UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
 
 
x
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

FOR THE QUARTERLY PERIOD ENDED September 30, 2013
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 0-2500111
 
Federated National Holding Company
(Exact name of registrant as specified in its charter)

Florida
 
 65-0248866
(State or Other Jurisdiction of Incorporation or Organization)
 
(IRS Employer Identification Number)
 
14050 N.W. 14th Street, Suite 180, Sunrise, Florida 33323
 
(Address of principal executive offices) (Zip Code)

800-293-2532
(Registrant's telephone number, including area code)
 
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.

Yes x No o
 
Indicate by check mark whether the registrant has electronically submitted and posted on its corporate website, 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 the definitions of “large accelerated filer”, “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.

Large accelerated filer o
Accelerated filer o
Non-accelerated filer o
Smaller reporting company x

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).
 
Yes o No x
 
Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date.

Common Stock, $.01 par value –8,325,856 outstanding as of October 29, 2013
 


FEDERATED NATIONAL HOLDING COMPANY

INDEX
 
PART I: FINANCIAL INFORMATION
PAGE
 
 
 
ITEM 1
3
 
 
 
ITEM 2
36
 
 
 
ITEM 3
57
 
 
 
ITEM 4
60
 
 
 
PART II: OTHER INFORMATION
 
 
 
 
ITEM 1
61
 
 
 
ITEM 1A
61
 
 
 
ITEM 2
62
 
 
 
ITEM 3
62
 
 
 
ITEM 4
62
 
 
 
ITEM 5
62
 
 
 
ITEM 6
63
 
 
 
64

- 2 -

PART I: FINANCIAL INFORMATION
Item 1 Financial Statements
FEDERATED NATIONAL HOLDING COMPANY
CONSOLIDATED BALANCE SHEETS
(UNAUDITED)

 
 
Period Ending
 
 
 
September 30, 2013
   
December 31, 2012
 
ASSETS
 
(Dollars in Thousands)
 
Investments
 
   
 
Debt maturities, available for sale, at fair value
 
$
126,013
   
$
101,755
 
Debt maturities, held to maturity, at amortized cost
   
7,295
     
7,359
 
Equity securities, available for sale, at fair value
   
34,734
     
20,982
 
 
               
Total investments
   
168,042
     
130,096
 
 
               
Cash and short term investments
   
46,994
     
21,143
 
Prepaid reinsurance premiums
   
1,707
     
7,045
 
Premiums receivable, net of allowance for credit losses of $103 and $69, respectively
   
20,110
     
8,023
 
Reinsurance recoverable, net
   
2,684
     
3,503
 
Deferred policy acquisition costs
   
14,360
     
8,479
 
Deferred income taxes, net
   
852
     
4,338
 
Income taxes receivable
   
868
     
39
 
Property, plant and equipment, net
   
915
     
564
 
Other assets
   
2,488
     
2,658
 
 
               
Total assets
 
$
259,020
   
$
185,888
 
 
               
LIABILITIES AND SHAREHOLDERS' EQUITY
               
Unpaid losses and LAE
 
$
51,950
   
$
49,908
 
Unearned premiums
   
116,988
     
59,006
 
Premiums deposits and customer credit balances
   
3,841
     
2,458
 
Bank overdraft
   
4,809
     
5,987
 
Accounts payable and accrued expenses
   
7,409
     
2,624
 
 
               
Total liabilities
   
184,997
     
119,983
 
 
               
Shareholders' equity:
               
Common stock, $0.01 par value. Authorized 25,000,000 shares; issued and outstanding 8,073,025 and 7,979,488, respectively
   
81
     
80
 
Preferred stock, $0.01 par value. Authorized 1,000,000 shares; none issued or outstanding
   
-
     
-
 
Additional paid-in capital
   
52,009
     
51,356
 
Accumulated other comprehensive income
               
Unrealized net gains on investments, available for sale
   
4,273
     
4,067
 
Total accumulated other comprehensive income
   
4,273
     
4,067
 
Retained earnings
   
17,660
     
10,402
 
Total shareholders' equity
   
74,023
     
65,905
 
Total liabilities and shareholders' equity
 
$
259,020
   
$
185,888
 

SEE ACCOMPANYING NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
- 3 -

FEDERATED NATIONAL HOLDING COMPANY
CONSOLIDATED STATEMENTS OF OPERATIONS
(UNAUDITED)

 
 
Three Months Ended September 30,
   
Nine Months Ended September 30,
 
 
 
2013
   
2012
   
2013
   
2012
 
 
 
(Dollars in Thousands except EPS and share and dividend data)
   
(Dollars in Thousands except EPS and share and dividend data)
 
Revenue:
 
   
   
   
 
Gross premiums written
 
$
61,489
   
$
25,338
   
$
177,623
   
$
89,683
 
Gross premiums ceded
   
(49,936
)
   
(35,733
)
   
(78,180
)
   
(49,318
)
 
                               
Net premiums written
   
11,553
     
(10,395
)
   
99,443
     
40,365
 
 
                               
Increase in prepaid reinsurance premiums
   
29,318
     
22,797
     
29,870
     
13,218
 
(Increase) decrease in unearned premiums
   
(12,762
)
   
2,686
     
(57,980
)
   
(10,983
)
 
                               
Net change in prepaid reinsurance premiums and unearned premiums
   
16,556
     
25,483
     
(28,110
)
   
2,235
 
 
                               
Net premiums earned
   
28,109
     
15,088
     
71,333
     
42,600
 
Commission income
   
637
     
400
     
1,989
     
1,101
 
Finance revenue
   
241
     
122
     
584
     
363
 
Managing general agent fees
   
884
     
435
     
2,580
     
1,529
 
Net investment income
   
800
     
953
     
2,382
     
2,849
 
Net realized investment gains (losses)
   
780
     
145
     
2,480
     
(83
)
Other income
   
466
     
118
     
618
     
468
 
 
                               
Total revenue
   
31,917
     
17,261
     
81,966
     
48,827
 
 
                               
Expenses:
                               
Losses and LAE
   
14,436
     
8,049
     
36,583
     
20,913
 
Operating and underwriting expenses
   
3,411
     
2,047
     
10,066
     
6,829
 
Salaries and wages
   
2,709
     
2,079
     
7,375
     
6,285
 
Policy acquisition costs - amortization
   
6,576
     
3,983
     
15,370
     
9,712
 
 
                               
Total expenses
   
27,132
     
16,158
     
69,394
     
43,739
 
 
                               
Income before provision for income tax expense
   
4,785
     
1,103
     
12,572
     
5,088
 
Provision for income tax expense
   
1,504
     
353
     
4,411
     
1,844
 
 
                               
Net income
 
$
3,281
   
$
750
   
$
8,161
   
$
3,244
 
 
                               
Net income per share - basic
 
$
0.41
   
$
0.09
   
$
1.02
   
$
0.40
 
 
                               
Net income per share - diluted
 
$
0.39
   
$
0.09
   
$
0.99
   
$
0.40
 
 
                               
Weighted average number of common shares outstanding - basic
   
8,066,773
     
7,948,716
     
8,023,505
     
7,947,459
 
 
                               
Weighted average number of common shares outstanding - diluted
   
8,345,924
     
8,042,356
     
8,260,435
     
8,008,470
 
 
                               
Dividends paid per share
 
$
0.03
   
$
-
   
$
0.08
   
$
-
 

SEE ACCOMPANYING NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
- 4 -

FEDERATED NATIONAL HOLDING COMPANY
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
(UNAUDITED)

 
 
Three Months Ended September 30,
   
Nine Months Ended September 30,
 
 
 
2013
   
2012
   
2013
   
2012
 
 
 
(Dollars in Thousands)
   
(Dollars in Thousands)
 
 
 
   
   
   
 
Net income
 
$
3,281
   
$
750
   
$
8,161
   
$
3,244
 
 
                               
Change in net unrealized gains on investments available for sale
   
2,658
     
3,180
     
331
     
6,203
 
 
                               
Comprehensive income before tax
   
5,939
     
3,930
     
8,492
     
9,447
 
 
                               
Income tax expense related to items of other comprehensive income
   
(1,000
)
   
(1,196
)
   
(125
)
   
(2,334
)
 
                               
Comprehensive income
 
$
4,939
   
$
2,734
   
$
8,367
   
$
7,113
 

SEE ACCOMPANYING NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

- 5 -

FEDERATED NATIONAL HOLDING COMPANY
CONSOLIDATED STATEMENTS OF CASH FLOWS
(UNAUDITED)

 
 
Nine Months Ended September 30,
 
 
 
2013
   
2012
 
 
 
(Dollars in Thousands)
 
Cash flow from operating activities:
 
   
 
Net income
 
$
8,161
   
$
3,244
 
Adjustments to reconcile net income to net cash provided by operating activities:
               
Amortization of investment premium discount, net
   
1,135
     
1,035
 
Depreciation and amortization of property plant and equipment, net
   
190
     
146
 
Net realized investment (gains) losses
   
(2,480
)
   
83
 
Non-cash impairment recognition
   
-
     
44
 
Recovery for credit losses, net
   
-
     
(12
)
(Recovery) provision for uncollectible premiums receivable
   
(34
)
   
9
 
Non-cash compensation
   
188
     
140
 
Changes in operating assets and liabilities:
               
Premiums receivable
   
(12,053
)
   
(2,530
)
Prepaid reinsurance premiums
   
5,339
     
2,952
 
Reinsurance recoverable, net
   
818
     
(118
)
Income taxes recoverable
   
(829
)
   
(70
)
Deferred income tax expense, net of other comprehensive income
   
3,361
     
1,796
 
Policy acquisition costs, net of amortization
   
(5,881
)
   
(766
)
Other assets
   
171
     
427
 
Unpaid losses and LAE
   
2,042
     
(8,805
)
Unearned premiums
   
57,981
     
10,983
 
Premium deposits and customer credit balances
   
1,383
     
(749
)
Income taxes payable
   
-
     
(77
)
Bank overdraft
   
(1,177
)
   
(1,702
)
Accounts payable and accrued expenses
   
4,785
     
211
 
Net cash provided by operating activities
   
63,100
     
6,241
 
Cash flow used by investing activities:
               
Proceeds from sale of investment securities
   
93,079
     
60,711
 
Purchases of investment securities available for sale
   
(129,349
)
   
(71,234
)
Purchases of property and equipment
   
(542
)
   
(81
)
Net cash used by investing activities
   
(36,812
)
   
(10,604
)
Cash flow (used) provided  by financing activities:
               
Exercised stock options
 
$
358
   
$
16
 
Dividends paid
   
(903
)
   
-
 
Tax benefit related to non-cash compensation
   
108
     
77
 
Net cash (used ) provided by financing activities
   
(437
)
   
93
 
Net increase (decrease) in cash and short term investments
   
25,851
     
(4,270
)
Cash and short term investments at beginning of period
   
21,143
     
15,205
 
Cash and short term investments at end of period
 
$
46,994
   
$
10,935
 

SEE ACCOMPANYING NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
- 6 -

FEDERATED NATIONAL HOLDING COMPANY
CONSOLIDATED STATEMENTS OF CASH FLOWS
(UNAUDITED)

 
 
Nine Months Ended September 30,
 
(continued)
 
2013
   
2012
 
 
 
(Dollars in Thousands)
 
Supplemental disclosure of cash flow information:
 
   
 
Cash paid during the period for:
 
   
 
Income taxes
 
$
1,870
   
$
165
 
Non-cash investing and finance activities:
               
Accrued dividends payable
 
$
250
   
$
-
 

SEE ACCOMPANYING NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

- 7 -

Federated National Holding Company
Notes to Condensed Consolidated Financial Statements
 
(1) Organization and Business

In this Quarterly Report on Form 10-Q, “FNHC” and the terms “Company”, “we”, “us” and “our” refer to Federated National Holding Company and its subsidiaries, unless the context indicates otherwise. We changed our name on September 11, 2012, pursuant to approval received at our annual shareholders’ meeting, from 21st Century Holding Company so that our parent company and other subsidiary companies’ names are consistent with our primary insurance subsidiary and the name under which we have been writing insurance for more than 20 years.

FNHC is an insurance holding company that controls substantially all steps in the insurance underwriting, distribution and claims processes through our subsidiaries and our contractual relationships with our independent agents and general agents.

We are authorized to underwrite, and/or place through our wholly owned subsidiaries, homeowners’ multi-peril (“homeowners”), commercial general liability, federal flood, personal auto and various other lines of insurance in Florida and various other states.  We market and distribute our own and third-party insurers’ products and our other services through a network of agents.

Our insurance subsidiary is Federated National Insurance Company (“FNIC”). FNIC is licensed as an admitted carrier in Florida. An admitted carrier is an insurance company that has received a license from the state insurance regulator for authority to write specific lines of insurance in that state.  Through contractual relationships with a network of approximately 3,400 independent agents, of which approximately 1,700 actively sell and service our products, FNIC is authorized to underwrite homeowners’, commercial general liability, fire, allied lines and personal and commercial automobile insurance in Florida. FNIC is licensed as an admitted carrier in Alabama, Louisiana, Georgia and Texas and underwrites commercial general liability insurance in those states, homeowners’ insurance in Louisiana and personal automobile insurance in Georgia and Texas.

FNIC is licensed as a non-admitted carrier in Arkansas, Kentucky, Missouri, Nevada, Oklahoma, South Carolina and Tennessee and can underwrite commercial general liability insurance in all of these states. A non-admitted carrier, sometimes referred to as a “excess and surplus lines” carrier, is permitted to do business in a state and, although it is strictly regulated to protect policyholders from a variety of illegal and unethical practices, including fraud, non-admitted carriers are subject to considerably less regulation with respect to policy rates and forms. Non-admitted carriers are not required to financially contribute to and benefit from the state guarantee fund, which is used to pay for losses if an insurance carrier becomes insolvent or unable to pay the losses due their policyholders.

In January 2011, we merged FNIC and our other wholly owned insurance subsidiary, American Vehicle Insurance Company (“American Vehicle”), with FNIC continuing the operations of both entities. As part of its approval of the merger between FNIC and American Vehicle, the Florida Office of Insurance Regulation (“Florida OIR”), the Company, FNIC and American Vehicle entered into a consent order with the Florida OIR dated January 25, 2011 (the “Consent Order”), which was amended in February 2013, due to FNIC’s statutory underwriting profit during 2012. Pursuant to the amended Consent Order, the Company and the resulting company in the merger (the “Merged Company”) have agreed to the following:

· The Merged Company retained the following licenses: (010) Fire, (020) Allied Lines, (040) Homeowners Multi Peril, (050) Commercial Multi Peril, (090) Inland Marine, (170) Other Liability, (192) Private Passenger Auto Liability, (194) Commercial Auto Liability, (211) Private Passenger Auto Physical Damage and (212) Commercial Auto Physical Damage.

· The Merged Company will not write commercial multi peril policy premium without prior approval from the Florida OIR. The Merged Company has no commercial multi peril policy premium in force.

· The Merged Company surrendered its surety license. The Merged Company has no surety policy premium in force.

· The Merged Company will not write new commercial habitation condominium associations without prior approval from the Florida OIR. The current commercial habitation book of business is fully earned.

- 8 -

Federated National Holding Company
Notes to Condensed Consolidated Financial Statements
 
· The Merged Company agreed to maintain the total number of its homeowners’ policies in Miami-Dade, Broward and Palm Beach counties (the “Tri-County Area”) to no more than 35% of its entire homeowners’ book. As of September 30, 2013, the Company had approximately 18.2% of its homeowners’ policies located within Tri-County Area.

· The managing general agency fees payable by the Merged Company to Federated National Underwriters, Inc. (“FNU”), formerly known as Assurance Managing General Agents, Inc., a wholly owned subsidiary of the Company, which were traditionally 6% of gross written premium, were reduced and will not exceed 4% without prior approval from the Florida OIR. The Merged Company has lowered the fee to amounts varying between 2% and 4% of gross written to further support the FNIC results of operations. This will have no impact on the Company’s consolidated financial results.

· The claims service fees payable by the Merged Company to Federated National Adjusting, Inc. (“FNA”), formerly known as Superior Adjusting, Inc., were reduced from the traditional 4.5% of gross earned premium to 3.6% of gross earned premium. This will have no impact on the Company’s consolidated financial results.

The merger of FNIC and American Vehicle will be an ongoing transition, many aspects of which will take effect over time. References to the companies contained herein are intended to be references to the operations of FNIC following the January 2011 merger. References to the historical activities of American Vehicle are appropriately identified throughout this document.

During the three months ended September 30, 2013, 88.0%, 4.2%, 2.9% and 4.9% of the premiums we underwrote were for homeowners’, commercial general liability, federal flood, and automobile insurance, respectively. During the three months ended September 30, 2013, 20.1% of the homeowners’ premiums we underwrote were produced under an agency agreement with Ivantage Select Agency, Inc., an affiliate of Allstate Insurance Company, that grants Allstate agents the authority to offer certain FNU products. This network of agents began writing for FNIC in March of this year. During the three months ended September 30, 2012, 81.1%, 9.4%, 6.2% and 3.3% of the premiums we underwrote were for homeowners’, commercial general liability, federal flood, and automobile insurance, respectively.

During the nine months ended September 30, 2013, 88.0%, 4.5%, 2.8% and 4.7% of the premiums we underwrote were for homeowners’, commercial general liability, federal flood, and automobile insurance, respectively. During the nine months ended September 30, 2012, 84.6%, 8.2%, 4.6% and 2.6% of the premiums we underwrote were for homeowners’, commercial general liability, federal flood, and automobile insurance, respectively.

Our business, results of operations and financial condition are subject to fluctuations due to a variety of factors. Abnormally high severity or frequency of claims in any period could have a material adverse effect on us. When our estimated liabilities for unpaid losses and loss adjustment expenses (“LAE”) are less than the actuarially determined amounts, we increase the expense in the current period. Conversely, when our estimated liabilities for unpaid losses and LAE are greater than the actuarially determined amounts, we decrease the expense in the current period.

We are focusing our marketing efforts on continuing to expand our distribution network while maintaining our commitment to long-term relationships. We market our products and services throughout Florida and in other states by establishing relationships with additional independent agents and general agents. There can be no assurance, however, that we will be able to obtain the required regulatory approvals to offer additional insurance products or expand into other states.

FNU acts as FNIC’s exclusive managing general agent in Florida and is also licensed as a managing general agent in the States of Alabama, Georgia, Louisiana, Mississippi, Missouri, North Carolina, Nevada, South Carolina, Texas and Virginia. FNU has contracted with several unaffiliated insurance companies to sell commercial general liability, workers compensation, personal umbrella, inland marine and other various lines of insurance through FNU’s existing network of agents.
- 9 -

Federated National Holding Company
Notes to Condensed Consolidated Financial Statements

FNU earns commissions and fees for providing policy administration, marketing, accounting and analytical services, and for participating in the negotiation of reinsurance contracts. FNU earns a $25 per policy fee, and traditionally a 6% commission fee from its affiliate, FNIC. During the fourth quarter of 2010, FNU, pursuant to the Consent Order as discussed above, reduced its fee to earn amounts varying between 2% and 4%, which we anticipate will return to 6% at an unknown future date with approval from the Florida OIR. A formal agreement reflecting this fee modification was executed during January 2011.

We internally process claims made by our insureds through our wholly owned claims adjusting company, FNA. Our agents have no authority to settle claims or otherwise exercise control over the claims process. Furthermore, we believe that the retention of independent adjusters, in addition to the employment of salaried claims personnel, results in reduced ultimate loss payments, lower LAE and improved customer service for our claimants and policyholders. We also employ an in-house Litigation Manager to cost effectively manage claims-related litigation and to monitor our claims handling practices for efficiency and regulatory compliance.

Insure-Link, Inc. (“Insure-Link”) serves as an independent insurance agency. The insurance agency markets direct to the public to provide a variety of insurance products and services to individual clients, as well as business clients, by offering a full line of insurance products including, but not limited to,  homeowners’, flood, personal and commercial automobile, commercial general liability and workers’ compensation insurance through their agency appointments with over thirty different carriers.

(2) Basis of Presentation

The accompanying unaudited condensed consolidated financial statements for the Company and its subsidiaries have been prepared in accordance with accounting principles generally accepted in the United States of America referred to as Generally Accepted Accounting Principles (“GAAP”) for interim financial information, and the Securities and Exchange Commission (“SEC”) rules for interim financial reporting. Certain information and footnote disclosures normally included in financial statements prepared in accordance with GAAP have been condensed or omitted pursuant to such rules and regulations. However, in the opinion of management, the accompanying financial statements reflect all normal recurring adjustments necessary to present fairly the Company’s financial position as of September 30, 2013 and the results of operations and cash flows for the periods presented.

The results of operations for the interim periods presented are not necessarily indicative of the results of operations to be expected for any subsequent interim period or for the fiscal year ending December 31, 2013. The accompanying unaudited condensed consolidated financial statements and notes thereto should be read in conjunction with the audited consolidated financial statements for the year ended December 31, 2012 included in the Company’s Form 10-K, which was filed with the SEC on April 1, 2013.

In preparing the interim unaudited condensed consolidated financial statements, management was required to make certain estimates and assumptions that affect the reported amounts of assets, liabilities, revenues, expenses and related disclosures at the financial reporting date and throughout the periods being reported upon. Certain of the estimates result from judgments that can be subjective and complex and consequently actual results may differ from these estimates.

Material estimates that are particularly susceptible to significant change in the near-term relate to the determination of loss and LAE, ceded reinsurance balances payable, the recoverability of Deferred Policy Acquisition Costs (“DPAC”), the determination of federal income taxes, and the net realizable value of reinsurance recoverables. Although considerable variability is inherent in these estimates, management believes that the amounts provided are reasonable. These estimates are continually reviewed and adjusted as necessary. Such adjustments are reflected in current operations.

All significant intercompany balances and transactions have been eliminated. No reclassifications have been made to the prior-period balances to conform to the current-period presentation.
- 10 -

Federated National Holding Company
Notes to Condensed Consolidated Financial Statements

(3) Summary of Significant Accounting Policies and Practices

(A)  Critical Accounting Policies

The preparation of financial statements in conformity with GAAP requires management to make estimates and assumptions about future events that affect the amounts reported in the financial statements and accompanying notes. Future events and their effects cannot be determined with absolute certainty. Therefore, the determination of estimates requires the exercise of judgment. Actual results inevitably will differ from those estimates, and such differences may be material to the financial statements.

The most significant accounting estimates inherent in the preparation of our financial statements include estimates associated with management’s evaluation of the determination of (i) liability for unpaid losses and LAE, (ii) the amount and recoverability of amortization of DPAC, (iii) the valuation of investments and (iv) estimates for our reserves with respect to finance contracts, premiums receivable and deferred income taxes. Various assumptions and other factors underlie the determination of these significant estimates, which are described in greater detail in Footnote 2 of the Company’s audited consolidated financial statements for the fiscal year ended December 31, 2012, which we included in the Company’s Annual Report on Form 10-K which was filed with the SEC on April 1, 2013.

We believe that there were no significant changes in those critical accounting policies and estimates during the nine months ended September 30, 2013. Senior management has reviewed the development and selection of our critical accounting policies and estimates and their disclosure in this Form 10-Q with the Audit Committee of our Board of Directors.

The process of determining significant estimates is fact-specific and takes into account factors such as historical experience, current and expected economic conditions, and in the case of unpaid losses and LAE, an actuarial valuation. Management regularly reevaluates these significant factors and makes adjustments where facts and circumstances dictate. In selecting the best estimate, we utilize various actuarial methodologies. Each of these methodologies is designed to forecast the number of claims we will be called upon to pay and the amounts we will pay on average to settle those claims. In arriving at our best estimate, our actuaries consider the likely predictive value of the various loss development methodologies employed in light of underwriting practices, premium rate changes and claim settlement practices that may have occurred, and weight the credibility of each methodology. Our actuarial methodologies take into account various factors, including, but not limited to, paid losses, liability estimates for reported losses, paid allocated LAE, salvage and other recoveries received, reported claim counts, open claim counts and counts for claims closed with and without payment for loss.

Accounting for loss contingencies pursuant to Financial Accounting Standards Board (“FASB”) issued guidance involves the existence of a condition, situation or set of circumstances involving uncertainty as to possible loss that will ultimately be resolved when one or more future event(s) occur or fail to occur. Additionally, accounting for a loss contingency requires management to assess each event as probable, reasonably possible or remote. Probable is defined as the future event or events are likely to occur. Reasonably possible is defined as the chance of the future event or events occurring is more than remote but less than probable, while remote is defined as the chance of the future event or events occurring is slight. An estimated loss in connection with a loss contingency shall be recorded by a charge to current operations if both of the following conditions are met: First, the amount can be reasonably estimated, and second, the information available prior to issuance of the financial statements indicates that it is probable that a liability has been incurred at the date of the financial statements. It is implicit in this condition that it is probable that one or more future events will occur confirming the fact of the loss or incurrence of a liability.

We are required to review the contractual terms of all our reinsurance purchases to ensure compliance with FASB issued guidance. The guidance establishes the conditions required for a contract with a reinsurer to be accounted for as reinsurance and prescribes accounting and reporting standards for those contracts. Contracts that do not result in the reasonable possibility that the reinsurer may realize a significant loss from the insurance risk assumed generally do not meet the conditions for reinsurance accounting and must be accounted for as deposits. The guidance also requires us to disclose the nature, purpose and effect of reinsurance transactions, including the premium amounts associated with reinsurance assumed and ceded. It also requires disclosure of concentrations of credit risk associated with reinsurance receivables and prepaid reinsurance premiums.
- 11 -

Federated National Holding Company
Notes to Condensed Consolidated Financial Statements
 
FASB issued guidance addresses accounting and reporting for (a) investments in equity securities that have readily determinable fair values and (b) all investments in debt securities. The guidance requires that these securities be classified into one of three categories: Held-to-maturity, Trading, or Available-for-sale securities.

Investments classified as held-to-maturity include debt securities wherein the Company’s intent and ability are to hold the investment until maturity. The accounting treatment for held-to-maturity investments is to carry them at amortized cost without consideration to unrealized gains or losses.

Investments classified as trading securities include debt and equity securities bought and held primarily for the sale in the near term. The accounting treatment for trading securities is to carry them at fair value with unrealized holding gains and losses included in current period operations.

Investments classified as available-for-sale include debt and equity securities that are not classified as held-to-maturity or as trading security investments. The accounting treatment for available-for-sale securities is to carry them at fair value with unrealized holding gains and losses excluded from earnings and reported as a separate component of shareholders’ equity, namely “Other Comprehensive Income” and the components of other comprehensive income are presented in a statement separate from and consecutive with the statement of operations.
A decline in the fair value of an available-for-sale security below cost that is deemed other-than temporary results in a charge to income, resulting in the establishment of a new cost basis for the security.

 Premiums and discounts are amortized or accreted, respectively, over the life of the related debt security as an adjustment to yield using a method that approximates the effective interest method. Dividends and interest income are recognized when earned. Realized gains and losses are included in earnings and are derived using the specific-identification method for determining the cost of securities sold.

Financial instruments, which potentially expose us to concentrations of credit risk, consist primarily of investments, premiums receivable, amounts due from reinsurers on paid and unpaid losses and finance contracts. We have not experienced significant losses related to premiums receivable from individual policyholders or groups of policyholders in a particular industry or geographic area. We believe no credit risk beyond the amounts provided for collection losses is inherent in our premiums receivable or finance contracts. In order to reduce credit risk for amounts due from reinsurers, we seek to do business with financially sound reinsurance companies and regularly review the financial strength of all reinsurers used. Additionally, our credit risk in connection with our reinsurers is mitigated by the establishment of irrevocable clean letters of credit in favor of FNIC.

The fair value of our investments is estimated based on prices published by financial services or quotations received from securities dealers and is reflective of the interest rate environment that existed as of the close of business on September 30, 2013 and December 31, 2012. Changes in interest rates subsequent to September 30, 2013 and December 31, 2012 may affect the fair value of our investments.

The carrying amounts for the following financial instrument categories approximate their fair values at September 30, 2013 and December 31, 2012 because of their short-term nature: cash and short term investments, premiums receivable, finance contracts, due from reinsurers, revolving credit outstanding, bank overdraft, accounts payable and accrued expenses.

(B) Impact of New Accounting Pronouncements

In July 2013, the FASB issued Accounting Standard Update (“ASU”) No. 2013-11: Income Taxes (Topic 740): Presentation of an Unrecognized Tax Benefit When a Net Operating Loss Carryforward, a Similar Tax Loss, or a Tax Credit Carryforward Exists.  Topic 740, Income Taxes, does not include explicit guidance on the financial statement presentation of an unrecognized tax benefit when a net operating loss carryforward, a similar tax loss, or a tax credit carryforward exists, and there is diversity in practice in the presentation of unrecognized tax benefit in those instances.  The objective of the amendments in this ASU is to eliminate that diversity in practice.  The ASU applies to all entities that have unrecognized tax benefits when a net operating loss carry forward, a similar tax loss, or a tax credit carryforward exists at the operating date. The ASU is effective for fiscal years, and interim periods within those years, beginning after December 15, 2013 and early adoption is permitted.  The amendments in this ASU should be applied prospectively to all unrecognized tax benefits that exist at the effective date and   retrospective application is permitted.  The adoption of the amendments in this ASU did not have a material impact on our financial condition, results of operations or cash flows.
- 12 -

Federated National Holding Company
Notes to Condensed Consolidated Financial Statements

In February 2013, the FASB issued ASU No. 2013-02: Comprehensive Income (Topic 220): Reporting of Amounts Reclassified Out of Accumulated Other Comprehensive Income.  The objective of this ASU is to improve the reporting of reclassifications out of accumulated other comprehensive income.  The amendments require an entity to report the effect of significant reclassifications out of accumulated other comprehensive income on the respective line items in net income if the amount being reclassified is required under U.S. GAAP to be reclassified in its entirety in net income.  For other amounts that are not required to be reclassified to net income in the same reporting period, an entity is required to cross-reference other disclosures required under U.S. GAAP that provide additional detail about those amounts.  The amendments in the ASU do not change the current requirements for reporting net income or other comprehensive income in financial statements.  The ASU is effective prospectively for reporting periods beginning after December 15, 2012.  The adoption of these amendments will not have a material impact on our financial condition, results of operations or cash flows.

In January 2013, the FASB issued ASU No. 2013-01: Balance Sheet (Topic 210): Clarifying the Scope of Disclosures about Offsetting Assets and Liabilities. The objective of this ASU is to clarify the scope of offsetting disclosures and to address implementation issues with ASU No. 2011-11, Balance Sheet (Topic 210): Disclosures about Offsetting Assets and Liabilities.  The amendments clarify that the scope of ASU 2011-11 applies to derivatives accounted for in accordance with Topic 815, Derivatives and Hedging, including bifurcated embedded derivatives, repurchase agreements and reverse repurchase agreements, and securities borrowing and securities lending transactions.  An entity is required to apply the amendments for fiscal years beginning on or after January 1, 2013, and interim periods within those annual periods.  An entity should provide the required disclosures retrospectively for all comparative periods.  The adoption of these amendments will not have a material impact on our financial condition, results of operations or cash flows.

In July 2012, the FASB issued ASU No. 2012-02: Intangibles – Goodwill and Other (Topic 350): Testing Indefinite-Lived Intangible Assets for Impairment. The objective of the amendments in this ASU is to reduce the cost and complexity of performing an impairment test for indefinite-lived intangible assets by simplifying how an entity tests those assets for impairment and to improve consistency in impairment testing guidance among long-lived asset categories.  The amendments permit an entity first to assess qualitative factors to determine whether it is more likely than not that an indefinite-lived intangible asset is impaired as a basis for determining whether it is necessary to perform the quantitative impairment test in accordance with Subtopic 350-30.  The more-likely-than-not threshold is defined as having a likelihood of more than 50 percent.   Upon adoption, these amendments are effective for annual and interim impairment tests performed for fiscal years beginning after September 15, 2012; early adoption is permitted.  The adoption of these amendments did not have a material impact on our financial condition, results of operations or cash flows.

In June 2011, the FASB issued ASU No. 2011-05: Comprehensive Income (Topic 220):  Presentation of Comprehensive Income. The guidance in this ASU is intended to increase the prominence of items reported in other comprehensive income in the financial statements by presenting the total of comprehensive income, the components of net income and the components of other comprehensive income either in a single continuous statement of comprehensive income or in two separate but consecutive statements. This ASU eliminates the option to present the components of other comprehensive income as part of the statement of changes in stockholders' equity. The guidance in this ASU does not change the items that must be reported in other comprehensive income or when an item of other comprehensive income must be reclassified to net income. Upon adoption, this update is to be applied retrospectively and is effective during interim and annual periods beginning after December 15, 2011.  Early adoption is permitted. The adoption of this ASU did not have a material impact on our financial condition, results of operations or cash flows.
- 13 -

Federated National Holding Company
Notes to Condensed Consolidated Financial Statements

In December 2011, the FASB issued ASU No. 2011-12:  Comprehensive Income (Topic 220): Deferral of the Effective Date for Amendments to the Presentation of Reclassifications of Items Out of Accumulated Other Comprehensive Income in Accounting Standards Update No. 2011-05.  The guidance defers certain provisions contained in ASU No. 2011-05 requiring the requirement to present components of reclassifications of other comprehensive income on the face of the income statement or in the notes to the financial statements. However, this deferral does not impact the other requirements contained in the new standard on comprehensive income as described above. This ASU is effective during interim and annual periods beginning after December 15, 2011.  The adoption of this ASU did not have a material impact on our financial condition, results of operations or cash flows.

In September 2011, the FASB issued ASU No. 2011-08: Intangibles – Goodwill and Other (Topic 350): Testing Goodwill for Impairment, which amends ASC Topic 350, Intangibles – Goodwill and Other. The guidance in this ASU permits an entity to first assess qualitative factors to determine whether it is more likely than not that the fair value of a reporting unit is less than its carrying amount as a basis for determining whether it is necessary to perform the two-step goodwill impairment test described in ASC Topic 350. Under the amendments in this ASU, an entity is not required to calculate the fair value of a reporting unit unless the entity determines that it is more likely than not that its fair value is less than its carrying amount. The amendments are effective for annual and interim goodwill impairment tests performed for fiscal years beginning after December 15, 2011. Early adoption is permitted, including for annual and interim goodwill impairment tests performed as of a date before September 15, 2011, if an entity’s financial statements for the most recent annual or interim period have not yet been issued or, for nonpublic entities, have not yet been made available for issuance. The adoption of this ASU did not have a material impact on our financial condition, results of operations or cash flows.

In December 2011, the FASB issued ASU No. 2011-11: Balance Sheet (Topic 210): Disclosures about Offsetting Assets and Liabilities, which requires new disclosure requirements mandating that entities disclose both gross and net information about instruments and transactions eligible for offset in the statement of financial position as well as instruments and transactions subject to an agreement similar to a master netting arrangement. In addition, the standard requires disclosure of collateral received and posted in connection with master netting agreements or similar arrangements. This ASU is effective for annual reporting periods beginning on or after January 1, 2013, and interim periods within those annual periods. The adoption of this ASU will not have a material impact on our financial condition, results of operations or cash flows.

In October 2010, the FASB issued ASU No. 2010-26: Financial Services – Insurance (Topic 944): Accounting for Costs Associated with Acquiring or Renewing Insurance Contracts, a consensus of FASB Emerging Issues Task Force.  The amendments in this update modify the definition of the types of costs incurred by insurance entities that can be capitalized in the acquisition of new and renewal contracts. The amendments in this update specify that the costs must be based on successful efforts (that is, acquiring a new or renewal contract).  The amendments also specify that advertising costs should be included as deferred acquisition costs under certain circumstances.  The amendments in this update are effective for fiscal years, and interim period within those fiscal years, beginning after December 15, 2011.  The amendments in this update should be applied prospectively upon adoption.  Retrospective application to all prior periods presented upon the date of adoption also is permitted.  The adoption of this ASU did not have a material impact on the Company’s consolidated financial statements.

Other recent accounting pronouncements issued by FASB, the American Institute of Certified Public Accountants (“AICPA”), and the SEC did not or are not believed by management to have a material impact on the Company’s present or future financial statements.
- 14 -

Federated National Holding Company
Notes to Condensed Consolidated Financial Statements

(C) Stock Options

Pursuant to FASB issued guidance, compensation cost recognized during the nine months ended September 30, 2013 includes compensation cost for all share-based payments granted subsequent to January 1, 2006, based on the grant date fair value estimated in accordance with the guidance.

(D) Earnings per Share

Basic earnings per share (“Basic EPS”) is computed by dividing net income by the weighted average number of common shares outstanding during the period presented. Diluted earnings per share (“Diluted EPS”) is computed by dividing net income by the weighted average number of shares of common stock and common stock equivalents outstanding during the period presented.

(E) Reclassifications

No reclassification of the 2012 financial statements was necessary to conform to the 2013 presentation.

(4) Commitments and Contingencies

Management has a responsibility to continually measure and monitor its commitments and its contingencies. The nature of the Company’s commitments and contingencies can be grouped into three major categories: insured claim activity, assessment related activities and operational matters.

(A) Insured Claim Activity

We are involved in claims and legal actions arising in the ordinary course of business. The amount of liability for these claims and lawsuits is uncertain. Revisions to our estimates are based on our analysis of subsequent information that we receive regarding various factors, including: (i) per claim information; (ii) company and industry historical loss experience; (iii) legislative enactments, judicial decisions, legal developments in the awarding of damages; and (iv) trends in general economic conditions, including the effects of inflation. Management revises its estimates based on the results of its analysis. This process assumes that experience, adjusted for the effects of current developments and anticipated trends, is an appropriate basis for estimating the ultimate settlement of all claims. There is no precise method for subsequently evaluating the impact of any specific factor on the adequacy of the reserves, because the eventual redundancy or deficiency is affected by multiple factors. In the opinion of management, the ultimate disposition of these matters may have a material adverse effect on our consolidated financial position, results of operations, or liquidity.

The Company’s subsidiaries are, from time to time, named as defendants in various lawsuits incidental to their insurance operations. Legal actions relating to claims made in the ordinary course of seeking indemnification for a loss covered by the insurance policy are considered by the Company in establishing loss and LAE reserves.

The Company also faces, in the ordinary course of business, lawsuits that seek damages beyond policy limits. The Company continually evaluates potential liabilities and reserves for litigation of these types using the criteria established by FASB issued guidance. Under this guidance, reserves for a loss are recorded if the likelihood of occurrence is probable and the amount can be reasonably estimated. If a loss, while not probable, is judged to be reasonably possible, management will make an estimate of a possible range of loss or state that an estimate cannot be made. Management considers each legal action using this guidance and records reserves for losses as warranted.

(B) Assessment Related Activity

We operate in a regulatory environment where certain entities and organizations have the authority to require us to participate in assessments. Currently these entities and organizations include, but are not limited to, Florida Insurance Guaranty Association (“FIGA”), Citizens Property Insurance Corporation (“Citizens”), Florida Hurricane Catastrophe Fund (“FHCF”) and Florida Joint Underwriters Insurance Association (“JUA”). As a direct premium writer in the state of Florida, we are required to participate in certain insurer solvency associations under Florida Statutes Section 631.57(3) (a), administered by FIGA.
- 15 -

Federated National Holding Company
Notes to Condensed Consolidated Financial Statements
 
During December 2012, the Company was assessed $0.8 million by FIGA relating to the failures of Florida domestic property and casualty insurance companies. Future assessments are likely, although the impact of these assessments on our balance sheet, results of operations or cash flow are undeterminable at this time.

FNIC is also required to participate in an insurance apportionment plan under Florida Statutes Section 627.351, which is referred to as a JUA Plan. The JUA Plan provides for the equitable apportionment of any profits realized, or losses and expenses incurred, among participating automobile insurers. In the event of an underwriting deficit incurred by the JUA Plan which is not recovered through the policyholders in the JUA Plan, such deficit shall be recovered from the companies participating in the JUA Plan in the proportion that the net direct written premiums of each such member during the preceding calendar year bear to the aggregate net direct premiums written in this state by all members of the JUA Plan. FNIC was not assessed by the JUA Plan during 2013 or 2012. Future assessments by this association are undeterminable at this time.

(C) Operational Matters

The Company’s consolidated federal and state income tax returns for 2010 - 2012 are open for review by the Internal Revenue Service (“IRS”) and various state taxing authorities. The Company’s 2011 federal tax return is currently under review by the IRS. The 2012 federal and state income tax returns were filed by the extended due date in the third quarter of 2013. The 2005 and 2006 income tax returns and net operating loss carry-back from tax year 2009 were reviewed by the Joint Committee on Taxation. The Joint Committee on Taxation completed its consideration in September 2011 and took no exception to the conclusions reached by the IRS regarding the net operating loss carry-back.

The Company has recorded a net deferred tax asset of $0.9 million and $4.3 million as of September 30, 2013 and December 31, 2012, respectively. Realization of net deferred tax asset is dependent on generating sufficient taxable income in future periods. Management believes that it is more likely than not that the deferred tax assets will be realized and as such no valuation allowance has been recorded against the net deferred tax asset. Management considers the scheduled reversal of deferred tax liabilities, projected future taxable income and tax planning strategies in making this assessment. At September 30, 2013, based upon the level of historical taxable income and projections for future taxable income over the periods in which the deferred tax assets are deductible, management believes it is more likely than not that the Company will realize the benefits of these deductible differences. When assessing the need for valuation allowances, the Company considers future taxable income and ongoing prudent and feasible tax planning strategies. Should a change in circumstances lead to a change in judgment about the realizability of deferred tax assets in future years, the Company would record valuation allowances as deemed appropriate in the period that the change in circumstances occurs, along with a corresponding increase or charge to net income. The resolution of tax reserves and changes in valuation allowances could be material to the Company’s results of operations for any period, but is not expected to be material to the Company’s financial position.

Our executive offices are located at 14050 N.W. 14th Street, Suite 180, Sunrise, Florida 33323 in an 18,500 square foot office facility. All of our operations are consolidated within this facility. We believe that the facilities are well maintained, in substantial compliance with environmental laws and regulations, and adequately covered by insurance. We also believe that these leased facilities are not unique and could be replaced, if necessary, at the end of the lease term. Our lease for this office space will expire in May 2017.

The expected future payments in connection with this lease are as follows.

Fiscal Year
 
Payments
 
 
 
(Dollars in Thousands)
 
2013
   
96
 
2014
   
392
 
2015
   
400
 
2016
   
408
 
2017
   
156
 
Total
 
$
1,452
 

- 16 -

Federated National Holding Company
Notes to Condensed Consolidated Financial Statements
 
The Company is not currently involved in any material legal actions arising from the ordinary course of business that are not related to the insured claims activity.

(5) Investments

FASB issued guidance addresses accounting and reporting for (a) investments in equity securities that have readily determinable fair values and (b) all investments in debt securities. The guidance requires that these securities be classified into one of three categories: Held-to-maturity, Trading, or Available-for-sale securities.

Investments classified as held-to-maturity include debt securities wherein the Company’s intent and ability are to hold the investment until maturity. The accounting treatment for held-to-maturity investments is to carry them at amortized cost without consideration to unrealized gains or losses. Investments classified as trading securities include debt and equity securities bought and held primarily for the sale in the near term. The accounting treatment for trading securities is to carry them at fair value with unrealized holding gains and losses included in current period operations. Investments classified as available-for-sale include debt and equity securities that are not classified as held-to-maturity or as trading security investments. The accounting treatment for available-for-sale securities is to carry them at fair value with unrealized holding gains and losses excluded from earnings and reported as a separate component of shareholders’ equity, namely “Other Comprehensive Income”.

Total investments increased $37.9 million, or 29.2%, to $168.0 million as of September 30, 2013, compared with $130.1 million as of December 31, 2012.

The debt and equity securities that are available for sale and carried at fair value represent 96% of total investments as of September 30, 2013, compared with 94% as of December 31, 2012.

We did not hold any trading investment securities during the nine months ended September 30, 2013.

The FASB issued guidance also addresses the determination as to when an investment is considered impaired, whether that impairment is other-than temporary, and the measurement of an impairment loss. The Company’s policy for the valuation of temporarily impaired securities is to determine impairment based on the analysis of the following factors.

· rating downgrade or other credit event (eg., failure to pay interest when due);

· length of time and the extent to which the fair value has been less than amortized cost;

· financial condition and near term prospects of the issuer, including any specific events which may influence the operations of the issuer such as changes in technology or discontinuance of a business segment;

· prospects for the issuer’s industry segment;

· intent and ability of the Company to retain the investment for a period of time sufficient to allow for anticipated recovery in market value;

· historical volatility of the fair value of the security.

Pursuant to FASB issued guidance, the Company records the unrealized losses, net of estimated income taxes that are associated with that part of our portfolio classified as available-for-sale through the shareholders' equity account titled “Other Comprehensive Income”. Management periodically reviews the individual investments that comprise our portfolio in order to determine whether a decline in fair value below our cost either is other-than temporarily or permanently impaired. Factors used in such consideration include, but are not limited to, the extent and length of time over which the market value has been less than cost, the financial condition and near-term prospects of the issuer and our ability and intent to keep the investment for a period sufficient to allow for an anticipated recovery in market value.
- 17 -

Federated National Holding Company
Notes to Condensed Consolidated Financial Statements
 
In reaching a conclusion that a security is either other-than-temporarily or permanently impaired we consider such factors as the timeliness and completeness of expected dividends, principal and interest payments, ratings from nationally recognized statistical rating organizations such as Standard and Poor’s (“S&P”) and Moody’s Investors Service, Inc. (“Moody’s”), as well as information released via the general media channels.

In connection with this process, we have not charged net realized losses to operations during the three and nine months ended September 30, 2013 or the three months ended September 30, 2012, whereas we have charged $44,000 of net realized investment losses to operations during the nine months ended September 30, 2012.

As of September 30, 2013 and December 31, 2012, respectively, all of our securities are in good standing and not impaired as defined by FASB issued guidance.

As of September 30, 2013 and December 31, 2012, our investments consisted primarily of corporate bonds held in various industries, municipal bonds and United States government bonds. As of September 30, 2013, 78% of our debt portfolio was in diverse industries and 22% was in United States government bonds. As of September 30, 2013, approximately 91% of our equity holdings were in equities related to diverse industries and 9% were in mutual funds. As of December 31, 2012, 69% of our debt portfolio was in diverse industries and 31% is in United States government bonds. As of December 31, 2012, approximately 87% of our equity holdings were in equities related to diverse industries and 13% were in mutual funds.

As of September 30, 2013 and December 31, 2012, we have classified $7.3 million and $7.4 million, respectively, of our bond portfolio as held-to-maturity. We classify bonds as held-to-maturity to support securitization of credit requirements.

During the three months ended September 30, 2013, we did not re-classify any of our bond portfolio between available-for-sale and held-to-maturity. During the nine months ended September 30, 2013, we re-classified $0.1 million of our bond portfolio between available-for-sale and held-to-maturity. During the three and nine months ended September 30, 2012 respectively, we did not re-classify any of our bond portfolio between available-for-sale and held-to-maturity.

During April 2006, American Vehicle finalized a $15.0 million irrevocable letter of credit in conjunction with the 100% Quota Share Reinsurance Agreement with Republic Underwriters Insurance Company (“Republic”) which was terminated in April 2007. During 2010, the letter of credit in favor of Republic was replaced by a fully funded trust agreement. As of September 30, 2013 and December 31, 2012 respectively, the amount held in trust was $1.0 million.
- 18 -

Federated National Holding Company
Notes to Condensed Consolidated Financial Statements

 (A) Debt and Equity Securities

The following table summarizes, by type, our investments as of September 30, 2013 and December 31, 2012.

 
 
September 30, 2013
   
December 31, 2012
 
 
 
Carrying
   
Percent
   
Carrying
   
Percent
 
 
 
Amount
   
of Total
   
Amount
   
of Total
 
 
 
(Dollars in Thousands)
 
Debt securities, at market:
 
   
   
   
 
United States government obligations and authorities
 
$
23,745
     
14.13
%
 
$
27,392
     
21.06
%
Obligations of states and political subdivisions
   
23,677
     
14.09
%
   
3,939
     
3.03
%
Corporate
   
75,201
     
44.75
%
   
67,313
     
51.74
%
International
   
3,390
     
2.02
%
   
3,111
     
2.39
%
 
   
126,013
     
74.99
%
   
101,755
     
78.22
%
Debt securities, at amortized cost:
                               
United States government obligations and authorities
   
5,150
     
3.07
%
   
6,016
     
4.62
%
Corporate
   
2,036
     
1.21
%
   
1,203
     
0.92
%
International
   
109
     
0.06
%
   
140
     
0.11
%
 
   
7,295
     
4.34
%
   
7,359
     
5.65
%
Total debt securities
   
133,308
     
79.33
%
   
109,114
     
83.87
%
 
                               
Equity securities, at market:
   
34,734
     
20.67
%
   
20,982
     
16.13
%
Total investments
 
$
168,042
     
100.00
%
 
$
130,096
     
100.00
%

The following table shows the realized gains (losses) for debt and equity securities for the three months ended September 30, 2013 and 2012.

 
 
Three Months Ended September 30,
 
 
 
2013
   
2012
 
 
 
Gains
   
Fair Value
   
Gains
   
Fair Value
 
 
 
(Losses)
   
at Sale
   
(Losses)
   
at Sale
 
 
 
(Dollars in Thousands)
 
 
 
   
   
   
 
Debt securities
 
$
202
   
$
6,183
   
$
410
   
$
9,716
 
Equity securities
   
1,274
     
5,619
     
145
     
1,349
 
Total realized gains
   
1,476
     
11,802
     
555
     
11,065
 
 
                               
Debt securities
   
(421
)
   
14,462
     
(56
)
   
1,637
 
Equity securities
   
(275
)
   
1,471
     
(354
)
   
682
 
Total realized losses
   
(696
)
   
15,933
     
(410
)
   
2,319
 
 
                               
Net realized gains on investments
 
$
780
   
$
27,735
   
$
145
   
$
13,384
 

- 19 -

Federated National Holding Company
Notes to Condensed Consolidated Financial Statements
 
The following table shows the realized gains (losses) for debt and equity securities for the nine months ended September 30, 2013 and 2012.

 
 
Nine Months Ended September 30,
 
 
 
2013
   
2012
 
 
 
Gains
   
Fair Value
   
Gains
   
Fair Value
 
 
 
(Losses)
   
at Sale
   
(Losses)
   
at Sale
 
 
 
(Dollars in Thousands)
 
 
 
   
   
   
 
Debt securities
 
$
1,595
   
$
36,918
   
$
958
   
$
27,760
 
Equity securities
   
2,437
     
10,063
     
805
     
5,437
 
Total realized gains
   
4,032
     
46,981
     
1,763
     
33,197
 
 
                               
Debt securities
   
(922
)
   
37,493
     
(371
)
   
11,050
 
Equity securities
   
(630
)
   
3,049
     
(1,475
)
   
6,073
 
Total realized losses
   
(1,552
)
   
40,542
     
(1,846
)
   
17,123
 
 
                               
Net realized gains (losses) on investments
 
$
2,480
   
$
87,523
   
$
(83
)
 
$
50,320
 

Net realized investment gains totaled $2.5 million for the nine months ended September 30, 2013, compared with net realized losses of $0.1 million during the nine months ended September 30, 2012. During the nine months ended September 30, 2013, the investment committee decided to shorten the duration of the bond portfolio by approximately two years and shifted $5.0 million from the equity to the bond portfolio. This decision generated approximately $0.7 million in realized gains.  Our equity asset managers make periodic sales from our equity portfolio; these sales along with the shift between the equity and bond portfolios generated approximately $1.8 million in realized gains.

- 20 -

Federated National Holding Company
Notes to Condensed Consolidated Financial Statements
 
A summary of the amortized cost, estimated fair value and gross unrealized gains and losses of debt and equity securities at September 30, 2013 and December 31, 2012 is as follows.

 
 
   
Gross
   
Gross
   
 
 
 
Amortized
   
Unrealized
   
Unrealized
   
Estimated
 
 
 
Cost
   
Gains
   
Losses
   
Fair Value
 
 
 
(Dollars in Thousands)
 
September 30, 2013
 
   
   
   
 
Debt Securities  - Available-For-Sale:
 
   
   
   
 
United States government obligations and authorities
 
$
23,713
   
$
227
   
$
195
   
$
23,745
 
Obligations of states and political subdivisions
   
23,537
     
192
     
52
     
23,677
 
Corporate
   
74,541
     
1,277
     
617
     
75,201
 
International
   
3,407
     
6
     
23
     
3,390
 
 
 
$
125,198
   
$
1,702
   
$
887
   
$
126,013
 
 
                               
Debt Securities  - Held-To-Maturity:
                               
United States government obligations and authorities
 
$
5,150
   
$
72
   
$
255
   
$
4,967
 
Corporate
   
2,036
     
22
     
13
     
2,045
 
International
   
109
     
-
     
1
     
108
 
 
 
$
7,295
   
$
94
   
$
269
   
$
7,120
 
 
                               
Equity securities - common stocks
 
$
28,697
   
$
6,433
   
$
396
   
$
34,734
 
 
                               
December 31, 2012
                               
Debt Securities  - Available-For-Sale:
                               
United States government obligations and authorities
 
$
26,825
   
$
632
   
$
65
   
$
27,392
 
Obligations of states and political subdivisions
   
3,738
     
202
     
1
     
3,939
 
Corporate
   
63,553
     
3,794
     
34
     
67,313
 
International
   
3,005
     
107
     
1
     
3,111
 
 
 
$
97,121
   
$
4,735
   
$
101
   
$
101,755
 
 
                               
Debt Securities  - Held-To-Maturity:
                               
United States government obligations and authorities
 
$
6,016
   
$
149
   
$
12
   
$
6,153
 
Corporate
   
1,203
     
61
     
2
     
1,262
 
International
   
140
     
-
     
1
     
139
 
 
 
$
7,359
   
$
210
   
$
15
   
$
7,554
 
 
                               
Equity securities - common stocks
 
$
19,095
   
$
2,505
   
$
618
   
$
20,982
 

- 21 -

Federated National Holding Company
Notes to Condensed Consolidated Financial Statements
 
The table below reflects our unrealized investment losses by investment class, aged for length of time in a continuous unrealized loss position as of September 30, 2013.

 
 
Unrealized Losses
   
Less than 12 months
   
12 months or longer
 
 
 
(Dollars in Thousands)
 
Debt securities:
 
   
   
 
United States government obligations and authorities
 
$
195
   
$
189
   
$
6
 
Obligations of states and political subdivisions
   
52
     
52
     
-
 
Corporate
   
617
     
617
     
-
 
International
   
23
     
23
     
-
 
 
   
887
     
881
     
6
 
Equity securities:
                       
Common stocks
   
396
     
250
     
146
 
 
                       
Total debt and equity securities
 
$
1,283
   
$
1,131
   
$
152
 

The table below reflects our unrealized investment losses by investment class, aged for length of time in a continuous unrealized loss position as of December 31, 2012.

 
 
Unrealized Losses
   
Less than 12 months
   
12 months or longer
 
 
 
(Dollars in Thousands)
 
Debt securities:
 
   
   
 
United States government obligations and authorities
 
$
65
   
$
65
   
$
-
 
Obligations of states and political subdivisions
   
1
     
1
     
-
 
Corporate
   
34
     
34
     
-
 
International
   
1
     
1
     
-
 
 
   
101
     
101
     
-
 
Equity securities:
                       
Common stocks
   
618
     
430
     
188
 
 
                       
Total debt and equity securities
 
$
719
   
$
531
   
$
188
 

Below is a summary of debt securities at September 30, 2013 and December 31, 2012, by contractual or expected maturity periods. Expected maturities may differ from contractual maturities because borrowers may have the right to call or prepay obligations with or without call or prepayment penalties.

 
 
September 30, 2013
   
December 31, 2012
 
 
 
Amortized
   
Estimated
   
Amortized
   
Estimated
 
 
 
Cost
   
Fair Value
   
Cost
   
Fair Value
 
 
 
(Dollars in Thousands)
 
 
 
   
   
   
 
Due in one year or less
 
$
4,651
   
$
4,689
   
$
2,925
   
$
2,944
 
Due after one through five years
   
81,448
     
82,071
     
49,826
     
51,523
 
Due after five through ten years
   
45,663
     
45,626
     
35,070
     
37,182
 
Due after ten years
   
731
     
747
     
16,659
     
17,660
 
 
                               
Total
 
$
132,493
   
$
133,133
   
$
104,480
   
$
109,309
 

- 22 -

Federated National Holding Company
Notes to Condensed Consolidated Financial Statements
 
United States Treasury notes with a book value of $62,744 and $2,198,829, maturing in 2016 and 2022, respectively, were on deposit with the Florida OIR as of September 30, 2013, as required by law for FNIC, and are included with other investments held until maturity.

United States Treasury notes with a book value of $63,481 and $2,193,300, maturing in 2016 and 2022, respectively, were on deposit with the Florida OIR as of December 31, 2012, as required by law for FNIC, and are included with other investments held until maturity.

The table below sets forth investment results for the three months ended September 30, 2013 and 2012.

 
 
Three Months Ended September 30,
 
 
 
2013
   
2012
 
 
 
(Dollars in Thousands)
 
 
 
   
 
Interest on debt securities
 
$
691
   
$
839
 
Dividends on equity securities
   
108
     
113
 
Interest on cash and cash equivalents
   
1
     
1
 
 
               
Total investment income
 
$
800
   
$
953
 
 
               
Net realized gains
 
$
780
   
$
145
 

Proceeds from sales, pay downs and maturities of debt securities and proceeds from sales of equity securities during the three months ended September 30, 2013 and 2012, were approximately $28.7 million and $17.9 million, respectively.

The table below sets forth investment results for the nine months ended September 30, 2013 and 2012.

 
 
Nine Months Ended September 30,
 
 
 
2013
   
2012
 
 
 
(Dollars in Thousands)
 
 
 
   
 
Interest on debt securities
 
$
2,059
   
$
2,563
 
Dividends on equity securities
   
320
     
279
 
Interest on cash and cash equivalents
   
3
     
7
 
 
               
Total investment income
 
$
2,382
   
$
2,849
 
 
               
Net realized gains (losses)
 
$
2,480
   
$
(83
)

Proceeds from sales, pay downs and maturities of debt securities and proceeds from sales of equity securities during the nine months ended September 30, 2013 and 2012, were approximately $93.1 million and $60.7 million, respectively.
- 23 -

Federated National Holding Company
Notes to Condensed Consolidated Financial Statements

            The table below sets forth a summary of net realized gains and unrealized investment gains during the three months ended September 30, 2013 and 2012.

 
 
Three Months Ended September 30,
 
 
 
2013
   
2012
 
 
 
(Dollars in Thousands)
 
Net realized gains
 
   
 
Debt securities
 
$
(219
)
 
$
354
 
Equity securities
   
999
     
(209
)
 
               
Total
 
$
780
   
$
145
 
 
               
Net unrealized gains
               
Debt securities
 
$
814
   
$
5,682
 
Equity securities
   
6,038
     
1,928
 
 
               
Total
 
$
6,852
   
$
7,610
 

The table below sets forth a summary of net realized gains (losses) and unrealized investment gains during the nine months ended September 30, 2013 and 2012.

 
 
Nine Months Ended September 30,
 
 
 
2013
   
2012
 
 
 
(Dollars in Thousands)
 
Net realized gains (losses)
 
   
 
Debt securities
 
$
673
   
$
587
 
Equity securities
   
1,807
     
(670
)
 
               
Total
 
$
2,480
   
$
(83
)
 
               
Net unrealized gains
               
Debt securities
 
$
814
   
$
5,682
 
Equity securities
   
6,038
     
1,928
 
 
               
Total
 
$
6,852
   
$
7,610
 

(6) Fair Value Disclosure

In April 2009, the FASB issued accounting guidance that if an entity determines that either the volume and/or level of activity for an investment security has significantly decreased (from normal conditions for that investment security) or price quotations or observable inputs are not associated with orderly transactions, increased analysis and management judgment will be required to estimate fair value. This guidance was effective for interim and annual periods ending after June 15, 2009, with early adoption permitted. This guidance was applied prospectively. The adoption of this guidance did not have an impact on our financial condition, results of operations or cash flows.

In October 2008, the FASB issued accounting guidance to clarify the application of GAAP in determining fair value of financial instruments in a market that is not active. The guidance was effective upon issuance, including prior periods for which financial statements had not been issued. Our adoption of this guidance did not have a material effect on our financial position, results of operations or cash flows.
- 24 -

Federated National Holding Company
Notes to Condensed Consolidated Financial Statements

In September 2006, FASB issued accounting guidance that defines fair value as the exchange price that would be received for an asset or paid to transfer a liability (an exit price) in the principal or most advantageous market for an asset or liability in an orderly transaction between market participants on the measurement date. This guidance also establishes a fair value hierarchy that requires an entity to maximize the use of observable inputs and minimize the use of unobservable inputs when measuring fair value. The guidance also categorizes assets and liabilities at fair value into one of three different levels depending on the observation of the inputs employed in the measurement, as follows.

Level 1 — inputs to the valuation methodology are quoted prices (unadjusted) for identical assets or liabilities in active markets.  A quoted price for an identical asset or liability in an active market provides the most reliable fair value measurement because it is directly observable to the market.

Level 2 — inputs to the valuation methodology include quoted prices for similar assets and liabilities in active markets, and inputs are observable for an asset or liability, either directly or indirectly, for substantially the full term of the financial instrument.

Level 3 — inputs to the valuation methodology are unobservable and significant to the fair value measurement.

Securities available for sale: The fair value of securities available for sale is determined by obtaining quoted prices on nationally recognized security exchanges.

Assets measured at fair value on a recurring basis as of September 30, 2013, presented in accordance with this guidance, are as follows.

 
 
As of September 30, 2013
 
 
 
Level 1
   
Level 2
   
Level 3
   
Total
 
 
 
(Dollars in Thousands)
 
Debt securities:
 
   
   
   
 
United States government obligations and authorities
 
$
15,468
   
$
8,277
   
$
-
   
$
23,745
 
Obligations of states and political subdivisions
   
-
     
23,677
     
-
     
23,677
 
Corporate
   
67,351
     
7,850
     
-
     
75,201
 
International
   
-
     
3,390
     
-
     
3,390
 
 
   
82,819
     
43,194
     
-
     
126,013
 
 
                               
Equity securities:
                               
Common stocks
   
34,734
     
-
     
-
     
34,734
 
 
   
34,734
     
-
     
-
     
34,734
 
 
                               
Total debt and equity securities
 
$
117,553
   
$
43,194
   
$
-
   
$
160,747
 

- 25 -

Federated National Holding Company
Notes to Condensed Consolidated Financial Statements
 
Assets measured at fair value on a recurring basis as of December 31, 2012, presented in accordance with this guidance, are as follows.

 
 
As of December 31, 2012
 
 
 
Level 1
   
Level 2
   
Level 3
   
Total
 
 
 
(Dollars in Thousands)
 
Debt securities:
 
   
   
   
 
United States government obligations and authorities
 
$
12,464
   
$
14,928
   
$
-
   
$
27,392
 
Obligations of states and political subdivisions
   
-
     
3,939
     
-
     
3,939
 
Corporate
   
67,313
     
-
     
-
     
67,313
 
International
   
-
     
3,111
     
-
     
3,111
 
 
   
79,777
     
21,978
     
-
     
101,755
 
 
                               
Equity securities:
                               
Common stocks
   
20,982
     
-
     
-
     
20,982
 
 
   
20,982
     
-
     
-
     
20,982
 
 
                               
Total debt and equity securities
 
$
100,759
   
$
21,978
   
$
-
   
$
122,737
 

(7) Reinsurance Agreements

Financing risk generally involves a combination of risk retention and risk transfer techniques. “Retention”, similar to a deductible, involves financing losses by funds internally generated. “Transfer” involves the existence of a contractual arrangement designed to shift financial responsibility to another party in exchange for premium. Secondary to the primary risk-transfer agreements, we use reinsurance agreements to transfer a portion of the risks insured under our policies to other companies through the purchase of reinsurance. We utilize reinsurance to reduce exposure to catastrophic and non-catastrophic risks and to help manage the cost of capital. Reinsurance techniques are designed to lessen earnings volatility, improve shareholder return, and to support the required statutory surplus requirements. We also use reinsurance to realize an arbitrage of premium rates, benefit from the availability of our reinsurers’ expertise, and benefit from the management of a profitable portfolio of insureds by way of enhanced analytical capacities. Our primary property line that is subject to catastrophic reinsurance is Homeowners Multiple Peril. FNIC cedes these risks to domestic and foreign reinsurance participants from Bermuda and Europe as well as to the FHCF.

Generally, there are three separate kinds of reinsurance structures – quota share, excess of loss, and facultative, each considered either proportional or non-proportional. Our reinsurance structures are maintained to protect our insurance subsidiary against the severity of losses on individual claims or unusually serious occurrences in which the frequency and or the severity of claims produce an aggregate extraordinary loss from catastrophic events. In addition to reinsurance agreements, we also from time to time enter into retro-cessionary reinsurance agreements; each designed to shift financial responsibility based on predefined conditions.

Although reinsurance does not discharge us from our primary obligation to pay for losses insured under the policies we issue, reinsurance does make the assuming reinsurer liable to the insurance subsidiary for the reinsured portion of the risk. A credit risk exposure exists with respect to ceded losses to the extent that any reinsurer is unable or unwilling to meet the obligations assumed under the reinsurance contracts. The collectability of reinsurance is subject to the solvency of the reinsurers, interpretation of contract language and other factors. A reinsurer's insolvency or inability to make payments under the terms of a reinsurance contract could have a material adverse effect on our results of operations and financial condition. Our reinsurance structure has significant risks, including the fact that the FHCF may not be able to raise sufficient money to pay its claims or impair its ability to pay its claims in a timely manner. This could result in significant financial, legal and operational challenges to all property and casualty companies associated with FHCF, including our company.
- 26 -

Federated National Holding Company
Notes to Condensed Consolidated Financial Statements
 
The availability and costs associated with the acquisition of reinsurance will vary year to year. These fluctuations, which can be significant, are not subject to our control and may limit our ability to purchase adequate coverage. For example, FHCF continues to restrict its reinsurance capacity and is expected to continue constricting capacity for future seasons. This gradual restriction is requiring us to replace that capacity with private market reinsurance. Our reinsurance program is subject to approval by the Florida OIR and review by Demotech, Inc. (“Demotech”). The recovery of increased reinsurance costs through rate action is not immediate and cannot be presumed and is subject to Florida OIR approval.

For the 2013–2014 hurricane season, the excess of loss and FHCF treaties insured the property lines for approximately $558.3 million of aggregate catastrophic losses and LAE with a maximum single event coverage totaling approximately $416.0 million, with the Company retaining the first $7.0 million of losses and LAE for each event. The reinsurance program includes coverage purchased from the private market, which affords optional reinstatement premium protection that provides coverage beyond the first event, along with any remaining coverage from the FHCF. Coverage afforded by the FHCF totals approximately $273.7 million, or 49.0% of the $558.3 million of aggregate catastrophic losses and LAE. The FHCF affords coverage for the entire season, subject to maximum payouts, without regard to any particular insurable event.

The estimated cost to the Company for the excess of loss reinsurance products for the 2013-2014 hurricane season, inclusive of approximately $21.4 million payable to the FHCF and the prepaid automatic premium reinstatement protection, is approximately $67.6 million.
- 27 -

Federated National Holding Company
Notes to Condensed Consolidated Financial Statements

The 2013-2014 private reinsurance companies and their respective A.M. Best Company (“A.M. Best”) rating are listed in the table as follows.

Reinsurer
 
A.M. Best Rating
     
S&P
Rating
 
 
 
 
 
 
 
UNITED STATES
 
 
 
 
 
 
American Agricultural Insurance Company
 
A-
 
 
 
NR
Everest Reinsurance Company
 
A+
 
 
 
A+
Houston Casualty Company, UK Branch
 
A
 
 
 
A+
Odyssey Reinsurance Company
 
A
 
 
 
A-
 
 
 
 
 
 
 
BERMUDA
 
 
 
 
 
 
ACE Tempest Reinsurance Limited
 
A+
 
 
 
AA-
Allied World Assurance Company Limited, Bermuda
 
A
 
 
 
A
Arch Reinsurance Limited
 
A+
 
 
 
A+
Argo Reinsurance Limited
 
A
 
 
 
NR
Ariel Reinsurance Bermuda Ltd for and on Behalf of Ariel Syndicate 1910 (ARE)
 
A-
 
 
 
NR
DaVinci Reinsurance Ltd
 
A
 
 
 
A+
Endurance Specialty Insurance Limited
 
A
 
 
 
A
JC Re Ltd. (aka Pillar Capital and fka Juniperus & Actua Re Ltd.)
 
NR
*
 
**
NR
Partner Reinsurance Company Limited
 
A+
 
 
 
A+
Platinum Underwriters Bermuda Limited
 
A
 
 
 
A-
Renaissance Reinsurance Ltd
 
A+
 
 
 
AA-
S.A.C. Re, Ltd.
 
A-
 
 
 
NR
XL Re Limited
 
A
 
 
 
A
 
 
 
 
 
 
 
UNITED KINGDOM
 
 
 
 
 
 
A.F. Beazley Syndicate No. 623 (AFB)
 
A
 
 
 
A+
A.F. Beazley Syndicate No. 2623 (AFB)
 
A
 
 
 
A+
Amlin Syndicate No. 2001 (AML)
 
A
 
 
 
A+
Ariel Syndicate No. 1910 (ARE)
 
A
 
 
 
A+
ARK Syndicate No. 3902 (NOA)
 
A
 
 
 
A+
Ascot Syndicate No. 1414 (ASC)
 
A
 
 
 
A+
Barbican Syndication No. 1955 (BAR)
 
A
 
 
 
A+
Canopius Syndicate No. 958 (CNP)
 
A
 
 
 
A+
Canopius Syndicate No. 4444 (CNP)
 
A
 
 
 
A+
Cathederal Syndicate No. 2010 (MMX)
 
A
 
 
 
A+
Kiln Syndicate No. 510 (KLN)
 
A
 
 
 
A+
Liberty Syndicates Services Limited, Paris for and on behalf of Lloyd's Syndicate  No. 4472 (LIB)
 
NR
 
 
 
A+
MAP Underwriting Syndicate No. 2791 (MAP)
 
A
 
 
 
A+
MAP Underwriting Syndicate No. 2791 (Parallel) (MAP)
 
A
 
 
 
A+
Novae Syndicate No. 2007 (NVA)
 
A
 
 
 
A+
Pembroke Syndicate No. 4000 (PEM)
 
A
 
 
 
A+
Tokio Marine Kiln Syndicate No. 1880 (TMK)
 
A
 
 
 
A+
 
 
 
 
 
 
 
EUROPE
 
 
 
 
 
 
Amlin Bermuda (Branch of Amlin AG)
 
A
 
 
 
A
SCOR Global P&C SE
 
A
 
 
 
A
 
 
 
 
 
 
 
* Reinstatement Premium Protection Program Participants
 
 
 
 
 
 
 
 
 
 
 
 
 
** Participant will fund a trust agreement for their exposure with cash and U.S. Government obligations of American institutions at fair market value.
 
 
 
 
 
 
 

- 28 -

Federated National Holding Company
Notes to Condensed Consolidated Financial Statements
 
For the 2012–2013 hurricane season, the excess of loss and FHCF treaties insured the property lines for approximately $328.3 million of aggregate catastrophic losses and LAE with a maximum single event coverage totaling approximately $246.5 million, with the Company retaining the first $8.0 million of losses and LAE for each event. The reinsurance program included coverage purchased from the private market, which affords optional reinstatement premium protection that provides coverage beyond the first event, along with any remaining coverage from the FHCF. Coverage afforded by the FHCF totals approximately $144.7 million, or 44.1% of the $328.3 million of aggregate catastrophic losses and LAE. The FHCF affords coverage for the entire season, subject to maximum payouts, without regard to any particular insurable event.

The estimated cost to the Company for the excess of loss reinsurance products for the 2012-2013 hurricane season, inclusive of approximately $9.6 million payable to the FHCF and the prepaid automatic premium reinstatement protection, was approximately $41.6 million.
- 29 -

Federated National Holding Company
Notes to Condensed Consolidated Financial Statements

The 2012-2013 private reinsurance companies and their respective A.M. Best and S&P ratings are listed in the table as follows.

Reinsurer
 
A.M. Best Rating
 
 
 
S&P
Rating
 
 
 
 
 
 
 
UNITED STATES
 
 
 
 
 
 
American Agricultural Insurance Company
 
A-
 
 
 
NR
Everest Reinsurance Company
 
A+
 
 
 
A+
Houston Casualty Company, (UK Branch)
 
A+
*
 
 
AA
Munich Reinsurance America, Inc.
 
A+
 
 
 
AA-
Odyssey Reinsurance Company
 
A
 
 
 
A-
 
 
 
 
 
 
 
BERMUDA
 
 
 
 
 
 
ACE Tempest Reinsurance Limited
 
A+
*
 
 
AA-
Arch Reinsurance Limited
 
A+
*
 
 
A+
Ariel Reinsurance Bermuda Limited for and on Behalf of Ariel Syndicate 1910 (ARE)
 
A-
*
 
 
NR
DaVinci Reinsurance Limited
 
A
*
 
 
A+
JC Re Limited (Juniperus & fka Actua Re Limited)
 
NR
*
 
**
NR
Montpelier Reinsurance Limited
 
A-
 
 
 
A-
Nephila (via Allianz Risk Transfer AG, Bermuda Branch)
 
NR
 
 
 
AA-
Platinum Underwriters Bermuda Limited
 
A
*
 
 
A-
Renaissance Reinsurance Limited
 
A+
*
 
 
AA-
 
 
 
 
 
 
 
UNITED KINGDOM
 
 
 
 
 
 
Amlin Syndicate No. 2001 (AML)
 
A
 
 
 
A+
Ariel Syndicate No. 1910 (ARE)
 
A
*
 
 
A+
ARK Syndicate No. 3902 (NOA)
 
A
 
 
 
A+
Barbican Syndication No. 1955 (BAR)
 
A
 
 
 
A+
Kiln Syndicate No. 510 (KLN)
 
A
 
 
 
A+
Liberty Syndicates Services Limited Paris, for and on Behalf of Lloyd's Syndicate  No. 4472 (LIB)
 
NR
 
 
 
A+
MAP Underwriting Syndicate No. 2791 (Parallel) (MAP)
 
A
 
 
 
A+
Novae Syndicate No. 2007 (NVA)
 
A
 
 
 
A+
Tokio Marine Kiln Syndicate No. 1880 (TMK)
 
A
 
 
 
A+
Torus Syndicate No. 1301 (TUL)
 
A
 
 
 
A+
 
 
 
 
 
 
 
EUROPE
 
 
 
 
 
 
Amlin Bermuda (Branch of Amlin AG)
 
A
 
 
 
A
SCOR Global P&C Zurich Branch
 
A
 
 
 
A
 
 
 
 
 
 
 
* Reinstatement Premium Protection Program Participants
 
 
 
 
 
 
 
 
 
 
 
 
 
** Participant will fund a trust agreement for their exposure with cash and U.S. Government obligations of American institutions at fair market value.
 

Annually, the cost and amounts of reinsurance are based on management's analysis of FNIC's exposure to catastrophic risk as of June 30 and estimated to September 30. Our data is then subjected to actual exposure level analysis as of September 30. This analysis of our exposure level in relation to the total exposures to the FHCF and excess of loss treaties may produce changes in limits and reinsurance premiums as a result of the reconciliation of estimated to actual exposure level. The September 30, 2013 change to total limits was an increase of $8.6 billion of total insured value or 25.4% and the change to reinsurance premiums was an increase of $7.9 million or 13.3%. The September 30, 2012 change to total limits was an increase of $2.1 billion of total limits or 12.6% and the change to reinsurance premiums was an increase of $2.4 million or 3.0%. These adjustments are amortized over the remaining underlying policy term.
- 30 -

Federated National Holding Company
Notes to Condensed Consolidated Financial Statements

To date, we have made no claims asserted against our reinsurers in connection with the 2013–2014 and 2012–2013 excess of loss and FHCF treaties.

The quota share retrocessionaire reinsurance agreements require FNIC to securitize credit, regulatory and business risk. Fully funded trust agreements totaled $4.8 million as of September 30, 2013 and December 31, 2012.

We are selective in choosing reinsurers and consider numerous factors, the most important of which are the financial stability of the reinsurer, their history of responding to claims and their overall reputation. In an effort to minimize our exposure to the insolvency of a reinsurer, we evaluate the acceptability and review the financial condition of the reinsurer at least annually.

(8) Unpaid losses and LAE

The liability for unpaid losses and LAE is determined on an individual-case basis for all incidents reported. The liability also includes amounts for unallocated expenses, anticipated future claim development and Incurred but Not Yet Reported (“IBNR”).

Activity in the liability for unpaid losses and LAE is summarized as follows.

 
 
Nine Months
   
Year Ended
 
 
 
Ended September 30,
   
December 31,
 
 
 
2013
   
2012
 
 
 
(Dollars in Thousands)
 
Balance at January 1
 
$
49,908
   
$
59,983
 
Less reinsurance recoverables
   
(3,503
)
   
(2,088
)
Net balance at January 1
 
$
46,405
   
$
57,895
 
 
               
Incurred related to
               
Current year
 
$
35,791
   
$
31,636
 
Prior years
   
792
     
(1,427
)
Total incurred
 
$
36,583
   
$
30,209
 
 
               
Paid related to
               
Current year
 
$
14,426
   
$
15,892
 
Prior years
   
19,296
     
25,807
 
Total paid
 
$
33,722
   
$
41,699
 
 
               
Net balance at period end
 
$
49,266
   
$
46,405
 
Plus reinsurance recoverables
   
2,684
     
3,503
 
Balance at period end
 
$
51,950
   
$
49,908
 

Based upon consultations with our independent actuarial consultants, we believe that the liability for unpaid losses and LAE is adequate to cover all claims and related expenses that may arise from incidents reported.

As a result of our review of liability for losses and LAE, which includes a re-evaluation of the adequacy of reserve levels for prior year’s claims, we increased the liability for losses and LAE for claims occurring in prior years by $0.8 million for the nine months ended September 30, 2013 and decreased the liability for losses and LAE for claims occurring in prior years by $1.4 million for the year ended December 31, 2012.
- 31 -

Federated National Holding Company
Notes to Condensed Consolidated Financial Statements

We continue to revise our estimates of the ultimate financial impact of claims made resulting from past storms. The revisions to our estimates are based on our analysis of subsequent information that we receive regarding various factors, including: (i) per claim information; (ii) Company and industry historical loss experience; (iii) legislative enactments, judicial decisions, legal developments in the awarding of damages, and (iv) trends in general economic conditions, including the effects of inflation.

(9) Stock Compensation Plans

We implemented a stock option plan in 1998 (the “1998 Plan”), which expired in September 2008. Under this plan, we were authorized to grant options to purchase up to 900,000 common shares, and as of September 30, 2013 and December 31, 2012, we had outstanding exercisable options to purchase 38,500 and 78,500 shares, respectively.

We implemented a stock option plan in 2002 (the “2002 Plan”), which expired in April 2012. Under this plan, we were authorized to grant options to purchase up to 1,800,000 common shares, and as of September 30, 2013 and December 31, 2012, we had outstanding exercisable options to purchase 598,061 and 702,597 shares, respectively.

In April 2012, our Board of Directors adopted, and in September 2012 our shareholders approved, the Company’s 2012 Stock Incentive Plan (the “2012 Plan”). The 2012 Plan permits the issuance of up to 1,000,000 shares of our common stock, subject to adjustment as provided for in the 2012 Plan, in connection with the grant of a variety of equity incentive awards, such as incentive stock options, non-qualified stock options, stock appreciation rights, dividend equivalent rights, restricted stock, restricted stock units, and performance shares. Officers, directors and executive, managerial, administrative and professional employees of the Company and its subsidiaries are eligible to participate in the 2012 Plan. Awards may be granted singly, in combination, or in tandem. The 2012 Plan was amended and restated in March 2013 to clarify the plan administrator’s authority to permit the vesting of unvested restricted shares in the event of the death of the grantee. The 2012 Plan will expire on April 5, 2022.

On August 5, 2013, a total of 150,000 restricted shares from the 2012 Plan were granted pursuant to the vesting requirements and other terms and conditions set forth in restricted stock agreements. Of the total, 100,000 shares were granted to the Company's Chief Executive Officer and President and 50,000 shares were granted to the Company's Chief Financial Officer.

On March 4, 2013, a total of 100,000 restricted shares from the 2012 Plan were granted pursuant to the vesting requirements and other terms and conditions set forth in restricted stock agreements. Of the total, 25,000 shares were granted to the Company's Chief Executive Officer and President and 15,000 shares were granted to the Company's Chief Financial Officer. An aggregate of 20,000 shares were granted to the Company's directors and the remaining 40,000 shares were granted to other employees of the Company.

FASB issued guidance requires that when valuing an employee stock option under the Black-Scholes option pricing model, the fair value be based on the option’s expected term and expected volatility rather than the contractual term. The estimate of the fair value on the grant date should reflect the assumptions marketplace participants now use on the date of the measurement (i.e. grant date). During 2011, management changed the expected term in the Black –Scholes option pricing model from four years to two years for new options granted.  Management believes that share price volatility over the last two years is more indicative of future share price volatility. The change has had an immaterial impact on the financial statements.
- 32 -

Federated National Holding Company
Notes to Condensed Consolidated Financial Statements

Activity in our stock option and incentive plans for the period from January 1, 2011 to September 30, 2013 is as follows.

 
 
1998 Plan
   
2002 Plan
   
2012 Plan
 
 
 
Number of Shares
   
Weighted Average Option Exercise Price
   
Number of Shares
   
Weighted Average Option Exercise Price
   
Number of Shares
   
Fair Market Value at Grant
 
Outstanding at January 1, 2011
   
89,750
   
$
12.83
     
574,800
   
$
9.12
     
-
   
$
-
 
Granted
   
-
   
$
-
     
179,000
   
$
2.45
     
-
   
$
-
 
Exercised
   
-
   
$
-
     
-
   
$
-
     
-
   
$
-
 
Cancelled
   
-
   
$
-
     
(129,100
)
 
$
14.29
     
-
   
$
-
 
Outstanding at January 1, 2012
   
89,750
   
$
12.83
     
624,700
   
$
6.15
     
-
   
$
-
 
Granted
   
-
   
$
-
     
181,500
   
$
4.40
     
-
   
$
-
 
Exercised
   
-
   
$
-
     
(33,104
)
 
$
3.86
     
-
   
$
-
 
Cancelled
   
(11,250
)
 
$
13.54
     
(70,499
)
 
$
12.45
     
-
   
$
-
 
Outstanding at January 1, 2013
   
78,500
   
$
12.73
     
702,597
   
$
5.17
     
-
   
$
-
 
Granted
   
-
   
$
-
     
-
   
$
-
     
250,000
   
$
5.54
 
Exercised
   
-
   
$
-
     
(93,537
)
 
$
3.83
     
-
   
$
-
 
Cancelled
   
(40,000
)
 
$
11.18
     
(10,999
)
 
$
3.64
     
(500
)
 
$
5.54
 
Outstanding at September 30, 2013
   
38,500
   
$
14.34
     
598,061
   
$
5.41
     
249,500
   
$
5.54
 

Options outstanding as of September 30, 2013 are exercisable as follows.

 
 
1998 Plan
   
2002 Plan
 
Options Exercisable at:
 
Number of Shares
   
Weighted Average Option Exercise Price
   
Number of Shares
   
Weighted Average Option Exercise Price
 
 
 
   
   
   
 
September 30, 2013
   
38,500
   
$
14.34
     
383,682
   
$
5.41
 
December 31, 2013
   
-
   
$
14.34
     
1,333
   
$
5.41
 
December 31, 2014
   
-
   
$
14.34
     
138,146
   
$
5.41
 
December 31, 2015
   
-
   
$
14.34
     
74,900
   
$
5.41
 
December 31, 2016
   
-
   
$
14.34
     
-
   
$
5.41
 
December 31, 2017
   
-
   
$
14.34
     
-
   
$
5.41
 
Thereafter
   
-
   
$
14.34
     
-
   
$
5.41
 
Total options exercisable
   
38,500
             
598,061
         

Upon the exercise of options, the Company issues authorized shares.

Prior to January 1, 2006, we accounted for the plans under the recognition and measurement provisions of stock-based compensation using the intrinsic value method prescribed by the APB and related Interpretation, as permitted by FASB issued guidance. Under these provisions, no stock-based employee compensation cost was recognized in the Statement of Operations as all options granted under those plans had an exercise price equal to or less than the market value of the underlying common stock on the date of grant.

Effective January 1, 2006, the Company adopted the fair value recognition provisions of FASB issued guidance using the modified-prospective-transition method. Under that transition method, compensation costs recognized during 2013 and 2012 include the following.

· Compensation cost for all share-based payments granted prior to, but not yet vested as of January 1, 2006, based on the grant date fair value estimated in accordance with the original provisions of FASB issued guidance, and

- 33 -

Federated National Holding Company
Notes to Condensed Consolidated Financial Statements
 
· Compensation cost for all share-based payments granted subsequent to January 1, 2006, based on the grant-date fair-value estimated in accordance with the provisions of FASB issued guidance. Results for prior periods have not been restated, as they are not required to be by the pronouncement.

As a result of adopting FASB issued guidance on January 1, 2006, the Company’s income from continuing operations before provision for income tax expense and net income for the three months ended September 30, 2013 are lower by approximately $132,000 and $82,000, respectively, than if it had continued to account for share-based compensation under APB guidance. The Company’s income from continuing operations before provision for income tax expense and net income for the three months ended September 30, 2012 are lower by approximately $73,000 and $45,000, respectively, than if it had continued to account for share-based compensation under APB guidance.

As a result of adopting FASB issued guidance on January 1, 2006, the Company’s income from continuing operations before provision for income tax expense and net income for the nine months ended September 30, 2013 are lower by approximately $287,000 and $179,000, respectively, than if it had continued to account for share-based compensation under APB guidance. The Company’s income from continuing operations before provision for income tax expense and net income for the nine months ended September 30, 2012 are lower by approximately $201,000 and $125,000, respectively, than if it had continued to account for share-based compensation under APB guidance.

Basic and diluted earnings per share for the three months ended September 30, 2013 would have been $0.42 and $0.40, respectively, if the Company had not adopted FASB issued guidance, compared with reported basic and diluted earnings per share of $0.41 and $0.39, respectively. Basic and diluted earnings per share for the three months ended September 30, 2012 would have been $0.10, if the Company had not adopted FASB issued guidance, compared with reported basic and diluted earnings per share of $0.09.

Basic and diluted earnings per share for the nine months ended September 30, 2013 would have been $1.04 and $1.01, respectively, if the Company had not adopted FASB issued guidance, compared with reported basic and diluted earnings per share of $1.02 and $0.99, respectively. Basic and diluted earnings per share for the nine months ended September 30, 2012 would have been $0.42, if the Company had not adopted FASB issued guidance, compared with reported basic and diluted earnings per share of $0.40.

Because the change in income taxes receivable includes the effect of excess tax benefits, those excess tax benefits also must be shown as a separate operating cash outflow so that operating cash flows exclude the effect of excess tax benefits. FASB issued guidance requires the cash flows resulting from the tax benefits resulting from tax deductions in excess of the compensation cost recognized for those options (excess tax benefits) to be classified as financing cash flows.

 The fair value of options granted is estimated on the date of grant using the following assumptions.

 
September 30, 2013
September 30, 2012
Dividend yield
N/A
N/A
Expected volatility
N/A
39.79%
Risk-free interest rate
N/A
0.28%
Expected life (in years)
N/A
4.45

- 34 -

Federated National Holding Company
Notes to Condensed Consolidated Financial Statements
 
Summary information about the Company’s stock option plans at September 30, 2013 is as follows.

 
 
   
   
Weighted Average
   
Weighted
   
 
 
 
Range of
   
Outstanding at
   
Contractual
   
Average
   
Exercisable at
 
 
 
Exercise Price
   
September 30, 2013
   
Periods in Years
   
Exercise Price
   
September 30, 2013
 
1998 Plan
 
$
8.67 - $16.59
     
38,500
     
0.17
   
$
14.34
     
38,500
 
2002 Plan
 
$
2.45 - $13.24
     
598,061
     
5.05
   
$
5.41
     
383,682
 

(10) Stockholders’ Equity

Capital Stock

The Company’s authorized capital consists of 1,000,000 shares of preferred stock, par value $0.01 per share, and 25,000,000 shares of common stock, par value $0.01 per share. As of September 30, 2013, there were no preferred shares issued or outstanding and there were 8,073,025 shares of common stock outstanding.

(11) Subsequent Events

 There were no subsequent events.
- 35 -

Federated National Holding Company

General information about Federated National Holding Company can be found at www.FedNat.com; however, the information that can be accessed through our web site is not part of our report. We make our annual report on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K and amendments to these reports filed or furnished pursuant to Section 13 or 15(d) of the Securities and Exchange Act of 1934 available free of charge on our web site, as soon as reasonably practicable after they are electronically filed with the SEC.

Item 2

Management’s Discussion and Analysis of Financial Condition and Results of Operations

You should read the following discussion in conjunction with our condensed consolidated financial statements and related notes and information included under this Item 2 and elsewhere in this Quarterly Report on Form 10-Q and in our Annual Report on Form 10-K filed with the Securities and Exchange Commission (“SEC”) on April 1, 2013 (“Form 10-K”). Unless the context requires otherwise, as used in this Form 10-Q, the terms “FNHC” “Company,” “we,” “us” and “our,” refers to Federated National Holding Company and its subsidiaries. We changed our name on September 11, 2012, pursuant to approval received at our annual shareholders’ meeting, from 21st Century Holding Company so that our parent company and other subsidiary companies’ names are consistent with our primary insurance subsidiary and the name under which we have been writing insurance for more than 20 years.

Forward-Looking Statements

Statements in this Quarterly Report on Form 10-Q for the three months ended September 30, 2013 (“Form 10-Q”)  or in documents that are incorporated by reference that are not historical fact are forward-looking statements that are subject to certain risks and uncertainties that could cause actual events and results to differ materially from those discussed herein.  Without limiting the generality of the foregoing, words such as “may,” “will,” “expect,” “believe,” “anticipate,” “intend,” “could,” “would,” “estimate,” or “continue” or the negative other variations thereof or comparable terminology are intended to identify forward-looking statements.  The risks and uncertainties include, without limitation, uncertainties related to estimates, assumptions and projections relating to unpaid losses and loss adjustment expenses and other accounting policies, losses from the nine hurricanes that occurred in fiscal years 2005 and 2004 and in other estimates, assumpt