KINGSWAY FINANCIAL SERVICES INC - Annual Report: 2018 (Form 10-K)

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•	its results of operations and financial condition (including, among other things, net and operating income, investment income and performance, return on equity and expected current returns);

•	changes in facts and circumstances affecting assumptions used in determining its provision for unpaid loss and loss adjustment expenses;

•	changes in facts and circumstances affecting assumptions used in evaluating its legal proceedings;

•	changes in industry trends and significant industry developments;

•	the impact of certain guarantees and indemnifications made by the Company;

•	its ability to complete and integrate current or future acquisitions successfully; and

•	its ability to implement its restructuring activities and execute its strategic initiatives successfully.

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•	our ability to engage in acquisitions without raising additional equity or obtaining additional debt financing could be limited;

•	our ability to obtain additional financing for working capital, capital expenditures, acquisitions, debt service requirements or general corporate purposes and our ability to satisfy our obligations with respect to our debt may be impaired in the future;

•	a large portion of our cash flow must be dedicated to the payment of interest on our debt, thereby reducing the funds available to us for other purposes;

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we are exposed to the risk of increased interest rates because our outstanding subordinated debt, representing $90.5 million of principal value, and our acquisition financing of $10.0 million bear interest directly related to the London interbank offered interest rate for three-month U.S. dollar deposits or any equivalent replacement benchmark as defined in the underlying loan documents ("LIBOR");

•	it may be more difficult for us to satisfy our obligations to our creditors, resulting in possible defaults on, and acceleration of, such debt;

•	we may be more vulnerable to general adverse economic and industry conditions;

•	we may be at a competitive disadvantage compared to our competitors with proportionately less debt or with comparable debt on more favorable terms and, as a result, they may be better positioned to withstand economic downturns;

•	our ability to refinance debt may be limited or the associated costs may increase;

•	our flexibility to adjust to changing market conditions and ability to withstand competitive pressures could be limited; and

•	we may be prevented from carrying out capital spending that is, among other things, necessary or important to our growth strategy and efforts to improve the operating results of our businesses.

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•	difficulties in the integration of the acquired business;

•	assumption of unknown material liabilities, including deficient provisions for unpaid loss and loss adjustment expenses;

•	diversion of management's attention from other business concerns;

•	failure to achieve financial or operating objectives; and

•	potential loss of customers or key employees of acquired companies.

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•	identification of appropriate management to run the new business;

•	understanding the strategic, competitive and marketplace dynamics of the new business and, perhaps, industry;

•	establishment of proper financial and operational controls;

•	diversion of management's attention from other business concerns; and

•	failure to achieve financial or operating objectives.

•	actuarial projections of the cost of settlement and administration of claims reflecting facts and circumstances then known;

•	estimates of future trends in claims severity and frequency;

•	legal theories of liability;

•	variability in claims-handling procedures;

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•	economic factors such as inflation;

•	judicial and legislative trends, actions such as class action lawsuits, and judicial interpretation of coverages or policy exclusions; and

•	the level of insurance fraud.

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•	the availability of reliable data and our ability to properly analyze available data;

•	the uncertainties that inherently characterize estimates and assumptions;

•	our selection and application of appropriate pricing techniques; and

•	changes in applicable legal liability standards and in the civil litigation system generally.

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Paid Loss Development - we use historical loss and loss adjustment expense payments over discrete periods of time to estimate future loss and loss adjustment expense payments. Paid development methods assume that the patterns of paid loss and loss adjustment expenses that occurred in past periods will be similar to loss and loss adjustment expense payment patterns that will occur in future periods.

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Incurred Loss Development - we use historical case incurred loss and loss adjustment expenses (the sum of cumulative loss and loss adjustment expense payments plus outstanding unpaid case losses) over discrete periods of time to estimate future loss and loss adjustment expenses. Incurred development methods assume that the case loss and loss adjustment expenses reserving practices are consistently applied over time.

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Frequency and Severity - we use historical claim count development over discrete periods of time to estimate future claim counts. We divide projected ultimate claim counts by an exposure base (earned premiums or exposures), select expected claim frequencies from the results, and adjust them for trends based on internal and external information. Concurrently, we divide projected ultimate losses by the projected ultimate claim counts to select expected loss severities. We use internal and external information to trend the severities and combine them with the trended, projected frequencies to develop ultimate loss projections.

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•	identifying all unrealized loss positions that have existed for at least six months;

•	identifying other circumstances management believes may affect the recoverability of the unrealized loss positions;

•	obtaining a valuation analysis from third-party investment managers regarding the intrinsic value of these investments based on their knowledge and experience together with market-based valuation techniques;

•	reviewing the trading range of certain investments over the preceding calendar period;

•	assessing if declines in market value are other-than-temporary for debt instruments based on the investment grade credit ratings from third-party rating agencies;

•	assessing if declines in market value are other-than-temporary for any debt instrument with a non-investment grade credit rating based on the continuity of its debt service record;

•	determining the necessary provision for declines in market value that are considered other-than-temporary based on the analyses performed; and

•	assessing the Company's ability and intent to hold these investments at least until the investment impairment is recovered.

•	the opinions of professional investment managers could be incorrect;

•	the past trading patterns of individual investments may not reflect future valuation trends;

•	the credit ratings assigned by independent credit rating agencies may be incorrect due to unforeseen or unknown facts related to a company's financial situation; and

•	the debt service pattern of non-investment grade instruments may not reflect future debt service capabilities and may not reflect a company's unknown underlying financial problems.

•	the opinions of external investment and portfolio managers;

•	the financial condition and prospects of the investee;

•	recent operating trends and forecasted performance of the investee;

•	current market conditions in the geographic area or industry in which the investee operates;

•	changes in credit ratings; and

•	changes in the regulatory environment.

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(a)	Principles of consolidation:

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(b)	Use of estimates:

(d)	Business combinations:

(e)	Investments:

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(f)	Cash and cash equivalents and restricted cash:

(g)	Investment in investee:

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(h)	Service fee receivable:

(i)	Reinsurance:

(j)	Deferred acquisition costs, net:

(k)	Property and equipment:

(l)	Goodwill and intangible assets:

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(m)	Unpaid loss and loss adjustment expenses:

(n)	Debt:

(o)	Contingent consideration:

(p)	Income taxes:

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(q)	Leases:

(r)	Revenue recognition:

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(s)	Cost of services sold:

(t)	Stock-based compensation:

(u)	Fair value of financial instruments:

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(a)	Reclassifications to conform to current presentation. Such reclassifications have no impact on previously reported net loss or total shareholders' equity.

(b)	Reclassifications as a result of misclassifications of amounts in a previous filing. Such reclassifications have no impact on previously reported net loss or total shareholders' equity.

(c)	Adjustments to Extended Warranty segment service fee receivable and accrued expenses and other liabilities, with offsetting adjustments to accrued expenses and other liabilities and service fee and commission income.

(d)

Adjustment to increase goodwill, with offsetting decreases to intangible assets, amortization of intangible assets and accumulated deficit, related to the Company's acquisition of Argo Management in 2016. Also includes the related tax impact of these adjustments, resulting in an increase to net deferred income tax liabilities, with offsetting decreases to income tax benefit and accumulated deficit.

(e)

Adjustment to decrease redeemable Class A preferred stock, with an offsetting increase to additional paid-in capital and an offsetting decrease to general and administrative expenses related to the Company’s issuance of Class A preferred stock and Class C Warrants on February 3, 2014. Also includes the related reclassifications of accrued dividends on equity-classified warrants from accrued expenses and other liabilities to redeemable Class A preferred stock and dividend expense from accumulated deficit to additional paid-in-capital.

(f)	Adjustments to accrued expenses and other liabilities, with offsetting adjustments to non-operating other income and accumulated deficit, related to escheat liability.

(g)	Adjustment to decrease Extended Warranty deferred service fees, with an offsetting increase to service fee and commission income.

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•	identifying all unrealized loss positions that have existed for at least six months;

•	identifying other circumstances management believes may affect the recoverability of the unrealized loss positions;

•	obtaining a valuation analysis from third-party investment managers regarding the intrinsic value of these investments based on their knowledge and experience together with market-based valuation techniques;

•	reviewing the trading range of certain investments over the preceding calendar period;

•	assessing if declines in market value are other-than-temporary for debt instruments based on the investment grade credit ratings from third-party rating agencies;

•	assessing if declines in market value are other-than-temporary for any debt instrument with a non-investment grade credit rating based on the continuity of its debt service record;

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•	determining the necessary provision for declines in market value that are considered other-than-temporary based on the analyses performed; and

•	assessing the Company's ability and intent to hold these investments at least until the investment impairment is recovered.

•	the opinions of professional investment managers could be incorrect;

•	the past trading patterns of individual investments may not reflect future valuation trends;

•	the credit ratings assigned by independent credit rating agencies may be incorrect due to unforeseen or unknown facts related to a company's financial situation; and

•	the debt service pattern of non-investment grade instruments may not reflect future debt service capabilities and may not reflect a company's unknown underlying financial problems.

•	the opinions of external investment and portfolio managers;

•	the financial condition and prospects of the investee;

•	recent operating trends and forecasted performance of the investee;

•	current market conditions in the geographic area or industry in which the investee operates;

•	changes in credit ratings; and

•	changes in the regulatory environment.

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•	Level 1 – Quoted prices for identical instruments in active markets.

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•	Level 2 – Quoted prices for similar instruments in active markets; quoted prices for identical or similar instruments in markets that are not active; and model-derived valuations in which all significant inputs are observable in active markets.

•	Level 3 – Valuations derived from valuation techniques in which one or more significant inputs are not observable.

•	U.S. government, government agencies and authorities are generally priced using the market approach. Inputs generally consist of trades of identical or similar securities, quoted prices in inactive markets and maturity.

•	States, municipalities and political subdivisions are generally priced using the market approach. Inputs generally consist of trades of identical or similar securities, quoted prices in inactive markets, new issuances and credit spreads.

•	Mortgage-backed securities are generally priced using the market approach. Inputs generally consist of trades of identical or similar securities, quoted prices in inactive markets, expected prepayments, expected credit default rates, delinquencies and issue specific information including, but not limited to, collateral type, seniority and vintage.

•	Corporate securities are generally priced using the market approach using pricing vendors. Inputs generally consist of trades of identical or similar securities, quoted prices in inactive markets, issuer rating, benchmark yields, maturity and credit spreads.

•	The fair value of the Company's investment in 1347 Investors is calculated based on a model that distributes the net equity of 1347 Investors to all classes of membership interests. The model uses quoted market prices and significant market observable inputs. This investment is categorized in Level 2 of the fair value hierarchy.

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The fair value of Net Lease's investments in limited liability companies is based upon the net asset values of the underlying investments companies as a practical expedient to estimate fair value. The Company applies the net asset value practical expedient to Net Lease's limited liability investments on an investment-by-investment basis unless it is probable that the Company will sell a portion of an investment at an amount different from the net asset value of the investment. Investments that are measured at fair value using the net asset value practical expedient are not required to be classified using the fair value hierarchy.

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The fair value of Argo Holdings' limited liability investments that hold investments in search funds is based on the initial investment in the search funds. The fair value of Argo Holdings' limited liability investments that hold investments in private operating companies is valued using a market approach including valuation multiples applied to corresponding performance metrics, such as earnings before interest, tax, depreciation and amortization; revenue; or net earnings. The selected valuation multiples were estimated using multiples provided by the investees and review of those multiples in light of investor updates, performance reports, financial statements and other relevant information. These investments are categorized in Level 3 of the fair value hierarchy.

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•	the reclassification of investment income, related to equity method investments, from loss from discontinued operations, net of taxes to net investment income in the consolidated statement of operations;

•	the identification, accounting and disclosure of investments demonstrating characteristics of variable interest entities, including the consolidation of certain investments;

•	the adoption and application of ASU 2014-09;

•	identification, disclosure and accounting for equity-classified warrants; and

•	purchase accounting, as it relates to the identification and valuation of intangible assets and goodwill.

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•	Perform a comprehensive assessment of all existing accounting policies and revise existing policies and/or introduce new policies, as needed;

•	Enhance the formality of its review procedures with respect to its accounting for any new investments, as well as the periodic evaluation of existing investments;

•	Implement additional review procedures with respect to its accounting under ASU 2014-09 to ensure the Company’s accounting will continue to be in accordance with that standard on a go-forward basis;

•	Implement additional identification, accounting and review controls with respect to complex and nonrecurring transactions, as well as augment existing staff with outside skilled accounting resources, as appropriate, and strengthen the review process to improve the operation of financial reporting and corresponding internal controls;

•	Enhance the formality and rigor with respect to identifying and tracking all material related party transactions, as well updating its disclosures controls to enhance the focus on related party disclosure requirements; and

•	Enhance the formality and rigor of review with respect to the collectability of accounts receivable balances, other-than-temporary impairment reviews on equity method investments and the account reconciliation procedures.

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(1)	All of the directors attended the 2018 annual meeting of shareholders.

(2)	“Independent” refers to the standards of independence established under section 301 of the Sarbanes-Oxley Act of 2002 (“SOX”) and the criteria for independence established by the NYSE and SEC.

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(1)	Mr. Fitzgerald has served as Chief Executive Officer of the Company since September 2018.

(2)	Mr. Swets served as Chief Executive Officer of the Company from July 2010 until September 2018.

(3)	Mr. Baqar served as Vice President of the Company from January 2014 until his resignation in January 2019.

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(1)	For each named executive officer, amounts reported in this column include employer-paid life insurance premiums and contributions to the Company’s 401(k) retirement plan and Employee Stock Purchase Plan. The Company also paid for executive wellness physicals for certain of our named executive officers.

(2)	This amount represents a discretionary cash bonus paid to Messrs. Fitzgerald and Hickey in 2019 for work performed in 2018.

(3)	This amount represents a discretionary cash bonus paid to Messrs. Swets, Hickey and Baqar in 2017 for work performed in 2016.

(4)

Amount reflects the aggregate grant date fair value of Restricted Stock Units. The amount was determined by multiplying the grant date fair value of the award by the number of Restricted Stock Units granted. This amount represents Restricted Stock Units awarded August 24, 2016, which become fully vested on March 28, 2024 if Mr. Fitzgerald remains in continuous employment with the Company through such date. The actual value that Mr. Fitzgerald may receive depends on market prices, and there can be no assurance that the amounts reflected will actually be realized.

(5)	Amount represents the aggregate grant date fair value of options. The amount does not represent the realized or unrealized earnings or value earned in the year. The actual value that the named executive officer may receive depends on market prices, and there can be no assurance that the amounts reflected will actually be realized.

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(1)	The value of the Common Shares is based on the closing price of the Common Shares on the NYSE of $2.87 as of December 31, 2018, the last trading day of the fiscal year.

(2)	This amount represents 40,000 options granted April 20, 2016, which were immediately vested and exercisable as of that date.

(3)	This amount represents Restricted Common Shares awarded September 5, 2018, which become fully vested on March 28, 2024 if Mr. Fitzgerald remains in continuous employment with the Company through such date.

(4)	This amount represents Restricted Common Shares awarded March 28, 2014, which become fully vested as of the tenth anniversary of the date of grant if the participant remains in continuous employment with the Company through such anniversary.

(5)	This amount represents Restricted Common Shares awarded September 5, 2018, which become fully vested after the satisfaction of certain performance conditions, as defined in the Amended and Restated Restricted Stock Award Agreement, dated September 5, 2018.

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(1)

Amounts reported in this column include the annual retainer paid to each non-employee director, plus an additional fee of CAD$50,000 paid to each of Messrs. Kavanagh and Hannon for serving as Chairman of the Board and Chair of the Audit Committee, respectively. The annual retainer and the additional fees paid to Messrs. Kavanagh and Hannon were paid in the currency of each director’s country of residence and converted to U.S. dollars based on the exchange rates in effect at the time the payments were made. Messrs. Hannon and Kavanagh were paid in Canadian dollars, and Messrs. Levine, Schaevitz and Stilwell were paid in U.S. dollars.

(2)	Mr. Levine was elected to the Board on May 30, 2018. He received three payments at the CAD$100,000 annualized rate.

(3)	Mr. Schaevitz was a member of the Board through May 30, 2018. He received two payments at the CAD$100,000 annualized rate.

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(i)	Assist the Board in discharging its responsibilities in respect of compensation of the Company’s executive officers and subsidiary Presidents;

(ii)	Provide recommendations to the Board in connection with directors' compensation;

(iii)	Provide recommendations to the Board in connection with succession planning for senior management of the Company; and

(iv)	Produce an annual report for inclusion in the Proxy Statement and Annual Report on Form 10-K.

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(1)

All percentages in this column are calculated based upon: (i) the total number of Common Shares, including Restricted Common Shares, held by the beneficial owner (or all directors and executive officers as a group); plus the number of options, Series B Warrants and Preferred Shares, held by the beneficial owner (or all directors and executive officers as a group), exercisable or convertible within sixty (60) days; divided by (ii) 22,843,909, being the total number of Common Shares, including Restricted Common Shares, outstanding as of February 27, 2020; plus the number of options, Series B Warrants and Preferred Shares, held by the beneficial owner (or all directors and executive officers as a group), exercisable or convertible within sixty (60) days. Accordingly, this calculation is not based upon maximum dilution and instead assumes that only the beneficial owner (or all directors and executive officers as a group) exercises or converts all options, Series B Warrants and Preferred Shares exercisable or convertible within sixty (60) days.

(2)	Mr. Fitzgerald owns 977,834 Common Shares, including 500,000 Restricted Common Shares, plus 40,000 options that are currently exercisable.

(3)

Number of Common Shares is reported as described in a Schedule 13D filed with the SEC on March 21, 2019 jointly on behalf of Oakmont Capital Inc., an Ontario corporation ("Oakmont"), E.J.K. Holdings Inc., an Ontario corporation ("EJK"), 1272562 Ontario Inc., an Ontario corporation ("1272562"), Gregory P. Hannon and Terence M. Kavanagh (collectively, the "Oakmont Group"). The business address of these shareholders is 45 St. Clair Avenue West, Suite 400, Toronto, Ontario, M4V 1K9 Canada.

(4)

Mr. Hannon has sole voting power and sole dispositive power with respect to 22,500 Common Shares owned directly by him or through a self-directed Retirement Savings Plan and 4,500 Common Shares owned directly by two trusts for Mr. Hannon’s children (Mr. Hannon is the sole trustee of both of these trusts). In addition, Mr. Hannon has shared voting power and shared dispositive power with respect to (i) 3,000 Common Shares owned directly by 1272562, by virtue of his ownership of all of the outstanding voting stock of 1272562; (ii) 4,000 Common Shares owned directly by Gilter Inc., an Ontario corporation of which all of the outstanding voting stock is owned by the Gregory Hannon Family Trust (Mr. Hannon is one of two trustees of this trust); (iii) 2,468,037 Common Shares owned directly by Oakmont, by virtue of his ownership of all of the capital stock of 1272562, and 1272562’s ownership of 50% of the outstanding voting stock of Oakmont and its right to nominate one of the two members of the Board of Directors of Oakmont; (iv) 82,143 Common Shares issuable upon the conversion of 13,143 shares of Preferred Shares owned by Oakmont; (v) 463,394 Common Shares currently issuable upon exercise of Series B Warrants owned by Oakmont; and (vi) 13,750 Common Shares owned directly by Mr. Hannon’s spouse. Mr. Hannon may be deemed to be a beneficial owner of the balance of the 3,096,074 Common Shares beneficially owned by the Oakmont Group, by virtue of his participation in the Oakmont Group.

(5)

Mr. Kavanagh has sole voting power and sole dispositive power with respect to 26,875 Common Shares owned through a self-directed Retirement Savings Plan, 1,750 Common Shares owned directly and 125 Common Shares owned directly by a trust for his nephew (Mr. Kavanagh is the sole trustee). Mr. Kavanagh has shared voting power and shared dispositive power with respect to (i) the 6,000 Common Shares owned directly by EJK, by virtue of Mr. Kavanagh’s ownership of all of the outstanding voting stock of EJK; (ii) the 2,468,037 Common Shares owned directly by Oakmont, by virtue of Mr. Kavanagh’s ownership of all the outstanding voting stock of EJK, and EJK’s ownership of 50% of the outstanding voting stock of Oakmont and its right to nominate one of the two members of the Board of Directors of Oakmont; (iii) 82,143 Common Shares issuable upon the conversion of 13,143 shares of Preferred Shares owned by Oakmont; and (iv) 463,394 Common Shares currently issuable upon exercise of Series B Warrants owned by Oakmont. Mr. Kavanagh may be deemed to be a beneficial owner of the balance of the 3,096,074 Common Shares beneficially owned by the Oakmont Group, by virtue of his participation in the Oakmont Group.

(6)

Oakmont has sole voting power and sole dispositive power with respect to: (i) the 2,468,037 Common Shares that it owns directly; (ii) 82,143 Common Shares issuable upon the conversion of 13,143 shares of Preferred Shares owned by Oakmont; and (iii) 463,394 Common Shares currently issuable upon exercise of Series B Warrants owned by Oakmont. Oakmont may be deemed to be a beneficial owner of the balance of the 3,096,074 Common Shares beneficially owned by the Oakmont Group, by virtue of its participation in the Oakmont Group.

(7)	Mr. Levine directly owns 991,484 Common Shares. Mr. Levine indirectly owns 90,200 Common Shares, through the holdings of family members, and 189,102 Common Shares via a trust.

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(8)

Number of Common Shares is reported as described in a Schedule 13D filed with the SEC on March 29, 2019 on behalf of Stilwell Activist Fund, L.P., a Delaware limited partnership ("Stilwell Activist Fund"); Stilwell Activist Investments, L.P., a Delaware limited partnership ("Stilwell Activist Investments"); Stilwell Associates, L.P., a Delaware limited partnership ("Stilwell Associates"); Stilwell Value Partners VII, L.P., a Delaware limited partnership ("Stilwell Value Partners VII"); Stilwell Value LLC, a Delaware limited liability company ("Stilwell Value LLC" and, collectively with Stilwell Activist Fund, Stillwell Activist Investments, Stilwell Associates, and Stilwell Value Partners VII, the "Investment Partnership"); and Joseph D. Stilwell, a U.S. citizen. The Investment Partnerships are private investment partnerships engaged in the purchase and sale of securities for their own accounts. Stilwell Value LLC is the general partner of each of the Investment Partnerships, and Mr. Stilwell is the managing member and owner of Stilwell Value LLC. The Investment Partnerships have shared voting and shared dispositive power over 5,679,539 Common Shares, consisting of (i) 5,597,396 Common Shares owned of record, and (ii) 82,143 Common Shares issuable upon the conversion of 13,143 shares of Preferred Shares. The members of the Group also hold Series B Warrants to purchase 708,347 Common Shares currently issuable upon exercise of Series B Warrants; however, each of the Investment Partnerships has entered a Statement of Undertaking with the Company in which they undertook not to exercise the Series B Warrants until the earlier of: (i) July 15, 2020; or (ii) the execution by all of the Investment Partnerships and the Company of a written instrument that terminates the Statement of Undertaking.. The business address of this shareholder is 111 Broadway, 12th Floor, New York, NY 10006.

(9)	Mr. Swets owns 963,273 Common Shares, including 247,450 Restricted Common Shares; and 182,536 Common Shares currently issuable upon exercise of Series B Warrants.

(10)	Mr. Hickey owns 333,177 Common Shares, including 229,500 Restricted Common Shares; and 25,500 Common Shares currently issuable upon exercise of Series B Warrants.

(11)	Mr. Baqar owns 124,243 Common Shares and 12,500 Common Shares currently issuable upon exercise of Series B Warrants.

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