10Q Q32012
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
September 30, 2012
or
o
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended September 30, 2012
 
Commission File Number: 001-15204
 
Kingsway Financial Services Inc.
(Exact name of registrant as specified in its charter)
_________________________
Ontario, Canada
(State or other jurisdiction of
incorporation or organization)
 
Not Applicable (I.R.S. Employer
Identification No.)
45 St. Clair Avenue West, Suite 400 Toronto, Ontario M4V 1K9
(Address of principal executive offices and zip code)
1-416-848-1171
(Registrant's telephone number, including area code)
_________________________

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

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T ( 232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes x No o

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See definitions of "large accelerated filer," "accelerated filer," and "smaller reporting company" in Rule 12b-2 of the Exchange Act.

Large accelerated filer o
Accelerated filer o
Non-accelerated filer o
(Do not check if a smaller reporting company)
Smaller Reporting Company x

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act). Yes o No x
The number of shares outstanding of the registrant's common stock as of November 9, 2012 was 13,148,971.


KINGSWAY FINANCIAL SERVICES INC.

Table Of Contents
PART I - FINANCIAL INFORMATION
 
ITEM 1. FINANCIAL STATEMENTS
 
Consolidated Balance Sheets as of September 30, 2012 (unaudited) and December 31, 2011
 
Consolidated Statements of Operations for the Three and Nine Months Ended September 30, 2012 and 2011 (unaudited)
 
Consolidated Statements of Comprehensive (Loss) Income for the Three and Nine Months Ended September 30, 2012 and 2011 (unaudited)
 
Consolidated Statements of Cash Flows for the Nine Months Ended September 30, 2012 and 2011 (unaudited)
 
Notes to Consolidated Financial Statements (unaudited)
 
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
 
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
 
ITEM 4. CONTROLS AND PROCEDURES
 
PART II - OTHER INFORMATION
 
ITEM 1. LEGAL PROCEEDINGS
 
ITEM 1A. RISK FACTORS
 
ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS
 
ITEM 3. DEFAULTS UPON SENIOR SECURITIES
 
ITEM 4. MINE SAFETY DISCLOSURES
 
ITEM 5. OTHER INFORMATION
 
ITEM 6. EXHIBITS
 
SIGNATURES
 


















 
2
 
KINGSWAY FINANCIAL SERVICES INC.



PART I. FINANCIAL INFORMATION
Item 1. Financial Statements
Consolidated Balance Sheets (in thousands, except per share data)
 
 
September 30, 2012

 
December 31, 2011

 
 
 (unaudited)

 
 
ASSETS
 
 
 
 
Investments:
 
 
 
 
Fixed maturities, at fair value (amortized cost of $88,054 and $91,344, respectively)
 
$
90,168

 
$
93,651

Equity investments, at fair value (cost of $2,303 and $2,689, respectively)
 
2,350

 
2,960

Limited liability investments
 
2,413

 
97

Other investments, at cost which approximates fair value
 
—

 
488

Short-term investments, at cost which approximates fair value
 
335

 
20,334

Total investments
 
95,266

 
117,530

Investment in investee
 
47,173

 
48,592

Cash and cash equivalents
 
60,871

 
85,486

Accrued investment income
 
2,999

 
1,999

Premiums receivable, net of allowance for doubtful accounts of 3,665 and 3,653, respectively
 
33,922

 
28,732

Service fee receivable
 
15,683

 
12,947

Other receivables, net of allowance for doubtful accounts of $806 and $806, respectively
 
5,579

 
6,322

Reinsurance recoverable
 
10,472

 
697

Prepaid reinsurance premiums
 
7,891

 
2,024

Deferred policy acquisition costs, net
 
8,039

 
8,116

Income taxes recoverable
 
—

 
8,134

Property and equipment, net of accumulated depreciation of $19,331 and $27,736
 
3,323

 
13,040

Goodwill
 
510

 
510

Intangible assets
 
39,121

 
39,121

Other assets
 
1,923

 
831

Asset held for sale
 
8,737

 
—

TOTAL ASSETS
 
$
341,509

 
$
374,081

LIABILITIES AND EQUITY
 
 
 
 
 
 
 
 
 
LIABILITIES
 
 
 
 
Unpaid loss and loss adjustment expenses
 
$
104,953

 
$
120,258

Unearned premiums
 
44,070

 
39,423

Reinsurance payable
 
9,107

 
1,913

LROC preferred units
 
13,987

 
8,845

Senior unsecured debentures
 
22,921

 
28,337

Subordinated debt
 
24,942

 
16,432

Deferred income tax liability
 
2,772

 
2,653

Notes payable
 
—

 
2,418

Deferred revenue
 
14,031

 
11,128

Accrued expenses and other liabilities
 
27,432

 
26,269

TOTAL LIABILITIES
 
$
264,215

 
$
257,676

EQUITY
 
 
 
 
Common stock, no par value; unlimited number authorized; 13,148,971 and 13,086,471 issued and outstanding at September 30, 2012 and December 31, 2011, respectively
 
$
296,621

 
$
296,489

Additional paid-in capital
 
15,631

 
15,403

Accumulated deficit
 
(248,369
)
 
(201,208
)
Accumulated other comprehensive income
 
13,752

 
12,749

Shareholders' equity attributable to common shareholders
 
77,635

 
123,433

Noncontrolling interests in consolidated subsidiaries
 
(341
)
 
(7,028
)
TOTAL EQUITY
 
77,294

 
116,405

TOTAL LIABILITIES AND EQUITY
 
$
341,509

 
$
374,081

See accompanying notes to unaudited consolidated financial statements.

 
3
 
KINGSWAY FINANCIAL SERVICES INC.


Consolidated Statements of Operations
(in thousands, except per share data)
(Unaudited)
 
 
Three months ended September 30,
 
Nine months ended September 30,
 
 
2012

 
2011

 
2012

 
2011

Revenue:
 
 
 
 
 
 
 
 
Net premiums earned
 
$
26,501

 
$
36,614

 
$
86,753

 
$
124,825

Service fee and commission income
 
7,648

 
7,687

 
25,315

 
24,465

Net investment income
 
782

 
999

 
2,414

 
3,228

Net realized gains
 
1,109

 
104

 
1,359

 
102

Other-than-temporary impairment loss
 
—

 
—

 
(488
)
 
—

(Loss) gain on change in fair value of debt
 
(3,177
)
 
17,189

 
(9,926
)
 
25,821

Other income
 
1,940

 
5,587

 
5,767

 
8,809

Total revenues
 
34,803

 
68,180

 
111,194

 
187,250

Expenses:
 
 
 
 
 
 
 
 
Loss and loss adjustment expenses
 
33,348

 
34,304

 
78,739

 
112,895

Commissions and premiums taxes
 
2,458

 
5,421

 
11,624

 
19,707

General and administrative expenses
 
16,819

 
17,986

 
52,774

 
62,367

Restructuring expense
 
1,972

 
—

 
1,972

 
—

Interest expense
 
1,887

 
1,874

 
5,652

 
5,610

Amortization of other intangible assets
 
—

 
18

 
—

 
54

Total expenses
 
56,484

 
59,603

 
150,761

 
200,633

(Loss) income before gain on buy-back of debt, equity in net income (loss) of investee and income tax (benefit) expense
 
(21,681
)
 
8,577

 
(39,567
)
 
(13,383
)
Gain on buy-back of debt
 
500

 
3

 
500

 
556

Equity in net income (loss) of investee
 
93

 
145

 
(2,085
)
 
(384
)
(Loss) income from continuing operations before income tax (benefit) expense
 
(21,088
)
 
8,725

 
(41,152
)
 
(13,211
)
Income tax (benefit) expense
 
(1,054
)
 
2,433

 
(879
)
 
2,292

(Loss) income from continuing operations
 
(20,034
)
 
6,292

 
(40,273
)
 
(15,503
)
Loss on disposal of discontinued operations, net of taxes
 
—

 
—

 
—

 
(1,293
)
Net (loss) income
 
(20,034
)
 
6,292

 
(40,273
)
 
(16,796
)
Less: net loss attributable to noncontrolling interests in consolidated subsidiaries
 
(1,165
)
 
(960
)
 
(1,888
)
 
(3,684
)
Net (loss) income attributable to common shareholders
 
$
(18,869
)
 
$
7,252

 
$
(38,385
)
 
$
(13,112
)
(Loss) income per share - continuing operations:
 
 
 
 
 
 
 
 
Basic:
 
$
(1.52
)
 
$
0.48

 
$
(3.07
)
 
$
(1.19
)
Diluted:
 
(1.52
)
 
0.48

 
(3.07
)
 
(1.19
)
(Loss) income per share – net (loss) income:
 
 
 
 
 
 
 
 
Basic:
 
$
(1.52
)
 
$
0.48

 
$
(3.07
)
 
$
(1.28
)
Diluted:
 
(1.52
)
 
0.48

 
(3.07
)
 
(1.28
)
Weighted average shares outstanding (in ‘000s):
 
 
 
 
 
 
 
 
Basic:
 
13,149

 
13,086

 
13,133

 
13,071

Diluted:
 
13,149

 
13,086

 
13,133

 
13,071

See accompanying notes to unaudited consolidated financial statements.



 
4
 
KINGSWAY FINANCIAL SERVICES INC.


Consolidated Statements of Comprehensive (Loss) Income
(in thousands)
(unaudited)
 
 
Three months ended September 30,
 
 
Nine months ended September 30,
 
 
 
2012

 
2011

 
2012

 
2011

 
 
 
 
 
 
 
 
 
Net (loss) income
 
$
(20,034
)
 
$
6,292

 
$
(40,273
)
 
$
(16,796
)
Other comprehensive income (loss), net of taxes(1):
 
 
 
 
 
 
 
 
Unrealized (losses) gains on fixed maturities and equity investments:
 
 
 
 
 
 
 
 
Unrealized (losses) gains arising during the period
 
(1,337
)
 
952

 
(1,140
)
 
2,115

Reclassification adjustment for losses included in net (loss) income
 
1,090

 
44

 
723

 
4

Foreign currency translation adjustments
 
539

 
(6,698
)
 
566

 
(1,832
)
Equity in other comprehensive income (loss) of investee
 
310

 
114

 
649

 
(574
)
Loss on cash flow hedge
 
—

 
—

 
—

 
(1,267
)
Other comprehensive income (loss)
 
602

 
(5,588
)
 
798

 
(1,554
)
Comprehensive (loss) income
 
(19,432
)
 
704

 
$
(39,475
)
 
$
(18,350
)
Less: comprehensive income (loss) attributable to noncontrolling interests in consolidated subsidiaries
 
1,474

 
(975
)
 
(1,844
)
 
(3,446
)
Comprehensive (loss) income attributable to common shareholders
 
$
(20,906
)
 
$
1,679

 
(37,631
)
 
(14,904
)
 (1) Net of income tax (benefit) expense of $0 for the three and nine months ended September 30, 2012 and September 30, 2011.
 
 
See accompanying notes to unaudited consolidated financial statements

 
5
 
KINGSWAY FINANCIAL SERVICES INC.


Consolidated Statements of Cash Flows
(in thousands)
(unaudited)
 
Nine months ended September 30,
 
 
2012

2011

Cash provided by (used in):
 
 
Operating activities:
 
 
Net loss
$
(40,273
)
$
(16,796
)
Adjustments to reconcile net loss to net cash used in operating activities:
 
 
Loss from discontinued operations and disposal of discontinued operations
—

1,293

Equity in net loss of investee
2,085

384

Depreciation and amortization
1,042

1,725

Stock based compensation expense, net of forfeitures
228

(165
)
Net realized gains
(1,359
)
(102
)
Loss (gain) on change in fair value of debt
9,926

(25,821
)
Deferred income taxes
—

3,422

Other than temporary impairment loss
488

—

Amortization of fixed maturities premiums and discounts
2,679

666

Realized gain on buy-back of debt
(500
)
(556
)
Changes in operating assets and liabilities:
 
 
Premiums and service fee receivable
(7,926
)
11,221

Reinsurance recoverable
(9,775
)
8,097

Deferred policy acquisition costs
77

4,613

Income taxes recoverable
8,134

5,602

Funds held in escrow
—

22,259

Unpaid loss and loss adjustment expenses
(15,305
)
(42,508
)
Unearned premiums
4,647

(24,099
)
Reinsurance payable
7,194

(1,001
)
Deferred revenue
2,903

(5,839
)
Other, net
(4,955
)
(311
)
Net cash used in operating activities
(40,690
)
(57,916
)
Investing activities:
 
 
Proceeds from sales and maturities of fixed maturities
64,578

101,497

Proceeds from sales of equity investments
2,459

550

Purchase of fixed maturities
(44,555
)
(92,062
)
Purchase of equity investments
—

(1,420
)
Acquisitions of limited liability investments
(2,403
)
—

Net purchases of property and equipment and other intangible assets
(62
)
(815
)
Net cash provided by investing activities
20,017

7,750

Financing activities:
 
 
Common stock issued
132

350

(Payments) proceeds from issuance of notes payable
(2,418
)
2,418

Redemption of senior unsecured debentures
(1,656
)
(10,707
)
Net cash used in financing activities
(3,942
)
(7,939
)
Net decrease in cash and cash equivalents
(24,615
)
(58,105
)
Cash and cash equivalents at beginning of period
85,486

140,567

Cash and cash equivalents at end of period
$
60,871

$
82,462

See accompanying notes to unaudited consolidated financial statements.

 
6
 
KINGSWAY FINANCIAL SERVICES INC.


NOTE 1 BUSINESS
Kingsway Financial Services Inc. (the "Company" or "Kingsway") was incorporated under the Business Corporations Act (Ontario) on September 19, 1989. Kingsway is a holding company and is engaged, through its subsidiaries, in the property and casualty insurance business.
NOTE 2 BASIS OF PRESENTATION
The accompanying unaudited consolidated interim financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America ("U.S. GAAP") for interim financial information and with the instructions to Form 10-Q and Article 10 of Regulation S-X. Accordingly, they do not include all of the information and notes required by U.S. GAAP for complete financial statements of the Company. In the opinion of management, all adjustments necessary for a fair presentation have been included and are of a normal recurring nature. Interim results are not necessarily indicative of the results that may be expected for the year.
The accompanying unaudited consolidated interim financial statements and footnotes should be read in conjunction with the audited consolidated financial statements and footnotes included within our Annual Report on Form 10-K ("2011 Annual Report") for the year ended December 31, 2011.
The unaudited consolidated interim financial statements include the accounts of the Company and its subsidiaries. All material intercompany transactions and balances have been eliminated in consolidation.
The preparation of consolidated financial statements in conformity with U.S. GAAP requires management to make estimates and assumptions that affect application of policies and the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the consolidated financial statements and the reported amounts of revenues and expenses during the year. Actual results could differ from these estimates. Estimates and their underlying assumptions are reviewed on an ongoing basis. Changes in estimates are recorded in the accounting period in which they are determined. The critical accounting estimates and assumptions in the accompanying unaudited consolidated interim financial statements include the provision for unpaid loss and loss adjustment expenses, valuation of fixed maturities and equity investments, valuation of deferred tax assets, valuation of other intangible assets, deferred policy acquisition costs, and fair value assumptions for debt obligations.
The fair values of the Company's investments in fixed maturities and equity investments, LROC preferred units, senior unsecured debentures and subordinated debt are estimated using a fair value hierarchy to categorize the inputs it uses in valuation techniques. The fair value disclosure of the Company's investment in investee is based on quoted market prices. Fair values for other investments approximate their unpaid principal balances. The carrying amounts reported in the consolidated balance sheets approximate fair values for cash, short-term investments and certain other assets and other liabilities because of their short-term nature.
The Company's financial results contained herein are reported in U.S. dollars unless otherwise indicated.
NOTE 3 SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
There have been no material changes to our significant accounting policies as reported in our 2011 Annual Report, except for the effects of adopting Accounting Standards Update ("ASU") 2010-26, Financial Services-Insurance (Topic 944): Accounting for Costs Associated with Acquiring or Renewing Insurance Contracts ("ASU 2010-26"). Refer to Note 8, "Deferred Policy Acquisition Costs," for further disclosure.
NOTE 4 RECENTLY ISSUED ACCOUNTING STANDARDS
In October 2010, the Financial Accounting Standards Board ("FASB") issued ASU 2010-26. The amendments in ASU 2010-26 address diversity in practice regarding the interpretation of which costs relating to the acquisition of new or renewal insurance contracts qualify for deferral. And, the amendments clarify which costs should be deferred and which costs should be expensed when incurred. The amendments in ASU 2010-26 became effective for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2011. We adopted this new accounting standard effective January 1, 2012 on a prospective basis. Refer to Note 8, "Deferred Policy Acquisition Costs," for further discussion regarding the impact of this new standard to the Company.

 
7
 
KINGSWAY FINANCIAL SERVICES INC.
Notes to Consolidated Financial Statements (Unaudited) September 30, 2012


In May 2011, the FASB issued ASU 2011-04, Fair Value Measurement (Topic 820): Amendments to Achieve Common Fair Value Measurement and Disclosure Requirements in U.S. GAAP and IFRS ("ASU 2011-04"). Most of the changes in the new standard are clarifications of existing guidance, but it expands the disclosures about fair value measurements. It will require the categorization by level of the fair value hierarchy for items that are not measured at fair value in the statement of financial position but for which the fair value is required to be disclosed. In addition, for fair value measurements categorized as Level 3 within the fair value hierarchy, the valuation processes and sensitivity of the fair value measurements to changes in unobservable inputs shall be disclosed. This standard is effective for interim and annual periods beginning after December 15, 2011 and should be applied prospectively. Effective January 1, 2012, the Company adopted ASU 2011-04 , and the adoption of the new standard did not have a material impact on the consolidated financial statements.
In June 2011, the FASB issued ASU 2011-05, Comprehensive Income (Topic 220): Presentation of Comprehensive Income ("ASU 2011-05"). ASU 2011-05 requires companies to present the components of net income and comprehensive income in either one or two consecutive financial statements. Companies are no longer permitted to present the components of other comprehensive income as part of the statement of changes in shareholders' equity. Reclassifications from other comprehensive income must be presented in both the consolidated statement of operations and the consolidated statement of other comprehensive income. This standard became effective for interim and annual periods beginning after December 15, 2011, and should be applied retrospectively. In December 2011, the FASB issued ASU 2011-12, Comprehensive Income (Topic 220): Deferral of the Effective Date for Amendments to the Presentation of Reclassifications of Items Out of Accumulated Other Comprehensive Income in Accounting Standards Update No. 2011-05 ("ASU 2011-12"). The amendments in ASU 2011-12 delay the effective date of certain provisions in ASU No. 2011-05 that relate to reclassification items until such time as the FASB has time to re-deliberate the presentation of those items. All other provisions of ASU No. 2011-05 take effect on the date originally noted in that ASU. Effective January 1, 2012, the Company adopted ASU 2011-05 and the adoption of the new standard did not have a material impact on the consolidated financial statements.
In September 2011, the FASB issued ASU 2011-08, Intangibles-Goodwill and Other (Topic 350): Testing Goodwill for Impairment ("ASU 2011-08"). The standard became effective for the first interim or annual period beginning on or after December 15, 2011, with early adoption permitted. The standard amends Accounting Standards Codification Topic 350, Intangibles-Goodwill and Other, and gave companies the option to first perform a qualitative assessment to determine whether it is more likely than not that the fair value of a reporting unit is less than its carrying amount. Effective January 1, 2012, the Company adopted ASU 2011-08 and the adoption did not have an impact on our financial statements. There have been no triggering events that would suggest possible impairment or that it is more-likely-than-not that the fair values of the reporting unit related to our goodwill are less than their carrying amounts. We will utilize the new guidance during our annual impairment testing in December 2012.
In July 2012, the FASB issued ASU 2012-02, Intangibles-Goodwill and Other (Topic 350): Testing Indefinite-Lived Intangible Assets for Impairment ("ASU 2012-02"). ASU 2012-02 provides entities with an option to first assess qualitative factors to determine whether events or circumstances indicate that it is more likely than not that the indefinite-lived intangible asset is impaired. If an entity concludes that it is more than 50% likely that an indefinite-lived intangible asset is not impaired, no further analysis is required. However, if an entity concludes otherwise, it would be required to determine the fair value of the indefinite-lived intangible asset to measure the amount of actual impairment, if any, as currently required under US GAAP. ASU 2012-02 is effective for annual and interim impairment tests performed for fiscal years beginning after September 15, 2012. Early adoption is permitted. Except for the option to perform the qualitative assessment, the Company does not anticipate that the adoption of the new standard will have a material impact on the Company.
NOTE 5 DISCONTINUED OPERATIONS, DISPOSITION AND REACQUISITION
(a)
Discontinued Operations
American Service Insurance Company ("American Service"), American Country Insurance Company ("American Country"), Southern United Fire Insurance Company ("Southern United"), and Jevco Insurance Company ("Jevco") were disposed of in 2010 and have been classified as discontinued operations and the results of their operations are reported separately for all periods presented.

 
8
 
KINGSWAY FINANCIAL SERVICES INC.
Notes to Consolidated Financial Statements (Unaudited) September 30, 2012


Summarized financial information for discontinued operations is shown below.
(in thousands)
 
Three months ended September 30,
 
Nine months ended September 30,
 
 
2012

 
2011

 
2012

 
2011

Disposals:
 
 
 
 
 
 
 
 
Loss on disposal before income taxes
 
$
—

 
$
—

 
$
—

 
$
(1,670
)
Income tax benefit
 
—

 
—

 
—

 
(377
)
Loss on disposal of discontinued operations, net of taxes
 
$
—

 
$
—

 
$
—

 
$
(1,293
)
American Country, American Service and Southern United:
During 2010, Southern United was merged into American Service.
On December 31, 2010, the previously announced going-public transaction involving the Company's subsidiaries American Country and American Service by way of a reverse takeover of JJR VI Acquisition Corp. ("J6") was completed. Upon completion of the transaction, J6 was renamed Atlas Financial Holdings Inc. ("Atlas"), and American Country and American Service became wholly-owned subsidiaries of Atlas. Total consideration to the Company as a result of the transaction was approximately $57.0 million, consisting of cash of $7.9 million, preferred shares of Atlas of $18.0 million, and common shares of Atlas of $31.1 million. As part of the transaction, a quota-share agreement was put in place for 90% of up to $10.0 million of adverse development in excess of $1.0 million, based on the provision for unpaid loss and loss adjustment expenses recorded by Atlas at September 30, 2010. The maximum obligation to the Company is $9.0 million.
As a result of the disposal of American Country, American Service and Southern United, the Company recognized an after-tax gain of zero for the three months ended September 30, 2011 ($0.6 million prior year to date).
Jevco:
On January 25, 2010, the Company entered into a definitive purchase agreement with The Westaim Corporation (“Westaim”) to sell all of the issued and outstanding shares of Jevco to Westaim. On March 29, 2010, after receipt of all required regulatory approvals, the sale was completed for a purchase price of C$263.3 million subject to certain future contingent adjustments. The contingent adjustments included up to a C$20.0 million decrease in the purchase price relating to specific future adverse development in Jevco's provision for unpaid loss and loss adjustment expenses at the end of 2012. On March 31, 2011, the Company settled the C$20.0 million contingent adjustments related to the Jevco transactions for C$17.8 million, recording a pre-tax loss of $2.3 million. As a result of the disposal of Jevco, the Company realized an after-tax loss of zero for the three months ended September 30, 2011 ($1.9 million prior year to date).
(b)
Disposition
Hamilton Risk Management Company:
On March 30, 2011, the Company's subsidiary, Kingsway America Inc. ("KAI"), sold all of the issued and outstanding shares of its wholly owned subsidiary Hamilton Risk Management Company (“Hamilton”) and its subsidiaries, including Kingsway Amigo Insurance Company ("Amigo"), to HRM Acquisition Corp., a wholly owned subsidiary of Acadia Acquisition Partners, L.P. (“Acadia”), in exchange for a $10.0 million senior promissory note due March 30, 2014, a $5.0 million junior promissory note due March 30, 2016, and a Class B partnership interest in Acadia, representing a 40% economic interest. A third-party and members of the Hamilton management team held Class A partnership interests in Acadia representing a 60% economic interest. KAI acted as the general partner of Acadia. As general partner, KAI controlled the policies and financial affairs of Hamilton; therefore, Kingsway continued to consolidate the financial statements of Hamilton. During the second quarter of 2011, HRM Acquisition Corp. merged into Hamilton.
As a result of this transaction, as of December 31, 2011, Hamilton had notes payable balances of $2.2 million maturing in March 2014 with the third-party and $0.2 million maturing in June 2015 with members of the Hamilton management team. The notes bore interest at 2% annually. On August 14, 2012, Hamilton repaid the note payable from the third-party with a carrying value of $2.2 million for $1.7 million, recording a gain of $0.5 million. On August 31, 2012, Hamilton repaid the

 
9
 
KINGSWAY FINANCIAL SERVICES INC.
Notes to Consolidated Financial Statements (Unaudited) September 30, 2012


notes payable from the members of the Hamilton management team with a carrying value of $0.2 million for $0.2 million, recording a gain of zero.
(c)
Reacquisition
Hamilton Risk Management Company:
On August 14, 2012 and August 31, 2012, respectively, Hamilton repurchased the Class A partnership interests held by the third-party and members of the Hamilton management team, respectively. The Company recorded no gain or loss related to the repurchase of the Class A partnership interests. As a result of these transactions, Acadia was dissolved, liquidated, and wound down, with all assets being distributed to its sole member KAI, thereby resulting in Hamilton becoming a fully owned subsidiary of KAI.

NOTE 6 INVESTMENTS

The amortized cost, gross unrealized gains (losses), and estimated fair value of the Company's investments in fixed maturities and equity investments at September 30, 2012 and December 31, 2011 are summarized in the tables shown below:
(in thousands)
 
September 30, 2012
 
 
 
Amortized Cost

 
Gross Unrealized Gains

 
Gross Unrealized Losses

 
Estimated  Fair Value

Fixed maturities:
 
 
 
 
 
 
 
 
U.S. government, government agencies and authorities
 
$
28,004

 
$
1,075

 
$
—

 
$
29,079

Canadian government
 
3,867

 
—

 
6

 
3,861

States municipalities and political subdivisions
 
7,166

 
194

 
—

 
7,360

Mortgage-backed
 
5,259

 
232

 
—

 
5,491

Asset-backed securities and collateralized mortgage obligations
 
1,329

 
11

 
—

 
1,340

Corporate
 
42,429

 
639

 
31

 
43,037

Total fixed maturities
 
$
88,054

 
$
2,151

 
$
37

 
$
90,168

Equity investments
 
2,303

 
65

 
18

 
2,350

Total fixed maturities and equity investments
 
$
90,357

 
$
2,216

 
$
55

 
$
92,518





















 
10
 
KINGSWAY FINANCIAL SERVICES INC.
Notes to Consolidated Financial Statements (Unaudited) September 30, 2012


(in thousands)
 
December 31, 2011
 
 
 
Amortized Cost

 
Gross Unrealized Gains

 
Gross Unrealized Losses

 
Estimated  Fair Value

Fixed maturities:
 
 
 
 
 
 
 
 
U.S. government, government agencies and authorities
 
$
45,316

 
$
1,498

 
$
—

 
$
46,814

Canadian government
 
3,788

 
57

 
55

 
3,790

States municipalities and political subdivisions
 
8,195

 
269

 
—

 
8,464

Mortgage-backed
 
5,958

 
222

 
3

 
6,177

Asset-backed securities and collateralized mortgage obligations
 
6,414

 
40

 
6

 
6,448

Corporate
 
21,673

 
397

 
112

 
21,958

Total fixed maturities
 
$
91,344

 
$
2,483

 
$
176

 
$
93,651

Equity investments
 
2,689

 
287

 
16

 
2,960

Total fixed maturities and equity investments
 
$
94,033

 
$
2,770

 
$
192

 
$
96,611


The table below summarizes the Company's fixed maturities at September 30, 2012, by contractual maturity periods. Actual results may differ as issuers may have the right to call or prepay obligations, with or without penalties, prior to the contractual maturity of these obligations.
(in thousands)
 
September 30, 2012
 
 
 
Amortized Cost

 
Estimated Fair Value

Due in one year or less
 
$
18,937

 
$
18,984

Due after one year through five years
 
60,112

 
61,540

Due after five years through ten years
 
3,897

 
4,322

Due after ten years
 
5,108

 
5,322

Total
 
$
88,054

 
$
90,168


Gross realized gains and losses on fixed maturities and equity investments for the three and nine months ended September 30, 2012 and September 30, 2011 were as follows:
(in thousands)
 
Three months ended September 30,
 
 
Nine months ended September 30,
 
 
 
2012

 
2011

 
2012

 
2011

Gross gains
 
1,109

 
110

 
1,433

 
114

Gross losses
 
—

 
(6
)
 
(74
)
 
(12
)
Total
 
$
1,109

 
$
104

 
1,359

 
102



 
11
 
KINGSWAY FINANCIAL SERVICES INC.
Notes to Consolidated Financial Statements (Unaudited) September 30, 2012


The following tables highlight the aggregate unrealized loss position, by security type, of fixed maturities and equity investments in unrealized loss positions as of September 30, 2012 and December 31, 2011. The tables segregate the holdings based on the period of time the investments have been continuously held in unrealized loss positions.
(in thousands)
 
 
 
 
 
 
 
 
September 30, 2012
 
 
Less than 12 Months
 
Greater than 12 Months
 
Total
 
Estimated Fair Value
 
Unrealized Loss
 
Estimated Fair Value
 
Unrealized Loss
 
Estimated Fair Value
 
Unrealized Loss
Fixed maturities:
 
 
 
 
 
 
 
 
 
 
 
Canadian government
3,861

 
6

 
—

 
—

 
3,861

 
6

Asset-backed securities and collateralized mortgage obligations
245

 
—

 
—

 
—

 
245

 
—

Corporate
6,341

 
17

 
1,991

 
14

 
8,332

 
31

Total fixed maturities
$
10,447

 
$
23

 
$
1,991

 
$
14

 
$
12,438

 
$
37

Equity investments
6

 
1

 
20

 
17

 
26

 
18

Total
$
10,453

 
$
24

 
$
2,011

 
$
31

 
$
12,464

 
$
55


(in thousands)
 
 
 
 
 
 
 
 
December 31, 2011
 
 
Less than 12 Months
 
Greater than 12 Months
 
Total
 
Estimated Fair Value
 
Unrealized Loss
 
Estimated Fair Value
 
Unrealized Loss
 
Estimated Fair Value
 
Unrealized Loss
Fixed maturities:
 
 
 
 
 
 
 
 
 
 
 
U.S. government, government agencies and authorities
$
7,500

 
$
—

 
$
—

 
$
—

 
$
7,500

 
$
—

Canadian government
1,105

 
55

 
—

 
—

 
1,105

 
55

Mortgage-backed
1,026

 
3

 
—

 
—

 
1,026

 
3

Asset-backed securities and collateralized mortgage obligations
2,252

 
6

 
—

 
—

 
2,252

 
6

Corporate
178

 
10

 
1,893

 
102

 
2,071

 
112

Total fixed maturities
$
12,061

 
$
74

 
$
1,893

 
$
102

 
$
13,954

 
$
176

Equity investments
224

 
16

 
—

 
—

 
224

 
16

Total
$
12,285

 
$
90

 
$
1,893

 
$
102

 
$
14,178

 
$
192

Fixed maturities and equity investments contain approximately 13 and 12 individual investments that were in unrealized loss positions as of September 30, 2012 and December 31, 2011, respectively. 
The establishment of an other-than-temporary impairment on an investment requires a number of judgments and estimates. The Company performs a quarterly analysis of the individual investments to determine if declines in market value are other-than-temporary. The analysis includes some or all of the following procedures as deemed appropriate by the Company:
•
identifying all unrealized loss positions that have existed for at least six months;
•
identifying other circumstances which management believes may impact the recoverability of the unrealized loss positions;
•
obtaining a valuation analysis from third-party investment managers regarding the intrinsic value of these investments based on their knowledge and experience together with market-based valuation techniques;
•
reviewing the trading range of certain investments over the preceding calendar period;

 
12
 
KINGSWAY FINANCIAL SERVICES INC.
Notes to Consolidated Financial Statements (Unaudited) September 30, 2012


•
assessing if declines in market value are other-than-temporary for debt instruments based on the investment grade credit
ratings from third-party rating agencies;
•
assessing if declines in market value are other-than-temporary for any debt instrument with a non-investment grade credit rating based on the continuity of its debt service record;
•
determining the necessary provision for declines in market value that are considered other-than-temporary based on the analyses performed; and
•
assessing the Company's ability and intent to hold these investments at least until the investment impairment is recovered.
The risks and uncertainties inherent in the assessment methodology used to determine declines in market value that are other-than-temporary include, but may not be limited to, the following:
•
the opinions of professional investment managers could be incorrect;
•
the past trading patterns of individual investments may not reflect future valuation trends;
•
the credit ratings assigned by independent credit rating agencies may be incorrect due to unforeseen or unknown facts related to a company's financial situation; and
•
the debt service patterns of non-investment grade instruments may not reflect future debt service capabilities and may not reflect a company's unknown underlying financial problems.
As a result of the above analysis performed by the Company to determine declines in market value that are other-than-temporary, there were no write-downs for other-than-temporary impairments related to other investments for the three months ended September 30, 2012 and September 30, 2011 (write-down for other-than-temporary impairment related to other investments of $0.5 million and zero for the nine months ended September 30, 2012 and September 30, 2011, respectively). There were no write-downs related to fixed maturities and equity investments for other-than-temporary impairments for the three and nine months ended September 30, 2012 and September 30, 2011. There were no other-than-temporary losses recognized in other comprehensive income (loss) for the three and nine months ended September 30, 2012 and September 30, 2011.
The Company has reviewed currently available information regarding investments with estimated fair values that are less than their carrying amounts and believes that these unrealized losses are not other-than-temporary and are primarily due to temporary market and sector-related factors rather than to issuer-specific factors. The Company does not intend to sell those investments, and it is not likely that it will be required to sell those investments before recovery of its amortized cost.
The Company does not have any exposure to subprime mortgage-backed investments.
Limited liability investments include investments in limited liability companies and a limited partnership that primarily invest in income-producing real estate. Limited liability investments are investments in which the Company's interests are not deemed minor and are accounted for under the equity method of accounting. As of September 30, 2012 and December 31, 2011, the carrying value of limited liability investments totaled $2.4 million and $0.1 million, respectively.
Net investment income for the three and nine months ended September 30, 2012 and September 30, 2011, respectively, is comprised as follows:
(in thousands)
 
Three months ended September 30,
 
Nine months ended September 30,
 
 
 
2012

 
2011

 
2012

 
2011

Investment income
 
 
 
 
 
 
 
 
Interest from fixed maturities
 
$
529

 
$
699

 
$
1,647

 
$
2,418

Interest from other
 
121

 
107

 
350

 
360

Dividends
 
239

 
240

 
743

 
704

Gross investment income
 
$
889

 
$
1,046

 
$
2,740

 
$
3,482

Investment expenses
 
(107
)
 
(47
)
 
(326
)
 
(254
)
Net investment income
 
$
782

 
$
999

 
$
2,414

 
$
3,228

As at September 30, 2012, fixed maturities and short-term investments with an estimated fair value of $14.9 million were on deposit with state and provincial regulatory authorities. Also, from time to time, securities are pledged to third parties to collateralize liabilities incurred under certain reinsurance arrangements. At September 30, 2012, the amount of such pledged securities was $26.7 million.

 
13
 
KINGSWAY FINANCIAL SERVICES INC.
Notes to Consolidated Financial Statements (Unaudited) September 30, 2012


NOTE 7 INVESTMENT IN INVESTEE
Investment in investee includes the Company's investment in the preferred and restricted voting common stock of Atlas and is accounted for under the equity method. The Company's investment in Atlas is recorded on a three-month lag basis. The carrying value, estimated fair value and approximate voting and equity percentages at September 30, 2012 and December 31, 2011 were as follows:
(in thousands, except for percentages)
 
 
 
 
 
 
 
 
 
 
 
September 30, 2012
 
December 31, 2011
 
Voting percentage
 
Equity percentage
 
Estimated Fair Value
 
Carrying value
 
Voting percentage
 
Equity percentage
 
Estimated Fair Value
 
Carrying value
Atlas
30.0
%
 
74.9
%
 
$
38,339

 
$
47,173

 
30.0
%
 
75.1
%
 
$
44,340

 
$
48,592


The fair values of the Company's investment in Atlas at September 30, 2012 and December 31, 2011 in the table above are calculated based on the published closing prices of Atlas at June 30, 2012 and September 30, 2011, respectively, to be consistent with the three-month lag in reporting its carrying value under the equity method. The estimated fair value of the Company's investment in Atlas based on the published closing price of Atlas at September 30, 2012 is $42.6 million.
Equity in net income of investee was $0.1 million and $0.1 million for the three months ended September 30, 2012 and September 30, 2011, respectively (loss of $2.1 million and $0.4 million, respectively, year to date). The Company also recognized an increase to shareholders' equity attributable to common shareholders of $0.3 million and $0.6 million for the three and nine months ended September 30, 2012, respectively, for the Company's pro rata share of its investee's accumulated other comprehensive income.
Summarized financial information for Atlas is presented below, to be consistent with the three-month lag in reporting, for the six months ended June 30, 2012 and three months ended December 31, 2011:
(in thousands)
 
Six months ended June 30, 2012

 
Three months ended December 31, 2011

Total revenue
 
17,612

 
11,216

Net income (loss)
 
265

 
(3,025
)

On September 28, 2012, the Company entered into an agreement with a third-party to sell 1,621,621 shares of Atlas common stock for C$1.88 per share. The trade is subject to regulatory approvals and is expected to settle during the fourth quarter of 2012. On October 4, 2012, the Company entered into an agreement with a third-party to sell 520,833 shares of Atlas common stock for $1.92 per share. The trade settled and the Company received the proceeds of $1.0 million during the fourth quarter of 2012.

NOTE 8 DEFERRED POLICY ACQUISITION COSTS
Policy acquisition costs consist primarily of commissions, premium taxes, and underwriting and agency expenses incurred related to successful efforts to acquire a new or renewal insurance contract, net of ceding commission income. Policy acquisition costs are deferred and expensed as the related premiums are earned.
As described in Note 4, "Recently Issued Accounting Standards," the Company adopted ASU 2010-26 effective January 1, 2012 on a prospective basis. The new standard affects the timing of recognition of policy acquisition costs. Costs associated with unsuccessful efforts or costs that cannot be tied directly to a successful policy acquisition are expensed as incurred, as opposed to being deferred and amortized as the premium is earned. In periods of growth, the standard will result in an acceleration of expense recognition. In periods of contraction, the opposite will occur. The application of the new standard resulted in capitalized acquisition costs of $5.8 million for the three months ended September 30, 2012 ($16.4 million year to date) compared with $6.7 million of acquisition costs that would have been capitalized for the three months ended September 30, 2012 ($19.3 million year to date) if the Company had not adopted the new standard. As a result, the Company recorded $0.9 million more in expense for the three months ended September 30, 2012 ($2.9 million year to date) than it would have had it not adopted the new standard.

 
14
 
KINGSWAY FINANCIAL SERVICES INC.
Notes to Consolidated Financial Statements (Unaudited) September 30, 2012


The components of deferred policy acquisition costs and the related amortization expense for the three and nine months ended September 30, 2012 and September 30, 2011, respectively, is comprised as follows:
(in thousands)
 
Three months ended September 30,
 
 
Nine months ended September 30,
 
 
 
2012

 
2011

 
2012

 
2011

Beginning balance, net
 
7,634

 
10,389

 
8,116

 
13,952

Additions
 
5,804

 
5,865

 
16,422

 
20,041

Amortization
 
(5,399
)
 
(6,915
)
 
(16,499
)
 
(24,654
)
Balance at September 30, net
 
8,039

 
9,339

 
8,039

 
9,339

NOTE 9 INTANGIBLE ASSETS
Intangible assets are comprised as follows:
(in thousands)
 
September 30, 2012

 
December 31, 2011

Intangible assets not subject to amortization
 
 
 
 
     Insurance licenses
 
$
7,803

 
$
7,803

     Renewal rights
 
31,318

 
31,318

Intangible assets
 
$
39,121

 
$
39,121


NOTE 10 ASSET HELD FOR SALE
As of September 30, 2012, property consisting of building and land located in Miami, Florida with a carrying value of $8.7 million was classified as held for sale. The carrying value of the property was less than the appraised value net of estimated selling costs at the time the property was deemed held for sale.

NOTE 11 UNPAID LOSS AND LOSS ADJUSTMENT EXPENSES
The establishment of the provision for unpaid loss and loss adjustment expenses is based on known facts and interpretation of circumstances and is therefore a complex and dynamic process influenced by a large variety of factors. These factors include the Company's experience with similar cases and historical trends involving loss payment patterns, pending levels of unpaid loss and loss adjustment expenses, product mix or concentration, loss severity and loss frequency patterns.
Other factors include the continually evolving and changing regulatory and legal environment; actuarial studies; professional experience and expertise of the Company's claims departments' personnel and independent adjusters retained to handle individual claims; the quality of the data used for projection purposes; existing claims management practices including claims-handling and settlement practices; the effect of inflationary trends on future loss settlement costs; court decisions; economic conditions; and public attitudes.
Consequently, the process of determining the provision necessarily involves risks that the actual results will deviate, perhaps materially, from the best estimates made.

 
15
 
KINGSWAY FINANCIAL SERVICES INC.
Notes to Consolidated Financial Statements (Unaudited) September 30, 2012


The Company's evaluation of the adequacy of unpaid loss and loss adjustment expenses includes a re-estimation of the liability for unpaid loss and loss adjustment expenses relating to each preceding financial year compared to the liability that was previously established. The results of this comparison and the changes in the provision for unpaid loss and loss adjustment expenses, net of amounts recoverable from reinsurers, as of September 30, 2012 and September 30, 2011 were as follows:
(in thousands)
 
September 30, 2012

 
September 30, 2011

Balance at beginning of period, gross
 
$
120,258

 
$
174,708

Less reinsurance recoverable on unpaid loss and loss adjustment expenses
 
298

 
7,974

Balance at beginning of period, net
 
119,960

 
166,734

Incurred related to:
 
 
 
 

      Current year
 
67,510

 
109,336

      Prior years
 
11,229

 
3,559

Paid related to:
 
 
 
 

      Current year
 
(36,751
)
 
(59,795
)
      Prior years
 
(60,530
)
 
(87,634
)
Balance at end of period, net
 
101,418

 
132,200

Plus reinsurance recoverable on unpaid loss and loss adjustment expenses
 
3,535

 
—

Balance at end of period, gross
 
$
104,953

 
$
132,200

NOTE 12 DEBT
Debt consists of the following instruments:
(in thousands)
 
September 30, 2012
 
December 31, 2011
 
 
Principal

 
Fair Value

 
Principal

 
Fair Value

6% Senior unsecured debentures due 2012
 
$
—

 
$
—

 
$
1,657

 
$
1,641

7.5% Senior notes due 2014
 
26,966

 
22,921

 
26,966

 
26,696

LROC preferred units due 2015
 
19,993

 
13,987

 
19,329

 
8,845

Subordinated debt
 
90,500

 
24,942

 
90,500

 
16,432

Total
 
$
137,459

 
$
61,850

 
$
138,452

 
$
53,614


During the third quarter of 2012, the Company repaid the $1.7 million principal balance of the 6% Senior unsecured debentures, which matured on July 11, 2012.

Subordinated indebtedness mentioned above consists of the following trust preferred debt instruments:
Issuer
Principal

Issue date
Interest
Redemption date
Kingsway CT Statutory Trust I
15,000

12/4/2002
annual interest rate equal to LIBOR, plus 4.00% payable quarterly
12/4/2032
Kingsway CT Statutory Trust II
17,500

5/15/2003
annual interest rate equal to LIBOR, plus 4.10% payable quarterly
5/15/2033
Kingsway CT Statutory Trust III
20,000

10/29/2003
annual interest rate equal to LIBOR, plus 3.95% payable quarterly
10/29/2033
Kingsway DE Statutory Trust III
15,000

5/23/2003
annual interest rate equal to LIBOR, plus 4.20% payable quarterly
5/23/2033
Kingsway DE Statutory Trust IV
10,000

9/30/2003
annual interest rate equal to LIBOR, plus 3.85% payable quarterly
9/30/2033
Kingsway DE Statutory Trust VI
13,000

1/8/2004
annual interest rate equal to LIBOR, plus 4.00% payable quarterly
1/8/2034


 
16
 
KINGSWAY FINANCIAL SERVICES INC.
Notes to Consolidated Financial Statements (Unaudited) September 30, 2012


During the first quarter of 2011, the Company gave notice to its Trust Preferred trustees of its intention to exercise its voluntary right to defer interest payments for up to 20 quarters, pursuant to the contractual terms of its outstanding Trust Preferred indentures, which permit interest deferral. This action does not constitute a default under the Company's Trust Preferred indentures or any of its other debt indentures.  At September 30, 2012, deferred interest payable of $7.1 million is included in accrued expenses and other liabilities in the consolidated balance sheets.  The cash interest due in 2016 is subject to changes in the London interbank offered interest rate for three-month U.S. dollar deposits ("LIBOR") over the deferral period.
No debt repurchases were made during the quarter and year ended September 30, 2012. During the third quarter of 2011, Kingsway 2007 General Partnership purchased for $0.2 million ($10.8 million prior year to date) and subsequently cancelled $0.2 million ($11.4 million prior year to date) par value of its senior unsecured debentures with a carrying value of $0.2 million ($11.4 million prior year to date), recording a gain of $0.0 million ($0.6 million prior year to date).
NOTE 13 INCOME TAXES
Income tax benefit for the three and nine months ended September 30, 2012 varies from the amount that would result by applying the applicable United States income tax rate of 34% to loss from continuing operations before income tax benefit primarily due to a valuation allowance being applied to the Company's operating losses and a tax benefit being recorded for a 2011 tax return to provision adjustment. Income tax expense for the three and nine months ended September 30, 2011 varies from the amount that would result by applying the applicable United States income tax rate of 34% to (loss) income from continuing operations before income tax expense primarily due to a valuation allowance being applied to the Company's operating losses.
The Company maintains a valuation allowance for its gross deferred tax assets at September 30, 2012 and December 31, 2011. The Company's operations have generated substantial operating losses during the last several years. These losses can be available to reduce income taxes that might otherwise be incurred on future taxable income. The Company's operations, however, remain challenged and, as a result, it is uncertain whether the Company will generate the taxable income necessary to utilize these losses or other reversing temporary differences. This uncertainty has caused management to place a full valuation allowance on its September 30, 2012 and December 31, 2011 net deferred tax asset. The Company carries a deferred tax liability of $2.8 million and $2.7 million at September 30, 2012 and December 31, 2011, respectively, all of which relates to indefinite life intangible assets.
As of September 30, 2012, the Company had no unrecognized tax benefits. The Company analyzed its tax positions in accordance with the provisions of ASC Topic 740, Income Taxes and has determined that there are currently no uncertain tax positions. The Company recognizes interest and penalties, if any, related to unrecognized tax benefits in income tax (benefit) expense.
Income taxes recoverable of $8.1 million at December 31, 2011 primarily related to tax receivables of the Company's Canadian operations. These tax receivables were all collected during the nine month period ended September 30, 2012.
NOTE 14 NET (LOSS) INCOME PER SHARE
Net (loss) income per share is based on the weighted-average number of shares outstanding. Diluted weighted-average shares is calculated by adjusting basic weighted-average shares outstanding by all potentially dilutive stock options. Since the Company is reporting a net loss for the three and nine months ended September 30, 2012 and the three months ended September 30, 2011 and because the exercise price of the options was greater than the average market price of the common stock for the nine months ended September 30, 2011, all stock options outstanding were excluded from the calculation of both basic and diluted (loss) income per share since their inclusion would have been anti-dilutive.
On July 3, 2012, the Company announced that the board of directors of the Company authorized the implementation of a share consolidation at a ratio of one post-consolidation share for every four pre-consolidation shares. The share consolidation, which was approved by the stockholders at the Company's Annual and Special Meeting held on May 31, 2012, was effective as of July 3, 2012 (the "Effective Date"). As a result of the consolidation, every four of the Company's common shares that were issued and outstanding on the Effective Date were automatically combined into one issued and outstanding common share, without any change in the par value of such shares. Any fractional shares resulting from the consolidation were rounded up to the nearest whole. The consolidation had the effect of reducing the number of common shares of the Company issued and outstanding from 52,595,828 shares pre-consolidation to 13,148,971 shares post-consolidation. The issued and outstanding shares reported in the consolidated balance sheets and the number of weighted-average shares outstanding included in the (loss) income per share computations, as reported in the consolidated statements of operations, have been restated for all periods presented to reflect the impact of the share consolidation.


 
17
 
KINGSWAY FINANCIAL SERVICES INC.
Notes to Consolidated Financial Statements (Unaudited) September 30, 2012


NOTE 15 ACCUMULATED OTHER COMPREHENSIVE INCOME
The table below details the components of accumulated other comprehensive income, net of tax, for the three and nine months ended September 30, 2012 and September 30, 2011 as relates to shareholders' equity attributable to common shareholders on the consolidated balance sheets. On the other hand, the unaudited consolidated statements of comprehensive (loss) income present the components of accumulated other comprehensive income, net of tax, for the three and nine months ended September 30, 2012 and September 30, 2011 inclusive of the components attributable to noncontrolling interests in consolidated subsidiaries.
 
 
Three months ended September 30,
 
 
Nine months ended September 30,
 
  
 
2012

 
2011

 
2012

 
2011

Beginning balance
 
$
13,047

 
$
18,188

 
$
12,749

 
$
14,407

Unrealized (losses) gains on fixed maturities and equity investments arising during the period
 
(1,191
)
 
906

 
(888
)
 
1,856

Reclassification adjustment for losses included in net (loss) income
 
1,090

 
44

 
723

 
4

Foreign currency translation adjustments
 
496

 
(6,637
)
 
519

 
(1,811
)
Equity in other comprehensive income (loss) of investee
 
310

 
114

 
649

 
(574
)
Loss on cash flow hedge
 
—

 
—

 
—

 
(1,267
)
Balance at September 30
 
$
13,752

 
$
12,615

 
$
13,752

 
$
12,615

NOTE 16 SEGMENTED INFORMATION
The Company is engaged, through its subsidiaries, in the non-standard property and casualty insurance business. The Company conducts its business through the following two reportable segments: Insurance Underwriting and Insurance Services.
On September 17, 2012, the Company announced that it was restructuring its Insurance Underwriting and Insurance Services segments under two separate management teams. As a result of the Company's intent to streamline its non-standard property and casualty insurance business operations under one management team, KAI Advantage Auto, Inc. ("Advantage Auto"), formerly included in Insurance Services, is now part of Insurance Underwriting. All segmented information has been restated for all periods presented to include Advantage Auto in Insurance Underwriting.
Insurance Underwriting Segment
The Company's property and casualty insurance business operations are conducted primarily through the following subsidiaries: Mendota Insurance Company, Mendakota Insurance Company, Universal Casualty Company, Amigo, Advantage Auto, Kingsway Reinsurance Corporation and Kingsway Reinsurance (Bermuda) Ltd. (collectively, "Insurance Underwriting"). Insurance Underwriting primarily provides non-standard automobile insurance to individuals and actively conducts business in 17 states.
Insurance Services Segment
Insurance Services includes the following subsidiaries of the Company: Assigned Risk Solutions Ltd. ("ARS") and Northeast Alliance Insurance Agency, LLC ("NEA") (collectively, "Insurance Services").
In 2011, ARS and NEA were organized to run as one business under the ARS name. ARS is a licensed property and casualty agent, full service managing general agent and third-party administrator focused primarily on the assigned risk market. ARS is licensed to administer business in 22 states but generates its revenues primarily by operating in the states of New York and New Jersey.
Results for the Company's reportable segments are based on the Company's internal financial reporting systems and are consistent with those followed in the preparation of the unaudited consolidated interim financial statements. The following tables provide financial data used by management. Segment assets are not allocated for management use and, therefore, are not included in the segment disclosures below.

 
18
 
KINGSWAY FINANCIAL SERVICES INC.
Notes to Consolidated Financial Statements (Unaudited) September 30, 2012


Segment revenues for the three and nine months ended September 30, 2012 and 2011 were:
(in thousands)
 
Three months ended September 30,
 
 
Nine months ended September 30,
 
 
 
2012

 
2011

 
2012

 
2011

Revenues:
 
 
 
 
 
 
 
 
Insurance Underwriting:
 
 
 
 
 
 
 
 
   Net premiums earned
 
$
26,501

 
$
36,614

 
$
86,753

 
$
124,825

Other income
 
1,856

 
2,116

 
5,340

 
7,383

Total Insurance Underwriting
 
28,357

 
38,730

 
92,093

 
132,208

Insurance Services:
 
 
 
 
 
 
 
 
Service fee and commission income
 
7,648

 
7,687

 
25,315

 
24,465

Total Insurance Services
 
7,648

 
7,687

 
25,315

 
24,465

Total segment revenues
 
36,005

 
46,417

 
117,408

 
156,673

Net investment income
 
782

 
999

 
2,414

 
3,228

Net realized gains
 
1,109

 
104

 
1,359

 
102

Other-than-temporary impairment loss
 
—

 
—

 
(488
)
 
—

(Loss) gain on change in fair value of debt
 
(3,177
)
 
17,189

 
(9,926
)
 
25,821

Other income not allocated to segments
 
84

 
3,471

 
427

 
1,426

Total revenues
 
$
34,803

 
$
68,180

 
$
111,194

 
$
187,250

The operating (loss) income of each segment is before income taxes and includes revenues and direct segment costs. Segment net (loss) income for the three and nine months ended September 30, 2012 and 2011 were:
 
 
Three months ended September 30,
 
 
Nine months ended September 30,
 
 
 
2012

 
2011

 
2012

 
2011

Segment operating (loss) income
 
 
 
 
 
 
 
 
Insurance Underwriting
 
$
(16,812
)
 
$
(8,980
)
 
$
(23,803
)
 
$
(28,312
)
Insurance Services
 
414

 
520

 
2,897

 
1,901

Total segment operating loss
 
(16,398
)
 
(8,460
)
 
(20,906
)
 
(26,411
)
Net investment income
 
782

 
999

 
2,414

 
3,228

Net realized gains
 
1,109

 
104

 
1,359

 
102

Other-than-temporary impairment loss
 
—

 
—

 
(488
)
 
—

(Loss) gain on change in fair value of debt
 
(3,177
)
 
17,189

 
(9,926
)
 
25,821

Other income and expenses not allocated to segments, net
 
(2,110
)
 
637

 
(6,368
)
 
(10,459
)
Interest expense
 
(1,887
)
 
(1,874
)
 
(5,652
)
 
(5,610
)
Amortization of other intangible assets
 
—

 
(18
)
 
—

 
(54
)
Gain on buy-back of debt
 
500

 
3

 
500

 
556

Equity in net income (loss) of investee
 
93

 
145

 
(2,085
)
 
(384
)
(Loss) income from continuing operations before income tax (benefit) expense
 
$
(21,088
)
 
$
8,725

 
$
(41,152
)
 
$
(13,211
)
Income tax (benefit) expense
 
(1,054
)
 
2,433

 
(879
)
 
2,292

(Loss) income from continuing operations
 
$
(20,034
)
 
$
6,292

 
$
(40,273
)
 
$
(15,503
)

 
19
 
KINGSWAY FINANCIAL SERVICES INC.
Notes to Consolidated Financial Statements (Unaudited) September 30, 2012


Net premiums earned by line of business for the three and nine months ended September 30, 2012 and 2011 were:
(in thousands)
 
Three months ended September 30,
 
 
Nine months ended September 30,
 
 
 
2012

 
2011

 
2012

 
2011

Insurance Underwriting:
 
 
 
 
 
 
 
 
Private passenger auto liability
 
$
17,211

 
$
25,163

 
$
57,031

 
$
86,111

Auto physical damage
 
6,914

 
8,750

 
21,733

 
30,595

Total non-standard automobile
 
24,125

 
33,913

 
$
78,764

 
$
116,706

Commercial auto liability
 
2,378

 
2,701

 
7,991

 
8,118

Other
 
(2
)
 
—

 
(2
)
 
1

Total net premiums earned
 
$
26,501

 
$
36,614

 
$
86,753

 
$
124,825

NOTE 17 RESTRUCTURING
On September 17, 2012, the Company announced that it was restructuring its Insurance Underwriting and Insurance Services segments under two separate management teams. As part of the restructuring, the Company intends to streamline its non-standard property and casualty insurance business operations. Specific to Insurance Underwriting, during the third quarter the Company began taking actions to significantly reduce the amount of commercial lines business written at Amigo and to update Amigo's personal lines product offering. As part of the restructuring, the Company will reduce staffing levels to be consistent with decreased premium volume at its Amigo business. The Company estimates that Insurance Underwriting will incur approximately $2.0 million in cash severance expenses due to reductions-in-force during the nine-month period following the announcement. Additionally during the third quarter of 2012, Insurance Underwriting recorded a liability of $1.3 million related to abandonment of leased space. The amount will be paid in cash over the remaining lease terms ranging from two to five years.
Changes in the restructuring liability, which is included in accrued expenses and other liabilities in the consolidated balance sheets, as of September 30, 2012 is as follows:
 
 
Severance
 
Lease abandonment
 
Total
Restructuring liability, beginning of period
 
$
—

 
$
—

 
$
—

Restructuring expense
 
668

 
1,304

 
1,972

Cash payments
 
—

 
(29
)
 
(29
)
Restructuring liability, end of period
 
668

 
1,275

 
1,943


NOTE 18 FAIR VALUE OF FINANCIAL INSTRUMENTS
Fair value amounts represent estimates of the consideration that would currently be agreed upon between knowledgeable, willing parties who are under no compulsion to act. Fair value is best evidenced by quoted bid or ask price, as appropriate, in an active market. Where bid or ask prices are not available, such as in an illiquid or inactive market, the closing price of the most recent transaction of that instrument subject to appropriate adjustments as required is used. Where quoted market prices are not available, the quoted prices of similar financial instruments or valuation models with observable market based inputs are used to estimate the fair value. These valuation models may use multiple observable market inputs, including observable interest rates, foreign exchange rates, index levels, credit spreads, equity prices, counterparty credit quality, corresponding market volatility levels and option volatilities. Minimal management judgment is required for fair values calculated using quoted market prices or observable market inputs for models. Greater subjectivity is required when making valuation adjustments for financial instruments in inactive markets or when using models where observable parameters do not exist. Also, the calculation of estimated fair value is based on market conditions at a specific point in time and may not be reflective of future fair values. For the Company's financial instruments carried at cost or amortized cost, the book value is not adjusted to reflect increases or decreases in fair value due to market fluctuations, including those due to interest rate changes, as it is the Company's intention to hold them until there is a recovery of fair value, which may be to maturity.


 
20
 
KINGSWAY FINANCIAL SERVICES INC.
Notes to Consolidated Financial Statements (Unaudited) September 30, 2012


The Company classifies its investments in fixed maturities and equity investments as available-for-sale and reports these investments at fair value. The Company's LROC preferred units, senior unsecured debentures and subordinated debt are measured and reported at fair value.
Fair values of equity investments are considered to approximate quoted market values based on the latest bid prices in active markets. Fair values of fixed maturities for which no active market exists are derived from quoted market prices of similar instruments or other third-party evidence.
The fair value of the LROC preferred units is based on quoted market prices, and the fair value of the subordinated debt is estimated using an internal model based on significant market observable inputs. The fair values of senior unsecured debentures, for which no active market exists, are derived from quoted market prices of similar instruments or other third-party evidence.
The Company employs a fair value hierarchy to categorize the inputs it uses in valuation techniques to measure the fair value. The extent of use of quoted market prices (Level 1), valuation models using observable market information (Level 2) and internal models without observable market information (Level 3) in the valuation of the Company's financial assets and liabilities measured at fair value on a recurring basis as of September 30, 2012 and December 31, 2011 was as follows:
(in thousands)
 
 
 
 
 
September 30, 2012
 
 
 
 
 
Fair Value Measurements at the End of the Reporting Period Using
 
 
 
 
 
 
 
 
 
 
 
Total

 
Quoted Prices in Active Markets for Identical Assets(Level 1)

 
Significant Other Observable Inputs (Level 2)

 
Significant Unobservable Inputs (Level 3)

Recurring fair value measurements
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Assets:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Fixed maturities:
 
 
 
 
 
 
 
 
U.S. government, government agencies and authorities
 
$
29,079

 
$
—

 
$
29,079

 
$
—

Canadian government
 
3,861

 
—

 
3,861

 
—

States municipalities and political subdivisions
 
7,360

 
—

 
7,360

 
—

Mortgage-backed
 
5,491

 
—

 
5,491

 
—

Asset-backed securities and collateralized mortgage obligations
 
1,340

 
—

 
1,340

 
—

Corporate
 
43,037

 
—

 
43,037

 
—

Total fixed maturities
 
$
90,168

 
$
—

 
$
90,168

 
$
—

 
 
 
 
 
 
 
 
 
Equity securities
 
2,350

 
2,350

 
—

 
—

Short-term investments
 
335

 
—

 
335

 
—

Total assets
 
$
92,853

 
$
2,350

 
$
90,503

 
$
—

 
 
 
 
 
 
 
 
 
Liabilities:
 
 
 
 
 
 
 
 
LROC preferred units
 
$
13,987

 
$
13,987

 
$
—