Edgar Filing: KINGSWAY FINANCIAL SERVICES INC

10Q Q2 2015

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 Quarterly Period Ended June 30, 2015
or
o	TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the Transition Period from _____ to _____

Commission File Number: 001-15204

Kingsway Financial Services Inc.

(Exact name of registrant as specified in its charter)

_________________________



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 August 6, 2015 was 19,709,706.



KINGSWAY FINANCIAL SERVICES INC.



Table Of Contents
PART I - FINANCIAL INFORMATION		3
ITEM 1. FINANCIAL STATEMENTS		3
Consolidated Balance Sheets as of June 30, 2015 (unaudited) and December 31, 2014		3
Consolidated Statements of Operations for the Three and Six Months Ended June 30, 2015 and 2014 (unaudited)		4
Consolidated Statements of Comprehensive Income (Loss) for the Three and Six Months Ended June 30, 2015 and 2014 (unaudited)		5
Consolidated Statements of Cash Flows for the Six Months Ended June 30, 2015 and 2014 (unaudited)		6
Notes to Consolidated Financial Statements (unaudited)		7
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS		33
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK		44
ITEM 4. CONTROLS AND PROCEDURES		44
PART II - OTHER INFORMATION		45
ITEM 1. LEGAL PROCEEDINGS		45
ITEM 1A. RISK FACTORS		45
ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS		45
ITEM 3. DEFAULTS UPON SENIOR SECURITIES		45
ITEM 4. MINE SAFETY DISCLOSURES		45
ITEM 5. OTHER INFORMATION		45
ITEM 6. EXHIBITS		46
SIGNATURES		47



	2



KINGSWAY FINANCIAL SERVICES INC.

PART I. FINANCIAL INFORMATION

Item 1. Financial Statements

Consolidated Balance Sheets

(in thousands, except per share data)



	June 30, 2015			December 31, 2014
	(unaudited)
Assets
Investments:
Fixed maturities, at fair value (amortized cost of $58,403 and $56,000, respectively)	$	58,733		$	56,195
Equity investments, at fair value (cost of $21,346 and $16,579, respectively)	24,446			19,618
Limited liability investments	12,688			7,294
Other investments, at cost which approximates fair value	3,527			3,576
Short-term investments, at cost which approximates fair value	400			400
Total investments	99,794			87,083
Cash and cash equivalents	86,175			71,234
Investment in investee	1,904			2,115
Accrued investment income	703			141
Premiums receivable, net of allowance for doubtful accounts of $258 and $1,889, respectively	29,792			28,885
Service fee receivable, net of allowance for doubtful accounts of $247 and $247, respectively	1,115			964
Other receivables, net of allowance for doubtful accounts of $806 and $806, respectively	6,852			5,145
Reinsurance recoverable	1,505			3,652
Prepaid reinsurance premiums	91			8
Deferred acquisition costs, net	12,617			12,197
Income taxes recoverable	57			74
Property and equipment, net of accumulated depreciation of $12,261 and $15,751, respectively	5,795			5,975
Goodwill	10,078			10,078
Intangible assets, net of accumulated amortization of $5,395 and $4,765, respectively	15,350			15,980
Other assets	3,282			3,638
Assets held for sale	—			54,553
Total Assets	$	275,110		$	301,722
Liabilities and Shareholders' Equity

Liabilities:
Unpaid loss and loss adjustment expenses:
Property and casualty	$	58,219		$	63,895
Vehicle service agreements	2,975			2,975
Total unpaid loss and loss adjustment expenses	61,194			66,870
Unearned premiums	37,848			36,432
Reinsurance payable	557			525
LROC preferred units, at fair value	—			13,618
Subordinated debt, at fair value	42,324			40,659
Deferred income tax liability	2,880			2,837
Deferred service fees	34,696			35,096
Accrued expenses and other liabilities	40,728			35,836
Liabilities held for sale	—			21,653
Total Liabilities	220,227			253,526

Class A preferred stock, no par value; unlimited number authorized; 262,876 and 262,876 issued and outstanding at June 30, 2015 and December 31, 2014, respectively	6,377			6,330

Shareholders' Equity:
Common stock, no par value; unlimited number authorized; 19,709,706 and 19,709,706 issued and outstanding at June 30, 2015 and December 31, 2014, respectively	—			—
Additional paid-in capital	341,249			340,844
Accumulated deficit	(305,764		)	(312,050		)
Accumulated other comprehensive income	11,271			8,670
Shareholders' equity attributable to common shareholders	46,756			37,464
Noncontrolling interests in consolidated subsidiaries	1,750			4,402
Total Shareholders' Equity	48,506			41,866
Total Liabilities and Shareholders' Equity	$	275,110		$	301,722

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 June 30,						Six months ended June 30,
	2015			2014			2015			2014
Revenues:
Net premiums earned	$	30,200		$	28,755		$	59,230		$	60,675
Service fee and commission income	5,848			6,026			11,246			12,091
Net investment income	528			341			1,841			754
Net realized gains	53			5,091			53			5,130
Other-than-temporary impairment loss	—			—			(10		)	—
Other income	2,514			2,286			10,871			4,560
Total revenues	39,143			42,499			83,231			83,210
Operating expenses:
Loss and loss adjustment expenses	24,187			21,794			46,140			42,855
Commissions and premium taxes	5,799			5,532			11,546			12,085
Cost of services sold	1,058			937			1,721			1,793
General and administrative expenses	10,175			11,066			21,751			22,990
Amortization of intangible assets	313			409			630			823
Contingent consideration expense	110			267			254			534
Impairment of asset held for sale	—			1,180			—			1,180
Total operating expenses	41,642			41,185			82,042			82,260
Operating (loss) income	(2,499		)	1,314			1,189			950
Other expenses, net:
Interest expense	1,414			1,364			2,805			2,797
Foreign exchange losses (gains), net	760			(175		)	1,152			41
Loss on change in fair value of debt	1,228			7,799			967			7,236
Loss on disposal of subsidiary	—			—			—			1,242
Loss on deconsolidation of subsidiary	4,420			—			4,420			—
Equity in net loss of investee	71			—			207			—
Total other expenses, net	7,893			8,988			9,551			11,316
Loss from continuing operations before income tax expense (benefit)	(10,392		)	(7,674		)	(8,362		)	(10,366		)
Income tax expense (benefit)	34			(1,059		)	56			(999		)
Loss from continuing operations	(10,426		)	(6,615		)	(8,418		)	(9,367		)
Income from discontinued operations, net of taxes	—			1,141			1,426			2,887
Gain on disposal of discontinued operations, net of taxes	11,259			—			11,259			—
Net income (loss)	833			(5,474		)	4,267			(6,480		)
Less: net (loss) income attributable to noncontrolling interests in consolidated subsidiaries	(1,064		)	(558		)	160			95
Less: dividends on preferred stock	82			82			163			135
Net income (loss) attributable to common shareholders	$	1,815		$	(4,998	)	$	3,944		$	(6,710	)
Loss per share - continuing operations:
Basic:	$	(0.48	)	$	(0.37	)	$	(0.44	)	$	(0.58	)
Diluted:	$	(0.48	)	$	(0.37	)	$	(0.44	)	$	(0.58	)
Earnings per share - discontinued operations:
Basic:	$	0.57		$	0.07		$	0.64		$	0.18
Diluted:	$	0.57		$	0.07		$	0.64		$	0.18
Earnings (loss) per share – net income (loss) attributable to common shareholders:
Basic:	$	0.09		$	(0.30	)	$	0.20		$	(0.41	)
Diluted:	$	0.09		$	(0.30	)	$	0.20		$	(0.41	)
Weighted average shares outstanding (in ‘000s):
Basic:	19,710			16,430			19,710			16,430
Diluted:	19,710			16,430			19,710			16,430

See accompanying notes to unaudited consolidated financial statements.



	4



KINGSWAY FINANCIAL SERVICES INC.

Consolidated Statements of Comprehensive Income (Loss)

(in thousands)

(Unaudited)



	Three months ended June 30,						Six months ended June 30,
	2015			2014			2015			2014

Net income (loss)	$	833		$	(5,474	)	$	4,267		$	(6,480	)
Other comprehensive income (loss), net of taxes⁽¹⁾:
Unrealized (losses) gains on fixed maturities and equity investments:
Unrealized losses arising during the period	(1,068		)	(1,906		)	(1,268		)	(680		)
Reclassification adjustment for amounts included in net income (loss)	1,451			1,287			1,464			1,339
Foreign currency translation adjustments	719			3			693			(15		)
Recognition of currency translation loss on deconsolidation of subsidiary	1,243			—			1,243			—
Other comprehensive income (loss)	2,345			(616		)	2,132			644
Comprehensive income (loss)	3,178			(6,090		)	$	6,399		$	(5,836	)
Less: comprehensive loss attributable to noncontrolling interests in consolidated subsidiaries	(1,237		)	(568		)	(310		)	(27		)
Comprehensive income (loss) attributable to common shareholders	$	4,415		$	(5,522	)	$	6,709		$	(5,809	)
(1) Net of income tax expense of $0 and $0 for the three and six months ended June 30, 2015 and June 30, 2014, respectively.

See accompanying notes to unaudited consolidated financial statements



	5



KINGSWAY FINANCIAL SERVICES INC.

Consolidated Statements of Cash Flows

(in thousands)

(Unaudited)



	Six months ended June 30,
	2015			2014
Cash provided by (used in):
Operating activities:
Net income (loss)	$	4,267		$	(6,480	)
Adjustments to reconcile net income (loss) to net cash used in operating activities:
Gain on disposal of discontinued operations	(11,259		)	—
Equity in net loss of investee	207			—
Equity in net income of limited liability investments	(995		)	(25		)
Depreciation and amortization expense	954			1,287
Contingent consideration expense	254			534
Stock based compensation expense, net of forfeitures	405			828
Net realized gains	(53		)	(5,130		)
Loss on change in fair value of debt	967			7,236
Deferred income taxes	43			219
Other-than-temporary impairment loss	10			—
Amortization of fixed maturities premiums and discounts	164			377
Loss on disposal of subsidiary	—			1,242
Impairment of asset held for sale	—			1,180
Changes in operating assets and liabilities:
Premiums and service fee receivable	(1,058		)	1,856
Other receivables	(1,707		)	(5,450		)
Reinsurance recoverable	2,147			4,483
Prepaid reinsurance premiums	(83		)	6,714
Deferred acquisition costs, net	(420		)	(233		)
Income taxes recoverable	17			—
Unpaid loss and loss adjustment expenses	(5,676		)	(11,952		)
Unearned premiums	1,416			(10,401		)
Reinsurance payable	32			(937		)
Deferred service fees	(400		)	977
Other, net	3,185			(850		)
Net cash used in operating activities	(7,583		)	(14,525		)
Investing activities:
Proceeds from sales and maturities of fixed maturities	18,861			11,210
Proceeds from sales of equity investments	307			5,703
Purchases of fixed maturities	(19,727		)	(12,368		)
Purchases of equity investments	(4,281		)	(9,430		)
Net acquisition of limited liability investments	(4,495		)	(2,494		)
Proceeds from other investments	—			1,000
Net proceeds from (purchases of) short-term investments	4			(103		)
Net proceeds from sale of discontinued operations	44,919			—
Net purchases of property and equipment	(144		)	(1,485		)
Net cash provided by (used in) investing activities	35,444			(7,967		)
Financing activities:
Proceeds from issuance of preferred stock, net	—			6,343
Redemption of LROC preferred units	(12,920		)	—
Redemption of senior unsecured debentures	—			(14,356		)
Net cash used in financing activities	(12,920		)	(8,013		)
Net increase (decrease) in cash and cash equivalents	14,941			(30,505		)
Cash and cash equivalents at beginning of period	71,234			97,505
Cash and cash equivalents at end of period	$	86,175		$	67,000

See accompanying notes to unaudited consolidated financial statements.



	6



KINGSWAY FINANCIAL SERVICES INC. Notes to Consolidated Financial Statements (Unaudited) June 30, 2015

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 Canadian holding company with operating subsidiaries located in the United States. The Company operates as a merchant bank primarily 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 ("2014 Annual Report") for the year ended December 31, 2014.

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 income taxes; valuation of intangible assets; goodwill recoverability; deferred acquisition costs; fair value assumptions for performance shares; fair value assumptions for debt obligations; and contingent consideration.

The fair values of the Company's investments in fixed maturities and equity investments, performance shares, LROC preferred units, subordinated debt and contingent consideration are estimated using a fair value hierarchy to categorize the inputs it uses in valuation techniques. The fair value of the Company's investment in investee is based on quoted market prices. Fair values for other investments approximate their unpaid principal balance. The carrying amounts reported in the consolidated balance sheets approximate fair values for cash, 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 2014 Annual Report, except as disclosed below.

Derivative financial instruments

Derivative financial instruments include investments in warrants and performance shares issued to the Company under various performance share grant agreements. Refer to Note 20, "Related Party Transactions," for further details regarding the performance shares. Warrants are classified as equity investments in the consolidated balance sheets.

The Company measures derivative financial instruments at fair value. The fair value of derivative financial instruments is required to be revalued each reporting period, with corresponding changes in fair value recorded in the consolidated statements of operations, or, in the case of warrants that are actively traded, in other comprehensive income (loss). Realized gains or losses are recognized upon settlement of the contracts.



	7



KINGSWAY FINANCIAL SERVICES INC. Notes to Consolidated Financial Statements (Unaudited) June 30, 2015

NOTE 4 RECENTLY ISSUED ACCOUNTING STANDARDS

(a) Adoption of New Accounting Standards:

In July 2013, the Financial Accounting Standards Board ("FASB") issued Accounting Standards Update ("ASU") 2013-11, Presentation of an Unrecognized Tax Benefit When a Net Operating Loss Carryforward, a Similar Tax Loss, or a Tax Credit Carryforward Exists ("ASU 2013-11"). ASU 2013-11 amends Accounting Standards Codification Topic 740, Income Taxes, to provide guidance and reduce diversity in practice on the financial statement presentation of an unrecognized tax benefit when a net operating loss carryforward, a similar tax loss, or a tax credit carryforward exists. Effective January 1, 2014, the Company adopted ASU 2013-11. Except for the new disclosure requirements, the adoption of the standard did not have an impact on the consolidated financial statements.

In April 2014, the FASB issued ASU 2014-08, Presentation of Financial Statements (Topic 205) and Property, Plant, and Equipment (Topic 360): Reporting Discontinued Operations and Disclosures of Disposals of Components of an Entity ("ASU 2014-08"). ASU 2014-08 amends the requirements for reporting and disclosing discontinued operations. Under ASU 2014-08, a disposal of a component of an entity or a group of components of an entity is required to be reported in discontinued operations if the disposal represents a strategic shift that has or will have a major effect on the entity’s operations and financial results. Effective January 1, 2015, the Company adopted ASU 2014-08. The adoption of the standard did not have an impact on the consolidated financial statements.

(b) Accounting Standards Not Yet Adopted:

In May 2014, the FASB issued ASU 2014-09, Revenue from Contracts with Customers ("ASU 2014-09"), which outlines a single comprehensive model for entities to use in accounting for revenue arising from contracts with customers. The core principle of ASU 2014-09 is that an entity recognizes revenue to depict the transfer of promised goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services. ASU 2014-09 is effective for reporting periods beginning after December 15, 2017 and early adoption is not permitted. Insurance contracts are not within the scope of ASU 2014-09, therefore this standard would not apply to the Company's Insurance Underwriting segment. The Company is currently evaluating the impact of the adoption of ASU 2014-09 on its consolidated financial statements.

In May 2015, the FASB issued ASU 2015-09, Financial Services - Insurance ("ASU 2015-09"). ASU 2015-09 was issued to enhance disclosures about an entity’s insurance liabilities, including the nature, amount, timing and uncertainty of cash flows related to those liabilities. ASU 2015-09 is effective for annual reporting periods beginning after December 15, 2015 and for interim periods beginning after December 15, 2016. Early adoption is permitted. Except for the increased disclosure requirements, the Company does not believe the adoption will have a material effect on its consolidated financial statements.

NOTE 5 DISPOSITION, DECONSOLIDATION AND DISCONTINUED OPERATIONS

(a) Disposition

Effective March 31, 2014, the Company's wholly owned subsidiary, 1347 Property Insurance Holdings, Inc. ("PIH"), formerly known as Maison Insurance Holdings, Inc., completed an initial public offering of its common stock. Total consideration to the Company as a result of this transaction was $7.7 million, consisting of a 28.7% interest in the common shares of PIH. As a result of the disposal, the Company recognized a loss of $1.2 million during the first quarter of 2014. The earnings of PIH are included in the unaudited consolidated statements of operations through the March 31, 2014 transaction date. At March 31, 2014, the Company's investment in the common stock of PIH was reported as investment in investee in the consolidated balance sheets.

During the second quarter of 2014, PIH announced the closing and settlement of an underwritten public offering of 2,875,000 shares of its common stock at a price to the public of $8.00 per share. As a result of the issuance of additional shares of common stock, the Company's approximate voting percentage in PIH was reduced to 15.7% at June 30, 2014. As a result of this change in ownership and other qualitative factors, the Company determined that its investment in the common stock of PIH no longer qualified for the equity method of accounting. During the fourth quarter of 2014, the Company purchased additional shares of PIH which increased the Company's approximate voting percentage in PIH to 16.9% at December 31, 2014. The Company's investment in PIH common stock is included in equity investments and reported at its estimated fair value of $8.8 million in the consolidated balance sheet at June 30, 2015.



	8



KINGSWAY FINANCIAL SERVICES INC. Notes to Consolidated Financial Statements (Unaudited) June 30, 2015

(b) Deconsolidation

On July 14, 2005, Kingsway Linked Return of Capital Trust ("KLROC Trust") completed its public offering of C$78.0 million million through the issuance of 3,120,000 LROC 5% preferred units due June 30, 2015 (“LROC preferred units”), of which the Company was a promoter. KLROC Trust’s net proceeds of the public offering was C$74.1 million.

Beginning in 2009, the Company began purchasing LROC preferred units. During 2009, the Company acquired 833,715 LROC preferred units. During the second quarter of 2010, the Company commenced the take-over bid (the “KLROC Offer”) to acquire up to 1,500,000 units at a price per unit of C$20.00 in cash. The KLROC Offer expired on July 23, 2010, and 1,525,150 units were tendered, of which 1,500,000 were purchased on a pro-rata basis. The tender was paid for using available cash.

As a result of these acquisitions, the Company beneficially owned and controlled 2,333,715 units, representing 74.8% of the issued and outstanding LROC preferred units and began consolidating the financial statements of KLROC Trust effective July 23, 2010. In the consolidated financial statements, the par value of the units owned was netted against the liability related to the LROC preferred units due June 30, 2015. At December 31, 2014, the Company's outstanding net obligation was C$15.8 million.

During the second quarter of 2015, the Company's controlling interest in KLROC Trust was reduced to zero upon the Company's repayment of its C$15.8 million outstanding on its LROC preferred units due June 30, 2015. As a result, the Company recorded a non-cash loss on deconsolidation of KLROC Trust of $4.4 million. This reported loss results from removing the net assets and accumulated other comprehensive loss of KLROC Trust from the Company’s consolidated balance sheets. The deconsolidation reduced consolidated shareholders’ equity by $2.8 million at June 30, 2015.

On April 1, 2015, the Company closed on the sale of its subsidiary, Assigned Risk Solutions Ltd. ("ARS") for $47.0 million in cash. During the second quarter of 2015, the Company received additional post-closing cash consideration of $2.0 million. The terms of the sale also provide for potential future earnout payments to the Company equal to 1.25% of ARS' written premium and fee income during the earnout periods. The earnout payments are payable in three annual installments beginning in April 2016 through April 2018. As a result of the sale, ARS, previously disclosed as part of the Insurance Services segment, has been classified as a discontinued operation. The earnings of ARS are disclosed as discontinued operations in the consolidated statements of operations for all periods presented. Summary financial information included in income from discontinued operations, net of taxes for the three and six months ended June 30, 2015 and 2014 is presented below:



(in thousands)	Three months ended June 30,					Six months ended June 30,
	2015			2014		2015			2014
Revenues:
Service fee and commission income	$	—		$	7,900	$	8,342		$	16,559
Other income (expense)	—			7		(20		)	21
Total revenues	—			7,907		8,322			16,580
Expenses:
General and administrative expenses	—			6,505		6,462			13,126
Income from discontinued operations before income tax expense	—			1,402		1,860			3,454
Income tax expense	—			261		434			567
Income from discontinued operations, net of taxes	—			1,141		1,426			2,887
Gain on disposal of discontinued operations before income tax benefit	11,010			—		11,010			—
Income tax benefit	(249		)	—		(249		)	—
Gain on disposal of discontinued operations, net of taxes	11,259			—		11,259			—
Total gain from discontinued operations, net of taxes	$	11,259		$	1,141	$	12,685		$	2,887



	9



KINGSWAY FINANCIAL SERVICES INC. Notes to Consolidated Financial Statements (Unaudited) June 30, 2015

At December 31, 2014, the assets and liabilities of ARS are presented as held for sale in the consolidated balance sheets. The carrying amounts of the major classes of assets and liabilities of ARS at December 31, 2014 were as follows:



(in thousands)	December 31, 2014

Assets
Cash and cash equivalents	$	2,792
Service fee receivable	19,006
Other receivables	257
Income taxes recoverable	150
Property and equipment, net of accumulated depreciation	193
Goodwill	510
Intangible assets, net of accumulated amortization	31,318
Other assets	327
Assets held for sale	$	54,553
Liabilities
Deferred income tax liability	$	2,550
Deferred service fees	14,358
Accrued expenses and other liabilities	4,745
Liabilities held for sale	$	21,653

For the six months ended June 30, 2015 and June 30, 2014, ARS' net cash used in operating activities was $0.0 million and $0.6 million, respectively. ARS had no cash flows from investing activities for the six months ended June 30, 2015 and June 30, 2014.



	10



KINGSWAY FINANCIAL SERVICES INC. Notes to Consolidated Financial Statements (Unaudited) June 30, 2015

NOTE 6 INVESTMENTS

The amortized cost, gross unrealized gains and losses, and estimated fair value of the Company's investments in fixed maturities and equity investments at June 30, 2015 and December 31, 2014 are summarized in the tables shown below:



(in thousands)	June 30, 2015
	Amortized Cost		Gross Unrealized Gains		Gross Unrealized Losses		Estimated Fair Value
Fixed maturities:
U.S. government, government agencies and authorities	$	21,081	$	214	$	29	$	21,266
States, municipalities and political subdivisions	3,357		43		—		3,400
Mortgage-backed	7,966		48		32		7,982
Asset-backed securities and collateralized mortgage obligations	6,431		7		2		6,436
Corporate	19,568		101		20		19,649
Total fixed maturities	58,403		413		83		58,733
Equity investments:
Common stock	20,141		3,865		930		23,076
Warrants	1,205		217		52		1,370
Total equity investments	21,346		4,082		982		24,446
Total fixed maturities and equity investments	$	79,749	$	4,495	$	1,065	$	83,179



(in thousands)	December 31, 2014
	Amortized Cost		Gross Unrealized Gains		Gross Unrealized Losses		Estimated Fair Value
Fixed maturities:
U.S. government, government agencies and authorities	$	20,436	$	333	$	10	$	20,759
Canadian government	4,519		—		277		4,242
States, municipalities and political subdivisions	3,358		61		—		3,419
Mortgage-backed	5,330		37		15		5,352
Asset-backed securities and collateralized mortgage obligations	7,221		3		10		7,214
Corporate	15,136		103		30		15,209
Total fixed maturities	56,000		537		342		56,195
Equity investments:
Common stock	16,450		3,360		284		19,526
Warrants	129		—		37		92
Total equity investments	16,579		3,360		321		19,618
Total fixed maturities and equity investments	$	72,579	$	3,897	$	663	$	75,813



	11



KINGSWAY FINANCIAL SERVICES INC. Notes to Consolidated Financial Statements (Unaudited) June 30, 2015

The table below summarizes the Company's fixed maturities at June 30, 2015 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)	June 30, 2015
	Amortized Cost		Estimated Fair Value
Due in one year or less	$	9,663	$	9,855
Due after one year through five years	39,158		39,277
Due after five years through ten years	2,399		2,414
Due after ten years	7,183		7,187
Total	$	58,403	$	58,733

The following tables highlight the aggregate unrealized loss position, by security type, of fixed maturities and equity investments in unrealized loss positions as of June 30, 2015 and December 31, 2014. The tables segregate the holdings based on the period of time the investments have been continuously held in unrealized loss positions.



(in thousands)									June 30, 2015
	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	$	7,276	$	29	$	—	$	—	$	7,276	$	29
Mortgage-backed	4,398		32		—		—		4,398		32
Asset-backed securities and collateralized mortgage obligations	3,343		2		—		—		3,343		2
Corporate	6,557		20		—		—		6,557		20
Total fixed maturities	21,574		83		—		—		21,574		83
Equity investments:
Common stock	4,559		930		—		—		4,559		930
Warrants	73		52		—		—		73		52
Total equity investments	4,632		982		—		—		4,632		982
Total	$	26,206	$	1,065	$	—	$	—	$	26,206	$	1,065



	12



KINGSWAY FINANCIAL SERVICES INC. Notes to Consolidated Financial Statements (Unaudited) June 30, 2015



(in thousands)									December 31, 2014
	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	$	12,784	$	10	$	473	$	—	$	13,257	$	10
Canadian government	—		—		4,242		277		4,242		277
States, municipalities and political subdivisions	250		—		—		—		250		—
Mortgage-backed	2,816		15		—		—		2,816		15
Asset-backed securities and collateralized mortgage obligations	5,097		10		—		—		5,097		10
Corporate	6,226		20		—		10		6,226		30
Total fixed maturities	27,173		55		4,715		287		31,888		342
Equity investments:
Common stock	4,164		284		—		—		4,164		284
Warrants	92		37		—		—		92		37
Total equity investments	4,256		321		—		—		4,256		321
Total	$	31,429	$	376	$	4,715	$	287	$	36,144	$	663

Fixed maturities and equity investments contain approximately 85 and 71 individual investments that were in unrealized loss positions as of June 30, 2015 and December 31, 2014, respectively.

The establishment of an other-than-temporary impairment on an investment requires a number of judgments and estimates. The Company performs a quarterly analysis of the individual investments to determine if declines in market value are other-than-temporary. The analysis includes some or all of the following procedures as deemed appropriate by the Company:


•	identifying all unrealized loss positions that have existed for at least six months;


•	identifying other circumstances which management believes may impact the recoverability of the unrealized loss positions;


•	obtaining a valuation analysis from third-party investment managers regarding the intrinsic value of these investments based on their knowledge and experience together with market-based valuation techniques;


•	reviewing the trading range of certain investments over the preceding calendar period;


•	assessing if declines in market value are other-than-temporary for debt instruments based on the investment grade credit ratings from third-party rating agencies;


•	assessing if declines in market value are other-than-temporary for any debt instrument with a non-investment grade credit rating based on the continuity of its debt service record;


•	determining the necessary provision for declines in market value that are considered other-than-temporary based on the analyses performed; and


•	assessing the Company's ability and intent to hold these investments at least until the investment impairment is recovered.

The risks and uncertainties inherent in the assessment methodology used to determine declines in market value that are other-than-temporary include, but may not be limited to, the following:


•	the opinions of professional investment managers could be incorrect;


•	the past trading patterns of individual investments may not reflect future valuation trends;


•	the credit ratings assigned by independent credit rating agencies may be incorrect due to unforeseen or unknown facts related to a company's financial situation; and


•	the debt service pattern of non-investment grade instruments may not reflect future debt service capabilities and may not reflect a company's unknown underlying financial problems.



	13



KINGSWAY FINANCIAL SERVICES INC. Notes to Consolidated Financial Statements (Unaudited) June 30, 2015

As a result of the analysis performed by the Company to determine declines in market value that are other-than-temporary, the Company recorded a write-down for other-than-temporary impairment related to fixed maturities of $0.0 million for the six months ended June 30, 2015. There were no write-downs for other-than-temporary impairments related to (1) fixed maturities for the three months ended June 30, 2015; (2) equity investments or other investments for the three and six months ended June 30, 2015; or (3) investments for the three and six months ended June 30, 2014.

There were $0.0 million of other-than-temporary losses recognized in other comprehensive income (loss) for the six months ended June 30, 2015. There were no other-than-temporary losses recognized in other comprehensive income (loss) for the three months ended June 30, 2015 and June 30, 2014, respectively, or for the six months ended June 30, 2014.

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 limited partnerships that primarily invest in income-producing real estate or real estate related investments. The Company's interests in these investments are not deemed minor and, therefore, are accounted for under the equity method of accounting. As of June 30, 2015 and December 31, 2014, the carrying value of limited liability investments totaled $12.7 million and $7.3 million, respectively. At June 30, 2015, the Company has unfunded commitments totaling $2.4 million to fund limited liability investments. Income from limited liability investments is recognized based on the Company's share of the earnings of the limited liability entities and is included in net investment income.

Other investments include mortgage loans and are reported at their unpaid principal balance. As of June 30, 2015 and December 31, 2014, the carrying value of other investments totaled $3.5 million and $3.6 million, respectively.

Gross realized gains and losses on fixed maturities, equity investments and limited liability investments for the three and six months ended June 30, 2015 and June 30, 2014 were as follows:



(in thousands)	Three months ended June 30,				Six months ended June 30,
	2015		2014		2015		2014
Gross realized gains	$	53	$	5,091	$	53	$	5,139
Gross realized losses	—		—		—		(9		)
Net realized gains	$	53	$	5,091	$	53	$	5,130

Net investment income for the three and six months ended June 30, 2015 and June 30, 2014, respectively, is comprised as follows:



(in thousands)	Three months ended June 30,						Six months ended June 30,
	2015			2014			2015			2014
Investment income
Interest from fixed maturities	$	124		$	271		$	393		$	543
Dividends	201			54			348			86
Income from limited liability investments	66			3			995			25
Gain on change in fair value of warrants	165			—			165			—
Other	32			86			66			228
Gross investment income	588			414			1,967			882
Investment expenses	(60		)	(73		)	(126		)	(128		)
Net investment income	$	528		$	341		$	1,841		$	754

At June 30, 2015, fixed maturities and short-term investments with an estimated fair value of $13.0 million were on deposit with state and provincial regulatory authorities. Also, from time to time, the Company pledges investments to third-parties to collateralize liabilities incurred under its policies of insurance. At June 30, 2015, the amount of such pledged securities was $16.5 million.



	14



KINGSWAY FINANCIAL SERVICES INC. Notes to Consolidated Financial Statements (Unaudited) June 30, 2015

NOTE 7 INVESTMENT IN INVESTEE

Investment in investee includes the Company's investment in the common stock and private units of 1347 Capital Corp. and is accounted for under the equity method. 1347 Capital Corp. was formed for the purpose of entering into a merger, share exchange, asset acquisition or other similar business combination with one or more businesses or entities. The carrying value, estimated fair value and approximate equity percentage for the Company's investment in 1347 Capital Corp. at June 30, 2015 and December 31, 2014 were as follows:



(in thousands, except for percentages)
	June 30, 2015						December 31, 2014
	Equity Percentage		Estimated Fair Value		Carrying Value		Equity Percentage		Estimated Fair Value		Carrying value
1347 Capital Corp.	21.0	%		$12,290	$	1,904	22.7	%		$13,038	$	2,115

Equity in net loss of investee was $0.1 million and zero for the three months ended June 30, 2015 and June 30, 2014, respectively ($0.2 million and zero for the six months ended June 30, 2015 and June 30, 2014, respectively).

NOTE 8 DEFERRED ACQUISITION COSTS

Policy acquisition costs consist primarily of commissions, premium taxes, and underwriting and agency expenses, net of ceding commission income, incurred related to successful efforts to acquire new or renewal insurance contracts and vehicle service agreements. Acquisition costs deferred on both property and casualty insurance products and vehicle service agreements are amortized over the period in which the related revenues are earned.

The components of deferred acquisition costs and the related amortization expense for the three and six months ended June 30, 2015 and 2014, respectively, are comprised as follows:



(in thousands)	Three months ended June 30,						Six months ended June 30,
	2015			2014			2015			2014
Beginning balance, net	$	13,203		$	12,559		$	12,197		$	12,392
Additions	6,164			6,827			13,718			14,101
Amortization	(6,750		)	(6,761		)	(13,298		)	(12,825		)
Acquisition costs disposed of during the year related to PIH	—			—			—			(1,043		)
Balance at June 30, net	$	12,617		$	12,625		$	12,617		$	12,625

NOTE 9 INTANGIBLE ASSETS

Intangible assets are comprised as follows:



(in thousands)			June 30, 2015
	Gross Carrying Value			Accumulated Amortization		Net Carrying Value
Intangible assets subject to amortization
Database	$	4,918		$	1,291	$	3,627
Vehicle service agreements in-force	3,680			3,169		511
Customer-related relationships	3,611			875		2,736
Non-compete agreement	70			60		10
Intangible assets not subject to amortization
Insurance licenses	7,803			—		7,803
Trade name	663			—		663
Total	$	20,745		$	5,395	$	15,350



	15



KINGSWAY FINANCIAL SERVICES INC. Notes to Consolidated Financial Statements (Unaudited) June 30, 2015



(in thousands)			December 31, 2014
	Gross Carrying Value			Accumulated Amortization		Net Carrying Value
Intangible assets subject to amortization
Database	$	4,918		$	1,045	$	3,873
Vehicle service agreements in-force	3,680			2,975		705
Customer-related relationships	3,611			695		2,916
Non-compete agreement	70			50		20
Intangible assets not subject to amortization
Insurance licenses	7,803			—		7,803
Trade name	663			—		663
Total	$	20,745		$	4,765	$	15,980

The Company's intangible assets with definite useful lives are amortized either based on the pattern in which the economic benefits of the intangible asset are expected to be consumed or using the straight-line method over their estimated useful lives, which range from three to fifteen years. Amortization of intangible assets was $0.3 million and $0.4 million for the three months ended June 30, 2015 and June 30, 2014, respectively ($0.6 million and $0.8 million for the six months ended June 30, 2015 and June 30, 2014, respectively). The insurance licenses and trade name intangible assets have indefinite useful lives and are not amortized.

NOTE 10 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.

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.



	16



KINGSWAY FINANCIAL SERVICES INC. Notes to Consolidated Financial Statements (Unaudited) June 30, 2015

(a) Property and Casualty

The results of this comparison and the changes in the provision for property and casualty unpaid loss and loss adjustment expenses, net of amounts recoverable from reinsurers, as of June 30, 2015 and June 30, 2014 were as follows:



(in thousands)	June 30, 2015			June 30, 2014
Balance at beginning of period, gross	$	63,895		$	84,534
Less reinsurance recoverable related to property and casualty unpaid loss and loss adjustment expenses	3,203			7,942
Balance at beginning of period, net	60,692			76,592
Incurred related to:
Current year	43,610			40,286
Prior years	(484		)	(866		)
Paid related to:
Current year	(21,418		)	(19,961		)
Prior years	(26,009		)	(27,361		)
Disposal of unpaid loss and loss adjustment expenses related to PIH	—			(405		)
Balance at end of period, net	56,391			68,285
Plus reinsurance recoverable related to property and casualty unpaid loss and loss adjustment expenses	1,828			4,373
Balance at end of period, gross	$	58,219		$	72,658

(b) Vehicle Service Agreements

The results of the comparison and the changes in the provision for vehicle service agreement unpaid loss and loss adjustment expenses as of June 30, 2015 and June 30, 2014 were as follows:



(in thousands)	June 30, 2015			June 30, 2014
Balance at beginning of period	$	2,975		$	3,128
Incurred related to:
Current year	3,014			3,435
Prior years	—			—
Paid related to:
Current year	(2,904		)	(3,450		)
Prior years	(110		)	(61		)
Balance at end of period	$	2,975		$	3,052

NOTE 11 DEBT

Debt consists of the following instruments:



(in thousands)	June 30, 2015				December 31, 2014
	Principal		Fair Value		Principal		Fair Value
LROC preferred units due 2015	$	—	$	—	$	13,618	$	13,618
Subordinated debt	90,500		42,324		90,500		40,659
Total	$	90,500	$	42,324	$	104,118	$	54,277



	17



KINGSWAY FINANCIAL SERVICES INC. Notes to Consolidated Financial Statements (Unaudited) June 30, 2015

Subordinated debt 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

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 June 30, 2015 and December 31, 2014, deferred interest payable of $19.8 million and $17.4 million, respectively, is included in accrued expenses and other liabilities in the consolidated balance sheets.

During the second quarter of 2015, the Company repaid its C$15.8 million outstanding on its LROC preferred units due June 30, 2015.

During the first quarter of 2014, the Company repaid the $14.4 million remaining amount outstanding on its senior unsecured debentures due February 1, 2014. No debt repurchases were made during the three and six months ended June 30, 2015 and June 30, 2014.

NOTE 12 FINANCE LEASE OBLIGATION LIABILITY

On October 2, 2014, the Company completed a sale and leaseback transaction involving building and land located in Miami, Florida, which was previously recorded as asset held for sale. The transaction did not qualify for sales recognition and was accounted for as a financing due to the Company's continuing involvement with the property as a result of nonrecourse financing provided to the buyer in the form of prepaid rent. A finance lease obligation liability equal to the selling price of the property was established at the date of the transaction. During the five-year lease term, the Company will record interest expense on the finance lease obligation at its incremental borrowing rate and will increase the finance lease obligation liability by the same amount. At the end of the lease term, the Company will no longer have continuing involvement with the property and will then recognize the sale of the property as well as the gain that will result from removing the net book value of the land and building and finance lease obligation liability from the consolidated balance sheets. At June 30, 2015 and December 31, 2014, finance lease obligation liability of $4.8 million and $4.7 million, respectively, is included in accrued expenses and other liabilities in the consolidated balance sheets.



	18



KINGSWAY FINANCIAL SERVICES INC. Notes to Consolidated Financial Statements (Unaudited) June 30, 2015

NOTE 13 INCOME TAXES

Income tax expense (benefit) for the three and six months ended June 30, 2015 and June 30, 2014, respectively, varies from the amount that would result by applying the applicable United States corporate income tax rate of 34% to loss from continuing operations before income tax expense (benefit). The following table summarizes the differences:



(in thousands)	Three months ended June 30,						Six months ended June 30,
	2015			2014			2015			2014
Income tax benefit at United States statutory income tax rate	$	(3,533	)	$	(2,609	)	$	(2,843	)	$	(3,524	)
Valuation allowance	1,172			2,952			533			3,618
Deconsolidation of subsidiary	2,391			—			2,391			—
Change in unrecognized tax benefits	—			(1,082		)	—			(1,024		)
Non-taxable dividend income	9			(415		)	(415		)	(830		)
Foreign operations subject to different tax rates	33			142			155			272
State income tax (net of federal tax benefit)	8			(1		)	8			211
Disposition of subsidiary	—			—			—			422
Prior year tax	—			—			—			(341		)
Other	(46		)	(46		)	227			197
Income tax expense (benefit)	$	34		$	(1,059	)	$	56		$	(999	)

The Company maintains a valuation allowance for its gross deferred tax assets at June 30, 2015 and December 31, 2014. 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 June 30, 2015 and December 31, 2014 net deferred tax asset. The Company carries a deferred income tax liability of $2.9 million and $2.8 million at June 30, 2015 and December 31, 2014, respectively, all of which relates to indefinite life intangible assets.

As of June 30, 2015, 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 expense.



	19



KINGSWAY FINANCIAL SERVICES INC. Notes to Consolidated Financial Statements (Unaudited) June 30, 2015

NOTE 14 LOSS FROM CONTINUING OPERATIONS PER SHARE

The following table sets forth the reconciliation of numerators and denominators for the basic and diluted loss from continuing operations per share computation for the three and six months ended June 30, 2015 and June 30, 2014:



(in thousands, except per share data)	Three months ended June 30,						Six months ended June 30,
	2015			2014			2015			2014
Numerator:
Loss from continuing operations	$	(10,426	)	$	(6,615	)	$	(8,418	)	$	(9,367	)
Plus (less): net loss (income) attributable to noncontrolling interests	1,064			558			(160		)	(95		)
Less: dividends on preferred stock	(82		)	(82		)	(163		)