10-Q


UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
 
FORM 10-Q
 
(Mark One)
 
x
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
 
For the quarterly period ended September 30, 2015
 
¨
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
 
For the transition period from ___________________ to ___________________
 
Commission file no. 001-33143
 
AmTrust Financial Services, Inc.
(Exact name of registrant as specified in its charter)
 
Delaware
 
04-3106389
(State or other jurisdiction of
 
(IRS Employer Identification No.)
incorporation or organization)
 
 
 
 
 
59 Maiden Lane, 43rd Floor, New York, New York
 
10038
(Address of principal executive offices)
 
(Zip Code)
 
(212) 220-7120
(Registrant’s telephone number, including area code)
 
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes      x No      ¨
 
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).  Yes       x No      ¨
 
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer or a smaller reporting company.  See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company" in Rule 12b-2 of the Exchange Act:
 
Large accelerated filer     x  
 
Accelerated filer       ¨
 
 
 
Non-accelerated filer         ¨
 
Smaller reporting company      ¨
(Do not check if a smaller reporting company)
 
 
 
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Securities Exchange Act).
Yes      ¨ No      x
 
As of November 2, 2015, the Registrant had one class of Common Stock ($.01 par value), of which 82,914,099 shares were issued and outstanding.



INDEX
 
 
Page
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 

2


PART 1 - FINANCIAL INFORMATION
Item 1. Financial Statements
AMTRUST FINANCIAL SERVICES, INC. AND SUBSIDIARIES
Condensed Consolidated Balance Sheet
(In Thousands, Except Par Value)
 
September 30,
2015
 
December 31,
2014
ASSETS
(Unaudited)
 
(Audited)
Investments:
 
 
 
Fixed maturities, available-for-sale, at fair value (amortized cost $5,112,504; $4,137,146)
$
5,125,808

 
$
4,253,274

Equity securities, available-for-sale, at fair value (cost $110,990; $84,075)
106,118

 
81,044

Equity securities, trading, at fair value (cost $20,745; $25,407)
19,860

 
26,749

Short-term investments
36,043

 
63,916

Equity investment in unconsolidated subsidiaries – related party
138,867

 
119,712

Other investments (recorded at fair value $21,826; $13,315)
97,184

 
31,186

Total investments
5,523,880

 
4,575,881

Cash and cash equivalents
910,653

 
902,750

Restricted cash and cash equivalents
257,050

 
186,225

Accrued interest and dividends
49,814

 
42,173

Premiums receivable, net
2,322,442

 
1,851,682

Reinsurance recoverable (related party $1,982,243; $1,517,499)
2,951,764

 
2,440,627

Prepaid reinsurance premium (related party $1,123,040; $918,505)
1,684,986

 
1,302,848

Other assets (related party $179,625; $136,516; recorded at fair value $271,249; $264,517)
1,448,665

 
1,094,943

Deferred policy acquisition costs
714,226

 
628,383

Property and equipment, net
225,826

 
154,175

Goodwill
501,025

 
352,685

Intangible assets
362,108

 
314,996

 
$
16,952,439

 
$
13,847,368

LIABILITIES AND STOCKHOLDERS’ EQUITY
 
 
 
Liabilities:
 
 
 
Loss and loss adjustment expense reserves
$
6,694,036

 
$
5,664,205

Unearned premiums
4,134,048

 
3,447,203

Ceded reinsurance premiums payable (related party $483,120; $410,075)
806,353

 
683,421

Accrued expenses and other liabilities (related party $167,975; $167,975; recorded at fair value $106,022; $31,619)
1,507,048

 
991,504

Deferred income taxes
—

 
106,363

Debt
1,010,334

 
757,871

Total liabilities
14,151,819

 
11,650,567

Commitments and contingencies


 


Redeemable non-controlling interest
1,140

 
600

Stockholders’ equity:
 
 
 
Common stock, $.01 par value; 150,000 shares authorized, 98,227 and 98,211 issued in 2015 and 2014, respectively; 82,908 and 77,739 outstanding in 2015 and 2014, respectively
982

 
980

Preferred stock, $.01 par value; 10,000 shares authorized, 4,968 and 4,785 issued and outstanding in 2015 and 2014, respectively, Aggregated liquidation preference $482,500, $300,000 in 2015 and 2014, respectively
482,500

 
300,000

Additional paid-in capital
1,122,504

 
1,022,769

Treasury stock at cost; 15,319 and 20,472 shares in 2015 and 2014, respectively
(218,927
)
 
(297,586
)
Accumulated other comprehensive (loss) income, net of tax
(61,118
)
 
56,123

Retained earnings
1,296,765

 
954,734

Total AmTrust Financial Services, Inc. equity
2,622,706

 
2,037,020

Non-controlling interest
176,774

 
159,181

Total stockholders’ equity
2,799,480

 
2,196,201

 
$
16,952,439

 
$
13,847,368


See accompanying notes to unaudited condensed consolidated financial statements.

3


AmTrust Financial Services, Inc.
Condensed Consolidated Statements of Income
(Unaudited)
(In Thousands, Except Per Share Data)
 
 
Three Months Ended September 30,

Nine Months Ended September 30,
 
 
2015

2014

2015

2014
Revenues:
 
 

 
 

 
 

 
 

Premium income:
 
 

 
 

 
 

 
 

Net written premium
 
$
1,142,983

 
$
1,004,196

 
$
3,194,893

 
$
3,058,147

Change in unearned premium
 
(97,575
)
 
(89,783
)
 
(231,138
)
 
(439,746
)
Net earned premium
 
1,045,408

 
914,413

 
2,963,755

 
2,618,401

Service and fee income (related parties - three months $19,250; $14,737 and nine months $57,935; $42,055)
 
126,143

 
117,583

 
346,766

 
308,083

Net investment income
 
40,425

 
34,552

 
111,281

 
95,673

Net realized and unrealized gain on investments
 
17,682

 
5,086

 
30,693

 
14,431

Total revenues
 
1,229,658

 
1,071,634

 
3,452,495

 
3,036,588

Expenses:
 
 

 
 

 
 

 
 

Loss and loss adjustment expense
 
709,604

 
609,352

 
1,961,362

 
1,755,155

Acquisition costs and other underwriting expenses (net of ceding commission - related party - three months $138,036; $109,540 and nine months $385,945; $288,891)
 
258,016

 
225,512

 
728,402

 
620,181

Other
 
116,900

 
103,493

 
313,487

 
278,672

Total expenses
 
1,084,520

 
938,357

 
3,003,251

 
2,654,008

Income before other income (expense), income taxes and equity in earnings of unconsolidated subsidiaries
 
145,138

 
133,277

 
449,244

 
382,580

Other income (expense):
 
 

 
 

 
 

 
 

Interest expense (net of interest income - related party - three months $2,115; $365 and nine months $6,514; $365)
 
(12,862
)
 
(11,801
)
 
(32,763
)
 
(35,885
)
Loss on extinguishment of debt
 
(557
)
 
—

 
(5,271
)
 
—

Gain (loss) on investment in life settlement contracts net of profit commission
 
4,616

 
(2,910
)
 
19,085

 
(5,180
)
Foreign currency gain
 
24,721

 
26,594

 
17,355

 
25,826

Acquisition gain on purchase
 
5,826

 
—

 
5,826

 
—

Gain on sale of subsidiary
 
—

 
—

 
—

 
6,631

Total other income (expense)
 
21,744

 
11,883

 
4,232

 
(8,608
)
Income before income taxes and equity in earnings of unconsolidated subsidiaries
 
166,882

 
145,160

 
453,476

 
373,972

(Benefit ) provision for income taxes
 
(12,649
)
 
(7,664
)
 
38,635

 
37,746

Income before equity in earnings of unconsolidated subsidiaries
 
179,531

 
152,824


414,841

 
336,226

Equity in earnings of unconsolidated subsidiaries – related parties
 
13,477

 
4,332

 
23,048

 
26,847

Net income
 
$
193,008

 
$
157,156

 
$
437,889

 
$
363,073

Net (income) loss attributable to redeemable non-controlling interest and non-controlling interest of subsidiaries
 
(1,511
)
 
2,939

 
(6,940
)
 
7,029

Net income attributable to AmTrust Financial Services, Inc.
 
$
191,497

 
$
160,095

 
$
430,949

 
$
370,102

Dividends on preferred stock
 
(8,789
)
 
(3,505
)
 
(22,797
)
 
(7,387
)
Net income attributable to AmTrust common stockholders
 
$
182,708

 
$
156,590

 
$
408,152

 
$
362,715

Earnings per common share:
 
 

 
 

 
 

 
 

Basic earnings per share
 
$
2.21

 
$
2.09

 
$
4.96

 
$
4.84

Diluted earnings per share
 
$
2.17


$
1.97

 
$
4.86

 
$
4.57

Dividends declared per common share
 
$
0.30

 
$
0.20

 
$
0.80

 
$
0.60

Net realized gain on investments:
 
 

 
 

 
 

 
 

Total other-than-temporary impairment loss
 
$
(7,636
)
 
$
(464
)
 
$
(10,118
)
 
$
(4,003
)
Portion of loss recognized in other comprehensive income
 
—

 
—

 
—

 
—

Net impairment losses recognized in earnings
 
(7,636
)
 
(464
)
 
(10,118
)
 
(4,003
)
Net realized gain on available for sale securities
 
16,049

 
3,385

 
29,306

 
16,618

Net unrealized gain on trading securities
 
9,269

 
2,165

 
11,505

 
1,816

Net realized investment gain
 
$
17,682

 
$
5,086

 
$
30,693

 
$
14,431


4



See accompanying notes to unaudited condensed consolidated financial statements.

5


AmTrust Financial Services, Inc.
Condensed Consolidated Statements of Comprehensive Income
(Unaudited)
(In Thousands)
 
 
 
Three Months Ended September 30,
 
Nine Months Ended September 30,
 
 
2015
 
2014
 
2015
 
2014
Net income
 
$
193,008

 
$
157,156

 
$
437,889

 
$
363,073

Other comprehensive (loss) income, net of tax:
 
 

 
 

 
 

 
 

Foreign currency translation adjustments
 
2,128

 
(13,092
)
 
(49,204
)
 
(5,289
)
Change in fair value of interest rate swap
 
107

 
347

 
297

 
581

Unrealized gain (loss) on securities:
 
 
 
 
 
 
 
 
Gross unrealized holding (loss) gain
 
(25,611
)
 
(2,654
)
 
(106,105
)
 
131,886

Tax (benefit) expense arising during period
 
(8,964
)

(929
)

(37,137
)

46,160

Net unrealized holding (loss) gain
 
(16,647
)
 
(1,725
)
 
(68,968
)
 
85,726

Reclassification adjustments for investment gain/loss included in net income, net of tax:
 
 
 
 
 
 
 
 
Other-than-temporary impairment loss
 
1,088

 
—

 
1,046

 
—

Other net realized gain (loss) on investments
 
751

 
(1,574
)
 
(412
)
 
(3,370
)
Reclassification adjustments for investment gain/loss included in net income:
 
1,839

 
(1,574
)
 
634

 
(3,370
)
Other comprehensive (loss) income, net of tax
 
$
(12,573
)
 
$
(16,044
)
 
$
(117,241
)
 
$
77,648

Comprehensive income
 
180,435

 
141,112

 
320,648

 
440,721

Less: Comprehensive income (loss) attributable to redeemable non-controlling interest and non-controlling interest
 
1,511

 
(2,939
)
 
6,940

 
(7,029
)
Comprehensive income attributable to AmTrust Financial Services, Inc.
 
$
178,924

 
$
144,051

 
$
313,708

 
$
447,750

 
See accompanying notes to unaudited condensed consolidated financial statements.

6



AmTrust Financial Services, Inc.
Consolidated Statements of Cash Flows
(Unaudited)
(In Thousands)
 
Nine Months Ended September 30,
 
2015
 
2014
Cash flows from operating activities:
 

 
 

Net income
$
437,889

 
$
363,073

Adjustments to reconcile net income to net cash provided by operating activities:
 

 
 

Depreciation and amortization
61,602

 
45,085

Net amortization of bond premium or discount
11,845

 
13,059

Equity earnings on investment in unconsolidated subsidiaries
(23,048
)
 
(26,847
)
(Gain) loss on investment in life settlement contracts, net
(19,085
)
 
5,180

Realized gain on available for sale securities and unrealized gain on trading securities
(40,811
)
 
(18,046
)
Non-cash write-down of available for sale securities
10,118

 
4,003

Discount on notes payable
4,226

 
2,425

Stock based compensation
16,678

 
13,911

Loss on extinguishment of debt
5,271

 
—

Bad debt expense
13,943

 
22,459

Foreign currency loss
(17,355
)
 
(25,826
)
Gain on sale of subsidiary
(5,826
)
 
(6,631
)
Changes in assets - (increase) decrease:
 

 
 

Premiums and note receivables
(492,354
)
 
(259,697
)
Reinsurance recoverable
(510,397
)
 
(352,731
)
Deferred policy acquisition costs, net
(87,597
)
 
(184,997
)
Prepaid reinsurance premiums
(304,361
)
 
(248,403
)
Other assets
(352,931
)
 
(37,931
)
Changes in liabilities - increase (decrease):
 
 
 
Reinsurance premium payable
138,192

 
5,655

Loss and loss expense reserve
999,371

 
910,360

Unearned premiums
495,499

 
710,590

Funds held under reinsurance treaties
20,685

 
1,019

Accrued expenses and other current liabilities
360,490

 
35,511

Deferred tax liability
(178,363
)
 
(73,654
)
Net cash provided by operating activities
543,681

 
897,567

Cash flows from investing activities:
 

 
 

Purchases of fixed maturities, available-for-sale
(1,671,330
)
 
(2,018,811
)
Purchases of equity securities, available-for-sale
(32,898
)
 
(287,743
)
Purchase of equity securities, trading
(154,524
)
 
(13,703
)
Purchase of other investments
(74,562
)
 
(6,145
)
Sales and maturity of fixed maturities, available-for-sale
971,448

 
1,336,830

Sales of equity securities, available-for-sale
18,639

 
231,295

Sales of equity securities, trading
161,723

 
9,520

Sales of other investments
2,960

 
17,854

Net sales (purchases) of short term investments
48,165

 
62,829

Acquisition of life settlement contracts
—

 
(25,419
)
Receipt of life settlement contract proceeds
86,033

 
5,027

Loan to ACP Re
—

 
(125,000
)
Acquisition of subsidiaries, net of cash obtained
(219,568
)
 
(75,914
)
Sale of subsidiary, net of cash for subsidiary
—

 
20,059

Increase in restricted cash and cash equivalents
(70,846
)
 
(72,060
)
Purchase of property and equipment
(100,421
)
 
(64,742
)
Net cash used in investing activities
(1,035,181
)
 
(1,006,123
)

7


Cash flows from financing activities:
 

 
 

Revolving credit facility borrowings
430,000

 
—

Revolving credit facility payments
(420,000
)
 
—

Repurchase agreements, net
—

 
(293,222
)
Secured loan proceeds
10,250

 
30,500

Secured loan agreements payments
(5,234
)
 
(806
)
Promissory notes payments
—

 
(10,695
)
  Convertible senior notes settlement
(62,079
)
 
—

Subordinated notes due 2055 proceeds
285,000

 
—

Financing fees
(9,451
)
 
(967
)
Common stock issuance (purchase), net
171,672

 
(44,564
)
Preferred stock issuance, net
176,529

 
178,641

Non-controlling interest capital contributions for consolidated subsidiaries, net
14,451

 
16,877

Stock option exercise and other
(219
)
 
4,981

Dividends distributed on common stock
(60,498
)
 
(40,705
)
Dividends distributed on preferred stock
(22,797
)
 
(7,387
)
Net cash provided by (used in) financing activities
507,624

 
(167,347
)
Effect of exchange rate changes on cash
(8,221
)
 
(7,878
)
Net increase in cash and cash equivalents
7,903

 
(283,781
)
Cash and cash equivalents, beginning of the period
902,750

 
830,022

Cash and cash equivalents, end of the period
$
910,653

 
$
546,241

Supplemental Cash Flow Information
 

 
 

Income tax payments
$
231,684

 
$
42,624

Interest payments on debt
$
31,573

 
$
29,129

 
See accompanying notes to unaudited condensed consolidated financial statements.

8


Notes to Unaudited Condensed Consolidated Financial Statements
(Unaudited)
(Dollars In Thousands, Except Share and Per Share Data)
1.
 Basis of Reporting
  
The accompanying unaudited interim consolidated financial statements have been prepared in accordance with U.S. generally accepted accounting principles (“GAAP”) for interim financial statements and with the instructions to Form 10-Q and Article 10 of Regulation S-X and, therefore, do not include all of the information and footnotes required by GAAP for complete financial statements. These interim statements should be read in conjunction with the financial statements and notes thereto included in the AmTrust Financial Services, Inc. (“AmTrust” or the “Company”) Annual Report on Form 10-K for the year ended December 31, 2014, previously filed with the Securities and Exchange Commission (“SEC”) on March 2, 2015. The balance sheet at December 31, 2014 has been derived from the audited consolidated financial statements at that date but does not include all of the information and footnotes required by GAAP for complete financial statements.
 
These interim consolidated financial statements reflect all adjustments that are, in the opinion of management, necessary for a fair presentation of the results for the interim period and all such adjustments are of a normal recurring nature. The results of operations for the interim period are not necessarily indicative, if annualized, of those to be expected for the full year. The preparation of financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the amounts reported in the financial statements and accompanying notes. Actual results could differ from those estimates.
 
A detailed description of the Company’s significant accounting policies and management judgments is located in the audited consolidated financial statements for the year ended December 31, 2014, included in the Company’s Form 10-K filed with the SEC.
 
All significant inter-company transactions and accounts have been eliminated in the consolidated financial statements.
 
To facilitate period-to-period comparisons, certain reclassifications have been made to prior period consolidated financial statement amounts to conform to current period presentation.

2.
Recent Accounting Pronouncements
 
With the exception of those discussed below, there have been no recent accounting pronouncements or changes in accounting pronouncements during the nine months ended September 30, 2015, as compared to those described in our Annual Report on Form 10-K for the fiscal year ended December 31, 2014, that are of significance, or potential significance, to the Company.

In September 2015, the Financial Accounting Standards Board ("FASB") issued Accounting Standards Update ("ASU") 2015-16, Business Combinations (Topic 805): Simplifying the Accounting for Measurement-Period Adjustments, which requires that an acquirer in a business combination transaction recognize adjustments to provisional amounts that are identified during the measurement period in the reporting period in which the adjustment amounts are determined. The ASU requires that the acquirer record, in the same period's financial statements, the effect on earnings of changes in depreciation, amortization, or other income effects, if any, as a result of the change to the provisional amounts, calculated as if the accounting had been completed at the acquisition date. It also requires an entity to present separately on the face of the income statement or disclose in the notes to the financial statements the portion of the amount recorded in current-period earnings by line item that would have been recorded in previous reporting periods if the adjustment to the provisional amounts had been recognized as of the acquisition date. The updated guidance is effective for reporting periods beginning after December 15, 2015, and should be applied prospectively to adjustments to provisional amounts that occur after the effective date of this ASU with earlier application permitted for financial statements that have not been issued. The Company elected to early adopt this ASU on September 30, 2015. The adoption of this guidance did not have a material effect on the Company's results of operations, financial position or liquidity.











9


In May 2015, the FASB issued ASU 2015-09, Financial Services - Insurance (Topic 944): Disclosure about Short-Duration Contracts, which provides certain new and additional disclosure requirements about the liability for unpaid claims and claim adjustment expenses associated with short-duration contracts as defined in Topic 944. Pursuant to the updated guidance, all insurance entities that issue short-duration contracts are required to disclose, among other things, incurred and paid claims development information, a reconciliation of such information to the aggregate carrying amount of the liability for unpaid claims and claim adjustment expenses, and significant changes in methodologies and assumptions used to calculate the liability for unpaid claims and claim adjustment expenses, including the reasons for the change and the effects on the financial statements. The updated guidance is effective for reporting periods beginning after December 15, 2015, and should be applied retrospectively by providing comparative disclosures for each period presented, except for those requirements that apply only to the current period. The adoption of this guidance is expected to be limited to disclosure requirements and is not expected to have a material impact on the Company's results of operations, financial position or liquidity.

In May 2015, the FASB issued ASU 2015-07, Fair Value Measurement (Topic 820): Disclosure for Investments in Certain Entities That Calculate Net Asset Value per Share (or Its Equivalent), which provides guidance that removes the requirement to categorize within the fair value hierarchy all investments for which fair value is measured using the net asset value per share practical expedient as well as limits certain disclosure requirements only to investments for which the entity elects to measure the fair value using that practical expedient. The updated guidance is effective for reporting periods beginning after December 15, 2015, and should be applied retrospectively for all periods presented. The adoption of this guidance is not expected to have a material effect on the Company’s results of operations, financial position or liquidity.

In April 2015, the FASB issued ASU 2015-05, Intangibles - Goodwill and Other - Internal-Use Software (Subtopic 350-40): Customer's Accounting for Fees Paid in a Cloud Computing Arrangement, which provides guidance to determine whether a cloud computing arrangement includes a software license. If a cloud computing arrangement includes a software license, then the customer should account for the software license element of the arrangement consistent with the acquisition of other software licenses. If a cloud computing arrangement does not include a software license, the customer should account for the arrangement as a service contract. The updated guidance is effective for reporting periods beginning after December 15, 2015, and can be adopted either prospectively to all arrangements entered into or materially modified after the effective date, or retrospectively. The adoption of this guidance is not expected to have a material effect on the Company’s results of operations, financial position or liquidity.

In April 2015, the FASB issued ASU 2015-03, Interest - Imputation of Interest (Subtopic 835-30): Simplifying the Presentation of Debt Issuance Costs, which provides updated guidance to clarify the required presentation of debt issuance costs. The amended guidance requires that debt issuance costs be presented in the balance sheet as a direct reduction from the carrying amount of the recognized debt liability, consistent with the treatment of debt discounts. Amortization of debt issuance costs is to be reported as interest expense. The recognition and measurement guidance for debt issuance costs are not affected by the updated guidance. The updated guidance is effective for reporting periods beginning after December 15, 2015. Early adoption is permitted. The adoption of this guidance is not expected to have a material effect on the Company’s results of operations, financial position or liquidity.

In February 2015, the FASB issued ASU 2015-02, Consolidation (Topic 810): Amendments to the Consolidation Analysis, which provides amended guidance on a reporting entity's evaluation whether to consolidate certain legal entities. Specifically, the amendments will modify the evaluation of whether limited partnerships and similar legal entities are variable interest entities ("VIEs") or voting entities, eliminate the presumption that a general partner should consolidate a limited partnership, affect the consolidation analysis of reporting entities with interests in VIEs, particularly those that have fee arrangements and related party relationships, and provide a scope exception from consolidation guidance for reporting entities with interests in legal entities that are required to comply with or operate in accordance with requirements that are similar to those in Rule 2a-7 of the Investment Company Act of 1940 for registered money market funds. The updated guidance is effective for periods beginning after December 15, 2015 and early adoption is permitted. The adoption of this guidance is not expected to have a material effect on the Company's results of operations, financial position or liquidity.

In November 2014, the FASB issued ASU 2014-16, Derivative and Hedging (Topic 815): Determining Whether the Host Contract in a Hybrid Financial Instrument Issued in the Form of a Share Is More Akin to Debt or to Equity, which requires an entity (an issuer or an investor) of hybrid financial instruments to determine the nature of the host contract by considering the economic characteristics and risks of the entire hybrid financial instrument, including the embedded derivative feature that is being evaluated for separate accounting from the host contract. The updated guidance is effective for periods ending after December 31, 2015. The adoption of this guidance is not expected to have a material effect on the Company's results of operations, financial position or liquidity.



10


In June 2014, the FASB issued ASU 2014-12, Compensation--Stock Compensation (Topic 718): Accounting for Share-Based Payments When the Terms of an Award Provide That a Performance Target Could Be Achieved after the Requisite Service Period, to clarify how entities should treat performance targets that can be met after the requisite service period of a share-based payment award. The ASU states that the share-based payment award should be treated as a performance condition that affects vesting and, therefore, an entity would not record compensation expense (measured as of the grant date without taking into account the effect of the performance target) related to an award for which transfer to the employee is contingent on the entity’s satisfaction of a performance target until it becomes probable that the performance target will be met. No new disclosures are required under this ASU. ASU 2014-12 is effective beginning after December 15, 2015. Early adoption is permitted. In addition, all entities will have the option of applying the guidance either prospectively (i.e., only to awards granted or modified on or after the effective date of the issue) or retrospectively. Retrospective application would only apply to awards with performance targets outstanding at or after the beginning of the first annual period presented (i.e., the earliest presented comparative period). The adoption of this guidance is not expected to have an impact on the Company's results of operations, financial condition or liquidity.

In June 2014, the FASB issued ASU 2014-11, Transfers and Servicing (Topic 860): Repurchase-to-Maturity Transactions, Repurchase Financings, and Disclosures. The new guidance aligned accounting for repurchase-to-maturity transactions and repurchase agreements executed as a repurchase financing with the accounting for other repurchase agreements. These transactions would all be accounted for as secured borrowings. The revised guidance also requires expanded disclosure for certain transactions comprising of (1) a transfer of a financial asset accounted for as a sale, and (2) an agreement with the same transferee entered into in contemplation of the initial transfer that results in the transferor retaining substantially all of the exposure to the economic return on the transferred financial asset throughout the term of the transaction, as well as expands disclosure for repurchase agreements, securities lending transactions, and repurchase-to-maturity transactions that are accounted for as secured borrowings. The Company adopted ASU 2014-11 on April 1, 2015 and the adoption did not have a material effect on the Company's results of operations, financial position or liquidity.

In May 2014, the FASB issued ASU 2014-09, Revenue from Contracts with Customers (Topic 606), to clarify the principles for recognizing revenue. While insurance contracts are not within the scope of this updated guidance, the Company’s service and fee income will be subject to this updated guidance. The updated guidance requires an entity to recognize revenue as performance obligations are met, in order to reflect the transfer of promised goods or services to customers in an amount that reflects the consideration the entity is entitled to receive for those goods or services. The following steps are applied in the updated guidance: (1) identify the contract(s) with a customer; (2) identify the performance obligations in the contract; (3) determine the transaction price; (4) allocate the transaction price to the performance obligations in the contract; and (5) recognize revenue when, or as, the entity satisfies a performance obligation. In August 2015, the FASB issued ASU 2015-14, Revenue from Contracts with Customers (Topic 606): Deferral of the Effective Date, which deferred the effective date of ASU 2014-09 to the quarter ending March 31, 2018. The Company is currently evaluating the impact this guidance will have on its results of operations, financial position or liquidity.

11



3.
Investments
 
(a) Available-for-Sale Securities
 
The cost or amortized cost, gross unrealized gains and losses, and estimated fair value of fixed maturities and equity securities classified as available-for-sale as of September 30, 2015 and December 31, 2014, are presented below:
(Amounts in Thousands)
As of September 30, 2015
 
Cost or amortized cost
 
Gross unrealized gains
 
Gross unrealized losses
 
Fair Value
Preferred stock
 
$
4,869

 
$
124

 
$
(38
)
 
$
4,955

Common stock
 
106,121

 
2,662

 
(7,620
)
 
101,163

U.S. treasury securities
 
56,714

 
1,878

 
(35
)
 
58,557

U.S. government agencies
 
36,014

 
387

 
(84
)
 
36,317

Municipal bonds
 
533,385

 
14,399

 
(2,837
)
 
544,947

Foreign government
 
105,209

 
5,571

 
(637
)
 
110,143

Corporate bonds:
 
 

 
 

 
 

 
 

Finance
 
1,277,615

 
42,064

 
(28,485
)
 
1,291,194

Industrial
 
1,571,174

 
25,514

 
(62,229
)
 
1,534,459

Utilities
 
143,081

 
2,456

 
(6,830
)
 
138,707

Commercial mortgage backed securities
 
146,329

 
3,838

 
(673
)
 
149,494

Residential mortgage backed securities:
 
 

 
 

 
 

 
 

Agency backed
 
929,389

 
24,312

 
(1,702
)
 
951,999

Non-agency backed
 
112,954

 
1,037

 
(1,374
)
 
112,617

Collateralized loan / debt obligations
 
177,144

 
50

 
(3,487
)
 
173,707

Asset-backed securities
 
23,496

 
206

 
(35
)
 
23,667

 
 
$
5,223,494

 
$
124,498

 
$
(116,066
)
 
$
5,231,926

 
(Amounts in Thousands)
As of December 31, 2014
 
Cost or amortized cost
 
Gross unrealized gains
 
Gross unrealized losses
 
 Fair value
Preferred stock
 
$
3,349

 
$
158

 
$
(1
)
 
$
3,506

Common stock
 
80,726

 
4,673

 
(7,861
)
 
77,538

U.S. treasury securities
 
42,416

 
1,558

 
(104
)
 
43,870

U.S. government agencies
 
12,968

 
575

 
(5
)
 
13,538

Municipal bonds
 
469,646

 
13,950

 
(1,555
)
 
482,041

Foreign government
 
106,054

 
6,760

 
(83
)
 
112,731

Corporate bonds:
 
 
 
 
 
 
 
 
Finance
 
1,167,011

 
60,322

 
(5,471
)
 
1,221,862

Industrial
 
1,187,818

 
38,317

 
(23,275
)
 
1,202,860

Utilities
 
137,169

 
3,200

 
(1,677
)
 
138,692

Commercial mortgage backed securities
 
36,964

 
1,890

 
(169
)
 
38,685

Residential mortgage backed securities:
 
 
 
 
 
 
 
 
Agency backed
 
954,320

 
23,340

 
(1,878
)
 
975,782

Non-agency backed
 
22,071

 
696

 
(264
)
 
22,503

Asset backed securities
 
709

 
2

 
(1
)
 
710

 
 
$
4,221,221

 
$
155,441

 
$
(42,344
)
 
$
4,334,318



12


Investments in foreign government securities include securities issued by national entities as well as instruments that are unconditionally guaranteed by such entities. As of September 30, 2015, the Company's foreign government securities were issued or guaranteed primarily by governments in Canada and Europe.

Proceeds from the sale of investments in available-for-sale securities during the three months ended September 30, 2015 and 2014 were approximately $417,517 and $845,278, respectively. Proceeds from the sale of investments in available-for-sale securities during the nine months ended September 30, 2015 and 2014 were approximately $990,087 and $1,568,125, respectively.

A summary of the Company’s available-for-sale fixed maturities as of September 30, 2015 and December 31, 2014, by contractual maturity, is shown below. Expected maturities may differ from contractual maturities because borrowers may have the right to call or prepay obligations with or without call or prepayment penalties.
 
 
September 30, 2015
 
December 31, 2014
(Amounts in Thousands)
 
Amortized Cost
 
Fair Value
 
Amortized Cost
 
 Fair Value
Due in one year or less
 
$
103,977

 
$
104,473

 
$
106,041

 
$
105,839

Due after one through five years
 
820,364

 
829,386

 
682,632

 
704,344

Due after five through ten years
 
2,453,188

 
2,431,882

 
1,998,740

 
2,062,942

Due after ten years
 
345,664

 
348,582

 
335,669

 
342,468

Mortgage and asset backed securities
 
1,389,311

 
1,411,485

 
1,014,064

 
1,037,681

Total fixed maturities
 
$
5,112,504

 
$
5,125,808

 
$
4,137,146

 
$
4,253,274


Other-than-temporary impairment ("OTTI") charges of our fixed maturities and equity securities classified as available-for-sale are presented below:
 
 
Three Months Ended September 30,

Nine Months Ended September 30,
(Amounts in Thousands)
 
2015

2014

2015

2014
Equity securities recognized in earnings
 
$
84

 
$
—

 
$
1,276

 
$
2,291

Fixed-maturity securities recognized in earnings
 
7,552

 
464

 
8,842

 
1,712

 
 
$
7,636

 
$
464

 
$
10,118

 
$
4,003



13


The tables below summarize the gross unrealized losses of our fixed maturity and equity securities by length of time the security has continuously been in an unrealized position as of September 30, 2015 and December 31, 2014:
 
 
 
Less Than 12 Months

12 Months or More

Total
(Amounts in Thousands)
As of September 30, 2015
 
Fair Market Value

Unrealized Losses

No. of Positions Held

Fair Market Value

Unrealized Losses

No. of Positions Held

Fair Market Value

Unrealized Losses
Common and preferred stock
 
$
69,168


$
(7,658
)

81


$
—


$
—


—


$
69,168


$
(7,658
)
U.S. treasury securities
 
6,782

 
(25
)
 
24

 
3,254

 
(10
)
 
9

 
10,036

 
(35
)
U.S. government agencies
 
4,675

 
(83
)
 
2

 
185

 
(1
)
 
2

 
4,860

 
(84
)
Municipal bonds
 
122,756


(2,218
)

113


18,579


(619
)

34


141,335


(2,837
)
Foreign government
 
13,522

 
(612
)
 
20

 
6,246

 
(25
)
 
1

 
19,768

 
(637
)
Corporate bonds:
 
 


 


 


 


 


 


 


 

Finance
 
547,924


(27,553
)

269


49,527


(932
)

20


597,451


(28,485
)
Industrial
 
690,152


(51,144
)

443


80,010


(11,085
)

60


770,162


(62,229
)
Utilities
 
57,481

 
(4,169
)
 
79

 
6,000

 
(2,661
)
 
2

 
63,481

 
(6,830
)
Commercial mortgage backed securities
 
25,593

 
(593
)
 
82

 
3,172

 
(80
)
 
6

 
28,765

 
(673
)
Residential mortgage backed securities:
 
 


 


 


 


 


 


 


 

Agency backed
 
67,582


(1,249
)

73


23,118


(453
)

28


90,700


(1,702
)
Non-agency backed
 
58,051


(1,323
)

21


4,337


(51
)

4


62,388


(1,374
)
Collateralized loan / debt obligations
 
148,697

 
(3,487
)
 
56

 
—

 
—

 
—

 
148,697

 
(3,487
)
Asset-backed securities
 
9,316

 
(35
)
 
24

 
—

 
—

 
—

 
9,316

 
(35
)
Total temporarily impaired securities
 
$
1,821,699


$
(100,149
)

1,287


$
194,428


$
(15,917
)

166


$
2,016,127


$
(116,066
)
  
 
 
Less Than 12 Months
 
12 Months or More
 
Total
(Amounts in Thousands)
December 31, 2014
 
Fair Market Value
 
Unrealized Losses
 
No. of Positions Held
 
Fair Market Value
 
Unrealized Losses
 
No. of Positions Held
 
Fair Market Value
 
Unrealized Losses
Common and preferred stock
 
$
38,970

 
$
(7,764
)
 
21

 
$
400

 
$
(98
)
 
2

 
$
39,370

 
$
(7,862
)
U.S. treasury securities
 
1,030

 
(54
)
 
7

 
3,219

 
(50
)
 
9

 
4,249

 
(104
)
U.S. government agencies
 
1,736

 
(3
)
 
3

 
222

 
(2
)
 
4

 
1,958

 
(5
)
Municipal bonds
 
24,695

 
(240
)
 
64

 
93,201

 
(1,315
)
 
98

 
117,896

 
(1,555
)
Foreign government
 
7,644

 
(83
)
 
4

 
—

 
—

 
—

 
7,644

 
(83
)
Corporate bonds:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Finance
 
192,520

 
(4,297
)
 
143

 
66,715

 
(1,174
)
 
27

 
259,235

 
(5,471
)
Industrial
 
236,845

 
(17,230
)
 
194

 
60,511

 
(6,045
)
 
43

 
297,356

 
(23,275
)
 Utilities
 
12,188

 
(490
)
 
22

 
13,908

 
(1,187
)
 
3

 
26,096

 
(1,677
)
Commercial mortgage backed securities
 
15

 
—

 
2

 
4,729

 
(169
)
 
8

 
4,744

 
(169
)
Residential mortgage backed securities:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Agency backed
 
41,187

 
(101
)
 
10

 
66,172

 
(1,777
)
 
29

 
107,359

 
(1,878
)
Non-agency backed
 
5,092

 
(263
)
 
3

 
28

 
(1
)
 
2

 
5,120

 
(264
)
Asset-backed securities
 
148

 
—

 
1

 
110

 
(1
)
 
2

 
258

 
(1
)
Total temporarily impaired securities
 
$
562,070

 
$
(30,525
)
 
474

 
$
309,215

 
$
(11,819
)
 
227

 
$
871,285

 
$
(42,344
)

There are 1,453 and 701 securities at September 30, 2015 and December 31, 2014, respectively, that account for the gross unrealized loss, none of which is deemed by the Company to be OTTI. At September 30, 2015, we have determined that the unrealized losses on fixed maturities were primarily due to market interest rate movements since their date of purchase. The Company considers an investment to be impaired when it has been in a significant unrealized loss position (in excess of 35% of cost if the issuer has a market capitalization of under $1,000,000 and in excess of 25% of cost if the issuer has a market capitalization of $1,000,000 or more) for over 24 months. Additionally, other factors influencing the Company’s determination that unrealized losses were temporary included an evaluation of the investment’s discounted cash flows, the magnitude of the

14


unrealized losses in relation to each security’s cost, near-term and long-term prospects of the issue or issuer ability to have adequate resources to fulfill contractual obligations, the nature of the investment and management’s intent not to sell these securities, it being not more likely than not that the Company will be required to sell these investments before anticipated recovery of fair value to the Company’s cost basis. As of September 30, 2015, for the $15,917 of unrealized losses related to securities in unrealized loss positions for a period of twelve or more consecutive months, $7,484 of those unrealized losses were related to securities in unrealized loss positions greater than or equal to 20% of amortized cost or cost.

(b) Trading Securities

The original or amortized cost, estimated market value and gross unrealized appreciation and depreciation of trading securities as of September 30, 2015 and December 31, 2014 are presented in the tables below:
(Amounts in Thousands)
As of September 30, 2015
 
Cost or amortized cost
 
Gross unrealized gains
 
Gross unrealized losses
 
 Market value
Common stock
 
$
20,745

 
$
405

 
$
(1,290
)
 
$
19,860


(Amounts in Thousands)
As of December 31, 2014
 
Cost or amortized cost
 
Gross unrealized gains
 
Gross unrealized losses
 
 Market value
Common stock
 
$
25,407

 
$
1,614

 
$
(272
)
 
$
26,749


Proceeds from the sale of investments in trading securities during the three months ended September 30, 2015 and 2014 were approximately $53,398 and $9,520, respectively. Proceeds from the sale of investments in trading securities during the nine months ended September 30, 2015 and 2014 were approximately $161,723 and $9,520, respectively. During the three months ended September 30, 2015 and 2014, the Company recognized approximately $12,362 and $4,638 gross realized gain, respectively, and approximately $3,108 and $2,472 gross realized loss, respectively, related to its investments in trading securities. During the nine months ended September 30, 2015 and 2014, the Company recognized approximately $19,568 and $6,942 gross realized gain, respectively, and approximately $8,077 and $5,126 gross realized loss, respectively, related to its investments in trading securities.

(c) Investment Income
 
Net investment income for the three and nine months ended September 30, 2015 and 2014 was derived from the following sources:
 
 
Three Months Ended September 30,
 
Nine Months Ended September 30,
(Amounts in Thousands)
 
2015
 
2014
 
2015
 
2014
Fixed maturities, available-for-sale
 
$
39,452

 
$
34,112

 
$
107,404

 
$
92,852

Equity securities, available-for-sale
 
1,183

 
249

 
2,253

 
550

Equity securities, trading
 
(640
)
 
77

 
(600
)
 
77

Cash and short term investments
 
844

 
854

 
3,432

 
4,278

 
 
40,839

 
35,292

 
112,489

 
97,757

Investment expenses
 
(414
)
 
(740
)
 
(1,208
)
 
(2,084
)
 
 
$
40,425

 
$
34,552

 
$
111,281

 
$
95,673

 
 
 
 
 
 
 
(d) Derivatives
 
The Company from time to time invests in a limited number of derivatives and other financial instruments as part of its investment portfolio to manage interest rate changes or other exposures to a particular financial market. The Company records changes in valuation on its derivative positions not designated as a hedge as a component of net realized gains and losses.
 
The Company records changes in valuation on its hedge positions as a component of other comprehensive income. As of September 30, 2015 and December 31, 2014, the Company had two interest rate swaps designated as hedges that were recorded as a liability in the total amount of $1,576 and $2,033, respectively, and were included as a component of accrued expenses and other liabilities.

15


 
The following table presents the notional amounts by remaining maturity of the Company’s interest rate swaps as of September 30, 2015:
 
 
 
Remaining Life of Notional Amount (1)
 
(Amounts in Thousands)
 
One Year
 
Two Through Five Years
 
Six Through Ten Years
 
After Ten Years
 
Total
Interest rate swaps
 
$
30,000

 
$
40,000

 
$
—

 
$
—

 
$
70,000

 
(1) 
Notional amount is not representative of either market risk or credit risk and is not recorded in the consolidated balance sheet. 

(e) Restricted Cash and Investments
 
The Company, in order to conduct business in certain states, is required to maintain letters of credit or assets on deposit to support state mandated regulatory requirements and certain third party agreements. The Company also utilizes trust accounts to collateralize business with its reinsurance counterparties. These assets are primarily in the form of cash and certain high grade securities. The fair values of the Company's restricted assets as of September 30, 2015 and December 31, 2014 are as follows:
 
(Amounts in Thousands)
 
2015
 
2014
Restricted cash and cash equivalents
 
$
257,050

 
$
186,225

Restricted investments - fixed maturities at fair value
 
1,344,393

 
734,271

Total restricted cash, cash equivalents, and investments
 
$
1,601,443

 
$
920,496

 
(f) Other

Securities sold but not yet purchased are securities that the Company has sold, but does not own, in anticipation of a decline in the market value of the security. The Company's risk is that the value of the security will increase rather than decline. Consequently, the settlement amount of the liability for securities sold, not yet purchased may exceed the amount recorded in the consolidated balance sheet as the Company is obligated to purchase the securities sold, not yet purchased in the market at prevailing prices to settle the obligations. To establish a position in security sold, not yet purchased, the Company needs to borrow the security for delivery to the buyer. When the transaction is open, the liability for the obligation to replace the borrowed security is marked to market and an unrealized gain or loss is recorded. At the time the transaction is closed, the Company realizes a gain or loss equal to the differences between the price at which the security was sold and the cost of replacing the borrowed security. While the transaction is open, the Company will also incur an expense for any dividends or interest which will be paid to the lender of the securities. The Company’s liability for securities to be delivered is measured at their fair value and was $88,627 and $13,052 as of September 30, 2015 and December 31, 2014, respectively. The securities sold but not yet purchased consisted primarily of equity and fixed maturity securities, and the liability for securities sold but not yet purchased is included in accrued expenses and other liabilities in the condensed consolidated balance sheet.



16



4.
Fair Value of Financial Instruments

The following tables present the level within the fair value hierarchy at which the Company’s financial assets and financial liabilities are measured on a recurring basis as of September 30, 2015 and December 31, 2014:
 
(Amounts in Thousands)
As of September 30, 2015
 
Total

Level 1

Level 2

Level 3
Assets:
 
 


 


 


 

U.S. treasury securities
 
$
58,557


$
58,557


$
—


$
—

U.S. government agencies
 
36,317


—


36,317


—

Municipal bonds
 
544,947


—


544,947


—

Foreign government
 
110,143

 
—

 
110,143

 
—

Corporate bonds and other bonds:
 
 


 


 


 

Finance
 
1,291,194


—


1,291,194


—

Industrial
 
1,534,459


—


1,534,459


—

Utilities
 
138,707


—


138,707


—

Commercial mortgage backed securities
 
149,494


—


149,494


—

Residential mortgage backed securities:
 
 


 


 


 

Agency backed
 
951,999


—


951,999


—

Non-agency backed
 
112,617


—


112,617


—

Collateralized loan / debt obligations
 
173,707

 
—

 
97,701

 
—

Asset-backed securities
 
23,667

 
—

 
23,667

 
—

Equity securities, available-for-sale
 
106,118


31,861


34,068


40,189

Equity securities, trading
 
19,860

 
19,860

 
—

 
—

Short term investments
 
36,043


36,043


—


—

Other investments
 
21,826


—


—


21,826

Life settlement contracts
 
271,249


—


—


271,249

 
 
$
5,580,904


$
146,321


$
5,025,313


$
333,264

Liabilities:
 
 


 


 


 

Equity securities sold but not yet purchased
 
$
42,170

 
$
42,170

 
$
—

 
$
—

Fixed maturity securities sold but not yet purchased
 
46,457

 
—

 
46,457

 
—

Life settlement contract profit commission
 
15,819


—


—


15,819

Derivatives
 
1,576


—


1,576


—

 
 
$
106,022


$
42,170


$
48,033


$
15,819

 

17


(Amounts in Thousands)
As of December 31, 2014
 
Total
 
Level 1
 
Level 2
 
Level 3
Assets:
 
 
 
 
 
 
 
 
U.S. treasury securities
 
$
43,870

 
$
43,870

 
$
—

 
$
—

U.S. government agencies
 
13,538

 
—

 
13,538

 
—

Municipal bonds
 
482,041

 
—

 
482,041

 
—

Foreign government
 
112,731

 
—

 
112,731

 
—

Corporate bonds and other bonds:
 

 
 
 

 
 
Finance
 
1,221,862

 
—

 
1,221,862

 
—

Industrial
 
1,202,860

 
—

 
1,202,860

 
—

Utilities
 
138,692

 
—

 
138,692

 
—

Commercial mortgage backed securities
 
38,685

 
—

 
38,685

 
—

Residential mortgage backed securities:
 
 
 
 
 
 
 
 
Agency backed
 
975,782

 
—

 
975,782

 
—

Non-agency backed
 
22,503

 
—

 
22,503

 
—

Asset-backed securities
 
710

 
—

 
710

 
—

Equity securities, available-for-sale
 
81,044

 
24,484

 
21,674

 
34,886

Equity securities, trading
 
26,749

 
26,749

 
—

 
—

Short term investments
 
63,916

 
63,916

 
—

 
—

Other investments
 
13,315

 
—

 
—

 
13,315

Life settlement contracts
 
264,517

 
—

 
—

 
264,517

 
 
$
4,702,815

 
$
159,019

 
$
4,231,078

 
$
312,718

Liabilities:
 
 
 
 
 
 
 
 
Equity securities sold but not yet purchased
 
$
13,052

 
$
13,052

 
$
—

 
$
—

Life settlement contract profit commission
 
16,534

 
—

 
—

 
16,534

Derivatives
 
2,033

 
—

 
2,033

 
—

 
 
$
31,619

 
$
13,052

 
$
2,033

 
$
16,534


The Company classifies its financial assets and liabilities in the fair value hierarchy based on the lowest level input that is significant to the fair value measurement.  This classification requires judgment in assessing the market and pricing methodologies for a particular security.  The fair value hierarchy includes the following three levels:
 
•
Level 1 – Valuations are based on unadjusted quoted market prices in active markets for identical financial assets or liabilities.

Examples of instruments utilizing Level 1 inputs include: exchange-traded securities and U.S. Treasury bonds.
 
•
Level 2 – Valuations of financial assets and liabilities are based on quoted prices for similar assets or liabilities in active markets, quoted prices for identical assets or liabilities in inactive markets obtained from third party pricing services or valuations based on models where the significant inputs are observable (e.g., interest rates, yield curves, prepayment speeds, default rates, loss severities, etc.) or can be corroborated by observable market data. The fair value of securities in this category are determined by management after reviewing market prices obtained from independent pricing services and brokers.
 
Examples of instruments utilizing Level 2 inputs include: U.S. government-sponsored agency securities; non-U.S. government obligations; corporate and municipal bonds; mortgage-backed bonds; asset-backed securities, listed derivatives that are not actively traded and equity securities that are not publicly traded.

•
Level 3 – Valuations are based on unobservable inputs for assets and liabilities where there is little or no market activity.  Management’s assumptions are used in internal valuation pricing models to determine the fair value of financial assets or liabilities, which may include projected cash flows, collateral performance or liquidity circumstances in the security or similar securities that may have occurred since the prior pricing period.

18



Examples of instruments utilizing Level 3 inputs include: hedge and credit funds with partial transparency.

The following tables provides a summary of changes in fair value of the Company’s Level 3 financial assets and liabilities for the three and nine months ended September 30, 2015 and 2014:
(Amounts in Thousands)

Balance as of June 30, 2015

Net income

Other comprehensive income

Purchases and issuances

Sales and settlements

Net transfers into (out of) Level 3

Balance as of September 30,
2015
Other investments

$
14,759


$
(793
)

$
(5,300
)

$
160


$
—


$
13,000


$
21,826

Equity securities, available-for-sale
 
40,232

 
—

 
3

 
—

 
(46
)
 
—

 
40,189

Life settlement contracts

267,393


13,875


—


—


(10,019
)

—


271,249

Life settlement contract profit commission

(16,994
)

1,175


—


—


—


—


(15,819
)
Total

$
305,390


$
14,257


$
(5,297
)

$
160


$
(10,065
)

$
13,000


$
317,445

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
(Amounts in Thousands)
 
Balance as of December 31, 2014
 
Net income
 
Other comprehensive income
 
Purchases and issuances
 
Sales and settlements
 
Net transfers into (out of) Level 3
 
Balance as of September 30,
2015
Other investments
 
$
13,315

 
$
(379
)
 
$
(5,300
)
 
$
1,527

 
$
(337
)
 
$
13,000

 
$
21,826

Equity securities, available-for-sale
 
34,886

 
—

 
5,395

 
—

 
(92
)
 
—

 
40,189

Life settlement contracts
 
264,517

 
52,765

 
—

 
—

 
(46,033
)
 
—

 
271,249

Life settlement contract profit commission
 
(16,534
)
 
715

 
—

 
—

 
—

 
—

 
(15,819
)
Total
 
$
296,184

 
$
53,101

 
$
95

 
$
1,527

 
$
(46,462
)
 
$
13,000

 
$
317,445

(Amounts in Thousands)
 
Balance as of June 30, 2014
 
Net income
 
Other comprehensive income
 
Purchases and issuances
 
Sales and settlements
 
Net transfers into (out of) Level 3
 
Balance as of September 30, 2014
Other investments
 
$
14,095

 
$
—

 
$
—

 
$
2,828

 
$
(481
)
 
$
—

 
$
16,442

Life settlement contracts
 
276,199

 
7,001

 
—

 
—

 
—

 
—

 
283,200

Life settlement contract profit commission
 
(12,529
)
 
1,272

 
—

 
—

 
—

 
—

 
(11,257
)
Total
 
$
277,765

 
$
8,273

 
$
—

 
$
2,828

 
$
(481
)
 
$
—

 
$
288,385

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
(Amounts in Thousands)
 
Balance as of December 31, 2013
 
Net income
 
Other comprehensive income
 
Purchases and issuances
 
Sales and settlements
 
Net transfers into (out of) Level 3
 
Balance as of September 30, 2014
Other investments
 
$
25,749

 
$
2,402

 
$
—

 
$
6,145

 
$
(17,854
)
 
$
—

 
$
16,442

Life settlement contracts
 
233,024

 
29,784

 
—

 
25,419

 
(5,027
)
 
—

 
283,200

Life settlement contract profit commission
 
(11,945
)
 
688

 
—

 
—

 
—

 
—

 
(11,257
)
Total
 
$
246,828

 
$
32,874

 
$
—

 
$
31,564

 
$
(22,881
)
 
$
—

 
$
288,385


 The Company changed its valuation methodology for certain privately placed investments of approximately $13,000 during the nine months ended September 30, 2015. As a result of the change in valuation methodology, the Company included the investment as Level 3 in the fair value hierarchy. The Company had no transfers between fair value hierarchy levels during the nine months ended September 30, 2014. The Company's policy is to recognize transfers between fair value hierarchy levels when events or circumstances warrant transfers.
 
A reconciliation of net income for life settlement contracts in the above table to gain (loss) on investment in life settlement contracts net of profit commission included in the Condensed Consolidated Statements of Income for the three and nine months ended September 30, 2015 and 2014 is as follows:

 
 
Three Months Ended September 30,
 
Nine Months Ended September 30,
(Amounts in Thousands)
 
2015
 
2014
 
2015
 
2014
Net income
 
$
13,875

 
$
7,001

 
$
52,765

 
$
29,784

Premiums paid
 
(11,326
)
 
(10,728
)
 
(33,614
)
 
(33,200
)
Profit commission
 
1,175

 
1,272

 
715

 
688

Other expenses
 
892

 
(455
)
 
(781
)
 
(2,452
)
Gain (loss) on investment in life settlement contracts
 
$
4,616

 
$
(2,910
)
 
$
19,085

 
$
(5,180
)

19



The Company uses the following methods and assumptions in estimating its fair value disclosures for financial instruments:

•
Equity and Fixed Income Investments: Fair value disclosures for these investments are disclosed above in this note. The Company also holds certain equity securities that are issued by private-held entities or direct equity investments that do not have an active market. The Company estimates the fair value of these securities primarily based on inputs such as third party broker quotes, issuers' book value, market multiples, and other inputs. These securities are classified as Level 3 due to significant unobservable inputs used in the valuation.

•
Cash and cash equivalents, restricted cash and cash equivalents, and short term investments: The carrying value of cash and cash equivalents, restricted cash and cash equivalents, and short term investments approximate their respective fair value and are classified as Level 1 in the financial hierarchy.

•
Premiums Receivable: The carrying values reported in the accompanying balance sheets for these financial instruments approximate their fair values due to the short term nature of the asset and are classified as Level 1 in the fair value hierarchy.

•
Other Investments: Other investments consisted primarily of investment in private equity limited partnerships, real estate partnerships and annuities. Other investments accounted for approximately 1.5% of the Company's investment portfolio as of September 30, 2015, which the Company believes is immaterial to its overall financial position or the results of operations. The Company uses the equity method of accounting to account for a majority of its other investments. The financial statements prepared by the investee are received by the Company typically on a three-month lag basis. For its other investments reported at fair value the Company estimates the fair value based on significant unobservable inputs in the valuations process. As a result, the Company classified the fair value estimates as Level 3 in the fair value hierarchy.

•
Equity Investment in Unconsolidated Subsidiaries - Related Party: The Company has an ownership percentage of approximately 12% in National General Holdings Corp. ("NGHC"). The Company accounts for this investment under the equity method of accounting as it has the ability to exert significant influence on NGHC. The fair value of the investment was approximately $237,179 as of September 30, 2015. The carrying value was $138,867 as of September 30, 2015.

•
Subordinated Debentures and Debt: For the Company's material debt arrangements, the current fair value of the Company's debt was as follows:
 
 
Carrying Value
 
Fair Value
 
 
7.25% Subordinated Notes due 2055
$
150,000

 
$
149,760

 
 
7.50% Subordinated Notes due 2055
135,000

 
135,540

 
 
2.75% Convertible senior notes due 2044
161,706

 
228,371

 
 
6.125% Notes due 2023
250,000

 
249,528

 
 
Junior subordinated debentures
123,714

 
79,400

 
 
Revolving credit facility
130,000

 
130,000

 

The 7.25% subordinated notes due 2055, 7.50% subordinated notes due 2055, 2.75% convertible senior notes due 2044, and the 6.125% notes due 2023 are publicly traded instruments and are classified as Level 1 in the fair value hierarchy. The fair value of the revolving credit facility approximates its carrying value due to the short period to maturity. The fair value of the junior subordinated debentures was determined using the Black-Derman-Toy interest rate lattice model and is classified as Level 3 in the fair value hierarchy.

•
Derivatives: The Company classifies interest rate swaps as Level 2 in the fair value hierarchy.  The Company uses these interest rate swaps to hedge floating interest rates on its debt, thereby changing the variable rate exposure to a fixed rate exposure for interest on these obligations.  The estimated fair value of the interest rate swaps, which is obtained from a third party pricing service, is measured using discounted cash flow analysis that incorporates significant observable inputs, including the LIBOR forward curve and a measurement of volatility.

•
Repurchase Agreements: The carrying value of the repurchase agreements in the accompanying condensed consolidated balance sheets represents their fair values and are classified as Level 2 in the financial hierarchy.

20


•
Life settlement contracts and life settlement contract profit commission: The fair value of life settlement contracts as well as life settlement profit commission liability is based on information available to the Company at the end of the reporting period. These financial instruments are classified as Level 3 in the fair value hierarchy. The Company considers the following factors in its fair value estimates: cost at date of purchase, recent purchases and sales of similar investments (if available and applicable), financial standing of the issuer, changes in economic conditions affecting the issuer, maintenance cost, premiums, benefits, standard actuarially developed mortality tables and life expectancy reports prepared by nationally recognized and independent third party medical underwriters. The Company estimates the fair value of a life insurance policy by applying an investment discount rate based on the cost of funding the Company's life settlement contracts as compared to returns on investments in asset classes with comparable credit quality, which the Company has determined to be 7.5%, to the expected cash flow generated by the policies in the Company's life settlement portfolio (death benefits less premium payments), net of policy specific adjustments and reserves. In order to confirm the integrity of its calculation of fair value, the Company, quarterly, retains an independent third-party actuary to verify that the actuarial modeling used by the Company to determine fair value was performed correctly and that the valuation, as determined through the Company’s actuarial modeling, is consistent with other methodologies. The Company considers this information in its assessment of the reasonableness of the life expectancy and discount rate inputs used in the valuation of these investments.

The Company adjusts the standard mortality for each insured for the insured's life expectancy based on reviews of the insured's medical records and the independent life expectancy reports based thereon. The Company establishes policy specific reserves for the following uncertainties: improvements in mortality, the possibility that the high net worth individuals represented in its portfolio may have access to better health care, the volatility inherent in determining the life expectancy of insureds with significant reported health impairments, the possibility that the issuer of the policy or a third party will contest the payment of the death benefit payable to the Company, and the future expenses related to the administration of the portfolio. The application of the investment discount rate to the expected cash flow generated by the portfolio, net of the policy specific reserves, yields the fair value of the portfolio. The effective discount rate reflects the relationship between the fair value and the expected cash flow gross of these reserves.

The following summarizes data utilized in estimating the fair value of the portfolio of life insurance policies as of September 30, 2015 and December 31, 2014 and, as described in Note 5. "Investments in Life Settlements", only includes data for policies to which the Company assigned value at those dates:
 
 
 
September 30,
2015
 
December 31,
2014
Average age of insured
 
81.8 years

 
81.1 years

Average life expectancy, months (1)
 
114


121

Average face amount per policy (Amounts in thousands)
 
$
6,588

 
$
6,624

Effective discount rate (2)
 
13.9
%
 
14.0
%

(1) 
Standard life expectancy as adjusted for specific circumstances.
(2) 
Effective Discount Rate ("EDR") is the Company's estimated internal rate of return on its life settlement contract portfolio and is determined from the gross expected cash flows and valuation of the portfolio. The valuation of the portfolio is calculated net of all reserves using a 7.5% discount rate. The EDR is inclusive of the reserves and the gross expected cash flows of the portfolio. The Company anticipates that the EDR's range is between 12.5% and 17.5% and reflects the uncertainty that exists surrounding the information available as of the reporting date. As the accuracy and reliability of information improves (declines), the EDR will decrease (increase).

The Company's assumptions are, by their nature, inherently uncertain and the effect of changes in estimates may be significant. The fair value measurements used in estimating the present value calculation are derived from valuation techniques generally used in the industry that include inputs for the asset that are not based on observable market data. The extent to which the fair value could reasonably vary in the near term has been quantified by evaluating the effect of changes in significant underlying assumptions used to estimate the fair value amount. If the life expectancies were increased or decreased by 4 months and the discount factors were increased or decreased by 1% while all other variables were held constant, the carrying value

21


of the investment in life insurance policies would increase or (decrease) by the unaudited amounts summarized below as of September 30, 2015 and December 31, 2014:
 
 
Change in life expectancy
(Amounts in Thousands)
 
Plus 4 Months
 
Minus 4 Months
Investment in life policies:
 
 

 
 

September 30, 2015
 
$
(35,235
)
 
$
37,787

December 31, 2014
 
$
(34,686
)
 
$
36,486

 
 
Change in discount rate (1)
(Amounts in Thousands)
 
Plus 1%
 
Minus 1%
Investment in life policies:
 
 

 
 

September 30, 2015
 
$
(22,330
)
 
$
24,938

December 31, 2014
 
$
(22,705
)
 
$
25,456

 
(1)
Discount rate is a present value calculation that considers legal risk, credit risk and liquidity risk and is a component of EDR.

5.
Investment in Life Settlements
 
The Company currently has a 50% ownership interest in each of four entities (collectively, the "LSC Entities") formed for the purpose of acquiring life settlement contracts, with a subsidiary of NGHC owning the other 50%. A life settlement contract is a contract between the owner of a life insurance policy and a third-party who obtains the ownership and beneficiary rights of the underlying life insurance policy.

The LSC Entities may also acquire premium finance loans made in connection with the borrowers’ purchase of life insurance policies that are secured by the policies. The LSC Entities acquire the underlying policies through the borrowers’ voluntary surrender of the policy in satisfaction of the loan or foreclosure. A third party serves as the administrator for two of the life settlement contract portfolios, for which it receives an administrative fee. The third party administrator is eligible to receive a percentage of profits after certain time and performance thresholds have been met. The Company provides certain actuarial and finance functions related to the LSC Entities. In conjunction with the Company’s approximate 12% ownership percentage of NGHC, the Company ultimately receives approximately 56% of the profits and losses of the LSC Entities. As such, in accordance with ASC 810-10, Consolidation, the Company has been deemed the primary beneficiary and, therefore, consolidates the LSC Entities.

The Company accounts for investments in life settlements in accordance with ASC 325-30, Investments in Insurance Contracts, which states that an investor shall elect to account for its investments in life settlement contracts by using either the investment method or the fair value method. The election is made on an instrument-by-instrument basis and is irrevocable. The Company has elected to account for these policies using the fair value method. Refer to Note 4 "Fair Value of Financial Instruments" for the discussion of the determination of the fair value of the Company's investment in life settlement contracts.

During the three months ended September 30, 2015 and 2014, total capital contributions made to the LSC entities were approximately $0 and $11,577, respectively, of which the Company contributed approximately $0 and $5,789, in those same periods, respectively. During the nine months ended September 30, 2015 and 2014, total capital contributions made to the LSC Entities were approximately $1,130 and $33,353, respectively, of which the Company contributed approximately $565 and $16,489 in those same periods, respectively. The LSC Entities used the contributed capital to pay premiums and purchase policies. The Company’s investments in life settlements were approximately $271,249 and $264,517 as of September 30, 2015 and December 31, 2014, respectively, and are included in other assets on the condensed consolidated balance sheet. The Company recorded a gain of $4,616 and $19,085 on investment in life settlement contracts, net of profit commission, for the three and nine months ended September 30, 2015, respectively. The Company recorded a loss of $2,910 and $5,180 on investment in life settlement contracts, net of profit commission, for the three and nine months ended September 30, 2014, respectively.
 

22


The following tables describe the Company’s investment in life settlements as of September 30, 2015 and December 31, 2014:
 
(Amounts in Thousands, except number of Life Settlement Contracts) 
Expected Maturity Term in Years
 
Number of Life Settlement Contracts
 
Fair Value (1)
 
Face Value
As of September 30, 2015
 
 
 
 
 
 
0-1
 
—

 
$
—

 
$
—

1-2
 
—

 
—

 
—

2-3
 
8

 
40,905

 
70,500

3-4
 
9

 
22,369

 
56,500

4-5
 
10

 
26,457

 
73,000

Thereafter
 
229

 
181,518

 
1,430,313

Total
 
256

 
$
271,249

 
$
1,630,313

(Amounts in Thousands, except number of Life Settlement Contracts) 
Expected Maturity Term in Years
 
Number of Life Settlement Contracts
 
Fair Value (1)
 
Face Value
As of December 31, 2014
 
 
 
 
 
 
0-1
 
—

 
$
—

 
$
—

1-2
 
—

 
—

 
—

2-3
 
8

 
43,593

 
70,500

3-4
 
5

 
10,081

 
22,500

4-5
 
7

 
14,335

 
49,000

Thereafter
 
254

 
196,508

 
1,596,209

Total
 
274

 
$
264,517

 
$
1,738,209


(1) 
The Company determined the fair value as of September 30, 2015 based on 212 policies out of 256 policies, as the Company assigned no value to 44 of the policies as of September 30, 2015. The Company determined the fair value as of December 31, 2014 based on 218 policies out of 274 policies, as the Company assigned no value to 56 of the policies as of December 31, 2014. The Company estimated the fair value of a life insurance policy using a cash flow model with an appropriate discount rate. In some cases, the cash flow model calculates the value of an individual policy to be negative, and therefore the fair value of the policy is zero as no liability exists when a negative value is calculated. The Company is not contractually bound to pay the premium on its life settlement contracts and, therefore, would not pay a willing buyer to assume title of these contracts. Additionally, certain of the Company's acquired policies were structured to have low premium payments at inception of the policy term, which later escalate greatly towards the tail end of the policy term. At the current time, the Company expenses all premium paid, even on policies with zero fair value. Once the premium payments escalate, the Company may allow the policies to lapse. In the event that death benefits are realized in the time frame between initial acquisition and premium escalation, it is a benefit to cash flow. 

For these contracts where the Company determined the fair value to be negative and therefore assigned a fair value of zero, the table below details the amount of premiums paid and the death benefits received during the twelve months preceding September 30, 2015 and December 31, 2014: 
(Amounts in Thousands, except number of Life Settlement Contracts)
 
September 30, 2015
 
December 31, 2014
Number of policies with a negative value from discounted cash flow model as of period end
 
44

 
56

Premiums paid for the preceding twelve month period for period ended
 
$
5,439

 
$
5,963

Death benefit received
 
$
—

 
$
4,950



23


Premiums to be paid by the LSC Entities for each of the five succeeding fiscal years to keep the life insurance policies in force as of September 30, 2015, are as follows:
 
(Amounts in Thousands)
 
Premiums Due on Life  Settlement Contracts
2015
 
$
45,181

2016
 
60,707

2017
 
40,446

2018
 
40,079

2019
 
37,652

Thereafter
 
514,923

Total
 
$
738,988

   

6. Deferred Policy Acquisition Costs

The following table reflects the amounts of policy acquisition costs deferred and amortized for the the three and nine months ended September 30, 2015 and 2014:

 
 
Three Months Ended September 30,
 
Nine Months Ended September 30,
(Amounts in Thousands)
 
2015
 
2014
 
2015
 
2014
Balance, beginning of period
 
$
695,150

 
$
609,743

 
$
628,383

 
$
468,404

Acquisition costs deferred
 
190,632

 
165,892

 
582,091

 
536,895

Amortization
 
(171,556
)
 
(143,951
)
 
(496,248
)
 
(373,615
)
Balance, end of period
 
$
714,226

 
$
631,684

 
$
714,226

 
$
631,684


7. Debt
 
The Company’s outstanding debt consisted of the following at September 30, 2015 and December 31, 2014:

 
(Amounts in Thousands)
 
September 30, 2015

December 31, 2014
Revolving credit facility
 
$
130,000

 
$
120,000

5.5% Convertible senior notes due 2021 (the "2021 Notes")
 
5,163


56,745

6.125% Senior notes due 2023 (the "2023 Notes")
 
250,000


250,000

Junior subordinated debentures due 2035 through 2037 (the "2035-2037 Notes")
 
123,714


123,714

2.75% Convertible senior notes due 2044 (the "2044 Notes")
 
161,706

 
157,679

7.25% Subordinated Notes due 2055 (the "7.25% 2055 Notes")
 
150,000

 
—

7.50% Subordinated Notes due 2055 (the "7.50% 2055 Notes")
 
135,000

 
—

Secured loan agreements
 
40,251


35,233

Promissory notes
 
14,500


14,500

 
 
$
1,010,334


$
757,871


 

24


Aggregate scheduled maturities of the Company’s outstanding debt at September 30, 2015 are:
(Amounts in Thousands)
 
 
 
2015
 
$
131,768

(1) 
2016
 
7,186

 
2017
 
7,423

 
2018
 
9,590

 
2019
 
4,467

 
Thereafter
 
849,900

(2) 
 
(1) 
Amount includes debt outstanding under revolving credit facility as of September 30, 2015. 
(2) 
Amount includes debt outstanding under the 2021 Notes and 2044 Notes, which is net of unamortized original issue discount of $878 and $50,887, respectively. 

Additionally, the Company utilizes various letters of credit in its operations. The following is a summary of the Company's letters of credit as of September 30, 2015:

(Amounts in Thousands)

 
Letters of Credit Limit
 
Letters of Credit Outstanding
 
Letters of Credit Available
Revolving credit facility
 
$
175,000

 
$
118,014

 
$
56,986

Funds at Lloyd's facility, in USD equivalent
 
355,485

 
355,485

 
—

Comerica bank letters of credit
 
75,000

 
48,467

 
26,533

Other letters of credit, in aggregate
 
255

 
255

 
—


Interest expense, including amortization of original issue discount and deferred origination costs, as well as applicable bank fees, related to the Company's outstanding debt and letters of credit for the three and nine months ended September 30, 2015 and 2014 was:

 
 
Three Months Ended September 30,
 
Nine Months Ended September 30,
(Amounts in Thousands)
 
2015
 
2014
 
2015
 
2014
Revolving credit facility
 
$
1,092


$
356


$
2,636


$
1,107

Funds at Lloyd's facility
 
639

 
754

 
2,320

 
2,067

2021 Notes
 
117


3,709


711


11,031

2023 Notes
 
3,896

 
3,896

 
11,690

 
11,690

2035-2037 Notes
 
1,442


2,028


5,157


6,076

2044 Notes
 
3,065

 
—

 
9,096

 
—

7.25% 2055 Notes
 
2,750

 
—

 
3,118

 
—

7.50% 2055 Notes
 
408

 
—

 
408

 
—

Secured loan agreements
 
212

 
138

 
671

 
309

Promissory notes
 
157

 
264

 
467

 
524

Other, including interest income
 
(916
)
 
656

 
(3,511
)
 
3,081

 
 
$
12,862

 
$
11,801

 
$
32,763

 
$
35,885


7.25% 2055 Notes
 
In June 2015, the Company issued $150,000 in aggregate principal amount of its 7.25% 2055 Notes through an underwritten public offering. The 7.25% 2055 Notes bear interest at an annual rate equal to 7.25%, payable quarterly in arrears on March 15, June 15, September 15 and December 15 of each year, commencing September 15, 2015. The 7.25% 2055 Notes mature on June 15, 2055. The Company has the right to redeem the 7.25% 2055 Notes, in whole or in part, on June 18, 2020, or on any interest payment date thereafter, at a redemption price equal to 100% of the principal amount of the 7.25% 2055 Notes plus accrued and unpaid interest to, but not including, the date of redemption.

25



The 7.25% 2055 Notes are the Company’s subordinated unsecured obligations and rank (i) senior in right of payment to any existing and future junior subordinated debt, (ii) equal in right of payment with any unsecured, subordinated debt that the Company incurs in the future that ranks equally with the 7.25% 2055 Notes (including the 7.50% 2055 Notes discussed below), and (iii) subordinate in right of payment to any of the Company’s existing and future senior debt. In addition, the 7.25% 2055 Notes are structurally subordinated to all existing and future indebtedness, liabilities and other obligations of the Company’s subsidiaries.

The Company incurred $4,990 in deferred origination costs associated with the 7.25% 2055 Notes, which is being amortized over the term of the 7.25% 2055 Notes. Deferred origination costs are included in other assets on the accompanying condensed consolidated balance sheet.

7.50% 2055 Notes

In September 2015, the Company issued $135,000 in aggregate principal amount of its 7.50% 2055 Notes through an underwritten public offering. The 7.50% 2055 Notes bear interest at an annual rate equal to 7.50%, payable quarterly in arrears on March 15, June 15, September 15 and December 15 of each year, commencing December 15, 2015. The 7.50% 2055 Notes mature on September 15, 2055. The Company has the right to redeem the 7.50% 2055 Notes, in whole or in part, on September 16, 2020, or on any interest payment date thereafter, at a redemption price equal to 100% of the principal amount of the 7.50% 2055 Notes plus accrued and unpaid interest to, but not including, the date of redemption.

The 7.50% 2055 Notes are the Company’s subordinated unsecured obligations and rank (i) senior in right of payment to any of the Company's existing and future junior subordinated debt, (ii) equal in right of payment with any of the Company's existing and future unsecured, subordinated debt that ranks equally with the 7.50% 2055 Notes (including the 7.25% 2055 Notes), and (iii) subordinate in right of payment to any of the Company’s existing and future senior debt. In addition, the 7.50% 2055 Notes are structurally subordinated to all existing and future indebtedness, liabilities and other obligations of the Company’s subsidiaries.

The Company incurred $4,461 in deferred origination costs associated with the 7.50% 2055 Notes, which is being amortized over the term of the 7.50% 2055 Notes. Deferred origination costs are included in other assets on the accompanying condensed consolidated balance sheet.

Credit Facilities

In July 2015, ING Bank transferred £50,000 (or $75,635) of its £235,000 (or $355,485) commitment under the Funds at Lloyd's facility to The Bank of Nova Scotia. As a result of The Bank of Nova Scotia's participation, the Company changed the title of its description of the former ING Credit Facility to the Funds at Lloyd's facility.

Secured Loan Agreements

In September 2015, the Company, through a subsidiary, entered into a seven year mortgage agreement in the aggregate principal amount of $10,250 to finance the purchase of a building. The mortgage bears interest at an annual rate equal to 3.75% and matures on September 18, 2022, with an option to extend the maturity date for an additional five years. The mortgage does not require monthly installments of principal until November 2017, but will require monthly principal payments thereafter. The final monthly payment will equal the then outstanding principal balance of the mortgage, together with all accrued and unpaid interest.

2021 Notes Conversion
 
Prior to September 15, 2021, the 2021 Notes are convertible during any fiscal quarter, and only during any such fiscal quarter, if the last reported sale price of the Company’s common stock was greater than or equal to 130% of the applicable conversion price for at least 20 trading days (whether or not consecutive) during the 30 consecutive trading days ending on the last trading day of the previous fiscal quarter (the "Sale Price Condition"). During the three and nine months ended September 30, 2015, $8,470 and $62,078, respectively, of the 2021 Notes were converted under the Sales Price Condition for cash in the amount of $8,470 and $62,079, respectively, and issuance of 200,328 and 1,270,539 shares of common stock, respectively. As a result of the conversion, the Company recorded a loss on extinguishment of debt in the amount of $557 and $5,271, respectively, during the three and nine months ended September 30, 2015. As of September 30, 2015, $6,041 in aggregate principal amount of the 2021 Notes remains outstanding.

26



8.
Acquisition Costs and Other Underwriting Expenses
 
The following table summarizes the components of acquisition costs and other underwriting expenses for the three and nine months ended September 30, 2015 and 2014:

 
 
Three Months Ended September 30,
 
Nine Months Ended September 30,
(Amounts in Thousands)
 
2015
 
2014
 
2015
 
2014
Policy acquisition expenses
 
$
131,083

 
$
122,331

 
$
336,977

 
$
332,219

Salaries and benefits
 
112,769

 
92,621

 
355,927

 
262,150

Other insurance general and administrative expenses
 
14,164

 
10,560

 
35,498

 
25,812

 
 
$
258,016

 
$
225,512

 
$
728,402

 
$
620,181

 
9. Earnings Per Share
 
Effective January 1, 2009, the Company adopted ASC subtopic 260-10, Determining Whether Instruments Granted in Share-Based Payments Transactions Are Participating Securities. ASC 260-10 provides that unvested share-based payment awards that contain nonforfeitable rights to dividends or dividend equivalents, whether paid or unpaid, are participating securities and are to be included in the computation of earnings per share under the two-class method. The Company’s unvested restricted shares contain rights to receive nonforfeitable dividends and are participating securities, requiring the two-class method of computing earnings per share.

The following table is a summary of the elements used in calculating basic and diluted earnings per share for the three and nine months ended September 30, 2015 and 2014:
 
 
 
Three Months Ended September 30,
 
Nine Months Ended September 30,
(Amounts in Thousands, except for earnings per share)
 
2015
 
2014
 
2015
 
2014
Basic earnings per share:
 
 
 
 
 
 
 
 
Net income attributable to AmTrust common shareholders
 
$
182,708

 
$
156,590

 
$
408,152

 
$
362,715

Less: Net income allocated to participating securities and redeemable non-controlling interest
 
469

 
545

 
1,072

 
1,174

Net income allocated to AmTrust common shareholders
 
$
182,239

 
$
156,045

 
$
407,080

 
$
361,541

 
 
 
 
 
 
 
 
 
Weighted average common shares outstanding – basic
 
82,804

 
74,809

 
82,235

 
74,934

Less: Weighted average participating shares outstanding
 
213

 
261

 
216

 
243

Weighted average common shares outstanding - basic
 
82,591

 
74,548

 
82,019

 
74,691

Net income per AmTrust common share - basic
 
$
2.21

 
$
2.09

 
$
4.96

 
$
4.84

 
 
 
 
 
 
 
 
 
Diluted earnings per share:
 
 

 
 

 
 

 
 

Net income attributable to AmTrust common shareholders
 
$
182,708

 
$
156,590

 
$
408,152

 
$
362,715

Less: Net income allocated to participating securities and redeemable non-controlling interest
 
469

 
545

 
1,072

 
1,174

Net income allocated to AmTrust common shareholders
 
$
182,239

 
$
156,045

 
$
407,080

 
$
361,541

 
 
 
 
 
 
 
 
 
Weighted average common shares outstanding – basic
 
82,591

 
74,548

 
82,019

 
74,691

Plus: Dilutive effect of stock options, convertible debt, other
 
1,545

 
4,841

 
1,727

 
4,394

Weighted average common shares outstanding – dilutive
 
84,136

 
79,389

 
83,746

 
79,085

Net income per AmTrust common shares – diluted
 
$
2.17

 
$
1.97

 
$
4.86

 
$
4.57

 

27


For the three and nine months ended September 30, 2015, there were approximately 16,000 anti-dilutive securities excluded from diluted earnings per share. For the three and nine months ended September 30, 2014, there were approximately 5,000 anti-dilutive securities excluded from diluted earnings per share.


10. Share Based Compensation
 
The Company’s 2010 Omnibus Incentive Plan (the “Plan”), which permits the Company to grant to its officers, employees and non-employee directors incentive compensation directly linked to the price of the Company’s stock, authorizes up to an aggregate of 7,315,068 shares of Company stock for awards of options to purchase shares of the Company’s common stock ("Stock Option"), restricted stock, restricted stock units (“RSU”), performance share units (“PSU”) or appreciation rights. Shares used may be either newly issued shares or treasury shares or both. The aggregate number of shares of common stock for which awards may be issued may not exceed 7,315,068 shares, subject to the authority of the Company’s board of directors to adjust this amount in the event of a consolidation, reorganization, stock dividend, stock split, recapitalization or similar transaction affecting the Company’s common stock. As of September 30, 2015, approximately 4,200,000 shares of Company common stock remained available for grants under the Plan.

The Company recognizes compensation expense under FASB ASC 718-10-25 for its share-based payments based on the fair value of the awards. Compensation expense for all share-based payments under ASC 718-10-30 was approximately $6,242 and $5,250 for the three months ended September 30, 2015 and 2014, respectively, and $16,678 and $13,911, for the nine months ended September 30, 2015 and 2014, respectively. The Company has unrecognized compensation cost related to unvested stock options, restricted stock and non-vested RSU awards of $44,876 and $36,882 at September 30, 2015 and December 31, 2014, respectively.
 
Stock Options

The Company grants stock options at prices equal to the closing stock price of the Company’s stock on the dates the options are granted. The options have a term of ten years from the date of grant and vest primarily in equal annual installments over the four year period following the date of grant for employee options. The Company uses the simplified method in determining the expected life. Employees have three months after the employment relationship ends to exercise all vested options. The fair value of each option grant is separately estimated for each vesting date. The fair value of each option is amortized into compensation expense on a straight-line basis between the grant date for the award and each vesting date. The Company has estimated the fair value of all stock option awards as of the date of the grant by applying the Black-Scholes-Merton multiple-option pricing valuation model. The application of this valuation model involves assumptions that are judgmental and highly sensitive in the determination of compensation expense.

The following schedule shows all options granted, exercised, and expired under the Plan for the nine months ended September 30, 2015 and 2014:
 
 
2015
 
2014
 
 
 
Shares
 
Weighted Average Exercise Price
 
 
 
Shares
 
Weighted Average Exercise Price
Outstanding at beginning of period
1,934,370

 
$
11.60

 
2,997,460

 
$
10.49

Granted
42,500

 
54.17

 
27,500

 
32.49

Exercised
(509,475
)
 
9.30

 
(765,603
)
 
8.81

Canceled or terminated
(37,574
)
 
18.34

 
(8,470
)
 
7.03

Outstanding at end of period
1,429,821

 
13.50

 
2,250,887

 
11.35

 
The weighted average per share fair value of options granted during the nine months ended September 30, 2015 and 2014 was approximately $21.87 and $14.16, respectively.


28


The per share fair value of options was estimated at the date of grant based on the following weighted average assumptions for the nine months ended September 30, 2015 and 2014:

 
 
2015
 
2014
Volatility
 
40.95
%
 
41.89
%
Risk-free interest rate
 
1.95
%
 
2.73
%
Weighted average expected lives in years
 
6.25

 
6.25

Dividend rate
 
1.85
%
 
1.72
%
Forfeiture rate
 
0.50
%
 
0.50
%

The intrinsic value of stock options exercised during the nine months ended September 30, 2015 and 2014 was $24,000 and $22,867, respectively. The intrinsic value of stock options that were outstanding as of September 30, 2015 and 2014 was $70,743 and $64,088, respectively.

Cash received from options exercised was $4,582 and $4,981 during the nine months ended September 30, 2015 and 2014, respectively. The excess tax benefit from award exercises was approximately $7,561 and $4,721 for the nine months ended September 30, 2015 and 2014, respectively.

Restricted stock, RSU and PSU

The Company grants restricted shares, RSUs and PSUs with a grant date fair value equal to the closing stock price of the Company’s stock on the dates the shares or units are granted. The restricted shares and RSUs vest over a period of one to four years, while PSUs vest based on the terms of the awards.

A summary of the Company’s restricted stock and RSU activity for the nine months ended September 30, 2015 and 2014 is shown below:
 
2015
 
2014
 
Shares or
Units
 
Weighted Average Grant Date Fair Value
 
Shares or
Units
 
Weighted Average Grant Date Fair Value
Non-vested at beginning of period
1,305,511

 
$
33.41

 
917,015

 
$
24.43

Granted
232,700

 
58.37

 
883,323

 
38.94

Vested
(419,459
)
 
29.06

 
(321,353
)
 
22.57

Forfeited
(16,824
)
 
41.90

 
(6,123
)
 
23.20

Non-vested at end of period
1,101,928

 
40.21

 
1,472,862

 
33.54

 
The Company has 379,297 PSUs outstanding as of September 30, 2015. PSUs are conditional grants of a specified maximum number of common shares. In general, grants are earned, subject to the attainment of pre-specified performance goals at the end of the pre-determined period. During the nine months ended September 30, 2015, the Company granted 186,814 PSUs with an aggregated fair value of $11,183. During the nine months ended September 30, 2014, the Company granted 169,075 PSUs with an aggregated fair value of $7,641. In addition, during the nine months ended September 30, 2014, 347,875 PSUs were converted to restricted share awards based on achievement of certain performance targets. During the nine months ended September 30, 2015, 77,921 PSUs vested, while 39,710 PSUs vested during the same period in 2014. In addition, 4,431 and 11,547 PSUs were forfeited during the nine months ended September 30, 2015 and 2014, respectively.

29


 
11. Income Taxes
 
The following table is a reconciliation of the Company’s statutory income tax expense to its effective tax rate for the three and nine months ended September 30, 2015 and 2014:
 
 
 
Three Months Ended September 30,
 
Nine Months Ended September 30,
(Amounts in Thousands)
 
2015
 
2014
 
2015
 
2014
Income before equity in earnings of unconsolidated subsidiaries
 
$
166,882

 
$
145,160

 
$
453,476

 
$
373,972

Tax at federal statutory rate of 35%
 
$
58,409

 
$
50,806

 
$
158,717

 
$
130,890

Tax effects resulting from:
 
 

 
 

 
 

 
 
Loss of non-includible foreign subsidiaries
 
10,816

 
(30,604
)
 
(6,797
)
 
(93,737
)
Other, net
 
(81,874
)
 
(27,866
)
 
(113,285
)
 
593

 
 
$
(12,649
)

$
(7,664
)

$
38,635

 
$
37,746

Effective tax rate
 
(7.6
)%
 
(5.3
)%
 
8.5
%
 
10.1
%
 
The Company's effective tax rate was positively impacted by approximately 12.4% and 9.8% during the three and nine months ended September 30, 2014, respectively, due to a decrease in the deferred tax liability associated with the Company's equalization reserves for its Luxembourg reinsurers. Without the impact of the equalization reserve, the effective tax rates for the three and nine months ended September 30, 2014 would have been 7.1% and 19.9%, respectively. The Company did not utilize any of the equalization reserves of its Luxembourg reinsurers during the three and ninth months ended September 30, 2015. In addition, the overall decrease in the effective tax rates in the three months ended September 30, 2015 compared to the three months ended September 30, 2014 was impacted by a change in the profitability by jurisdiction.

The effective tax rate during the three and nine months ended September 30, 2015 and September 30, 2014 was impacted by favorable return to provision adjustments in connection with the filing of the Company's 2014 and 2013 federal income tax returns, respectively. Without the impacts of the favorable return to provision adjustments and the decrease in deferred tax liability associated with the equalization reserves, the Company's effective tax rate for the three months ended September 30, 2015 and 2014 would have been approximately 27.2% and 25.9%, respectively, and for the nine months ended September 30, 2015 and 2014 would have been approximately 25.6% and 27.2%, respectively.

The Company’s management believes that as of September 30, 2015, except for a portion of foreign net operating losses ("NOLs"), it will realize the benefits of its deferred tax assets, which are included as a component of the net deferred income taxes on the condensed consolidated balance sheet. As a result, the Company recorded a valuation allowance of $17,013 as of September 30, 2015 related to the foreign NOLs.  No valuation allowance was recorded as of December 31, 2014. The earnings of certain of the Company’s foreign subsidiaries have been indefinitely reinvested in foreign operations. Therefore, no provision has been made for any U.S. taxes or foreign withholding taxes that may be applicable upon any repatriation or disposition.
 
As of September 30, 2015, the Company has U.S. NOL of $24,368 that expire beginning in 2019 through 2033. In addition, these NOLs are subject to certain limitations under Section 382 of the Internal Revenue Code due to changes in ownership of $1,723 per year. The Company also has foreign NOLs of $503,483 that currently have no expiration.

The Company’s major taxing jurisdictions include the U.S. (federal and state), the United Kingdom and Ireland. The years subject to potential audit vary depending on the tax jurisdiction. Generally, the Company’s statute of limitation is open for tax years ended December 31, 2011 and forward.

As permitted by FASB ASC 740-10 Income Taxes, the Company recognizes interest and penalties, if any, related to unrecognized tax benefits in its income tax provision. The Company does not have any unrecognized tax benefits and, therefore, has not recorded any unrecognized tax benefits, or any related interest and penalties, as of September 30, 2015 and December 31, 2014. No interest or penalties have been recorded by the Company for the three or nine months ended September 30, 2015 and 2014, respectively. The Company does not anticipate any significant changes to its total unrecognized tax benefits in the next 12 months.




30


12. Related Party Transactions
 
Significant Transactions with Maiden Holdings, Ltd.
 
The Company has various reinsurance and service agreements with Maiden Holdings, Ltd. (“Maiden”). Maiden is a publicly-held Bermuda insurance holding company (Nasdaq: MHLD) formed by Michael Karfunkel, George Karfunkel and Barry Zyskind, principal shareholders, and, respectively, the chairman of the board of directors, a director, and the chief executive officer and director of the Company. As of September 30, 2015, our principal shareholders, Michael Karfunkel, Leah Karfunkel (wife of Michael Karfunkel and sole trustee of The Michael Karfunkel Family 2005 Trust), George Karfunkel and Barry Zyskind, own or control approximately 6.1%, 7.5%, 2.3% and 4.4%, respectively, of the issued and outstanding capital stock of Maiden. Mr. Zyskind serves as the non-executive chairman of the board of Maiden’s board of directors. Maiden Reinsurance Ltd. (“Maiden Reinsurance”), a wholly-owned subsidiary of Maiden, is a Bermuda reinsurer. The following section describes the agreements in place between the Company and its subsidiaries and Maiden and its subsidiaries.
 
Reinsurance Agreements with Maiden Holdings, Ltd.
 
In 2007, the Company and Maiden entered into a master agreement, as amended, by which the parties caused the Company’s Bermuda subsidiary, AmTrust International Insurance, Ltd. (“AII”), and Maiden Reinsurance to enter into a quota share reinsurance agreement (the “Maiden Quota Share”), as amended, by which AII retrocedes to Maiden Reinsurance an amount equal to 40% of the premium written by the Company’s U.S., Irish and U.K. insurance companies (the “AmTrust Ceding Insurers”), net of the cost of unaffiliated inuring reinsurance (and in the case of the Company’s U.K. insurance subsidiary, AmTrust Europe Ltd. ("AEL"), net of commissions). AII also retrocedes 40% of losses. Certain business that the Company commenced writing after the effective date of the Maiden Quota Share, including the Company’s European medical liability business discussed below, business assumed from Tower Group International, Ltd. ("Tower") pursuant to the cut-through quota share reinsurance agreement, and risks, other than workers’ compensation risks and certain business written by the Company’s Irish subsidiary, AmTrust International Underwriters Limited (“AIU”), for which the AmTrust Ceding Insurers’ net retention exceeds $5,000 is not ceded to Maiden Reinsurance under the Maiden Quota Share (ceded business defined as “Covered Business”).

AII receives a ceding commission of 31% of ceded written premiums with respect to all Covered Business other than retail commercial package business, for which the ceding commission remains 34.375%. With regards to the Specialty Program portion of Covered Business only, the Company will be responsible for ultimate net loss otherwise recoverable from Maiden Reinsurance to the extent that the loss ratio to Maiden Reinsurance, which shall be determined on an inception to date basis from July 1, 2007 through the date of calculation, is between 81.5% and 95% (the "Specialty Program Loss Corridor"). For the purpose of determining whether the loss ratio falls within the Specialty Program Loss Corridor, workers’ compensation business written in the Company’s Specialty Program segment from July 1, 2007 through December 31, 2012 is excluded from the loss ratio calculation.

The Maiden Quota Share was renewed through June 30, 2019 and will automatically renew for successive three-year terms unless either AII or Maiden Reinsurance notifies the other of its election not to renew not less than nine months prior to the end of any such three-year term. In addition, either party is entitled to terminate on thirty days’ notice or less upon the occurrence of certain early termination events, which include a default in payment, insolvency, change in control of AII or Maiden Reinsurance, run-off, or a reduction of 50% or more of the shareholders’ equity of Maiden Reinsurance or the combined shareholders’ equity of AII and the AmTrust Ceding Insurers.

The Company, through its subsidiaries AEL and AIU, has a reinsurance agreement with Maiden Reinsurance by which the Company cedes to Maiden Reinsurance 40% of its European medical liability business, including business in force at April 1, 2011. The quota share had an initial term of one year and has been renewed through March 31, 2016. The agreement can be terminated by either party on four months’ prior written notice. Maiden Reinsurance pays the Company a 5% ceding commission, and the Company will earn a profit commission of 50% of the amount by which the ceded loss ratio is lower than 65%.

 

31


The following is the effect on the Company’s results of operations for the three and nine months ended September 30, 2015 and 2014 related to Maiden Reinsurance agreements:
 
 
Three Months Ended September 30,
 
Nine Months Ended September 30,
(Amounts in Thousands)
 
2015
 
2014
 
2015
 
2014
Results of operations:
 
 
 
 
 
 
 
 
Premium written – ceded
 
$
(453,981
)
 
$
(385,452
)
 
$
(1,504,701
)
 
$
(1,157,716
)
Change in unearned premium – ceded
 
(13,522
)
 
25,474

 
204,170

 
169,632

Earned premium - ceded
 
$
(467,503
)
 
$
(359,978
)
 
$
(1,300,531
)
 
$
(988,084
)
Ceding commission on premium written
 
$
144,625

 
$
131,893

 
$
473,480

 
$
361,202

Ceding commission – deferred
 
(6,589
)
 
(22,353
)
 
(87,535
)
 
(72,311
)
Ceding commission – earned
 
$
138,036

 
$
109,540

 
$
385,945

 
$
288,891

Incurred loss and loss adjustment expense – ceded
 
$
346,123

 
$
229,045

 
$
932,053

 
$
666,026

 
Note Payable to Maiden – Collateral for Proportionate Share of Reinsurance Obligations
 
In conjunction with the Maiden Quota Share, as described above, the Company entered into a loan agreement with Maiden Reinsurance during the fourth quarter of 2007, whereby Maiden Reinsurance loaned to the Company the amount equal to AII's quota share of the obligations of the AmTrust Ceding Insurers that AII was then obligated to secure. The loan agreement provides for interest at a rate of LIBOR plus 90 basis points and is payable on a quarterly basis. Advances under the loan are secured by a promissory note and totaled $167,975 as of September 30, 2015 and December 31, 2014, respectively. The Company recorded $471 and $453 of interest expense during the three months ended September 30, 2015 and 2014, respectively, and $1,380 and $1,344 during the nine months ended September 30, 2015 and 2014, respectively. Effective December 1, 2008, AII and Maiden Reinsurance entered into a Reinsurer Trust Assets Collateral agreement whereby Maiden Reinsurance is required to provide AII the assets required to secure Maiden’s proportional share of the Company’s obligations to its U.S. subsidiaries. The amount of this collateral as of September 30, 2015 was approximately $2,481,112. Maiden retains ownership of the collateral in the trust account.
 
Reinsurance Brokerage Agreement
 
The Company, through a subsidiary, has a reinsurance brokerage agreement with Maiden. Pursuant to the brokerage agreement, the Company provides brokerage services relating to the Maiden Quota Share for a fee equal to 1.25% of reinsured premium. The Company recorded $5,828 and $4,814 of brokerage commission during the three months ended September 30, 2015 and 2014, respectively, and $18,688 and $14,484 during the nine months ended September 30, 2015 and 2014, respectively. The brokerage commission was recorded as a component of service and fee income.
 
Asset Management Agreement
 
The Company, through a subsidiary, has an asset management agreement with Maiden Reinsurance, pursuant to which the Company provides investment management services to Maiden Reinsurance and certain of its affiliates. As of September 30, 2015, the Company managed approximately $4,148,964 of assets related to this agreement. The asset management services fee is an annual rate of 0.20% for periods in which average invested assets are $1,000,000 or less and an annual rate of 0.15% for periods in which the average invested assets exceeds $1,000,000. As a result of this agreement, the Company recorded $1,518 and $1,325 of asset management fees during the three months ended September 30, 2015 and 2014, respectively, and $4,455 and $3,814 during the nine months ended September 30, 2015 and 2014, respectively. The asset management fees were recorded as a component of service and fee income.

Significant Transactions with National General Holding Corp.
 
The Company has an ownership interest in NGHC of approximately 12%. NGHC is a publicly-held specialty personal lines insurance holding company (Nasdaq: NGHC) that operates fifteen insurance companies in the United States and provides a variety of insurance products, including personal and commercial automobile, homeowners and umbrella, and supplemental health. As of September 30, 2015, NGHC's two largest shareholders are The Michael Karfunkel 2005 Family Trust (the “Trust”) and Michael Karfunkel individually. Michael Karfunkel is the Chairman of the Board of Directors of the Company and the father-in-law of Barry D. Zyskind, the Chief Executive Officer of the Company. The ultimate beneficiaries of the Trust include Michael Karfunkel’s children, one of whom is married to Mr. Zyskind. In addition, Michael Karfunkel is the chairman, president and chief executive

32


offer of NGHC. In accordance with ASC 323-10-15, Investments-Equity Method and Joint Ventures, the Company accounts for its investment in NGHC under the equity method as it has the ability to exert significant influence on NGHC's operations.

In August 2015, NGHC issued 11,500,000 shares in a follow on public offering, which resulted in the Company reducing its ownership percentage in NGHC from 13% to 12%. As a result of the stock issuance, the Company recognized a gain on sale of its equity investment of approximately $9,271, which is included in equity in earnings of unconsolidated subsidiary. Similarly, during the first quarter of 2014, the Company recognized a gain on sale of its equity investment of approximately $14,712 as a result of NGHC's issuance of shares in a follow on Rule 144A offering. In total, the Company recorded $13,477 and $4,332 of income during the three months ended September 30, 2015 and 2014, respectively, and $23,048 and $26,847 during the nine months ended September 30, 2015 and 2014, respectively. related to its equity investment in NGHC.

Master Services Agreement
 
The Company provides NGHC and its affiliates information technology development services in connection with the development and licensing of a policy management system. The Company provides the license at a cost that is currently 1.25% of gross written premium of NGHC and its affiliates plus the Company’s costs for development and support services. The Company provides development services at a price of cost plus 20%. In addition, the Company provides NGHC and its affiliates printing and mailing services at a per piece cost for policy and policy related materials, such as invoices, quotes, notices and endorsements, associated with the policies the Company processes for NGHC and its affiliates on the policy management system. The Company recorded approximately $8,650 and $6,140 of fee income during the three months ended September 30, 2015 and 2014, respectively, and $26,019 and $19,203 during the nine months ended September 30, 2015 and 2014, respectively, related to this agreement.The fees for these services were recorded as a component of service and fee income.

Asset Management Agreement
 
A subsidiary of the Company manages the assets of certain of NGHC's subsidiaries, including the assets of reciprocal insurers managed by subsidiaries of NGHC, for an annual fee equal to 0.20% of the average aggregate value of the assets under management for the preceding quarter if the average aggregate value for the preceding quarter is $1,000,000 or less and 0.15% of the average aggregate value of the assets under management for the preceding quarter if the average aggregate value for that quarter is more than $1,000,000. The Company managed approximately $1,715,275 of assets as of September 30, 2015 related to this agreement. As a result of this agreement, the Company earned approximately $720 and $564 of asset management fees during the three months ended September 30, 2015 and 2014, respectively, and $1,859 and $1,454 during the nine months ended September 30, 2015 and 2014, respectively. The asset management fees were recorded as a component of service and fee income.

As a result of the above service agreements with NGHC, the Company recorded fees totaling approximately $9,370 and $7,761 for the three months ended September 30, 2015 and 2014, respectively, and $27,878 and $21,714 during the nine months ended September 30, 2015 and 2014, respectively.

800 Superior, LLC

The Company and NGHC each have a fifty percent ownership interest in 800 Superior, LLC ("800 Superior"), which owns an office building in Cleveland, Ohio. The cost of the building was approximately $7,500. The Company has been appointed managing member of 800 Superior. Additionally, in conjunction with the Company’s 12% ownership percentage of NGHC, the Company ultimately receives 56% of the profits and losses of 800 Superior. As such, in accordance with ASC 810-10, Consolidation, the Company consolidates this entity. NGHC's portion of the net assets and earnings are recorded within non-controlling interest in the condensed consolidated financial statements.

NGHC has an office lease agreement with 800 Superior under which it currently leases approximately 157,000 square feet of office space. The lease agreement is through 2027. NGHC paid 800 Superior approximately $663 and $560 of rent during the three months ended September 30, 2015 and 2014, respectively, and $1,929 and $1,495 during the nine months ended September 30, 2015 and 2014, respectively, under the lease agreement. As discussed in Note 14. "New Market Tax Credit," 800 Superior, the Company and NGHC participated in a financing transaction related to capital improvements on the office building. As part of that transaction, NGHC and the Company entered into an agreement related to the payment and performance guaranties provided by the Company to the various parties to the financing transaction whereby NGHC has agreed to contribute 50% toward any payments the Company is required to make pursuant to the guaranties.


33


4455 LBJ Freeway, LLC

The Company and NGHC each have a fifty percent ownership interest in 4455 LBJ Freeway, LLC ("4455 LBJ Freeway"), which owns an office building in Dallas, Texas. The cost of the building was approximately $21,050. The Company has been appointed managing member of 4455 LBJ Freeway. Additionally, in conjunction with the Company’s 12% ownership percentage of NGHC, the Company ultimately receives 56% of the profits and losses of 4455 LBJ Freeway. As such, in accordance with ASC 810-10, Consolidation, the Company consolidates this entity. NGHC's portion of the net assets and earnings are recorded within non-controlling interest in the condensed consolidated financial statements.
 
Significant Transactions with ACP Re, Ltd.

ACP Re, Ltd. (“ACP Re”) is a privately-held Bermuda reinsurance holding company owned by the Trust. ACP Re operates 10 insurance companies in the United States and Bermuda as a result of its merger with Tower during the third quarter of 2014. The following section describes the agreements in place between the Company and its subsidiaries and ACP Re and its subsidiaries.

Asset Management Agreement

A subsidiary of the Company provides asset management services to ACP Re and certain of its subsidiaries at (i) an annual rate of 0.20% of the average value of the invested assets under management, excluding investment in AmTrust stock, for the preceding calendar quarter if the average value of such assets for the quarter was $1,000,000 or less, or (ii) an annual rate of 0.15% of the average value of the invested assets under management, excluding investment in AmTrust stock, for the preceding calendar quarter if the average value of such assets for the quarter was greater than $1,000,000. The Company managed approximately $1,221,803 of assets as of September 30, 2015, which included assets of the ten statutory insurance companies that ACP Re acquired as a result of its September 15, 2014 merger with Tower described below. The Company recorded approximately $457 and $66 of asset management fees during the three months ended September 30, 2015 and 2014, respectively, and $1,281 and $182 during the nine months ended September 30, 2015 and 2014, respectively. The asset management fees were recorded as a component of service and fee income.

Agreements as a result of ACP Re / Tower Merger

In January 2014, ACP Re, through a subsidiary, agreed to acquire 100% of the outstanding stock of Tower and merge with Tower on September 15, 2014 (the “Merger”). As a result of the Merger, the Company and ACP Re entered into the agreements and transactions described below, as well as an asset management agreement described above.
Commercial Lines Master Agreement
On July 23, 2014, the Company and ACP Re entered into the Amended and Restated Commercial Lines Master Agreement (the “Master Agreement”), which provides for the implementation of the various transactions associated with the acquisition of Tower by ACP Re pursuant to the Merger, including entering into the agreements described below, all of which became effective on September 15, 2014. In addition, the Master Agreement requires the Company to pay ACP Re contingent consideration in the form of a three year earn-out (the “Contingent Payments”), payable semi-annually on the last day of January and July, of 3% of gross written premium of the Tower commercial lines business written or assumed by the Company following the Merger. The Contingent Payments to be made by the Company are subject to a maximum of $30,000, in the aggregate, over the three-year period. NGHC will pay contingent consideration to ACP Re on the same terms. As a result of entering into this agreement, the Company initially assigned a value of $25,200 to the renewal rights, $1,700 to goodwill, and $26,900 to the contingent consideration, which is recorded as a component of accrued expense and other liability.
Commercial Lines Reinsurance Agreements
Technology Insurance Company, Inc. ("TIC") entered into the Commercial Lines Quota Share Reinsurance Agreement (the “CL Reinsurance Agreement”) with Tower’s ten statutory insurance companies (the “Tower Companies”) pursuant to which TIC reinsures 100% of all losses under the Tower Companies’ new and renewal commercial lines business written after September 15, 2014. The ceding commission payable by TIC under the CL Reinsurance Agreement is equal to the sum of (i) reimbursement of the Tower Companies’ acquisition costs in respect of the business covered, including commission payable to AmTrust North America, Inc., a subsidiary of the Company (“ANA”), pursuant to the CL MGA Agreement described below, and premium taxes and (ii) 2% of gross written premium (net of cancellations and return premiums) collected pursuant to the CL MGA Agreement described below. The CL Reinsurance Agreement will remain in effect until termination of the CL MGA Agreement. As a result of the Master Agreement and CL Reinsurance Agreement, the Company generated approximately $104,984 and $296,825 of gross

34


written premium, recorded approximately $100,162 and $266,149 of earned premium, and incurred approximately $24,449 and $95,124 of loss and loss adjustment expense during the three and nine months ended September 30, 2015, respectively.
In connection with the execution of the CL Reinsurance Agreement, the Commercial Lines Cut-Through Quota Share Reinsurance Agreement, dated January 3, 2014, between TIC and the Tower Companies whereby TIC, through a 100% quota share, reinsured at least 60% of the Tower Companies’ then in-force commercial lines policies and most new and renewal commercial lines business from January 3, 2014 forward, was terminated on a run-off basis, with the reinsurance of all policies reinsured under that agreement remaining in effect. During the three and nine months ended September 30, 2014, the Company assumed approximately $68,312 and $475,038 of gross written premium, respectively, recorded approximately $104,250 and $300,288 of earned premium, respectively, and incurred approximately $72,586 and $198,050 of loss and loss adjustment expense, respectively, related to the Cut-Through Reinsurance Agreement. Additionally, the Company incurred approximately $26,302 and $71,712 of commission expense and $4,384 and $12,444 of unallocated claims expense during the three and nine months ended September 30, 2014, respectively.
Commercial Lines MGA Agreement
ANA produces and manages all new and renewal commercial lines business written by the Tower Companies pursuant to the Commercial Lines Managing General Agency Agreement (the “CL MGA Agreement”). As described above, all post-September 15, 2014 commercial lines business written by the Tower Companies is reinsured by TIC pursuant to the CL Reinsurance Agreement. The Tower Companies pay ANA a 10% commission on all business written pursuant to the CL MGA Agreement and reimburse ANA for commissions payable to agents producing such business. All payments by the Tower Companies to ANA pursuant to the CL MGA Agreement will be netted out of the ceding commission payable by TIC to the Tower Companies pursuant to the CL Reinsurance Agreement. The CL MGA Agreement has a term of ten years. The Company recorded $1,386 and $3,444 of commission under the CL MGA Agreement during the three and nine months ended September 30, 2015, respectively. The impact of the CL MGA Agreement on the Company during the three and nine months ended September 30, 2014 was immaterial. The commission income was recorded as a component of service and fee income.
Commercial Lines Administrative Services Agreement
ANA, the Tower Companies and CastlePoint Reinsurance Company, Ltd. (“CP Re,” a subsidiary of ACP Re) entered into the Commercial Lines LPTA Administrative Services Agreement (the “CL Administrative Agreement”) pursuant to which ANA administers the runoff of CP Re’s and the Tower Companies’ commercial lines business written prior to September 15, 2014 at cost. CP Re and the Tower Companies reimburse ANA for its actual costs, including costs incurred in connection with claims operations, out-of-pocket expenses, costs incurred in connection with any required modifications to ANA’s claims systems and an allocated portion of the claims service expenses paid by TIC to the Tower Companies pursuant to the CL Reinsurance Agreement. The CL Administrative Agreement will remain in effect until the first to occur of (i) the completed performance of all obligations and duties arising under the agreement, or (ii) mutual written consent. The Company charged ACP Re $6,033 and $29,589 for these services during the three and nine months ended September 30, 2015, which were recorded as a reduction of salary and other expense.
Stop-Loss and Retrocession Agreements
AII and National General Re, Ltd., a subsidiary of NGHC (“NG Re Ltd.”), as reinsurers, entered into a $250,000 Aggregate Stop Loss Reinsurance Agreement (the “Stop-Loss Agreement”) with CP Re. AII and NG Re Ltd. also entered into an Aggregate Stop Loss Retrocession Contract (the “Retrocession Agreement”) with ACP Re pursuant to which ACP Re will reinsure the full amount of any payments that AII and NG Re Ltd. are obligated to make to CP Re under the Stop-Loss Agreement. Pursuant to the Stop-Loss Agreement, each of the Company and NGHC will provide, severally, $125,000 of stop loss coverage with respect to the run-off of the Tower business written on or before September 15, 2014. The reinsurers’ obligation to indemnify CP Re under the Stop-Loss Agreement will be triggered only at such time as CP Re’s ultimate net loss related to the run-off of the pre-September 15, 2014 Tower business exceeds a retention equal to the Tower Companies’ loss and loss adjustment reserves and unearned premium reserves as of September 15, 2014. CP Re will pay AII and NG Re Ltd. total premium of $56,000 on the five-year anniversary of the Stop-Loss Agreement. The premium payable by AII and NG Re Ltd. to ACP Re pursuant to the Retrocession Agreement will be $56,000 in the aggregate, less a ceding commission of 5.5% to be retained by AII and NG Re Ltd.
Credit Agreement
The Company, AII, and NG Re Ltd. entered into a credit agreement (the “ACP Re Credit Agreement”) among the Company, as Administrative Agent, ACP Re and Tower, now a wholly-owned subsidiary of ACP Re, as the borrowers (collectively, the “Borrowers”), ACP Re Holdings, LLC, as Guarantor, and AII and NG Re Ltd., as Lenders pursuant to which the Lenders made a

35


$250,000 loan ($125,000 made by each Lender) to the Borrowers. ACP Re used the proceeds of such loan to (i) finance the Merger, (ii) repay certain indebtedness of Tower and its related companies in connection with the Merger, and (iii) pay certain transaction costs and expenses incurred by the Borrowers in connection with the Merger.
The ACP Re Credit Agreement has a maturity date of September 15, 2021. Outstanding borrowings under the ACP Re Credit Agreement bear interest at a fixed annual rate of 7%, payable semi-annually on the last day of January and July. Fees payable to the Company for its service as Administrative Agent include an annual fee equal to $30, plus reimbursement of costs, expenses and certain other charges. The obligations of the Borrowers are secured by (i) a first-priority pledge of 100% of the stock of ACP Re and ACP Re’s U.S. subsidiaries and 65% of the stock of certain of ACP Re’s foreign subsidiaries, and (ii) a first-priority lien on all of the assets of the Borrowers and Guarantor and certain of the assets of ACP Re’s subsidiaries (other than the Tower Companies).
The Borrowers have the right to prepay the amounts borrowed, in whole or in part. The Borrowers are required to prepay the amounts borrowed within thirty (30) days from the receipt of net cash proceeds received by ACP Re from (i) certain asset sales, (ii) the disposition of certain equity interests, (iii) the issuance or incurrence of certain debt, (iv) any dividend or distribution from Tower subsidiaries to ACP Re, (v) premiums and other payments received pursuant to the Retrocession Agreement, and (vi) any tax refunds, pension plan reversions, insurance proceeds, indemnity payments, purchase price adjustments (excluding working capital adjustments) under acquisition agreements, litigation proceeds and other similar receipts received by the Borrowers after the effective date of the ACP Re Credit Agreement, unless any of the foregoing proceeds (other than payments received pursuant to the Retrocession Agreement) are required for the ordinary course business operations of the Borrowers. The Borrowers are also required to deposit any excess cash flow (including payments under the Master Agreement) into a reserve account that also secures Borrowers’ obligations under the ACP Re Credit Agreement. Any funds in the reserve account after January 1, 2018 that exceed the amount of interest payable by the Borrowers for the remainder of the term of the ACP Re Credit Agreement must be applied by the Borrowers as a prepayment of principal under the ACP Re Credit Agreement.
The ACP Re Credit Agreement contains certain customary restrictive covenants (subject to negotiated exceptions and baskets), including restrictions on indebtedness, liens, acquisitions and investments, dispositions, creation of subsidiaries and restricted payments. There are also financial covenants that require ACP Re to maintain minimum current assets, a maximum leverage ratio, and a minimum fixed charge coverage ratio. If ACP Re fails to comply with the leverage ratio or fixed charge coverage ratio covenants as of any measurement date, the Borrowers may cure such breach by making a capital contribution to ACP Re sufficient to bring the Borrowers into compliance.
The ACP Re Credit Agreement also provides for customary events of default, with grace periods where appropriate, including failure to pay principal when due, failure to pay interest or fees within three business days after becoming due, failure to comply with covenants, breaches of representations and warranties, default under certain other indebtedness, certain insolvency, receivership or insurance regulatory events affecting the Borrowers, the occurrence of certain material judgments, certain amounts of reportable ERISA or foreign pension plan noncompliance events, a change in control of the Guarantor, any security interest created under the ACP Re Credit Agreement ceases to be in full force and effect, or if ACP Re defaults on its obligations under the Retrocession Agreement. Upon the occurrence and during the continuation of an event of default, the Company, as Administrative Agent, upon the request of any Lender, will declare the Borrowers’ obligations under the ACP Re Credit Agreement immediately due and payable and/or exercise any and all remedies and other rights under the ACP Re Credit Agreement.
As of September 30, 2015 and December 31, 2014, the Company recorded $127,188 and $127,601, respectively, of loan and related interest receivable as a component of other assets on the condensed consolidated balance sheet. The Company recorded total interest income of approximately $2,115 and $6,514 for the three and nine months ended September 30, 2015, respectively, and $365 for each of the three and nine months ended September 30, 2014, under the ACP Re Credit Agreement.
Other Related Party Transactions

Lease Agreements
 
The Company has a lease for its office space at 59 Maiden Lane in New York, New York from 59 Maiden Lane Associates, LLC, an entity that is wholly-owned by Michael Karfunkel and George Karfunkel. The Company currently leases 39,992 square feet of office space and the lease term is through May 2023. The Company paid approximately $527 and $490 of rent during the three months ended September 30, 2015 and 2014, respectively, and $1,475 and $1,410 during the nine months ended September 30, 2015 and 2014, respectively, for the leased office space.

The Company leases 26,849 square feet of office space in Chicago, Illinois from 135 LaSalle Property, LLC, an entity that is wholly-owned by entities controlled by Michael Karfunkel and George Karfunkel. The lease term is through November 30, 2022.

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The Company paid rent of approximately $196 and $74 during the three months ended September 30, 2015 and 2014, respectively, and $466 and $259 during the nine months ended September 30, 2015 and 2014, respectively, for the leased office space.

Equity Investments

In February 2015, the Company invested approximately $9,700 in North Dearborn Building Company, L.P. (“North Dearborn”), a limited partnership that owns an office building in Chicago, Illinois. NGHC is also a limited partner in North Dearborn, and the general partner is NA Advisors GP LLC (“NA Advisors”), an entity controlled by Michael Karfunkel and managed by an unrelated third party. The Company and NGHC each received a 45% limited partnership interest in North Dearborn for their respective $9,700 investments, while NA Advisors invested approximately $2,200 and holds a 10% general partnership interest and a 10% profit interest, which NA Advisors pays to the unrelated third party manager. North Dearborn appointed NA Advisors as the general manager to oversee the day-to-day operations of the office building and pays NA Advisors an annual fee for these services. This investment is included within other investments and is accounted for using the equity method of accounting. The Company recorded $319 and $542 of income from this investment during the three and nine months ended September 30, 2015, respectively.

In August 2015, certain of the Company's subsidiaries invested approximately $53,715 in Illinois Center Building Company, L.P. ("Illinois Center"), a limited partnership that owns an office building complex in Chicago, Illinois. NGHC and ACP Re are also limited partners in Illinois Center, and the general partner is NA Advisors. The Company and NGHC each have a 37.5% limited partnership interest in Illinois Center, while ACP Re has a 15.0% limited partnership interest. NA Advisors holds a 10% general partnership interest and a 10% profit interest, which NA Advisors pays to the unrelated third party manager. Illinois Center appointed NA Advisors as the general manager to oversee the day-to-day operations of the office building and pays NA Advisors an annual fee for these services. This investment is included within other investments and is accounted for using the equity method of accounting on a three month lag basis.
 
Use of the Company Aircraft
 
The Company and its wholly-owned subsidiary, AmTrust Underwriters, Inc. (“AUI”), are each a party to aircraft time share agreements with each of Maiden and NGHC. The agreements provide for payment to the Company or AUI for the usage of their respective company-owned aircraft and cover actual expenses incurred and permissible under federal aviation regulations. Such expenses include, among others, travel and lodging expenses of the crew, in-flight catering, flight planning and weather contract services, ground transportation, fuel, landing and hanger fees, and airport taxes. Neither the Company nor AUI charge Maiden or NGHC for the fixed costs that would be incurred in any event to operate the aircraft (for example, aircraft purchase costs, insurance and flight crew salaries). The amount that each of Maiden and NGHC paid for the use of the company-owned aircraft under these agreements was not material, either individually or in the aggregate, during the three and nine months ended September 30, 2015 and 2014, respectively.

In addition, for personal travel, Mr. Barry Zyskind, the Company’s President and Chief Executive Officer and Mr. Michael Karfunkel, the Chairman of the Board, each entered into an aircraft reimbursement agreement with the Company and AUI. Since entering into such agreements, both Mr. Zyskind and Mr. Karfunkel have fully reimbursed the Company and AUI for the incremental cost billed by the Company and AUI for their personal use of the respective company-owned aircraft. During the three and nine months ended September 30, 2015, Mr. Zyskind reimbursed the Company and AUI, in aggregate, $70 and $404, respectively, for his personal use of the company-owned aircraft. During the three and nine months ended September 30, 2015, Mr. Karfunkel reimbursed the Company and AUI, in aggregate, $91 and $203, respectively, for his personal use of the company-owned aircraft. The amount that each of Mr. Zyskind and Mr. Karfunkel reimbursed the Company and AUI for his personal use of the company-owned aircraft under these agreements was not material, either individually or in the aggregate, during the three and nine months ended September 30, 2014, respectively.

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13. Acquisitions

Warranty Solutions

On September 25, 2015, the Company acquired all of the issued and outstanding stock of Warranty Solutions, a Wells Fargo business ("Warranty Solutions") for $157,841 in cash. Warranty Solutions designs, markets, administers and underwrites vehicle service contracts for new and used automobiles through a national network of more than 70 active agencies and 1,500 franchised and independent dealers.

A summary of the preliminary assets acquired and liabilities assumed for Warranty Solutions are as follows:

(Amounts in Thousands)
 
 
Assets
 
 
 
Cash and investments
 
$
188,545

 
Prepaid reinsurance premium
 
77,777

 
Other assets
 
50,399

 
Deferred tax asset
 
24,460

 
Goodwill and Intangible assets
 
80,293

Total assets
 
$
421,474

 
 
 
 
Liabilities
 
 
 
Loss and loss expense reserves
 
$
3,013

 
Unearned premiums
 
175,549

 
Accrued expenses and other liabilities
 
85,071

Total liabilities
 
$
263,633

Acquisition price
 
$
157,841


The goodwill and intangible assets associated with the acquisition was initially measured at $80,293. The Company is in the process of completing its acquisition accounting and expects to have it completed in 2016. The Company does not expect the goodwill to be taxable. The goodwill and intangible assets as well as Warranty Solutions' results of operations will be included as a component of the Special Risk and Extended Warranty segment.

CorePointe Insurance Company

On March 2, 2015, the Company acquired all of the issued and outstanding stock of CorePointe Insurance Company ("CorePointe"). CorePointe, a Michigan-based specialty property and casualty insurance company, markets commercial package insurance products primarily to automobile and motorcycle dealerships and auto repair shops. The majority of CorePointe's insurance products and services are distributed through managing general agents ("MGAs") with whom it has long-standing relationships. In 2014, Corepointe had revenue of approximately $50,782 and net income of approximately $4,118.


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A summary of the assets acquired and liabilities assumed for CorePointe are as follows:

(Amounts in Thousands)
 
 
Assets
 
 
 
Cash and investments
 
$
123,338

 
Premium receivables
 
20,441

 
Reinsurance recoverable
 
1,635

 
Other assets
 
1,703

 
Deferred tax asset
 
4,303

 
Property and equipment
 
226

 
Intangible assets
 
2,710

Total assets
 
$
154,356

 
 
 
 
Liabilities
 
 
 
Loss and loss expense reserves
 
$
46,539

 
Unearned premiums
 
24,230

 
Accrued expenses and other liabilities
 
7,781

 
Deferred tax liability
 
1,206

Total liabilities
 
$
79,756

Acquisition price
 
$
68,774

Acquisition gain
 
$
5,826


The Company accounts for business combinations under the acquisition method of accounting and therefore increased the acquired loss reserves by approximately $10,107 to their fair value. The Company adjusted the acquired loss and LAE reserves to fair value by recording the acquired loss reserves based on the Company’s existing accounting policies and then discounting them based on expected reserve payout patterns using a current risk-free rate of interest. This risk-free interest rate was then adjusted based on different cash flow scenarios that use different payout and ultimate reserve assumptions deemed to be reasonably possible based upon the inherent uncertainties present in determining the amount and timing of payment of such reserves. The difference between the acquired loss and LAE reserves and the Company’s best estimate of the fair value of such reserves at the acquisition date was recorded as an intangible asset in the amount of approximately $1,210 and will be amortized proportionately to the decrease in the acquired loss and LAE reserves over the payout period for the acquired loss and LAE reserves. Additionally, the Company recorded approximately $1,500 for state licenses and have an indefinite life. These intangible assets, as well as CorePointe's results of operations, are included as a component of the Specialty Program segment.

During the three months ended September 30, 2015, the Company finalized its acquisition accounting for CorePointe, which resulted in a gain on acquisition of approximately $5,826. The majority of the gain related to deferred tax assets and liabilities. The Company early adopted ASU 2015-16, Business Combinations, and therefore recognized the acquisition gain during the three months ended September 30, 2015. Under prior accounting guidance, any adjustments to provisional amounts would have been recognized retrospectively to the period of acquisition. Any amount recorded in current-period earnings that would have been recorded in previous reporting periods if the adjustment to the provisional amounts had been recognized as of the acquisition date were immaterial to the Company's results of operations. In addition, the Company recorded approximately $10,193 and $33,530 of written premium related to CorePointe during the three and nine months ended September 30, 2015, respectively.

TMI Solutions, LLC

On January 6, 2015, the Company acquired all of the issued and outstanding stock of TMI Solutions, LLC ("TMIS"). TMIS offers monthly billed warranty solutions for a variety of consumer electronics as well as consumer protection services. TMIS's warranties are primarily distributed in conjunction with large telecommunication monthly customer billing services and their customers include various Fortune 500 companies. The purchase agreement required the Company to pay approximately $29,503 in cash on the acquisition date and contained an earn-out provision that is contingent on TMIS meeting certain performance conditions over a three-year period. The contingent consideration associated with the earn-out provision was initially valued at $32,000 as of the acquisition date.


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A summary of the preliminary assets acquired and liabilities assumed for TMIS are as follows:

(Amounts in Thousands)
 
 
Assets
 
 
 
Cash and investments
 
$
749

 
Other assets
 
1,354

 
Property and equipment
 
53

 
Goodwill and intangible assets
 
70,791

Total assets
 
$
72,947

 
 
 
 
Liabilities
 
 
 
Accrued expenses and other liabilities
 
$
69

 
Deferred tax liability
 
11,375

Total liabilities
 
$
11,444

Acquisition price
 
$
61,503


As part of the acquisition, the Company obtained identifiable intangible assets of approximately $32,500, which included customer relationships for $28,000 and software for $1,000 with finite lives ranging from four to eight years and tradenames of $2,500 and licenses of $1,000 with indefinite lives. A remaining value of $38,291 was assigned to goodwill and will not be taxable. The goodwill and intangible assets, as well as TMIS's results of operations, are included as a component of the Specialty Risk and Extended Warranty segment. The Company is in the process of completing its acquisition accounting and expects to have it completed in 2015.

As a result of this acquisition, the Company recorded approximately $3,420 and $10,087 of service and fee income related to TMIS during the three and nine months ended September 30, 2015, respectively.

Oryx Insurance Brokerage, Inc.

On January 6, 2015, the Company acquired all of the issued and outstanding stock of Oryx Insurance Brokerage, Inc. ("Oryx"). Oryx, established in 1996, is a managing general agent and wholesaler providing insurance products to the construction industry in upstate New York. For 2014, Oryx placed $80,000 in premiums through over 135 agencies with the majority of business underwritten by the Company. The purchase agreement required the Company to pay approximately $30,556 in cash on the acquisition date and contained an earn-out provision that is contingent on Oryx meeting certain performance conditions over a five-year period. The contingent consideration associated with the earn-out provision was initially valued at $12,444 as of the acquisition date.

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A summary of the preliminary assets acquired and liabilities assumed for Oryx are as follows:

(Amounts in Thousands)
 
 
Assets
 
 
 
Cash and investments
 
$
4,669

 
Premium receivables
 
3,438

 
Other assets
 
1,717

 
Goodwill
 
41,975

Total assets
 
$
51,799

 
 
 
 
Liabilities
 
 
 
Loss and loss expense reserves
 
$
1,405

 
Accrued expenses and other liabilities
 
7,394

Total liabilities
 
$
8,799

Acquisition price
 
$
43,000


The goodwill and intangible assets, as well as Oryx's results of operations, are included as a component of the Specialty Program segment. The Company is in the process of completing its acquisition accounting and expects to have it completed in 2015.

As a result of its underwriting relationship with Oryx, the Company had approximately $11,853 and $9,143 of written premium during the three months ended September 30, 2015 and 2014, respectively, and approximately $76,829 and $62,128 during the nine months ended September 30, 2015 and 2014, respectively. The Company recorded approximately $60 and $299 of service and fee income related to Oryx during the three and nine months ended September 30, 2015, respectively. Additionally, the Company reduced its overall commission expense by approximately $1,276 and $3,577 during the three and nine months ended September 30, 2015, respectively, as a result of this acquisition.

Other

The Company had additional immaterial acquisitions totaling approximately $27,000 during the nine months ended September 30, 2015. No individual acquisition or acquisitions in the aggregate were significant. Therefore, the Company is not required to include any pro forma financial information in this report.

14. New Market Tax Credit

In 2012, the Company's subsidiary, 800 Superior, LLC (an entity owned equally by the Company and NGHC) received $19,400 in net proceeds from a financing transaction the Company and NGHC entered into with Key Community Development Corporation (“KCDC”) related to a capital improvement project for an office building in Cleveland, Ohio owned by 800 Superior, LLC. The Company, NGHC and KCDC collectively made capital contributions (net of allocation fees) and loans to 800 Superior NMTC Investment Fund II LLC and 800 Superior NMTC Investment Fund I LLC (collectively, the “Investment Funds”) under a qualified New Markets Tax Credit (“NMTC”) program. The NMTC program was provided for in the Community Renewal Tax Relief Act of 2000 (the “Act”) and is intended to induce capital investment in qualified lower income communities. The Act permits taxpayers to claim credits against their federal income taxes for up to 39% of qualified investments in the equity of community development entities (“CDEs”). CDEs are privately managed investment institutions that are certified to make qualified low-income community investments (“QLICIs”).

In addition to the capital contributions and loans from the Company, NGHC and KCDC, as part of the transaction, the Investment Funds received, directly and indirectly, proceeds of approximately $8,000 from two loans originating from state and local governments of Ohio. These loans are each for a period of 15 years and have a weighted average interest rate approximately of 2.0% per annum.

The Investment Funds then contributed the loan proceeds and capital contributions of $19,400 to two CDEs, which, in turn, loaned the funds on similar terms to 800 Superior, LLC. The proceeds of the loans from the CDEs (including loans representing

41


the capital contribution made by KCDC, net of allocation fees) will be used to fund the capital improvement project. As collateral for these loans, the Company has granted a security interest in the assets acquired with the loan proceeds.

The Company and NGHC are each entitled to receive an equal portion of 49% of the benefits derived from the NMTCs generated by 800 Superior Investment Fund II LLC, while KCDC is entitled to the remaining 51%. The NMTC is subject to 100% recapture for a period of 7 years as provided in the Internal Revenue Code. During this seven-year compliance period, the entities involved are required to be in compliance with various regulations and contractual provisions that apply to the NMTC arrangement. Non-compliance with applicable requirements could result in the projected tax benefits not being realized and, therefore, could require the Company to indemnify KCDC for any loss or recapture of NMTCs related to the financing until such time as the obligation to deliver tax benefits is relieved. The Company does not anticipate any credit recaptures will be required in connection with this arrangement. In addition, this transaction includes a put/call provision whereby the Company may be obligated or entitled to repurchase KCDC's interest in the Investment Funds in September 2019 at the end of the recapture period. The Company believes that KCDC will exercise its put option and, therefore, attributed an insignificant value to the put/call.
 
The Company has determined that the Investment Funds are variable interest entities (“VIEs”). The ongoing activities of the Investment Funds - collecting and remitting interest and fees and NMTC compliance - were all considered in the initial design and are not expected to significantly affect economic performance throughout the life of the Investment Funds. When determining whether to consolidate the Investment Funds, Company management considered the contractual arrangements that obligate it to deliver tax benefits and provide various other guarantees to the structure, KCDC's lack of a material interest in the underlying economics of the project, and the fact that the Company is obligated to absorb losses of the Investment Funds. Also, the Company has an approximate 12% ownership in NGHC. The Company concluded that it was the primary beneficiary and consolidated the Investment Funds, as VIEs, in accordance with the accounting standard for consolidation. KCDC's contribution, net of syndication fees, is included as accrued liability in the accompanying condensed consolidated balance sheets. Direct costs incurred in structuring the financing arrangement are deferred and will be recognized as expense over the term of the loans. Incremental costs to maintain the structure during the compliance period are recognized as incurred.

15. Stockholder's Equity and Accumulated Other Comprehensive Income (Loss)

Issuance of Common Stock

During 2015, the Company issued an aggregate of 3,450,000 shares of Common Stock in an underwritten public offering. Proceeds received from this offering were $172,500. Fees and expenses related to the offering were approximately $250.

Issuances of Preferred Stock

On March 19, 2015, the Company completed a public offering of 6,600,000 of its depositary shares, each representing a 1/40th interest in a share of its 7.50% Non-Cumulative Preferred Stock, Series D, $0.01 par value per share (the "Series D Preferred Stock"), with a liquidation preference of $1,000 per share (equivalent to $25 per depositary share). Each depositary share entitles the holder to a proportional fractional interest in all rights and preferences of the Series D Preferred Stock represented thereby (including any dividend, liquidation, redemption and voting rights). Dividends on the Series D Preferred Stock represented by the depositary shares will be payable on the liquidation preference amount, on a non-cumulative basis, when, as and if declared by the Company’s board of directors, at a rate of 7.50% per annum, quarterly in arrears, on March 15, June 15, September 15, and December 15 of each year, beginning on June 15, 2015, from and including the date of original issuance. The Series D Preferred Stock represented by the depositary shares is not redeemable prior to March 19, 2020. After that date, the Company may redeem at its option, in whole or in part, the Series D Preferred Stock represented by the depositary shares at a redemption price of $1,000 per share (equivalent to $25 per depositary share) plus any declared and unpaid dividends for prior dividend periods and accrued but unpaid dividends (whether or not declared) for the then current dividend period. On March 19, 2015, the underwriters exercised, in part, their over-allotment option with respect to 700,000 additional depositary shares, each representing a 1/40th interest in a share of Series D Preferred Stock, on the same terms and conditions as the original issuance. A total of 7,300,000 depositary shares (equivalent to 182,500 shares of Series D Preferred Stock) were issued. Net proceeds from this offering, including the over-allotment, were $176,511. In addition, the Company incurred $5,989 in underwriting discount and commissions and expenses, which were recognized as a reduction to additional paid-in capital.

42



Stockholders' Equity

The following table summarizes the ownership components of total stockholders' equity:

 
 
 
2015
 
2014
(Amounts in Thousands)
 
AmTrust
 
Non-Controlling Interest
 
Total
 
AmTrust
 
Non-Controlling Interest
 
Total
Balance, December 31,
 
$
2,037,020

 
$
159,181

 
$
2,196,201

 
$
1,441,005

 
$
137,860

 
$
1,578,865

Net income (loss)
 
430,949

 
5,978

 
436,927

 
370,102

 
(7,029
)
 
363,073

Unrealized holding (loss) gain
 
(68,968
)
 
—

 
(68,968
)
 
85,726

 
—

 
85,726

Reclassification adjustment
 
634

 
—

 
634

 
(3,370
)
 
—

 
(3,370
)
Foreign currency translation
 
(49,204
)
 
6

 
(49,198
)
 
(5,289
)
 
(271
)
 
(5,560
)
Unrealized gain on interest rate swap
 
297

 
—

 
297

 
581

 
—

 
581

Extinguishment of 2021 senior notes, equity component
 
(3,764
)
 
—

 
(3,764
)
 
—

 


 
—

Share exercises, compensation and other
 
16,459

 
—

 
16,459

 
18,892

 
—

 
18,892

Common share issuance (purchase), net
 
171,672

 
—

 
171,672

 
(44,564
)
 
—

 
(44,564
)
Common share dividends
 
(66,121
)
 
—

 
(66,121
)
 
(45,147
)
 
—

 
(45,147
)
Preferred stock issuance, net of fees
 
176,529

 
—

 
176,529

 
178,641

 
—

 
178,641

Preferred stock dividends
 
(22,797
)
 
—

 
(22,797
)
 
(7,387
)
 
—

 
(7,387
)
Capital contribution, net
 
—

 
11,609

 
11,609

 
—

 
24,013

 
24,013

Balance, September 30,
 
$
2,622,706

 
$
176,774

 
$
2,799,480

 
$
1,989,190

 
$
154,573

 
$
2,143,763


During the nine months ended September 30, 2015, net income attributable to non-controlling interest was $5,978 and net income attributable to redeemable non-controlling interest was $962. Net income for AmTrust, Non-controlling interest and Redeemable non-controlling interest totaled $437,889 for the nine months ended September 30, 2015. Additionally, the Company made a distribution of $422 for redeemable non-controlling interest during the nine months ended September 30, 2015.


43


Accumulated Other Comprehensive Income (Loss)

The following table summarizes the activities and components of accumulated other comprehensive income (loss):

(Amounts in Thousands)
 
Foreign Currency Items
Unrealized Gains (Losses) on Investments
Interest Rate Swap Hedge
Net Benefit Plan Assets and Obligations Recognized in Stockholders' Equity
Accumulated Other Comprehensive Income (Loss)
Balance, June 30, 2015
 
$
(66,108
)
$
21,487

$
(1,131
)
$
(2,793
)
$
(48,545
)
Other comprehensive (loss) income before reclassification
 
3,274

(25,611
)
165

—

(22,172
)
Amounts reclassed from accumulated other comprehensive income
 
—

2,830

—

—

2,830

Income tax benefit (expense)
 
(1,146
)
7,973

(58
)
—

6,769

Net current-period other comprehensive (loss) income
 
2,128

(14,808
)
107

—

(12,573
)
Balance, September 30, 2015
 
$
(63,980
)
$
6,679

$
(1,024
)
$
(2,793
)
$
(61,118
)
 
 
 
 
 
 
 
Balance, June 30, 2014
 
$
10,385

$
78,632

$
(1,751
)
$
(1,738
)
$
85,528

Other comprehensive income before reclassification
 
(20,142
)
(16,433
)
534

—

(36,041
)
Amounts reclassed from accumulated other comprehensive income
 
—

(2,422
)
—

—

(2,422
)
Income tax benefit (expense)
 
7,050

15,556

(187
)
—

22,419

Net current-period other comprehensive income
 
(13,092
)
(3,299
)
347

—

(16,044
)
Balance, September 30, 2014
 
$
(2,707
)
$
75,333

$
(1,404
)
$
(1,738
)
$
69,484


(Amounts in Thousands)
 
Foreign Currency Items
Unrealized Gains (Losses) on Investments
Interest Rate Swap Hedge
Net Benefit Plan Assets and Obligations Recognized in Stockholders' Equity
Accumulated Other Comprehensive Income (Loss)
Balance, December 31, 2014
 
$
(14,776
)
$
75,013

$
(1,321
)
$
(2,793
)
$
56,123

Other comprehensive (loss) income before reclassification
 
(75,698
)
(106,105
)
457

—

(181,346
)
Amounts reclassed from accumulated other comprehensive income
 
—

976

—

—

976

Income tax benefit (expense)
 
26,494

36,795

(160
)
—

63,129

Net current-period other comprehensive (loss) income
 
(49,204
)
(68,334
)
297

—

(117,241
)
Balance, September 30, 2015
 
$
(63,980
)
$
6,679

$
(1,024
)
$
(2,793
)
$
(61,118
)
 
 
 
 
 
 
 
Balance, December 31, 2013
 
$
2,582

$
(7,023
)
$
(1,985
)
$
(1,738
)
$
(8,164
)
Other comprehensive income before reclassification
 
(8,137
)
118,107

894

—

110,864

Amounts reclassed from accumulated other comprehensive income
 
—

(5,185
)
—

—

(5,185
)
Income tax benefit (expense)
 
2,848

(30,566
)
(313
)

(28,031
)
Net current-period other comprehensive income
 
(5,289
)
82,356

581

—

77,648

Balance, September 30, 2014
 
$
(2,707
)
$
75,333

$
(1,404
)
$
(1,738
)
$
69,484





44


16. Commitment and Contingent Liabilities
 
Litigation
 
From time to time, the Company is subject to routine legal proceedings, including arbitrations, arising in the ordinary course of business. The Company’s insurance subsidiaries are named as defendants in various legal actions arising principally from claims made under insurance policies and contracts. Those actions are considered by the Company in estimating the loss and LAE reserves. The Company’s management believes the resolution of those actions will not have a material adverse effect on the Company’s financial position or results of operations.

ARI Mutual Insurance Company

In March 2015, the Company entered into a definitive agreement to acquire ARI Mutual Insurance Company ("ARI") following the completion of the conversion of ARI to a stock company from a mutual company, which requires regulatory and policyholder approval. ARI is an underwriter of commercial automobile insurance in New Jersey, Pennsylvania and Maryland. The acquisition is anticipated to close during the fourth quarter of 2015. The Company expects that the aggregate purchase price for the stock of ARI will be between $23,800 and $32,200.

N.V. Nationale Borg-Maatschappij

In August 2015, the Company entered into a definitive agreement to acquire N.V. Nationale Borg-Maatschappij and its affiliates ("Nationale Borg") from Egeria and HAL Investments for approximately €154,000 (or $172,126). Nationale Borg is a 120-year old, Amsterdam-based international direct writer and reinsurer of surety and trade credit insurance with business in over 70 countries. The acquisition is subject to regulatory approval and is expected to close in the fourth quarter of 2015.

Republic Companies, Inc

In September 2015, the Company entered into agreements to acquire Republic Companies, Inc. and its affiliates ("Republic") from Delek Group Ltd. and Republic Insurance Holdings, LLC, for approximately $233,000, which is subject to purchase price adjustments. The purchase price consisted of $112,000 in cash at closing, $16,000 in cash to be paid over five years and $105,000 in a note to be issued by the Company to Delek Group Ltd. bearing annual interest of 5.75% with a four year maturity and scheduled principal payments to be made over the term of the note. The acquisition is subject to regulatory approval and is expected to close in the first half of 2016.

17. Segments
 
The Company currently operates three business segments: Small Commercial Business; Specialty Risk and Extended Warranty; and Specialty Program. The Company also has a former segment, Personal Lines Reinsurance, which is in run-off and is now included within its Corporate and Other segment. The Corporate and Other segment also represents the activities of the holding company as well as a portion of service and fee revenue. In determining total assets (excluding cash and invested assets) by segment, the Company identifies those assets that are attributable to a particular segment such as deferred acquisition cost, reinsurance recoverable, goodwill, intangible assets and prepaid reinsurance while the remaining assets are allocated based on gross written premium by segment. In determining cash and invested assets by segment, the Company matches certain identifiable liabilities such as unearned premium and loss and loss adjustment expense reserves by segment. The remaining cash and invested assets are then allocated based on gross written premium by segment. Investment income and realized gains (losses) are determined by calculating an overall annual return on cash and invested assets and applying that overall return to the cash and invested assets by segment. Ceding commission is allocated to each segment based on that segment’s proportionate share of the Company’s overall acquisition costs. Interest expense is allocated based on gross written premium by segment. Income taxes are allocated on a pro-rata basis based on the Company’s effective tax rate. Additionally, management reviews the performance of underwriting income in assessing the performance of and making decisions regarding the allocation of resources to the segments. Underwriting income excludes, primarily, service and fee revenue, investment income and other revenues, other expenses, interest expense and income taxes. Management believes that providing this information in this manner is essential to providing Company’s stockholders with an understanding of the Company’s business and operating performance.

During each of the nine months ended September 30, 2015 and 2014, the Company's Specialty Program segment derived over ten percent of its gross written premium primarily from one agent.

45



The following tables summarize the results of operations of the business segments for the three months ended September 30, 2015 and 2014:
 
 
 
 
 
 
 
 
 
 
 
(Amounts in Thousands)
 
Small Commercial Business
 
Specialty Risk and Extended Warranty
 
Specialty Program
 
Corporate and  Other
 
Total
Three Months Ended September 30, 2015:
 
 
 
 
 
 
 
 
 
 
Gross written premium
 
$
797,654

 
$
577,284

 
$
405,875

 
$
—

 
$
1,780,813

 
 
 
 
 
 
 
 
 
 
 
Net written premium
 
459,290

 
380,600

 
303,093

 
—

 
1,142,983

Change in unearned premium
 
34,364

 
(30,218
)
 
(101,721
)
 
—

 
(97,575
)
Net earned premium
 
493,654

 
350,382

 
201,372

 
—

 
1,045,408

 
 
 
 
 
 
 
 
 
 
 
Loss and loss adjustment expense
 
(320,391
)
 
(253,136
)
 
(136,077
)
 
—

 
(709,604
)
Acquisition costs and other underwriting expenses
 
(130,792
)
 
(69,876
)
 
(57,348
)
 
—

 
(258,016
)
 
 
(451,183
)
 
(323,012
)
 
(193,425
)
 
—

 
(967,620
)
Underwriting income
 
42,471

 
27,370

 
7,947

 
—

 
77,788

Service and fee income
 
24,793

 
79,064

 
482

 
21,804

 
126,143

Investment income and realized gain
 
24,359

 
21,312

 
12,423

 
13

 
58,107

Other expenses
 
(53,047
)
 
(37,471
)
 
(26,382
)
 
—

 
(116,900
)
Interest expense and loss on extinguishment of debt
 
(6,038
)
 
(4,333
)
 
(3,048
)
 
—

 
(13,419
)
Foreign currency gain
 
—

 
24,721

 
—

 
—

 
24,721

Gain on life settlement contracts
 
1,926

 
1,584

 
1,106

 
—

 
4,616

Acquisition gain on purchase
 
5,826

 
—

 
—

 
—

 
5,826

Benefit for income taxes
 
2,880

 
7,898

 
245

 
1,626

 
12,649

Equity in earnings of unconsolidated subsidiary  – related party
 
—

 
—

 
—

 
13,477

 
13,477

Net income
 
$
43,170

 
$
120,145

 
$
(7,227
)
 
$
36,920

 
$
193,008

 
 
 
 
 
 
 
 
 
 
 
(Amounts in Thousands)
 
Small Commercial Business
 
Specialty Risk and Extended Warranty
 
Specialty Program
 
Corporate and  Other
 
Total
Three Months Ended September 30, 2014:
 
 
 
 
 
 
 
 
 
 
Gross written premium
 
$
722,897

 
$
436,845

 
$
358,739

 
$
—

 
$
1,518,481

 
 
 
 
 
 
 
 
 
 
 
Net written premium
 
422,539

 
331,590

 
250,067

 
—

 
1,004,196

Change in unearned premium
 
(815
)
 
(3,564
)
 
(85,551
)
 
147

 
(89,783
)
Net earned premium
 
421,724

 
328,026

 
164,516

 
147

 
914,413

 
 
 
 
 
 
 
 
 
 
 
Loss and loss adjustment expense
 
(279,056
)
 
(219,535
)
 
(110,654
)
 
(107
)
 
(609,352
)
Acquisition costs and other underwriting expenses
 
(111,939
)
 
(68,612
)
 
(44,915
)
 
(46
)
 
(225,512
)
 
 
(390,995
)
 
(288,147
)
 
(155,569
)
 
(153
)
 
(834,864
)
Underwriting income
 
30,729

 
39,879

 
8,947

 
(6
)
 
79,549

Service and fee income
 
26,781

 
75,178

 
117

 
15,507

 
117,583

Investment income and realized gain
 
16,819

 
13,770

 
9,016

 
33

 
39,638

Other expenses
 
(49,901
)
 
(29,992
)
 
(23,600
)
 
—

 
(103,493
)
Interest expense and loss on extinguishment of debt
 
(5,619
)
 
(3,396
)
 
(2,786
)
 
—

 
(11,801
)
Foreign currency gain
 
—

 
26,594

 
—

 
—

 
26,594

Loss on life settlement contracts
 
(1,449
)
 
(859
)
 
(602
)
 
—

 
(2,910
)
Benefit for income taxes
 
1,709

 
2,646

 
689

 
2,620

 
7,664

Equity in earnings of unconsolidated subsidiary  – related party
 
—

 
—

 
—

 
4,332

 
4,332

Net income
 
$
19,069

 
$
123,820

 
$
(8,219
)
 
$
22,486

 
$
157,156



46


 
 
 
 
 
 
 
 
 
 
 
(Amounts in Thousands)
 
Small Commercial Business
 
Specialty Risk and Extended Warranty
 
Specialty Program
 
Corporate and  Other
 
Total
Nine Months Ended September 30, 2015:
 
 
 
 
 
 
 
 
 
 
Gross written premium
 
$
2,574,602

 
$
1,528,017

 
$
1,087,719

 
$
—

 
$
5,190,338

 
 
 
 
 
 
 
 
 
 
 
Net written premium
 
1,499,922

 
975,073

 
719,898

 
—

 
3,194,893

Change in unearned premium
 
(99,218
)
 
(11,592
)
 
(120,328
)
 
—

 
(231,138
)
Net earned premium
 
1,400,704

 
963,481

 
599,570

 
—

 
2,963,755

 
 
 
 
 
 
 
 
 
 
 
Loss and loss adjustment expense
 
(909,081
)
 
(647,121
)
 
(405,160
)
 
—

 
(1,961,362
)
Acquisition costs and other underwriting expenses
 
(365,184
)
 
(197,450
)
 
(165,768
)
 
—

 
(728,402
)
 
 
(1,274,265
)
 
(844,571
)
 
(570,928
)
 
—

 
(2,689,764
)
Underwriting income
 
126,439

 
118,910

 
28,642

 
—

 
273,991

Service and fee income
 
76,468

 
208,596

 
846

 
60,856

 
346,766

Investment income and realized gain
 
63,209

 
49,859

 
28,789

 
117

 
141,974

Other expenses
 
(155,502
)
 
(92,289
)
 
(65,696
)
 
—

 
(313,487
)
Interest expense and loss on extinguishment of debt
 
(18,866
)
 
(11,197
)
 
(7,971
)
 
—

 
(38,034
)
Foreign currency gain
 
—

 
17,355

 
—

 
—

 
17,355

Gain on life settlement contracts
 
9,466

 
5,619

 
4,000

 
—

 
19,085

Acquisition gain on purchase
 
5,826

 
—

 
—

 
—

 
5,826

(Provision) benefit for income taxes
 
(8,678
)
 
(24,068
)
 
923

 
(6,812
)
 
(38,635
)
Equity in earnings of unconsolidated subsidiary – related party
 
—

 
—

 
—

 
23,048

 
23,048

Net income
 
$
98,362

 
$
272,785

 
$
(10,467
)
 
$
77,209

 
$
437,889

 
 
 
 
 
 
 
 
 
 
 
(Amounts in Thousands)
 
Small Commercial Business
 
Specialty Risk and Extended Warranty
 
Specialty Program
 
Corporate and  Other
 
Total
Nine Months Ended September 30, 2014:
 
 
 
 
 
 
 
 
 
 
Gross written premium
 
$
2,366,451

 
$
1,387,651

 
$
874,215

 
$
—

 
$
4,628,317

 
 
 
 
 
 
 
 
 
 
 
Net written premium
 
1,526,347

 
933,245

 
598,555

 
—

 
3,058,147

Change in unearned premium
 
(337,362
)
 
(12,096
)
 
(99,197
)
 
8,909

 
(439,746
)
Net earned premium
 
1,188,985

 
921,149

 
499,358

 
8,909

 
2,618,401

 
 
 
 
 
 
 
 
 
 
 
Loss and loss adjustment expense
 
(792,224
)
 
(618,469
)
 
(338,483
)
 
(5,979
)
 
(1,755,155
)
Acquisition costs and other underwriting expenses
 
(299,082
)
 
(185,120
)
 
(133,355
)
 
(2,624
)
 
(620,181
)
 
 
(1,091,306
)
 
(803,589
)
 
(471,838
)
 
(8,603
)
 
(2,375,336
)
Underwriting income
 
97,679

 
117,560

 
27,520

 
306

 
243,065

Service and fee income
 
69,801

 
193,534

 
328

 
44,420

 
308,083

Investment income and realized gain
 
45,390

 
42,604

 
21,912

 
198

 
110,104

Other expenses
 
(142,484
)
 
(83,551
)
 
(52,637
)
 
—

 
(278,672
)
Interest expense and loss on extinguishment of debt
 
(18,348
)
 
(10,759
)
 
(6,778
)
 
—

 
(35,885
)
Foreign currency gain
 
—

 
25,826

 
—

 
—

 
25,826

Loss on life settlement contracts
 
(2,649
)
 
(1,553
)
 
(978
)
 
—

 
(5,180
)
Gain on sale of a subsidiary
 
6,631

 
—

 
—

 
—

 
6,631

(Provision) benefit for income taxes
 
(5,276
)
 
(26,713
)
 
1,001

 
(6,758
)
 
(37,746
)
Equity in earnings of unconsolidated subsidiary – related party
 
—

 
—

 
—

 
26,847

 
26,847

Net income
 
$
50,744

 
$
256,948

 
$
(9,632
)
 
$
65,013

 
$
363,073


47


The following tables summarize net earned premium by major line of business, by segment, for the three and nine months ended September 30, 2015 and 2014:

(Amounts in Thousands)
 
Small
Commercial
Business
 
Specialty
Risk and
Extended
Warranty
 
Specialty
Program
 
Corporate and  Other
 
Total
Three Months Ended September 30, 2015:
 
  

 
  

 
  

 
  

 
  

Workers' compensation
 
$
328,099

 
$
—

 
$
86,454

 
$
—

 
$
414,553

Warranty
 
—

 
143,202

 
—

 
—

 
143,202

Other liability
 
12,081

 
36,042

 
58,072

 
—

 
106,195

Commercial auto and liability, physical damage
 
89,078

 
(413
)
 
27,170

 
—

 
115,835

Medical malpractice
 
—

 
52,879

 
—

 
—

 
52,879

Other
 
64,396

 
118,672

 
29,676

 
—

 
212,744

Total net earned premium
 
$
493,654

 
$
350,382

 
$
201,372

 
$
—

 
$
1,045,408

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
(Amounts in Thousands)
 
Small
Commercial
Business
 
Specialty
Risk and
Extended
Warranty
 
Specialty
Program
 
Corporate and  Other
 
Total
Three Months Ended September 30, 2014:
 
  

 
  

 
  

 
  

 
  

Workers' compensation
 
$
268,351

 
$
—

 
$
70,029

 
$
—

 
$
338,380

Warranty
 
—

 
159,178

 
51

 
—

 
159,229

Other liability
 
28,330

 
46,971

 
40,676

 
—

 
115,977

Commercial auto and liability, physical damage
 
53,581

 
11,994

 
29,670

 
23

 
95,268

Medical malpractice
 
—

 
44,385

 
—

 
—

 
44,385

Other
 
71,462

 
65,498

 
24,090

 
124

 
161,174

Total net earned premium
 
$
421,724

 
$
328,026

 
$
164,516

 
$
147

 
$
914,413

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
(Amounts in Thousands)
 
Small
Commercial
Business
 
Specialty
Risk and
Extended
Warranty
 
Specialty
Program
 
Corporate and  Other
 
Total
Nine Months Ended September 30, 2015:
 
  

 
  

 
  

 
  

 
  

Workers' compensation
 
$
942,867

 
$
—

 
$
250,400

 
$
—

 
$
1,193,267

Warranty
 
—

 
439,049

 
—

 
—

 
439,049

Other liability
 
37,025

 
101,338

 
133,925

 
—

 
272,288

Commercial auto and liability, physical damage
 
208,489

 
11,741

 
96,868

 
—

 
317,098

Medical malpractice
 
—

 
129,333

 
—

 
—

 
129,333

Other
 
212,323

 
282,020

 
118,377

 
—

 
612,720

Total net earned premium
 
$
1,400,704

 
$
963,481

 
$
599,570

 
$
—

 
$
2,963,755

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
(Amounts in Thousands)
 
Small
Commercial
Business
 
Specialty
Risk and
Extended
Warranty
 
Specialty
Program
 
Corporate and  Other
 
Total
Nine Months Ended September 30, 2014:
 
  

 
  

 
  

 
  

 
  

Workers' compensation
 
$
770,578

 
$
—

 
$
184,650

 
$
—

 
$
955,228

Warranty
 
—

 
421,680

 
224

 
—

 
421,904

Other liability
 
56,837

 
147,444

 
144,621

 
—

 
348,902

Commercial auto and liability, physical damage
 
123,739

 
26,721

 
84,359

 
1,564

 
236,383

Medical malpractice
 
—

 
135,982

 
—

 
—

 
135,982

Other
 
237,831

 
189,322

 
85,504

 
7,345

 
520,002

Total net earned premium
 
$
1,188,985

 
$
921,149

 
$
499,358

 
$
8,909

 
$
2,618,401

 
 
 
 
 
 
 
 
 
 
 


48



The following table summarizes total assets of the business segments as of September 30, 2015 and December 31, 2014:

(Amounts in Thousands)
 
September 30, 2015
 
December 31, 2014
Small Commercial Business
 
$
7,663,693

 
$
6,142,645

Specialty Risk and Extended Warranty
 
6,222,438

 
5,441,378

Specialty Program
 
3,052,297

 
2,248,901

Corporate and Other
 
5,508

 
14,444

 
 
$
16,943,936

 
$
13,847,368


18. Subsequent Event

On October 27, 2015, the Company entered into an agreement to acquire Genworth Financial Mortgage Insurance Limited ("GFMI") from a subsidiary of Genworth Financial, Inc. (NYSE:GNW), for approximately $60,000 in cash. Based in the U.K., GFMI is a well-known organization in the European mortgage insurance market, currently providing products in the U.K., Finland, Italy and Germany. As of June 30, 2015, GFMI's tangible book value was approximately $155,000. The acquisition is expected to close during the first quarter of 2016, subject to regulatory approval and customary closing conditions.




49


Item 2. 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 in conjunction with our condensed consolidated financial statements and related notes included elsewhere in this Form 10-Q. Amounts in the following discussion may not reconcile due to rounding differences.
 
Note on Forward-Looking Statements
 
This Form 10-Q contains certain forward-looking statements that are intended to be covered by the safe harbors created by The Private Securities Litigation Reform Act of 1995. When we use words such as “anticipate,” “intend,” “plan,” “believe,” “estimate,” “expect,” or similar expressions, we do so to identify forward-looking statements. Examples of forward-looking statements include the plans and objectives of management for future operations, including those relating to future growth of our business activities and availability of funds, and are based on current expectations that involve assumptions that are difficult or impossible to predict accurately and many of which are beyond our control. Actual results may differ materially from those expressed or implied in these statements as a result of significant risks and uncertainties, including, but not limited to, non-receipt of expected payments from insureds or reinsurers, changes in interest rates, a downgrade in the financial strength ratings of our insurance subsidiaries, the effect of the performance of financial markets on our investment portfolio, the amounts, timing and prices of any share repurchases made by us under our share repurchase program, our estimates of the fair value of our life settlement contracts, development of claims and the effect on loss reserves, accuracy in projecting loss reserves, the cost and availability of reinsurance coverage, the effects of emerging claim and coverage issues, changes in the demand for our products, our degree of success in integrating acquired businesses, the effect of general economic conditions, state and federal legislation, regulations and regulatory investigations into industry practices, risks associated with conducting business outside the United States, developments relating to existing agreements, disruptions to our business relationships with Maiden Holdings, Ltd., National General Holding Corp., ACP Re, Ltd., or third party agencies and warranty administrators, breaches in data security or other disruptions with our technology, heightened competition, changes in pricing environments, and changes in asset valuations. Additional information about these risks and uncertainties, as well as others that may cause actual results to differ materially from those projected, is contained in our filings with the SEC, including our Annual Report on Form 10-K for the year ended December 31, 2014, and our quarterly reports on Form 10-Q. The projections and statements in this report speak only as of the date of this report and we undertake no obligation to update or revise any forward-looking statement, whether as a result of new information, future developments or otherwise, except as may be required by law.
 
Overview
 
We are a multinational specialty property and casualty insurer focused on generating consistent underwriting profits. We provide insurance coverage for small businesses and products with high volumes of insureds and loss profiles that we believe are predictable. We target lines of insurance that we believe generally are underserved by the market. We have grown by hiring teams of underwriters with expertise in our specialty lines, through acquisitions of companies and assets that, in each case, provide access to distribution networks and renewal rights to established books of specialty insurance business. We have operations in three business segments:
 
•
Small Commercial Business.  We provide workers’ compensation, commercial package and other commercial insurance lines produced by wholesale agents, retail agents and brokers in the United States.
•
Specialty Risk and Extended Warranty. We provide coverage for consumer and commercial goods and custom designed coverages, such as accidental damage plans and payment protection plans offered in connection with the sale of consumer and commercial goods, in the United States and Europe, and certain niche property, casualty and specialty liability risks in the United States and Europe, including general liability, employers’ liability and professional and medical liability.
•
Specialty Program. We write commercial insurance for narrowly defined classes of insureds, requiring an in-depth knowledge of the insured’s industry segment, through general and other wholesale agents.

We transact business primarily through our seventeen insurance subsidiaries domiciled in the United States and six insurance subsidiaries domiciled in Europe and Mexico. We are authorized to write business in all 50 states in the United States and in the European Union. Through our subsidiary, AmTrust at Lloyd's, we are licensed to underwrite business internationally in locations where Lloyd's is licensed. Our principal operating subsidiaries are rated "A"(Excellent) by A.M. Best Company ("A.M. Best").


50


For the nine months ended September 30, 2015, our results of operations include activity for the following entities that were acquired subsequent to September 30, 2014:

•
CorePointe Insurance Company ("CorePointe")
•
TMI Solutions, LLC ("TMIS")
•
Oryx Insurance Brokerage, Inc. ("Oryx")
•
Comp Options Insurance Company ("Comp Options")

Insurance, particularly workers’ compensation, is generally affected by seasonality. The first quarter generally produces greater premiums than subsequent quarters. Nevertheless, the impact of seasonality on our Small Commercial Business and Specialty Program segments has not been significant. We believe that this is because we serve many small businesses in different geographic locations. In addition, we believe seasonality may be muted by our acquisition activity. Additionally, our Specialty Risk and Extended Warranty segment may be impacted by the seasonality of the automotive and consumer electronic markets.

 We evaluate our operations by monitoring key measures of growth and profitability, including return on equity and net combined ratio. Our return on annualized average equity was 35.4% and 39.5% for the three months ended September 30, 2015 and 2014, respectively, and 28.1% and 32.1% for the nine months ended September 30, 2015 and 2014, respectively. Our overall financial objective is to produce a return on equity of 15.0% or more over the long term. In addition, we target a net combined ratio of 95.0% or lower over the long term, while seeking to maintain optimal operating leverage in our insurance subsidiaries commensurate with our A.M. Best rating objectives. Our net combined ratio was 92.6% and 91.3% for the three months ended September 30, 2015 and 2014, respectively, and 90.8% and 90.7% for the nine months ended September 30, 2015 and 2014, respectively.

The following summary further describes our principal revenue and expense measures and key ratios that we use to evaluate our results of operations:
 
Gross Written Premium. Gross written premium represents estimated premiums from each insurance policy that we write, including as a servicing carrier for assigned risk plans, during a reporting period based on the effective date of the individual policy. Certain policies that we underwrite are subject to premium audit at that policy’s cancellation or expiration. The final actual gross premiums written may vary from the original estimate based on changes to the final rating parameters or classifications of the policy.
 
Net Written Premium. Net written premium is gross written premium less that portion of premium that we ceded to third party reinsurers under reinsurance agreements. The amount ceded under these reinsurance agreements is based on the contractual formula contained in the individual reinsurance agreements.
  
Net Earned Premium. Net earned premium is the earned portion of our net written premiums. We earn insurance premiums on a pro-rata basis over the term of the policy. At the end of each reporting period, premiums written that are not earned are classified as unearned premiums, which are earned in subsequent periods over the remaining term of the policy. Our workers’ compensation insurance and commercial package policies typically have a term of one year. Thus, for a one-year policy written on July 1, 2014 for an employer with a constant payroll during the term of the policy, we would earn half of the premiums in 2014 and the other half in 2015. We earn our specialty risk and extended warranty coverages over the estimated exposure time period. The terms vary depending on the risk. The coverages range in duration from one month to 120 months. Our U.S. warranty business has an average duration of 42 months, while our European warranty business has an average duration of 19 months and our European casualty business has an average duration of 12 months.

Service and Fee Income. We currently generate service and fee income from the following sources:
 
•
Product warranty registration and service — Our Specialty Risk and Extended Warranty business generates fee revenue for product warranty registration and claims handling services provided to unaffiliated third party retailers, manufacturers and dealerships. Additionally, we provide credit monitoring services for a fee.
•
Servicing carrier — We act as a servicing carrier for workers’ compensation assigned risk plans in multiple states. In addition, we also offer claims adjusting and loss control services for fees to unaffiliated third parties.
•
Management services — We provide services to insurance consumers, traditional insurers and insurance producers by offering flexible and cost effective alternatives to traditional insurance tools in the form of various risk retention groups and captive management companies, as well as management of workers’ compensation and commercial property programs. We also offer programs and alternative funding options

51


for non-profit and public sector organizations for the management of their state unemployment insurance obligations.
•
Insurance fees — We recognize fee income associated with the issuance of workers’ compensation policies for installment fees, in jurisdictions where it is permitted and approved, and reinstatement fees, which are fees charged to reinstate a policy after it has been canceled for non-payment, in jurisdictions where it is permitted and approved. Additionally, we recognize broker commissions and policy management fees associated with general liability policies placed by one of our managing general agencies.
•
Broker services — We provide brokerage services to Maiden Holdings Ltd. ("Maiden") in connection with our reinsurance agreement for which we receive a fee.
•
Asset management services — We currently manage the investment portfolios of certain subsidiaries of Maiden, National General Holdings Corp. ("NGHC") and ACP Re, Ltd. ("ACP Re") for which we receive a management fee.
•
Information technology services — We provide information technology and printing and mailing services to NGHC and its affiliates for a fee.

Net Investment Income and Realized Gains and (Losses). We invest our statutory surplus funds and the funds supporting our insurance liabilities primarily in cash and cash equivalents, fixed maturity and equity securities. Our net investment income includes interest and dividends earned on our invested assets. We report net realized gains and losses on our investments separately from our net investment income. Net realized gains occur when we sell our investment securities for more than their costs or amortized costs, as applicable. Net realized losses occur when we sell our investment securities for less than their costs or amortized costs, as applicable, or we write down the investment securities as a result of other-than-temporary impairment. We classify equity securities and our fixed maturity securities primarily as available-for-sale. We report net unrealized gains (losses) on those securities classified as available-for-sale separately within accumulated other comprehensive income on our balance sheet. Additionally, we have a small portfolio of equity securities classified as trading securities. We report unrealized gains (losses) on those securities classified as trading securities within realized gains (losses).

Loss and Loss Adjustment Expenses Incurred.   Loss and loss adjustment expenses (“LAE”) incurred represent our largest expense item and, for any given reporting period, include estimates of future claim payments, changes in those estimates from prior reporting periods and costs associated with investigating, defending and servicing claims. These expenses fluctuate based on the amount and types of risks we insure. We record loss and loss adjustment expenses related to estimates of future claim payments based on case-by-case valuations and statistical analysis. We seek to establish all reserves at the most likely ultimate exposure based on our historical claims experience. It is typical for our more serious bodily injury claims to take several years to settle and we revise our estimates as we receive additional information about the condition of injured employees and claimants and the costs of their medical treatment. Our ability to estimate loss and loss adjustment expenses accurately at the time of pricing our insurance policies is a critical factor in our profitability.

 Acquisition Costs and Other Underwriting Expenses.   Acquisition costs and other underwriting expenses consist of policy acquisition expenses, salaries and benefits and general and administrative expenses, net of ceding commissions. These items are described below:
 
•
Policy acquisition expenses comprise commissions directly attributable to those agents, wholesalers or brokers that produce premiums written on our behalf. In most instances, we pay commissions based on collected premium, which reduces our credit risk exposure associated with producers in case a policyholder does not pay a premium. We pay state and local taxes, licenses and fees, assessments and contributions to various state guaranty funds based on our premiums or losses in each state. Surcharges that we may be required to charge and collect from insureds in certain jurisdictions are recorded as accrued liabilities, rather than expense. These expenses are offset by ceding commissions received.
•
Salaries and benefits expenses are those salaries and benefits expenses for employees that are directly involved in the origination, issuance and maintenance of policies, claims adjustment and accounting for insurance transactions. We classify salaries and benefits associated with employees that are involved in fee generating activities as other expenses.
•
General and administrative expenses are comprised of other costs associated with our insurance activities, such as federal excise tax, postage, telephones and internet access charges, as well as legal and auditing fees and board and bureau charges.
•
Ceding commission on reinsurance transactions is a commission we receive from ceding gross written premium to third party reinsurers, and is netted against acquisition costs and other underwriting expenses. In connection with the Maiden Quota Share, which is our primary source of ceding commissions, the amount we receive is a blended rate based on a contractual formula contained in the individual reinsurance agreements, and the rate may not correlate specifically to the cost structure of the individual segments. The

52


ceding commissions we receive cover a portion of our capitalized direct acquisition costs and a portion of other underwriting expenses. Ceding commissions received from reinsurance transactions that represent recovery of capitalized direct acquisition costs are recorded as a reduction of capitalized unamortized deferred acquisition costs and the net amount is charged to expense in proportion to net premium revenue recognized. Ceding commissions received from reinsurance transactions that represent the recovery of other underwriting expenses are recognized in the income statement over the insurance contract period in proportion to the insurance protection provided and classified as a reduction of acquisition costs and other underwriting expenses. Ceding commissions received, but not yet earned, that represent the recovery of other underwriting expenses are classified as a component of accrued expenses and other current liabilities. We allocate earned ceding commissions to its segments based on each segment’s proportionate share of total acquisition costs and other underwriting expenses recognized during the period.

Gain (loss) on Investment in Life Settlement Contracts.  The gain (loss) on investment in life settlement contracts includes the gain (loss) on acquisition of life settlement contracts, the gain (loss) realized upon a mortality event and the change in fair value of the investments in life settlements as evaluated at the end of each reporting period. We determine fair value based upon our estimate of the discounted cash flow related to policies (net of reserves for improvements in mortality, the possibility that the high net worth individuals represented in our portfolio may have access to better health care, the volatility inherent in determining the life expectancy of insureds with significant reported health impairments, the possibility that the issuer of the policy or a third party will contest the payment of the death benefit payable to us and the future expenses related to the administration of the portfolio), which incorporates current life expectancy assumptions, premium payments, credit exposure to the insurance companies that issued the life insurance policies and the rate of return that a buyer would require on the policies as no comparable market pricing is available. The gain (loss) realized upon a mortality event is the difference between the death benefit received and the recorded fair value of that particular policy. We allocate gain (loss) on investment in life settlement contracts to our segments based on gross written premium by segment.
 
Net Loss Ratio. The net loss ratio is a measure of the underwriting profitability of an insurance company's business. Expressed as a percentage, this is the ratio of net losses and LAE incurred to net premiums earned.
 
Net Expense Ratio. The net expense ratio is a measure of an insurance company’s operational efficiency in administering its business. Expressed as a percentage, this is the ratio of the sum of acquisition costs and other underwriting expenses to net premiums earned. As we allocate certain acquisition costs and other underwriting expenses based on premium volume to our segments, net loss ratio on a segment basis may be impacted period over period by a shift in the mix of net written premium.
 
Net Combined Ratio. The net combined ratio is a measure of an insurance company's overall underwriting profit. This is the sum of the net loss and net expense ratios. If the net combined ratio is at or above 100 percent, an insurance company cannot be profitable without investment income, and may not be profitable if investment income is insufficient.
 
Net Premiums Earned less Expenses Included in Combined Ratio (Underwriting Income).  Underwriting income is a measure of an insurance company’s overall operating profitability before items such as investment income, interest expense and income taxes.
 
Return on Equity. We calculate return on equity by dividing net income by the average of shareholders’ equity.
 
Critical Accounting Policies
 
Our discussion and analysis of our results of operations, financial condition and liquidity are based upon our consolidated financial statements, which have been prepared in accordance with U.S. generally accepted accounting principles. The preparation of these financial statements requires us to make estimates and judgments that affect the amounts of assets and liabilities, revenues and expenses and disclosure of contingent assets and liabilities as of the date of the financial statements. As more information becomes known, these estimates and assumptions could change, which would have an impact on actual results that may differ materially from these estimates and judgments under different assumptions. Except as discussed below, we have not made any changes in estimates or judgments that have had a significant effect on the reported amounts as previously disclosed in our Annual Report on Form 10-K for the fiscal period ended December 31, 2014.



53


Results of Operations

Consolidated Results of Operations for the Three and Nine Months Ended September 30, 2015 and 2014 (Unaudited)
 
 
Three Months Ended September 30,

Nine Months Ended September 30,
(Amounts in Thousands)
 
2015

2014

2015

2014
Gross written premium
 
$
1,780,813

 
$
1,518,481

 
$
5,190,338

 
$
4,628,317

 
 
 
 
 
 
 
 
 
Net written premium
 
$
1,142,983

 
$
1,004,196

 
$
3,194,893

 
$
3,058,147

Change in unearned premium
 
(97,575
)
 
(89,783
)
 
(231,138
)
 
(439,746
)
Net earned premium
 
1,045,408

 
914,413

 
2,963,755

 
2,618,401

Service and fee income (related parties - three months $19,250; $14,737 and nine months $57,935; $42,055)
 
126,143

 
117,583

 
346,766

 
308,083

Net investment income
 
40,425

 
34,552

 
111,281

 
95,673

Net realized and unrealized gain on investments
 
17,682

 
5,086

 
30,693

 
14,431

Total revenues
 
1,229,658

 
1,071,634

 
3,452,495

 
3,036,588

Loss and loss adjustment expense
 
709,604

 
609,352

 
1,961,362

 
1,755,155

Acquisition costs and other underwriting expenses (net of ceding commission - related party - three months $138,036; $109,540 and nine months $385,945; $288,891)
 
258,016

 
225,512

 
728,402

 
620,181

Other
 
116,900

 
103,493

 
313,487

 
278,672

Total expenses
 
1,084,520

 
938,357

 
3,003,251

 
2,654,008

Income before other income (expense), income taxes and equity in earnings of unconsolidated subsidiaries
 
145,138

 
133,277

 
449,244

 
382,580

Other income (expense):
 
 

 
 

 
 

 
 

Interest expense (net of interest income - related party - three months $2,115; $365 and nine months $6,514; $365)
 
(12,862
)
 
(11,801
)
 
(32,763
)
 
(35,885
)
Loss on extinguishment of debt
 
(557
)
 
—

 
(5,271
)
 
—

Net gain (loss) on investment in life settlement contracts net of profit commission
 
4,616

 
(2,910
)
 
19,085

 
(5,180
)
Foreign currency gain
 
24,721

 
26,594

 
17,355

 
25,826

Acquisition gain on purchase
 
5,826

 
—

 
5,826

 
—

Gain on sale of subsidiary
 
—


—

 
—

 
6,631

Total other income (expense)
 
21,744

 
11,883

 
4,232

 
(8,608
)
Income before income taxes and equity in earnings (loss) of unconsolidated subsidiaries
 
166,882

 
145,160

 
453,476

 
373,972

(Benefit) provision for income taxes
 
(12,649
)
 
(7,664
)
 
38,635

 
37,746

Income before equity in earnings of unconsolidated subsidiaries
 
179,531

 
152,824

 
414,841

 
336,226

Equity in earnings of unconsolidated subsidiaries – related parties
 
13,477

 
4,332

 
23,048

 
26,847

Net income
 
193,008

 
157,156

 
437,889

 
363,073

Net (income) loss attributable to redeemable non-controlling interest and non-controlling interest of subsidiaries
 
(1,511
)
 
2,939

 
(6,940
)
 
7,029

Net income attributable to AmTrust Financial Services, Inc.
 
191,497

 
160,095

 
430,949

 
370,102

Dividends on preferred stock
 
(8,789
)
 
(3,505
)
 
(22,797
)
 
(7,387
)
Net income attributable to AmTrust common shareholders
 
$
182,708

 
$
156,590

 
$
408,152

 
$
362,715

 
 
 
 
 
 
 
 
 
Net realized gain (loss) on investments:
 
 

 
 

 
 

 
 

Total other-than-temporary impairment loss
 
$
(7,636
)
 
$
(464
)
 
$
(10,118
)
 
$
(4,003
)
Portion of loss recognized in other comprehensive income
 
—

 
—

 
—

 
—

Net impairment losses recognized in earnings
 
(7,636
)
 
(464
)
 
(10,118
)
 
(4,003
)
Net realized gain on available for sale securities
 
16,049

 
3,385

 
29,306

 
16,618

Net unrealized gain on trading securities
 
9,269

 
2,165

 
11,505

 
1,816

Net realized investment gain
 
$
17,682

 
$
5,086

 
$
30,693

 
$
14,431

 
 
 
 
 
 
 
 
 
Key measures:
 
 

 
 

 
 

 
 

Net loss ratio
 
67.9
%
 
66.6
%
 
66.2
%
 
67.0
%
Net expense ratio
 
24.7
%
 
24.7
%
 
24.6
%
 
23.7
%
Net combined ratio
 
92.6
%
 
91.3
%
 
90.8
%
 
90.7
%

54


 
Consolidated Results of Operations for the Three Months Ended September 30, 2015 and 2014 (Unaudited)

Gross Written Premium. Gross written premium increased $262.2 million, or 17.3%, to $1,780.8 million from $1,518.5 million for the three months ended September 30, 2015 and 2014, respectively. The increase of $262.2 million was attributable to growth in all three of our segments. The majority of the increase in the Small Commercial Business segment was attributable to an increase in the number of workers' compensation policies issued. The increase in Specialty Risk and Extended Warranty segment was attributable to expansion of our existing programs, which was partially offset by a decrease in our European business due to the strengthening of the U.S. dollar relative to the Euro and British Pound. The increase in the Specialty Program segment resulted primarily from expansion of our existing programs.

Net Written Premium. Net written premium increased $138.8 million, or 13.8%, to $1,143.0 million from $1,004.2 million for the three months ended September 30, 2015 and 2014, respectively. The increase by segment was: Small Commercial Business - $36.8 million, Specialty Risk and Extended Warranty - $49.0 million and Specialty Program – $53.0 million. Net written premium increased for the three months ended September 30, 2015 compared to the same period in 2014 due to the increase in gross written premium. This increase was partially offset by a decrease in the retention of gross written premium to 64.2% from 66.1% for the three months ended September 30, 2015 and 2014, respectively, and the negative impact of currency fluctuation on our European business.
 
Net Earned Premium. Net earned premium increased $131.0 million, or 14.3%, to $1,045.4 million from $914.4 million for the three months ended September 30, 2015 and 2014, respectively. The increase by segment was: Small Commercial Business — $71.9 million, Specialty Risk and Extended Warranty — $22.4 million and Specialty Program — $36.9 million. The increase in net earned premium resulted from an increase in net written premium of 20% on a trailing twelve-month basis, partially offset by the negative impact of currency fluctuation on our European business.
  
Service and Fee Income. Service and fee income increased $8.6 million, or 7.3%, to $126.1 million from $117.6 million for the three months ended September 30, 2015 and 2014, respectively. We increased service and fee income by $6.3 million during the third quarter of 2015 from acquisitions, primarily from Oryx and TMIS. Services provided to Maiden, NGHC and ACP Re generated higher fees of approximately $4.5 million during the three months ended September 30, 2015 compared to the same period in 2014. The increases were partially offset by a decrease of approximately $5.7 million in fees generated by the administration of commercial property and casualty insurance, and from product warranty registration and claims handling services during the third quarter of 2015 compared to the same period in 2014.
 
Net Investment Income. Net investment income increased $5.9 million, or 17.0%, to $40.4 million from $34.6 million for the three months ended September 30, 2015 and 2014, respectively. The increase resulted primarily from a higher average portfolio of fixed maturity securities during the three months ended September 30, 2015 compared to the same period in 2014 achieved by our investment of certain proceeds from stock and debt offerings in 2014 and 2015 and the acquisitions of CorePointe and Comp Options. Additionally, our investment yields were slightly higher period over period.
 
Net Realized Gains/(Loss) on Investments. We had a net realized gain on investments of $17.7 million and $5.1 million for the three months ended September 30, 2015 and 2014, respectively. A majority of the increase resulted from the recognition of a gain on trading securities of $9.3 million and $2.2 million during the three months ended September 30, 2015 and 2014, respectively. Additionally, we had an increase in realized gains on available for sale investments as a result of increased sales of securities in a gain position. The increase was partially offset by impairments, which were approximately $7.6 million and $0.5 million during the three months ended September 30, 2015 and 2014, respectively.

 Loss and Loss Adjustment Expenses. Loss and loss adjustment expenses increased $100.3 million, or 16.5%, to $709.6 million for the three months ended September 30, 2015 from $609.4 million for the three months ended September 30, 2014. Our loss ratio for the three months ended September 30, 2015 and 2014 was 67.9% and 66.6%, respectively. The increase in the loss ratio resulted from higher current and prior accident years selected ultimate losses as compared to previously selected ultimate losses in prior accident years in our Specialty Risk and Extended Warranty segment. This was a result, primarily, from a revision to our ultimate losses on certain casualty lines in our European specialty risk and extended warranty business due to an increase in our carried incurred but not reported claim reserves. The increase in the loss ratio was partially offset by our Small Commercial Business segment's loss ratio, which decreased from improved pricing on policy issuances combined with stable claims frequency and severity. We did not have any material increases or decreases as a result of prior year loss development.

Acquisition Costs and Other Underwriting Expenses. Acquisition costs and other underwriting expenses increased $32.5 million, or 14.4%, to $258.0 million for the three months ended September 30, 2015 from $225.5 million for the three months ended September 30, 2014. Acquisition costs and other underwriting expenses in each period were reduced by ceding commission

55


primarily earned through the Maiden Quota Share, whereby we receive a ceding commission of 31% of premiums ceded for all business except retail commercial package business, and 34.375% for retail commercial package business. The ceding commission earned during the three months ended September 30, 2015 and 2014 was $139.5 million and $109.5 million, respectively. Ceding commission increased period over period as a result of increases in gross written premium and lower retention of gross written premium, and was consistent period over period as a percentage of earned premium. The expense ratio was 24.7% during each of the three months ended September 30, 2015 and 2014.

Income Before Other Income (Expense), Income Taxes and Equity Earnings of Unconsolidated Subsidiaries. Income before other income (expense), income taxes and equity earnings of unconsolidated subsidiaries increased $11.9 million, or 8.9%, to $145.1 million for the three months ended September 30, 2015 from $133.3 million for the three months ended September 30, 2014. The $11.9 million increase resulted primarily from an increase in earned premium and higher net investment income period over period.
 
Net Interest Expense. Net interest expense for the three months ended September 30, 2015 was $12.9 million, compared to $11.8 million for the same period in 2014. The majority of the increase related to additional interest expense of approximately $3.2 million related to the issuance of $285 million of subordinated notes in 2015, partially offset by additional interest income of approximately $1.8 million related to our $125 million loan to ACP Re, which we entered into at the end of the third quarter of 2014.

 Net Gain (Loss) on Investment in Life Settlement Contracts Net of Profit Commission. We recognized a gain on investment in life settlement contracts of $4.6 million for the three months ended September 30, 2015 compared to a loss of $2.9 million for the three months ended September 30, 2014. The increase related primarily to increases in the fair value of the life settlement contracts without a corresponding increase in premium payments as well as two maturities in the three months ended September 30, 2015.

Foreign Currency Gain (Loss). The foreign currency transaction gain was $24.7 million during the three months ended September 30, 2015 compared to a transaction gain of $26.6 million during the same period in 2014. The gain during the three months ended September 30, 2015 resulted from fluctuations in exchange rates related to internal reinsurance transactions between our European insurance companies and our Bermuda reinsurance company.

Benefit for Income Tax. Income tax benefit for the three months ended September 30, 2015 was $12.6 million, which resulted in an effective tax rate of (7.6)%, compared to income tax benefit of $7.7 million, which resulted in an effective tax rate of (5.3)% for the three months ended September 30, 2014. During the three months ended September 30, 2015 and 2014, we benefited from a return to provision adjustment in connection with filing our 2014 and 2013 federal tax returns, respectively. During the three months ended September 30, 2014 only, the effective tax rate was impacted by a reduction of the deferred tax liability attributable to the equalization reserves of our Luxembourg reinsurers of approximately $18.0 million, which reduced our effective tax rate by approximately 12.4%. Without the impact of the equalization reserve, the effective tax rate for the three months ended September 30, 2014 would have been 7.1%. There was no corresponding decrease attributable to equalization reserves during the three months ended September 30, 2015. The overall decrease in the effective tax rates in the three months ended September 30, 2015 compared to the three months ended September 30, 2014 resulted from a change in the profitability by jurisdiction.

 Equity in Earnings of Unconsolidated Subsidiaries - Related Parties. Equity in earnings of unconsolidated subsidiaries - related parties was $13.5 million and $4.3 million for the three months ended September 30, 2015 and September 30, 2014, respectively. The $9.2 increase in equity income was driven by approximately $9.3 million of a realized gain due to a decrease in ownership percentage of NGHC from 13% to 12% as a result of NGHC's share offering in August 2015.

Consolidated Results of Operations for the Nine Months Ended September 30, 2015 and 2014 (Unaudited)

Gross Written Premium. Gross written premium increased $562.0 million, or 12.1%, to $5,190.3 million from $4,628.3 million for the nine months ended September 30, 2015 and 2014, respectively. The increase of $562.0 million is attributable to growth in all three of our segments. The increase in the Specialty Program segment resulted primarily from expansion of our existing programs. The majority of the increase in the Small Commercial Business segment was attributable to an increase in the number of workers' compensation policies issued, partially offset by the assumption of $199.7 million of non-recurring premium during the first quarter of 2014 as part of the cut through reinsurance agreement with Tower. The majority of the increase in our Specialty Risk and Extended Warranty segment resulted from growth in our domestic business from expansion of existing programs. The overall increase was partially offset by a decline in our Specialty Risk and Extended Warranty segment related to declines in gross written premium in our European business due to the strengthening of the U.S. dollar relative to the Euro and British Pound.


56


Net Written Premium. Net written premium increased $136.7 million, or 4.5%, to $3,194.9 million from $3,058.1 million for the nine months ended September 30, 2015 and 2014, respectively. The increase/(decrease) by segment was: Small Commercial Business - $(26.4) million, Specialty Risk and Extended Warranty - $41.8 million and Specialty Program – $121.3 million. Net written premium increased for the nine months ended September 30, 2015 compared to the same period in 2014 due to an increase in gross written premium, which was partially offset by a decrease in the retention of gross written premium to 61.6% from 66.1% for the nine months ended September 30, 2015 and 2014, respectively. The decrease in retention resulted from the assumption of non-recurring premium during the first quarter of 2014 that was not subject to the Maiden Quota Share
 
Net Earned Premium. Net earned premium increased $345.4 million, or 13.2%, to $2,963.8 million from $2,618.4 million for the nine months ended September 30, 2015 and 2014, respectively. The increase by segment was: Small Commercial Business — $211.7 million, Specialty Risk and Extended Warranty — $42.3 million and Specialty Program — $100.2 million. The increase in net earned premium resulted from an increase in net written premium of 20% on a trailing twelve-month basis, partially offset by premium assumed in 2014 through the cut through reinsurance agreement with Tower, which was not subject to the Maiden Quota Share and negative impact of currency fluctuation on our European business.

Service and Fee Income. Service and fee income increased $38.7 million, or 12.6%, to $346.8 million from $308.1 million for the nine months ended September 30, 2015 and 2014, respectively. We increased service and fee income by $30.8 million during the nine months ended September 30, 2015 from acquisitions, including Oryx and TMIS. Services provided to Maiden, NGHC and ACP Re generated higher fees of approximately $15.9 million during the nine months ended September 30, 2015 compared to the same period in 2014. The increases were partially offset by a decrease of approximately $7.1 million in fees generated by the administration of commercial property and casualty insurance, and from product warranty registration and claims handling services during the nine months ended September 30, 2015 compared to the same period in 2014.
 
Net Investment Income. Net investment income increased $15.6 million, or 16.3%, to $111.3 million from $95.7 million for the nine months ended September 30, 2015 and 2014, respectively. The increase resulted primarily from a higher average portfolio of fixed maturity securities during the nine months ended September 30, 2015 compared to the same period in 2014 achieved by our investment of certain proceeds from stock and debt offerings in 2014 and 2015 and the acquisitions of CorePointe and Comp Options. Additionally, our investment yields were slightly higher period over period.
 
Net Realized Gains on Investments. We had a net realized gain on investments of $30.7 million and $14.4 million for the nine months ended September 30, 2015 and 2014, respectively. A majority of the increase resulted from recognizing a gain on trading securities of $11.5 million and $1.8 million during the nine months ended September 30, 2015 and 2014, respectively. Additionally, we had an increase in realized gains on available for sale investments as a result of increased sales of securities in a gain position. The increase was partially offset by impairments, which were approximately $10.1 million and $4.0 million during the nine months ended September 30, 2015 and 2014, respectively.

 Loss and Loss Adjustment Expenses. Loss and loss adjustment expenses increased $206.2 million, or 11.7%, to $1,961.4 million for the nine months ended September 30, 2015 from $1,755.2 million for the nine months ended September 30, 2014. Our loss ratio for the nine months ended September 30, 2015 and 2014 was 66.2% and 67.0%, respectively. The decrease in loss ratio was a result of lower current accident year selected ultimate losses as compared to selected ultimate losses in prior accident years, primarily in our Small Commercial Business segment. A majority of the decrease resulted from improved pricing on policy issuances combined with stable claims frequency and severity. We did not have any material increases or decreases as a result of prior year loss development.

Acquisition Costs and Other Underwriting Expenses. Acquisition costs and other underwriting expenses increased $108.2 million, or 17.4%, to $728.4 million for the nine months ended September 30, 2015 from $620.2 million for the nine months ended September 30, 2014. Acquisition costs and other underwriting expenses in each period were reduced by ceding commission primarily earned through the Maiden Quota Share. The ceding commission earned during the nine months ended September 30, 2015 and 2014 was $389.0 million and $288.9 million, respectively. Ceding commission increased period over period as a result of increases in gross written premium and was consistent period over period as a percentage of earned premium. The expense ratio increased to 24.6% during the nine months ended September 30, 2015 from 23.7% during the nine months ended September 30, 2014, as a result of increases in our Small Commercial Business and Specialty Risk and Extended Warranty segments. The increase in the expense ratio was primarily related to the issuance of a higher percentage of commercial package and excess and surplus lines policies, which have higher policy acquisition costs.

Income Before Other Income (Expense), Income Taxes and Equity Earnings of Unconsolidated Subsidiaries. Income before other income (expense), income taxes and equity earnings of unconsolidated subsidiaries increased $66.7 million, or 17.4%, to $449.2 million for the nine months ended September 30, 2015 from $382.6 million for the nine months ended September 30,

57


2014. The $66.7 million increase resulted primarily from an increase in earned premium with a consistent combined ratio and higher net investment income.
 
Net Interest Expense. Net interest expense for the nine months ended September 30, 2015 was $32.8 million, compared to $35.9 million for the same period in 2014. The decrease in net interest expense related primarily to interest income of approximately $6.1 million related to our $125 million loan to ACP Re, which we entered into during the third quarter of 2014, partially offset by additional interest expense of approximately $3.5 million related to the issuance of $285 million of subordinated notes in 2015.

 Net Gain (Loss) on Investment in Life Settlement Contracts Net of Profit Commission. We recognized a gain on investment in life settlement contracts of $19.1 million for the nine months ended September 30, 2015 compared to a loss of $5.2 million for the nine months ended September 30, 2014. The increase related primarily to increases in the fair value of the life settlement contracts without a corresponding increase in premium payments as well as seven maturities during the nine months ended September 30, 2015.

Foreign Currency Gain (Loss). The foreign currency transaction gain decreased $8.5 million during the nine months ended September 30, 2015 to $17.4 million from a transaction gain of $25.8 million during the same period in 2014. The gain during the nine months ended September 30, 2015 resulted from fluctuations in exchange rates related to internal reinsurance transactions between our European insurance companies and our Bermuda reinsurance company.

Provision for Income Tax. Provision for income tax for the nine months ended September 30, 2015 was $38.6 million, which resulted in an effective tax rate of 8.5%, compared to income tax expense of $37.7 million, which resulted in an effective tax rate of 10.1%, for the nine months ended September 30, 2014. During the nine months ended September 30, 2014 only, the effective tax rate was favorably impacted by a reduction of the deferred tax liability attributable to the equalization reserves of our Luxembourg reinsurers for $36.7 million, which reduced the effective tax rate by 9.8%. Without the impact of the equalization reserve, the effective tax rate for the nine months ended September 30, 2014 would have been 19.9%. There was no corresponding decrease attributable to equalization reserves during the three months ended September 30, 2015. The overall decrease in the effective tax rates in the nine months ended September 30, 2015 compared to the nine months ended September 30, 2014 resulted from a change in the profitability by jurisdiction.

 Equity in Earnings of Unconsolidated Subsidiaries - Related Parties. Equity in earnings of unconsolidated subsidiaries - related party decreased by $3.8 million for the nine months ended September 30, 2015 to $23.0 million compared to $26.8 million for the nine months ended September 30, 2014. The decrease resulted primarily from realized gains recognized of $9.3 million in 2015 and $14.7 million in 2014 as a result of a decrease in our ownership percentage of NGHC from 13% to 12% in 2015 and 15% to 13% in 2014. The overall decrease was partially offset by an increase in equity income attributable to our pro rata share of NGHC's results of operations in 2015 compared to 2014.


58


Small Commercial Business Segment Results of Operations for the Three and Nine Months Ended September 30, 2015 and 2014 (Unaudited)
 
 
 
Three Months Ended September 30,

Nine Months Ended September 30,
(Amounts in Thousands)
 
2015

2014

2015

2014
Gross written premium
 
$
797,654

 
$
722,897

 
$
2,574,602

 
$
2,366,451

 
 
 
 
 
 
 
 
 
Net written premium
 
$
459,290

 
$
422,539

 
$
1,499,922

 
$
1,526,347

Change in unearned premium
 
34,364

 
(815
)
 
(99,218
)
 
(337,362
)
Net earned premium
 
493,654

 
421,724

 
1,400,704

 
1,188,985

 
 
 
 
 
 
 
 
 
Loss and loss adjustment expense
 
(320,391
)
 
(279,056
)
 
(909,081
)
 
(792,224
)
Acquisition costs and other underwriting expenses
 
(130,792
)
 
(111,939
)
 
(365,184
)
 
(299,082
)
 
 
(451,183
)
 
(390,995
)
 
(1,274,265
)
 
(1,091,306
)
Underwriting income
 
$
42,471

 
$
30,729

 
$
126,439

 
$
97,679

 
 
 
 
 
 
 
 
 
Key measures:
 
 

 
 

 
 

 
 

Net loss ratio
 
64.9
%
 
66.2
%
 
64.9
%
 
66.6
%
Net expense ratio
 
26.5
%
 
26.5
%
 
26.1
%
 
25.2
%
Net combined ratio
 
91.4
%
 
92.7
%
 
91.0
%
 
91.8
%
 
Small Commercial Business Segment Results of Operations for the Three Months Ended September 30, 2015 and 2014 (Unaudited)

Gross Written Premium.  Gross written premium increased $74.8 million, or 10.3%, to $797.7 million for the three months ended September 30, 2015 from $722.9 million for the three months ended September 30, 2014. The majority of the increase was attributable to an increase in the number of workers' compensation policies issued. The increase consisted of additional workers' compensation premium in the states of California, New Jersey and New York. Additionally, the acquisition of Comp Options contributed approximately $11 million of incremental gross written premium for the three months ended September 30, 2015.
 
Net Written Premium. Net written premium increased $36.8 million, or 8.7%, to $459.3 million for the three months ended September 30, 2015 from $422.5 million for the three months ended September 30, 2014. The increase resulted from an increase in gross written premium for the three months ended September 30, 2015 compared to the same period in 2014. The increase was partially offset by cession of a greater percentage of gross written premium to reinsurers during 2015 compared to 2014. Our retention of gross written premium for the segment was 57.6% and 58.5% for the three months ended September 30, 2015 and 2014, respectively, as the three months ended September 30, 2014 included business assumed from Tower that we did not cede to Maiden.
 
Net Earned Premium. Net earned premium increased $71.9 million, or 17.0%, to $493.7 million for the three months ended September 30, 2015 from $421.7 million for the three months ended September 30, 2014. As premiums written are earned ratably over an annual period, the increase in net earned premium resulted from higher net written premium for the twelve months ended September 30, 2015 compared to the same period in 2014.

Loss and Loss Adjustment Expenses. Loss and loss adjustment expenses increased $41.3 million, or 14.8%, to $320.4 million for the three months ended September 30, 2015 from $279.1 million for the three months ended September 30, 2014. Our loss ratio for the segment for the three months ended September 30, 2015 decreased to 64.9% compared to 66.2% for the three months ended September 30, 2014. The decrease in the loss ratio was the result, primarily, of lower current accident year selected ultimate losses as compared to selected ultimate losses in the prior period. The decrease in the loss ratio resulted from improved pricing on policy issuances combined with stable claims frequency and severity. We did not have any material increases or decreases as a result of prior year loss development.

Acquisition Costs and Other Underwriting Expenses. Acquisition costs and other underwriting expenses increased $18.9 million, or 16.9%, to $130.8 million for the three months ended September 30, 2015 from $111.9 million for the three months ended September 30, 2014. Acquisition costs and other underwriting expenses were reduced by ceding commission of $70.7 million

59


and $54.3 million earned during the three months ended September 30, 2015 and 2014, respectively. The ceding commission increased period over period as a result of an increase in net earned premium, as the segment received a consistent allocation of ceding commission for its proportionate share of our overall policy acquisition expense. The expense ratio remained consistent period over period and was 26.5% for each of the three months ended September 30, 2015 and 2014.

Net Earned Premiums less Expense Included in Combined Ratio (Underwriting Income). Net premiums earned less expenses included in combined ratio increased $11.7 million, or 38.2%, to $42.5 million for the three months ended September 30, 2015 from $30.7 million for the three months ended September 30, 2014. The increase resulted from higher earned premium coupled with a lower loss ratio during the three months ended September 30, 2015 compared to the three months ended September 30, 2014.

Small Commercial Business Segment Results of Operations for the Nine Months Ended September 30, 2015 and 2014 (Unaudited)

Gross Written Premium. Gross written premium increased $208.2 million, or 8.8%, to $2,574.6 million for the nine months ended September 30, 2015 from $2,366.5 million for the nine months ended September 30, 2014. The majority of the increase was attributable to an increase in the number of workers' compensation policies issued. Approximately 76% of this increase was from the states of California, Florida, New Jersey and New York. Additionally, the acquisitions of Comp Options and CorePointe contributed approximately $79 million of incremental gross written premium for the nine months ended September 30, 2015. Absent the assumption of $199.7 million of non-recurring premium during the first three months of 2014, primarily related to our cut through reinsurance agreement with Tower, gross written premium would have increased $407.9 million, or 18.8%.

Net Written Premium. Net written premium decreased $26.4 million, or (1.7)%, to $1,499.9 million for the nine months ended September 30, 2015 from $1,526.3 million for the nine months ended September 30, 2014. The decrease resulted from the 2014 assumption of $199.7 million of non-recurring premium that was not subject to the Maiden Quota Share. As a result, our retention of gross written premium for the segment decreased to 58.3% from 64.5% for the nine months ended September 30, 2015 and 2014, respectively.
 
Net Earned Premium. Net earned premium increased $211.7 million, or 17.8%, to $1,400.7 million for the nine months ended September 30, 2015 from $1,189.0 million for the nine months ended September 30, 2014. As premiums written are earned ratably over an annual period, the increase in net earned premium resulted from higher net written premium for the twelve months ended September 30, 2015 compared to the same period in 2014, and premium assumed in 2014 through the cut through reinsurance agreement with Tower, which was not subject to the Maiden Quota Share.

Loss and Loss Adjustment Expenses. Loss and loss adjustment expenses increased $116.9 million, or 14.8%, to $909.1 million for the nine months ended September 30, 2015 from $792.2 million for the nine months ended September 30, 2014. Our loss ratio for the segment for the nine months ended September 30, 2015 decreased to 64.9% compared to 66.6% for the nine months ended September 30, 2014. The decrease in the loss ratio was the result, primarily, of lower current accident year selected ultimate losses as compared to selected ultimate losses in the prior period. The decrease in the loss ratio resulted from improved pricing on policy issuances combined with stable claims frequency and severity. We did not have any material increases or decreases as a result of prior year loss development.

Acquisition Costs and Other Underwriting Expenses. Acquisition costs and other underwriting expenses increased $66.1 million, or 22.1%, to $365.2 million for the nine months ended September 30, 2015 from $299.1 million for the nine months ended September 30, 2014. Acquisition costs and other underwriting expenses were reduced by ceding commission earned during the nine months ended September 30, 2015 and 2014 of $195.0 million and $139.9 million, respectively. The ceding commission increased period over period as a result of an increase in net earned premium, as the segment received a larger allocation of ceding commission for its proportionate share of our overall policy acquisition expense. The expense ratio was 26.1% and 25.2% for the nine months ended September 30, 2015 and 2014, respectively. The increase in the expense ratio related to the issuance of a higher percentage of commercial package and excess and surplus lines policies, which have higher policy acquisition costs, during the first half of the year.

Net Earned Premiums less Expense Included in Combined Ratio (Underwriting Income).  Net premiums earned less expenses included in combined ratio increased $28.8 million, or 29.4%, to $126.4 million for the nine months ended September 30, 2015 from $97.7 million for the nine months ended September 30, 2014. The increase resulted primarily from higher earned premium and a lower loss ratio during the nine months ended September 30, 2015 compared to the nine months ended September 30, 2014, partially offset by a higher expense ratio.


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Specialty Risk and Extended Warranty Segment Results of Operations for the Three and Nine Months Ended September 30, 2015 and 2014 (Unaudited)
 
 
 
Three Months Ended September 30,

Nine Months Ended September 30,
(Amounts in Thousands)
 
2015

2014

2015

2014
Gross written premium
 
$
577,284

 
$
436,845

 
$
1,528,017

 
$
1,387,651

 
 
 
 
 
 
 
 
 
Net written premium
 
$
380,600

 
$
331,590

 
$
975,073

 
$
933,245

Change in unearned premium
 
(30,218
)
 
(3,564
)
 
(11,592
)
 
(12,096
)
Net earned premium
 
350,382

 
328,026

 
963,481

 
921,149

 
 
 
 
 
 
 
 
 
Loss and loss adjustment expense
 
(253,136
)
 
(219,535
)
 
(647,121
)
 
(618,469
)
Acquisition costs and other underwriting expenses
 
(69,876
)
 
(68,612
)
 
(197,450
)
 
(185,120
)
 
 
(323,012
)
 
(288,147
)
 
(844,571
)
 
(803,589
)
Underwriting income
 
$
27,370

 
$
39,879

 
$
118,910

 
$
117,560

 
 
 
 
 
 
 
 
 
Key measures:
 
 

 
 

 
 

 
 

Net loss ratio
 
72.2
%
 
66.9
%
 
67.2
%
 
67.1
%
Net expense ratio
 
20.0
%
 
20.9
%
 
20.5
%
 
20.1
%
Net combined ratio
 
92.2
%
 
87.8
%
 
87.7
%
 
87.2
%

Specialty Risk and Extended Warranty Segment Results of Operations for the Three Months Ended September 30, 2015 and 2014 (Unaudited)

Gross Written Premium. Gross written premium increased $140.4 million, or 32.1%, to $577.3 million for the three months ended September 30, 2015 from $436.8 million for the three months ended September 30, 2014. We experienced growth in our U.S. business during the three months ended September 30, 2015 compared to the same period in 2014 as a result of new programs and expansion of existing lines of business. The segment's European business was negatively impacted during the three months ended September 30, 2015 by currency fluctuations of approximately $29 million. Absent the impact of currency fluctuations, gross written premium for our European business would have increased by approximately $20 million for the three months ended September 30, 2015 compared to the same period in 2014.
 
Net Written Premium. Net written premium increased $49.0 million, or 14.8%, to $380.6 million for the three months ended September 30, 2015 from $331.6 million for the three months ended September 30, 2014. The increase in net written premium resulted from an increase of gross written premium for the three months ended September 30, 2015 compared to the same period in 2014, partially offset by a decrease in our retention of gross written premium period over period. Our overall retention of gross written premium for the segment was 65.9% and 75.9% for the three months ended September 30, 2015 and 2014, respectively. The decrease in the retention of gross written premium related to an increase in business that is covered under the Maiden Quota Share.
 
Net Earned Premium. Net earned premium increased $22.4 million, or 6.8%, to $350.4 million for the three months ended September 30, 2015 from $328.0 million for the three months ended September 30, 2014. As net written premium is earned ratably over the term of a policy, the increase in net earned premium resulted from the increase in net written premium partially offset by the writing of longer tail business written by AmTrust at Lloyd's during the three months ended September 30, 2015 compared to September 30, 2014.

Loss and Loss Adjustment Expenses. Loss and loss adjustment expenses increased $33.6 million, or 15.3%, to $253.1 million for the three months ended September 30, 2015 from $219.5 million for the three months ended September 30, 2014. Our loss ratio for the segment for the three months ended September 30, 2015 increased to 72.2% compared to 66.9% for the same period in 2014. The increase in the loss ratio resulted from higher current and prior accident years selected ultimate losses as compared to previously selected ultimate losses in prior accident years. This was the result, primarily, from a revision to our ultimate losses on certain casualty lines in our European specialty risk and extended warranty business due to an increase in our carried incurred but not reported claim reserves, while the selected ultimate losses in our domestic business was consistent period over period. We did not have any material increases or decreases as a result of prior year loss development.

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Acquisition Costs and Other Underwriting Expenses. Acquisition costs and other underwriting expenses decreased $1.3 million, or 1.8%, to $69.9 million for the three months ended September 30, 2015 from $68.6 million for the three months ended September 30, 2014. Acquisition costs and other underwriting expenses were reduced by ceding commission of $37.8 million and $33.3 million earned during the three months ended September 30, 2015 and 2014, respectively. Although ceding commission increased period over period, the segment received a smaller allocation of ceding commission for its proportionate share of our overall policy acquisition expense. The expense ratio was 20.0% for the three months ended September 30, 2015 and slightly improved from 20.9% for the three months ended September 30, 2014.
 
Net Earned Premiums less Expenses Included in Combined Ratio (Underwriting Income).  Net earned premiums less expenses included in combined ratio decreased $12.5 million, or 31.4%, to $27.4 million for the three months ended September 30, 2015 from $39.9 million for the three months ended September 30, 2014. The decrease was attributable primarily to an increase in the segment’s loss ratio offset by a lower expense ratio during the three months ended September 30, 2015 compared to the three months ended September 30, 2014.

Specialty Risk and Extended Warranty Segment Results of Operations for the Nine Months Ended September 30, 2015 and 2014 (Unaudited)

Gross Written Premium. Gross written premium increased $140.4 million, or 10.1%, to $1,528.0 million for the nine months ended September 30, 2015 from $1,387.7 million for the nine months ended September 30, 2014. We experienced growth in our U.S. business during the nine months ended September 30, 2015 compared to the same period in 2014, from new programs, expansion of existing lines of business and the assumption of unearned premium of approximately $48 million. The segment's European business was negatively impacted during the nine months ended September 30, 2015 by currency fluctuations of approximately $106 million. Absent the impact of currency fluctuations, gross written premium for our European business would have increased by approximately $49 million for the nine months ended September 30, 2015 compared to the same period in 2014.
 
Net Written Premium. Net written premium increased $41.8 million, or 4.5%, to $975.1 million for the nine months ended September 30, 2015 from $933.2 million for the nine months ended September 30, 2014. The increase in net written premium resulted from an increase of gross written premium for the nine months ended September 30, 2015 compared to the same period in 2014. The increase was partially offset by a cession of a greater percentage of gross written premium to reinsurers during 2015 compared to 2014. Our overall retention of gross written premium for the segment was 63.8% and 67.3% for the nine months ended September 30, 2015 and 2014, respectively.
 
Net Earned Premium. Net earned premium increased $42.3 million, or 4.6%, to $963.5 million for the nine months ended September 30, 2015 from $921.1 million for the nine months ended September 30, 2014. As net written premium is earned ratably over the term of a policy, the increase in net earned premium resulted from the increase in net written premium period over period.

Loss and Loss Adjustment Expenses. Loss and loss adjustment expenses increased $28.7 million, or 4.6%, to $647.1 million for the nine months ended September 30, 2015 from $618.5 million for the nine months ended September 30, 2014. Our loss ratio for the segment for the nine months ended September 30, 2015 was 67.2% and was consistent compared to 67.1% for the same period in 2014. The loss ratio remained stable period to period as increases in current and prior accident year selected ultimate losses in our European business were higher as compared to selected ultimate losses in prior accident years due to an increase in our carried incurred but not reported claim reserves, which was offset by declines in our domestic selected ultimate losses compared to selected losses in prior accident years. This increase was muted by consistent accident year selected ultimate losses compared to selected ultimate losses in prior accident years for our domestic business. We did not have any material increases or decreases as a result of prior year loss development.

Acquisition Costs and Other Underwriting Expenses. Acquisition costs and other underwriting expenses increased $12.3 million, or 6.7%, to $197.5 million for the nine months ended September 30, 2015 from $185.1 million for the nine months ended September 30, 2014. Acquisition costs and other underwriting expenses were reduced by ceding commission of $105.5 million and $86.6 million earned during the nine months ended September 30, 2015 and 2014, respectively. Although ceding commission increased period over period, the segment received a consistent allocation of ceding commission for its proportionate share of our overall policy acquisition expense. As a result, the expense ratio increased to 20.5% for the nine months ended September 30, 2015 from 20.1% for the nine months ended September 30, 2014. In addition, a part of the increase in the expense ratio related to changes in business mix as premium written by AmTrust at Lloyd's has higher policy acquisition costs than the average costs associated with other business in this segment.
 
Net Earned Premiums less Expenses Included in Combined Ratio (Underwriting Income). Net earned premiums less expenses included in combined ratio increased $1.4 million, or 1.1%, to $118.9 million for the nine months ended September 30, 2015 from

62


$117.6 million for the nine months ended September 30, 2014. The increase was attributable primarily to an increase in net earned premium offset by a slightly higher combined ratio.

Specialty Program Segment Results of Operations for The Three and Nine Months Ended September 30, 2015 and 2014 (Unaudited)
 
 
 
Three Months Ended September 30,

Nine Months Ended September 30,
(Amounts in Thousands)
 
2015

2014

2015

2014
Gross written premium
 
$
405,875

 
$
358,739

 
$
1,087,719

 
$
874,215

 
 
 
 
 
 
 
 
 
Net written premium
 
$
303,093

 
$
250,067

 
$
719,898

 
$
598,555

Change in unearned premium
 
(101,721
)
 
(85,551
)
 
(120,328
)
 
(99,197
)
Net earned premium
 
201,372

 
164,516

 
599,570

 
499,358

 
 
 
 
 
 
 
 
 
Loss and loss adjustment expense
 
(136,077
)
 
(110,654
)
 
(405,160
)
 
(338,483
)
Acquisition costs and other underwriting expenses
 
(57,348
)
 
(44,915
)
 
(165,768
)
 
(133,355
)
 
 
(193,425
)
 
(155,569
)
 
(570,928
)
 
(471,838
)
Underwriting income
 
$
7,947

 
$
8,947

 
$
28,642

 
$
27,520

 
 
 
 
 
 
 
 
 
Key measures:
 
 

 
 

 
 

 
 

Net loss ratio
 
67.6
%
 
67.3
%
 
67.6
%
 
67.8
%
Net expense ratio
 
28.5
%
 
27.3
%
 
27.6
%
 
26.7
%
Net combined ratio
 
96.1
%
 
94.6
%
 
95.2
%
 
94.5
%

Specialty Program Segment Results of Operations for The Three Months Ended September 30, 2015 and 2014 (Unaudited)

Gross Written Premium. Gross written premium increased $47.1 million, or 13.1%, to $405.9 million for the three months ended September 30, 2015 from $358.7 million for the same period in 2014. The majority of the increase resulted primarily from the expansion of existing programs, which included primarily workers' compensation programs.

Net Written Premium. Net written premium increased $53.0 million, or 21.2%, to $303.1 million for the three months ended September 30, 2015 from $250.1 million for the same period in 2014. The increase in net written premium resulted from an increase in gross written premium for the three months ended September 30, 2015 compared to the three months ended September 30, 2014, and cession of a smaller percentage of gross written premium to reinsurers during 2015 compared to 2014. Our overall retention of gross written premium for the segment was 74.7% and 69.7% for the three months ended September 30, 2015 and 2014, respectively. The increase in the retention of gross written premium related to an increase in business written that is not covered under the Maiden Quota Share.

Net Earned Premium. Net earned premium increased $36.9 million, or 22.4%, to $201.4 million for the three months ended September 30, 2015 from $164.5 million for the same period in 2014. As premiums written are earned ratably over an annual period, the increase in net premium earned resulted from higher net written premium for the annual period prior to the three months ended September 30, 2015 compared to the same period in 2014.
 
Loss and Loss Adjustment Expenses. Loss and loss adjustment expenses increased $25.4 million, or 23.0%, to $136.1 million for the three months ended September 30, 2015, compared to $110.7 million for the same period in 2014. Our loss ratio for the segment for the three months ended September 30, 2015 was 67.6% compared to 67.3% for the three months ended September 30, 2014. The increase in the loss ratio resulted primarily from higher current accident year selected ultimate losses as compared to selected ultimate losses in prior accident years in certain general liability programs, and was partially offset by improved pricing. We did not have any material increases or decreases as a result of prior year loss development.
 
Acquisition Costs and Other Underwriting Expenses. Acquisition costs and other underwriting expenses increased $12.4 million, or 27.7%, to $57.3 million for the three months ended September 30, 2015 from $44.9 million for the same period in 2014. Acquisition costs and other underwriting expenses were reduced by ceding commission of $30.9 million and $21.9 million earned during the three months ended September 30, 2015 and 2014, respectively. The ceding commission increased period over period

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as a result of an increase in net earned premium, as the segment received a larger allocation of ceding commission for its proportionate share of our overall policy acquisition expense. The expense ratio was 28.5% for the three months ended September 30, 2015 compared to 27.3% for the three months ended September 30, 2014. The increase in the expense ratio during the three months ended September 30, 2015 related to the issuance of a higher percentage of commercial automobile and general liability policies, which have higher policy acquisition costs than other types of business in this segment.
 
Net Earned Premiums less Expense Included in Combined Ratio (Underwriting Income). Net earned premiums less expenses included in combined ratio decreased $1.0 million, or (11)%, to $7.9 million for the three months ended September 30, 2015 from $8.9 million for the three months ended September 30, 2014 due to a higher combined ratio.

Specialty Program Segment Results of Operations for The Nine Months Ended September 30, 2015 and 2014 (Unaudited)

Gross Written Premium. Gross written premium increased $213.5 million, or 24.4%, to $1,087.7 million for the nine months ended September 30, 2015 from $874.2 million for the same period in 2014. The increase in gross written premium resulted from expansion of existing programs, including workers' compensation, commercial automobile and general liability programs.

Net Written Premium. Net written premium increased $121.3 million, or 20.3%, to $719.9 million for the nine months ended September 30, 2015 from $598.6 million for the same period in 2014. The increase in net written premium resulted from an increase in gross written premium for the nine months ended September 30, 2015 compared to the nine months ended September 30, 2014. Our overall retention of gross written premium for the segment decreased to 66.2% from 68.5% for the nine months ended September 30, 2015 and 2014, respectively. The decrease in the retention of gross written premium in 2015 related to an increase in business written that is covered under the Maiden Quota Share.

Net Earned Premium. Net earned premium increased $100.2 million, or 20.1%, to $599.6 million for the nine months ended September 30, 2015 from $499.4 million for the same period in 2014. As premiums written are earned ratably over an annual period, the increase in net premium earned resulted from higher net written premium for the annual period prior to the nine months ended September 30, 2015 compared to the same period in 2014.
 
Loss and Loss Adjustment Expenses. Loss and loss adjustment expenses increased $66.7 million, or 19.7%, to $405.2 million for the nine months ended September 30, 2015, compared to $338.5 million for the same period in 2014. Our loss ratio for the segment for the nine months ended September 30, 2015 was 67.6% compared to 67.8% for the nine months ended September 30, 2014. The decrease in the loss ratio resulted primarily from lower current accident year selected ultimate losses as compared to selected ultimate losses in prior accident years, caused by increases in rates combined with stable claims frequency and severity. We did not have any material increases or decreases as a result of prior year loss development.
 
Acquisition Costs and Other Underwriting Expenses. Acquisition costs and other underwriting expenses increased $32.4 million, or 24.3%, to $165.8 million for the nine months ended September 30, 2015 from $133.4 million for the same period in 2014. Acquisition costs and other underwriting expenses were reduced by ceding commission of $88.5 million and $62.4 million earned during the nine months ended September 30, 2015 and 2014, respectively. The ceding commission increased period over period as a result of an increase in net earned premium, as the segment received a larger allocation of ceding commission for its proportionate share of our overall policy acquisition expense. The expense ratio was 27.6% for the nine months ended September 30, 2015 compared to 26.7% for the nine months ended September 30, 2014. The increase in the expense ratio during the nine months ended September 30, 2015 related to the issuance of a higher percentage of commercial automobile and general liability policies, which have higher policy acquisition costs than other types of business in this segment.

Net Earned Premiums less Expense Included in Combined Ratio (Underwriting Income). Net earned premiums less expenses included in the combined ratio increased $1.1 million, or 4.1%, to $28.6 million for the nine months ended September 30, 2015 from $27.5 million for the same period in 2014. The increase of $1.1 million resulted primarily from an increase in earned premium partially offset by a higher combined ratio during the nine months ended September 30, 2015 compared to the nine months ended September 30, 2014.


Liquidity and Capital Resources
 
Our principal sources of operating funds are premiums, service and fee income, investment income and proceeds from sales and maturities of investments. Our primary uses of operating funds include payments of claims and operating expenses. Currently, we pay claims using cash flow from operations and invest our excess cash primarily in fixed maturity and equity securities. We forecast claim payments based on our historical trends. We seek to manage the funding of claim payments by actively managing available cash and forecasting cash flows on short-term and long-term bases. Cash payments for claims were approximately $1,391

64


million and $1,070 million in the nine months ended September 30, 2015 and 2014, respectively. We expect that projected cash flow from operations will provide us sufficient liquidity for at least twelve months to fund our anticipated growth, by providing capital to increase the surplus of our insurance subsidiaries, as well as for the payment of claims and operating expenses, payment of interest and principal on our debt facilities, payment of any cash in settlement of convertible senior notes submitted by holders for conversion, and other holding company expenses. We anticipate net income from operations will create sufficient additional surplus at our insurance subsidiaries, which will fund our growth. However, if our growth attributable to potential acquisitions, internally generated growth or a combination of these, exceeds our projections, we may have to raise additional capital sooner to support our growth and manage our debt profile. As a result, we may from time to time raise capital from the issuance of equity, debt, equity-related debt or other capital securities, or seek to redeem, repurchase or exchange for other securities, prior to maturity, some or all of our outstanding debt in the open market, as circumstances allow. If we cannot obtain adequate capital or refinance all or a portion of our debt on favorable terms or at all, we may be unable to support future growth or operating requirements and, as a result, our business, financial condition and results of operation could be adversely affected.

The following table is summary of our statement of cash flows: 
 
 
Nine Months Ended September 30,
(Amounts in Thousands)
 
2015
 
2014
Cash and cash equivalents provided by (used in):
 
 

 
 

Operating activities
 
$
543,681

 
$
897,567

Investing activities
 
(1,035,181
)
 
(1,006,123
)
Financing activities
 
507,624

 
(167,347
)
  
Net cash provided by operating activities for the nine months ended September 30, 2015 decreased compared to cash provided by operating activities in the nine months ended September 30, 2014. The decrease in cash provided from operations resulted primarily from an increase in reinsurance recoverable, premium receivables, and other assets, as well as a decrease in our deferred tax liability in 2015 compared to 2014.

Net cash used in investing activities was approximately $1,035 million during the nine months ended September 30, 2015 and consisted primarily of approximately $659 million for the net purchase of fixed maturity securities, equity securities and short-term investments, approximately $71 million for restricted cash, approximately $220 million for acquisitions and approximately $100 million for capital expenditures, partially offset by the net proceeds of approximately $86 million received from the maturity of life settlement policies. Net cash used in investing activities was $1,006 million for the nine months ended September 30, 2014 and consisted primarily of approximately $680 million for the net purchase of fixed maturity securities, equity securities, and short-term investments, approximately $72 million for restricted cash, approximately $125 million for a loan to ACP Re, approximately $76 million for acquisitions, approximately $25 million for the acquisition of life settlement contracts, and approximately $65 million for capital expenditures, partially offset by the net proceeds of approximately $20 million received from the sale of a subsidiary and approximately $11 million from the net sales of other investments.

Net cash provided by financing activities was approximately $508 million for the nine months ended September 30, 2015 compared to approximately $167 million net cash used in financing activities during the nine months ended September 30, 2014. In 2015, we issued preferred stock for approximately $177 million, common stock for approximately $172 million, issued $285 million in subordinated notes, and utilized our revolving credit facility for $10 million, which was partially offset by common and preferred stock dividends paid of $83 million, and approximately $62 million paid to settle conversions of our 2021 Notes. During the nine months ended September 30, 2014, cash used in financing activities was approximately $167 million, of which approximately $293 million was used to settle repurchase agreements, approximately $48 million was used to pay dividends, approximately $45 million was used to repurchase common shares, and $10 million was used to pay off a promissory note from the acquisition of Insco Dico. The use of cash in 2014 was partially offset by the receipt of approximately $179 million for preferred stock issuances, proceeds of $31 million from a loan, and approximately $17 million received from non-controlling interest capital contributions.
 

65



Other Material Changes in Financial Position

(Amounts in thousands)
 
September 30, 2015
 
December 31, 2014
Selected Assets:
 
 
 
 
Fixed maturities, available-for-sale
 
$
5,125,808

 
$
4,253,274

Premium receivable, net
 
2,322,442

 
1,851,682

Reinsurance recoverable
 
2,951,764

 
2,440,627

Selected Liabilities:
 
 
 
 
Loss and loss expense reserve
 
6,694,036

 
5,664,205

Unearned premium
 
4,134,048

 
3,447,203

Accrued expense and other current liabilities
 
1,507,048

 
991,504


The increase in fixed maturities, available-for-sale, from December 31, 2014 to September 30, 2015 was primarily attributable to the acquisition of CorePointe and Warranty Solutions as well as the utilization of excess cash from the debt and equity offerings during the nine months ended September 30, 2015. The increase in premium receivable, net related to increased premium writing in the first nine months of 2015. The increase in reinsurance recoverable related to an increase in premium writing and a lower retention of premium in 2015 compared to 2014. The increase in loss and loss expense reserve and unearned premium related to an increase in gross written premium during the nine months ended September 30, 2015 compared to 2014, and the acquisition of CorePointe, which contributed $48 million and $29 million to the increase, respectively, and unearned premium from the acquisition of Warranty Solutions. The increase in accrued expense and other current liabilities was a result of a general increase in business activities.


Common Stock
                                                                                                                                                                                                                                                                                                                                                                                                                                               
During the nine months ended September 30, 2015, we issued 3,450,000 shares of our Common Stock in an underwritten public offering, resulting in net cash proceeds of approximately $172.5 million.

Preferred Stock
                                                                                                                                                                                                                                                                                                                                                                                                                                               
We have outstanding four separate series (Series A through D) of non-cumulative preferred stock. Three of these series (Series B, C and D) were issued in offerings using depositary shares, each representing a 1/40th interest in a share of the particular series of preferred stock. Dividends on the Series A Preferred Stock and the Series B, C and D Preferred Stock represented by depositary shares are payable on the liquidation preference amount, on a non-cumulative basis, when, as and if declared by our Board of Directors, quarterly in arrears, on March 15, June 15, September 15, and December 15 of each year.
 
A summary description of the terms of these series of preferred stock is presented in the table below:
Series
 
Dividend rate per year %
 
Shares of Preferred Stock issued
 
Depositary shares issued
 
Liquidation preference amount per share of Preferred Stock $
 
Net proceeds ($ in thousands)
 
Dividend paid during the nine months ended September 30, 2015 ($ in thousands)
A
 
6.75
 
4,600,000
 
N/A
 
$
25

 
$
111,130

 
$
5,823

B
 
7.25
 
105,000
 
4,200,000
 
1,000

 
101,702

 
5,709

C
 
7.625
 
80,000
 
3,200,000
 
1,000

 
77,480

 
4,575

D
 
7.50
 
182,500
 
7,300,000
 
1,000

 
176,529

 
6,690


For a detailed description of our Series A Preferred Stock and Series B and C Preferred Stock represented by depositary shares, refer to Note 20. “Stockholder’s Equity” in Item 8. “Financial Statements and Supplementary Data” in our 2014 Form 10-K. For a detailed description related to our Series D Preferred Stock represented, refer to Note 15. “Stockholder’s Equity and Accumulated Other Comprehensive Income (Loss)” to the accompanying financial statements included elsewhere in this report.



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Credit Facilities
 
$350 million credit facility

Our five-year, $350 million credit facility is a revolving credit facility with a letter of credit sublimit of $175 million and an expansion feature of not more than an additional $150 million. As of September 30, 2015, we had an outstanding balance of $130 million and outstanding letters of credit in place under this Credit Agreement for $118.0 million, which reduced the availability under the facility to $102.0 million and the availability for letters of credit to $57.0 million.

Borrowings under this credit facility bear interest at either the Alternate Base Rate or the LIBO rate. Borrowings bearing interest at a rate determined by reference to the Alternate Base Rate will bear interest at (x) the greatest of (a) the administrative agent’s prime rate, (b) the federal funds effective rate plus 0.5% or (c) the adjusted LIBO rate for a one-month interest period on such day plus 1.0%, plus (y) a margin ranging from 0.125% to 0.625%, adjusted on the basis of our consolidated leverage ratio. Eurodollar borrowings will bear interest at the adjusted LIBO rate for the interest period in effect plus a margin ranging from 1.125% to 1.625%, adjusted on the basis of our consolidated leverage ratio.

Fees payable by us under this credit facility include a letter of credit participation fee (equal to the margin applicable to Eurodollar borrowings), a letter of credit fronting fee with respect to each letter of credit (0.125%) and a commitment fee on the available commitments of the lenders (a range based on our consolidated leverage ratio, which was greater than or equal to 15% but less than 25%, resulting in a commitment fee rate of 0.175%).

Interest expense, including amortization of the deferred origination costs and fees associated with the letters of credit, was approximately $2.6 million and $1.1 million for nine months ended September 30, 2015 and 2014, respectively.

Funds at Lloyd's facility

We use this £235 million (or $355 million) letter of credit facility to support our capacity at Lloyd’s as a member and/or reinsurer of Syndicates 2526, 1206 and 44 for the 2015 underwriting year of account, as well as prior open years of account. The facility is 40% secured by a pledge of a collateral account.

Fees payable under this letter of credit facility include a letter of credit issuance fee payable on the secured portion of the letters of credit at the rate of 0.50% and on the unsecured portion of the letters of credit determined based on AII's then-current financial strength rating issued by A.M. Best. As of September 30, 2015, the applicable letter of credit fee rate on the unsecured portion was 1.15% based on the AII's A.M. Best financial strength rating of “A”. We also pay a commitment fee of 0.35% per year on the aggregate unutilized and uncanceled amount of the facility, and pay a facility fee upon closing of 0.15% of the total aggregate commitment.

As of September 30, 2015, the Company had outstanding letters of credit of £235.0 million (or $355.5 million) in place under this credit facility. The facility was fully utilized as of September 30, 2015. We recorded total interest expense of approximately $2.3 million and $2.1 million during the nine months ended September 30, 2015 and 2014, respectively.

Other letters of credit facilities
 
We, through one of our subsidiaries, have a secured letter of credit facility with Comerica Bank that we utilize to comply with the deposit requirements of the State of California and the U.S. Department of Labor as security for our obligations to workers’ compensation and Federal Longshore and Harbor Workers’ Compensation Act policyholders. The credit limit is for $75 million, of which $48.5 million was utilized as of September 30, 2015. We are required to pay a letter of credit participation fee for each letter of credit in the amount of 0.40%. In addition, we, through certain subsidiaries, have additional existing stand-by letters of credit with various lenders in the amount of $0.3 million as of September 30, 2015.

For further information on these credit facilities, including applicable restrictive covenants and events of default, see Note 12. "Debt" in Item 8. "Financial Statements and Supplementary Data" in our 2014 Form 10-K.

67


 
Outstanding Notes
 
Convertible Debt

We have an outstanding principal balance of $213 million Convertible Senior Notes due 2044 ("2044 Notes"), with a carrying value of $162 million, that bear interest at a rate equal to 2.75% per year, payable semiannually in arrears on June 15th and December 15th of each year. Additionally we have an outstanding principal balance of $6.0 million Convertible Senior Notes due 2021 ("2021 Notes"), with a carrying a value of $5.2 million, that bear interest at a rate equal to 5.5% per year, payable semiannually in arrears on June 15th and December 15th of each year. Interest expense recognized on the 2044 Notes was $9.1 million during the nine months ended September 30, 2015. Interest expense recognized on the 2021 Notes was $0.7 million and $11.0 million for the nine months ended September 30, 2015 and 2014, respectively. For further information on the 2044 Notes and the 2021 Notes, including contingent interest on the 2044 Notes, conversion triggers, redemption and repurchase features and the exchange of 2021 Notes for 2044 Notes, see Note 12. "Debt" in Item 8. "Financial Statements and Supplementary Data" in our 2014 Form 10-K
  
6.125% Notes due 2023

We have outstanding $250 million aggregate principal amount of our 6.125% notes due 2023 that bear interest at a rate equal to 6.125% per year, payable semiannually in arrears on February 15th and August 15th of each year. The interest rate will increase by 0.50% per year if our consolidated leverage ratio exceeds 30% and will increase an additional 1.00% per year (for an aggregate increase of 1.50% per year) if the consolidated leverage ratio exceeds 35%. As of September 30, 2015, the consolidated leverage ratio was less than 30%. Interest expense recognized on these notes was approximately $11.7 million for the nine months ended September 30, 2015 and 2014, respectively. For further information on these notes, including restrictive covenants and events of default, see Note 12. "Debt" in Item 8. "Financial Statements and Supplementary Data" in our 2014 Form 10-K.

7.25% Subordinated Notes due 2055
 
We have outstanding $150 million aggregate principal amount of our 7.25% subordinated notes due 2055 (the "7.25% 2055 Notes") that bear interest at a rate equal to 7.25% per year, payable quarterly in arrears on March 15, June 15, September 15 and December 15 of each year, commencing on September 15, 2015. We have the right to redeem the 7.25% 2055 Notes, in whole or in part, on June 18, 2020, or on any interest payment date thereafter, at a redemption price equal to 100% of the principal amount of the notes plus accrued and unpaid interest to, but not including, the date of redemption. The 7.25% 2055 Notes are our subordinated unsecured obligations and are structurally subordinated to all our existing and future indebtedness, liabilities and other obligations of our subsidiaries. Interest expense, including amortization of deferred origination costs, recognized on the 7.25% 2055 Notes was $3.1 million for the nine months ended September 30, 2015. For further information on the 7.25% 2055 Notes, see Note 7. "Debt" to the accompanying financial statements included elsewhere in this report.


7.50% Subordinated Notes due 2055

We have outstanding $135 million aggregate principal amount of our 7.50% subordinated notes due 2055 (the "7.50% 2055 Notes") that bear interest at a rate equal to 7.50% per year, payable quarterly in arrears on March 15, June 15, September 15 and December 15 of each year, commencing December 15, 2015. The 7.50% 2055 Notes mature on September 15, 2055. We have the right to redeem the 7.50% 2055 Notes, in whole or in part, on September 16, 2020, or on any interest payment date thereafter, at a redemption price equal to 100% of the principal amount of the 7.50% 2055 Notes plus accrued and unpaid interest to, but not including, the date of redemption. The 7.50% 2055 Notes are our subordinated unsecured obligations and are structurally subordinated to all existing and future indebtedness, liabilities and other obligations of our subsidiaries. Interest expense, including amortization of deferred origination costs, recognized on the 7.50% 2055 Notes was $0.4 million for the nine months ended September 30, 2015. For further information on the 7.50% 2055 Notes, see Note 7. "Debt" to the accompanying financial statements included elsewhere in this report.

68




Short-Term Borrowings

We did not engage in short-term borrowings to fund our operations or for liquidity purposes during the nine months ended September 30, 2015.

Contractual Obligations

During the nine months ended September 30, 2015, our contractual obligations have not changed materially from those discussed in our Annual Report on Form 10-K for the year ended December 31, 2014.

Reinsurance
 
 Our insurance subsidiaries utilize reinsurance agreements to transfer portions of the underlying risk of the business we write to various affiliated and third-party reinsurance companies. Reinsurance does not discharge or diminish our obligation to pay claims covered by the insurance policies we issue; however, it does permit us to recover certain incurred losses from our reinsurers and our reinsurance recoveries reduce the maximum loss that we may incur as a result of a covered loss event. We believe it is important to ensure that our reinsurance partners are financially strong and they generally carry at least an A.M. Best rating of ‘‘A-’’ (Excellent) at the time we enter into our reinsurance agreements. We also enter into reinsurance relationships with third-party captives formed by agents and other business partners as a mechanism for sharing risk and profit. The total amount, cost and limits relating to the reinsurance coverage we purchase may vary from year to year based upon a variety of factors, including the availability of quality reinsurance at an acceptable price and the level of risk that we choose to retain for our own account. We have not experienced any significant changes to our reinsurance programs since December 31, 2014. For a more detailed description of our reinsurance arrangements, including our reinsurance arrangements with Maiden Reinsurance Company Ltd., see ‘‘Reinsurance’’ in ‘‘Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations’’ in our Annual Report on Form 10-K for the year ended December 31, 2014.

Cash and Investment Portfolio
 
Cash, which consists of cash, cash equivalents and restricted cash and cash equivalents, along with our investment portfolio, which consists of fixed maturity securities, equity securities, and short-term investments, but excludes life settlement contracts, other investments and equity investments, increased $942 million, or 17.1%, to $6.5 billion for the nine months ended September 30, 2015 from $5.5 billion as of December 31, 2014. Our investment portfolio is primarily classified as available-for-sale, as defined by ASC 320, Investments — Debt and Equity Securities. The increase in our investment portfolio during the nine months ended September 30, 2015 compared to December 31, 2014 was primarily attributable to the acquisitions of CorePointe and Warranty Solutions as well as the utilization of excess cash from our debt and equity offerings during 2015. Our fixed maturity securities, including fixed maturity securities pledged to support our repurchase agreement, had a fair value of $5.1 billion and an amortized cost of $5.1 billion as of September 30, 2015. Our equity securities, including both available-for-sale and trading equity securities, had a fair value of $126.0 million with a cost of $131.7 million as of September 30, 2015.


69


Our cash and investment portfolio exclusive of life settlement contracts and other investments is summarized in the table below by type of investment:
 
 
September 30, 2015
 
December 31, 2014
(Amounts in Thousands)
 
Carrying Value
 
Percentage of Portfolio
 
Carrying Value
 
Percentage of Portfolio
Cash, cash equivalents and restricted cash
 
$
1,167,703

 
18.1
%
 
$
1,088,975

 
19.7
%
Short-term investments
 
36,043

 
0.6

 
63,916

 
1.2

U.S. treasury securities
 
58,557

 
0.9

 
43,870

 
0.8

U.S. government agencies
 
36,317

 
0.6

 
13,538

 
0.2

Municipals
 
544,947

 
8.4

 
482,041

 
8.7

Foreign government
 
110,143

 
1.7

 
112,731

 
2.0

Commercial mortgage back securities
 
149,494

 
2.3

 
38,685

 
0.7

Residential mortgage backed securities:
 
 

 
 

 
 

 
 

Agency backed
 
951,999

 
14.7

 
975,782

 
17.7

Non-agency backed
 
112,617

 
1.7

 
22,503

 
0.4

Collateralized loan / debt obligations
 
173,707

 
2.7

 
—

 
—

Asset-backed securities
 
23,667

 
0.4

 
710

 
—

Corporate bonds
 
2,964,360

 
45.9

 
2,563,414

 
46.6

Preferred stocks
 
4,955

 
0.1

 
3,506

 
0.1

Common stocks
 
121,023

 
1.9

 
104,287

 
1.9

 
 
$
6,455,532

 
100.0
%
 
$
5,513,958

 
100.0
%
 
The table below summarizes the credit quality of our fixed maturity securities as of September 30, 2015 and December 31, 2014, as rated by Standard and Poor’s.
 
 
September 30, 2015
 
December 31, 2014
U.S. Treasury
1.1
%
 
1.0
%
AAA
5.7

 
6.7

AA
36.4

 
39.0

A
30.5

 
27.9

BBB, BBB+, BBB-
23.2

 
23.4

BB, BB+, BB-
1.8

 
1.6

B, B+, B-
0.1

 
0.1

Other
1.2

 
0.3

Total
100.0
%
 
100.0
%


70


The table below summarizes the average duration by type of fixed maturity as well as detailing the average yield as of September 30, 2015 and December 31, 2014:

 
September 30, 2015
 
December 31, 2014
 
Average Yield %
 
Average Duration in Years
 
Average Yield %
 
Average Duration in Years
U.S. treasury securities
2.00
 
3.9

 
1.95
 
3.9

U.S. government agencies
2.99
 
4.3

 
2.80
 
4.5

Foreign government
2.28
 
5.6

 
2.30
 
5.8

Corporate bonds
3.33
 
6.0

 
3.09
 
5.3

Municipals
3.66
 
6.7

 
3.48
 
5.3

Collateralized loan / debt obligations
4.07
 
0.2

 
—
 
—

Mortgage and asset backed
3.32
 
4.5

 
3.24
 
4.1

 
As of September 30, 2015, the weighted average duration of our fixed income securities was 5.45 years and had a yield of 3.35%.

Based on guidance in FASB ASC 320-10-65, in the event of the decline in fair value of a debt security, a holder of that security that does not intend to sell the debt security and for whom it is not more than likely than not that such holder will be required to sell the debt security before recovery of its amortized cost basis, is required to separate the decline in fair value into (a) the amount representing the credit loss and (b) the amount related to other factors. The amount of total decline in fair value related to the credit loss shall be recognized in earnings as an other than temporary impairment ("OTTI") with the amount related to other factors recognized in accumulated other comprehensive loss net loss, net of tax. OTTI credit losses result in a permanent reduction of the cost basis of the underlying investment. The determination of OTTI is a subjective process, and different judgments and assumptions could affect the timing of the loss realization.

Quarterly, our Investment Committee (“Committee”) evaluates each available-for-sale security that has an unrealized loss as of the end of the subject reporting period for OTTI. We generally consider an investment to be impaired when it has been in a significant unrealized loss position (in excess of 35% of cost if the issuer has a market capitalization of under $1 billion and in excess of 25% of cost if the issuer has a market capitalization of $1 billion or more) for over 24 months. In addition, the Committee uses a set of quantitative and qualitative criteria to review our investment portfolio to evaluate the necessity of recording impairment losses for other-than-temporary declines in the fair value of our investments. The criteria the Committee primarily considers include:
 
•
the current fair value compared to amortized cost;
•
the length of time the security’s fair value has been below its amortized cost;
•
specific credit issues related to the issuer such as changes in credit rating, reduction or elimination of dividends or non-payment of scheduled interest payments;
•
whether management intends to sell the security and, if not, whether it is not more than likely than not that we will be required to sell the security before recovery of its amortized cost basis;
•
the financial condition and near-term prospects of the issuer of the security, including any specific events that may affect its operations or earnings;
•
the occurrence of a discrete credit event resulting in the issuer defaulting on material outstanding obligations or the issuer seeking protection under bankruptcy laws; and
•
other items, including company management, media exposure, sponsors, marketing and advertising agreements, debt restructuring, regulatory changes, acquisitions and dispositions, pending litigation, distribution agreements and general industry trends.

Impairment of investment securities results in a charge to operations when a market decline below cost is deemed to be other-than-temporary. We write down investments immediately that we consider to be impaired based on the above criteria collectively.


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The impairment charges of our fixed and equity securities classified as available-for-sale for the nine months ended September 30, 2015 and 2014 are presented in the table below:

(Amounts in Thousands)
 
2015
 
2014
Equity securities
 
$
1,276

 
$
2,291

Fixed maturity securities
 
8,842

 
1,712

 
 
$
10,118

 
$
4,003


Additionally, we had gross unrealized losses of $108.4 million related to available-for-sale fixed maturity securities and $7.7 million related to available-for-sale equity securities during the nine months ended September 30, 2015.

As of September 30, 2015, we own 1,831 purchase lots of corporate bonds in the financial institutions, industrial, and other sectors, which account for approximately 25%, 30% and 3%, respectively, and 58% in the aggregate of the total fair value of our fixed maturity securities, and 26%, 57% and 6%, respectively, and 89% in the aggregate of the total unrealized losses of our fixed maturity securities. We believe that the unrealized losses in these securities are the result, primarily, of general economic conditions and not the condition of the issuers, which we believe are solvent and have the ability to meet their obligations. Therefore, we expect that the market price for these securities should recover within a reasonable time. Additionally, we do not intend to sell the investments and it is not more likely than not that we will be required to sell the investments before recovery of their amortized cost basis.
 
Our investment in marketable equity securities classified as available-for-sale consist of investments in preferred and common stock across a wide range of sectors. We evaluated the near-term prospects for recovery of fair value in relation to the severity and duration of the impairment and have determined in each case that the probability of recovery is reasonable and we have the ability and intent to hold these investments until a recovery of fair value. We believe the gross unrealized losses of $7.7 million as of September 30, 2015 are not material to our financial position.

Item 3. Quantitative and Qualitative Disclosures About Market Risk
 
Market Risk. Market risk is the risk of potential economic loss principally arising from adverse changes in the fair value of financial instruments. The major components of market risk affecting us are interest rate risk and equity price risk.

Interest Rate Risk. We had fixed maturity securities (excluding $36.0 million of short-term deposits) with a fair value of $5.1 billion and carrying value of $5.1 billion as of September 30, 2015 that are subject to interest rate risk. Interest rate risk is the risk that we may incur losses due to adverse changes in interest rates. Fluctuations in interest rates have a direct impact on the market valuation of our fixed maturity securities. We manage our exposure to interest rate risk through a disciplined asset and liability matching and capital management process. In the management of this risk, the characteristics of duration, credit and variability of cash flows are critical elements. These risks are assessed regularly and balanced within the context of our liability and capital position.

The table below summarizes the interest rate risk associated with our fixed maturity securities by illustrating the sensitivity of the fair value and carrying value of our fixed maturity securities as of September 30, 2015 to selected hypothetical changes in interest rates, and the associated impact on our stockholders’ equity. We anticipate that we will continue to meet our obligations out of income. We classify our fixed securities and equity securities as available-for-sale. Temporary changes in the fair value of our fixed maturity securities impact the carrying value of these securities and are reported in our stockholders’ equity as a component of other comprehensive income, net of deferred taxes.

 

72


The selected scenarios in the table below are not predictions of future events, but rather are intended to illustrate the effect such events may have on the fair value and carrying value of our available-for-sale fixed maturity securities and on our stockholders’ equity, each as of September 30, 2015.
Hypothetical Change in Interest Rates
 
Fair Value
 
Estimated Change in Fair Value
 
Hypothetical Percentage (Increase)Decrease in Shareholders’ Equity
(Amounts in Thousands)
200 basis point increase
 
$
4,524,160

 
$
(601,648
)
 
(21.5
)%
100 basis point increase
 
4,759,397

 
(366,411
)
 
(13.1
)%
No change
 
5,125,808

 
—

 
—

100 basis point decrease
 
5,284,301

 
158,493

 
5.7
 %
200 basis point decrease
 
5,561,557

 
435,749

 
15.6
 %
 
Changes in interest rates would affect the fair market value of our fixed rate debt instruments but would not have an impact on our earnings or cash flow. We currently have $1,178.3 million of debt instruments of which $822.3 million are fixed rate debt instruments. A fluctuation of 100 basis points in interest on our variable rate debt instruments, which are tied to LIBOR, would affect our earnings and cash flows by $3.6 million before income tax, on an annual basis, but would not affect the fair market value of the variable rate debt.
 
Liquidity Risk.   Liquidity risk represents our potential inability to meet all payment obligations when they become due. We maintain sufficient cash and marketable securities to fund claim payments and operations. We purchase reinsurance coverage to mitigate the liquidity risk of an unexpected rise in claims severity or frequency from catastrophic events or a single large loss. The availability, amount and cost of reinsurance depend on market conditions and may vary significantly.

Credit Risk. Credit risk is the potential loss arising principally from adverse changes in the financial condition of the issuers of our fixed maturity securities and the financial condition of our third party reinsurers. Additionally, we have counter-party credit risk with our repurchase agreement counter-parties and interest rate swap counter-parties.

We address the credit risk related to the issuers of our fixed maturity securities by investing primarily in fixed maturity securities that are rated “BBB-” or higher by Standard & Poor’s. We also independently monitor the financial condition of all issuers of our fixed maturity securities. To limit our risk exposure, we employ diversification policies that limit the credit exposure to any single issuer or business sector.

We are subject to credit risk with respect to our third party reinsurers. Although our third party reinsurers are obligated to reimburse us to the extent we cede risk to them, we are ultimately liable to our policyholders on all risks that have ceded. As a result, reinsurance contracts do not limit our ultimate obligations to pay claims covered under the insurance policies we issue and we might not collect amounts recoverable from our reinsurers. We address this credit risk by selecting reinsurers that have an A.M. Best rating of “A-” (Excellent) or better at the time we enter into the agreement and by performing, along with our reinsurance brokers, periodic credit reviews of our reinsurers. If one of our reinsurers suffers a credit downgrade, we may consider various options to lessen the risk of asset impairment, including commutation, novation and letters of credit.  See “Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations —Reinsurance.”

Counter-party credit risk with our repurchase agreement counter-parties is mitigated by obtaining collateral. We obtain collateral in the amount of 110% of the value of the securities we have sold with agreement to repurchase. Additionally, repurchase agreements are only transacted with pre-approved counter-parties.

Foreign Currency Risk. We write insurance in the United Kingdom and certain other European Union member countries through several of our foreign insurance subsidiaries. While the functional currencies of these subsidiaries are the Euros and the British Pound, we write coverages that are settled in local currencies, including, primarily, the Euro and British Pound. We attempt to maintain sufficient local currency assets on deposit to minimize our exposure to realized currency losses. Assuming a 5% increase in the exchange rate of the local currency in which the claims will be paid and that we do not hold that local currency, we would recognize a $60.2 million after tax realized currency loss based on our outstanding foreign denominated reserves of $1,851.6 million at September 30, 2015.
 

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 Equity Price Risk. Equity price risk is the risk that we may incur losses due to adverse changes in the market prices of the equity securities we hold in our investment portfolio, which include common stocks, non-redeemable preferred stocks and master limited partnerships. We classify our portfolio of equity securities as either available-for-sale or trading and carry these securities on our balance sheet at fair value. Accordingly, adverse changes in the market prices of our equity securities result in a decrease in the value of our total assets and a decrease in our shareholders’ equity. As of September 30, 2015, the equity securities in our investment portfolio had a fair value of $126.0 million, representing approximately 2% of our total invested assets on that date.

The table below illustrates the impact on our equity portfolio and financial position given a hypothetical movement in the broader equity markets. The selected scenarios in the table below are not predictions of future events, but rather are intended to illustrate the effect such events may have on the carrying value of our equity portfolio and on shareholders’ equity as of September 30, 2015.
Hypothetical Change in S&P 500 Index
 
Fair Value
 
Estimated Change in Fair Value
 
Hypothetical Percentage (Increase) Decrease in Shareholders’ Equity
(Amounts in Thousands)
25% increase
 
$
157,473

 
$
31,495

 
1.1
 %
No change
 
125,978

 
—

 
 
25% decrease
 
94,483

 
(31,495
)
 
(1.1
)%
 
Off Balance Sheet Risk. Securities sold but not yet purchased represent our obligations to deliver the specified security at the contracted price and, thereby, create a liability to purchase the security in the market at prevailing prices. Our liability for securities to be delivered is measured at their fair value and as of September 30, 2015 was $88.6 million primarily consisted of equity securities. These transactions result in off-balance sheet risk, as our ultimate cost to satisfy the delivery of securities sold but not yet purchased may exceed the amount reflected at September 30, 2015.

Item 4. Controls and Procedures
 
Our management, with the participation and under the supervision of our Chief Executive Officer and Chief Financial Officer, has evaluated the effectiveness of our disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) of the Securities Exchange Act of 1934, as amended (the "Exchange Act")) as of the end of the period covered by this report. Based on such evaluation, our Chief Executive Officer and Chief Financial Officer have concluded that, as of the end of such period, our disclosure controls and procedures are effective in ensuring that information required to be disclosed by us in the reports we file of submit under the Exchange Act is timely recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and forms, and accumulated and communicated to our management, including our principal executive officer and principal financial officer, as appropriate, to allow timely decisions regarding required disclosure.

During the most recent fiscal quarter, there have been no changes in our internal controls over financial reporting (as defined in Exchange Act Rule 13a-15(f) and 15d-15(f)) that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

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PART II - OTHER INFORMATION
 

Item 1.  Legal Proceedings

Securities Class Actions and Derivative Suit

We and certain of our officers were defendants in related putative securities class action lawsuits filed in February 2014 in the United States District Court for the Southern District of New York. Plaintiffs in the lawsuits purported to represent a class of our stockholders who purchased shares between February 15, 2011 and December 11, 2013. On April 24, 2014, the court issued an order consolidating the related actions, appointing lead plaintiffs and approving the selection of co-lead counsel. On September 4, 2014, the lead plaintiffs filed a consolidated amended complaint. The consolidated amended complaint asserted claims under Sections 10(b) and 20(a) of the Securities Exchange Act of 1934, as amended, and under Section 11 of the Securities Act of 1933, as amended, and sought damages in an unspecified amount, attorney’s fees and other relief. The lead plaintiffs asserted the Section 11 claim on behalf of persons or entities who purchased our Series A preferred stock in or traceable to our public offering on June 5, 2013, and did not sell those shares of Series A preferred stock prior to December 12, 2013. On October 24, 2014, we filed a motion to dismiss the consolidated amended complaint, which the lead plaintiffs opposed on December 10, 2014. On January 14, 2015, we filed our reply in support of the motion to dismiss. The Court granted our motion to dismiss with prejudice on September 29, 2015. On October 19, 2015, the plaintiffs filed a notice of appeal.

In addition, we have received three stockholder demands for production, pursuant to Section 220 of the Delaware General Corporation Law, of our books and records. On April 7, 2015, one of those stockholders, Cambridge Retirement System, filed a derivative action in the Court of Chancery of the State of Delaware against the Company, as nominal defendant, and against our board of directors, Leah Karfunkel, and ACP Re, Ltd., as defendants. The stockholder purports to bring the derivative action on our behalf, alleging breaches of the duties of loyalty and care on the part of our directors related to our transactions involving Tower Group International, Ltd. The complaint seeks damages, disgorgement and reform of our governance practices. We believe the allegations in this action to be unfounded and will vigorously pursue our defenses; however, we cannot reasonably estimate the potential range of loss, if any.

Trust Risk Group dispute

In October 2014, a dispute arose between our subsidiary, AmTrust Europe Ltd., and its Italian medical liability broker, Trust Risk Group SpA ("TRG"), and agent, Trust Risk Italia SRL ("TRI," a subsidiary of TRG, collectively, “TRG”). TRG asserted that it was entitled to advanced commissions of approximately €95.8 million (or $101.1 million) related to our Italian medical liability business produced by TRG. TRG deducted approximately €42.2 million (or $47.2 million) from premium payable to us with the intention of deducting approximately €48.7 million (or $54.4 million) from future premium payable to us. We dispute that TRG is entitled to advanced commission. We terminated our brokerage and agency relationship with TRG and TRI, respectively, and notified our insureds and retail brokers to pay premiums directly to us.
TRG has initiated arbitration proceedings against us in Milan, Italy seeking monetary damages based upon its allegations that we improperly terminated the producer agreements and an entitlement to advanced commissions on the business produced for us. We believe the allegations to be unfounded and will vigorously pursue our defenses; however, we cannot reasonably estimate the potential range of loss, if any.

Other than as discussed above, we are not involved presently in any material litigation nor, to our knowledge, is any material litigation threatened against us or our properties.

Item 1A.  Risk Factors
 
There are no material changes to the risk factors previously reported in our Annual Report on Form 10-K for the year ended December 31, 2014.  For more information regarding such risk factors, refer to Item 1A of our Annual Report on Form 10-K for the year ended December 31, 2014.
 
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds

None.

75




Item 3. Defaults Upon Senior Securities
 
None.
 
Item 4.  Mine Safety Disclosures
 
None.

Item 5. Other Information
 
None.

Item 6.  Exhibits
Exhibit
Number
 
Description
4.1
 
Sixth Supplemental Indenture, dated as of September 16, 2015, by and between the Company and the Bank of New York Mellon Trust Company, N.A., as trustee (incorporated by reference to Exhibit 4.2 to the Company's Current Report on Form 8-K (No. 001-33143) filed on September 16, 2015).
 
 
 
4.2
 
Form of 7.50% Subordinated Notes due 2055 (included as Exhibit A to Exhibit 4.1) (incorporated by reference to Exhibit 4.3 to the Company's Current Report on Form 8-K (001-33143) filed on September 16, 2015).
 
 
 
10.1
 
Amendment No. 3, dated September 8, 2015, to the Credit Agreement, dated September 12, 2014, among the Company, JPMorgan Chase Bank, N.A., as Administrative Agent, and the various lending institutions party thereto (incorporated by reference to Exhibit 10.1 to the Company's Current Report on Form 8-K (No. 001-33143) filed on September 10, 2015).
 
 
 
31.1
 
Certification of the Chief Executive Officer, pursuant to Rule 13a-14(a) or 15d-14(a), for the quarter ended September 30, 2015.
 
 
 
31.2
 
Certification of the Chief Financial Officer, pursuant to Rule 13a-14(a) or 15d-14(a), for the quarter ended September 30, 2015.
 
 
 
32.1
 
Certification of the Chief Executive Officer, pursuant to 18 U.S.C. Section 1350, for the quarter ended September 30, 2015.
 
 
 
32.2
 
Certification of the Chief Financial Officer, pursuant to 18 U.S.C. Section 1350, for the quarter ended September 30, 2015.
 
 
 
101.1
 
The following materials from the Company’s Quarterly Report on Form 10-Q for the quarter ended September 30, 2015, formatted in XBRL (Extensible Business Reporting Language): (i) the Condensed Consolidated Balance Sheets at September 30, 2015 and December 31, 2014; (ii) the Condensed Consolidated Statements of Income for the three and nine months ended September 30, 2015 and 2014; (iii) the Condensed Consolidated Statements of Comprehensive Income for the three and nine months ended September 30, 2015 and 2014; (iv) the Consolidated Statements of Cash Flows for the nine months ended September 30, 2015 and 2014; and (v) the Notes to Unaudited Condensed Consolidated Financial Statements.


 

76



SIGNATURES
 
Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned hereunto duly authorized.
 
 
 
AmTrust Financial Services, Inc.
 
 
(Registrant)
 
 
 
 
Date:
November 9, 2015
 
/s/ Barry D. Zyskind
 
 
 
Barry D. Zyskind
 
 
 
President and Chief Executive Officer
 
 
 
 
 
 
 
/s/ Ronald E. Pipoly, Jr.
 
 
 
Ronald E. Pipoly, Jr.
 
 
 
Chief Financial Officer
 

77