beneficial owner of the balance of the 3,096,074 Common Shares beneficially owned by the Oakmont Group, by virtue
of his participation in the Oakmont Group.
(6) Oakmont has sole voting power and sole dispositive power with respect to: (i) the 2,468,037 Common Shares that it owns directly; (ii) 82,143 Common
Shares issuable upon the conversion of 13,143 shares of Preferred Shares owned by Oakmont; and (iii) 463,394 Common Shares currently issuable upon
exercise of Series B Warrants owned by Oakmont. Oakmont may be deemed to be a beneficial owner of the balance of the 3,096,074 Common Shares
beneficially owned by the Oakmont Group, by virtue of its participation in the Oakmont Group.
(7) Mr. Levine directly owns 991,484 Common Shares. Mr. Levine indirectly owns 90,200 Common Shares, through the holdings of family members, and
189,102 Common Shares via a trust.
133
KINGSWAY FINANCIAL SERVICES INC.
(8) Number of Common Shares is reported as described in a Schedule 13D filed with the SEC on March 29, 2019 on behalf of Stilwell Activist Fund, L.P., a
Delaware limited partnership ("Stilwell Activist Fund"); Stilwell Activist Investments, L.P., a Delaware limited partnership ("Stilwell Activist Investments");
Stilwell Associates, L.P., a Delaware limited partnership ("Stilwell Associates"); Stilwell Value Partners VII, L.P., a Delaware limited partnership ("Stilwell
Value Partners VII"); Stilwell Value LLC, a Delaware limited liability company ("Stilwell Value LLC" and, collectively with Stilwell Activist Fund, Stillwell
Activist Investments, Stilwell Associates, and Stilwell Value Partners VII, the "Investment Partnership"); and Joseph D. Stilwell, a U.S. citizen. The Investment
Partnerships are private investment partnerships engaged in the purchase and sale of securities for their own accounts. Stilwell Value LLC is the general
partner of each of the Investment Partnerships, and Mr. Stilwell is the managing member and owner of Stilwell Value LLC. The Investment Partnerships
have shared voting and shared dispositive power over 5,679,539 Common Shares, consisting of (i) 5,597,396 Common Shares owned of record, and (ii)
82,143 Common Shares issuable upon the conversion of 13,143 shares of Preferred Shares. The members of the Group also hold Series B Warrants to
purchase 708,347 Common Shares currently issuable upon exercise of Series B Warrants; however, each of the Investment Partnerships has entered a
Statement of Undertaking with the Company in which they undertook not to exercise the Series B Warrants until the earlier of: (i) July 15, 2020; or (ii) the
execution by all of the Investment Partnerships and the Company of a written instrument that terminates the Statement of Undertaking.. The business address
of this shareholder is 111 Broadway, 12th Floor, New York, NY 10006.
(9) Mr. Swets owns 963,273 Common Shares, including 247,450 Restricted Common Shares; and 182,536 Common Shares currently issuable upon exercise
of Series B Warrants.
(10) Mr. Hickey owns 333,177 Common Shares, including 229,500 Restricted Common Shares; and 25,500 Common Shares currently issuable upon exercise
of Series B Warrants.
(11) Mr. Baqar owns 124,243 Common Shares and 12,500 Common Shares currently issuable upon exercise of Series B Warrants.
Item 13. Certain Relationships and Related Transactions, and Director Independence
Certain Relationships and Transactions with Related Persons
For a description of the Company’s relationships and transactions with related persons, see Note 30, "Related Parties," to the
Consolidated Financial Statements.
Item 14. Principal Accounting Fees and Services
Audit Fees
The aggregate fees billed by RSM US LLP ("RSM US") for professional services rendered for the audit of the consolidated financial
statements of the Company and its subsidiaries, including expenses reimbursed, were $1,274,171 related to fiscal year 2018. The
aggregate fees billed by BDO USA, LLP ("BDO USA") for professional services rendered for the audit of the consolidated financial
statements of the Company and its subsidiaries, and for the reviews of the Company’s quarterly financial statements, including
expenses reimbursed, were $108,768 for partial year worked performed in fiscal year 2018 and $957,237 related to fiscal year
2017.
Audit-Related Fees
The aggregate audit-related fees, including expenses reimbursed, billed by RSM US for services rendered to the Company and its
subsidiaries pertaining to the audit of the 401(k) plan were $18,703 related to fiscal year 2018. The aggregate audit-related fees,
including expenses reimbursed, billed by BDO USA for services rendered to the Company and its subsidiaries pertaining to the
audit of the 401(k) plan were $17,910 related to fiscal year 2017.
Tax Fees
The aggregate fees, including expenses reimbursed, billed by RSM US for tax compliance, tax advice and tax planning serviceswere
zero in fiscal year 2018. The aggregate fees, including expenses reimbursed, billed by BDO USA for tax compliance, tax advice
and tax planning services were zero in fiscal years 2018 and 2017.
All Other Fees
The aggregate fees, including expenses reimbursed, billed by RSM US for services other than the services reported above under
"Audit Fees," "Audit-Related Fees" and "Taxes" were zero in fiscal year 2018. The aggregate fees, including expenses reimbursed,
billed by BDO USA for services other than the services reported above under "Audit Fees," "Audit-Related Fees" and "Taxes"
were $60,015 related to fiscal year 2018 and $4,175 related to fiscal year 2017.
134
KINGSWAY FINANCIAL SERVICES INC.
135
KINGSWAY FINANCIAL SERVICES INC.
Part IV
Item 15. Exhibits, Financial Statement Schedules
(a) Documents filed as part of this Report
(1) Financial Statements. We have filed the following documents, which are included in Part II, Item 8 of this 2018 Annual
Report on Form 10-K.
Reports of Independent Registered Public Accounting Firms
Consolidated Balance Sheets
Consolidated Statements of Operations
Consolidated Statements of Comprehensive Loss
Consolidated Statements of Shareholders' Equity
Consolidated Statements of Cash Flow
Notes to Consolidated Financial Statements
(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
Valuation and Qualifying Accounts
(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
136
KINGSWAY FINANCIAL SERVICES INC.
SCHEDULE I. Investments Other Than Investments in Related Parties
(in thousands)
Fixed maturities:
Cost or
Amortized
Cost
December 31, 2018
Amount Shown
on Consolidated
Balance Sheet
Fair Value
U.S. government, government agencies and authorities
$
5,594
$
5,547
$
States, municipalities and political subdivisions
Mortgage-backed
Corporate
Total fixed maturities
Equity investments:
Common stock
Warrants
Total equity investments
Limited liability investments (1)
Limited liability investments, at fair value
Investments in private companies
Real estate investments
Other investments (1)
Short-term investments (1)
Total investments
621
3,256
2,961
12,432
1,286
988
2,274
4,790
26,015
2,465
10,225
2,079
152
607
3,186
2,920
12,260
801
55
856
—
26,015
3,090
10,662
—
—
$
60,432
$
52,883
$
5,547
607
3,186
2,920
12,260
801
55
856
4,790
26,015
3,090
10,662
2,079
152
59,904
(1) Cost approximates fair value for limited liability investments, other investments and short-term investments.
See accompanying report of independent registered accounting firm.
137
KINGSWAY FINANCIAL SERVICES INC.
SCHEDULE II. Financial Information of Registrant (Parent Company)
Parent Company Balance Sheets
(in thousands)
December 31, 2018
December 31, 2017
Assets
Investments in subsidiaries
Equity investments
Cash and cash equivalents
Investment in investee
Other assets
Total Assets
Liabilities and Shareholders' Equity
Liabilities:
Accrued expenses and other liabilities
Total Liabilities
Class A preferred stock
Shareholders' Equity:
Common stock
Additional paid-in capital
Accumulated deficit
Accumulated other comprehensive income (loss)
Shareholders' equity attributable to common shareholders
Total Liabilities, Class A preferred stock and Shareholders' Equity
See accompanying report of independent registered accounting firm.
$
$
$
$
16,843
71
759
951
82
18,706
444
444
5,800
—
353,890
(382,196)
40,768
12,462
18,706
$
$
$
$
39,186
491
688
5,230
3,134
48,729
2,183
2,183
5,180
—
356,171
(310,953)
(3,852)
41,366
48,729
138
KINGSWAY FINANCIAL SERVICES INC.
SCHEDULE II. Financial Information of Registrant (Parent Company)
Parent Company Statements of Operations
(in thousands)
Revenues:
Net investment (loss) income
Loss on change in fair value of equity investments
Total revenues
Expenses:
General and administrative expenses
Non-operating other expense (income)
Equity in net loss (income) of investee
Total expenses
Loss from continuing operations before income tax expense (benefit) and
equity in loss of subsidiaries
Income tax expense (benefit)
Equity in loss of subsidiaries
Net loss
See accompanying report of independent registered accounting firm.
Years ended December 31,
2017
2018
$
$
$
(2)
(211)
(213)
223
132
2,499
2,854
(3,067)
—
(25,269)
(28,336)
$
35
—
35
3,760
(165)
(2,115)
1,480
(1,445)
—
(10,164)
(11,609)
139
KINGSWAY FINANCIAL SERVICES INC.
SCHEDULE II. Financial Information of Registrant (Parent Company)
Parent Company Statements of Comprehensive Loss
(in thousands)
Net loss
Other comprehensive income (loss), net of taxes(1):
Unrealized losses on available-for-sale investments:
Unrealized losses arising during the period
Reclassification adjustment for amounts included in net loss
Other comprehensive loss - parent only
Equity in other comprehensive income (loss) of subsidiaries
Other comprehensive income (loss)
Comprehensive loss
Years ended December 31,
2017
2018
$
(28,336) $
(11,609)
—
—
—
4,124
4,124
(24,212) $
(139)
—
(139)
(3,504)
(3,643)
(15,252)
$
(1) Net of income tax expense (benefit) of $0 and $0 in 2018 and 2017, respectively
See accompanying report of independent registered accounting firm.
140
KINGSWAY FINANCIAL SERVICES INC.
SCHEDULE II. Financial Information of Registrant (Parent Company)
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
Equity in net loss (income) of investee
Dividend received from investee
Stock-based compensation (benefit) expense, net of forfeitures
Loss on change in fair value of equity investments
Other, net
Net cash used in operating activities
Investing activities:
Purchases of equity investments
Proceeds from sale of equity investments
Proceeds from sale of investee
Net cash provided by (used in) investing activities
Financing activities:
Proceeds from issuance of common stock, net
Capital contributions to subsidiaries
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
See accompanying report of independent registered accounting firm.
Years ended December 31,
2017
2018
$
(28,336)
$
(11,609)
25,269
2,499
780
(1,661)
211
138
(1,100)
—
215
1,001
1,216
—
(45)
(45)
71
688
759
$
10,164
(2,115)
—
1,186
—
(404)
(2,778)
(630)
—
—
(630)
(47)
(7,326)
(7,373)
(10,781)
11,469
688
$
141
KINGSWAY FINANCIAL SERVICES INC.
SCHEDULE III. Valuation and Qualifying Accounts
(in thousands)
Balance at
Beginning
of Year
Charged to
Income Tax
(Benefit)
Expense
Tax Act
Rate Change
Disposals
and Other
Balance at
End of Year
Valuation Allowance for Deferred Tax
Assets:
Year Ended December 31, 2018
Year Ended December 31, 2017
$
$
173,965
268,418
$
$
4,562
3,169
$
$
— $
(105,598) $
(7,071) $
$
7,976
171,456
173,965
See accompanying report of independent registered accounting firm.
Item 16. Form 10-K Summary
None.
142
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.
Date:
February 27, 2020
KINGSWAY FINANCIAL SERVICES INC.
/s/ John T. Fitzgerald
By:
Name: John T. Fitzgerald
Title: Chief Executive Officer, President 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/ John T. Fitzgerald
John T. Fitzgerald
Chief Executive Officer, President and Director
February 27, 2020
/s/ William A. Hickey, Jr.
William A. Hickey, Jr.
Executive Vice President and Chief Financial Officer
(principal financial and accounting officer)
February 27, 2020
/s/ Terence Kavanagh
Terence Kavanagh
/s/ Gregory Hannon
Gregory Hannon
/s/ Doug Levine
Doug Levine
/s/ Joseph Stilwell
Joseph Stilwell
Chairman of the Board and Director
February 27, 2020
Director
Director
Director
February 27, 2020
February 27, 2020
February 27, 2020
143
KINGSWAY FINANCIAL SERVICES INC.
EXHIBIT INDEX
Exhibit Description
2.1
2.2
2.3
2.4
3.1
3.2
4.1
4.2
4.3
4.4
4.5
4.6
4.7
4.8
10.1
10.2
Stock Purchase Agreement, dated April 1, 2015, by and among National General Holdings Corp., as Buyer, and
Kingsway America Inc. and Mendota Insurance Company, as Sellers (included as Exhibit 2.1 to the Form 8-K,
filed April 7, 2015, and incorporated herein by reference).
Stock Purchase Agreement, dated as of May 17, 2016, by and among CMC Acquisition, LLC, CRIC TRT
Acquisition LLC and BNSF-Delpres Investments Ltd. (included as Exhibit 2.1 to the Form 8-K, filed July 20,
2016, and incorporated herein by reference).
Amendment to Stock Purchase Agreement, dated as of June 17, 2016, by and among CMC Acquisition, LLC,
CRIC TRT Acquisition LLC, and BNSF-Delpres Investments Ltd. (included as Exhibit 2.1 to the Form 8-K, filed
June 17, 2016, and incorporated herein by reference).
Stock Purchase Agreement by and among Premier Holdings, LLC, Advantage Auto MGA, LLC, Mendota
Insurance Company, Kingsway America Inc. and Kingsway Financial Services Inc., dated as of July 16, 2018
(included as Exhibit 2.1 to the Form 8-K, filed July 20, 2018, and incorporated herein by reference).
Certificate of Incorporation of Kingsway Financial Services Inc. (included as Exhibit 3.1 to the Form 8-K, filed
December 31, 2018, and incorporated herein by reference).
By laws of Kingsway Financial Services Inc. (included as Exhibit 3.2 to the Form 8-K, filed December 31, 2018,
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 among 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 among 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 Common Stock Series B Warrant Agreement, dated July 8, 2014 (included as Exhibit 4.1
to the Form 8-K, filed July 10, 2014, and incorporated herein by reference).
Form of Stock Certificate (included as Exhibit 4.1 to the Form 8-K, filed December 31, 2018, and incorporated
herein by reference).
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). *
Form of Subscription Agreement (included as Exhibit 10.1 to the Form 8-K, filed December 27, 2013, and
incorporated herein by reference).
144
KINGSWAY FINANCIAL SERVICES INC.
10.3
10.4
10.5
10.6
Registration Rights Agreement, dated as of February 3, 2014, by and among the Company and the other parties
signatory thereto (included as Exhibit 10.2 to the Form 8-K, filed February 4, 2014, and incorporated herein by
reference).
Kingsway America Inc. Employee Share Purchase Plan (included as Schedule B to the Definitive Proxy Statement
on Schedule 14A filed with the SEC on April 30, 2014 and incorporated herein by reference). *
Agreement to Buyout and Release, dated as of February 24, 2015, by and between 1347 Advisors LLC and 1347
Property Insurance Holdings, Inc. (included as Exhibit 10.1 to the Form 8-K, filed February 27, 2015, and
incorporated herein by reference).
Stockholders’ Agreement, dated as of July 14, 2016, by and between CMC Industries, Inc., CMC Acquisition LLC
and CRIC TRT Acquisition LLC (included as Exhibit 10.1 to Form 8-K, filed July 20, 2016, and incorporated
herein by reference).
10.7 Management Services Agreement, dated as of July 14, 2016, by and between TRT LeaseCo, LLC and DGI-BNSF
Corp. (included as Exhibit 10.2 to Form 8-K, filed July 20, 2016, and incorporated herein by reference).
10.8
10.9
10.10
10.11
TRT LeaseCo, LLC 4.07% Senior Secured Note, Due May 15, 2034 (included as Exhibit 10.3 to Form 10-Q, filed
August 4, 2016, and incorporated herein by reference).
Deed of Trust, Security Agreement, Assignment of Leases and Rents and Fixture Filing Statement, dated as of
March 12, 2015, from TRT LeaseCo, LLC to Malcolm Morris, as Deed of Trust Trustee for the benefit of Wells
Fargo Bank Northwest, N.A., as trustee (included as Exhibit 10.4 to Form 10-Q, filed August 4, 2016, and
incorporated herein by reference).
Lease between TRT LeaseCo, LLC, as Landlord, and BNSF Railway Company (f/k/a The Burlington Northern and
Santa Fe Railway Company), as Tenant, dated as of June 1, 2014 (included as Exhibit 10.5 to Form 10-Q, filed
August 4, 2016, and incorporated herein by reference).
Stock Purchase Agreement, dated as of November 9, 2016, by and between the Company and GrizzlyRock
Institutional Value Partners, LP (included as Exhibit 10.1 to Form 8-K, filed November 16, 2016, and incorporated
herein by reference).
10.12
Stock Purchase Agreement, dated as of November 9, 2016, by and between the Company and W.H.I. Growth Fund
Q.P., L.P. (included as Exhibit 10.2 to Form 8-K, filed November 16, 2016, and incorporated herein by reference).
10.13
10.14
10.15
10.16
10.17
10.18
10.19
Stock Purchase Agreement, dated as of November 9, 2016, by and between the Company and Yorkmont Capital
Partners, LP (included as Exhibit 10.3 to Form 8-K, filed November 16, 2016, and incorporated herein by
reference).
Registration Rights Agreement, dated as of November 16, 2016, by and among the Company, GrizzlyRock
Institutional Value Partners, LP and W.H.I. Growth Fund Q.P., L.P. (included as Exhibit 10.4 to Form 8-K, filed
November 16, 2016, and incorporated herein by reference).
Registration Rights Agreement, dated as of November 16, 2016, by and between the Company and Yorkmont
Capital Partners, LP (included as Exhibit 10.5 to Form 8-K, filed November 16, 2016, and incorporated herein by
reference).
Right of First Offer Agreement, dated as of November 16, 2016, by and between the Company and GrizzlyRock
Institutional Value Partners, LP (included as Exhibit 10.6 to Form 8-K, filed November 16, 2016, and incorporated
herein by reference).
Right of First Offer Agreement, dated as of November 16, 2016, by and between the Company and W.H.I. Growth
Fund Q.P., L.P. (included as Exhibit 10.7 to Form 8-K, filed November 16, 2016, and incorporated herein by
reference).
Amendment No. 1 to the Kingsway Financial Services Inc. 2013 Equity Incentive Plan (included as Exhibit 10.1
to Form 10-Q, filed August 8, 2018, and incorporated herein by reference).
Offer Letter, dated as of September 5, 2018, by and between the Company and John T. Fitzgerald (included as
Exhibit 10.2 to Form 8-K, filed September 10, 2018, and incorporated herein by reference).
145
KINGSWAY FINANCIAL SERVICES INC.
10.20
10.21
10.22
10.23
10.24
10.25
Severance Agreement, dated as of September 5, 2018, by and between the Company and John T. Fitzgerald
(included as Exhibit 10.3 to Form 8-K, filed September 10, 2018, and incorporated herein by reference).
Restricted Stock Agreement, dated as of September 5, 2018, by and between the Company and John T. Fitzgerald
(included as Exhibit 10.4 to Form 8-K, filed September 10, 2018, and incorporated herein by reference).
Form of Indemnification Agreement for Directors and Officers (included as Exhibit 10.5 to Form 8-K, filed
September 10, 2018, and incorporated herein by reference).
Separation Agreement and Release, dated as of September 5, 2018, by and between Kingsway America Inc. and
Larry G. Swets, Jr. (included as Exhibit 10.6 to Form 8-K, filed September 10, 2018, and incorporated herein by
reference).
Senior Advisor Agreement, dated as of September 5, 2018, by and between Kingsway America Inc. and Larry G.
Swets, Jr. (included as Exhibit 10.7 to Form 8-K, filed September 10, 2018, and incorporated herein by reference).
Amended and Restated Restricted Stock Agreement, dated as of September 5, 2018, by and between the Company
and Larry G. Swets, Jr. (included as Exhibit 10.8 to Form 8-K, filed September 10, 2018, and incorporated herein
by reference).
10.26 Membership Interest Purchase Agreement, dated as of September 5, 2018, by and between 1347 Capital LLC and
IGI Partners, LLC (included as Exhibit 10.9 to Form 8-K, filed September 10, 2018, and incorporated herein by
reference).
10.27
14
Letter Agreement, dated as of May 30, 2018, by and between the Company and Larry Swets (included as Exhibit
10.9 to Form 10-Q, Filed November 9, 2018, and incorporated herein by reference).
Kingsway Financial Services Inc. Code of Business Conduct & Ethics (included as Exhibit 14 to Form 10-K, Filed
March 16, 2018, and incorporated herein by reference).
21
Subsidiaries of Kingsway Financial Services Inc.
23.1
Consent of RSM US LLP
23.2
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
* Management contract or compensatory plan or arrangement.
146
Subsidiaries of Kingsway Financial Services Inc.
Exhibit 21
Subsidiaries
Kingsway America II Inc.
1347 Advisors LLC
1347 Capital LLC
Itasca Investors LLC
Itasca Capital Corp.
1347 Venture Opportunity LLC
American Country Underwriting Agency Inc.
Argo Management Group, LLC
ARM Holdings, Inc.
Mattoni Insurance Brokerage, Inc.
Appco Finance Corporation
CMC Acquisition LLC
CMC Industries Inc.
Texas Rail Terminal LLC
TRT Leaseco, LLC
DPM SPV, LLC
Flower Portfolio 001, LLC
KAI Management Services Inc.
Kingsway America Inc.
Kingsway Amigo Insurance Company
Kingsway America Agency Inc.
Kingsway General Insurance Company
Kingsway LGIC Holdings, LLC
Kingsway Reinsurance Corporation
Kingsway Warranty Holdings LLC
IWS Acquisition Corporation
Trinity Warranty Solutions LLC
Net Lease Investment Grade Portfolio LLC
Professional Warranty Services LLC
Professional Warranty Service Corporation
Jurisdiction of Incorporation/Organization
Delaware
Delaware
Delaware
Delaware
Delaware
Delaware
Illinois
Delaware
Illinois
Washington
Pennsylvania
Delaware
Texas
Delaware
Delaware
Delaware
Delaware
Illinois
Delaware
Florida
Illinois
Ontario
Delaware
Barbados
Delaware
Florida
Delaware
Delaware
Delaware
Virginia
Exhibit 23.1
Consent of Independent Registered Public Accounting Firm
We consent to the incorporation by reference in the Registration Statements (Nos. 333-228286, 333-196633 and 333-194108)
on Form S-8 of Kingsway Financial Services Inc. of our report dated February 27, 2020 relating to the consolidated financial
statements and the financial statement schedules of Kingsway Financial Services Inc., appearing in this Annual Report on
Form 10-K of Kingsway Financial Services Inc. for the year ended December 31, 2018.
/s/ RSM US LLP
Chicago, Illinois
February 27, 2020
Exhibit 23.2
Consent of Independent Registered Public Accounting Firm
Kingsway Financial Services Inc.
Itasca, Illinois
We hereby consent to the incorporation by reference in the Registration Statements on Form S -8 (Nos. 333-228286, 333-196633
and 333-194108) of Kingsway Financial Services Inc. of our report dated March 16, 2018 except for Notes 3, 6 and 28, as to which
the date is February 27, 2020, relating to the consolidated financial statements and schedules as of and for the year ended December
31, 2017 which appears in this Form 10-K.
/s/ BDO USA, LLP
Grand Rapids, Michigan
February 27, 2020
EXHIBIT 31.1
Certification of Chief Executive Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
CERTIFICATION PURSUANT TO SECTION 302
I, John T. Fitzgerald, certify that:
1. I have reviewed this 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 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; and
5. The registrant's other certifying officer 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: February 27, 2020
By /s/ John T. Fitzgerald
John T. Fitzgerald, Chief Executive Officer and President
(Principal Executive Officer)
EXHIBIT 31.2
CERTIFICATION
Certification of Chief Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
I, William A. Hickey, Jr., certify that:
1. I have reviewed this 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 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; and
5. The registrant's other certifying officer 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: February 27, 2020
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 of Kingsway Financial Services Inc. (the “Company”) for the year ended
December 31, 2018 as filed with the Securities and Exchange Commission on the date hereof (the "Report"), the undersigned
John T. Fitzgerald, the Chief Executive Officer and Principal Executive Officer of the Company, hereby certifies, 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 the
undersigned's 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: February 27, 2020
By /s/ John T. Fitzgerald
John T. Fitzgerald, Chief Executive Officer and President
(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 of Kingsway Financial Services Inc. (the “Company”) for the year ended
December 31, 2018 as filed with the Securities and Exchange Commission on the date hereof (the "Report"), the undersigned
William A. Hickey, Jr., the Chief Financial Officer and Principal Financial Officer of the Company, hereby certifies, 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 the
undersigned's 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: February 27, 2020
By /s/ William A. Hickey, Jr.
William A. Hickey, Jr., Chief Financial Officer and Executive Vice President
(Principal Financial Officer)