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
September 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 November 3, 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 September 30, 2016 (unaudited) and December 31, 2015
 
Consolidated Statements of Operations for the Three and Nine Months Ended September 30, 2016 and 2015 (unaudited)
 
Consolidated Statements of Comprehensive Income (Loss) for the Three and Nine Months Ended September 30, 2016 and 2015 (unaudited)
 
Consolidated Statements of Cash Flows for the Nine Months Ended September 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 share data)
 
 
September 30, 2016

 
December 31, 2015

 
 
(unaudited)

 
 
Assets
 
 
 
 
Investments:
 
 
 
 
Fixed maturities, at fair value (amortized cost of $60,934 and $55,606, respectively)
 
$
61,326

 
$
55,559

Equity investments, at fair value (cost of $21,145 and $26,428, respectively)
 
21,518

 
27,559

Limited liability investments
 
29,091

 
20,141

Other investments, at cost which approximates fair value
 
7,251

 
4,077

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

 
400

Total investments
 
119,856

 
107,736

Cash and cash equivalents
 
30,705

 
51,701

Investments in investees
 
3,129

 
1,772

Accrued investment income
 
535

 
594

Premiums receivable, net of allowance for doubtful accounts of $135 and $165, respectively
 
33,570

 
27,090

Service fee receivable, net of allowance for doubtful accounts of $295 and $276, respectively
 
1,278

 
911

Other receivables, net of allowance for doubtful accounts of $806 and $806, respectively
 
4,979

 
3,789

Reinsurance recoverable
 
830

 
1,422

Prepaid reinsurance premiums
 
49

 
7

Deferred acquisition costs, net
 
14,553

 
12,143

Income taxes recoverable
 
—

 
61

Property and equipment, net of accumulated depreciation of $9,613 and $12,537, respectively
 
91,239

 
5,577

Goodwill
 
10,078

 
10,078

Intangible assets, net of accumulated amortization of $7,320 and $6,009, respectively
 
123,178

 
14,736

Other assets
 
4,823

 
3,405

Total Assets
 
$
438,802

 
$
241,022

Liabilities and Shareholders' Equity
 
 
 
 
Liabilities:
 
 
 
 
Unpaid loss and loss adjustment expenses:
 
 
 
 
Property and casualty
 
$
48,991

 
$
55,471

Vehicle service agreements
 
3,055

 
2,975

Total unpaid loss and loss adjustment expenses
 
52,046

 
58,446

Unearned premiums
 
42,650

 
35,234

Reinsurance payable
 
241

 
145

Note payable
 
190,931

 
—

Subordinated debt, at fair value
 
38,774

 
39,898

Deferred income tax liability
 
6,086

 
2,924

Deferred service fees
 
36,641

 
34,319

Income taxes payable
 
2,031

 
—

Accrued expenses and other liabilities
 
20,411

 
19,959

Total Liabilities
 
389,811

 
190,925

 
 
 
 
 
Class A preferred stock, no par value; unlimited number authorized; 262,876 and 262,876 issued and outstanding at September 30, 2016 and December 31, 2015, respectively; redemption amount of $6,572
 
6,419

 
6,394

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

 
—

Additional paid-in capital
 
343,106

 
341,646

Accumulated deficit
 
(310,493
)
 
(308,995
)
Accumulated other comprehensive income
 
9,195

 
9,300

Shareholders' equity attributable to common shareholders
 
41,808

 
41,951

Noncontrolling interests in consolidated subsidiaries
 
764

 
1,752

Total Shareholders' Equity
 
42,572

 
43,703

Total Liabilities and Shareholders' Equity
 
$
438,802

 
$
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 September 30,
 
 
Nine months ended September 30,
 
 
 
2016

 
2015

 
2016

 
2015

Revenues:
 
 
 
 
 
 
 
 
Net premiums earned
 
$
32,949

 
$
29,197

 
$
94,189

 
$
88,427

Service fee and commission income
 
6,330

 
6,184

 
17,046

 
17,430

Rental income
 
2,426

 
—

 
2,426

 
—

Net investment income
 
1,036

 
791

 
2,036

 
2,632

Net realized gains (losses)
 
46

 
83

 
(58
)
 
136

Other-than-temporary impairment loss
 
—

 
—

 
—

 
(10
)
Other income
 
3,038

 
2,303

 
8,203

 
13,174

Total revenues
 
45,825

 
38,558

 
123,842

 
121,789

Operating expenses:
 
 
 
 
 
 
 
 
Loss and loss adjustment expenses
 
26,804

 
22,914

 
75,139

 
69,054

Commissions and premium taxes
 
5,928

 
5,653

 
17,629

 
17,199

Cost of services sold
 
1,381

 
1,408

 
2,924

 
3,129

General and administrative expenses
 
9,949

 
9,997

 
30,326

 
31,748

Amortization of intangible assets
 
779

 
307

 
1,381

 
937

Contingent consideration (benefit) expense
 
—

 
110

 
(657
)
 
364

Total operating expenses
 
44,841

 
40,389

 
126,742

 
122,431

Operating income (loss)
 
984

 
(1,831
)
 
(2,900
)
 
(642
)
Other (revenues) expenses, net:
 
 
 
 
 
 
 
 
Interest expense
 
2,448

 
1,248

 
4,649

 
4,053

Foreign exchange losses, net
 
4

 
58

 
14

 
1,210

Loss (gain) on change in fair value of debt
 
2,472

 
(2,458
)
 
(1,124
)
 
(1,491
)
(Gain) loss on deconsolidation of subsidiary
 
(5,643
)
 
—

 
(5,643
)
 
4,420

Equity in net loss of investees
 
61

 
192

 
1,004

 
399

Total other (revenues) expenses, net
 
(658
)
 
(960
)
 
(1,100
)
 
8,591

Income (loss) from continuing operations before income tax expense
 
1,642

 
(871
)
 
(1,800
)
 
(9,233
)
Income tax expense
 
55

 
23

 
107

 
79

Income (loss) from continuing operations
 
1,587

 
(894
)
 
(1,907
)
 
(9,312
)
Income from discontinued operations, net of taxes
 
—

 
—

 
—

 
1,426

Gain on disposal of discontinued operations, net of taxes
 
—

 
—

 
1,124

 
11,259

Net income (loss)
 
1,587

 
(894
)
 
(783
)
 
3,373

Less: net income (loss) attributable to noncontrolling interests in consolidated subsidiaries
 
48

 
(86
)
 
(352
)
 
74

Less: dividends on preferred stock
 
110

 
83

 
274

 
246

Net income (loss) attributable to common shareholders
 
$
1,429

 
$
(891
)
 
$
(705
)
 
$
3,053

Earnings (loss) per share - continuing operations:
 
 
 
 
 
 
 
 
Basic:
 
$
0.07

 
$
(0.05
)
 
$
(0.09
)
 
$
(0.49
)
Diluted:
 
$
0.06

 
$
(0.05
)
 
$
(0.09
)
 
$
(0.49
)
Earnings per share - discontinued operations:
 
 
 
 
 
 
 
 
Basic:
 
$
—

 
$
—

 
$
0.06

 
$
0.64

Diluted:
 
$
—

 
$
—

 
$
0.06

 
$
0.64

Earnings (loss) per share – net income (loss) attributable to common shareholders:
 
 
 
 
 
 
 
 
Basic:
 
$
0.07

 
$
(0.05
)
 
$
(0.04
)
 
$
0.15

Diluted:
 
$
0.06

 
$
(0.05
)
 
$
(0.04
)
 
$
0.15

Weighted average shares outstanding (in ‘000s):
 
 
 
 
 
 
 
 
Basic:
 
19,843

 
19,710

 
19,791

 
19,710

Diluted:
 
22,958

 
19,710

 
19,791

 
19,710


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 September 30,
 
 
Nine months ended September 30,
 
 
 
2016

 
2015

 
2016

 
2015

 
 
 
 
 
 
 
 
 
Net income (loss)
 
$
1,587

 
$
(894
)
 
$
(783
)
 
$
3,373

Other comprehensive loss, net of taxes(1):
 
 
 
 
 
 
 
 
Unrealized (losses) gains on fixed maturities and equity investments:
 
 
 
 
 
 
 
 
Unrealized (losses) gains arising during the period
 
(328
)
 
(2,271
)
 
377

 
(3,704
)
Reclassification adjustment for amounts included in net income (loss)
 
21

 
90

 
(484
)
 
1,554

Foreign currency translation adjustments
 
—

 
—

 
—

 
858

Recognition of currency translation loss on deconsolidation of subsidiary
 
—

 
—

 
—

 
1,243

Other comprehensive loss
 
(307
)
 
(2,181
)
 
(107
)
 
(49
)
Comprehensive income (loss)
 
1,280

 
(3,075
)
 
(890
)
 
3,324

Less: comprehensive income (loss) attributable to noncontrolling interests in consolidated subsidiaries
 
45

 
(85
)
 
(354
)
 
(395
)
Comprehensive income (loss) attributable to common shareholders
 
$
1,235

 
$
(2,990
)
 
$
(536
)
 
$
3,719

 (1) Net of income tax expense of $0 and $0 for the three and nine months ended September 30, 2016 and September 30, 2015, respectively.
See accompanying notes to unaudited consolidated financial statements

 
5
 
KINGSWAY FINANCIAL SERVICES INC.

Consolidated Statements of Cash Flows
(in thousands)
(Unaudited)
 
 
Nine months ended September 30,
 
 
 
2016

 
2015

Cash provided by (used in):
 
 
 
 
Operating activities:
 
 
 
 
Net (loss) income
 
$
(783
)
 
$
3,373

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 investees
 
1,004

 
399

Equity in net income of limited liability investments
 
(800
)
 
(1,590
)
Depreciation and amortization expense
 
1,962

 
1,400

Contingent consideration (benefit) expense
 
(657
)
 
364

Stock-based compensation expense, net of forfeitures
 
716

 
598

Net realized losses (gains)
 
58

 
(136
)
Gain on change in fair value of debt
 
(1,124
)
 
(1,491
)
Deferred income taxes
 
76

 
66

Other-than-temporary impairment loss
 
—

 
10

Amortization of fixed maturities premiums and discounts
 
176

 
245

Amortization of note payable premium
 
(203
)
 
—

(Gain) loss on deconsolidation of subsidiary
 
(5,643
)
 
4,420

Changes in operating assets and liabilities:
 
 
 
 
Premiums and service fee receivable, net
 
(6,847
)
 
(1,591
)
Other receivables, net, adjusted for CMC assets acquired
 
773

 
(670
)
Reinsurance recoverable
 
592

 
1,965

Prepaid reinsurance premiums
 
(42
)
 
(41
)
Deferred acquisition costs, net
 
(2,410
)
 
(344
)
Income taxes recoverable
 
61

 
18

Unpaid loss and loss adjustment expenses
 
(6,400
)
 
(8,457
)
Unearned premiums
 
7,416

 
1,320

Reinsurance payable
 
96

 
(73
)
Deferred service fees
 
2,322

 
(363
)
Other, net, adjusted for CMC assets acquired and liabilities assumed
 
(345
)
 
1,299

Net cash used in operating activities
 
(11,126
)
 
(10,538
)
Investing activities:
 
 
 
 
Proceeds from sales and maturities of fixed maturities
 
19,805

 
23,302

Proceeds from sales of equity investments
 
3,721

 
617

Purchases of fixed maturities
 
(24,816
)
 
(25,788
)
Purchases of equity investments
 
(1,541
)
 
(7,666
)
Net acquisitions of limited liability investments
 
(2,870
)
 
(6,604
)
Net purchases of other investments
 
(3,173
)
 
(600
)
Net (purchases of) proceeds from short-term investments
 
(533
)
 
4

Net proceeds from sale of discontinued operations
 
1,404

 
44,919

Acquisition of business, net of cash acquired
 
(494
)
 
—

Net purchases of property and equipment, adjusted for CMC assets acquired
 
(641
)
 
(175
)
Net cash (used in) provided by investing activities
 
(9,138
)
 
28,009

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

Principal payments on note payable assumed in CMC acquisition
 
(607
)
 
—

Redemption of LROC preferred units
 
—

 
(12,920
)
Net cash used in financing activities
 
(732
)
 
(12,920
)
Net (decrease) increase in cash and cash equivalents
 
(20,996
)
 
4,551

Cash and cash equivalents at beginning of period
 
51,701

 
71,234

Cash and cash equivalents at end of period
 
$
30,705

 
$
75,785

See accompanying notes to unaudited consolidated financial statements.

 
6
 
KINGSWAY FINANCIAL SERVICES INC.
Notes to Consolidated Financial Statements (Unaudited) September 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 subordinated 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 values of the Company's investments in investees are 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 accounting policies during 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 consolidated statements of operations as gain on disposal of discontinued operations, net of taxes.
Rental income
Rental income from operating leases is recognized on a straight-line basis, based on contractual lease terms with fixed and determinable increases over the non-cancellable term of the related lease when collectability is reasonably assured. Rental income recognized in excess of amounts contractually due and collected pursuant to the underlying lease is recorded in other receivables in the consolidated balance sheets.
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 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. In addition, the FASB has issued four related ASU's on principal versus agent guidance (ASU 2016-08), identifying performance obligations and the licensing implementation guidance (ASU 2016-10),  a revision of certain SEC Staff Observer comments (ASU 2016-11) and implementation guidance (ASU 2016-12). 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.

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




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 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 income (loss), but could have a significant impact on the Company's results of operations and earnings (loss) per share as changes in fair value will be presented in net income (loss) rather than other comprehensive loss.
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.
In August 2016, the FASB issued ASU 2016-15, Classification of Certain Cash Receipts and Cash Payments ("ASU 2016-15"). The objective of ASU 2016-15 is to reduce diversity in the classification of cash receipts and payments for specific cash flow issues, including debt prepayment or debt extinguishment costs, contingent consideration payments made after a business combination and proceeds from the settlement of insurance claims. ASU 2016-15 is effective for fiscal years beginning after December 31, 2017, and interim periods within those fiscal years. Early adoption of ASU 2016-15 is permitted. The Company does not believe the adoption of ASU 2016-15 will have a material impact on its consolidated financial statements.


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




NOTE 5 ACQUISITIONS, DECONSOLIDATIONS AND DISCONTINUED OPERATIONS
(a)     Acquisitions
CMC Industries, Inc.:

On July 14, 2016, the Company completed the acquisition of 81% of CMC Industries, Inc. ("CMC") for cash consideration of $1.5 million.  The consolidated statements of operations include the earnings of CMC from the date of acquisition. As further discussed in Note 18, "Segmented Information," CMC is included in the Leased Real Estate segment. CMC owns, through an indirect wholly owned subsidiary (the "Property Owner"), a parcel of real property consisting of approximately 192 acres located in the State of Texas (the "Real Property"). The Real Property is leased to a third party pursuant to a long-term triple net lease. The Real Property is also subject to a mortgage in the principal amount of $180.0 million (the "Mortgage") at the date of acquisition. The Mortgage is nonrecourse indebtedness with respect to CMC and its subsidiaries (including the Property Owner), and the Mortgage is not, nor will it be, guaranteed by Kingsway or its affiliates. All cash rental income generated by the Real Property is applied to make principal and interest payments on the Mortgage.  The Mortgage is recorded as note payable on the consolidated balance sheets.
The Company intends to finalize by December 31, 2016 its fair value analysis of the assets acquired and liabilities assumed. The assets acquired and liabilities assumed are recorded in the unaudited consolidated interim financial statements at their estimated fair market values. These estimates, allocations and calculations are subject to change as we obtain further information; therefore, the final fair market values of the assets acquired and liabilities assumed may not agree with the estimates included in the unaudited consolidated interim financial statements. The following is an estimated allocation of the assets acquired and liabilities assumed at the date of acquisition:

(in thousands)
 
 
 
 
July 14, 2016

Cash and cash equivalents
 
$
1,006

Other receivables
 
1,963

Property and equipment
 
86,333

Intangible asset - subject to amortization
 
109,092

Other assets
 
1,385

Total assets
 
$
199,779

 
 
 
Note payable
 
$
191,741

Deferred income tax liability
 
3,086

Income taxes payable
 
2,056

Accrued expenses and other liabilities
 
1,097

Noncontrolling interest in CMC
 
299

Total liabilities and noncontrolling interest
 
$
198,279

 
 
 
Purchase price
 
$
1,500

The consolidated statements of operations include the earnings of CMC from the date of acquisition. From the date of acquisition through September 30, 2016, CMC earned revenue of $2.4 million and net income of $0.2 million. The following unaudited pro forma summary presents the Company's consolidated financial statements for the nine months ended September 30, 2016 and September 30, 2015 as if CMC had been acquired on January 1, 2015. The pro forma summary is presented for illustrative purposes only and does not purport to represent the results of our operations that would have actually occurred had the acquisition occurred on January 1, 2015 or project our results of operations as of any future date or for any future period, as applicable.


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




(in thousands, except per share data)
 
Nine months ended September 30,
 
 
 
2016

 
2015

Revenues
 
$
130,464

 
$
130,799

Loss from continuing operations attributable to common shareholders
 
$
(466
)
 
$
(8,768
)
Basic loss per share - continuing operations
 
$
(0.02
)
 
$
(0.44
)
Diluted loss per share - continuing operations
 
$
(0.02
)
 
$
(0.44
)

Argo Management Group LLC:

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 pro forma revenue and earnings information related to the acquisition has been presented for the nine months ended September 30, 2016 and September 30, 2015, 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 acquired 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.
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)     Deconsolidations
1347 Investors LLC:
At June 30, 2016, the Company owned 61.0% of the outstanding units of 1347 Investors LLC ("1347 Investors"). Because the Company owned more than 50% of the outstanding units, 1347 Investors was included in the unaudited consolidated interim financial statements of the Company. 1347 Investors had an investment in the common stock and private units of 1347 Capital Corp. which was reflected in investments in investees in the consolidated balance sheets. 1347 Capital Corp., which completed an initial public offering on July 21, 2014 and which had 24 months from the date of the initial public offering to complete a successful business combination, 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.
On March 23, 2016, 1347 Capital Corp. announced the signing of a definitive agreement with Limbach Holdings LLC ("Limbach"), in which 1347 Capital Corp. would merge with Limbach. On July 21, 2016, Limbach announced the closing of the previously

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




announced merger, and 1347 Capital Corp. was renamed Limbach Holdings, Inc. As a result of this transaction, the Company's ownership percentage in 1347 Investors was reduced to 26.7% at the transaction date, leading the Company to record a non-cash gain of $5.6 million during the third quarter of 2016 related to the deconsolidation of 1347 Investors. This gain results from removing the carrying value of the noncontrolling interest in 1347 Investors and the carrying value of the consolidated net assets of 1347 Investors, which the Company reported prior to the closing of the transaction, and recording the fair value of the Company's 26.7% retained noncontrolling investment in 1347 Investors as of the transaction date. Subsequent to the transaction date, the Company will account for its remaining noncontrolling investment in 1347 Investors under the equity method of accounting.
Kingsway Linked Return of Capital Trust:
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 during the second quarter of 2015. 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 nine months ended September 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 nine months ended September 30, 2016 and September 30, 2015 is presented below:

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




(in thousands)
 
Three months ended September 30,
 
 
Nine months ended September 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

Income tax benefit
 
—

 
—

 
—

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

 
—

 
1,124

 
11,259

Total gain from discontinued operations, net of taxes
 
$
—

 
$
—

 
$
1,124

 
$
12,685

For the nine months ended September 30, 2016 and September 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 nine months ended September 30, 2016 and September 30, 2015.

 
12
 
KINGSWAY FINANCIAL SERVICES INC.
Notes to Consolidated Financial Statements (Unaudited) September 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 September 30, 2016 and December 31, 2015 are summarized in the tables shown below:
(in thousands)
 
September 30, 2016
 
 
 
Amortized Cost

 
Gross Unrealized Gains

 
Gross Unrealized Losses

 
Estimated  Fair Value

Fixed maturities:
 
 
 
 
 
 
 
 
U.S. government, government agencies and authorities
 
$
23,850

 
$
114

 
$
11

 
$
23,953

States, municipalities and political subdivisions
 
2,898

 
13

 
3

 
2,908

Mortgage-backed
 
9,698

 
79

 
15

 
9,762

Asset-backed securities and collateralized mortgage obligations
 
4,560

 
23

 
1

 
4,582

Corporate
 
19,928

 
220

 
27

 
20,121

Total fixed maturities
 
60,934

 
449

 
57

 
61,326

Equity investments:
 
 
 
 
 
 
 
 
Common stock
 
19,868

 
3,053

 
2,182

 
20,739

Warrants
 
1,277

 
55

 
553

 
779

Total equity investments
 
21,145

 
3,108

 
2,735

 
21,518

Total fixed maturities and equity investments
 
$
82,079

 
$
3,557

 
$
2,792

 
$
82,844


(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




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




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

 
Estimated Fair Value

Due in one year or less
 
$
7,257

 
$
7,263

Due after one year through five years
 
42,517

 
42,830

Due after five years through ten years
 
3,646

 
3,670

Due after ten years
 
7,514

 
7,563

Total
 
$
60,934

 
$
61,326


The following tables highlight the aggregate unrealized loss position, by security type, of fixed maturities and equity investments in unrealized loss positions as of September 30, 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)
 
 
 
 
 
 
 
 
September 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
$
4,843

 
$
11

 
$
—

 
$
—

 
$
4,843

 
$
11

States, municipalities and political subdivisions
1,652

 
3

 
—

 
—

 
1,652

 
3

Mortgage-backed
4,341

 
15

 
110

 
—

 
4,451

 
15

Asset-backed securities and collateralized mortgage obligations
1,107

 
1

 
—

 
—

 
1,107

 
1

Corporate
3,653

 
23

 
447

 
4

 
4,100

 
27

Total fixed maturities
15,596

 
53

 
557

 
4

 
16,153

 
57

Equity investments:
 
 
 
 
 
 
 
 


 


Common stock
1,156

 
419

 
7,265

 
1,763

 
8,421

 
2,182

Warrants
104

 
86

 
525

 
467

 
629

 
553

Total equity investments
1,260

 
505

 
7,790

 
2,230

 
9,050

 
2,735

Total
$
16,856

 
$
558

 
$
8,347

 
$
2,234

 
$
25,203

 
$
2,792



 
14
 
KINGSWAY FINANCIAL SERVICES INC.
Notes to Consolidated Financial Statements (Unaudited) September 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 84 and 127 individual investments that were in unrealized loss positions as of September 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 nine months ended

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




September 30, 2016. For the three months ended September 30, 2015, there were no write-downs for other-than-temporary impairments related to investments. For the nine months ended September 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 nine months ended September 30, 2016, or for the three months ended September 30, 2015. There were $0.0 million of other-than-temporary losses recognized in other comprehensive loss for the nine months ended September 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 September 30, 2016 and December 31, 2015, the carrying value of limited liability investments totaled $29.1 million and $20.1 million, respectively. At September 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 September 30, 2016 and December 31, 2015, the carrying value of other investments totaled $7.3 million and $4.1 million, respectively.
Gross realized gains and losses on fixed maturities, equity investments and limited liability investments for the three and nine months ended September 30, 2016 and September 30, 2015, respectively, is comprised as follows:
(in thousands)
 
Three months ended September 30,
 
 
Nine months ended September 30,
 
 
 
2016

 
2015

 
2016

 
2015

Gross realized gains
 
$
47

 
$
84

 
$
295

 
$
137

Gross realized losses
 
(1
)
 
(1
)
 
(353
)
 
(1
)
Net realized gains (losses)
 
$
46

 
$
83

 
$
(58
)
 
$
136


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

 
2015

 
2016

 
2015

Investment income
 
 
 
 
 
 
 
 
  Interest from fixed maturities
 
$
189

 
$
255

 
$
649

 
$
648

Dividends
 
132

 
169

 
524

 
517

Income from limited liability investments
 
490

 
595

 
800

 
1,590

Gain (loss) on change in fair value of warrants
 
27

 
(222
)
 
(219
)
 
(57
)
Other
 
234

 
40

 
373

 
106

Gross investment income
 
1,072

 
837

 
2,127

 
2,804

Investment expenses
 
(36
)
 
(46
)
 
(91
)
 
(172
)
Net investment income
 
$
1,036

 
$
791

 
$
2,036

 
$
2,632

Fixed maturities and short-term investments with an estimated fair value of $13.3 million and $12.9 million were on deposit with state and provincial regulatory authorities at September 30, 2016 and December 31, 2015, respectively. Also, from time to time, the Company pledges investments to third-parties as deposits or to collateralize liabilities incurred under its policies of insurance.

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




The amount of such pledged securities was $17.3 million and $15.8 million at September 30, 2016 and December 31, 2015, respectively.
NOTE 7 INVESTMENTS IN INVESTEES
At September 30, 2016, investment in investee includes the Company's investment in the common stock of Itasca Capital Ltd. ("ICL"). 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 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 September 30, 2016. The Company's investment in ICL is recorded on a three-month lag basis.
At December 31, 2015, investment in investee includes 1347 Investors' investment in the common stock and private units of 1347 Capital Corp. As discussed in Note 5, "Acquisitions, Deconsolidations and Discontinued Operations," during the third quarter of 2016, the Company's ownership percentage in 1347 Investors was reduced to 26.7% and the Company deconsolidated 1347 Investors. As a result of removing the net assets of 1347 Investors from the Company’s consolidated balance sheets, the Company no longer has a direct investment in the common stock and private units of 1347 Capital Corp. at September 30, 2016.
Investments in investees are accounted for under the equity method. The carrying value, estimated fair value and approximate equity percentage for each of the Company's investments in investees at September 30, 2016 and December 31, 2015 were as follows:
(in thousands, except for percentages)
 
 
 
 
 
 
September 30, 2016
 
December 31, 2015
 
 
Equity Percentage
 
Estimated Fair Value
 
Carrying Value
 
Equity Percentage
 
Estimated Fair Value
 
Carrying value
1347 Capital Corp.
 
—
%
 
$
—

 
$
—

 
21.0
%
 
$
12,369

 
$
1,772

ICL
 
31.2
%
 
$
3,474

 
$
3,129

 
—
%
 
$
—

 
$
—

Total
 
 
 
$
3,474

 
$
3,129

 
 
 
$
12,369

 
$
1,772


The estimated fair value of the Company's investment in ICL at September 30, 2016 in the table above is calculated based on the published closing price of ICL at June 30, 2016 to be consistent with the three-month lag in reporting its carrying value under the equity method. The estimated fair value of the Company's investment in ICL based on the published closing price of ICL at September 30, 2016 is $4.3 million.
For the three months ended September 30, 2016 and September 30, 2015, equity in net loss of investees was $0.1 million and $0.2 million, respectively ($1.0 million and $0.4 million for the nine months ended September 30, 2016 and September 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.

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




The components of deferred acquisition costs and the related amortization expense for the three and nine months ended September 30, 2016 and 2015, respectively, are comprised as follows:
(in thousands)
 
Three months ended September 30,
 
 
Nine months ended September 30,
 
 
 
2016

 
2015

 
2016

 
2015

Beginning balance, net
 
$
13,824

 
$
12,617

 
$
12,143

 
$
12,197

Additions
 
7,565

 
5,843

 
22,334

 
19,561

Amortization
 
(6,836
)
 
(5,919
)
 
(19,924
)
 
(19,217
)
Balance at September 30, net
 
$
14,553

 
$
12,541

 
$
14,553

 
$
12,541

NOTE 9 INTANGIBLE ASSETS
Intangible assets are comprised as follows:
(in thousands)
 
 
September 30, 2016
 
 
 
Gross Carrying Value
 
Accumulated Amortization
 
Net Carrying Value
Intangible assets subject to amortization
 
 
 
 
 
 
Acquired lease
 
$
109,092

 
$
473

 
$
108,619

Database
 
4,918

 
1,906

 
3,012

Vehicle service agreements in-force
 
3,680

 
3,506

 
174

Customer-related relationships
 
3,611

 
1,404

 
2,207

Contract-based revenues
 
731

 
31

 
700

Intangible assets not subject to amortization
 
 
 
 
 
 
Insurance licenses
 
7,803

 
—

 
7,803

Trade name
 
663

 
—

 
663

Total
 
$
130,498

 
$
7,320

 
$
123,178


(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, "Acquisitions, Deconsolidations and Discontinued Operations," during the third quarter of 2016, the Company recorded a $109.1 million separately identifiable intangible asset for acquired lease as part of the acquisition of CMC. The acquired lease intangible asset is being amortized on a straight-line basis over its estimated useful life of 48 years. The Company intends to finalize by December 31, 2016 its fair value analysis of the assets acquired and liabilities assumed as

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




part of the acquisition of CMC. These estimates, allocations and calculations are subject to change as we obtain further information; therefore, the final fair market values of the assets acquired and liabilities assumed may not agree with the estimates included in the unaudited consolidated interim financial statements.
As further discussed in Note 5, "Acquisitions, Deconsolidations 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 $0.8 million and $0.3 million for the three months ended September 30, 2016 and September 30, 2015, respectively ($1.4 million and $0.9 million for the nine months ended September 30, 2016 and September 30, 2015, 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 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.



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




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

 
September 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
 
71,193

 
64,893

      Prior years
 
(207
)
 
(299
)
Paid related to:
 
 
 
 

      Current year
 
(42,672
)
 
(37,378
)
      Prior years
 
(34,293
)
 
(33,993
)
Balance at end of period, net
 
48,285

 
53,915

Plus reinsurance recoverable related to property and casualty unpaid loss and loss adjustment expenses
 
706

 
1,523

Balance at end of period, gross
 
$
48,991

 
$
55,438

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

 
September 30, 2015

Balance at beginning of period
 
$
2,975

 
$
2,975

Incurred related to:
 
 
 
 
      Current year
 
4,153

 
4,460

      Prior years
 
—

 
—

Paid related to:
 
 
 
 
      Current year
 
(3,920
)
 
(4,350
)
      Prior years
 
(153
)
 
(110
)
Balance at end of period
 
$
3,055

 
$
2,975


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

 
Carrying Value

 
Principal

 
Carrying Value

Note payable
 
$
179,395

 
$
190,931

 
$
—

 
$
—

Subordinated debt
 
90,500

 
38,774

 
90,500

 
39,898

Total
 
$
269,895

 
$
229,705

 
$
90,500

 
$
39,898



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




Subordinated debt mentioned above consists of the following trust preferred debt instruments:
Issuer
Principal (in thousands)
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

As further discussed in Note 5, "Acquisitions, Deconsolidations and Discontinued Operations," as part of the acquisition of CMC, the Company assumed a note payable with a principal amount of $180.0 million on the date of acquisition that matures on May 15, 2034 and has a fixed interest rate of 4.07%. The note payable was recorded at the date of acquisition at its estimated fair market value, which includes an estimated premium of $11.7 million. This estimated premium is being amortized through the maturity date of the note payable using the effective interest rate method. The carrying value of the note payable at September 30, 2016 represents its estimated amortized cost. These estimates are subject to change as we obtain further information; therefore, the final fair market value of the note payable assumed and the amortization of the premium may not agree with the estimates included in the unaudited consolidated interim financial statements.

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 of approximately $1.1 million 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 September 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 September 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.


 
21
 
KINGSWAY FINANCIAL SERVICES INC.
Notes to Consolidated Financial Statements (Unaudited)