FG Financial Group, Inc. - Quarter Report: 2021 September (Form 10-Q)

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

(Mark One)

For the Quarterly Period Ended September 30, 2021

Or

Commission File Number: 001-36366

FG Financial Group, Inc.

(Exact name of registrant as specified in its charter)

360 Central Avenue, Suite 800, St. Petersburg, FL 33701

(Address of principal executive offices and zip code)

727-304-5666

(Registrant’s telephone number, including area code)

Not Applicable

(Former name, former address and former fiscal year, if changed since last report)

Securities registered pursuant to Section 12(b) of the Act:

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 submitted electronically every Interactive Data File required to be submitted 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 such files). Yes ☒ No ☐

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 definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company,” and “emerging growth company” in Rule 12b-2 of the Exchange Act.

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 number of shares outstanding of the registrant’s common stock as of November 11, 2021 was 5,801,471.

Table of Contents

PART I. FINANCIAL INFORMATION

ITEM 1. FINANCIAL STATEMENTS

See accompanying notes to consolidated financial statements

See accompanying notes to consolidated financial statements

See accompanying notes to consolidated financial statements

See accompanying notes to consolidated financial statements.

FG FINANCIAL GROUP, INC.

Notes to Consolidated Financial Statements

1. Nature of Business

FG Financial Group, Inc. (“FGF”, the “Company”, “we”, or “us”) is a reinsurance and investment management holding company focused on opportunistic collateralized and loss capped reinsurance, while allocating capital in partnership with Fundamental Global^® to SPAC and SPAC sponsor-related businesses. The Company’s principal business operations are conducted through its subsidiaries and affiliates. We were incorporated on October 2, 2012 in the State of Delaware under the name Maison Insurance Holdings, Inc., and changed our legal name to 1347 Property Insurance Holdings, Inc. on November 19, 2013. On March 31, 2014, we completed an initial public offering of our common stock. Prior to the offering, we were a wholly owned subsidiary of Kingsway America Inc., which, in turn, is a wholly owned subsidiary of Kingsway Financial Services Inc., or KFSI, a publicly owned Delaware holding company. From our inception through December 2, 2019, we operated as an insurance holding company, writing property and casualty insurance throughout the states of Louisiana, Florida and Texas through our subsidiaries. On December 2, 2019, we sold our three insurance subsidiaries, and embarked on a new strategy focused on insurance, reinsurance, real estate, and asset management. Accordingly, on December 14, 2020, our shareholders approved a change in our corporate name to FG Financial Group, Inc., to better align with this new business strategy.

As of September 30, 2021, Fundamental Global GP, LLC, a privately owned investment management company, and its affiliates, or “FG,” beneficially owned approximately 60% of our outstanding shares of common stock. D. Kyle Cerminara, the Chairman of our Board of Directors, serves as Chief Executive Officer, Co-Founder and Partner of FG.

Sale of the Maison Business

On December 2, 2019, we completed the sale of all of the issued and outstanding equity of three of the Company’s then wholly-owned subsidiaries, Maison Insurance Company (“Maison”), Maison Managers Inc. (“MMI”) and ClaimCor, LLC (“ClaimCor” and, together with Maison and MMI, the “Maison Business” or the “Insurance Companies”), to FedNat Holding Company, a Florida corporation (“FedNat”), pursuant to the terms and conditions of the Equity Purchase Agreement, dated as of February 25, 2019 (the “Purchase Agreement”), by and among the Company and each of Maison, MMI and ClaimCor, on the one hand, and FedNat, on the other hand (the “Asset Sale”).

As consideration for the Asset Sale, FedNat paid the Company $51.0 million, consisting of $25.5 million in cash and $25.5 million in FedNat’s common stock, or 1,773,102 shares of FedNat common stock. In addition, upon the closing of the Asset Sale, $18.0 million of outstanding surplus note obligations payable by Maison to the Company, plus all accrued but unpaid interest, was repaid to the Company.

On December 31, 2019, the shares of FedNat common stock issued to the Company in connection with the Asset Sale were registered under the Securities Act of 1933, as amended (the “Securities Act”), pursuant to the terms of the Registration Rights Agreement entered into by the Company and FedNat at the closing of the Asset Sale.

In addition to the Registration Rights Agreement, the Company and FedNat entered into a Standstill Agreement, a Reinsurance Capacity Right of First Refusal Agreement (the “Reinsurance Agreement”), and an Investment Advisory Agreement at the closing of the Asset Sale.

Standstill Agreement

The Standstill Agreement imposes certain limitations and restrictions with respect to the voting securities of FedNat (including shares of FedNat common stock) that are owned or held beneficially or of record by the Company. Under the Standstill Agreement, the Company has agreed to vote all of the voting securities of FedNat beneficially owned by the Company in accordance with the recommendation of the board of directors of FedNat with respect to any matter that is before the stockholders of FedNat for a vote by such stockholders. The Standstill Agreement imposes limitations on the sale of voting securities of FedNat held by the Company and restricts the Company from taking certain actions as a holder of voting securities of FedNat. The Standstill Agreement expires on December 2, 2024.

For insurance regulatory purposes, the Company has waived any rights that it may have to exercise control of FedNat.

FG FINANCIAL GROUP, INC.

Notes to Consolidated Financial Statements

Reinsurance Capacity Right of First Refusal Agreement

The Reinsurance Agreement provides the Company with a right of first refusal to sell reinsurance coverage to the insurance company subsidiaries of FedNat, providing reinsurance on up to 7.5% of any layer in FedNat’s catastrophe reinsurance program, subject to the annual reinsurance limit of $15.0 million, on the terms and subject to the conditions set forth in the Reinsurance Agreement. All reinsurance sold by the Company pursuant to the right of first refusal, if any, will be memorialized in an agreement in such form and subject to such terms and conditions as are customary in the property and casualty insurance industry. The Reinsurance Agreement is assignable by the Company subject to conditions set forth in the agreement. The term of the Reinsurance Agreement is five years, expiring on December 2, 2024. As of September 30, 2021, the Company has not provided any reinsurance coverage to FedNat under the Reinsurance Agreement.

Investment Advisory Agreement

Pursuant to the Investment Advisory Agreement, FG Strategic Consulting, LLC (“FGSC,” formerly Fundamental Global Advisors LLC), a wholly-owned subsidiary of the Company, was formed to provide investment advisory services to FedNat, which include identifying, analyzing and recommending potential investments, advising as to existing investments and investment optimization, recommending investment dispositions, and providing advice regarding macro-economic conditions. In exchange for providing the investment advisory services, FedNat has agreed to pay FGSC an annual fee of $100,000. The term of the Investment Advisory Agreement is five years, expiring on December 2, 2024.

Current Business

Our strategy has evolved to focus on opportunistic collateralized and loss capped reinsurance, while allocating capital to special purpose acquisition companies (“SPACs”) and SPAC sponsor-related businesses. Accordingly, in the first quarter 2021, we have launched our “SPAC Platform,” as further discussed below. As part of our refined focus, we have adopted the following capital allocation philosophy:

“Grow intrinsic value per share with a long-term focus using fundamental research, allocating capital to asymmetric risk/reward opportunities.”

Historically, the Company has operated a real estate business through its subsidiary, FGI Metrolina Property Income Fund, LP; however, the Company does not anticipate that its real estate business will be a significant component of its future business plans.

Reinsurance

The Company has formed a wholly-owned reinsurance subsidiary, FG Reinsurance Ltd. (“FGRe”), a Cayman Islands limited liability company, to provide specialty property and casualty reinsurance. FGRe has been granted a Class B (iii) insurer license in accordance with the terms of The Insurance Law, 2010 and underlying regulations thereto and is subject to regulation by the Cayman Islands Monetary Authority (the “Authority”). The terms of the license required FGRe to receive a capital infusion in the amount of $5.0 million, which the Company effected in July 2020 via the transfer of 156,000 shares of FedNat common stock from the Company along with approximately $3.3 million in cash. The terms of the license also require advance approval from the Authority should FGRe wish to enter into any reinsurance agreements which are not fully collateralized to their aggregate exposure limit. In November 2020, FGRe entered into its first reinsurance transaction, effective January 1, 2021, through a Funds at Lloyds syndicate (“FAL”). The maximum loss exposure in the transaction is approximately $2.9 million and covers all risks written by the syndicate during the 2021 calendar year. On November 12, 2020 FGRe initially funded a trust account at Lloyd’s with approximately $2.4 million in cash to collateralize its obligations under the contract. Effective April 1, 2021, FGRe entered into its second reinsurance contract with a leading insurtech company that provides automotive insurance utilizing driver monitoring to predictively segment and price drivers. FGRe’s exposure is limited by a loss-cap stipulated within the quota-share agreement.

Asset Management

FGSC serves as an investment advisor to FedNat under the investment advisory agreement entered into at the closing of the Asset Sale. The Company has also formed Fundamental Global Asset Management, LLC (“FGAM”), a joint venture with an affiliate of FG, to sponsor investment advisors that will manage private funds ranging the full spectrum of alternative equities, fixed income, private equity and real estate. In September 2020, the joint venture sponsored the launch of FG Special Situations Fund via an investment of $5.0 million. Approximately $4.0 million of this investment represented the sponsorship of our first SPAC.

FG FINANCIAL GROUP, INC.

Notes to Consolidated Financial Statements

Insurance

FGRe is currently in the process of establishing and seeking regulatory approvals for a Risk Retention Group (“RRG”) to be domiciled in the State of Vermont for the purpose of providing directors and officers insurance coverage to special purpose acquisition vehicles. The Company expects to obtain the necessary regulatory approvals for the RRG in the fourth quarter of 2021. FGRe also anticipates providing capital, along with other participants, to facilitate the underwriting of such insurance coverage. The Company will focus on fee income derived from originating, underwriting, and servicing the insurance business, while mitigating our financial risk with external reinsurance partners.

SPAC Platform

On December 21, 2020, we formed FG SPAC Solutions LLC (“FGSS”), a Delaware company, to facilitate the launch of our “SPAC Platform”. Under the SPAC Platform, we plan to provide various strategic, administrative, and regulatory support services to newly formed SPACs for a monthly fee. The Company co-founded a partnership, FG SPAC Partners, LP (“FGSP”) to participate as a co-sponsor for newly formed SPACs. The Company also participates in the risk capital investments associated with the launch of such SPACs through its Asset Management business, specifically FG Special Situations Fund, LP. The first transaction entered into under the SPAC Platform occurred on January 11, 2021, by and among FGSS and Aldel Investors, LLC, the sponsor of Aldel Financial, Inc. (“Aldel”), a special purpose acquisition company which consummated its initial public offering on April 12, 2021. Under the services agreement between FGSS and Aldel Investors, LLC (the “Agreement”), FGSS has agreed to provide certain accounting, regulatory, strategic advisory, and other administrative services to Aldel, which include assistance with negotiations with a potential merger target for the SPAC as well as assistance with the de-SPAC process. Additional information regarding our formation of FGSS and our SPAC Platform can be found in Note 10 – Related Party Transactions under the heading “Formation of FG SPAC Partners, LP.”

2. Significant Accounting Policies

Basis of Presentation

These statements have been prepared in conformity with accounting principles generally accepted in the United States of America (“GAAP”).

Nature of Operations and Basis of Consolidation

The accompanying Consolidated Financial Statements include the accounts of FG Financial Group, Inc., consolidated with the accounts of all subsidiaries and affiliates in which we hold a controlling financial interest as of the financial statement date.

Normally, a controlling financial interest reflects ownership of a majority of the voting interests. We also consolidate variable interest entities (“VIE”) when we possess both the power to direct the activities of the VIE that most significantly affect their economic performance, and we (i) are obligated to absorb the losses that could be significant to the VIE or (ii) hold the right to receive benefits from the VIE that could be significant to the VIE. Significant intercompany balances and transactions have been eliminated upon consolidation.

Information regarding our reportable business segments is contained in Note 13 – Segment reporting.

Discontinued Operations

Due to the sale of all of the issued and outstanding equity of Maison, MMI and ClaimCor on December 2, 2019, these operations have been classified as discontinued operations in the Company’s financial statements presented herein. For the nine months ended September 30, 2021, we recognized a gain from the sale of the Maison Business of approximately $145,000. This was related to a final true-up and settlement in the first quarter 2021, for income taxes due to the Company under the sale agreement. The following table presents a reconciliation of the major classes of line items constituting pretax profit (loss) of discontinued operations to the after-tax profit (loss) of discontinued operations that are presented in the Company’s consolidated statements of operations for the three and nine months ended September 30, 2021 and 2020:

 Schedule of Discontinued Operations

FG FINANCIAL GROUP, INC.

Notes to Consolidated Financial Statements

The Use of Estimates in the Preparation of Consolidated Financial Statements

The preparation of consolidated financial statements in conformity with U.S. GAAP requires management to make estimates and assumptions that affect the application of policies and the reported amounts of assets and liabilities and the disclosure of contingent assets and liabilities at the date of the consolidated financial statements and the reported amounts of revenues and expenses for the reporting period. Actual results could differ from these estimates. Estimates and their underlying assumptions are reviewed on an ongoing basis. Changes in estimates are recorded in the accounting period in which they are determined. The critical accounting estimates and assumptions in the accompanying consolidated financial statements include the valuation of our investments, the valuation of net deferred income taxes and deferred policy acquisition costs, premium revenue recognition, reserves for loss and loss adjustment expenses, and stock-based compensation expense.

Investments in Equity Securities

Investments in equity securities are carried at fair value with subsequent changes in fair value recorded to the Consolidated Statements of Operations as a component of net investment income.

Other Investments

Other investments consist, in part, of equity investments made in privately held companies accounted for under the equity method. We utilize the equity method to account for investments when we possess the ability to exercise significant influence, but not control, over the operating and financial policies of the investee. The ability to exercise significant influence is presumed when the investor possesses more than 20% of the voting interests of the investee. This presumption may be overcome based on specific facts and circumstances that demonstrate that the ability to exercise significant influence is restricted. We apply the equity method to investments in common stock and to other investments when such other investments possess substantially identical subordinated interests to common stock.

In applying the equity method, we record the investment at cost and subsequently increase or decrease the carrying amount of the investment by our proportionate share of the net earnings or losses and other comprehensive income of the investee. We record dividends or other equity distributions as reductions in the carrying value of the investment. Should net losses of the investee reduce the carrying amount of the investment to zero, additional net losses may be recorded if other investments in the investee are at-risk, even if we have not committed to provide financial support to the investee. Such additional equity method losses, if any, are based upon the change in our claim on the investee’s book value.

Other investments also consist of equity we have purchased in a limited partnership and a limited liability company for which there does not exist a readily determinable fair value. The Company accounts for these investments at their cost, minus impairment, if any, plus or minus changes resulting from observable price changes in orderly transactions for identical or similar investment of the same issuer. Any profit distributions the Company receives on these investments are included in net investment income.

Investment Company Accounting

In September 2020, the Company invested approximately $5.0 million, through its joint venture, Fundamental Global Asset Management, LLC (“FGAM”) to sponsor the launch of FG Special Situations Fund, LP a Delaware limited partnership formed on September 2, 2020 (the “Fund”). The Fund, a VIE which the Company is required to consolidate, is considered an investment company for GAAP purposes and follows the accounting and reporting guidance in the Financial Accounting Standards Codification (“ASC”) Topic 946, Financial Services-Investment Companies, which includes the presentation of its investments at fair value. All of the Fund’s investments have been included in ‘equity securities’ in the Company’s consolidated balance sheets presented herein.

FG FINANCIAL GROUP, INC.

Notes to Consolidated Financial Statements

Cash and Cash Equivalents

Cash and cash equivalents include cash and highly liquid investments with original maturities of 90 days or less.

Income Taxes

The Company follows the asset and liability method of accounting for income taxes, whereby deferred income tax assets and liabilities are recognized for (i) the differences between the financial statement carrying amount of existing assets and liabilities and their respective tax bases and (ii) loss and tax credit carry-forwards. Deferred income tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. The effect on deferred tax assets and liabilities of a change in tax rates is recognized in income in the period that includes the date of enactment. Future tax benefits are recognized to the extent that realization of such benefits is more likely than not and a valuation allowance is established for any portion of a deferred tax asset that management believes will not be realized. Current federal income taxes are charged or credited to operations based upon amounts estimated to be payable or recoverable as a result of taxable operations for the current year. The Company recognizes interest and penalties, if any, related to unrecognized tax benefits in income tax expense (benefit).

Concentration of Credit Risk

Financial instruments which potentially expose the Company to concentrations of credit risk include investments, cash, amounts held as collateral under our quota share insurance agreements, as well as other amounts due to us under our quota share insurance agreements. The Company maintains its cash with a major U.S. domestic banking institution which is insured by the Federal Deposit Insurance Corporation (“FDIC”) for up to $250,000. As of September 30, 2021, the Company held funds in excess of these FDIC insured amounts. The terms of these deposits are on demand to mitigate some of the associated risk. The Company has not incurred losses related to these deposits.

The Company had not experienced any credit losses related to amounts due to us under our quota share agreements.

Premium Revenue Recognition

The Company participates in a quota share contracts and estimates the ultimate premiums for the contract period. These estimates are based on information received from the ceding companies, whereby premiums are recorded as written in the same periods in which the underlying insurance contracts are written and are based on cession statements from cedents. These statements are received quarterly and in arrears, and thus for any reporting lag, premiums written are estimated based on the portion of the ultimate estimated premiums relating to the risks underwritten during the lag period.

Premium estimates are reviewed by management periodically. Such review includes a comparison of actual reported premiums to expected ultimate premiums. Based on management’s review, the appropriateness of the premium estimates is evaluated, and any adjustments to these estimates are recorded in the period in which they are determined. Changes in premium estimates, including premiums receivable, are not unusual and may result in significant adjustments in any period. A significant portion of amounts included in the caption “Reinsurance balances receivable” in the Company’s consolidated balance sheets represent estimated premiums written, net of commissions, brokerage, and loss and loss adjustment expense, and are not currently due based on the terms of the underlying contracts. Additional premiums due on a contract that has no remaining coverage period are earned in full when written.

Premiums written are generally recognized as earned over the contract period in proportion to the risk covered. Unearned premiums represent the unexpired portion of reinsurance provided.

Policy Acquisition Costs

Policy acquisition costs are costs that vary with, and are directly related to, the successful production of new and renewal business, and consist principally of commissions, taxes and brokerage expenses. If the sum of a contract’s expected losses and loss expenses and deferred acquisition costs exceeds associated unearned premiums and expected investment income, a premium deficiency is determined to exist. In this event, deferred acquisition costs are written off to the extent necessary to eliminate the premium deficiency. If the premium deficiency exceeds deferred acquisition costs then a liability is accrued for the excess deficiency. There were no premium deficiency adjustments recognized during the periods presented herein.

FG FINANCIAL GROUP, INC.

Notes to Consolidated Financial Statements

Funds Held by Cedents

The caption “Funds Deposited with Reinsured Companies” in the Company’s consolidated balance sheets includes amounts held by Funds at Lloyd’s provided to support our reinsurance contracts with Lloyd’s syndicates. As of September 30, 2021, funds held by cedents were $2.7 million. On October 20, 2021, we posted additional collateral in the amount of approximately $1.0 million, to support our automotive insurance quota-share agreement entered into on April 1, 2021.

Loss and Loss Adjustment Expense Reserves

Loss and loss adjustment reserve estimates are based on estimates derived from reports the Company has received from ceding companies. These estimates are periodically reviewed by the Company’s management and adjusted as necessary. Since reserves are estimates, the final settlement of losses may vary from the reserves established and any adjustments to the estimates, which may be material, are recorded in the period they are determined.

Loss estimates may also be based upon actuarial and statistical projections, an assessment of currently available data, predictions of future developments, estimates of future trends and other factors. The final settlement of losses may vary, perhaps materially, from the reserves recorded. All adjustments to the estimates are recorded in the period in which they are determined. U.S. GAAP does not permit establishing loss reserves, which include case reserves and IBNR loss reserves, until the occurrence of an event which may give rise to a claim. As a result, only loss reserves applicable to losses incurred up to the reporting date are established, with no allowance for the establishment of loss reserves to account for expected future loss events.

Generally, the Company obtains regular updates of premium and loss related information for the current and historical periods, which are utilized to update the initial expected loss ratio. We also experience a lag between (i) claims being reported by the underlying insured to the Company’s cedent and (ii) claims being reported by the Company’s cedent to the Company. This lag may impact the Company’s loss reserve estimates. Client reports have pre-determined due dates (for example, thirty days after each month end). As a result, the lag depends in part upon the terms of the specific contract. The timing of the reporting requirements is designed so that the Company receives premium and loss information as soon as practicable once the client has closed its books. Accordingly, there should be a short lag in such reporting. Additionally, most of the contracts that have the potential for large single event losses have provisions that such loss notifications are provided to the Company immediately upon the occurrence of an event.

Stock-Based Compensation

The Company has accounted for stock-based compensation under the provisions of ASC Topic 718 – Stock Compensation which requires the use of the fair-value based method to determine compensation for all arrangements under which employees and others receive shares of stock or equity instruments. The fair value of each stock option award is estimated on the date of grant using the Black-Scholes valuation model using assumptions for expected volatility, expected dividends, expected term, and the risk-free interest rate. The fair value of each stock option award is recorded as compensation expense on a straight-line basis over the requisite service period, which is generally the period in which the stock options vest, with a corresponding increase to additional paid-in capital.

The Company has also issued restricted stock units (“RSUs”) to certain of its employees and directors which have been accounted for as equity-based awards since, upon vesting, they are required to be settled in the Company’s common shares. We have used the fair value of the Company’s common stock on the date the RSUs were issued to estimate the grant date fair value of those RSUs which vest solely based upon the passage of time, as well as a Monte Carlo valuation model to estimate the fair value of those RSUs which vest solely upon market-based conditions. The fair value of each RSU is recorded as compensation expense over the requisite service period, which is generally the expected period over which the awards will vest. In the case of those RSUs which vest upon market-based conditions, should the market-based condition be achieved prior to the expiration of the derived service period, any unrecognized cost will be recorded as compensation expense in the period in which the RSUs actually vest.

Based upon the Company’s historical forfeiture rates relating to stock options and RSUs, the Company has not made any adjustment to stock compensation expense for expected forfeitures.

FG FINANCIAL GROUP, INC.

Notes to Consolidated Financial Statements

Fair Value of Financial Instruments

The carrying values of certain financial instruments, including cash, short-term investments, deposits held, accounts payable, and other accrued expenses approximate fair value due to their short-term nature. The Company measures the fair value of financial instruments in accordance with GAAP which defines fair value as the exchange price that would be received for an asset (or paid to transfer a liability) in the principal or most advantageous market for the asset (or liability) in an orderly transaction between market participants on the measurement date. GAAP also establishes a fair value hierarchy, which requires an entity to maximize the use of observable inputs and minimize the use of unobservable inputs when measuring fair value. See Note 5 for further information on the fair value of the Company’s financial instruments.

Earnings (loss) Per Common Share

Basic earnings (loss) per common share is computed using the weighted average number of shares outstanding during the respective period.

Diluted earnings (loss) per common share assumes conversion of all potentially dilutive outstanding stock options, restricted stock units, warrants or other convertible financial instruments. Potential common shares outstanding are excluded from the calculation of diluted earnings (loss) per share if their effect is anti-dilutive.

3. Recently Adopted and Issued Accounting Standards

Accounting Standards Pending Adoption

ASU 2016-13: Financial Instruments – Credit Losses

In June 2016, the FASB issued ASU 2016-13: Financial Instruments – Credit Losses: Measurement of Credit Losses on Financial Instruments. ASU 2016-13 was issued to provide financial statement users with more useful information regarding the expected credit losses on financial instruments held as assets. Under current GAAP, financial statement recognition for credit losses on financial instruments is generally delayed until the occurrence of the loss was probable. The amendments of ASU 2016-13 eliminate this probable initial recognition threshold and instead reflect an entity’s current estimate of all expected credit losses. The amendments also broaden the information that an entity must consider in developing its expected credit loss estimates for those assets measured at amortized cost by using forecasted information instead of the current methodology which only considered past events and current conditions. Under ASU 2016-13, credit losses on available-for-sale debt securities will be measured in a manner similar to current GAAP; however, the amendments require that credit losses be presented as an allowance against the investment, rather than as a write-down. The amendments also allow the entity to record reversals of credit losses in current period net income, which is prohibited under current GAAP. The amendments in this update are effective for fiscal years beginning after December 15, 2019, including interim periods within those fiscal years, with early adoption permitted, however smaller reporting companies, like the Company, may delay adoption until January 2023. The Company is currently evaluating the impact of the adoption of ASU 2016-13 on its consolidated financial statements.

4. Investments

The following table summarizes the Company’s investments in equity securities as of September 30, 2021 and December 31, 2020:

 Schedule of Investments

FG FINANCIAL GROUP, INC.

Notes to Consolidated Financial Statements

FedNat Common Stock

On December 2, 2019, the Company received 1,773,102 shares of FedNat Holding Company common stock (Nasdaq: FNHC), along with $25.5 million cash as consideration for the Asset Sale. On July 14, 2020, the Company transferred 156,000 shares of FedNat common stock to FGRe, a wholly-owned subsidiary of the Company, as a capital contribution for no consideration, and, on September 15, 2020, the Company transferred 330,231 shares of FedNat common stock to the Hale Parties as further discussed in Note 10 – “Related Party Transactions”. Following the transactions, the Company directly holds 1,286,871 shares of FedNat common stock. As of November 10, 2021, the estimated fair value of the 1,442,871 shares of FedNat common stock held in the aggregate by the Company and its subsidiary was $3.2 million.

SPAC Investments

SPAC investments consist of the public equity of newly formed special purpose acquisition companies held by the Fund. The investments typically consist of one share of common stock of the SPAC, along with one-half of one redeemable warrant entitling the holder to purchase one share of common stock at an exercise price of $11.50 per share, although the number of warrants and/or the exercise price of the warrant may vary. The investments are typically issued by the SPAC as a combined unit consisting of both the common stock and warrant at a price of $10.00 per unit however the offering price may also vary. Following the initial public offering of the SPAC, these units are separated into individual shares of common stock and warrants. The SPAC investments which we have purchased trade on either of the Nasdaq Stock Market or New York Stock Exchange.

Private Placements

Private placements consist of the private equity and risk capital associated with the sponsorship of SPACs and are held by the Fund. In September 2020, the Company invested $5.0 million into its joint venture, Fundamental Global Asset Management, LLC (“FGAM”), to capitalize FG Special Situations Fund Advisor, LLC (the “Advisor”), a Delaware limited liability company formed on September 2, 2020, and to sponsor the launch of the Fund. Of the initial $5.0 million investment, approximately $4.0 million was used by FG New America Investors, LLC (the “Sponsor”) as part of a total $8.6 million of risk capital used to launch FG New America Acquisition Corp (“FGNA”), a special purpose acquisition company which consummated its initial public offering on October 2, 2020. On July 20, 2021, FGNA completed its definitive business combination with Opportunity Financial, LLC and began operating as OppFi Inc. (“OppFi”), with OppFi’s common stock trading on the NYSE under the ticker symbol “OPFI”. The Fund’s specific investment consists of both class A and class A-1 interests of the Sponsor. On July 15, 2021, the Sponsor entered into a sponsor forfeiture agreement with FGNA and Opportunity Financial, LLC, under which the Sponsor agreed to forfeit a portion of FGNA Class B common stock as well as a portion of warrants to purchase FGNA Class A common stock which the Sponsor previously held. As a result, as of July 20, 2021, the class A and class A-1 interests represent a potential beneficial ownership of approximately 0.86 million common shares of OPFI as well as approximately 0.36 million warrants to purchase common shares of OPFI at a price of $11.50 per share. The class A and class A-1 interests have not been registered under the Securities Act of 1933, as amended, and are not transferrable except as provided for in the operating agreement of the Sponsor.

The Company has determined that its investment in the Fund represents an investment in a variable interest entity (“VIE”) in which the Company is the primary beneficiary and as such, has consolidated the financial results of the Fund as of September 30, 2021. The Company evaluates whether it is the primary beneficiary of a VIE at the time it becomes involved with a variable interest entity and continuously reconsiders that conclusion. In determining whether the Company is the primary beneficiary, the Company evaluates its control rights as well as economic interests in the entity held either directly or indirectly through affiliates via both qualitative and quantitative analysis. Further investments in, or redemptions of investments in FGAM, by either member of joint venture could affect the entity’s status as a VIE or the determination of the primary beneficiary. At each reporting date, the Company assesses whether it is the primary beneficiary and will consolidate or deconsolidate accordingly.

For the nine months ended September 30, 2021, the Company invested an additional $1.65 million into the Fund and the Fund also received outside investment of approximately $4.1 million, resulting in the presentation of noncontrolling interests in the Company’s consolidated balance sheet as of September 30, 2021. A portion of this additional investment was used by the Fund to sponsor its second SPAC via an investment of $1.65 million in Aldel Investors, LLC, the sponsor of Aldel Financial, Inc. (NYSE: ADF). Of the total $1.65 million the Fund invested in Aldel, $1.0 million was allocated to the Company, with the remaining $0.65 million allocated to noncontrolling interests. The Company’s $1.0 million investment in Aldel represents the beneficial ownership of approximately 286,000 Aldel founder shares.

FG FINANCIAL GROUP, INC.

Notes to Consolidated Financial Statements

Additionally, in the third quarter 2021, the Fund invested approximately $4.8 million in a private placement not related to the sponsorship of a SPAC, but which instead seeks to benefit from the underlying publicly traded stock which it owns. Of the total $4.8 million invested by the Fund, approximately $1.5 million has been allocated to the Company.

Schedule of Investments

The assets and liabilities of the Fund, our investment company subsidiary, have been included in the Company’s consolidated balance sheets presented herein and as listed in the table below. The assets of the Fund may only be used to settle its obligations. The Company’s maximum exposure to loss as a result of its involvement with the Fund is $6.65 million as of September 30, 2021.

 Schedule of Subsidiaries Assets

Other Investments

Other investments consist, in part, of equity investments made in privately held companies accounted for under the equity method. Equity method investments include our investment of $4.0 million in FGI Metrolina Property Income Fund, LP (“Metrolina”), which invests in real estate through a real estate investment trust which is wholly owned by Metrolina. The general partner of Metrolina, FGI Metrolina GP, LLC, is managed, in part, by Mr. Cerminara, the Chairman of the Company’s Board of Directors. The Company, a limited partner of Metrolina, does not have a controlling interest, but exerts significant influence over the entity’s operating and financial policies as it owns an economic interest of approximately 52% as of September 30, 2021. We have recorded equity method earnings from our investment in Metrolina of approximately $137,000 and $61,000 for each of the nine months ended September 30, 2021 and 2020, respectively. The carrying value of our investment in Metrolina as of September 30, 2021 was approximately $4.83 million. In the third quarter, 2021, Metrolina announced it would be liquidating and returning capital to its investors. Accordingly, on November 11, 2021, we received approximately $4.4 million in cash back from the Fund, representing our initial investment of $4.0 million plus approximately $0.4 million in distributed earnings. We anticipate receiving additional earnings from Metrolina in the fourth quarter of 2021, based upon the final net asset value calculated by Metrolina as of November 30, 2021.

Equity method investments also include our investment in FG SPAC Partners, LP (“FGSP”). On January 4, 2021, FGSP was formed as a Delaware limited partnership to co-sponsor newly formed SPACs with their founders or partners. The Company is the sole managing member of the general partner of FGSP and holds an approximate 49% limited partner interest in FGSP directly and through its subsidiaries. Certain of our directors and officers also hold limited partner interests in FGSP. Our Chief Executive Officer and Director, Larry G. Swets, Jr., holds a limited partner interest through Itasca Financial LLC, an advisory and investment firm for which Mr. Swets is managing member. Hassan R. Baqar, our Chief Financial Officer effective August 6, 2021, also holds a limited partner interest through Sequoia Financial LLC, an advisory firm for which Mr. Baqar is managing member. The Chairman of our Board of Directors, D. Kyle Cerminara, also holds a limited partner interest through Fundamental Global, LLC, a holding company for which Mr. Cerminara is the manager and one of the members. We have recorded equity method earnings from our investment in FGSP of approximately $2.39 million for the nine months ended September 30, 2021. The carrying value of our investment in FGSP as of September 30, 2021 was approximately $2.46 million, representing $2.39 million in undistributed earnings.

On January 11, 2021, FGSP purchased 1,075,000 founder shares from Aldel, for total consideration of $4,674. On March 25, 2021, FGSP entered into a forfeiture agreement with Aldel whereby FGSP agreed to transfer 575,000 of these founder shares back to Aldel at no cost. Concurrent with Aldel’s initial public offering, on April 12, 2021, FGSP also purchased 650,000 warrants at a price of $0.10 per warrant, each exercisable to purchase one share of Aldel’s Class A common stock at an exercise price of $15.00 per share (the “OTM Warrants”), for a purchase price of $65,000. In addition, as discussed above, the Company, through the Fund, has invested $1.0 million in the risk capital of Aldel Investors, LLC, which represent beneficial ownership of approximately 286,000 Aldel founder shares. Altogether, the Company’s investment represents beneficial interests of approximately 533,000 Aldel founder shares and approximately 321,000 OTM Warrants. Mr. Swets serves as senior advisor to Aldel. Mr. Baqar serves as a director and chief financial officer of Aldel. Mr. Cerminara serves as a director of Aldel.

FG FINANCIAL GROUP, INC.

Notes to Consolidated Financial Statements

Other investments also consist of equity we have purchased in a limited partnership and a limited liability company for which there does not exist readily determinable fair values. The Company accounts for these investments at their cost, minus impairment, if any, plus or minus changes resulting from observable price changes in orderly transactions for identical or similar investment of the same issuer. Any profit distributions the Company receives on these investments are included in net investment income. The Company’s total investment in these two entities was approximately $483,000 as of September 30, 2021. For the nine months ended September 30, 2021 and 2020, the Company has received profit distributions of $73,000 and $42,000 on these investments, respectively, which has been included in income. Furthermore, both investments began the process of returning capital back to its investors beginning in 2020. As of September 30, 2021, the Company has received approximately 38% of its initial $776,000 investment back from these investments.

Impairment

For equity securities without readily determinable fair values, impairment is determined via a qualitative assessment which considers indicators to evaluate whether the investment is impaired. Some of these indicators include a significant deterioration in the earnings performance or asset quality of the investee, a significant adverse change in regulatory, economic or general market conditions in which the investee operates, or doubt over an investee’s ability to continue as a going concern. If the investment is deemed to be impaired after conducting this analysis, the Company would estimate the fair value of the investment to determine the amount of impairment loss.

For equity method investments, such as the Company’s investment in Metrolina, evidence of a loss in value might include a series of operating losses of an investee, the absence of an ability to recover the carrying amount of the investment, or a deterioration in the value of the investee’s underlying assets. If these, or other indicators lead to the conclusion that there is a decrease in the value of the investment that is other than temporary, the Company would recognize that decrease in value even though the decrease may be in excess of what would otherwise be recognized under the equity method of accounting.

The risks and uncertainties inherent in the assessment methodology used to determine impairment include, but may not be limited to, the following:

We have not recorded an impairment on our investments for either of the nine months ended September 30, 2021 and 2020.

Net investment income (loss) for the three and nine months ended September 30, 2021 and 2020 is as follows:

 Schedule of Net Investment Income (Loss)

FG FINANCIAL GROUP, INC.

Notes to Consolidated Financial Statements

5. Fair Value Measurements

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

The availability of valuation techniques and observable inputs can vary from investment to investment and are affected by a variety of factors, including the type of investment, whether the investment is new and not yet established in the marketplace, the liquidity of markets and other characteristics specific to the individual investment. In some cases, the inputs used to measure fair value might be categorized within different levels of the fair value hierarchy. In those instances, the fair value measurement is categorized in its entirety in the hierarchy based on the lowest level input that is significant to the fair value measurement. When determining fair value, the Company uses valuation techniques that maximize the use of observable inputs and minimize the use of unobservable inputs.

We have valued our investment in FedNat and SPAC units at their last reported sales price as the shares and units are traded on a national exchange. They have been characterized in Level 1 of the fair value hierarchy. Furthermore, certain of our private placement investments are characterized in Level 1 of the fair value hierarchy as their value is based on the underlying investments it holds (those investments also traded on a national exchange).

The remainder of our private placement investments have been characterized in Level 3 of the fair value hierarchy. As of September 30, 2021, these consist of the Fund’s private placement investments in the equity interests of the sponsor companies of OppFi (formerly FGNA) and Aldel. The estimated fair value of our OppFi sponsor interests consist of both class A and A-1 interests in the Sponsor, which, represent the beneficial interest of approximately 860,000 shares of OppFi as well as approximately 360,000 warrants to purchase OppFi common stock at $11.50 per share. The estimated fair value of our Aldel sponsor interests consist of a total of approximately 471,000 Aldel founder shares held by the Fund to which the Company was allocated approximately 286,000 founder shares, with the remaining 185,000 founder shares allocated to noncontrolling interests.

The value of these interests was determined using Monte-Carlo simulation and option pricing models. Inherent in Monte-Carlo simulation and option pricing models are assumptions related to expected volatility, expected term, dividend yield and risk-free interest rate of the underlying SPAC common stock. The Company estimates the volatility of the common stock based on the historical performance of various broad market indices blended with various peer companies which the Company considers having similar characteristics to the underlying SPAC.

Following are the significant inputs in the valuation model for the fair value of our OppFi and Aldel sponsorship interests as of September 30, 2021:

 Summary of Valuation Model for Fair Value

At each subsequent measurement date, we will review the valuation of these investments and will record adjustments as necessary to reflect the expected exit value of the investment under current market conditions. The Fund uses an independent pricing service to value its private operating company investments which may include an income approach, a market approach, or a combination thereof. The Fund may use multiple valuation approaches and estimate fair value based on a weighted average or a selected outcome within a range of multiple valuation results. Due to the inherent uncertainty of valuations, the fair values reflected in the financial statements as of the measurement date may differ materially from: 1) values that would have been used had a readily available market existed for these investments; and 2) the values that may ultimately be realized upon sale of the investments.

FG FINANCIAL GROUP, INC.

Notes to Consolidated Financial Statements

Financial instruments measured, on a recurring basis, at fair value as of September 30, 2021 and December 31, 2020 in accordance with the guidance promulgated by the FASB are as follows.

 Schedule of Financial Instruments Measured at Fair Value

The following table presents the changes in assets classified in Level 3 of the fair value hierarchy for the nine months ended September 30, 2021. There was no activity with respect to Level 3 assets for the nine months ended September 30, 2020.

 Schedule of Changes in Classified Assets

6. Loss and Loss Adjustment Expense Reserves

A significant degree of judgment is required to determine amounts recorded in the consolidated financial statements for the provision for loss and loss adjustment expense (“LAE”) reserves. The process for establishing this provision reflects the uncertainties and significant judgmental factors inherent in predicting future results of both known and unknown loss events. The process of establishing the provision for loss and LAE reserves relies on the judgment and opinions of a large number of individuals, including the opinions of the Company’s management, as well as the management of ceding companies and their actuaries.

The COVID-19 pandemic is unprecedented, and the Company does not have previous loss experience on which to base the associated estimate for loss and loss adjustment expenses. In estimating losses, the Company may assess any of the following:

Significant assumptions which served as the basis for the Company’s estimates of reserves for the COVID-19 pandemic losses and loss adjustment expenses include:

FG FINANCIAL GROUP, INC.

Notes to Consolidated Financial Statements

Under the terms of our quota share agreements, and due to the nature of claims and premium reporting, a lag exists between (i) claims being reported by the underlying insured to the Company’s cedent and (ii) claims being reported by the Company’s cedent to the Company. This lag may impact the Company’s loss reserve estimates. The reports we receive from our cedents have pre-determined due dates. In the case of the Company’s FAL contract, third quarter 2021 premium and loss information will not be made available to the Company until subsequent to the filing of this quarterly report. Thus, our third quarter results, including the loss and loss adjustment expense reserves presented herein, have been based upon a combination of first and second quarter actual results as well as full-year forecasts reported to us by the ceding companies for which we used to approximate third quarter results.

While the Company believes its estimate of loss and loss adjustment expense reserves are adequate as of September 30, 2021, based on available information, actual losses may ultimately differ materially from the Company’s current estimates. The Company will continue to monitor the appropriateness of its assumptions as new information is provided.

A summary of changes in outstanding loss and loss adjustment expense reserves for the nine months ended September 30, 2021, is as follows and includes reserves related to both our FAL contract, as well as our automotive insurance quota-share agreement which became effective April 1, 2021. There was no activity with respect to loss and loss adjustment expense reserves for the nine months ended September 30, 2020.

 Summary of Changes in Outstanding Loss and Loss Adjustment Expense Reserves

7. Income Taxes

Income tax expense for the three and nine months ended September 30, 2021 and 2020 varies from the amount that would result by applying the applicable statutory federal income tax rate to income before income taxes as summarized in the following table:

 Summary of Income Tax Expense (Benefit)

Due to the sale of all of the issued and outstanding equity of Maison, MMI and Claimcor on December 2, 2019, these operations have been classified as discontinued operations in the Company’s financial statements presented herein. For the quarter ended March 31, 2021, we recognized a gain from the sale of the Maison Business of approximately $145,000. This was related to a final true-up and settlement in the current quarter, for income taxes due to the Company under the sale agreement.

FG FINANCIAL GROUP, INC.

Notes to Consolidated Financial Statements

As a result of the passage of the Coronavirus Aid, Relief, and Economic Security Act (the “CARES Act”), the Company recorded a credit of $214,000 against its income tax expense for the quarter ended March 31, 2020, due to a provision in the CARES Act which allows for the five-year carryback of net operating losses. Prior to the passage of the CARES Act, these net operating losses were only available to offset future taxable income generated by the Company.

Deferred income taxes reflect the net tax effects of temporary differences between carrying amounts of assets and liabilities for financial reporting purposes as compared to the amounts used for income tax purposes. As of September 30, 2021, the Company has gross net deferred tax assets of approximately $5.3 million; however the Company has recorded a valuation allowance against all of its net deferred tax assets due to the uncertain nature surrounding our ability to realize these tax benefits in the future, resulting in a net deferred income tax asset of $0 as of September 30, 2021. Significant components of the Company’s net deferred tax assets are as follows:

 Schedule of Deferred Income Taxes