Document
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, 2016
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 x
Non-accelerated filer o
(Do not check if a smaller reporting company)
Smaller Reporting Company o

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 4, 2016 was 19,842,806.


KINGSWAY FINANCIAL SERVICES INC.

Table Of Contents
PART I - FINANCIAL INFORMATION
 
ITEM 1. FINANCIAL STATEMENTS
 
Consolidated Balance Sheets as of June 30, 2016 (unaudited) and December 31, 2015
 
Consolidated Statements of Operations for the Three and Six Months Ended June 30, 2016 and 2015 (unaudited)
 
Consolidated Statements of Comprehensive (Loss) Income for the Three and Six Months Ended June 30, 2016 and 2015 (unaudited)
 
Consolidated Statements of Cash Flows for the Six Months Ended June 30, 2016 and 2015 (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)
 
 
June 30, 2016

 
December 31, 2015

 
 
(unaudited)

 
 
Assets
 
 
 
 
Investments:
 
 
 
 
Fixed maturities, at fair value (amortized cost of $62,397 and $55,606, respectively)
 
$
63,003

 
$
55,559

Equity investments, at fair value (cost of $21,121 and $26,428, respectively)
 
21,508

 
27,559

Limited liability investments
 
21,768

 
20,141

Other investments, at cost which approximates fair value
 
5,435

 
4,077

Short-term investments, at cost which approximates fair value
 
670

 
400

Total investments
 
112,384

 
107,736

Cash and cash equivalents
 
39,887

 
51,701

Investments in investees
 
4,018

 
1,772

Accrued investment income
 
496

 
594

Premiums receivable, net of allowance for doubtful accounts of $135 and $165, respectively
 
31,915

 
27,090

Service fee receivable, net of allowance for doubtful accounts of $288 and $276, respectively
 
950

 
911

Other receivables, net of allowance for doubtful accounts of $806 and $806, respectively
 
3,107

 
3,789

Reinsurance recoverable
 
959

 
1,422

Prepaid reinsurance premiums
 
91

 
7

Deferred acquisition costs, net
 
13,824

 
12,143

Income taxes recoverable
 
66

 
61

Property and equipment, net of accumulated depreciation of $12,632 and $12,537, respectively
 
5,373

 
5,577

Goodwill
 
10,078

 
10,078

Intangible assets, net of accumulated amortization of $6,541 and $6,009, respectively
 
14,865

 
14,736

Other assets
 
3,124

 
3,405

Total Assets
 
$
241,137

 
$
241,022

Liabilities and Shareholders' Equity
 
 
 
 
 
 
 
 
 
Liabilities:
 
 
 
 
Unpaid loss and loss adjustment expenses:
 
 
 
 
Property and casualty
 
$
52,195

 
$
55,471

Vehicle service agreements
 
2,975

 
2,975

Total unpaid loss and loss adjustment expenses
 
55,170

 
58,446

Unearned premiums
 
41,122

 
35,234

Reinsurance payable
 
284

 
145

Subordinated debt, at fair value
 
36,302

 
39,898

Deferred income tax liability
 
2,968

 
2,924

Deferred service fees
 
35,999

 
34,319

Accrued expenses and other liabilities
 
20,456

 
19,959

Total Liabilities
 
192,301

 
190,925

 
 
 
 
 
Class A preferred stock, no par value; unlimited number authorized; 262,876 and 262,876 issued and outstanding at June 30, 2016 and December 31, 2015, respectively; redemption amount of $6,572
 
6,411

 
6,394

 
 
 
 
 
Shareholders' Equity:
 
 
 
 
Common stock, no par value; unlimited number authorized; 19,842,806 and 19,709,706 issued and outstanding at June 30, 2016 and December 31, 2015, respectively
 
—

 
—

Additional paid-in capital
 
342,864

 
341,646

Accumulated deficit
 
(311,292
)
 
(308,995
)
Accumulated other comprehensive income
 
9,500

 
9,300

Shareholders' equity attributable to common shareholders
 
41,072

 
41,951

Noncontrolling interests in consolidated subsidiaries
 
1,353

 
1,752

Total Shareholders' Equity
 
42,425

 
43,703

Total Liabilities and Shareholders' Equity
 
$
241,137

 
$
241,022

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,
 
 
 
2016

 
2015

 
2016

 
2015

Revenues:
 
 
 
 
 
 
 
 
Net premiums earned
 
$
31,813

 
$
30,200

 
$
61,240

 
$
59,230

Service fee and commission income
 
5,394

 
5,848

 
10,716

 
11,246

Net investment income
 
1,072

 
528

 
1,000

 
1,841

Net realized gains (losses)
 
67

 
53

 
(104
)
 
53

Other-than-temporary impairment loss
 
—

 
—

 
—

 
(10
)
Other income
 
2,791

 
2,514

 
5,165

 
10,871

Total revenues
 
41,137

 
39,143

 
78,017

 
83,231

Operating expenses:
 
 
 
 
 
 
 
 
Loss and loss adjustment expenses
 
24,838

 
24,187

 
48,335

 
46,140

Commissions and premium taxes
 
6,103

 
5,799

 
11,701

 
11,546

Cost of services sold
 
770

 
1,058

 
1,543

 
1,721

General and administrative expenses
 
10,826

 
10,175

 
20,377

 
21,751

Amortization of intangible assets
 
307

 
313

 
602

 
630

Contingent consideration (benefit) expense
 
(657
)
 
110

 
(657
)
 
254

Total operating expenses
 
42,187

 
41,642

 
81,901

 
82,042

Operating (loss) income
 
(1,050
)
 
(2,499
)
 
(3,884
)
 
1,189

Other expenses (revenues), net:
 
 
 
 
 
 
 
 
Interest expense
 
1,108

 
1,414

 
2,201

 
2,805

Foreign exchange losses, net
 
9

 
760

 
10

 
1,152

(Gain) loss on change in fair value of debt
 
(1,068
)
 
1,228

 
(3,596
)
 
967

Loss on deconsolidation of subsidiary
 
—

 
4,420

 
—

 
4,420

Equity in net loss of investee
 
874

 
71

 
943

 
207

Total other expenses (revenues), net
 
923

 
7,893

 
(442
)
 
9,551

Loss from continuing operations before income tax expense
 
(1,973
)
 
(10,392
)
 
(3,442
)
 
(8,362
)
Income tax expense
 
26

 
34

 
52

 
56

Loss from continuing operations
 
(1,999
)
 
(10,426
)
 
(3,494
)
 
(8,418
)
Income from discontinued operations, net of taxes
 
—

 
—

 
—

 
1,426

Gain on disposal of discontinued operations, net of taxes
 
1,124

 
11,259

 
1,124

 
11,259

Net (loss) income
 
(875
)
 
833

 
(2,370
)
 
4,267

Less: net (loss) income attributable to noncontrolling interests in consolidated subsidiaries
 
(361
)
 
(1,064
)
 
(400
)
 
160

Less: dividends on preferred stock
 
82

 
82

 
164

 
163

Net (loss) income attributable to common shareholders
 
$
(596
)
 
$
1,815

 
$
(2,134
)
 
$
3,944

Loss per share - continuing operations:
 
 
 
 
 
 
 
 
Basic:
 
$
(0.09
)
 
$
(0.48
)
 
$
(0.16
)
 
$
(0.44
)
Diluted:
 
$
(0.09
)
 
$
(0.48
)
 
$
(0.16
)
 
$
(0.44
)
Earnings per share - discontinued operations:
 
 
 
 
 
 
 
 
Basic:
 
$
0.06

 
$
0.57

 
$
0.06

 
$
0.64

Diluted:
 
$
0.06

 
$
0.57

 
$
0.06

 
$
0.64

(Loss) earnings per share – net (loss) income attributable to common shareholders:
 
 
 
 
 
 
 
 
Basic:
 
$
(0.03
)
 
$
0.09

 
$
(0.11
)
 
$
0.20

Diluted:
 
$
(0.03
)
 
$
0.09

 
$
(0.11
)
 
$
0.20

Weighted average shares outstanding (in ‘000s):
 
 
 
 
 
 
 
 
Basic:
 
19,818

 
19,710

 
19,764

 
19,710

Diluted:
 
19,818

 
19,710

 
19,764

 
19,710


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 June 30,
 
 
Six months ended June 30,
 
 
 
2016

 
2015

 
2016

 
2015

 
 
 
 
 
 
 
 
 
Net (loss) income
 
$
(875
)
 
$
833

 
$
(2,370
)
 
$
4,267

Other comprehensive income, net of taxes(1):
 
 
 
 
 
 
 
 
Unrealized gains (losses) on fixed maturities and equity investments:
 
 
 
 
 
 
 
 
Unrealized gains (losses) arising during the period
 
430

 
(1,068
)
 
705

 
(1,268
)
Reclassification adjustment for amounts included in net (loss) income
 
(73
)
 
1,451

 
(505
)
 
1,464

Foreign currency translation adjustments
 
—

 
719

 
—

 
693

Recognition of currency translation loss on deconsolidation of subsidiary
 
—

 
1,243

 
—

 
1,243

Other comprehensive income
 
357

 
2,345

 
200

 
2,132

Comprehensive (loss) income
 
(518
)
 
3,178

 
(2,170
)
 
6,399

Less: comprehensive loss attributable to noncontrolling interests in consolidated subsidiaries
 
(360
)
 
(1,237
)
 
(399
)
 
(310
)
Comprehensive (loss) income attributable to common shareholders
 
$
(158
)
 
$
4,415

 
$
(1,771
)
 
$
6,709

 (1) Net of income tax expense of $0 and $0 for the three and six months ended June 30, 2016 and June 30, 2015, 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,
 
 
 
2016

 
2015

Cash provided by (used in):
 
 
 
 
Operating activities:
 
 
 
 
Net (loss) income
 
$
(2,370
)
 
$
4,267

Adjustments to reconcile net (loss) income to net cash used in operating activities:
 
 
 
 
Gain on disposal of discontinued operations, net of taxes
 
(1,124
)
 
(11,259
)
Equity in net loss of investee
 
943

 
207

Equity in net income of limited liability investments
 
(310
)
 
(995
)
Depreciation and amortization expense
 
697

 
954

Contingent consideration (benefit) expense
 
(657
)
 
254

Stock-based compensation expense, net of forfeitures
 
474

 
405

Net realized losses (gains)
 
104

 
(53
)
(Gain) loss on change in fair value of debt
 
(3,596
)
 
967

Deferred income taxes
 
44

 
43

Other-than-temporary impairment loss
 
—

 
10

Amortization of fixed maturities premiums and discounts
 
133

 
164

Loss on deconsolidation of subsidiary
 
—

 
4,420

Changes in operating assets and liabilities:
 
 
 
 
Premiums and service fee receivable, net
 
(4,864
)
 
(1,058
)
Other receivables, net
 
682

 
(1,707
)
Reinsurance recoverable
 
463

 
2,147

Prepaid reinsurance premiums
 
(84
)
 
(83
)
Deferred acquisition costs, net
 
(1,681
)
 
(420
)
Income taxes recoverable
 
(5
)
 
17

Unpaid loss and loss adjustment expenses
 
(3,276
)
 
(5,676
)
Unearned premiums
 
5,888

 
1,416

Reinsurance payable
 
139

 
32

Deferred service fees
 
1,680

 
(400
)
Other, net
 
1,408

 
(1,235
)
Net cash used in operating activities
 
(5,312
)
 
(7,583
)
Investing activities:
 
 
 
 
Proceeds from sales and maturities of fixed maturities
 
13,349

 
18,861

Proceeds from sales of equity investments
 
3,721

 
307

Purchases of fixed maturities
 
(19,781
)
 
(19,727
)
Purchases of equity investments
 
(1,541
)
 
(4,281
)
Net acquisitions of limited liability investments
 
(1,017
)
 
(4,495
)
Net purchases of other investments
 
(1,357
)
 
—

Net (purchases of) proceeds from short-term investments
 
(533
)
 
4

Net proceeds from sale of discontinued operations
 
1,404

 
44,919

Net purchases of property and equipment and intangible assets
 
(622
)
 
(144
)
Net cash (used in) provided by investing activities
 
(6,377
)
 
35,444

Financing activities:
 
 
 
 
Repurchase of common stock for cancellation
 
(125
)
 
—

Redemption of LROC preferred units
 
—

 
(12,920
)
Net cash used in financing activities
 
(125
)
 
(12,920
)
Net (decrease) increase in cash and cash equivalents
 
(11,814
)
 
14,941

Cash and cash equivalents at beginning of period
 
51,701

 
71,234

Cash and cash equivalents at end of period
 
$
39,887

 
$
86,175

See accompanying notes to unaudited consolidated financial statements.

 
6
 
KINGSWAY FINANCIAL SERVICES INC.
Notes to Consolidated Financial Statements (Unaudited) June 30, 2016





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 ("2015 Annual Report") for the year ended December 31, 2015.
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 and impairment assessment 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, 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 investments in investees 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 2015 Annual Report. The Company has added the following significant account policy, effective beginning with the second quarter of 2016.
Revenue recognition:
Contingent revenue
The terms of the sale of one of the Company's subsidiaries includes potential receipt by the Company of future earnout payments. The gain related to the earnout payments is recorded when the consideration is determined to be realizable and is reported in the statements of operations as gain on disposal of discontinued operations, net of taxes.
NOTE 4 RECENTLY ISSUED ACCOUNTING STANDARDS
(a)    Adoption of New Accounting Standards:
In April 2014, the Financial Accounting Standards Board ("FASB") issued Accounting Standards Update ("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

 
7
 
KINGSWAY FINANCIAL SERVICES INC.
Notes to Consolidated Financial Statements (Unaudited) June 30, 2016




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.
In February 2015, the FASB issued ASU 2015-02, Consolidation (Topic 810): Amendments to the Consolidation Analysis ("ASU 2015-02"). The amendments in ASU 2015-02 affect reporting entities that are required to evaluate whether they should consolidate certain legal entities. All legal entities are subject to reevaluation under the revised consolidation model. Specifically, the amendments modify the evaluation of whether limited partnerships and similar legal entities are variable interest entities ("VIEs") or voting interest entities while also eliminating the presumption that a general partner should consolidate a limited partnership. Effective January 1, 2016, the Company adopted ASU 2015-02. The adoption of the standard did not have an impact on the consolidated financial statements.
In September 2015, the FASB issued ASU 2015-16, Business Combinations (Topic 805): Simplifying the Accounting for Measurement-Period Adjustments ("ASU 2015-16"). ASU 2015-16 simplifies the accounting for measurement-period adjustments in a business combination by requiring the acquirer to recognize adjustments to provisional amounts that are identified during the measurement period in the reporting period in which the adjustment amounts are determined. The effect on earnings as a result of the change to the provisional amounts, calculated as if the accounting had been completed as of the acquisition date, must be recorded in the reporting period in which the adjustment amounts are determined rather than retrospectively. The effects, by line item, if any, must be disclosed. Effective January 1, 2016, the Company adopted ASU 2015-16. The adoption of the standard did not have an impact on the consolidated financial statements.
In March 2016, the FASB issued ASU 2016-07, Investments-Equity Method and Joint Ventures (Topic 323): Simplifying the Transition to the Equity Method of Accounting ("ASU 2016-07"). ASU 2016-07 simplifies the transition to equity method accounting by requiring an equity method investor to add the cost of acquiring the additional interest in the investee to the current basis of the investor's previously held interest and adopt the equity method of accounting as of the date the investment becomes qualified for equity method accounting. ASU 2016-07 is effective for annual reporting periods beginning after December 15, 2016 and should be applied prospectively upon the effective date. Early adoption is permitted. Effective January 1, 2016, the Company adopted ASU 2016-07. The adoption of the standard did not have a material 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. In August 2015, the FASB issued ASU 2015-14, Revenue from Contracts with Customers (Topic 606): Deferral of the Effective Date ("ASU 2015-14"). This amendment defers the effective date of the previously issued ASU 2014-09 until the interim and annual reporting periods beginning after December 15, 2017. Earlier application is permitted for interim and annual reporting periods beginning after December 15, 2016. 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 (Topic 944): Disclosures about Short-Duration Contracts ("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.
In January 2016, the FASB issued ASU 2016-01, Financial Instruments-Overall (Subtopic 825-10): Recognition and Measurement of Financial Assets and Financial Liabilities ("ASU 2016-01"). The amendments in ASU 2016-01 address certain aspects of recognition, measurement, presentation, and disclosure of financial instruments. Most significantly, ASU 2016-01 requires equity investments (except those accounted for under the equity method of accounting or those that result in consolidation of an investee) to be measured at fair value with changes in fair value recognized in net income (loss). For public business entities, the amendments in ASU 2016-01 are effective for fiscal years beginning after December 15, 2017, including interim periods within those fiscal years, and will be applied using a cumulative-effect adjustment to accumulated deficit as of the beginning of the fiscal year of adoption. The Company currently records its equity investments at fair value with net unrealized gains or losses reported in accumulated other comprehensive income. Adoption of ASU 2016-01 will require the changes in fair value on equity investments

 
8
 
KINGSWAY FINANCIAL SERVICES INC.
Notes to Consolidated Financial Statements (Unaudited) June 30, 2016




with readily determinable fair values to be recorded in net (loss) income. Adoption of ASU 2016-01 is not expected to have a material impact on the Company's financial position, cash flows, or total comprehensive (loss) income, but could have a significant impact on the Company's results of operations and (loss) earnings per share as changes in fair value will be presented in net (loss) income rather than other comprehensive (loss) income.
In February 2016, the FASB issued ASU 2016-02, Leases ("ASU 2016-02"). ASU 2016-02 was issued to improve the financial reporting of leasing transactions. Under current guidance for lessees, leases are only included on the balance sheet if certain criteria, classifying the agreement as a capital lease, are met. This update will require the recognition of a right-of-use asset and a corresponding lease liability, discounted to the present value, for all leases that extend beyond 12 months. For operating leases, the asset and liability will be expensed over the lease term on a straight-line basis, with all cash flows included in the operating section of the statement of cash flows. For finance leases, interest on the lease liability will be recognized separately from the amortization of the right-of-use asset in the statement of comprehensive income and the repayment of the principal portion of the lease liability will be classified as a financing activity while the interest component will be included in the operating section of the statement of cash flows. ASU 2016-02 is effective for annual and interim reporting periods beginning after December 15, 2018. Early adoption is permitted. Upon adoption, leases will be recognized and measured at the beginning of the earliest period presented using a modified retrospective approach. The Company is currently evaluating the impact of the adoption of ASU 2016-02 on its consolidated financial statements.
In March 2016, the FASB issued ASU 2016-09, Compensation - Stock Compensation (Topic 718): Improvements to Employee Share-Based Payment Accounting ("ASU 2016-09"). ASU 2016-09 was issued to simplify the accounting for share-based payment awards. The guidance requires that, prospectively, all tax effects related to share-based payments be made through the statement of operations at the time of settlement as opposed to excess tax benefits being recognized in additional paid-in-capital under the current guidance. ASU 2016-09 also removes the requirement to delay recognition of a tax benefit until it reduces current taxes payable. This change is required to be applied on a modified retrospective basis, with a cumulative-effect adjustment to opening accumulated deficit. Additionally, all tax related cash flows resulting from share-based payments are to be reported as operating activities on the statement of cash flows, a change from the current requirement to present tax benefits as an inflow from financing activities and an outflow from operating activities. ASU 2016-09 is effective for annual and interim reporting periods beginning after December 15, 2016. Early adoption is permitted with any adjustments reflected as of the beginning of the fiscal year of adoption. The Company does not believe the adoption of ASU 2016-09 will have a material impact on its consolidated financial statements.
NOTE 5 ACQUISITION, DECONSOLIDATION AND DISCONTINUED OPERATIONS
(a)     Acquisition
Effective April 21, 2016, the Company issued 160,000 shares of its common stock to acquire Argo Management Group LLC ("Argo"). The Argo purchase price of $0.7 million was determined using the closing price of Kingsway common stock on the date the 160,000 shares were issued. The consolidated statements of operations include the earnings of Argo from the date of acquisition. No supplemental proforma revenue and earnings information related to the acquisition has been presented for the three and six months ended June 30, 2016, as the impact is immaterial. Argo’s primary business is to act as the Managing Member of Argo Holdings Fund I, LLC, an investment fund organized for purposes of making control-oriented equity investments in established lower middle market companies based in North America, with a focus on search fund investments.

This acquisition was accounted for as a business combination using the acquisition method of accounting. The purchase price was allocated to the assets purchased and liabilities assumed based upon their estimated fair values at the date of acquisition. During the second quarter of 2016, the Company completed its fair value analysis on the assets acquired and liabilities assumed. Separately identifiable intangible assets of $0.7 million were recognized resulting from the valuations of contract-based management fee and promote fee revenues. Refer to Note 9, "Intangible Assets," for further disclosure of the intangible assets related to this acquisition.






 
9
 
KINGSWAY FINANCIAL SERVICES INC.
Notes to Consolidated Financial Statements (Unaudited) June 30, 2016




The following table summarizes the estimated fair value of the assets acquired and liabilities assumed at the date of acquisition.
(in thousands)
 
 
 
 
April 21, 2016

Cash and cash equivalents
 
$
5

Other receivables
 
17

Intangible assets - subject to amortization
 
731

Other assets
 
5

Total assets
 
$
758

 
 
 
Accrued expenses and other liabilities
 
$
14

Total liabilities
 
$
14

 
 
 
Purchase price
 
$
744

(b)     Deconsolidation
On July 14, 2005, Kingsway Linked Return of Capital Trust ("KLROC Trust") completed its public offering of C$78.0 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.
(c)     Discontinued Operations
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 receipt by the Company of future earnout payments equal to 1.25% of ARS' written premium and fee income during the earnout periods. The earnout payments are payable in three annual installments beginning in April 2016 through April 2018. During the second quarter of 2016, the Company received cash consideration of $1.4 million, representing the first annual installment earnout payment. Net of expenses, the Company recorded an additional gain on disposal of ARS of $1.1 million for the three and six months ended June 30, 2016. 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 unaudited 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, 2016 and June 30, 2015 is presented below:


 
10
 
KINGSWAY FINANCIAL SERVICES INC.
Notes to Consolidated Financial Statements (Unaudited) June 30, 2016




(in thousands)
 
Three months ended June 30,
 
 
Six months ended June 30,
 
 
 
2016

 
2015

 
2016

 
2015

Revenues:
 
 
 
 
 
 
 
 
Service fee and commission income
 
$
—

 
$
—

 
$
—

 
$
8,342

Other expense
 
—

 
—

 
—

 
(20
)
Total revenues
 
—

 
—

 
—

 
8,322

Expenses:
 
 
 
 
 
 
 
 
General and administrative expenses
 
—

 
—

 
—

 
6,462

Income from discontinued operations before income tax expense
 
—

 
—

 
—

 
1,860

Income tax expense
 
—

 
—

 
—

 
434

Income from discontinued operations, net of taxes
 
—

 
—

 
$
—

 
$
1,426

Gain on disposal of discontinued operations before income tax benefit
 
1,124

 
11,010

 
1,124

 
11,010

Income tax benefit
 
—

 
(249
)
 
—

 
(249
)
Gain on disposal of discontinued operations, net of taxes
 
1,124

 
11,259

 
1,124

 
11,259

Total gain from discontinued operations, net of taxes
 
$
1,124

 
$
11,259

 
$
1,124

 
$
12,685

For the six months ended June 30, 2016 and June 30, 2015, ARS' net cash used in operating activities was zero and $0.2 million, respectively. ARS had no cash flows from investing activities for the six months ended June 30, 2016 and June 30, 2015.

 
11
 
KINGSWAY FINANCIAL SERVICES INC.
Notes to Consolidated Financial Statements (Unaudited) June 30, 2016




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, 2016 and December 31, 2015 are summarized in the tables shown below:
(in thousands)
 
June 30, 2016
 
 
 
Amortized Cost

 
Gross Unrealized Gains

 
Gross Unrealized Losses

 
Estimated  Fair Value

Fixed maturities:
 
 
 
 
 
 
 
 
U.S. government, government agencies and authorities
 
$
27,501

 
$
215

 
$
—

 
$
27,716

States, municipalities and political subdivisions
 
3,892

 
23

 
—

 
3,915

Mortgage-backed
 
7,236

 
118

 
4

 
7,350

Asset-backed securities and collateralized mortgage obligations
 
4,595

 
23

 
2

 
4,616

Corporate
 
19,173

 
251

 
18

 
19,406

Total fixed maturities
 
62,397

 
630

 
24

 
63,003

Equity investments:
 
 
 
 
 
 
 
 
Common stock
 
19,870

 
2,988

 
2,045

 
20,813

Warrants
 
1,251

 
18

 
574

 
695

Total equity investments
 
21,121

 
3,006

 
2,619

 
21,508

Total fixed maturities and equity investments
 
$
83,518

 
$
3,636

 
$
2,643

 
$
84,511


(in thousands)
 
December 31, 2015
 
 
 
Amortized Cost

 
Gross Unrealized Gains

 
Gross Unrealized Losses

 
Estimated  Fair Value

Fixed maturities:
 
 
 
 
 
 
 
 
U.S. government, government agencies and authorities
 
$
20,443

 
$
73

 
$
63

 
$
20,453

States, municipalities and political subdivisions
 
2,241

 
20

 
5

 
2,256

Mortgage-backed
 
7,997

 
25

 
59

 
7,963

Asset-backed securities and collateralized mortgage obligations
 
6,040

 
4

 
21

 
6,023

Corporate
 
18,885

 
60

 
81

 
18,864

Total fixed maturities
 
55,606

 
182

 
229

 
55,559

Equity investments:
 
 
 
 
 
 
 
 
Common stock
 
25,177

 
3,464

 
2,055

 
26,586

Warrants
 
1,251

 
52

 
330

 
973

Total equity investments
 
26,428

 
3,516

 
2,385

 
27,559

Total fixed maturities and equity investments
 
$
82,034

 
$
3,698

 
$
2,614

 
$
83,118




 
12
 
KINGSWAY FINANCIAL SERVICES INC.
Notes to Consolidated Financial Statements (Unaudited) June 30, 2016




The table below summarizes the Company's fixed maturities at June 30, 2016 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, 2016
 
 
 
Amortized Cost

 
Estimated Fair Value

Due in one year or less
 
$
8,686

 
$
8,702

Due after one year through five years
 
42,813

 
43,258

Due after five years through ten years
 
3,378

 
3,418

Due after ten years
 
7,520

 
7,625

Total
 
$
62,397

 
$
63,003


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, 2016 and December 31, 2015. 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, 2016
 
 
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
$
701

 
$
—

 
$
—

 
$
—

 
$
701

 
$
—

States, municipalities and political subdivisions
160

 
—

 
—

 
—

 
160

 
—

Mortgage-backed
981

 
3

 
146

 
1

 
1,127

 
4

Asset-backed securities and collateralized mortgage obligations
1,587

 
1

 
252

 
1

 
1,839

 
2

Corporate
2,623

 
13

 
745

 
5

 
3,368

 
18

Total fixed maturities
6,052

 
17

 
1,143

 
7

 
7,195

 
24

Equity investments:
 
 
 
 
 
 
 
 


 


Common stock
8,461

 
1,657

 
982

 
388

 
9,443

 
2,045

Warrants
651

 
542

 
1

 
32

 
652

 
574

Total equity investments
9,112

 
2,199

 
983

 
420

 
10,095

 
2,619

Total
$
15,164

 
$
2,216

 
$
2,126

 
$
427

 
$
17,290

 
$
2,643



 
13
 
KINGSWAY FINANCIAL SERVICES INC.
Notes to Consolidated Financial Statements (Unaudited) June 30, 2016




(in thousands)
 
 
 
 
 
 
 
 
December 31, 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
$
12,635

 
$
63

 
$
—

 
$
—

 
$
12,635

 
$
63

States, municipalities and political subdivisions
745

 
5

 
—

 
—

 
745

 
5

Mortgage-backed
5,685

 
59

 
—

 
—

 
5,685

 
59

Asset-backed securities and collateralized mortgage obligations
5,035

 
21

 
—

 
—

 
5,035

 
21

Corporate
9,171

 
81

 
—

 
—

 
9,171

 
81

Total fixed maturities
33,271

 
229

 
—

 
—

 
33,271

 
229

Equity investments:
 
 
 
 
 
 
 
 
 
 
 
Common stock
15,711

 
2,055

 
—

 
—

 
15,711

 
2,055

Warrants
897

 
330

 
—

 
—

 
897

 
330

Total equity investments
16,608

 
2,385

 
—

 
—

 
16,608

 
2,385

Total
$
49,879

 
$
2,614

 
$
—

 
$
—

 
$
49,879

 
$
2,614

Fixed maturities and equity investments contain approximately 61 and 127 individual investments that were in unrealized loss positions as of June 30, 2016 and December 31, 2015, respectively. 
The establishment of an other-than-temporary impairment on an investment requires a number of judgments and estimates. The Company performs a quarterly analysis of the individual investments to determine if declines in market value are other-than-temporary. The analysis includes some or all of the following procedures as deemed appropriate by the Company:
•
identifying all unrealized loss positions that have existed for at least six months;
•
identifying other circumstances which management believes may impact the recoverability of the unrealized loss positions;
•
obtaining a valuation analysis from third-party investment managers regarding the intrinsic value of these investments based on their knowledge and experience together with market-based valuation techniques;
•
reviewing the trading range of certain investments over the preceding calendar period;
•
assessing if declines in market value are other-than-temporary for debt instruments based on the investment grade credit ratings from third-party rating agencies;
•
assessing if declines in market value are other-than-temporary for any debt instrument with a non-investment grade credit rating based on the continuity of its debt service record;
•
determining the necessary provision for declines in market value that are considered other-than-temporary based on the analyses performed; and
•
assessing the Company's ability and intent to hold these investments at least until the investment impairment is recovered.
The risks and uncertainties inherent in the assessment methodology used to determine declines in market value that are other-than-temporary include, but may not be limited to, the following:
•
the opinions of professional investment managers could be incorrect;
•
the past trading patterns of individual investments may not reflect future valuation trends;
•
the credit ratings assigned by independent credit rating agencies may be incorrect due to unforeseen or unknown facts related to a company's financial situation; and
•
the debt service pattern of non-investment grade instruments may not reflect future debt service capabilities and may not reflect a company's unknown underlying financial problems.
As a result of the 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 investments recorded for the three and six months ended

 
14
 
KINGSWAY FINANCIAL SERVICES INC.
Notes to Consolidated Financial Statements (Unaudited) June 30, 2016




June 30, 2016. For the three months ended June 30, 2015, there were no write-downs for other-than-temporary impairments related to investments. For the six months ended June 30, 2015, the Company recorded a write-down of $0.0 million for other-than-temporary impairment related to fixed maturities.
There were no other-than-temporary losses recognized in other comprehensive loss for the three and six months ended June 30, 2016, or for the three months ended June 30, 2015. There were $0.0 million of other-than-temporary losses recognized in other comprehensive income for the six months ended June 30, 2015.
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, limited partnerships and a general partnership 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. The most recently available financial statements are used in applying the equity method. The difference between the end of the reporting period of the limited liability entities and that of the Company is no more than three months. As of June 30, 2016 and December 31, 2015, the carrying value of limited liability investments totaled $21.8 million and $20.1 million, respectively. At June 30, 2016, the Company has unfunded commitments totaling $1.8 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 and collateral loans and are reported at their unpaid principal balance. As of June 30, 2016 and December 31, 2015, the carrying value of other investments totaled $5.4 million and $4.1 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, 2016 and June 30, 2015 were as follows:
(in thousands)
 
Three months ended June 30,
 
 
Six months ended June 30,
 
 
 
2016

 
2015

 
2016

 
2015

Gross realized gains
 
$
214

 
$
53

 
$
248

 
$
53

Gross realized losses
 
(147
)
 
—

 
(352
)
 
—

Net realized gains (losses)
 
$
67

 
$
53

 
$
(104
)
 
$
53


Net investment income for the three and six months ended June 30, 2016 and June 30, 2015, respectively, is comprised as follows:
(in thousands)
 
Three months ended June 30,
 
 
Six months ended June 30,
 
 
 
2016

 
2015

 
2016

 
2015

Investment income
 
 
 
 
 
 
 
 
  Interest from fixed maturities
 
$
242

 
$
124

 
$
460

 
$
393

Dividends
 
126

 
201

 
392

 
348

Income from limited liability investments
 
511

 
66

 
310

 
995

Gain (loss) on change in fair value of warrants
 
141

 
165

 
(246
)
 
165

Other
 
100

 
32

 
139

 
66

Gross investment income
 
1,120

 
588

 
1,055

 
1,967

Investment expenses
 
(48
)
 
(60
)
 
(55
)
 
(126
)
Net investment income
 
$
1,072

 
$
528

 
$
1,000

 
$
1,841

At June 30, 2016, fixed maturities and short-term investments with an estimated fair value of $13.4 million were on deposit with state and provincial regulatory authorities. Also, from time to time, the Company pledges investments to third-parties as a deposit or to collateralize liabilities incurred under its policies of insurance. At June 30, 2016, the amount of such pledged securities was $17.3 million.


 
15
 
KINGSWAY FINANCIAL SERVICES INC.
Notes to Consolidated Financial Statements (Unaudited) June 30, 2016




NOTE 7 INVESTMENTS IN INVESTEES
Investments in investees includes the Company's investments in the common stock and private units of 1347 Capital Corp. and the common stock of Itasca Capital Ltd. ("ICL"). Investments in investees are accounted for under the equity method. Prior to the second quarter of 2016, the Company's investment in ICL was included in equity investments in the consolidated balance sheets. During the second quarter of 2016, the Company's ownership percentage in ICL was increased to 31.2%. As a result of this change in ownership, the Company has determined that its investment in the common stock of ICL qualifies for the equity method of accounting and, thus, is included in investments in investees in the consolidated balance sheet at June 30, 2016. The Company's investment in ICL will be recorded on a three-month lag basis. The carrying value, estimated fair value and approximate equity percentage for the Company's investments in investees at June 30, 2016 and December 31, 2015 were as follows:
(in thousands, except for percentages)
 
 
 
 
 
 
June 30, 2016
 
December 31, 2015
 
 
Equity Percentage
 
Estimated Fair Value
 
Carrying Value
 
Equity Percentage
 
Estimated Fair Value
 
Carrying value
1347 Capital Corp.
 
21.0
%
 
$
11,654

 
$
828

 
21.0
%
 
$
12,369

 
$
1,772

ICL
 
31.2
%
 
$
3,190

 
$
3,190

 
—
%
 
$
—

 
$
—

Total
 
 
 
$
14,844

 
$
4,018

 
 
 
$
12,369

 
$
1,772


For the three months ended June 30, 2016 and June 30, 2015, equity in net loss of investee represents the Company's investment in 1347 Capital Corp. and was $0.9 million and $0.1 million, respectively ($0.9 million and $0.2 million for the six months ended June 30, 2016 and June 30, 2015, 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, 2016 and 2015, respectively, are comprised as follows:
(in thousands)
 
Three months ended June 30,
 
 
Six months ended June 30,
 
 
 
2016

 
2015

 
2016

 
2015

Beginning balance, net
 
$
13,440

 
$
13,203

 
$
12,143

 
$
12,197

Additions
 
7,180

 
6,164

 
14,769

 
13,718

Amortization
 
(6,796
)
 
(6,750
)
 
(13,088
)
 
(13,298
)
Balance at June 30, net
 
$
13,824

 
$
12,617

 
$
13,824

 
$
12,617


 
16
 
KINGSWAY FINANCIAL SERVICES INC.
Notes to Consolidated Financial Statements (Unaudited) June 30, 2016




NOTE 9 INTANGIBLE ASSETS
Intangible assets are comprised as follows:
(in thousands)
 
 
June 30, 2016
 
 
 
Gross Carrying Value
 
Accumulated Amortization
 
Net Carrying Value
Intangible assets subject to amortization
 
 
 
 
 
 
Database
 
$
4,918

 
$
1,783

 
$
3,135

Vehicle service agreements in-force
 
3,680

 
3,458

 
222

Customer-related relationships
 
3,611

 
1,287

 
2,324

Contract-based revenues
 
731

 
13

 
718

Intangible assets not subject to amortization
 
 
 
 
 
 
Insurance licenses
 
7,803

 
—

 
7,803

Trade name
 
663

 
—

 
663

Total
 
$
21,406

 
$
6,541

 
$
14,865


(in thousands)
 
 
December 31, 2015
 
 
 
Gross Carrying Value
 
Accumulated Amortization
 
Net Carrying Value
Intangible assets subject to amortization
 
 
 
 
 
 
Database
 
$
4,918

 
$
1,537

 
$
3,381

Vehicle service agreements in-force
 
3,680

 
3,362

 
318

Customer-related relationships
 
3,611

 
1,040

 
2,571

Non-compete agreement
 
70

 
70

 
—

Intangible assets not subject to amortization
 
 
 
 
 
 
Insurance licenses
 
7,803

 
—

 
7,803

Trade name
 
663

 
—

 
663

Total
 
$
20,745

 
$
6,009

 
$
14,736

As further discussed in Note 5, "Acquisition, Deconsolidation and Discontinued Operations," during the second quarter of 2016, the Company recorded $0.7 million of separately identifiable intangible assets for contract-based management fee and promote fee revenues as part of the acquisition of Argo. The contract-based management fee revenue intangible asset is being amortized over nine years. The contract-based promote fee revenue intangible asset is being amortized over a three-year period beginning in 2022. The amortization periods for the contract-based revenues intangible assets are based on the patterns in which the economic benefits of the intangible assets are expected to be consumed.
The Company's other intangible assets with definite useful lives are amortized either based on the patterns in which the economic benefits of the intangible assets are expected to be consumed or using the straight-line method over their estimated useful lives, which range from three to fifteen years. Amortization of intangible assets was $0.3 million and $0.3 million for the three months ended June 30, 2016 and June 30, 2015, respectively ($0.6 million and $0.6 million for the six months ended June 30, 2016 and June 30, 2015, respectively). The insurance licenses and trade name intangible assets have indefinite useful lives and are not amortized.

 
17
 
KINGSWAY FINANCIAL SERVICES INC.
Notes to Consolidated Financial Statements (Unaudited) June 30, 2016




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 for unpaid loss and loss adjustment expenses necessarily involves risks that the actual loss and loss adjustment expenses incurred by the Company will deviate, perhaps materially, from the estimates recorded.
The Company's evaluation of the adequacy of unpaid loss and loss adjustment expenses includes a re-estimation of the liability for unpaid loss and loss adjustment expenses relating to each preceding financial year compared to the liability that was previously established.
(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, 2016 and June 30, 2015 were as follows:
(in thousands)
 
June 30, 2016

 
June 30, 2015

Balance at beginning of period, gross
 
$
55,471

 
$
63,895

Less reinsurance recoverable related to property and casualty unpaid loss and loss adjustment expenses
 
1,207

 
3,203

Balance at beginning of period, net
 
54,264

 
60,692

Incurred related to:
 
 
 
 

      Current year
 
45,614

 
43,610

      Prior years
 
67

 
(484
)
Paid related to:
 
 
 
 

      Current year
 
(22,060
)
 
(21,418
)
      Prior years
 
(26,535
)
 
(26,009
)
Balance at end of period, net
 
51,350

 
56,391

Plus reinsurance recoverable related to property and casualty unpaid loss and loss adjustment expenses
 
845

 
1,828

Balance at end of period, gross
 
$
52,195

 
$
58,219


 
18
 
KINGSWAY FINANCIAL SERVICES INC.
Notes to Consolidated Financial Statements (Unaudited) June 30, 2016




(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, 2016 and June 30, 2015 were as follows:
(in thousands)
 
June 30, 2016

 
June 30, 2015

Balance at beginning of period
 
$
2,975

 
$
2,975

Incurred related to:
 
 
 
 
      Current year
 
2,654

 
3,014

      Prior years
 
—

 
—

Paid related to:
 
 
 
 
      Current year
 
(2,502
)
 
(2,904
)
      Prior years
 
(152
)
 
(110
)
Balance at end of period
 
$
2,975

 
$
2,975


NOTE 11 DEBT
Debt consists of the following:
(in thousands)
 
June 30, 2016
 
December 31, 2015
 
 
Principal

 
Fair Value

 
Principal

 
Fair Value

Subordinated debt
 
$
90,500

 
$
36,302

 
$
90,500

 
$
39,898


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

5/22/2003
annual interest rate equal to LIBOR, plus 4.20% payable quarterly
5/22/2033
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



 
19
 
KINGSWAY FINANCIAL SERVICES INC.
Notes to Consolidated Financial Statements (Unaudited) June 30, 2016





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, 2016 and December 31, 2015, finance lease obligation liability of $5.0 million and $4.9 million, respectively, is included in accrued expenses and other liabilities in the consolidated balance sheets. At June 30, 2016 and December 31, 2015, the carrying value of the land and building of $4.8 million and $4.9 million, respectively, is included in property and equipment in the consolidated balance sheets.

NOTE 13 INCOME TAXES
Income tax expense for the three and six months ended June 30, 2016 and June 30, 2015, 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. The following table summarizes the differences:
(in thousands)
 
Three months ended June 30,
 
 
Six months ended June 30,
 
 
 
2016

 
2015

 
2016

 
2015

Income tax benefit at United States statutory income tax rate
 
$
(671
)
 
$
(3,533
)
 
$
(1,170
)
 
$
(2,843
)
Non-deductible compensation
 
381

 
70

 
449

 
138

Valuation allowance
 
251

 
1,172

 
640

 
533

Foreign operations subject to different tax rates
 
38

 
33

 
74

 
155

Deconsolidation of subsidiary
 
—

 
2,391

 
—

 
2,391

Non-taxable dividend income
 
—

 
9

 
—

 
(415
)
Other
 
27

 
(108
)
 
59

 
97

Income tax expense
 
$
26

 
$
34

 
$
52

 
$
56

The Company maintains a valuation allowance for its gross deferred tax assets at June 30, 2016 and December 31, 2015. The Company's operations have generated substantial operating losses in prior years. These losses can be available to reduce income taxes that might otherwise be incurred on future taxable income; however, it is uncertain whether the Company will generate the taxable income necessary to utilize these losses or other reversing temporary differences. This uncertainty has caused management to place a full valuation allowance on its June 30, 2016 and December 31, 2015 net deferred tax asset. The Company carries a deferred income tax liability of $3.0 million and $2.9 million at June 30, 2016 and December 31, 2015, respectively, all of which relates to indefinite life intangible assets.
As of June 30, 2016, 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.

 
20
 
KINGSWAY FINANCIAL SERVICES INC.
Notes to Consolidated Financial Statements (Unaudited) June 30, 2016




NOTE 14 LOSS PER SHARE FROM CONTINUING OPERATIONS
The following table sets forth the reconciliation of numerators and denominators for the basic and diluted loss per share from continuing operations computation for the three and six months ended June 30, 2016 and June 30, 2015:
(in thousands, except per share data)
 
Three months ended June 30,
 
Six months ended June 30,
 
 
2016
 
2015
 
2016
 
2015
Numerator:
 
 
 
 
 
 
 
 
Loss from continuing operations
 
$
(1,999
)
 
$
(10,426
)
 
$
(3,494
)
 
$
(8,418
)
Plus (less): net loss (income) attributable to noncontrolling interests
 
361

 
1,064

 
400

 
(160
)
Less: dividends on preferred stock
 
(82
)
 
(82
)
 
(164
)
 
(163
)
Loss from continuing operations attributable to common shareholders
 
$
(1,720
)
 
$
(9,444
)
 
$
(3,258
)
 
$
(8,741
)
Denominator:
 
 
 
 
 
 
 
 
Weighted average basic shares
 
 
 
 
 
 
 
 
Weighted average common shares outstanding
 
19,818

 
19,710

 
19,764

 
19,710

Weighted average diluted shares