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EX-32.2 - EXHIBIT 32.2 - FedNat Holding Cofnhc-123117ex322.htm
EX-32.1 - EXHIBIT 32.1 - FedNat Holding Cofnhc-123117ex321.htm
EX-31.2 - EXHIBIT 31.2 - FedNat Holding Cofnhc-123117ex312.htm
EX-31.1 - EXHIBIT 31.1 - FedNat Holding Cofnhc-123117ex311.htm
EX-23.1 - EXHIBIT 23.1 - FedNat Holding Cofnhc123117ex231.htm
EX-21.1 - EXHIBIT 21.1 - FedNat Holding Cofnhc-123117ex211.htm



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

FOR THE FISCAL YEAR ENDED December 31, 2017
OR
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 000-25001 
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, FL
 
33323
(Address of principal executive offices)
 
(Zip Code)
 
Registrant’s telephone number, including area code: 800-293-2532
 
 
Securities registered pursuant to Section 12(b) of the Exchange Act:
 
Title of Each Class
 
Name of Each Exchange on Which Registered
Common Stock, par value $0.01 per share
 
NASDAQ Global Market
Securities registered pursuant to Section 12(g) of the Exchange Act:    None
Indicate by check mark if the Registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.     Yes ☐   No ☒
Indicate by check mark if the Registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act.     Yes ☐   No ☒
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 ☒   No ☐
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 ☒   No ☐
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. ☒
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company or an emerging growth company. See the definitions of “large accelerated filer”, “accelerated filer”, “smaller reporting company” and "emerging growth company" in Rule 12b-2 of the Exchange Act. (Check one):
Large accelerated filer ☐
Accelerated filer ☒
Non‑accelerated filer ☐
Smaller reporting company ☐
Emerging growth company ☐
 
(Do not check if a smaller reporting company)
 
If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. ☐
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).     Yes ☐   No ☒
The aggregate market value of the Registrant’s common stock held by non-affiliates was $192,340,736 on June 30, 2017, computed on the basis of the closing sale price of the Registrant’s common stock on that date.
As of March 8, 2018, the total number of common shares outstanding of Registrant’s common stock was 12,708,152.
Certain information required by Part III of this Form 10-K will be incorporated by reference from the Registrant’s definitive proxy statement or included in a Form 10-K/A that will be filed not later than 120 days after the end of the fiscal year ended December 31, 2017.





FEDERATED NATIONAL HOLDING COMPANY
TABLE OF CONTENTS
PART I
 
 
 
 
 
ITEM 1
 
 
 
ITEM 1A
 
 
 
ITEM 1B
 
 
 
ITEM  2
 
 
 
ITEM 3
 
 
 
ITEM 4
 
 
 
PART II
 
 
 
 
 
ITEM 5
 
 
 
ITEM 6
 
 
 
ITEM 7
 
 
 
ITEM 7A
 
 
 
ITEM 8
 
 
 
ITEM 9
 
 
 
ITEM 9A
 
 
 
ITEM 9B
 
 
 
PART III
 
 
 
 
 
ITEM 10
 
 
 
ITEM 11
 
 
 
ITEM 12
 
 
 
ITEM 13
 
 
 
ITEM 14
 
 
 
PART IV
 
 
 
 
 
ITEM 15
 
 
 
ITEM 16
 
 
 
 



PART I

CAUTIONARY NOTE ABOUT FORWARD-LOOKING STATEMENTS

This Annual Report on Form 10-K (“Annual Report”) contains forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended, or the Securities Act, and Section 21E of the Securities Exchange Act of 1934, as amended, or the Exchange Act. These statements are therefore entitled to the protection of the safe harbor provisions of these laws. These statements may be identified by the use of forward-looking terminology such as “anticipate,” “believe,” “budget,” “contemplate,” “continue,” “could,” “envision,” “estimate,” “expect,” “forecast,” “guidance,” “indicate,” “intend,” “may,” “might,” “outlook,” “plan,” “possibly,” “potential,” “predict,” “probably,” “pro-forma,” “project,” “seek,” “should,” “target,” “will,” “would,” “will be,” “will continue” or the negative thereof  or other variations thereon or comparable terminology. We have based these forward-looking statements on our current expectations, assumptions, estimates and projections. While we believe these expectations, assumptions, estimates and projections are reasonable, such forward-looking statements are only predictions and involve a number of risks and uncertainties, many of which are beyond our control. These and other important factors may cause our actual results, performance or achievements to differ materially from any future results, performance or achievements expressed or implied by these forward-looking statements. Management cautions that the forward-looking statements contained in this Annual Report are not guarantees of future performance, and we cannot assume that such statements will be realized or the forward-looking events and circumstances will occur. Factors that might cause such a difference include, without limitation, the risks and uncertainties discussed under “Risk Factors” in this Annual Report, and discussed from time to time in our reports filed with the Securities and Exchange Commission (“SEC”).

Given these risks and uncertainties, you are cautioned not to place undue reliance on such forward-looking statements. The forward-looking statements included or incorporated by reference into this Annual Report are made only as of the date hereof. We do not undertake and specifically decline any obligation to update any such statements or to publicly announce the results of any revisions to any such statements to reflect future events or developments.

ITEM 1.  BUSINESS

GENERAL

Federated National Holding Company (“FNHC,” the “Company,” “we,” “us,” or “our”) is an insurance holding company that controls substantially all aspects of the insurance underwriting, distribution and claims processes through our subsidiaries and contractual relationships with independent agents and general agents.   We, through our wholly owned subsidiaries, are authorized to underwrite, and/or place homeowners multi-peril (“homeowners”), personal automobile, commercial general liability, federal flood and other lines of insurance in Florida and other states. We market, distribute and service our own and third-party insurers’ products and other services through a network of independent and general agents.

Federated National Insurance Company (“FNIC”), one of our wholly owned insurance subsidiaries, is licensed as an admitted carrier, to write specific lines of insurance by the state’s insurance departments, in Florida, Louisiana, Texas, Georgia, South Carolina and Alabama.  Monarch National Insurance Company (“MNIC”), our other insurance subsidiary, is licensed as an admitted carrier in Florida. Admitted carriers are bound by rate and form regulations, and are strictly regulated to protect policyholders. Admitted carriers are also required to financially contribute to the state guarantee fund used to pay for losses if an insurance carrier becomes insolvent or unable to pay loss amounts due to their policyholders.

Through our wholly-owned subsidiary, FedNat Underwriters, Inc. (“FNU”), we serve as managing general agent for FNIC and MNIC. MNIC was founded in 2015 through a joint venture. On February 21, 2018, FNIC acquired the interests in MNIC’s indirect parent company, Monarch Delaware Holdings LLC (“Monarch Delaware”) from our joint venture partners (see “Joint Venture,” below, for more information).


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໿
 
Year Ended December 31,
 
2017
 
2016
 
2015
Gross premiums written
(In thousands)
Homeowners:
 
 
 
 
 
Florida
$
482,039

 
$
477,489

 
$
427,428

Louisiana
31,312

 
25,385

 
18,540

South Carolina
10,803

 
6,531

 
1,518

Alabama
4,110

 
3,332

 
2,280

Texas
8,491

 

 

Total homeowners
536,755

 
512,737

 
449,766

 
 
 
 
 
 
Personal automobile:
 
 
 
 
 
Texas
19,324

 
34,239

 
17,916

Georgia
22,479

 
31,831

 
2,762

Florida
1,265

 
1,745

 
1,200

Alabama
437

 
1,664

 
34

Total personal automobile
43,505

 
69,479

 
21,912


 
 
 
 
 
Commercial general liability
11,048

 
13,256

 
13,928

 
 
 
 
 
 
Federal flood
12,109

 
10,013

 
8,164

Gross premiums written total
$
603,417

 
$
605,485

 
$
493,770

໿

Joint Venture

Monarch National Insurance Company

In March 2015, we organized MNIC and obtained its certificate of authority to write homeowners property and casualty insurance in Florida from the Florida Office of Insurance Regulation (the “Florida OIR”). We and Crosswinds Investor Monarch LP (“Crosswinds Investor”), a wholly-owned subsidiary of Crosswinds Holdings Inc. (“Crosswinds Holdings”), a private equity firm and asset manager, each invested $14.0 million for a 42.4% membership interest (each holding 50.0% of the voting interests in Monarch Delaware). Transatlantic Reinsurance Company (“TransRe”), an international property and casualty reinsurance company invested $5.0 million for a 15.2% non-voting membership interest in Monarch Delaware. TransRe also received a six-year promissory note in the principal amount of $5.0 million bearing an annual interest rate of 6.0% payable by Monarch National Holding Company, (“Monarch Holding”) the direct parent of MNIC and wholly owned subsidiary of Monarch Delaware (together with MNIC and Monarch Holding, the “Monarch Entities”). Crosswinds AUM LLC (“Crosswinds AUM”) provided investment management services to the Monarch Entities pursuant to an investment management agreement between the Monarch Entities and Crosswinds AUM.

MNIC expands our ability to provide insurance policies in Florida and strengthens our relationships with our partner agents. In connection with the organization of MNIC through the joint venture, we entered into the following agreements:

FNU and MNIC entered into a managing general agent and claims administration agreement, pursuant to which FNU provides underwriting, accounting, reinsurance placement and claims administration services to MNIC. FNU receives 4% of MNIC’s total written annual premium, excluding acquisition expenses payable to agents, for FNU’s managing general agent services; 3.6% of MNIC’s total earned annual premium for FNU’s claims administration services; and, a per-policy administrative fee of $25 for each policy underwritten for MNIC.  We also receive an annual expense reimbursement for accounting and related services.



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The Monarch Entities and Crosswinds AUM, a wholly owned subsidiary of Crosswinds Holdings, entered into an investment management agreement, pursuant to which Crosswinds AUM will manage the investment portfolios of the Monarch Entities.  The management fee, on an annual basis, is 0.75% of assets under management up to $100 million 0.50% of assets under management of more than $100 million but less than $200 million; and, 0.30% of assets under management of more than $200 million.

MNIC and TransRe also entered into a reinsurance capacity right of first refusal agreement, pursuant to which TransRe has a right of first refusal for all quota share and excess of loss reinsurance agreements that MNIC deems necessary in its sole discretion for so long as TransRe remains a member of Monarch Delaware or the MNHC debt remains outstanding.  TransRe also has the right to provide, at market rates and terms, a maximum of 15% of any reinsurance coverage obtained by MNIC in any individual reinsurance contract.

Our Chief Executive Officer holds his respective position and our Chief Accounting Officer holds the position of Chief Financial Officer with the Monarch Entities while each remain employed by us.

On November 27, 2017, we entered into a purchase and sale agreement with Crosswinds Investor and TransRe, whereby we agreed to purchase Crosswinds Investor’s 42.4% Class A membership interest and 50.0% voting interest for $12.3 million, and TransRe’s 15.2% non-voting membership interest in Monarch Delaware for $4.4 million. We completed this transaction on February 21, 2018 for the agreed upon purchase price and repaid the outstanding principal balance and interest due on the $5.0 million promissory note to TransRe. Following the closing, Monarch Delaware and Monarch Holdings were merged into FNIC. With the completion of these transaction, FNIC owns 100% of MNIC.

Crosswinds AUM continues to serve as a consultant to FNHC for a quarterly fee of $75,000 through December 31, 2018, and a subsidiary of Crosswinds Holdings and TransRe each have a right of first refusal through December 31, 2018 to participate in our catastrophe excess of loss reinsurance program, at market rates and terms, up to a placement of $10.0 million in reinsurance limit in the aggregate from Crosswinds Holdings and up to a placement of $10.0 million in reinsurance limit in excess of its placement on our current catastrophe excess of loss reinsurance program from TransRe.

Refer to Note 14. Variable Interest Entity, in the Notes to Consolidated Financial Statements set forth in Part II, Item 8. Financial Statements and Supplementary Data of this Annual Report, for additional information regarding the accounting and consolidation of the joint venture.

Southeast Catastrophe Consulting Company, LLC

The Company owns 33% of Southeast Catastrophe Consulting Company, LLC (“SECCC”), based in Mobile, Alabama. The Company has an agreement with SECCC in which it provides claims adjusting services for FNIC and MNIC, primarily in the event of catastrophes, such as Hurricane Irma and Matthew.

Material Distribution Relationships

We are a party to an insurance agency master agreement with Ivantage Select Agency, Inc. (“ISA”), an affiliate of Allstate Insurance Company (“Allstate”), pursuant to which we have been authorized by ISA to appoint Allstate agents to offer our homeowners and commercial general liability insurance products to consumers in Florida.

We are a party to a managing general underwriting agreement with SageSure Insurance Managers, LLC (“SageSure”) to facilitate growth in our FNIC homeowners business outside of Florida. 

Executive Offices

Our executive office is located at 14050 N.W. 14th Street, Suite 180, Sunrise, Florida 33323. Our telephone number is (800) 293-2532.

Available Information
 
Our internet web site is www.FedNat.com for policy holders, agents and investors. Our annual reports on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K and amendments to such reports are available, free of charge, through our website as soon as reasonably practicable after we electronically file or furnish such material to the SEC. The SEC maintains an internet site that contains reports, proxy and information statements and other information regarding our filings at www.sec.gov.


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INSURANCE OPERATIONS AND RELATED SERVICES

Business Strategy

We expect that in 2018 we will advance our enterprise value through:

focusing on our core operations, the Homeowners line of business, while withdrawing from our Automobile and Commercial General Liability coverages;

leveraging our recently attained 100% ownership of MNIC by developing and implementing a plan in 2018 to expand upon MNIC’s pricing and product offerings in 2019 to increase market share in the risk-adjusted portion of the Florida homeowners market;
    
focusing on operational efficiencies in our homeowners operations to reduce expenses and increase our use of technology;

enhancing our property analytical metrics, such as an increased geographical dispersion of risks, while managing our underwriting appetite, whether new or renewal, to ensure a balanced book of business;

continued expansion of our homeowners products into other states;

maintaining a commitment to provide high quality customer service to our agents and insureds;

strengthening of our marketing efforts by retaining key personnel and implementing direct marketing technologies;

offering attractive incentives to our agents to place a high volume of quality business with our companies;

continuing with our strong catastrophe reinsurance programs; and

additional strategies that may include possible mergers, acquisitions and joint ventures or dispositions of assets.

Overview of Insurance Lines of Business

Homeowners Property and Casualty Insurance

FNIC and MNIC underwrite homeowners insurance in Florida and FNIC also underwrites homeowners insurance in Louisiana, Texas, South Carolina and Alabama. Homeowners insurance generally protects an owner of real and personal property against covered causes of loss to that property. As of December 31, 2017, the total homeowners policies in-force was 302,925, of which 272,346 were in Florida and 30,579 were outside of Florida. As of December 31, 2016, the total homeowners policies in-force was 299,512, of which 279,109 were in Florida and 20,403 were outside of Florida.

Florida
Our homeowners insurance products provide maximum dwelling coverage of approximately $3.5 million, with the aggregate maximum policy limit being approximately $6.3 million. We currently offer dwelling coverage “A” up to $4.0 million with an aggregate total insured value of $6.5 million. We continually review and update these limits; during 2015, coverage “A” and total insured value were increased by $1.0 million and $1.5 million, respectively, each of which has remained unchanged to date. The approximate average premium on the policies currently in-force is $1,785, as compared with $1,716 for 2016. The typical deductible is either $2,500 or $1,000 for non-hurricane-related claims and generally 2% of the coverage amount for the structure for hurricane-related claims.

Premium rates charged to our homeowners insurance policyholders are continually evaluated to assure that they meet the expectation that they are actuarially sound and produce a reasonable level of profit (neither excessive, inadequate or discriminatory). Premium rates in Florida and other states are regulated and approved by the respective states’ office of insurance regulation.  We continuously monitor and seek appropriate adjustment to our rates in order to remain competitive and profitable.

In 2017, FNIC applied for a statewide average rate increase of 6.5% for Florida homeowners multiple-peril insurance policies only, which was approved and increased by the Florida OIR to a statewide average rate increase of 10.0% and became effective for new and renewal policies on August 1, 2017. In 2016, FNIC applied for a rate increase of 5.6% for Florida homeowners multiple-peril insurance policies, which was approved by the Florida OIR and became effective for new and renewal policies on August 1, 2016.

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Also in 2016, MNIC applied for a statewide rate decrease of 11.9% for Florida homeowners multiple-peril insurance policies, which was approved by the Florida OIR and became effective for new and renewal policies on April 15, 2016. Lastly, in 2017, MNIC applied for a statewide rate increase of 2.0% for Florida homeowners multiple-peril insurance policies, which was approved by the Florida OIR and became effective for new and renewal policies on October 1, 2017.
  
Non-Florida
Our non-Florida homeowners insurance products provide maximum dwelling coverage of approximately $1.8 million, with the aggregate maximum policy limit being approximately $3.5 million. We currently offer dwelling coverage “A” up to $2.0 million with an aggregate total insured value of $3.5 million. The approximate average premium on the policies currently in-force is $1,803, as compared with $1,868 for 2016. The typical deductible is either $2,500 or $1,000 for non-hurricane-related claims and generally 2% of the coverage amount for the structure for hurricane-related claims.

Other Lines of Business

Personal Automobile: On December 19, 2017, we announced our decision to undergo an orderly withdrawal from this line of business and began the appropriate steps, including submitting all required regulatory filings and obtaining regulatory approvals. Subject to such approvals, we expect our personal automobile line of business to materially cease by the fourth quarter of 2018. We provide nonstandard personal automobile insurance principally to insureds who were unable to obtain standard insurance coverage due to such factors such as driving record, age, vehicle type or other, including market conditions. FNIC offered this line of business as an admitted carrier in Florida, Texas, Georgia and Alabama, and marketed the insurance through licensed general agents in their respective territories.

Commercial General Liability: On March 13, 2018, we announced our decision to undergo an orderly withdrawal from this line of business and will begin the appropriate steps, including submitting all required regulatory filings and obtaining regulatory approvals. We underwrite for approximately 380 classes of skilled craft workers (excluding home-builders and developers) and mercantile trades (such as owners, landlords and tenants). The limits of liability range from $100,000 per occurrence with a $200,000 policy aggregate to $1.0 million per occurrence with a $2.0 million policy aggregate.  We market the commercial general liability insurance products through independent agents and a limited number of unaffiliated general agencies.

Flood:  FNIC writes flood insurance through the National Flood Insurance Program (“NFIP”). We write the policy for the NFIP, which assumes 100% of the flood risk while we retain a commission for our service. FNIC offers this line of business in Florida, Louisiana, Texas, South Carolina and Alabama.

MARKETING AND DISTRIBUTION

Our independent agents and general agents have the authority to sell and bind insurance coverage in accordance with procedures established by FNU. FNU reviews all coverage bound by the agents promptly and generally accepts all coverage that falls within stated underwriting criteria. For all policies issued, FNU also has the right, within a period that varies by state between 60 days and 120 days from a policy’s inception, to cancel any policy, upon an advanced notice provided in accordance with statutory specific guidelines, even if the risk falls within our underwriting criteria.  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.

We believe that our integrated computer systems, which allow for rapid automated premium quotation and policy issuance by our agents, are key elements in providing quality service to both our agents and insureds for our various lines of business.

LIABILITY FOR LOSS AND LOSS ADJUSTMENT EXPENSE RESERVES

We are directly liable for loss and loss adjustment expense (“LAE”) payments under the terms of the insurance policies that are underwritten by our insurance companies.  In many cases, there may be a time lag between the occurrence and reporting of an insured loss and our payment of that loss. As required by insurance regulations and accounting rules, we reflect the liability for the ultimate payment of all incurred losses and LAE by establishing a liability for those unpaid losses and LAE for both reported and unreported claims, which represent estimates of future amounts needed to pay claims and related expenses.

When a claim involving a probable loss is reported, we establish a liability for the estimated amount of our ultimate loss and LAE payments. We based our estimate upon such factors as the type of loss, jurisdiction of the occurrence, knowledge of the circumstances

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surrounding the claim, severity of injury or damage, potential for ultimate exposure, estimate of liability on the part of the insured, past experience with similar claims and the applicable policy provisions.

We also establish a liability on an aggregate basis to provide for incurred but not yet reported (“IBNR”). The estimates of the liability for loss and LAE reserves are subject to the effect of trends in claims severity and frequency and are continually reviewed. As part of this process, we review historical data and consider various factors, including known and anticipated legal developments, inflation and economic conditions. As experience develops and other data becomes available, these estimates are revised, as required, resulting in an increase or decrease of the existing liability for loss and LAE reserves. Adjustments are reflected in results of operations in the period in which they are made and the liability may deviate substantially from prior estimates.

Among our classes of insurance, the automobile and homeowners liability claims historically tend to have longer time lapses between the occurrence of the event, the reporting of the claim and the final settlement, than do automobile physical damage and homeowners property claims. These liability claims often involve parties filing suit and therefore may result in litigation. By comparison, property damage claims tend to be reported in a relatively shorter period of time and settled in a shorter time frame with less occurrence of litigation.

REINSURANCE

Reinsurance is used to mitigate the insurance loss exposure related to certain events such as natural and man-made catastrophes, manage overall capital adequacy and protect capital resources. We reinsure (cede) a portion of written premiums on an excess of loss or a quota share basis in order to limit our loss exposure. To the extent that reinsuring companies are unable to meet their obligations assumed under these reinsurance agreements, we remain primarily liable to our policyholders.

Reinsurance markets include:

Traditional local and global reinsurance markets including those in the United States (“U.S.”), Bermuda, London and Europe, accessed directly and through reinsurance intermediaries;

Capital markets through insurance-linked securities and collateralized reinsurance transactions, such as catastrophe bonds, sidecars and similar vehicles; and,

Other insurers that engage in both direct and assumed reinsurance.

The form of reinsurance that we may choose from time to time will generally depend on whether we are seeking:

Proportional reinsurance, whereby we cede a specified percentage of premium and losses to reinsurers;

Non-proportional or excess of loss reinsurance, whereby we cede all or a specified portion of losses in excess of a specified amount on a per risk, per occurrence (including catastrophe reinsurance) or aggregate basis; or

Facultative contracts that reinsure individual policies.

Significant Reinsurance Contracts

FNIC and MNIC operate primarily by underwriting and accepting risks for their direct accounts on a gross basis and reinsuring a portion of the exposure on either an individual risk or an aggregate basis to the extent those exceed the desired retention level.  We continually evaluate the relative attractiveness of different forms of reinsurance contracts and different markets that may be used to achieve our risk and profitability objectives.  Our reinsurance contracts do not relieve FNIC or MNIC from their direct obligations to the insured. 

While it is not always possible to reinsure every known and unknown risk to our company, an effective reinsurance program substantially mitigates our exposure to potentially significant losses.  There is a credit risk exposure 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.  The availability and amount of ceded premiums and losses associated with the acquisition of reinsurance will vary year to year.  Our reinsurance program is subject to approval primarily by the Florida OIR and other regulators in states where we do business, and subject to review by Demotech, Inc. (“Demotech”). Demotech provides Financial Stability Ratings (“FSR”) for property and casualty insurance companies throughout the United States.

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We are selective in choosing reinsurers and consider numerous factors, the most important of which are the financial stability of the reinsurer or capital specifically pledged to uphold the contract, its history of responding to claims and its 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 with the assistance of our reinsurance broker. As of December 31, 2017 and 2016, we had over 75 reinsurance companies on our program which are required to have at least an “A-” or better rating by A.M. Best Company (“A.M. Best”) or the agreement would need to be fully collateralized.

2016-2017 Reinsurance Programs

FNIC’s 2016-2017 reinsurance programs, costing $179.5 million, included $125.6 million for the private reinsurance for FNIC’s Florida exposure, including prepaid automatic premium reinstatement protection on all layers, along with $53.9 million payable to the Florida Hurricane Catastrophe Fund (“FHCF”). The combination of private and FHCF reinsurance treaties afforded FNIC with $2.2 billion of aggregate coverage with a maximum single event coverage totaling $1.6 billion, exclusive of retentions.  FNIC maintained its FHCF participation at 75% for the 2016 hurricane season.  FNIC’s single event pre-tax retention for a catastrophic event in Florida was $18.5 million.  In addition, FNIC purchased separate underlying reinsurance layers in Louisiana, Texas, South Carolina and Alabama to cover losses and LAE outside of Florida for each catastrophic event from $8.0 million to $18.5 million. Depending on the characteristics of the catastrophic event, and the states involved, FNIC’s single event pre-tax retention could have been as low as $8.0 million. The maximum pre-tax retention was $18.5 million.

Additionally, our private market excess of loss treaties became effective June 1, 2016 and July 1, 2016, and all private layers, except the FHCF supplemental layer reinsurance contract, have prepaid automatic reinstatement protection, which afforded us with additional coverage against multiple catastrophic events in the same hurricane season. We obtained multiple year protection for a portion of its program; as a result, some of the coverage expired on June 30, 2017, and a portion of the coverage will remain in-force one additional treaty year until June 30, 2018. These private market excess of loss treaties structure coverage into layers, with a cascading feature such that substantially all private layers attach after $18.5 million in losses for FNIC’s Florida exposure. If the aggregate limit of the preceding layer is exhausted, the next layer drops down (cascades) in its place. Additionally, any unused layer protection drops down for subsequent events until exhausted.

MNIC’s 2016-2017 catastrophe reinsurance program, which ran from either June 1 to May 31 or June 1 to June 30 (13 month period), consisted of the FHCF and private market excess of loss treaties. All private layers had prepaid automatic reinstatement protection, which afforded MNIC additional coverage, and had a cascading feature such that substantially all layers attached at $3.4 million for MNIC’s Florida exposure.

2017-2018 Reinsurance Programs

FNIC’s 2017-2018 reinsurance programs costing $173.9 million, including $124 million for the private reinsurance for FNIC’s Florida exposure including prepaid automatic premium reinstatement protection on all layers, along with $49.9 million payable to the FHCF.  The combination of private and FHCF reinsurance treaties will afford FNIC with $2.2 billion of aggregate coverage with a maximum single event coverage totaling $1.5 billion, exclusive of retentions. FNIC maintained its FHCF participation at 75% for the 2017 hurricane season.  FNIC’s single event pre-tax retention for a catastrophic event in Florida is $18.0 million, down slightly from the 2016-2017 reinsurance programs.

FNIC’s private market excess of loss treaties, covering both Florida and non-Florida exposures, became effective June 1, 2017 and July 1, 2017. All private layers have prepaid automatic reinstatement protection, except the FHCF supplemental layer reinsurance contract, which affords FNIC additional coverage for subsequent events.  The reinsurance program includes multiple year protection with $89.0 million of new multiple year protection this year and $156.0 million of renewing multiple year protection from last year. 

As in our 2016-2017 program, these private market excess of loss treaties structure coverage into layers, with a cascading feature such that substantially all layers attach after $25.1 million in losses for FNIC’s exposure. FNIC purchased an underlying limit of protection for $7.1 million excess of $18.0 million with prepaid automatic reinstatement protection.  These treaties are with reinsurers that currently have an A.M. Best or Standard & Poor’s rating of “A-” or better, or have fully collateralized their maximum potential obligations in dedicated trusts.


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FNIC’s non-Florida excess of loss reinsurance treaties affords us up to an additional $21.0 million of aggregate coverage with first event coverage totaling $5.0 million and second event coverage up to $16.0 million.  The non-Florida retention is lowered to $13.0 million for the first event and $2.0 million for the second event (for hurricane losses only) on a gross basis, though the retention is reduced to $6.5 million and to $1.0 million on a net basis after taking into account the profit share agreement that FNIC has with our non-affiliated managing general underwriter that writes our non-Florida property business.  FNIC’s non-Florida reinsurance program cost includes $1.7 million for this private reinsurance, including prepaid automatic premium reinstatement protection.

MNIC’s 2017-2018 reinsurance program costing $5.0 million, including $3.2 million for the private reinsurance for MNIC’s Florida exposure including prepaid automatic premium reinstatement protection on all layers, along with $1.8 million payable to the FHCF. The combination of private and FHCF reinsurance treaties affords MNIC with $109.0 million of aggregate coverage with a maximum single event coverage of $64.9 million, exclusive of retentions.  MNIC maintained its FHCF participation at 75% for the 2017 hurricane season.

MNIC’s private market excess of loss treaties became effective July 1, 2017, and all private layers have prepaid automatic reinstatement protection, which affords MNIC additional coverage for subsequent events, and have a cascading feature such that substantially all layers attach at $3.4 million for MNIC’s Florida exposure.  These treaties are with reinsurers that currently have an A.M. Best or Standard & Poor’s rating of “A-” or better, or have fully collateralized their maximum potential obligations in dedicated trusts.

In addition to the excess of loss coverages described above, our reinsurance program also includes property quota-share treaties. One such treaty for 30% became effective July 1, 2014, and another for 10% became effective July 1, 2015 with each running for two years. The combined treaties provided up to a 40% quota-share reinsurance on all non-catastrophe homeowners property insurance claims in Florida, and 40% quota share coverage on the first $100 million of covered catastrophe losses for the homeowners property insurance program in Florida per occurrence; $200 million any one contract year. The treaties embodied an experience account and are accounted for as retrospectively rated contracts whereby the estimated ultimate premium or commission is recognized over the period of the contracts.

On July 1, 2016, the 30% property quota-share treaty expired on a cut-off basis, which means as of that date we retained an incremental 30% of the underlying unearned premiums and losses. On July 1, 2017, the 10% property quota-share treaty expired on a cut-off basis, which means as of that date we retained an incremental 10% of the underlying unearned premiums and losses. The reinsurers remain liable for 30% and 10% of the paid losses occurring during the terms of the treaties, until each treaty is commuted.

On July 1, 2017, FNIC bound a new 10% quota-share on its Florida homeowners book of business, which excludes named storms. This treaty is not subject to accounting as a retrospectively rated contract.

Our private passenger automobile quota share treaties are typically one year programs which become effective at different points in the year and cover automobile policies across several states. These automobile quota share treaties cede approximately 75% of all written premiums entered into by the Company, subject to certain limitations including but not limited to premium and other caps.

Certain reinsurance agreements require FNIC and MNIC to secure the credit, regulatory and business risk. Fully funded trust agreements securing these risks for FNIC were $2.6 million as of December 31, 2017 and 2016. Fully funded trust agreements securing these risks for MNIC were $0.3 million as of December 31, 2017 and 2016.

EMPLOYEES

As of December 31, 2017, we had 419 employees. We are not a party to any collective bargaining agreement and we have not experienced work stoppages or strikes as a result of labor disputes. We consider relations with our employees to be satisfactory.

COMPETITION

We operate in highly competitive markets and face competition from national, regional and residual market insurance companies in the homeowners, commercial general liability, automobile and flood markets. Our competitors include companies that market their products through agents and companies that sell insurance directly to their customers. Large national captive writers may have certain competitive advantages over independent agency writers, including increased name recognition, increased loyalty of their customer base and reduced policy acquisition costs. We compete based on underwriting criteria, our distribution network and superior service to our agents and insureds. Although our pricing is inevitably influenced, to an extent, by that of our competitors, we believe that it is generally not in our best interest to compete solely on price.


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In Florida, more than 50 companies compete with us in the homeowners insurance market. Three of our larger competitors are Citizens Property Insurance Corporation (“Citizens”), Universal Property and Casualty Insurance Company and Security First Insurance Company.

Significant competition also emerged because of fundamental changes made to the property and casualty insurance business in Florida in recent years which resulted in a multi-pronged approach to address the cost of residential property insurance in Florida. First, the law increased the capacity of reinsurance that stabilized the reinsurance market to the benefit of the insurance companies writing in Florida. Second, the law provided for rate relief to all policyholders. The law also authorized the state-owned insurance company, Citizens, which is free of many of the restraints on private carriers such as surplus, ratios, income taxes and reinsurance expense, to reduce its premium rates and begin competing against private insurers in the residential property insurance market and expands the authority of Citizens to write commercial insurance.

REGULATION

Overview

Our insurance operations are subject to the laws and regulations of Florida, Georgia, Louisiana, Texas, South Carolina, and Alabama. We are subject to employment regulations of California, Florida, Louisiana, Massachusetts, Nevada, North Carolina and other states in which we seek to conduct business in the future. The regulations cover all aspects of our business and are generally designed to protect the interests of insurance policyholders, as opposed to the interests of shareholders. Such regulations relate to authorized lines of business, capital and surplus requirements, allowable rates and forms, investment parameters, underwriting limitations, transactions with affiliates, dividend limitations, changes in control, market conduct, maximum amount allowable for premium financing service charges and a variety of other financial and non-financial components of our business. Our failure to comply with certain provisions of applicable insurance laws and regulations could have a material adverse effect on our business, results of operations or financial condition. In addition, any changes in such laws and regulations, including the adoption of consumer initiatives regarding rates charged for coverage, could materially and adversely affect our operations or our ability to expand.

Most states’ laws restrict an insurer’s underwriting discretion, such as the ability to terminate policies, terminate agents or reject insurance coverage applications, and many state regulators have the power to reduce, or to disallow, increases in premium rates. In addition, state laws generally require that rate schedules and other information be filed with the state’s insurance regulatory authority, either directly or through a rating organization with which the insurer is affiliated. The regulatory authority may disapprove a rate filing if it finds that the rates are inadequate, excessive or unfairly discriminatory. Rates, which are not necessarily uniform for all insurers, vary by class of business, hazard covered, and size of risk. Certain states, including Florida, as discussed above, have adopted laws or are considering proposed legislation which, among other things, limit the ability of insurance companies to effect rate increases or to cancel, reduce or non-renew insurance coverage with respect to existing policies, particularly personal automobile insurance.
    
Most states require licensure or regulatory approval prior to the marketing of new insurance products. Typically, licensure review is comprehensive and includes a review of a company’s business plan, solvency, reinsurance, character of its officers and directors, rates, forms and other financial and non-financial aspects of a company. The regulatory authorities may prohibit entry into a new market by not granting a license or by withholding approval.
    
All insurance companies must file quarterly and annual statements with certain regulatory agencies and are subject to regular and special examinations by those agencies. We may be the subject of additional special examinations or analysis. These examinations or analysis may result in one or more corrective orders being issued by the Florida OIR. The Florida OIR has completed their regularly scheduled statutory examination of FNIC for the five years ended December 31, 2015, of MNIC for the period of March 17, 2015 (inception) through December 31, 2015 and of MNIC for the year ended December 31, 2016. There were no material findings by the Florida OIR in connection with these examinations.
    
Various states routinely require deposits of assets for the protection of policyholders either in those states or for all policyholders. As of December 31, 2017, FNIC and MNIC held investment securities with a fair value of approximately $12.9 million, as deposits with the state of Florida, Texas, Georgia, South Carolina and Alabama.


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Insurance Holding Company Regulation

FNHC, as the parent holding company, is subject to laws governing insurance holding companies in Florida where FNIC and MNIC are domiciled. Among other things, these laws: (i) require us to file periodic information with the Florida OIR, including information concerning our capital structure, ownership, financial condition and general business operations; (ii) regulate certain transactions between us and our affiliates, including the amount of dividends and other distributions, the terms of surplus notes and amounts that our affiliates can charge the holding company for services such as management fees or commissions; and, (iii) restrict the ability of any one person to acquire certain levels of our voting securities without prior regulatory approval. Any purchaser of 10% or more of the outstanding shares of our common stock will be presumed to have acquired control of FNIC or MNIC unless the Florida OIR, upon application, determines otherwise.

Restrictions in Payments of Dividends by Domestic Insurance Companies

Under Florida law, a domestic insurer may not pay any dividend or distribute cash or other property to its shareholders except out of that part of its available and accumulated capital surplus funds which is derived from realized net operating profits on its business and net realized capital gains. A Florida domestic insurer may not make dividend payments or distributions to shareholders without prior approval of the Florida OIR if the dividend or distribution would exceed the larger of (i) the lesser of (a) 10.0% of its capital surplus or (b) net income, not including realized capital gains, plus a two-year carryforward, (ii) 10.0% of capital surplus with dividends payable constrained to unassigned funds minus 25.0% of unrealized capital gains or (iii) the lesser of (a) 10.0% of capital surplus or (b) net investment income plus a three-year carryforward with dividends payable constrained to unassigned funds minus 25.0% of unrealized capital gains.

Alternatively, a Florida domestic insurer may pay a dividend or distribution without the prior written approval of the Florida OIR: (i) if the dividend is equal to or less than the greater of: (a) 10.0% of the insurer’s capital surplus as regards policyholders derived from realized net operating profits on its business and net realized capital gains or (b) the insurer’s entire net operating profits and realized net capital gains derived during the immediately preceding calendar year; (ii) the insurer will have policy holder capital surplus equal to or exceeding 115.0% of the minimum required statutory capital surplus after the dividend or distribution; (iii) the insurer files a notice of the dividend or distribution with the Florida OIR at least ten business days prior to the dividend payment or distribution; and, (iv) the notice includes a certification by an officer of the insurer attesting that, after the payment of the dividend or distribution, the insurer will have at least 115.0% of required statutory capital surplus as to policyholders. Except as provided above, a Florida domiciled insurer may only pay a dividend or make a distribution: (i) subject to prior approval by the Florida OIR; or (ii) 30 days after the Florida OIR has received notice of such dividend or distribution and has not disapproved it within such time.

No dividends were paid by FNIC or MNIC in 2017, 2016 and 2015, and none are anticipated in 2018.  Although we believe that amounts required to meet our financial and operating obligations will be available from sources other than dividends from our insurance subsidiaries, there can be no assurance in this regard. Further, there can be no assurance that, if requested, the Florida OIR will allow any dividends to be paid by FNIC or MNIC to us, the parent company, in the future. The maximum dividends permitted by state law are not necessarily indicative of an insurer’s actual ability to pay dividends or other distributions to a parent company, which also may be constrained by business and regulatory considerations, such as the impact of dividends on capital surplus, which could affect an insurer’s competitive position, the amount of premiums that can be written and the ability to pay future dividends. Further, state insurance laws and regulations require that the statutory capital surplus of an insurance company following any dividend or distribution by it be reasonable in relation to its outstanding liabilities and adequate for its financial needs.

While the non-insurance company subsidiaries (FNU and any other affiliate) are not subject directly to the dividend and other distribution limitations, insurance holding company regulations govern the amount that any affiliate within the holding company structure may charge any of the insurance companies for service (e.g., management fees and commissions).

Underwriting and Marketing Restrictions

During the past several years, various regulatory and legislative bodies have adopted or proposed new laws or regulations to address the cyclical nature of the insurance industry, catastrophic events and insurance capacity and pricing. These regulations include: (i) the creation of “market assistance plans” under which insurers are induced to provide certain coverages; (ii) restrictions on the ability of insurers to rescind or otherwise cancel certain policies in mid-term; (iii) advance notice requirements or limitations imposed for certain policy non-renewals; and, (iv) limitations upon or decreases in rates permitted to be charged.


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National Association of Insurance Commissioners Risk-Based Capital Requirements

In order to enhance the regulation of insurer solvency, National Association of Insurance Commissioners (“NAIC”), established risk-based capital (“RBC”) requirements for insurance companies that are designed to assess capital adequacy and to raise the level of protection that statutory surplus provides for policy holders. These requirements measure three major areas of risk facing property and casualty insurers: (i) underwriting risks, which encompass the risk of adverse loss developments and inadequate pricing; (ii) declines in asset values arising from credit risk; (iii) other business risks from investments; and (iv) catastrophe risk. Insurers having less statutory surplus than required will be subject to varying degrees of regulatory action, depending on the level of capital inadequacy. The Florida OIR, which follows these requirements, could require FNIC or MNIC to cease operations in the event they fail to maintain the required statutory capital.
    
Based upon the 2017 and 2016 statutory financial statements for FNIC and MNIC, statutory surplus exceeded the regulatory action levels established by the NAIC’s RBC requirements.
    
Based on RBC requirements, the extent of regulatory intervention and action increases as the ratio of an insurer’s statutory surplus to its Authorized Control Level (“ACL”), as calculated under the NAIC’s requirements, decreases.  The first action level, the Company Action Level, requires an insurer to submit a plan of corrective actions to the insurance regulators if statutory surplus falls below 200.0% of the ACL amount.  The second action level, the Regulatory Action Level, requires an insurer to submit a plan containing corrective actions and permits the insurance regulators to perform an examination or other analysis and issue a corrective order if statutory surplus falls below 150.0% of the ACL amount. The third action level, ACL, allows the regulators to rehabilitate or liquidate an insurer in addition to the aforementioned actions if statutory surplus falls below the ACL amount. The fourth action level is the Mandatory Control Level, which requires the regulators to rehabilitate or liquidate the insurer if statutory surplus falls below 70.0% of the ACL amount. FNIC’s ratio of statutory surplus to its ACL was 301.9% and 307.5% as of December 31, 2017 and 2016, respectively. MNIC’s ratio of statutory surplus to its ACL was 1,070.1% and 2,419.8% as of December 31, 2017 and 2016, respectively.

Industry Ratings Services
    
Third-party rating agencies assess and rate the ability of insurers to pay their claims. The insurance industry uses financial strength ratings to assess the financial strength and quality of insurers. Ratings are based upon criteria established by the rating agencies and reflect evaluations of each insurer’s profitability, debt and cash levels, customer base, adequacy and soundness of reinsurance, quality and estimated market value of assets, adequacy of reserves and management. Ratings are also based upon factors of concern to agents, reinsurers and policyholders and are not directed toward the protection of investors, such as purchasers of our common stock.
    
As of December 31, 2017 and 2016, FNIC and MNIC are rated by Demotech as “A” (“Exceptional”), which is the third of seven ratings, and defined as “Regardless of the severity of a general economic downturn or deterioration in the insurance cycle, insurers earning an FSR of “A” possess “Exceptional” financial stability related to maintaining surplus as regards to policyholders.” Demotech’s ratings are based upon factors of concern to agents, reinsurers and policyholders and are not primarily directed toward the protection of investors. Our Demotech rating could be jeopardized by factors including adverse development and various surplus related ratio exceptions. On February 9, 2018, Demotech reaffirmed the FSR of “A” (“Exceptional”) for FNIC and MNIC.


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ITEM 1A.  RISK FACTORS 

We are subject to various risks in our business operations as described below. The risks and uncertainties described below are the
known risk factors we consider material. Additional risks and uncertainties not currently known, or currently deemed immaterial, may also impair our business operations. Investors should carefully consider these risks before making an investment decision.

Risks Related to Our Business

Our financial condition could be adversely affected by the occurrence of natural and man-made disasters.

We write insurance policies that cover homeowners, business owners and automobile owners for losses that result from, among other things, catastrophes and sinkholes. Catastrophic losses can be caused by natural events such as hurricanes, tropical storms, tornadoes, wind, hail, fires, explosions and other events. The incidence and severity of these events are inherently unpredictable. Catastrophic losses can also be caused by terrorist attacks, war, riots, political instability and other man-made events. The extent of losses from a catastrophe is a function of two factors: the total amount of the insurance company’s exposure in the area affected by the event and the severity of the event. Our homeowners policyholders are disbursed throughout the southeast United States, although the majority of our policyholders are located in Florida. Further, a substantial portion of our Florida homeowners policyholders, are located in southeastern Florida, and therefore are especially subject to adverse weather conditions such as hurricanes and tropical storms.

The occurrence of claims from catastrophic events can result in substantial volatility in our results of operations or financial condition for any fiscal quarter or years as seen in 2017 and 2016. An elevation in the values and concentrations of insured property may increase the severity of the occurrence of claims in the future. Although we attempt to manage our exposure to such events through the use of underwriting controls and the purchase of third-party reinsurance, catastrophic events are inherently unpredictable and the actual nature of such events when they occur could be more frequent or severe than contemplated in our pricing and risk management expectations. As a result, the occurrence of one or more catastrophic events could have a material adverse effect on our results of operations or financial condition.

Florida, South Carolina and Texas, all states in which we write homeowners policies, experienced several significant hurricanes in 2016 and 2017, which some weather analysts believe is consistent with a period of greater hurricane activity. We are exploring alternatives to reduce our exposure to these types of storms, which alternatives may increase operating expenses and may not be successful in protecting long-term profitability. If our loss experience is more adverse than is contemplated by our loss reserves, the related increase in our loss reserves may have a material adverse effect on our results of operations in the period in which the increase occurs.

Our loss reserves are estimates and may be inadequate to cover our actual liability for losses, causing our results of operations to be adversely affected.

We maintain reserves to cover our estimated ultimate liabilities for losses and LAE. These reserves are estimates based on historical data and statistical projections of what we believe the settlement and administration of claims will cost based on facts and circumstances then known to us. Actual loss and LAE reserves, however, may vary significantly from our estimates. Factors that affect loss and LAE reserves include the estimates made on a claim-by-claim basis known as “case reserves” coupled with bulk estimates known as IBNR. Periodic estimates by management of the ultimate costs required to settle all claim files are based on our analysis of historical data and estimations of the impact of numerous factors such as:

• per-claim information;
• company and industry historical loss experience, including the impact of trends such as the assignment of benefits (“AOB”) by insureds;
• legislative enactments, judicial decisions, legal developments in the awarding of damages, and changes in political attitudes; and
• 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 past 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. Because of the uncertainties that surround estimated loss reserves, we cannot be certain that our reserves will be adequate to cover our actual losses. If our loss and LAE reserves are less than actual losses and LAE, we will be required to increase our reserves with a corresponding reduction in our net income in the

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period in which the deficiency is identified. Future loss experience, substantially in excess of our loss and LAE reserves, could substantially harm our results of operations and financial condition.

Although we follow the industry practice of reinsuring a portion of our risks, our costs of obtaining reinsurance fluctuates and we may not be able to successfully alleviate risk through reinsurance arrangements.

We have a reinsurance structure that is a combination of private reinsurance and the FHCF. Our reinsurance structure is composed of several reinsurance companies with varying levels of participation providing coverage for losses and LAE at pre-established minimum and maximum amounts. Losses incurred in connection with a catastrophic event below the minimum and above the maximum are the responsibility of FNIC and MNIC.

The availability and costs associated with the acquisition of reinsurance varies year to year. We are not able to control these fluctuations which may be significant and may limit our ability to purchase adequate coverage. The recovery of increased reinsurance costs through rate increases is not immediate and cannot be presumed, as rate increases are subject to approval of the Florida OIR.

We face a risk of non-collectability of reinsurance, which could materially and adversely affect our business, results of operations and financial condition.

As is common practice within the insurance industry, we transfer a portion of the risks insured under our policies to other companies through the purchase of reinsurance. This reinsurance is maintained to protect our insurance subsidiary against the severity of losses on individual claims, unusually serious occurrences in which a number of claims produce an aggregate extraordinary loss and other catastrophic events. Although reinsurance does not discharge our insurance subsidiary from its primary obligation to pay for losses insured under the policies it issues, reinsurance does make the assuming reinsurer liable to the insurance subsidiary for the reinsured portion of the risk. A credit 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 business, results of operations and financial condition.

Our reinsurance structure has significant risks, including the fact that the FHCF or our other reinsurers may not have available capital resources to pay their claims or that their ability to pay their claims in a timely manner may be impaired. This could result in significant financial, legal and operational challenges to our company. Therefore, in the event of a catastrophic loss, we may become dependent upon the FHCF’s and our other reinsurers’ ability to pay their claims. With respect to the FHCF, we may, in turn, be dependent upon the ability of the State Board of Administration of Florida (“SBA”) to issue bonds in amounts that would be required to meet its reinsurance obligations in the event of such a catastrophic loss.

If we are unable to continue our growth because our capital must be used to pay greater than anticipated claims, our financial results may suffer.

Our ability to grow in the future will depend on our ability to expand the types of insurance products we offer and the geographic markets in which we do business, both balanced by the business risks we choose to assume and cede. We believe that our company is sufficiently capitalized to operate our business as it now exists and as we currently plan to expand it. Our existing sources of funds include issuance of debt securities, possible sales of our investment securities, and our earnings from operations and investments. Unexpected catastrophic events in our market areas, such as the hurricanes experienced in Florida, South Carolina and Texas in 2016 and 2017, have resulted and may result in greater claims losses than anticipated, which could require us to limit or halt our growth while we redeploy our capital to pay these unanticipated claims.

The failure of any of the loss limitation methods we employ could have a material adverse effect on our financial condition or our results of operations.

Various provisions of our policies, such as limitations or exclusions from coverage which have been negotiated to limit our risks, may not be enforceable in the manner we intend. At the present time, we employ a variety of exclusions to our policies that limit exposure to known risks, including, but not limited to, exclusions relating to certain named liabilities, types of vehicles and specific artisan activities. In addition, the policies we issue contain conditions requiring the prompt reporting of claims to us and our right to decline coverage in the event of a violation of that condition. While we believe our insurance product exclusions and limitations reduce the loss exposure to us and help eliminate known exposures to certain risks, it is possible that a court or regulatory authority could nullify or void an exclusion or that legislation could be enacted modifying or barring the use of such endorsements and limitations in a way that would adversely affect our loss experience, which could have a material adverse effect on our financial condition or results of operations.

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Trends in claims and coverage issues have had, and may continue to have, a material adverse impact on our business.

As industry practices and legal, judicial, social and other conditions change, unexpected and unintended issues related to claims and coverage emerge. These issues adversely affect our business by either extending coverage beyond our underwriting intent or by increasing the number or size of claims. In some instances, these changes may not become apparent until sometime after we have issued insurance policies that are affected by the changes. As a result, the full extent of liability under our insurance policies may not be known for many years after a policy is issued.

An example of an existing trend, particularly in Florida homeowners insurance, is the assignment of homeowner benefits for a claim where a service provider agrees to make a repair that may be covered by an insurance policy in exchange for the policyholder’s right to sue the insurance carrier directly. The assignment of the insurance benefits has substantially increased, and may continue to increase, our exposure to inflated claims, attorney’s fees and costs. Although legislative actions in the State of Florida to limit the effect of AOB on insurance companies are being contemplated, there can be no assurances that any such legislative actions will become law or, if enacted, that such actions will have the effect of limiting the impact on us of assignments of benefits by insureds.

MNIC, which is now a wholly owned subsidiary of FNIC, has focused on the Florida homeowners insurance market since its formation, which has increased our exposure to the factors that impact the Florida insurance market generally, such as the occurrence of hurricanes, trends in claims experience, and the impact of changes in Florida insurance law and regulations.

MNIC is organized as a Florida property and casualty insurer and has initially focused on the Florida homeowners insurance market. As a result, the presence of MNIC in the Florida market increases our exposure to the factors that impact insurers in the Florida market generally, such as the occurrence of catastrophic events such as hurricanes, the trends experienced in administering and resolving claims resulting from the increased use of public adjusters, and the impact of changes in Florida’s insurance laws and regulations. To the extent that these factors may adversely affect our operations, the presence of MNIC in the Florida market will have the effect of magnifying the effect of those factors.

MNIC currently writes insurance policies that have a higher risk profile than those written by FNIC, allowing MNIC to reach a broader market and charge higher premiums. While MNIC’s underwriting standards attempts to avoid the highest risk policies, the occurrence of a catastrophic event would be likely to result in greater losses per policy for MNIC and have a material adverse effect on our results of operations, financial position and cash flows.

Our failure to comply with the covenants in our senior note indenture, including as a result of events beyond our control, could result in an event of default, which could materially and adversely affect our financial condition and results of operations.

The indenture for our senior notes requires us to maintain certain financial ratios and to comply with various operational and other covenants, including limitations on our ability to incur additional debt without the approval of the existing noteholders. If there were an event of default under the indenture that was not cured or waived, the holders of the senior notes could cause all amounts outstanding with respect to the senior notes to be due and payable immediately. We cannot assure you that our assets or cash flow would be sufficient to fully repay the senior notes, either upon maturity or, if accelerated, upon an event of default, or that we would be able to refinance or restructure the payments on the senior notes. This would have a material adverse impact on our liquidity, financial condition and results of operations.

We have recently issued debt securities, a portion of which bears interest at a floating rate, as a result of which we will have increased interest expense and exposure to rising interest rates.

In late December 2017, the Company issued $45 million of unsecured senior notes, $20 million of which bear interest at a fixed interest rate and $25 million of which bear interest at a floating rate of 7% above three-month LIBOR.  As such, interest expense will increase substantially in 2018 and beyond (in the range of approximately $4 million, pre-tax) from historical levels (of approximately $350,000, pre-tax).  In addition, the floating rate debt exposes the Company to the risk of further erosion of earnings if short-term interest rates rise, which they are likely to do in 2018, given the extended period of low interest rates experienced in the United States in recent years.  Each 1% increase in the three-month LIBOR will increase the Company’s interest expense by $250,000, pre-tax.


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We may require additional capital in the future which may not be available or only available on unfavorable terms.

Our future capital requirements depend on many factors, including our ability to write new business successfully and to establish premium rates and reserves at levels sufficient to cover losses. To the extent that our capital may be insufficient to meet future operating requirements and/or cover losses, we may need to raise additional funds through financings or curtail our growth. Many factors will affect the amount and timing of our capital needs, including our growth and profitability, our claims experience, and the availability of reinsurance, as well as possible acquisition opportunities, market disruptions and other unforeseeable developments.

If we were required to raise additional capital, equity or debt financing may not be available at all or may be available only on terms that are not favorable to us. In the case of equity financings, dilution to our shareholders’ ownership could result, and in any case such securities may have rights, preferences and privileges that are senior to those of existing shareholders. If we raise additional funds by incurring debt financing, the terms of the debt may involve significant cash payment obligations as well as covenants and specific financial ratios that may restrict our ability to operate our business or pay dividends. If we cannot obtain adequate capital on favorable terms or at all, our business, financial condition or results of operations could be materially adversely affected.

Our business is heavily regulated, and changes in regulation may reduce our profitability and limit our growth.

We are subject to extensive regulation in the states in which we conduct business. This regulation is generally designed to protect the interests of policyholders, as opposed to shareholders and other investors, and relates to authorization for lines of business, capital and surplus requirements, investment limitations, underwriting limitations, transactions with affiliates, dividend limitations, changes in control, premium rates and a variety of other financial and non-financial components of an insurance company’s business. These regulatory requirements may adversely affect or inhibit our ability to achieve some or all of our business objectives. State regulatory authorities also conduct periodic examinations into insurers’ business practices. These reviews may reveal deficiencies in our insurance operations or differences between our interpretations of regulatory requirements and those of the regulators.

The NAIC and state insurance regulators are constantly reexamining existing laws and regulations, generally focusing on modifications to holding company regulations, interpretations of existing laws and the development of new laws.

From time to time, some states in which we conduct business have considered or enacted laws that may alter or increase state authority to regulate insurance companies and insurance holding companies. In other situations, states in which we conduct business have considered or enacted laws that impact the competitive environment and marketplace for property and casualty insurance. In addition, in recent years the state insurance regulatory framework has come under increased federal scrutiny. Changes in federal legislation and administrative policies in several areas, including changes in financial services regulation and federal taxation, can significantly impact the insurance industry and us.

We cannot predict with certainty the effect any enacted, proposed or future state or federal legislation or NAIC initiatives may have on the conduct of our business. Furthermore, there can be no assurance that the regulatory requirements applicable to our business will not become more stringent in the future or result in materially higher costs than current requirements. Changes in the regulation of our business may reduce our profitability, limit our growth or otherwise adversely affect our operations.

We may experience financial exposure from climate change.

A body of scientific evidence indicates that climate change may be occurring. Climate change, to the extent that it affects weather patterns, may cause an increase in the frequency and/or the severity of catastrophic events or severe weather conditions. Our financial exposure from climate change is most notably associated with losses in connection with the occurrence of hurricanes striking Florida. We mitigate the risk of financial exposure from climate change by restrictive underwriting criteria, sensitivity to geographic concentrations, and reinsurance.

Restrictive underwriting criteria can include, but are not limited to, higher premiums and deductibles and more specifically excluded policy risks such as fences and screened-in enclosures. New technological advances in computer generated geographical mapping afford us an enhanced perspective as to geographic concentrations of policyholders and proximity to flood prone areas. Our amount of maximum reinsurance coverage is determined by subjecting our homeowners exposures to statistical forecasting models that are designed to quantify a catastrophic event in terms of the frequency of a storm occurring once in every “n” years. If the statistical forecasting models fail to contemplate an emerging claim trend, such as the assignment of insurance benefits in Florida, then there is the risk we may not purchase adequate catastrophic wind coverage.  Our reinsurance coverage contemplates the effects of a catastrophic event that occurs only once every 100 years. Our amount of losses retained (our deductible) in connection with a catastrophic event is determined by market capacity, pricing conditions and surplus preservation. There can be no assurance that

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our reinsurance coverage and other measures taken will be sufficient to mitigate losses resulting from one or more catastrophic events.

Our revenues and operating performance will fluctuate due to statutorily approved assessments that support property and casualty insurance pools and associations.

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, the Florida Joint Underwriters Association (“JUA”), the Florida Insurance Guaranty Association (“FIGA”), Citizens and the FHCF.

Insurance companies currently pass these assessments on to holders of insurance policies in the form of a policy surcharge, and reflect the collection of these assessments as fully earned credits to operations in the period collected. The collection of these fees, however, may adversely affect our overall marketing strategy due to the competitive landscape in Florida. As a result, the impact of possible future assessments on our balance sheet, results of operations or cash flow are indeterminable at this time.

Our investment portfolio may suffer reduced returns, or losses, which would significantly reduce our earnings.

Like other insurance companies, we depend on income from our investment portfolio for a portion of our earnings. During the time that normally elapses between the receipt of insurance premiums and any payment of insurance claims, we invest the premiums received, together with our other available capital, primarily in debt securities and to a lesser extent in equity securities, in order to generate investment income.

Our investment portfolio contains interest rate sensitive instruments, such as bonds, which may be adversely affected by changes in interest rates. A significant increase in interest rates or decrease in credit worthiness could have a material adverse effect on our financial condition or results of operations. Declines in interest rates could have an adverse effect on our investment income.

We are required to review our investment portfolio to evaluate and assess known and inherent risks associated with each investment type. We revise our evaluations and assessments as conditions change and new information becomes available. This may result in changes in an other-than-temporary impairment (“OTTI”) in our consolidated statements of income. We base our assessment of whether an OTTI has occurred on our case-by-case evaluation of the underlying reasons for the decline in fair value. Because historical trends may not be indicative of future impairments and additional impairments may need to be recorded in the future, no assurances can be provided that we have accurately assessed whether any such impairment is temporary or other-than-temporary or that we have accurately recorded amounts for an OTTI in our financial statements.

In addition, volatile and illiquid markets increase the likelihood that investment securities may not behave in historically predictable manners, resulting in fair value estimates that may be overstated compared with actual amounts that could be realized upon disposition or maturity of the security. The effects of market volatility and declining economic conditions may have unforeseen consequences on the credit quality, liquidity and financial stability of the issuers of securities we hold. Such deteriorations in financial condition can occur rapidly, leaving us unable to react to such a scenario in a prudent manner consistent with our historical practices in dealing with more orderly markets. This, in turn, could adversely and negatively affect our results of operations, liquidity or financial condition.

Our failure to pay claims accurately could adversely affect our business, financial results and capital requirements.

We must accurately evaluate and pay claims that are made under our policies. Many factors affect our ability to pay claims accurately, including the training and experience of our claims representatives, the culture of our claims organization and the effectiveness of our management, our ability to develop or select and implement appropriate procedures and systems to support our claims functions and other factors. Our failure to pay claims accurately could lead to material litigation, undermine our reputation in the marketplace, impair our image and negatively affect our financial results.

In addition, if we are not able to handle an increasing number of claims as a result of a catastrophic event, or if we do not train new claims adjusting employees effectively or lose a significant number of experienced claims adjusting employees, our claims department’s ability to handle an increasing workload could be adversely affected. In addition to potentially requiring that growth be slowed in the affected markets, we could suffer decreased quality of claims work, which in turn could lower our operating margins.


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Our insurance companies are subject to minimum capital and surplus requirements, and our failure to meet these requirements could subject us to regulatory action.

Our insurance companies are subject to RBC standards and other minimum capital and surplus requirements imposed under applicable state laws, including the laws of the State of Florida. The RBC standards, based upon the Risk Based Capital Model Act adopted by the NAIC, require our insurance companies to report their results of RBC calculations to state departments of insurance and the NAIC. These RBC standards provide for different levels of regulatory attention depending upon the ratio of an insurance company’s total adjusted capital, as calculated in accordance with NAIC guidelines, to its ACL RBC.

If we fail to meet the applicable RBC or minimum statutory capital requirements imposed by the laws of Florida or other states where we do business, we would be required to raise additional capital and we could be subject to further examination or corrective action imposed by state regulators, including limitations on out writing of additional business, additional state supervision, or liquidation. Similarly, an increase in existing RBC requirements or minimum statutory capital requirements, such as the catastrophic risk component of RBC that took effect in 2017, may require us to increase our statutory capital levels.

Ratios calculated based on RBC tend to be a key criteria in the assignment of ratings by insurance rating agencies.

Our revenues and operating performance may fluctuate with business cycles in the property and casualty insurance industry.

Historically, the financial performance of the property and casualty insurance industry has tended to fluctuate in cyclical patterns characterized by periods of significant competition in pricing and underwriting terms and conditions, which is known as a “soft” insurance market, followed by periods of lessened competition and increasing premium rates, which is known as a “hard” insurance market. Although an individual insurance company’s financial performance is dependent upon its own specific business characteristics, the profitability of most property and casualty insurance companies tends to follow this cyclical market pattern, with profitability generally increasing in hard markets and decreasing in soft markets.  At present, we are experiencing rate indications that support a hardening market in the Florida property and casualty market. Elsewhere in the United States, we are experiencing a softening market because of increased competition. We cannot predict how long these market conditions will persist. Although we do not compete entirely on price or targeted market share, negative market conditions may impair our ability to write insurance at rates that we consider appropriate relative to the risk assumed. If we cannot write insurance at appropriate rates, our revenues and operating performance may be adversely affected.

We are beginning the process of exiting from the automobile and commercial general liability lines of business. As a result, we may experience increased costs as a result of these exit activities and will experience increased concentration of our business in homeowners insurance.

In the fourth quarter of 2017, we determined to exit from the automobile insurance business, and in the first quarter of 2018, we determined to exit from the commercial general liability business. We may experience increased costs in connection with our exit activities, which will include require regulatory filings and notices to policyholders. In addition, after our exit activities are complete, our business will be completely focused on homeowners insurance. Although we will attempt to diversify our risks through geographic and other market diversification, there can be no assurances that we will be able to do so.

If we determine to expand to additional states or to expand the types of insurance products we offer, we may incur additional costs and may not obtain the necessary regulatory approvals.

Although we are currently exiting our automobile and commercial general liability lines of insurance, we may determine to expand our product offerings in the future by underwriting additional insurance products and programs, and marketing them through our distribution network. Expansion of our product offerings will result in increases in expenses due to additional costs incurred in actuarial rate justifications, software and personnel. Offering additional insurance products may also require regulatory approval, further increasing our costs. Before we can write insurance in a new state, or a sell a new insurance product in a state, we must obtain a license or other approvals from the applicable state insurance regulators. These state insurance regulators may request additional information, add conditions to the license that we find unacceptable, or deny our application. This would delay or prevent us from operating in that state or offering that new product. There can be no assurance that we would be successful bringing new insurance products to our markets in a manner that is profitable.


-17-


New homeowners insurance operations outside of Florida may not be profitable.

We plan to continue the expansion of admitted homeowners property and casualty programs into other states as opportunities arise. Expanding our operations to additional states present risks similar to those we currently face with our existing operations, including risks associated with the inability to market an adequately priced policy, inadequate commission structures, and overpriced or unavailable catastrophic reinsurance for wind events. Additionally, we would become subject to the insurance regulators in each state and the laws and regulations designed to regulate the insurance products and operations of new and existing insurance companies under their respective authority. As a result, there can be no guarantees that state regulators will allow us to do business in those states or, if we are approved to operate in a state, that our operations will be profitable in that state.

Our success depends on our ability to accurately price the risks we underwrite.
 
The results of operations and the financial condition of our insurance company depend on our ability to underwrite and set premium rates accurately for a wide variety of risks. Rate adequacy is necessary to generate sufficient premiums to pay losses, LAE and underwriting expenses and to earn a profit. In order to price our products accurately, we must collect and properly analyze a substantial amount of data; develop, test and apply appropriate rating formulas; closely monitor and timely recognize changes in trends; and project both severity and frequency of losses with reasonable accuracy. Our ability to undertake these efforts successfully and price
our products accurately is subject to a number of risks and uncertainties, some of which are outside our control, including:
    
• the availability of sufficient reliable data and our ability to properly analyze available data;
• the uncertainties that inherently characterize estimates and assumptions;
• our selection and application of appropriate rating and pricing techniques;
• changes in legal standards, claim settlement practices, medical care expenses and restoration costs;
• regulatory restrictions, including, without limitation regulatory approval of rates sought; and
• legislatively imposed consumer initiatives.

Consequently, we could underprice risks, which would negatively affect our profit margins, or we could overprice risks, which could reduce our sales volume and competitiveness. In either event, the profitability of our insurance company could be materially and adversely affected.

Adverse ratings by insurance rating agencies may adversely impact our ability to write new policies, renew desirable policies or obtain adequate reinsurance, which could limit or halt our growth and harm our business.

Third-party rating agencies assess and rate the ability of insurers to pay their claims. The insurance industry uses financial strength ratings to assess the financial strength and quality of insurers. Ratings are based on criteria established by the rating agencies and reflect evaluations of each insurer’s profitability, debt and cash levels, customer base, adequacy and soundness of reinsurance, quality and estimated market value of assets, adequacy of reserves, capital and RBC ratios, and management. Ratings are also based upon factors of concern to agents, reinsurers and policyholders and are not directed toward the protection of investors, such as purchasers of our common stock.

Our ability to compete successfully in states outside of Florida to expand our business footprint may also be negatively affected by our lack of an A.M. Best company rating of our financial strength. Although our insurance subsidiaries have a Demotech rating of “A” (Exceptional), which is generally accepted in Florida and certain other states, a rating by A.M. Best is more widely accepted outside of Florida and may cause customers and agents to prefer a policy written by an A.M. Best-rated company over a policy written by us. In addition, some mortgage companies outside of Florida may require homeowners to obtain property insurance from an insurance company with a minimum A.M. Best rating.

The withdrawal or downgrade of our ratings could limit or prevent us from writing or renewing desirable insurance policies, from competing with insurers who have higher ratings, from obtaining adequate reinsurance, or from borrowing on a line of credit or cause us to default on financial covenants contained in certain of our debt financing agreements.  The withdrawal or downgrade of our ratings could have a material adverse effect on our results of operations and financial position because our insurance products might no longer be acceptable to the secondary marketplace and mortgage lenders. Furthermore, a withdrawal or downgrade of our ratings could prevent independent agents from selling and servicing our insurance products or could increase the commissions we must pay to these agents.


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We rely on independent and general agents to write our insurance policies, and if we are not able to attract and retain independent and general agents, our revenues would be negatively affected.

We currently market and distribute our products and services through contractual relationships with a network of independent agents and a select number of general agents. Our independent agents are our primary source for our property and liability insurance policies. Many of our competitors also rely on independent agents. As a result, we must compete with other insurers for independent agents’ business. Our competitors may offer a greater variety of insurance products, lower premiums for insurance coverage, or higher commissions to their agents. If our products, pricing and commissions do not remain competitive, we may find it more difficult to attract business from independent agents to sell our products. A material reduction in the amount of our products that independent agents sell or a material reduction in the number of independent agents with whom we maintain a relationship could negatively affect our results of operations and financial condition.

We are a party to an insurance agency master agreement with ISA, an affiliate of Allstate, pursuant to which we are authorized by ISA to appoint Allstate agents to offer our homeowners and commercial general liability insurance products to consumers in Florida. Since that time, our homeowners premiums and the percentage of homeowners premiums attributable to Allstate agents has increased rapidly. During 2017, 23.8% of the homeowners premiums we underwrote were from Allstate’s network of Florida agents, and this concentration may continue to increase. An interruption or change in our relationship with ISA could have a material adverse effect on the amount of premiums we are able to write, as well as our results of operations.

We are a party to a managing general underwriting agreement with SageSure to facilitate growth in our FNIC homeowners business outside of Florida.  As a percentage of our total homeowners premiums, 10.2%, 6.9% and 5.0%, for the years ended December 31, 20172016 and 2015, respectively, were underwritten by SageSure. The profitability of the business we obtain outside of Florida through this agreement will depend substantially on the quality of underwriting performed by SageSure. An interruption in SageSure’s services for us, or issues with the quality of SageSure’s underwriting, could have a material adverse effect on the profitability of the business obtained through this relationship.

Certain of our agreements with agents provide that the renewal rights for policies written under those agreements belong to the agents, making it more difficult for us to maintain the policies written and the premium income generated through these relationships.

Our agreements with ISA and SageSure provide that ISA and SageSure, respectively, own the expirations of the policies underwritten under these agreements. This means that we do not have the right to solicit renewals of these policies. As a result, we may be less able to maintain the policies and the corresponding premium income from renewals of policies written by us under these agreements.

Cybersecurity breaches and other disruptions could compromise our information and expose us to loss of data or liability, which would cause our business and reputation to suffer.

In the ordinary course of our business, we store sensitive data, including our proprietary business information and personally identifiable information of our insureds and employees, on our networks. The secure processing and maintenance of this information is critical to our operations and business strategy. Despite our security measures, our information technology and infrastructure may be vulnerable to attacks by hackers or breached due to employee error, malfeasance or other disruptions. Any such breach could compromise our networks and the information stored there could be accessed, publicly disclosed, or stolen. Any such access, disclosure or loss of information could result in legal claims against us, liability under laws that protect the privacy of personal information, regulatory penalties, disruption to our operations, and damage our reputation, which could materially adversely affect our results of operations. Although we have implemented security measures to protect our systems from viruses and other intrusions by third parties, there can be no assurances that these measures will be effective. To mitigate these costs, we carry a cyber-liability insurance policy. Our insurance may not be sufficient to protect against all financial and other loss. Additionally, this policy will not cover us for security breaches, data loss, or cyber-attacks experienced by our third-party business partners who have access to our customer, agent, or employee data.

Our business could be materially and adversely affected by a security breach or other attack involving the systems of one or more of our business partners or vendors.

We conduct significant business functions and computer operations using the systems of third-party business partners and vendors, who provide software, hosting, communication, and other computer services to us. Our networks could be compromised by the errors or actions of our vendors and other business partners with legitimate access to our systems. If one of our vendors or other business partners are the subject of a security breach or cyber-attack, such breach or attack may result in improper or unauthorized access to our systems, and the loss, theft or unauthorized publication of our information or the confidential information of our customers,

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agents or employees, notwithstanding our substantial efforts to protect our systems and sensitive or confidential information. While we expend significant resources on these defensive measures, there can be no assurance that we will be successful in preventing attacks or detecting and stopping them once they have begun.

We rely on our information technology and telecommunications systems, and the failure of these systems could disrupt our operations.

Our business is highly dependent upon the successful and uninterrupted functioning of our current information technology and telecommunications systems. We rely on these systems to process new and renewal business, provide  customer service, make claims payments and facilitate collections and cancellations, as well as to perform actuarial and other analytical functions necessary for pricing and product development. As a result, the failure of these systems could interrupt our operations and adversely affect our financial results.

Nonstandard automobile insurance historically has a higher frequency of claims than standard automobile insurance, thereby increasing our potential for loss exposure beyond what we would be likely to experience if we offered only standard automobile insurance.

Nonstandard automobile insurance is provided to insureds who are unable to obtain preferred or standard insurance coverage because of their payment histories, driving records, age, vehicle types, or prior claims histories. This type of automobile insurance historically has a higher frequency of claims than does preferred or standard automobile insurance policies, although the average dollar amount of the claim is usually smaller under nonstandard insurance policies. As a result, we are exposed to the possibility of increased loss exposure and higher claims experience than would be the case if we offered only standard automobile insurance.

Increased competition, competitive pressures, industry developments and market conditions could affect the growth of our business and adversely impact our financial results.

We operate in highly competitive markets and face competition from national, regional and residual market insurance companies in the homeowners, commercial general liability, and automobile markets, many of whom are larger, have greater financial and other resources, have higher financial strength ratings and offer more diversified insurance coverage. Our competitors include companies that market their products through agents, as well as companies that sell insurance directly to their customers. Large national captive writers may have certain competitive advantages over independent agency writers, including increased name recognition, increased loyalty of their customer base and reduced policy acquisition costs. We may be forced to reduce our premiums or increase our commissions significantly to compete, which could make us less profitable and have a material adverse effect on our business, results of operations and financial condition. If we do not meet the prices offered by our competitors, we may lose business in the short term, which could also result in a material adverse effect on our business, results of operations and financial condition.

Our executive management team is critical to the strategic direction of our company. If there were an unplanned loss of service by any of our officers our business could be harmed.

We depend, and will continue to depend, on the services of our executive management team, which includes Michael H. Braun, Chief Executive Officer and President, Ronald Jordan, Chief Financial Officer, Erick A. Fernandez, Chief Accounting Officer, and others. Our success also will depend in part upon our ability to attract and retain qualified executive officers, experienced underwriting talent and other skilled employees who are knowledgeable about our business. If we were to lose the services of one or more members of our executive management team, our business could be adversely affected. Although we have employment agreements with certain of our executive officers, any unplanned loss of service could substantially harm our business.

The recently enacted U.S. tax reform legislation will have an impact on our results of operations and financial condition, which we are currently assessing.

On December 22, 2017, the U.S. Tax Cuts and Jobs Act (the “Tax Act”) was enacted, which significantly amends the Internal Revenue Code of 1986. Among other things, the Tax Act reduces the corporate tax rate from a statutory rate of 35% to 21%, imposes additional limitations on net operating losses and executive compensation, allows for the full expensing of certain capital expenditures, and enacts other changes impacting the insurance industry. While we expect the overall impact of the Tax Act to be favorable due to the decrease in the statutory tax rate, we are currently assessing the impact of other changes therein on our results of operations. In addition, it is possible that state insurance regulators, including the OIR, may determine to take regulatory action, such as disapproving requested rate increases, because of the perception that the Tax Act has benefited insurance companies.


-20-


Risks Related to an Investment in Our Shares

Our stock price in recent years has been volatile and is likely to continue to be volatile. As a result, the market price of our common stock may drop below the price you pay, and you may not be able to resell your shares at a profit.

The market price of our common stock has experienced, and may continue to experience, significant volatility from time to time. Such volatility may be affected by various factors and events, such as:

our operating results, including a shortfall in operating revenue or net income from that expected by securities analysts and investors;
recognition of large unanticipated accounting charges, such as related to a loss reserve enhancement;
changes in securities analysts’ estimates of our financial performance or the financial performance of our competitors or companies in our industry generally;
the announcement of a material event or anticipated event involving us or our industry or the markets in which we operate;
the issuance of a significant number of shares; and,
the other risk factors described in this Annual Report, the accompanying notes and the documents incorporated by reference herein.
    
In recent years, the U.S. stock market has experienced extreme price and volume fluctuations, which have sometimes affected the market price of the securities issued by a particular company in a manner unrelated to the operational performance of the company. This type of market effect could impact our common stock price as well. The volatility of our common stock means that the price of our common stock may have declined substantially at such time as you may look to sell your shares of our common stock. If our share price decreases, the value of your investment could decline.

We have authorized but unissued preferred stock, which could affect rights of holders of common stock.

Our articles of incorporation authorize the issuance of preferred stock with designations, rights and preferences determined from time to time by our board of directors. Accordingly, our board of directors is empowered, without shareholder approval, to issue preferred stock with dividends, liquidation, conversion, voting or other rights that could adversely affect the voting power or other rights of the holders of common stock. In addition, the preferred stock could be issued as a method of discouraging a takeover attempt. Although we do not intend to issue any preferred stock at this time, we may do so in the future.

Provisions in our articles of incorporation and our bylaws and the Florida Business Corporation Act could make it more difficult to acquire us and may reduce the market price of our common stock.

Our articles of incorporation and our bylaws contain certain provisions that may make it more difficult and time-consuming for shareholders or third parties to influence our management, policies or affairs, and may discourage, delay or prevent a transaction involving a change-in-control of our company and offering a premium over the current market price of our common stock. These provisions include those which:

prohibit cumulative voting in the election of our directors;
establish a classified board of directors with staggered three-year terms;
establish advance notice and disclosure procedures for shareholders to bring matters, including nominations for election to our board, before a meeting of our shareholders; and,
eliminate the ability of shareholders to take action by written consent in lieu of a shareholder meeting.

As a result, we may be less likely to receive unsolicited offers to acquire us that some of our shareholders might consider beneficial.

The Florida Business Corporation Act, as amended, contains provisions, which our directors have elected not to opt out of, that are designed to enhance the ability of our board of directors to respond to and potentially defer attempts to acquire control of our company. These provisions may discourage altogether takeover attempts that have not been approved by our board of directors. These provisions may also adversely affect the price that a potential purchaser would be willing to pay for our common stock and, therefore, deprive you of the opportunity to obtain a takeover premium for your shares. These provisions could make the removal of our incumbent directors and management more difficult. These provisions may enable a minority of our directors and the holders of a minority of our outstanding voting stock or the holders of an existing control block to prevent, delay, discourage or make more difficult a merger, tender offer or proxy contest, even though the transaction may be favorable to the interests of a majority of our non-affiliate shareholders. These provisions could also potentially adversely affect the market price of our common stock.

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As a holding company, we depend on the earnings of our subsidiaries and their ability to pay management fees and dividends to the holding company as the primary source of our income.

We are an insurance holding company whose primary assets are our subsidiaries. Our operations, and our ability to pay dividends or service our debt, are limited by the earnings of our subsidiaries and their payment of their earnings to us in the form of management fees, commissions, dividends, loans, advances or the reimbursement of expenses. These payments can be made only when our subsidiaries have adequate earnings. In addition, dividend payments made to us by our insurance subsidiaries are restricted by Florida law governing the insurance industry. Generally, Florida law limits the dividends payable by insurance companies under complicated formulas based on the subsidiaries’ available capital and earnings.

Payment of dividends in the future will depend upon our earnings and financial position and such other factors, as our board of directors deems relevant.

Future sales of our common stock by our existing shareholders in the public market, or the possibility or perception of such future sales, or sales of additional shares of common stock by us, could depress our stock price.

Investors currently known to be the beneficial owners of more than 5.0% of our common stock hold approximately 45% of our outstanding shares. Sales of a substantial number of shares of our common stock in the public market or otherwise by our existing shareholders, or the possibility or perception that such sales could occur, could depress the market price of our common stock and impair our ability to raise capital through the sale of additional equity securities.
    
In addition, we may issue additional shares of our common stock from time to time in the future in amounts that may be significant. The sale of substantial amounts of our common stock by us, or the perception that these sales may occur, could adversely impact our stock price.


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ITEM 1B.  UNRESOLVED STAFF COMMENTS

None.

ITEM  2.  PROPERTIES
    
Our executive offices are located at 14050 N.W. 14th Street, Suite 180, Sunrise, Florida 33323 in an 18,554 square foot office facility. Our lease for this office space is scheduled to expire in December 2022. Refer to Note 9. Commitments and Contingencies, in the Notes to Consolidated Financial Statements set forth in Part II, Item 8. Financial Statements and Supplementary Data of this Annual Report, for further information regarding our leases.

ITEM 3.  LEGAL PROCEEDINGS

In the ordinary course of conducting our business, we become involved in various legal actions and claims.  Litigation is subject to many uncertainties and we may be unable to accurately predict the outcome of such matters, some of which could be decided unfavorably to us.  Management does not believe the ultimate outcome of any pending matters of this nature would be material.

We have been a party to a Co-Existence Agreement effective as of August 30, 2013 (the “Co-Existence Agreement”) with Federated Mutual Insurance Company (“Mutual”) pursuant to which we agreed to certain restrictions on its use of the word “FEDERATED” without the word “NATIONAL” when referring to the Company and FNIC. In response to Mutual’s allegations that our use of the word “FED” as part of our federally registered “FEDNAT” trademark infringes on Mutual’s federal and common law trademark rights, in July 2016 we filed a declaratory judgment action for non-infringement of trademark in the U.S. District Court for the Southern District of Florida seeking a declaration that our federally registered trademark “FEDNAT” does not infringe any alleged trademark rights of Mutual and that Mutual does not own any trademark rights to the name or mark “FED” in connection with insurance services outside of Owatonna, Minnesota. In response to Mutual’s demand for arbitration against us alleging a breach of the Co-Existence Agreement, on February 16, 2018 the arbitrator agreed that our “FEDNAT” trademark does not infringe on Mutual’s federal or common law trademark rights. As a result, we have begun the process of re-branding the Company to use the FEDNAT name. The arbitrator also required us to cease using the Federated National name within 90 days. Unless the Company is able to reach agreement with Mutual regarding the timing of the name change, the Company intends to challenge that portion of the arbitration award in federal court.

On March 2, 2017, we filed a complaint in Broward County, Florida court to enforce the terms of the restrictive covenants set forth in the Amended and Restated Non-Competition, Non-Disclosure and Non-Solicitation Agreement dated August 5, 2013, as amended, entered into between Peter J. Prygelski, III and our company during Mr. Prygelski’s employment with us and set forth in the separation agreement he entered into in connection with his separation from our company. We believe that he accepted employment with a competitor in contravention of these restrictive covenants and therefore we are seeking injunctive relief, declaratory relief and damages. Prygelski has also filed an arbitration seeking declaratory relief as to his obligations under the above-referenced agreements and to recover the remainder of his severance and health insurance premium reimbursements. Because we are seeking monetary relief, we have filed a counterclaim in the arbitration seeking damages and recovery of separation payments. The litigation seeking injunctive relief and the companion arbitration related to damages are ongoing. The final hearing on the arbitration is scheduled for May 14, 2018. There can be no assurances as to the outcome of this matter.

Refer to Note 9. Commitments and Contingencies, in the Notes to Consolidated Financial Statements set forth in Part II, Item 8. Financial Statements and Supplementary Data of this Annual Report, for further information regarding our legal proceedings.

ITEM 4.  MINE SAFETY DISCLOSURES

Not applicable.


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PART II
ITEM 5.  MARKET FOR REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND    ISSUER PURCHASES OF EQUITY SECURITIES

Our common stock is listed for trading on the NASDAQ Global Market under the symbol “FNHC.” The following table sets forth quarterly high and low closing sale prices as reported on the NASDAQ Global Market. These reported prices reflect prices between dealers, without accounting for retail mark-ups, markdowns or commissions, and may not represent actual transactions.

໿
Quarter Ended:
 
High
 
Low
March 31, 2017
 
$
21.19

 
$
16.45

June 30, 2017
 
17.60

 
14.46

September 30, 2017
 
17.34

 
9.78

December 31, 2017
 
16.75

 
12.84


 
 
 
 
March 31, 2016
 
$
29.08

 
$
18.68

June 30, 2016
 
22.93

 
18.00

September 30, 2016
 
22.45

 
17.08

December 31, 2016
 
19.33

 
14.03


The closing price of our common stock on March 8, 2018 was $16.35.
    
HOLDERS

As of March 8, 2018, there were 120 holders of record of our common stock. We believe that the number of beneficial owners of our common stock is in excess of 2,770.

DIVIDENDS

The Board of Directors of FNHC declared regular quarterly dividends as follows:

In November 2017, the Company’s Board of Directors declared a dividend of $0.08 per common share, paid in March 2018, totaling $1.0 million.
In September 2017, the Company’s Board of Directors declared a dividend of $0.08 per common share, paid in December 2017, totaling $1.1 million.
In June 2017, the Company’s Board of Directors declared a dividend of $0.08 per common share, paid in September 2017, totaling $1.1 million.
In March 2017, the Company’s Board of Directors declared a dividend of $0.08 per common share, paid in June 2017, totaling $1.1 million.
In December 2016, our Board of Directors declared a dividend of $0.08 per common share, paid in March 2017, totaling $1.1 million.
In September 2016, our Board of Directors declared a dividend of $0.08 per common share, paid in December 2016, totaling $1.1 million.
In June 2016, our Board of Directors declared dividends of $0.06 per common share, respectively, paid in September 2016, totaling $1.7 million.
In January 2016, our Board of Directors declared a dividend of $0.05 per common share, paid in March 2016, totaling $0.7 million.
Payment of dividends in the future will depend on our earnings and financial position and such other factors, as our Board of Directors deems relevant. Our ability to continue to pay dividends may be restricted by regulatory limits on the amount of dividends that FNIC and MNIC are permitted to pay to the parent company.


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SECURITIES AUTHORIZED FOR ISSUANCE UNDER EQUITY COMPENSATION PLANS

The following table summarizes our equity compensation plans as of December 31, 2017. All equity compensation plans were approved by our shareholders. We have not granted any options, warrants or rights to our shareholders outside of these equity compensation plans.
Equity Compensation Plan Information

 
 
 
 
 
Number of securities

 
 
 
 
 
remaining available for

 
Number of securities to
 
Weighted-average
 
future issuance under

 
be issued upon exercise of
 
exercise price of
 
equity compensation plans

 
outstanding options,
 
outstanding options,
 
(excluding securities

 
warrants and rights
 
warrants and rights
 
reflected in column (a))
Plan category
 
(a)
 
(b)
 
(c)
Equity compensation plans approved by stockholders
 
50,351

 
3.72

 
142,905

    
Refer to Note 10. Shareholders’ Equity, in the Notes to Consolidated Financial Statements set forth in Part II, Item 8. Financial Statements and Supplementary Data of this Annual Report, for additional information regarding our equity compensation.
    
STOCK PERFORMANCE GRAPH

The following graph shows the cumulative total shareholder return on our common stock over the last five fiscal years as compared with the total returns of the NASDAQ Composite Index and the SNL Property & Casualty Insurance Index. In accordance with SEC rules, this graph includes indices that we believe are comparable and appropriate.

Federated National Holding Company
item53stockperformancegraph.jpg

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Period Ending
Index
 
12/31/2012
 
12/31/2013
 
12/31/2014
 
12/31/2015
 
12/31/2016
 
12/31/2017
Federated National Holding Company
 
100.00

 
277.76

 
460.35

 
566.62

 
362.79

 
327.96

NASDAQ Composite
 
100.00

 
140.12

 
160.78

 
171.97

 
187.22

 
242.71

SNL Insurance P&C
 
100.00

 
132.48

 
152.15

 
157.39

 
185.75

 
212.37


Returns are based on the change in year-end to year-end price. The graph assumes $100 was invested on December 31, 2012 in our common stock, the NASDAQ Composite Index and the SNL Property & Casualty Insurance Index and that all dividends were reinvested. Past performance is not necessarily an indicator of future results.

Our filings with the SEC may incorporate information by reference, including this Annual Report.  Unless we specifically state otherwise, the information under this heading “Stock Performance Graph” shall not be deemed to be “soliciting materials” and shall not be deemed to be “filed” with the SEC or incorporated by reference into any of our filings under the Securities Act of 1933, as amended, or the Securities Exchange Act of 1934.



-26-


ITEM 6.  SELECTED FINANCIAL DATA

The following selected consolidated financial data should be read in conjunction with the consolidated financial statements and notes thereto and Management’s Discussion and Analysis of Financial Condition and Results of Operations set forth elsewhere in this Annual Report.

Year Ended December 31,  

2017
 
2016 (1)
 
2015 (1)
 
2014 (1)
 
2013 (1)
Statement of Operations Data:
(In thousands, except per share data)
Revenue:
 
 
 
 
 
 
 
 
 
Net premiums earned
$
333,481

 
$
261,369

 
$
213,020

 
$
173,774

 
$
104,381

Net investment income
10,254

 
9,063

 
7,226

 
5,385

 
3,332

Net realized investment gains
8,548

 
3,045

 
3,616

 
4,426

 
2,881

Direct written policy fees
17,173

 
16,619

 
9,740

 
7,728

 
3,976

Other income
22,206

 
17,429

 
9,869

 
7,303

 
4,352

Total revenue
391,662

 
307,525

 
243,471

 
198,616

 
118,922

Costs and expenses:
 
 
 
 
 
 
 
 
 
Losses and loss adjustment expenses
247,557

 
197,810

 
112,710

 
81,224

 
58,610

Commissions and other underwriting expenses
114,867

 
90,378

 
52,862

 
48,294

 
35,350

General and administrative expenses
19,963

 
17,186

 
14,698

 
10,797

 
7,529

Interest expense
348

 
348

 
256

 

 

Total costs and expenses
382,735

 
305,722

 
180,526

 
140,315

 
101,489

Income before income taxes
8,927

 
1,803

 
62,945

 
58,301

 
17,433

Income taxes
3,585

 
542

 
24,089

 
20,491

 
5,803

Net income
5,342

 
1,261

 
38,856

 
37,810

 
11,630

Net (loss) income attributable to non-controlling interest
(2,647
)
 
246

 
(445
)
 

 

Net income attributable to Federated National Holding Company shareholders
$
7,989

 
$
1,015

 
$
39,301

 
$
37,810

 
$
11,630


 

 
 

 
 

 
 

 
 

Per share data:
 

 
 

 
 

 
 

 
 

Net income per share attributable to Federated National
  Holding Company shareholders:
 

 
 

 
 

 
 

 
 

Basic
$
0.61

 
$
0.07

 
$
2.86

 
$
3.13

 
$
1.37

Diluted
$
0.60

 
$
0.07

 
$
2.81

 
$
3.04

 
$
1.33

Dividends
$
0.32

 
$
0.27

 
$
0.18

 
$
0.13

 
$
0.11


໿

December 31,

2017
 
2016 (1)
 
2015 (1)
 
2014 (1)
 
2013 (1)

(In thousands, except per share data)
Balance Sheet Data:
 
 
 
 
 
 
 
 
 
Cash and invested assets
$
530,249

 
$
484,275

 
$
437,369

 
$
370,920

 
$
262,156

Total assets
$
904,873

 
$
815,390

 
$
701,373

 
$
506,828

 
$
317,167

Loss and loss adjustment expense reserves
$
230,515

 
$
158,110

 
$
97,706

 
$
78,587

 
$
61,203

Total liabilities
$
677,414

 
$
580,925

 
$
455,216

 
$
317,267

 
$
210,463

Total shareholders’ equity
$
227,459

 
$
234,465

 
$
246,157

 
$
189,561

 
$
106,704

Book value per share, excluding non-controlling interest
$
16.29

 
$
16.01

 
$
16.52

 
$
13.91

 
$
9.79


(1) Prior years reflect revisions of our previously issued financial statements. Refer to Note 1. Organization, Consolidation and Basis of Presentation within the Revisions of Previously Issued Financial Statements section, in the Notes to Consolidated Financial Statements set forth in Part II, Item 8. Financial Statements and Supplementary Data of this Annual Report, for information regarding the adjustments.

-27-


ITEM 7.  MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

RESULTS OF OPERATIONS

Operating Results Overview Year Ended December 31, 2017 Compared to Year Ended December 31, 2016

The following table sets forth results of operations for the periods presented:
໿

Year Ended December 31,

2017
 
% Change
 
2016
Revenue:
(Dollars in thousands)
Gross premiums written
$
603,417

 
(0.3
)%
 
$
605,485

Increase in unearned premiums
(224
)
 
(99.4
)%
 
(40,062
)
Gross premiums earned
603,193

 
6.7
 %
 
565,423

Ceded premiums earned
(269,712
)
 
(11.3
)%
 
(304,054
)
Net premiums earned
333,481

 
27.6
 %
 
261,369

Net investment income
10,254

 
13.1
 %
 
9,063

Net realized investment gains
8,548

 
180.7
 %
 
3,045

Direct written policy fees
17,173

 
3.3
 %
 
16,619

Other income
22,206

 
27.4
 %
 
17,429

     Total revenue
391,662

 
27.4
 %
 
307,525


 
 
 
 
 
Costs and expenses:
 
 
 
 
 
Losses and loss adjustment expenses
247,557

 
25.1
 %
 
197,810

Commissions and other underwriting expenses
114,867

 
27.1
 %
 
90,378

General and administrative expenses
19,963

 
16.2
 %
 
17,186

Interest expense
348

 
 %
 
348

     Total costs and expenses
382,735

 
25.2
 %
 
305,722


 
 
 
 
 
Income before income taxes
8,927

 
395.1
 %
 
1,803

Income taxes
3,585

 
561.4
 %
 
542

Net income
5,342

 
323.6
 %
 
1,261

Net (loss) income attributable to non-controlling interest
(2,647
)
 
(1,176.0
)%
 
246

Net income attributable to Federated National Holding Company shareholders
$
7,989

 
687.1
 %
 
$
1,015


 
 
 
 
 
Ratios to net premiums earned:
 
 
 
 
 

Net loss ratio (1)
74.2
%
 
 
 
75.7
%
Net expense ratio (2)
40.4
%
 
 
 
41.2
%
Combined ratio (3)
114.6
%
 
 
 
116.9
%
(1)
Net loss ratio is calculated as losses and loss adjustment expenses divided by net premiums earned.
(2)
Net expense ratio is calculated as all operating expenses less interest expense divided by net premiums earned.
(3)
Combined ratio is calculated as the sum of losses and loss adjustment expenses and all operating expenses less interest expense divided by net premiums earned.

The following table summarizes our results of operations by line of business for the periods presented. Although we conduct our operations under a single reportable segment, we have provided line of business information as we believe it is useful to our shareholders and the investing public. “Homeowners” line of business consists of our homeowners and fire property and casualty insurance business. “Automobile” line of business consists of our nonstandard personal automobile insurance business. “Other” line of business primarily consists of our commercial general liability and federal flood businesses, along with corporate and investment operations.


-28-


 
 
2017
 
2016
 
 
Homeowners
 
Automobile
 
Other
 
Consolidated
 
Homeowners
 
Automobile
 
Other
 
Consolidated
Revenue:
 
(Dollars in thousands)
Gross premiums written
 
$
536,755

 
$
43,505

 
$
23,157

 
$
603,417

 
$
512,737

 
$
69,479

 
$
23,269

 
$
605,485

(Increase) decrease in unearned premiums
 
(11,231
)
 
11,174

 
(167
)
 
(224
)
 
(28,384
)
 
(11,167
)
 
(511
)
 
(40,062
)
Gross premiums earned
 
525,524

 
54,679

 
22,990

 
603,193

 
484,353

 
58,312

 
22,758

 
565,423

Ceded premiums earned
 
(227,269
)
 
(31,037
)
 
(11,406
)
 
(269,712
)
 
(249,972
)
 
(44,291
)
 
(9,791
)
 
(304,054
)
Net premiums earned
 
298,255

 
23,642

 
11,584

 
333,481

 
234,381

 
14,021

 
12,967

 
261,369

Net investment income
 

 

 
10,254

 
10,254

 

 

 
9,063

 
9,063

Net realized investment gains
 

 

 
8,548

 
8,548

 

 

 
3,045

 
3,045

Direct written policy fees
 
8,715

 
7,846

 
612

 
17,173

 
7,844

 
8,171

 
604

 
16,619

Other income
 
13,662

 
3,277

 
5,267

 
22,206

 
9,106

 
5,479

 
2,844

 
17,429

Total revenue
 
320,632

 
34,765

 
36,265

 
391,662

 
251,331

 
27,671

 
28,523

 
307,525


 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Expenses:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Losses and loss adjustment expenses
 
206,842

 
32,752

 
7,963

 
247,557

 
169,920

 
14,885

 
13,005

 
197,810

Commissions and other underwriting expenses
 
97,111

 
12,976

 
4,780

 
114,867

 
73,215

 
12,471

 
4,692

 
90,378

General and administrative expenses
 
15,403

 
650

 
3,910

 
19,963

 
13,079

 
600

 
3,507

 
17,186

Interest expense
 
348

 

 

 
348

 
348

 

 

 
348

Total costs and expenses
 
319,704

 
46,378

 
16,653

 
382,735

 
256,562

 
27,956

 
21,204

 
305,722


 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Income (loss) before income taxes
 
928

 
(11,613
)
 
19,612

 
8,927

 
(5,231
)
 
(285
)
 
7,319

 
1,803

Income taxes
 
360

 
(4,481
)
 
7,706

 
3,585

 
(2,015
)
 
(111
)
 
2,668

 
542

Net income (loss)
 
568

 
(7,132
)
 
11,906

 
5,342

 
(3,216
)
 
(174
)
 
4,651

 
1,261

Net (loss) income attributable to non-controlling interest
 
(2,647
)
 

 

 
(2,647
)
 
246

 

 

 
246

Net income (loss) attributable to Federated National Holding Company shareholders
 
$
3,215

 
$
(7,132
)
 
$
11,906

 
$
7,989

 
$
(3,462
)
 
$
(174
)
 
$
4,651

 
$
1,015


 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Ratios to net premiums earned:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Net loss ratio
 
69.4
%
 
138.5
%
 
68.7
%
 
74.2
%
 
72.5
%
 
106.2
%
 
100.3
%
 
75.7
%
Net expense ratio
 
37.7
%
 


 


 
40.4
%
 
36.8
%
 


 


 
41.2
%
Combined ratio
 
107.1
%
 


 


 
114.6
%
 
109.3
%
 


 


 
116.9
%

Revenue

Total revenue increased $84.1 million, or 27.4%, to $391.7 million for the year ended December 31, 2017, as compared to $307.5 million for the year ended December 31, 2016. The increase in revenue was due to higher gross earned premiums and lower ceded premiums as described below.

Gross Premiums Written

The following table sets forth the gross premiums written for the periods presented:

 
Year Ended December 31,

 
2017
 
2016
Gross premiums written:
 
(In thousands)
Homeowners Florida
 
$
482,039

 
$
477,489

Homeowners non-Florida
 
54,716

 
35,248

Personal automobile
 
43,505

 
69,479

Commercial general liability
 
11,048

 
13,256

Federal flood
 
12,109

 
10,013

Total gross premiums written
 
$
603,417

 
$
605,485


-29-



Gross premiums written decreased $2.1 million, or 0.3%, to $603.4 million for the year ended December 31, 2017, as compared to $605.5 million for the year ended December 31, 2016. Gross premiums written decreased due to the decline in gross premiums written in Automobile, offset by the growth in gross premiums written in Homeowners, both Florida and non-Florida.

The lower premiums in Automobile was due to our decision to select specific types and amounts of premiums to be underwritten with consideration and focus on profitability. Automobile was not profitable throughout the year 2017 and we announced in December 2017 that we were taking the appropriate steps, including the completion of all required regulatory filings and approvals, to withdraw from Automobile. The increase in gross premiums written in the homeowners non-Florida was due to the expansion of our operations outside of Florida, allowing us to leverage personnel and diversify insurance risk. The increase in homeowners Florida reflects our strategy to grow market share in a controlled manner with a renewed focus on risk profile and profitability.

Gross Premiums Earned

The following table sets forth the gross premiums earned for the periods presented:

 
Year Ended December 31,

 
2017
 
2016
Gross premiums earned:
 
(In thousands)
Homeowners Florida
 
$
481,541

 
$
455,252

Homeowners non-Florida
 
43,983

 
29,101

Personal automobile
 
54,679

 
58,312

Commercial general liability
 
12,216

 
13,675

Federal flood
 
10,774

 
9,083

Total gross premiums earned
 
$
603,193

 
$
565,423


Gross premiums earned increased $37.8 million, or 6.7%, to $603.2 million for the year ended December 31, 2017, as compared to $565.4 million for the year ended December 31, 2016. Gross premiums earned increased due to higher premiums written in homeowners non-Florida and homeowners Florida over the past twelve to eighteen months, which resulted in higher earned premiums as the premiums written has earned in.

Ceded Premiums Earned

Ceded premiums earned decreased $34.3 million, or 11.3%, to $269.7 million for the year ended December 31, 2017, as compared to $304.1 million for the year ended December 31, 2016. The decrease in ceded premiums earned was driven by the expiration of the 30% and 10% Florida-only property quota share treaties, which ended on July 1, 2016 and 2017, respectively. The effect of these expirations was partially offset by the new 10% Florida-only property quota share treaty, which became effective on July 1, 2017.

Net Investment Income

Net investment income increased $1.2 million, or 13.1%, to $10.3 million for the year ended December 31, 2017, as compared to $9.1 million for the year ended December 31, 2016. The increase in net investment income was primarily due to the growth in our fixed income portfolio including a re-allocation of $30 million of equity investments into fixed income securities. The increase was also due to the improvement in the yield on our fixed income portfolio as a result of portfolio repositioning during the first quarter of 2017, particularly the sale of tax-free municipal bonds, the proceeds of which were reinvested in taxable municipal and corporate fixed income securities with higher coupon rates. A portion of the increase in net investment income will be offset by higher federal income taxes, given that a lower percentage of our investment income originates from tax-free securities.
  
Net Realized Investment Gains

Net realized investment gains increased $5.5 million, to $8.5 million for the year ended December 31, 2017, as compared to $3.0 million for the year ended December 31, 2016. This increase was driven by our decision to re-deploy approximately $30.6 million of equity securities into fixed-income securities during the year in order to reduce our exposure to the equity markets, which generated realized gains of $5.6 million.  Additionally, during the first half of 2017, we redistributed a portion of our equity portfolio between our investment managers, which yielded $2.8 million of realized gains.


-30-


Direct Written Policy Fees

Direct written policy fees increased by $0.6 million, or 3.3%, to $17.2 million for the year ended December 31, 2017, as compared to $16.6 million for the year ended December 31, 2016. The increase in direct written policy fees is correlated to the increase in gross premiums earned in Homeowners, offset by the decrease in gross premiums earned in Automobile, as compared to the prior year.

Other Income

Other income increased $4.8 million, or 27.4%, to $22.2 million for the year ended December 31, 2017, as compared to $17.4 million for the year ended December 31, 2016. Other income included the following for the periods presented:

໿

 
Year Ended December 31,

 
2017
 
% Change
 
2016

 
(Dollars in thousands)
Other income:
 
 
 
 
 
 
Commission income
 
$
6,227

 
(19.4
)%
 
$
7,730

Brokerage revenue
 
11,781

 
61.0
 %
 
7,316

Partnership income
 
1,973

 
722.1
 %
 
240

Financing revenue
 
2,225

 
3.8
 %
 
2,143

Total other income
 
$
22,206

 
27.4
 %
 
$
17,429

    
The increase in other income was due to the improvement in brokerage revenue and partnership income, partially offset by the decline in commission income. The improvement in brokerage revenue was due to the increase in the amount of our homeowners reinsurance placed, the type of reinsurance purchased and the commissions paid on these reinsurance agreements for the year ended December 31, 2017, as compared to the year ended December 31, 2016. The improvement in partnership income from our 33% investment in SECCC, was driven by the increased claims adjustment services provided by SECCC to its customers, primarily related to Hurricanes Irma and Harvey for the year ended December 31, 2017, as compared to the prior year. The decline in commission income was primarily due to the lower premiums in Automobile for the year ended December 31, 2017, as compared to the year ended December 31, 2016.

Expenses

Losses and Loss Adjustment Expenses

Losses and LAE increased $49.7 million, or 25.1%, to $247.6 million for the year ended December 31, 2017, as compared to $197.8 million for the year ended December 31, 2016. Year over year premium volume growth from Homeowners primarily drove approximately $23.0 million of the increase. During 2017, we experienced losses, net of reinsurance from catastrophe claims of $30.4 million, of which $21.4 million related to Hurricane Irma and $14.6 million related to Hurricane Harvey and other severe weather events in the states of Florida, Louisiana and Texas in Homeowners and Automobile; offset by $5.6 million of income for catastrophe claims handling, which is a reduction to net losses. We experienced adverse development, net of reinsurance, of $13.9 million, primarily in Automobile and Homeowners. The adverse development for Automobile of approximately $8.0 million was primarily driven by adjustments to cession percentages. Homeowners’ adverse development of approximately $8.0 million was driven by the continued impact of AOB and related ligation costs. Unallocated loss adjustment expense also increased by $6.5 million for the year ended December 31, 2017, as compared to the year ended December 31, 2016. Approximately $15.0 million of the period over period increase stems from lower ceded losses for the year ended December 31, 2017, from the combination of the expiration of the retrospectively-rated 10% Florida-only property quota share treaty and the new 10% Florida-only property quota share treaty. These increased losses were offset by 2016 activity related to $33.3 million of catastrophe claims from Hurricane Matthew and other severe events and $11.0 million of adverse development.


-31-


Commissions and Other Underwriting Expenses
    
The following table sets forth the commissions and other underwriting expenses for the periods presented:
໿

 
Year Ended December 31,

 
2017
 
2016
Commissions and other underwriting expenses:
 
(In thousands)
Homeowners Florida
 
$
57,151

 
$
55,370

All others
 
32,105

 
28,720

Ceded commissions
 
(19,199
)
 
(36,445
)
  Total commissions and other fees
 
70,057

 
47,645

Salaries and wages
 
14,521

 
13,748

Other underwriting expenses
 
30,289

 
28,985

Total commissions and other underwriting expenses
 
$
114,867

 
$
90,378


Commissions and other underwriting expenses increased $24.5 million, or 27.1%, to $114.9 million for the year ended December 31, 2017, as compared to $90.4 million for the year ended December 31, 2016. The increase was due primarily to a reduction in ceding commissions as a result of the termination of our 30% Florida-only property quota share treaty on July 1, 2016. The remaining increase is due to higher gross premiums earned in Homeowners, as discussed above.

General and Administrative Expenses

General and administrative expenses increased $2.8 million, or 16.2%, to $20.0 million for the year ended December 31, 2017, as compared to $17.2 million for the year ended December 31, 2016.  The increase in general and administrative expenses was primarily due to higher legal and professional fees, including audit, tax and actuarial fees.

Interest Expense

Interest expense was unchanged at $0.3 million for the years ended December 31, 2017 and 2016. In late December 2017, the Company issued $45.0 million of senior notes. Refer to Note 7. Long-Term Debt, in the Notes to Consolidated Financial Statements set forth in Part II, Item 8. Financial Statements and Supplementary Data of this Annual Report, for further information regarding the senior notes. As a result, interest expense will increase substantially in 2018 to approximately $4.0 million, based on the level of three-month LIBOR as of December 31, 2017.

Income Taxes

Income taxes increased $3.0 million, or 561.4%, to $3.6 million for the year ended December 31, 2017, as compared to $0.5 million for the year ended December 31, 2016. The increase in income taxes was primarily due to an increase in taxable income. The revaluation of our net deferred tax asset as during the fourth quarter of 2017 pursuant to Tax Act added $0.3 million of expense to our 2017 tax provision. Due to the decrease in the federal corporate tax rate from 35% to 21%, effective January 1, 2018, we expect our effective tax to decline approximately 14 points in 2018, which will benefit our earnings in the coming year. Refer to Note 8. Income Taxes, in the Notes to Consolidated Financial Statements set forth in Part II, Item 8. Financial Statements and Supplementary Data of this Annual Report, for additional information on federal income tax reform.


-32-


Operating Results Overview Year Ended December 31, 2016 Compared to Year Ended December 31, 2015

The following table sets forth selected results of operations for the periods presented: 


 
Year Ended December 31,

 
2016
 
% Change
 
2015
Revenue:
 
(Dollars in thousands)
Gross premiums written
 
$
605,485

 
22.6
 %
 
$
493,770

Increase in unearned premiums
 
(40,062
)
 
(34.9
)%
 
(61,537
)
Gross premiums earned
 
565,423

 
30.8
 %
 
432,233

Ceded premiums earned
 
(304,054
)
 
38.7
 %
 
(219,213
)
Net premiums earned
 
261,369

 
22.7
 %
 
213,020

Net investment income
 
9,063

 
25.4
 %
 
7,226

Net realized investment gains
 
3,045

 
(15.8
)%
 
3,616

Direct written policy fees
 
16,619

 
70.6
 %
 
9,740

Other income
 
17,429

 
76.6
 %
 
9,869

     Total revenue
 
307,525

 
26.3
 %
 
243,471


 
 
 
 
 
 
Costs and expenses:
 
 
 
 
 
 
Losses and loss adjustment expenses
 
197,810

 
75.5
 %
 
112,710

Commissions and other underwriting expenses
 
90,378

 
71.0
 %
 
52,862

General and administrative expenses
 
17,186

 
16.9
 %
 
14,698

Interest expense
 
348

 
35.9
 %
 
256

      Total costs and expenses
 
305,722

 
69.4
 %
 
180,526


 
 
 
 
 
 
Income before income taxes
 
1,803

 
(97.1
)%
 
62,945

Income taxes
 
542

 
(97.8
)%
 
24,089

Net income
 
1,261

 
(96.8
)%
 
38,856

Net income (loss) attributable to non-controlling interest
 
246

 
(155.3
)%
 
(445
)
Net income attributable to Federated National Holding Company shareholders
 
$
1,015

 
(97.4
)%
 
$
39,301


 
 
 
 
 
 

Ratios to net premiums earned:
 
 

 
 

 
 

Net loss ratio
 
75.7
%
 
 

 
52.9
%
Net expense ratio
 
41.2
%
 
 

 
31.7
%
Combined ratio
 
116.9
%
 
 

 
84.6
%
໿

-33-


 
 
2016
 
2015
 
 
Homeowners
 
Automobile
 
Other
 
Consolidated
 
Homeowners
 
Automobile
 
Other
 
Consolidated
Revenue:
 
(Dollars in thousands)
Gross premiums written
 
$
512,737

 
$
69,479

 
$
23,269

 
$
605,485

 
$
449,766

 
$
21,912

 
$
22,092

 
$
493,770

Increase in unearned premiums
 
(28,384
)
 
(11,167
)
 
(511
)
 
(40,062
)
 
(52,940
)
 
(7,804
)
 
(793
)
 
(61,537
)
Gross premiums earned
 
484,353

 
58,312

 
22,758

 
565,423

 
396,826

 
14,108

 
21,299

 
432,233

Ceded premiums earned
 
(249,972
)
 
(44,291
)
 
(9,791
)
 
(304,054
)
 
(199,731
)
 
(11,101
)
 
(8,381
)
 
(219,213
)
Net premiums earned
 
234,381

 
14,021

 
12,967

 
261,369

 
197,095

 
3,007

 
12,918

 
213,020

Net investment income
 

 

 
9,063

 
9,063

 

 

 
7,226

 
7,226

Net realized investment gains
 

 

 
3,045

 
3,045

 

 

 
3,616

 
3,616

Direct written policy fees
 
7,844

 
8,171

 
604

 
16,619

 
7,020

 
2,115

 
605

 
9,740

Other income
 
9,106

 
5,479

 
2,844

 
17,429

 
6,567

 
1,657

 
1,645

 
9,869

Total revenue
 
251,331

 
27,671

 
28,523

 
307,525

 
210,682

 
6,779

 
26,010

 
243,471


 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Expenses:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Losses and loss adjustment expenses
 
169,920

 
14,885

 
13,005

 
197,810

 
97,219

 
5,196

 
10,295

 
112,710

Commissions and other underwriting expenses
 
73,215

 
12,471

 
4,692

 
90,378

 
46,684

 
1,576

 
4,602

 
52,862

General and administrative expenses
 
13,079

 
600

 
3,507

 
17,186

 
11,956

 
100

 
2,642

 
14,698

Interest expense
 
348

 

 

 
348

 
256

 

 

 
256

Total costs and expenses
 
256,562

 
27,956

 
21,204

 
305,722

 
156,115

 
6,872

 
17,539

 
180,526


 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Income before income taxes
 
(5,231
)
 
(285
)
 
7,319

 
1,803

 
54,567

 
(93
)