Document

UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, DC 20549
 
FORM 10-Q
 

(Mark One)
x
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the Quarterly Period Ended June 30, 2016

OR
o
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the Transition Period from to
Commission File Number: 001-36311
 

NATIONAL GENERAL HOLDINGS CORP.
(Exact Name of Registrant as Specified in Its Charter)

Delaware
 
27-1046208
(State or Other Jurisdiction of
Incorporation or Organization)
 
(IRS Employer
Identification No.)

59 Maiden Lane, 38th Floor
New York, New York
 
10038
(Address of Principal Executive Offices)
 
(Zip Code)
(212) 380-9500
(Registrant’s Telephone Number, Including Area Code)

Indicate by check mark whether the registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes x No o

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).Yes x No o

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):

Large Accelerated Filer x
 
Accelerated Filer o
 
Non-Accelerated Filer o
(Do not check if a smaller
reporting company)
 
Smaller Reporting Company o

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).Yes o No x

As of August 3, 2016, the number of common shares of the registrant outstanding was 105,932,281.




NATIONAL GENERAL HOLDINGS CORP.

TABLE OF CONTENTS


 
 
Page
 
 
 
 
 
 
 


i


PART I - FINANCIAL INFORMATION


Item 1. Financial Statements

NATIONAL GENERAL HOLDINGS CORP.
CONDENSED CONSOLIDATED BALANCE SHEETS
(In Thousands, Except Shares and Par Value per Share)
 
June 30,
2016
 
December 31,
2015
ASSETS
(unaudited)
 
(audited)
Investments - NGHC
 
 
 
Fixed maturities, available-for-sale, at fair value (amortized cost $2,299,155 and $2,081,456)
$
2,385,461

 
$
2,063,051

Equity securities, available-for-sale, at fair value (cost $126,787 and $63,303)
110,500

 
57,216

Short-term investments
52,708

 
1,528

Equity investment in unconsolidated subsidiaries
245,703

 
234,948

Other investments
59,360

 
13,031

Securities pledged (amortized cost $132,300 and $54,955)
137,448

 
55,394

Investments - Exchanges
 
 
 
Fixed maturities, available-for-sale, at fair value (amortized cost $277,473 and $244,069)
290,569

 
238,969

Equity securities, available-for-sale, at fair value (cost $0 and $1,501)
—

 
1,574

Short-term investments
—

 
1,999

Total investments
3,281,749

 
2,667,710

Cash and cash equivalents (Exchanges - $12,990 and $8,393)
271,694

 
282,277

Accrued investment income (Exchanges - $2,643 and $2,347)
25,337

 
20,402

Premiums and other receivables, net (Related parties $32,362 and $62,306) (Exchanges - $58,402 and $56,194)
893,373

 
758,633

Deferred acquisition costs (Exchanges - $14,362 and $23,803)
174,660

 
160,531

Reinsurance recoverable on unpaid losses (Related parties - $33,746 and $42,774) (Exchanges - $39,617 and $39,085)
853,559

 
833,176

Prepaid reinsurance premiums (Exchanges - $61,912 and $61,730)
146,405

 
128,343

Income tax receivable (Exchanges - $300 and $300)
300

 
300

Notes receivable from related party
125,000

 
125,057

Due from affiliate (Exchanges - $0 and $12,060)
29,774

 
41,536

Premises and equipment, net (Exchanges - $2,812 and $332)
79,224

 
42,931

Intangible assets, net (Exchanges - $25,433 and $4,825)
383,700

 
348,898

Goodwill
208,971

 
112,414

Prepaid and other assets (Exchanges - $89 and $93)
39,195

 
41,184

Total assets
$
6,512,941

 
$
5,563,392

LIABILITIES AND STOCKHOLDERS’ EQUITY
 
 
 
Liabilities:
 
 
 
Unpaid loss and loss adjustment expense reserves (Exchanges - $133,531 and $132,392)
$
1,966,752

 
$
1,755,624

Unearned premiums (Exchanges - $148,502 and $146,186)
1,425,139

 
1,192,499

Unearned service contract and other revenue
22,330

 
12,504

Reinsurance payable (Related parties - $31,511 and $31,923) (Exchanges - $21,928 and $14,357)
91,961

 
69,172

Accounts payable and accrued expenses (Related parties - $27,930 and $51,755) (Exchanges - $4,497 and $19,845)
279,281

 
284,902

Due to affiliate (Exchanges - $7,520 and $0)
7,520

 
—

Securities sold under agreements to repurchase, at contract value
119,472

 
52,484

Deferred tax liability (Exchanges - $26,993 and $32,724)
21,436

 
12,247

Income tax payable
24,883

 
5,593

Debt (Exchanges owed to related party - $0 and $45,476)
678,715

 
491,537


See accompanying notes to unaudited condensed consolidated financial statements.
1


NATIONAL GENERAL HOLDINGS CORP.
CONDENSED CONSOLIDATED BALANCE SHEETS
(In Thousands, Except Shares and Par Value per Share)
Other liabilities (Exchanges - $38,246 and $38,105)
167,886

 
150,190

Total liabilities
4,805,375

 
4,026,752

Commitments (Note 16)


 


Stockholders’ equity:
 
 
 
Common stock, $0.01 par value - authorized 150,000,000 shares, issued and outstanding 105,932,281 shares - 2016; authorized 150,000,000 shares, issued and outstanding 105,554,331 shares - 2015
1,059

 
1,056

Preferred stock, $0.01 par value - authorized 10,000,000 shares, issued and outstanding 2,365,000 shares - 2016; authorized 10,000,000 shares, issued and outstanding 2,365,000 shares - 2015. Aggregate liquidation preference $220,000 - 2016, $220,000 - 2015
220,000

 
220,000

Additional paid-in capital
908,276

 
900,114

Accumulated other comprehensive income (loss):
 
 
 
Unrealized foreign currency translation adjustments
(4,135
)
 
(3,780
)
Unrealized gains (losses) on investments
48,859

 
(15,634
)
Total accumulated other comprehensive income (loss)
44,724

 
(19,414
)
Retained earnings
502,741

 
412,044

Total National General Holdings Corp. Stockholders' Equity
1,676,800

 
1,513,800

Non-controlling interest (Exchanges - $30,588 and $22,619)
30,766

 
22,840

Total stockholders’ equity
1,707,566

 
1,536,640

Total liabilities and stockholders' equity
$
6,512,941

 
$
5,563,392


See accompanying notes to unaudited condensed consolidated financial statements.
2


NATONAL GENERAL HOLDINGS CORP.
CONDENSED CONSOLIDATED STATEMENTS OF INCOME
(In Thousands, Except Shares and Per Share Data)
(Unaudited)
 
Three Months Ended June 30,
 
Six Months Ended June 30,
 
2016
 
2015
 
2016
 
2015
Revenues:
 
 
 
 
 
 
 
Premium income:
 
 
 
 
 
 
 
Gross premium written
$
850,507

 
$
575,681

 
$
1,666,701

 
$
1,219,136

Ceded premiums (related parties - three months $733; $373 and six months $1,141; $721)
(113,058
)
 
(96,271
)
 
(184,665
)
 
(209,701
)
Net premium written
737,449

 
479,410

 
1,482,036

 
1,009,435

Change in unearned premium
(24,509
)
 
(10,594
)
 
(114,176
)
 
(61,454
)
Net earned premium
712,940

 
468,816

 
1,367,860

 
947,981

Ceding commission income
11,704

 
9,970

 
9,809

 
15,050

Service and fee income
90,017

 
57,558

 
186,961

 
112,428

Net investment income
27,528

 
18,335

 
49,198

 
34,483

Net realized gain on investments
4,382

 
389

 
7,999

 
1,576

Other revenue (expense)
(387
)
 
(1,415
)
 
314

 
(170
)
Total revenues
846,184

 
553,653

 
1,622,141

 
1,111,348

Expenses:
 
 
 
 
 
 
 
Loss and loss adjustment expense
472,358

 
286,829

 
881,408

 
593,515

Acquisition costs and other underwriting expenses
108,874

 
96,502

 
221,773

 
186,387

General and administrative expenses
191,120

 
119,158

 
367,747

 
224,845

Interest expense
8,939

 
8,601

 
18,080

 
17,681

Total expenses
781,291

 
511,090

 
1,489,008

 
1,022,428

Income before provision for income taxes and equity in earnings of unconsolidated subsidiaries
64,893

 
42,563

 
133,133

 
88,920

Provision for income taxes
14,551

 
7,891

 
32,634

 
16,278

Income before equity in earnings of unconsolidated subsidiaries
50,342

 
34,672

 
100,499

 
72,642

Equity in earnings of unconsolidated subsidiaries
7,356

 
1,654

 
14,038

 
6,612

Net income
57,698

 
36,326

 
114,537

 
79,254

Less: Net (income) loss attributable to non-controlling interest
(9,228
)
 
2,201

 
(9,240
)
 
2,041

Net income attributable to National General Holdings Corp. ("NGHC")
$
48,470

 
$
38,527

 
$
105,297

 
$
81,295

Dividends on preferred stock
(4,125
)
 
(4,744
)
 
(8,250
)
 
(5,775
)
Net income attributable to NGHC common stockholders
$
44,345

 
$
33,783

 
$
97,047

 
$
75,520

Earnings per common share:
 
 
 
 
 
 
 
Basic earnings per share
$
0.42

 
$
0.36

 
$
0.92

 
$
0.81

Diluted earnings per share
$
0.41

 
$
0.35

 
$
0.90

 
$
0.79

Dividends declared per common share
$
0.03

 
$
0.02

 
$
0.06

 
$
0.04

Weighted average common shares outstanding:
 
 
 
 
 
 
 
Basic
105,803,802

 
93,597,448

 
105,700,682

 
93,527,977

Diluted
108,197,897

 
96,181,037

 
107,987,406

 
96,005,397

Net realized gain on investments:
 
 
 
 
 
 
 
Other-than-temporary impairment loss
$
—

 
$
(1,467
)
 
$
—

 
$
(2,483
)
Portion of loss recognized in other comprehensive income
—

 
—

 
—

 
—

Net impairment losses recognized in earnings
—

 
(1,467
)
 
—

 
(2,483
)
Other net realized gain on investments
4,382

 
1,856

 
7,999

 
4,059

Net realized gain on investments
$
4,382

 
$
389

 
$
7,999

 
$
1,576


See accompanying notes to unaudited condensed consolidated financial statements.
3


NATIONAL GENERAL HOLDINGS CORP.
CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
(In Thousands)
(Unaudited)

 
Three Months Ended June 30,
 
Six Months Ended June 30,
 
2016
 
2015
 
2016
 
2015
Net income
$
57,698

 
$
36,326

 
$
114,537

 
$
79,254

Other comprehensive income (loss), net of tax:
 
 
 
 
 
 
 
Foreign currency translation adjustment
(1,221
)
 
2,728

 
(355
)
 
3,752

Gross unrealized holding gain (loss) on securities, net of tax of $27,351 and $(10,932) for the three months ended June 30, 2016 and 2015, respectively, and $41,046 and $(4,527) for the six months ended June 30, 2016 and 2015, respectively
50,796

 
(25,005
)
 
76,229

 
(11,065
)
Reclassification adjustments for investment gain/loss included in net income:
 
 
 
 
 
 
 
Other-than-temporary impairment loss, net of tax of $0 and $513 for the three months ended June 30, 2016 and 2015, respectively, and $0 and $869 for the six months ended June 30, 2016 and 2015, respectively
—

 
954

 
—

 
1,614

Other net realized gain on investments, net of tax of $(1,534) and $(650) for the three months ended June 30, 2016 and 2015, respectively, and $(2,800) and $(1,421) for the six months ended June 30, 2016 and 2015, respectively
(2,848
)
 
(1,206
)
 
(5,199
)
 
(2,638
)
Other comprehensive income (loss), net of tax
46,727

 
(22,529
)
 
70,675

 
(8,337
)
Comprehensive income
104,425

 
13,797

 
185,212

 
70,917

Less: Comprehensive (income) loss attributable to non-controlling interest
(15,765
)
 
7,040

 
(15,777
)
 
5,179

Comprehensive income attributable to NGHC
$
88,660

 
$
20,837

 
$
169,435

 
$
76,096




See accompanying notes to unaudited condensed consolidated financial statements.
4


NATIONAL GENERAL HOLDINGS CORP.
CONDENSED CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS’ EQUITY
(In Thousands, Except Shares)
(Unaudited)

 
Six Months Ended June 30, 2016
 
Common Stock
 
Preferred Stock
 
 
 
 
 
 
 
 
 
 
 
Shares
 
$
 
Shares
 
$
 
Additional Paid-in Capital
 
Retained Earnings
 
Accumulated Other Comprehensive Income (Loss)
 
Non-controlling Interest
 
Total
Balance January 1, 2016
105,554,331

 
$
1,056

 
2,365,000

 
$
220,000

 
$
900,114

 
$
412,044

 
$
(19,414
)
 
$
22,840

 
$
1,536,640

Cumulative effect adjustment of change in accounting principle
—

 
—

 
—

 
—

 
—

 
—

 
—

 
(22,619
)
 
(22,619
)
Net income
—

 
—

 
—

 
—

 
—

 
105,297

 
—

 
9,240

 
114,537

Foreign currency translation adjustment, net of tax
—

 
—

 
—

 
—

 
—

 
—

 
(355
)
 
—

 
(355
)
Change in unrealized gain on investments, net of tax
—

 
—

 
—

 
—

 
—

 
—

 
64,493

 
6,537

 
71,030

Reciprocal Exchanges' equity on March 31, 2016, date of consolidation
—

 
—

 
—

 
—

 
—

 
—

 
—

 
14,768

 
14,768

Preferred stock dividends
—

 
—

 
—

 
—

 
—

 
(8,250
)
 
—

 
—

 
(8,250
)
Common stock dividends
—

 
—

 
—

 
—

 
—

 
(6,350
)
 
—

 
—

 
(6,350
)
Return of capital
—

 
—

 
—

 
—

 
(150
)
 
—

 
—

 
—

 
(150
)
Common stock issued under employee stock plans and exercises of stock options
377,950

 
3

 
—

 
—

 
3,064

 
—

 
—

 
—

 
3,067

Stock-based compensation
—

 
—

 
—

 
—

 
4,148

 
—

 
—

 
—

 
4,148

Tax benefit from stock-based compensation
—

 
—

 
—

 
—

 
1,100

 
—

 
—

 
—

 
1,100

Balance June 30, 2016
105,932,281

 
$
1,059

 
2,365,000

 
$
220,000

 
$
908,276

 
$
502,741

 
$
44,724

 
$
30,766

 
$
1,707,566


 
Six Months Ended June 30, 2015
 
Common Stock
 
Preferred Stock
 
 
 
 
 
 
 
 
 
 
 
Shares
 
$
 
Shares
 
$
 
Additional Paid-in Capital
 
Retained Earnings
 
Accumulated Other Comprehensive Income
 
Non-controlling Interest
 
Total
Balance January 1, 2015
93,427,382

 
$
934

 
2,200,000

 
$
55,000

 
$
690,736

 
$
292,832

 
$
20,192

 
$
13,756

 
$
1,073,450

Net income
—

 
—

 
—

 
—

 
—

 
81,295

 
—

 
(2,041
)
 
79,254

Foreign currency translation adjustment, net of tax
—

 
—

 
—

 
—

 
—

 
—

 
3,752

 
—

 
3,752

Change in unrealized loss on investments, net of tax
—

 
—

 
—

 
—

 
—

 
—

 
(8,951
)
 
(3,138
)
 
(12,089
)
Change in non-controlling interest
—

 
—

 
—

 
—

 
—

 
—

 
—

 
(942
)
 
(942
)
Preferred stock dividends
—

 
—

 
—

 
—

 
—

 
(5,775
)
 
—

 
—

 
(5,775
)
Common stock dividends
—

 
—

 
—

 
—

 
—

 
(3,743
)
 
—

 
—

 
(3,743
)
Issuance of preferred stock
—

 
—

 
165,000

 
165,000

 
(5,448
)
 
—

 
—

 
—

 
159,552

Common stock issued under employee stock plans and exercises of stock options
286,604

 
3

 
—

 
—

 
1,415

 
—

 
—

 
—

 
1,418

Stock-based compensation
—

 
—

 
—

 
—

 
2,264

 
—

 
—

 
—

 
2,264

Balance June 30, 2015
93,713,986

 
$
937

 
2,365,000

 
$
220,000

 
$
688,967

 
$
364,609

 
$
14,993

 
$
7,635

 
$
1,297,141




See accompanying notes to unaudited condensed consolidated financial statements.
5


NATIONAL GENERAL HOLDINGS CORP.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(In Thousands)
(Unaudited)
 
 
 
 
 
 
 
 
 
Six Months Ended June 30,
 
2016
 
2015
Cash flows from operating activities:
 
 
 
Net income
$
114,537

 
$
79,254

Reconciliation of net income to net cash provided by (used in) operating activities:
 
 
 
Depreciation and amortization
27,378

 
14,751

Net amortization of premium on fixed maturities
(1,936
)
 
2,565

Net amortization of discount on debt
366

 
4,173

Stock-compensation expense
4,148

 
2,264

Equity in earnings of unconsolidated subsidiaries
(14,038
)
 
(6,612
)
Net realized gain on investments
(7,999
)
 
(4,059
)
Other-than-temporary impairment loss
—

 
2,483

Bad debt expense
14,061

 
10,722

Foreign currency translation adjustment, net of tax
461

 
1,204

Changes in assets and liabilities:
 
 
 
Accrued investment income
(1,010
)
 
(988
)
Premiums and other receivables
(101,789
)
 
(102,993
)
Deferred acquisition costs, net
(37,095
)
 
(15,261
)
Reinsurance recoverable on unpaid losses
(3,165
)
 
33,132

Prepaid reinsurance premiums
(20,086
)
 
(21,133
)
Prepaid expenses and other assets
10,443

 
809

Unpaid loss and loss adjustment expense reserves
63,369

 
(8,581
)
Unearned premiums
134,920

 
81,339

Unearned service contract and other revenue
9,826

 
30,424

Reinsurance payable
18,422

 
(21,958
)
Accounts payable
(73,884
)
 
(23,163
)
Income tax payable
19,290

 
15,651

Deferred tax liability
(14,363
)
 
(32,107
)
Other liabilities
13,277

 
42,358

Net cash provided by operating activities
155,133

 
84,274

Cash flows from investing activities:
 
 
 
Investment in unconsolidated subsidiaries
(6,625
)
 
(17,425
)
Distributions from unconsolidated subsidiaries
10,158

 
1,923

Purchases of other investments
(133,180
)
 
(3,315
)
Proceeds from sale of other investments
2,834

 
—

Decrease in cash due to deconsolidation of the Reciprocal Exchanges
(8,393
)
 
—

Increase in cash due to consolidation of the Reciprocal Exchanges
2,673

 
—

Acquisition of consolidated subsidiaries, net of cash
(115,505
)
 
(61,413
)
Purchases of equity securities
(15,873
)
 
(245
)
Proceeds from sale of equity securities
15,142

 
1,259

Purchases of short-term investments
(63,919
)
 
(82,162
)
Proceeds from sale of short-term investments
12,149

 
83,391

Purchases of premises and equipment
(14,466
)
 
(3,670
)
Purchases of fixed maturities
(298,015
)
 
(355,504
)

See accompanying notes to unaudited condensed consolidated financial statements.
6


NATIONAL GENERAL HOLDINGS CORP.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(In Thousands)
(Unaudited)

Proceeds from sale and maturity of fixed maturities
343,252

 
219,595

Net cash used in investing activities
(269,768
)
 
(217,566
)
Cash flows from financing activities:
 
 
 
Securities sold under agreements to repurchase, net
66,989

 
14,350

Proceeds from long-term debt
50,000

 
—

Repayments of debt
—

 
(631
)
Issuance of preferred stock, net (fees $0 and $5,448, respectively)
—

 
159,552

Exercises of stock options
3,067

 
1,418

Return of capital
(150
)
 
—

Dividends paid to preferred shareholders
(8,250
)
 
(2,062
)
Dividends paid to common shareholders
(6,350
)
 
(3,736
)
Net cash provided by financing activities
105,306

 
168,891

Effect of exchange rate changes on cash and cash equivalents
(1,254
)
 
(153
)
Net increase (decrease) in cash and cash equivalents
(10,583
)
 
35,446

Cash and cash equivalents, beginning of the period
282,277

 
132,615

Cash and cash equivalents, end of the period
$
271,694

 
$
168,061

 
 
 
 
Supplemental disclosures of cash flow information:
 
 
 
Cash paid for income taxes
$
4,200

 
$
31,100

Cash paid for interest
15,740

 
8,469

Supplemental disclosures of non-cash investing and financing activities:
 
 
 
Promissory note issued for acquisition
$
182,287

 
$
—

Unsettled investment security purchases
23,230

 
—

Decrease in non-controlling interest due to deconsolidation of the Reciprocal Exchanges
22,619

 
—

Increase in non-controlling interest due to consolidation of the Reciprocal Exchanges
14,768

 
—

Accrued preferred stock dividends
4,125

 
4,744

Accrued common stock dividends
3,178

 
1,875


See accompanying notes to unaudited condensed consolidated financial statements.
7
NATIONAL GENERAL HOLDINGS CORP.

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(In Thousands, Except Shares and Per Share Data)


1. Basis of Reporting

The accompanying unaudited interim condensed consolidated financial statements include the accounts of National General Holdings Corp. and its subsidiaries (the “Company” or “NGHC”) and have been prepared in accordance with accounting principles generally accepted in the United States (“GAAP” or “U.S. GAAP”) for interim financial statements and with the instructions to Form 10-Q and Article 10 of Regulation S-X as promulgated by the U.S. Securities and Exchange Commission (“SEC”). Accordingly, they do not include all of the information and footnotes required by GAAP for complete financial statements. These interim condensed consolidated financial statements should be read in conjunction with the financial statements and notes thereto included in the Company's Annual Report on Form 10-K for the year ended December 31, 2015, previously filed with the SEC on February 29, 2016. The balance sheet at December 31, 2015 has been derived from the audited consolidated financial statements at that date but does not include all of the information and footnotes required by GAAP for complete financial statements.

The unaudited condensed consolidated balance sheet as of June 30, 2016 and the audited condensed consolidated balance sheet as of December 31, 2015, also include the accounts and operations of Adirondack Insurance Exchange, a New York reciprocal insurer, and New Jersey Skylands Insurance Association, a New Jersey reciprocal insurer (together with their subsidiaries, the “Reciprocal Exchanges” or "Exchanges"). The unaudited condensed financial statements for the six months ended June 30, 2016 excludes the accounts and operations of the Reciprocal Exchanges, from January 1, 2016 to March 31, 2016, as these entities did not meet the criteria for consolidation under FASB ASU 2015-02, "Consolidation (Topic 810): Amendments to the Consolidation Analysis," during that period but met the criteria on March 31, 2016. As discussed in Note 2, “Recent Accounting Pronouncements,” ASU 2015-02 was adopted using a modified retrospective approach by recording a cumulative effect adjustment as of January 1, 2016. As a result, periods prior to the adoption were not impacted by the deconsolidation of the Reciprocal Exchanges.

The Company does not own the Reciprocal Exchanges but manages their business operations through its wholly-owned management companies.

These interim condensed consolidated financial statements reflect all adjustments that are, in the opinion of management, necessary for a fair presentation of the results for the interim period and all such adjustments are of a normal recurring nature. The results of operations for the interim period are not necessarily indicative, if annualized, of those to be expected for the full year. The preparation of financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the amounts reported in the condensed consolidated financial statements and accompanying notes. Actual results could differ from those estimates.

A detailed description of the Company’s significant accounting policies and management judgments is located in the audited consolidated financial statements, included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2015 filed with the SEC.

All significant inter-company transactions and accounts have been eliminated in the condensed consolidated financial statements.


2. Recent Accounting Pronouncements

With the exception of those discussed below, there have been no recent accounting pronouncements or changes in accounting pronouncements during the six months ended June 30, 2016, as compared to those described in the Company's Annual Report on Form 10-K for the year ended December 31, 2015, that are of significance, or potential significance, to the Company.

In November 2014, the FASB issued ASU 2014-16, "Determining Whether the Host Contract in a Hybrid Financial Instrument Issued in the Form of a Share is More Akin to Debt or Equity (a consensus of the FASB Emerging Issues Task Force)", to reduce diversity in practice in the accounting for hybrid financial instruments issued in the form of a share. The amendments in ASU 2014-16 do not change the current criteria in GAAP for determining when separation of certain embedded derivative features in a hybrid financial instrument is required. An entity will continue to evaluate whether the economic characteristics and risks of the embedded derivative feature are clearly and closely related to those of the host contract, among other relevant criteria. ASU 2014-16 clarifies how current GAAP should be interpreted in evaluating the economic characteristics and risks of a host contract in a hybrid financial instrument that is issued in the form of a share. Specifically, ASU 2014-16 clarifies that an entity should consider all relevant terms and features-including the embedded derivative feature being evaluated for bifurcation-in evaluating the nature of

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(In Thousands, Except Shares and Per Share Data)

the host contract. Furthermore, ASU 2014-16 clarifies that no single term or feature would necessarily determine the economic characteristics and risks of the host contract. Rather, the nature of the host contract depends upon the economic characteristics and risks of the entire hybrid financial instrument. In addition, the amendments in ASU 2014-16 clarify that, in evaluating the nature of a host contract, an entity should assess the substance of the relevant terms and features (that is, the relative strength of the debt-like or equity-like terms and features given the facts and circumstances) when considering how to weight those terms and features. The effects of initially adopting the amendments in ASU 2014-16 are to be applied on a modified retrospective basis to existing hybrid financial instruments issued in the form of a share as of the beginning of the fiscal year for which the amendments are effective. Retrospective application is permitted to all relevant prior periods. The amendments in ASU 2014-16 are effective for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2015. The Company adopted ASU 2014-16 on January 1, 2016 and the implementation of the standard did not have an impact on the Company’s results of operations, financial position or liquidity.

In January 2015, the FASB issued ASU 2015-01, "Income Statement-Extraordinary and Unusual Items (Subtopic 225-20) (simplifying income statement presentation by eliminating the concept of extraordinary items)”, as part of its initiative to reduce complexity in accounting standards. ASU No. 2015-01 eliminates from GAAP the concept of extraordinary items. Subtopic 225-20, Income Statement-Extraordinary and Unusual Items, required that an entity separately classify, present, and disclose extraordinary events and transactions. Previously, an event or transaction was presumed to be an ordinary and usual activity of the reporting entity unless evidence clearly supports its classification as an extraordinary item. If an event or transaction met the criteria for extraordinary classification, an entity was required to segregate the extraordinary item from the results of ordinary operations and show the item separately in the income statement, net of tax, after income from continuing operations. The entity also was required to disclose applicable income taxes and either present or disclose earnings-per-share data applicable to the extraordinary item. An entity has a choice of transition methods. It may apply the amendments in ASU 2015-01 either prospectively or retrospectively to all prior periods presented in the financial statements. The amendments in ASU 2015-01 are effective for annual periods, and interim periods within those annual periods, beginning after December 15, 2015. An entity has the option to adopt the changes earlier provided that the guidance is applied from the beginning of the fiscal year of adoption. The Company adopted ASU 2015-01 prospectively on January 1, 2016 and the implementation of the standard did not have an impact on the Company’s results of operations, financial position or liquidity.

In February 2015, the FASB issued ASU 2015-02, "Consolidation (Topic 810): Amendments to the Consolidation Analysis" to address concerns that GAAP might require a reporting entity to consolidate another legal entity in situations in which the reporting entity's contractual rights do not give it the ability to act primarily on its own behalf, the reporting entity does not hold a majority of the legal entity's voting rights, or the reporting entity is not exposed to a majority of the legal entity's economic benefits or obligations. Specifically, the amendments: (1) modify the evaluation of whether limited partnerships and similar legal entities are variable interest entities ("VIEs") or voting interest entities; (2) eliminate the presumption that a general partner should consolidate a limited partnership; (3) affect the consolidation analysis of reporting entities that are involved with VIEs, particularly those that have fee arrangements and related party relationships; and (4) provide a scope exception from consolidation guidance for reporting entities with interests in legal entities that are required to comply with or operate in accordance with requirements that are similar to those in Rule 2a-7 of the Investment Company Act of 1940 for registered money market funds. ASU 2015-02 amends certain areas in the consolidation analysis including: (i) the effect of related parties on the primary beneficiary determination; (ii) the evaluation of fees paid to a decision maker or a service provider as a variable interest; (iii) the effect of fee arrangements on the primary beneficiary determination; and (iv) certain investment funds. The amendments in ASU 2015-02 are effective for public business entities for fiscal years, and for interim periods within those fiscal years, beginning after December 15, 2015. The adoption of ASU 2015-02 on January 1, 2016 required the Company to evaluate whether its VIEs met the amended criteria for consolidation at the earliest date of involvement unless certain reconsideration events existed. The Reciprocal Exchanges were evaluated based on the facts and circumstances that existed in September 2014 when the Company acquired the managing entities for the Reciprocal Exchanges. As a result of the evaluation, the Company was not required to consolidate the Reciprocal Exchanges as of January 1, 2016 (the Reciprocal Exchanges had previously been included in the Company’s consolidated results). The Company adopted ASU 2015-02 using a modified retrospective approach by recording a cumulative effect adjustment as of January 1, 2016. The total NGHC stockholders’ equity was not affected by this change. On March 31, 2016, the Company purchased the surplus notes representing the obligation of the Reciprocal Exchanges from a related party for consideration of $88,900 (see Note 3, "Reciprocal Exchanges" for additional information). The Company has significant economic interest in the Reciprocal Exchanges due to its ownership of the surplus notes. In addition, the Company, through its wholly-owned subsidiaries, earns fees from the Reciprocal Exchanges that are variable interests. The Company is the primary beneficiary because it, through its wholly-owned management companies, has both the power to direct the activities of the Reciprocal Exchanges that most significantly impact their economic performance and the Company, through its wholly-owned subsidiary that holds the surplus notes, would absorb

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(In Thousands, Except Shares and Per Share Data)

more than an insignificant amount of expected losses or residual returns of the Reciprocal Exchanges. Therefore, the Company was required to consolidate the Reciprocal Exchanges at March 31, 2016.

In May 2015, the FASB issued ASU 2015-07, "Fair Value Measurement (Topic 820): Disclosure for Investments in Certain Entities That Calculate Net Asset Value per Share (or Its Equivalent)", which provides guidance that removes the requirement to categorize within the fair value hierarchy all investments for which fair value is measured using the net asset value per share practical expedient as well as limits certain disclosure requirements only to investments for which the entity elects to measure the fair value using that practical expedient. The updated guidance is effective for reporting periods beginning after December 15, 2015, and should be applied retrospectively for all periods presented. Early adoption is permitted. The Company adopted ASU 2015-07 on January 1, 2016 and the implementation of the standard did not have an impact on the Company’s results of operations, financial position or liquidity.

In September 2015, the FASB issued ASU 2015-16, "Business Combinations (Topic 805): Simplifying the Accounting for Measurement-Period Adjustments" which applies to all entities that have reported provisional amounts for items in a business combination for which the accounting is incomplete by the end of the reporting period in which the combination occurs and during the measurement period have an adjustment to provisional amounts recognized. The amendments in ASU 2015-16 require that an acquirer recognize adjustments to provisional amounts that are identified during the measurement period in the reporting period in which the adjustment amounts are determined. The amendments in ASU 2015-16 require that the acquirer record, in the same period’s financial statements, the effect on earnings of changes in depreciation, amortization, or other income effects, if any, as a result of the change to the provisional amounts, calculated as if the accounting had been completed at the acquisition date. The amendments in ASU 2015-16 require an entity to present separately on the face of the income statement or disclose in the notes the portion of the amount recorded in current-period earnings by line item that would have been recorded in previous reporting periods if the adjustment to the provisional amounts had been recognized as of the acquisition date. The amendments in ASU 2015-16 are effective for fiscal years beginning after December 15, 2015, including interim periods within those fiscal years, and should be applied prospectively to adjustments to provisional amounts that occur after the effective date with earlier application permitted for financial statements that have not been issued. The only disclosures required at transition will be the nature of and reason for the change in accounting principle. An entity should disclose that information in the first annual period of adoption and in the interim periods within the first annual period if there is a measurement-period adjustment during the first annual period in which the changes are effective. The Company adopted ASU 2015-16 on January 1, 2016 and the effects of adoption will be limited to disclosures relating to adjustments for acquisitions to provisional amounts when identified during the measurement period in which the adjustment amounts are determined. The implementation of the standard did not have a material impact on the Company’s results of operations, financial position or liquidity.

In January 2016, the FASB issued ASU 2016-01, "Financial Instruments—Overall (Subtopic 825-10): Recognition and Measurement of Financial Assets and Financial Liabilities" to provide users of financial statements with more useful information on the recognition, measurement, presentation, and disclosure of financial instruments. The amendments in ASU 2016-01 affect all entities that hold financial assets or owe financial liabilities and make targeted improvements to existing GAAP by: (1) requiring equity investments (except those accounted for under the equity method of accounting, or those that result in consolidation of the investee) to be measured at fair value with changes in fair value recognized in net income. However, an entity may choose to measure equity investments that do not have readily determinable fair values at cost minus impairment, if any, plus or minus changes resulting from observable price changes in orderly transactions for the identical or a similar investment of the same issuer; (2) simplifying the impairment assessment of equity investments without readily determinable fair values by requiring a qualitative assessment to identify impairment. When a qualitative assessment indicates that impairment exists, an entity is required to measure the investment at fair value; (3) eliminating the requirement to disclose the fair value of financial instruments measured at amortized cost for entities that are not public business entities; (4) eliminating the requirement for public business entities to disclose the method(s) and significant assumptions used to estimate the fair value that is required to be disclosed for financial instruments measured at amortized cost on the balance sheet; (5) requiring public business entities to use the exit price notion when measuring the fair value of financial instruments for disclosure purposes; (6) requiring an entity to present separately in other comprehensive income ("OCI") the portion of the total change in the fair value of a liability resulting from a change in the instrument-specific credit risk (also referred to as "own credit") when the entity has elected to measure the liability at fair value in accordance with the fair value option for financial instruments; (7) requiring separate presentation of financial assets and financial liabilities by measurement category and form of financial asset (that is, securities or loans and receivables) on the balance sheet or the accompanying notes to the financial statements; and (8) clarifying that an entity should evaluate the need for a valuation allowance on a deferred tax asset related to available-for-sale securities in combination with the entity’s other deferred tax assets. The amendments in ASU 2016-01 are effective for fiscal years beginning after December 15, 2017, including interim periods within those fiscal years. Early application of the following provisions in ASU 2016-01 is permitted as of the beginning of the fiscal year

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(In Thousands, Except Shares and Per Share Data)

of adoption: (i) the "own credit" provision, in which an organization should present separately in OCI the portion of the total change in the fair value of a liability resulting from a change in the instrument-specific credit risk if the organization has elected to measure the liability at fair value in accordance with the fair value option for financial instruments; and (ii) the provision that exempts entities that are not public business entities from the requirement to apply the fair value of financial instruments disclosure guidance. Except for the early application guidance discussed above, early adoption of the amendments in ASU 2016-01 is not permitted. The amendments should be applied by means of a cumulative-effect adjustment to the balance sheet as of the beginning of the fiscal year of adoption. The amendments related to equity securities without readily determinable fair values (including disclosure requirements) should be applied prospectively to equity investments that exist as of the date of adoption. The Company currently records equity securities, available-for-sale, at fair value. As of June 30, 2016 and December 31, 2015, the Company had $10,587 and $3,909 net unrealized losses, net of tax, recognized as a component of accumulated other comprehensive income (loss).

In March 2016, the FASB issued ASU 2016-07, "Investments-Equity Method and Joint Ventures (Topic 323): Simplifying the Transition to the Equity Method of Accounting" as part of its initiative to reduce complexity in accounting standards. The amendments in ASU 2016-07 eliminate the requirement that when an investment qualifies for use of the equity method as a result of an increase in the level of ownership interest or degree of influence, an investor must adjust the investment, results of operations, and retained earnings retroactively on a step-by-step basis as if the equity method had been in effect during all previous periods that the investment had been held. The amendments require that the equity method investor add the cost of acquiring the additional interest in the investee to the current basis of the investor’s previously held interest and adopt the equity method of accounting as of the date the investment becomes qualified for equity method accounting. Therefore, upon qualifying for the equity method of accounting, no retroactive adjustment of the investment is required. In addition, the amendments in ASU 2016-07 require that an entity that has an available-for-sale equity security that becomes qualified for the equity method of accounting recognize through earnings the unrealized holding gain or loss in accumulated other comprehensive income at the date the investment becomes qualified for use of the equity method. The amendments in ASU 2016-07 are effective for all entities for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2016. The amendments should be applied prospectively upon their effective date to increases in the level of ownership interest or degree of influence that result in the adoption of the equity method. Earlier application is permitted. No additional disclosures are required at transition. The adoption of ASU 2016-07 is not expected to have a material effect on the Company’s results of operations, financial position or liquidity.

In March 2016, the FASB issued ASU 2016-08, "Revenue from Contracts with Customers (Topic 606): Principal versus Agent Considerations", which improves the operability and understandability of the implementation guidance on principal versus agent considerations by clarifying that: 1) an entity determines whether it is a principal or an agent for each specific good or service promised to the customer; 2) an entity determines the nature of each specific good or service; 3) when another party is involved in providing goods or services to a customer, an entity that is a principal obtains control of (a) a good or another asset from the other party that it then transfers to the customer; (b) a right to a service that will be performed by another party, which gives the entity the ability to direct that party to provide the service to the customer on the entity's behalf, or (c) a good or service from the other party that it combines with other goods or services to provide the specific good or service to the customer; and 4) the purpose of the indicators in paragraph 606-10-55-39 in Topic 606 is to support or assist in the assessment of control. The effective date and transition requirement for ASU 2016-08 are the same as the effective date and transition requirements of ASU 2014-09, which were deferred to the quarter ending March 31, 2018 by ASU 2015-14. The Company is currently evaluating the impact this guidance will have on its results of operations, financial position or liquidity.

In March 2016, the FASB issued ASU 2016-09, "Compensation-Stock Compensation (Topic 718): Improvements to Employee Share-Based Payment Accounting" as part of its initiative to reduce complexity in accounting standards. The areas for simplification in ASU 2016-09 involve several aspects of the accounting for share-based payment transactions, including the income tax consequences, classification of awards as either equity or liabilities, and classification on the statement of cash flows. Specifically, the amendments require: (1) All excess tax benefits and tax deficiencies (including tax benefits of dividends on share-based payment awards) should be recognized as income tax expense or benefit in the income statement. The tax effects of exercised or vested awards should be treated as discrete items in the reporting period in which they occur. An entity also should recognize excess tax benefits regardless of whether the benefit reduces taxes payable in the current period; (2) Excess tax benefits should be classified along with other income tax cash flows as an operating activity; (3) An entity can make an entity-wide accounting policy election to either estimate the number of awards that are expected to vest (current GAAP) or account for forfeitures when they occur; (4) The threshold to qualify for equity classification permits withholding up to the maximum statutory tax rates in the applicable jurisdictions; and (5) Cash paid by an employer when directly withholding shares for tax withholding purposes should be classified as a financing activity. The amendments in ASU 2016-09 are effective for annual periods beginning after December 15, 2016, and interim periods within those annual periods. Early adoption is permitted for any entity in any interim or annual period. If an entity

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(In Thousands, Except Shares and Per Share Data)

early adopts the amendments in an interim period, any adjustments should be reflected as of the beginning of the fiscal year that includes that interim period. An entity that elects early adoption must adopt all of the amendments in the same period. Amendments related to the timing of when excess tax benefits are recognized, minimum statutory withholding requirements, and forfeitures, should be applied using a modified retrospective transition method by means of a cumulative-effect adjustment to equity as of the beginning of the period in which the guidance is adopted. Amendments related to the presentation of employee taxes paid on the statement of cash flows when an employer withholds shares to meet the minimum statutory withholding requirement should be applied retrospectively. Amendments requiring recognition of excess tax benefits and tax deficiencies in the income statement should be applied prospectively. An entity may elect to apply the amendments related to the presentation of excess tax benefits on the statement of cash flows using either a prospective transition method or a retrospective transition method. The Company is currently evaluating the impact this guidance will have on its consolidated financial condition, results of operations, cash flows and disclosures and is currently unable to estimate the impact of adopting this guidance.

In April 2016, the FASB issued ASU 2016-10, "Revenue from Contracts with Customers (Topic 606): Identifying Performance Obligations and Licensing", which sought to address certain issues identified in the guidance on identifying performance obligation and licensing by reducing the potential for diversity in practice at initial application and the cost and complexity of applying the guidance in Topic 606 both at transition and on an ongoing basis as noted: 1) identifying performance obligations (a) when identifying performance obligations, whether it is necessary to assess whether promised goods or services are performance obligations if they are immaterial in the context of the contract; (b) determining whether promised goods and services are separately identifiable (that is, distinct within the context of the contract); (c) determining whether shipping and handling activities are a promised service in a contract or are activities to fulfill an entity’s other promises in the contract; (2) licensing; (a) determining whether the nature of an entity’s promise in granting a license is to provide a right to access the entity’s intellectual property, which is satisfied over time and for which revenue is recognized over time, or to provide a right to use the entity’s intellectual property, which is satisfied at a point in time and for which revenue is recognized at a point in time; (b) the scope and applicability of the guidance about when to recognize revenue for sales-based or usage-based royalties promised in exchange for a license of intellectual property; (c) distinguishing contractual provisions that require an entity to transfer additional licenses (that is, rights to use or access intellectual property) to a customer from contractual provisions that define the attributes of a promised license (for example, restrictions of time, geographical region, or use). The effective date and transition requirement for ASU 2016-10 are the same as the effective date and transition requirements of ASU 2014-09, which were deferred to the quarter ending March 31, 2018 by ASU 2015-14. The Company is currently evaluating the impact this guidance will have on its results of operations, financial position or liquidity.

In May 2016, the FASB issued ASU 2016-12, "Revenue from Contracts with Customers (Topic 606): Narrow-Scope Improvements and Practical Expedients", which sought to address certain issues identified in the guidance by reducing the potential for diversity in practice at initial application and the cost and complexity of applying the guidance in Topic 606 both at transition and on an ongoing basis as noted: 1) assessing the collectibility criterion in paragraph 606-10-25-1(e) and accounting for contracts that do not meet the criteria for Step 1 (applying paragraph 606-10-25-7), the amendments in ASU 2016-12 clarify the objective of the collectibility criterion in Step 1. The objective of this assessment is to determine whether the contract is valid and represents a substantive transaction on the basis of whether a customer has the ability and intention to pay the promised consideration in exchange for the goods or services that will be transferred to the customer. The amendments in ASU 2016-12 also add a new criterion to paragraph 606-10-25-7 to clarify when revenue would be recognized for a contract that fails to meet the criteria in Step 1. That criterion allows an entity to recognize revenue in the amount of consideration received when the entity has transferred control of the goods or services, the entity has stopped transferring goods or services (if applicable) and has no obligation under the contract to transfer additional goods or services, and the consideration received from the customer is nonrefundable; 2) presentation of sales taxes and other similar taxes collected from customers, the amendments in ASU 2016-12 permit an entity, as an accounting policy election, to exclude amounts collected from customers for all sales (and other similar) taxes from the transaction price; 3) noncash consideration, the amendments in ASU 2016-12 specify that the measurement date for noncash consideration is contract inception and clarify that the variable consideration guidance applies only to variability resulting from reasons other than the form of the consideration; 4) contract modifications at transition, the amendments in ASU 2016-12 provide a practical expedient that permits an entity to reflect the aggregate effect of all modifications that occur before the beginning of the earliest period presented in accordance with the guidance in Topic 606 when identifying the satisfied and unsatisfied performance obligations, determining the transaction price, and allocating the transaction price to the satisfied and unsatisfied performance obligations; 5) completed contracts at transition, the amendments in ASU 2016-12 clarify that a completed contract for purposes of transition is a contract for which all (or substantially all) of the revenue was recognized under legacy generally accepted accounting principles (GAAP) before the date of initial application. Accounting for elements of a contract that do not affect revenue under legacy GAAP are irrelevant to the assessment of whether a contract is complete. In addition, the amendments permit an entity to apply the modified retrospective transition method either to all contracts or only to contracts that are not completed contracts; 6) technical

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(In Thousands, Except Shares and Per Share Data)

correction, the amendments in ASU 2016-12 clarify that an entity that retrospectively applies the guidance in Topic 606 to each prior reporting period is not required to disclose the effect of the accounting change for the period of adoption. However, an entity is still required to disclose the effect of the changes on any prior periods retrospectively adjusted. The effective date and transition requirement for ASU 2016-12 are the same as the effective date and transition requirements of ASU 2014-09, which were deferred to the quarter ending March 31, 2018 by ASU 2015-14. The Company is currently evaluating the impact this guidance will have on its results of operations, financial position or liquidity.

In June 2016, the FASB issued ASU 2016-13, "Financial Instruments-Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments", which is intended to provide financial statement users with more decision-useful information about the expected credit losses on financial instruments and other commitments to extend credit held by a reporting entity at each reporting date. To achieve this objective, the amendments in ASU 2016-13 replace the incurred loss impairment methodology in current GAAP with a methodology that reflects expected credit losses and requires consideration of a broader range of reasonable and supportable information to inform credit loss estimates. Specifically, the amendments require, a financial asset (or a group of financial assets) measured at amortized cost basis to be presented at the net amount expected to be collected. The allowance for credit losses is a valuation account that is deducted from the amortized cost basis of the financial asset(s) to present the net carrying value at the amount expected to be collected on the financial asset. The income statement reflects the measurement of credit losses for newly recognized financial assets, as well as the expected increases or decreases of expected credit losses that have taken place during the period. The measurement of expected credit losses is based on relevant information about past events, including historical experience, current conditions, and reasonable and supportable forecasts that affect the collectibility of the reported amount. An entity must use judgment in determining the relevant information and estimation methods that are appropriate in its circumstances. The allowance for credit losses for purchased financial assets with a more-than insignificant amount of credit deterioration since origination (PCD assets) that are measured at amortized cost basis is determined in a similar manner to other financial assets measured at amortized cost basis; however, the initial allowance for credit losses is added to the purchase price rather than being reported as a credit loss expense. Only subsequent changes in the allowance for credit losses are recorded as a credit loss expense for these assets. Interest income for PCD assets should be recognized based on the effective interest rate, excluding the discount embedded in the purchase price that is attributable to the acquirer’s assessment of credit losses at acquisition. Credit losses relating to available-for-sale debt securities should be recorded through an allowance for credit losses. Available-for-sale accounting recognizes that value may be realized either through collection of contractual cash flows or through sale of the security. Therefore, the amendments limit the amount of the allowance for credit losses to the amount by which fair value is below amortized cost because the classification as available for sale is premised on an investment strategy that recognizes that the investment could be sold at fair value, if cash collection would result in the realization of an amount less than fair value. The allowance for credit losses for purchased available-for-sale securities with a more-than-insignificant amount of credit deterioration since origination is determined in a similar manner to other available-for-sale debt securities; however, the initial allowance for credit losses is added to the purchase price rather than reported as a credit loss expense. Only subsequent changes in the allowance for credit losses are recorded in credit loss expense. Interest income should be recognized based on the effective interest rate, excluding the discount embedded in the purchase price that is attributable to the acquirer’s assessment of credit losses at acquisition. The amendments in ASU 2016-13 are effective for fiscal years beginning after December 15, 2019, including interim periods within those fiscal years. All entities may adopt the amendments in ASU 2016-13 earlier as of the fiscal years beginning after December 15, 2018, including interim periods within those fiscal years. An entity will apply the amendments in ASU 2016-13 through a cumulative-effect adjustment to retained earnings as of the beginning of the first reporting period in which the guidance is effective (that is, a modified-retrospective approach). A prospective transition approach is required for debt securities for which an other-than-temporary impairment had been recognized before the effective date. The effect of a prospective transition approach is to maintain the same amortized cost basis before and after the effective date of ASU 2016-13. Amounts previously recognized in accumulated other comprehensive income as of the date of adoption that relate to improvements in cash flows expected to be collected should continue to be accreted into income over the remaining life of the asset. Recoveries of amounts previously written off relating to improvements in cash flows after the date of adoption should be recorded in earnings when received. The Financial Accounting Standards Board determined that financial assets for which the guidance in Subtopic 310-30, Receivables-Loans and Debt Securities Acquired with Deteriorated Credit Quality, has previously been applied should prospectively apply the guidance in ASU 2016-13 for PCD assets. A prospective transition approach should be used for PCD assets where upon adoption, the amortized cost basis should be adjusted to reflect the addition of the allowance for credit losses. This transition relief will avoid the need for a reporting entity to reassess its purchased financial assets that exist as of the date of adoption to determine whether they would have met at acquisition the new criteria of more-than insignificant credit deterioration since origination. The transition relief also will allow an entity to accrete the remaining noncredit discount (based on the revised amortized cost basis) into interest income at the effective interest rate at the adoption date of ASU 2016-13. The same transition requirements should be applied to beneficial interests that previously applied Subtopic 310-30 or have a significant difference between contractual cash flows and expected cash flows. The Company

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(In Thousands, Except Shares and Per Share Data)

is currently evaluating the impact this guidance will have on its consolidated financial condition, results of operations, cash flows and disclosures and is currently unable to estimate the impact of adopting this guidance.


3. Reciprocal Exchanges

As of September 15, 2014, through its wholly-owned management companies, the Company manages the business operations of the Reciprocal Exchanges and has the ability to direct their activities. The Reciprocal Exchanges are insurance carriers organized as unincorporated associations. Each policyholder insured by the Reciprocal Exchanges shares risk with the other policyholders.

In the event of dissolution, policyholders would share any residual unassigned surplus in the same proportion as the amount of insurance purchased but are not subject to assessment for any deficit in unassigned surplus of the Reciprocal Exchanges. The Company receives management fee income for the services provided to the Reciprocal Exchanges. The assets of the Reciprocal Exchanges can be used only to settle the obligations of the Reciprocal Exchanges and general creditors to their liabilities have no recourse to the Company.

Effective March 31, 2016, a subsidiary of the Company, purchased from subsidiaries of ACP Re Ltd. ("ACP Re"), a related party, the surplus notes that were issued by the Reciprocal Exchanges when they were originally capitalized. The purchase price of $88,900 was based on an independent third party valuation of the fair market value of the surplus notes. The obligation to repay principal and interest on the surplus notes is subordinated to the Reciprocal Exchanges’ other liabilities including obligations to policyholders and claimants for benefits under insurance policies. Principal and interest on the surplus notes are payable only with regulatory approval. The Company has no ownership interest in the Reciprocal Exchanges.

Under ASU 2015-02, as a result of the Company's purchase of the surplus notes effective March 31, 2016, the Company determined that it holds a variable interest in each of the Reciprocal Exchanges. The Company would absorb more than an insignificant amount of the Reciprocal Exchanges expected losses or residual returns through its ownership of the surplus notes. In addition, the Company, through its wholly-owned subsidiaries, earns fees from the Reciprocal Exchanges that are variable interests. Each of the Reciprocal Exchanges qualifies as a Variable Interest Entity ("VIE") because they do not have sufficient equity to finance their operations without the surplus notes. The policyholders of the Reciprocal Exchanges lack the ability to direct the activities of the Reciprocal Exchanges that have a significant impact on the Reciprocal Exchanges' economic performance. The Company is the primary beneficiary because it, through its wholly-owned management companies, has both the power to direct the activities of the Reciprocal Exchanges that most significantly impact their economic performance and the Company, through its wholly-owned subsidiary that holds surplus notes, would absorb more than an insignificant amount of expected losses or residual returns of the Reciprocal Exchanges. Accordingly, the Company consolidates these Reciprocal Exchanges as of March 31, 2016 and for the periods thereafter, and eliminates all intercompany balances and transactions with the Company.

Prior to the adoption of ASU 2015-02 on January 1, 2016, the Company consolidated the Reciprocal Exchanges under the previous guidance. Upon adoption of ASU 2015-02, on January 1, 2016, and before the purchase of the surplus notes, the Company did not meet the requirements for consolidation as it did not hold a variable interest in the Reciprocal Exchanges. Therefore, the operations of the Reciprocal Exchanges for the period from January 1, 2016 to March 31, 2016 are not included in the Company's condensed consolidated financial statements.


14
NATIONAL GENERAL HOLDINGS CORP.

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(In Thousands, Except Shares and Per Share Data)

The following table presents the opening balance sheet of the Reciprocal Exchanges as of March 31, 2016:
March 2016
 
Assets:
 
Cash and investments
$
258,274

Accrued investment income
2,658

Premiums and other receivables, net
52,922

Reinsurance recoverable on unpaid losses
43,401

Prepaid reinsurance premiums
59,706

Income tax receivable
300

Due from affiliate
11,703

Premises and equipment, net
2,386

Intangible assets, net
32,638

Prepaid and other assets
187

Total assets
$
464,175

 
 
Liabilities:
 
Unpaid loss and loss adjustment expense reserves
$
137,093

Unearned premiums
143,194

Reinsurance payable
11,982

Accounts payable and accrued expenses
6,972

Deferred tax liability
23,716

Debt
88,900

Other liabilities
37,550

Total liabilities
449,407

Stockholders’ equity:
 
Non-controlling interest
14,768

Total stockholders’ equity
14,768

Total liabilities and stockholders' equity
$
464,175


The consolidation of the Reciprocal Exchanges at March 31, 2016 is treated as a business combination with the assets, liabilities and non-controlling interest recognized at fair value at the date of consolidation. The Company has no ownership in the Reciprocal Exchanges. Therefore, the difference between the fair value of the assets and liabilities acquired represents the fair value of non-controlling interest acquired.

For the three and six months ended June 30, 2016, the Reciprocal Exchanges recognized total revenues, total expenses and net income of $54,521, $45,297 and $9,224, respectively. For the three months ended June 30, 2015, the Reciprocal Exchanges recognized total revenues, total expenses and net loss of $34,754, $36,975 and $(2,221), respectively. For the six months ended June 30, 2015, the Reciprocal Exchanges recognized total revenues, total expenses and net loss of $84,204, $86,289 and $(2,085), respectively.

For the three months ended June 30, 2016 and 2015, the Company earned service and fee income from the Reciprocal Exchanges in the amounts of $10,807 and $10,732, respectively. For the six months ended June 30, 2016 and 2015, the Company earned service and fee income from the Reciprocal Exchanges in the amounts of $20,397 and $19,310, respectively. Such amounts are eliminated in the Company's consolidated earnings, except for $9,590 of service and fee income included in the six months ended June 30, 2016, for the period in which the Company and the Reciprocal Exchanges did not meet requirements for consolidation.



15
NATIONAL GENERAL HOLDINGS CORP.

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(In Thousands, Except Shares and Per Share Data)

4. Investments

(a) Available-for-Sale Securities

The cost or amortized cost, fair value, and gross unrealized gains and losses on available-for-sale securities were as follows:
June 30, 2016
 
Cost or
Amortized
Cost
 
Gross
Unrealized
Gains
 
Gross
Unrealized
Losses
 
Fair
Value
Equity securities:
 
 
 
 
 
 
 
 
   Common stock
 
$
110,752

 
$
7,153

 
$
(23,156
)
 
$
94,749

   Preferred stock
 
16,035

 
296

 
(580
)
 
15,751

Fixed maturities:
 
 
 
 
 
 
 
 
   U.S. Treasury
 
27,174

 
1,851

 
—

 
29,025

   States and political subdivision bonds
 
399,438

 
14,414

 
(192
)
 
413,660

   Foreign government
 
59,644

 
1,283

 
(340
)
 
60,587

   Corporate bonds
 
1,533,488

 
93,788

 
(17,588
)
 
1,609,688

   Residential mortgage-backed securities
 
336,498

 
13,594

 
(60
)
 
350,032

   Commercial mortgage-backed securities
 
106,290

 
3,281

 
(1,053
)
 
108,518

   Structured securities
 
246,396

 
1,675

 
(6,103
)
 
241,968

Total
 
$
2,835,715

 
$
137,335

 
$
(49,072
)
 
$
2,923,978

Less: Securities pledged
 
132,300

 
5,148

 
—

 
137,448

Total net of Securities pledged
 
$
2,703,415

 
$
132,187

 
$
(49,072
)
 
$
2,786,530

NGHC
 
$
2,558,242

 
$
123,177

 
$
(48,010
)
 
$
2,633,409

Reciprocal Exchanges
 
277,473

 
14,158

 
(1,062
)
 
290,569

Total
 
$
2,835,715

 
$
137,335

 
$
(49,072
)
 
$
2,923,978


December 31, 2015
 
Cost or
Amortized
Cost
 
Gross
Unrealized
Gains
 
Gross
Unrealized
Losses
 
Fair
Value
Equity securities:
 
 
 
 
 
 
 
 
   Common stock
 
$
53,356

 
$
569

 
$
(6,960
)
 
$
46,965

   Preferred stock
 
11,448

 
377

 
—

 
11,825

Fixed maturities:
 
 
 
 
 
 
 
 
   U.S. Treasury
 
19,348

 
1,052

 
(48
)
 
20,352

   Federal agencies
 
1,945

 
7

 
—

 
1,952

   States and political subdivision bonds
 
193,017

 
4,516

 
(609
)
 
196,924

   Foreign government
 
31,383

 
31

 
(352
)
 
31,062

   Corporate bonds
 
1,375,336

 
22,224

 
(47,902
)
 
1,349,658

   Residential mortgage-backed securities
 
419,293

 
6,254

 
(978
)
 
424,569

   Commercial mortgage-backed securities
 
135,134

 
720

 
(3,649
)
 
132,205

   Structured securities
 
205,024

 
15

 
(4,347
)
 
200,692

Total
 
$
2,445,284

 
$
35,765

 
$
(64,845
)
 
$
2,416,204

Less: Securities pledged
 
54,955

 
439

 
—

 
55,394

Total net of Securities pledged
 
$
2,390,329

 
$
35,326

 
$
(64,845
)
 
$
2,360,810

NGHC
 
$
2,199,714

 
$
34,773

 
$
(58,826
)
 
$
2,175,661

Reciprocal Exchanges
 
245,570

 
992

 
(6,019
)
 
240,543

Total
 
$
2,445,284

 
$
35,765

 
$
(64,845
)
 
$
2,416,204


16
NATIONAL GENERAL HOLDINGS CORP.

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(In Thousands, Except Shares and Per Share Data)


The amortized cost and fair value of available-for-sale fixed maturities and securities pledged, held as of June 30, 2016, by contractual maturity, are shown in the table below. Actual maturities may differ from contractual maturities because some borrowers may have the right to call or prepay obligations with or without call or prepayment penalties.

 
 
NGHC
 
Reciprocal Exchanges
 
Total
June 30, 2016
 
Amortized
Cost
 
Fair
Value
 
Amortized
Cost
 
Fair
Value
 
Amortized
Cost
 
Fair
Value
Due in one year or less
 
$
25,213

 
$
25,338

 
$
—

 
$
—

 
$
25,213

 
$
25,338

Due after one year through five years
 
323,244

 
344,450

 
34,416

 
36,626

 
357,660

 
381,076

Due after five years through ten years
 
1,250,796

 
1,303,856

 
181,099

 
190,721

 
1,431,895

 
1,494,577

Due after ten years
 
414,001

 
415,519

 
37,371

 
38,418

 
451,372

 
453,937

Mortgage-backed securities
 
418,201

 
433,746

 
24,587

 
24,804

 
442,788

 
458,550

Total
 
$
2,431,455

 
$
2,522,909

 
$
277,473

 
$
290,569

 
$
2,708,928

 
$
2,813,478


(b) Investment Income

The components of net investment income consisted of the following:
 
 
Three Months Ended June 30,
 
Six Months Ended June 30,
 
 
2016
 
2015
 
2016
 
2015
Interest
 
 
 
 
 
 
 
 
Cash and short-term investments
 
$
2,173

 
$
4

 
$
2,857

 
$
9

Equity securities
 
58

 
122

 
391

 
197

Fixed maturities
 
23,879

 
15,916

 
43,618

 
30,922

Investment income
 
26,110

 
16,042

 
46,866

 
31,128

Investment expense
 
(1,046
)
 
(59
)
 
(2,684
)
 
(1,271
)
Repurchase agreements interest expense
 
(176
)
 
(33
)
 
(320
)
 
(103
)
Other income (1)
 
2,640

 
2,385

 
5,336

 
4,729

Net Investment Income
 
$
27,528

 
$
18,335

 
$
49,198

 
$
34,483

NGHC
 
$
25,280

 
$
16,154

 
$
46,950

 
$
30,263

Reciprocal Exchanges
 
2,248

 
2,181

 
2,248

 
4,220

Net Investment Income
 
$
27,528

 
$
18,335

 
$
49,198

 
$
34,483


(1) Includes interest income of $2,187 and $2,211 for the three months ended June 30, 2016 and 2015, respectively, and $4,375 and $4,399 for the six months ended June 30, 2016 and 2015, respectively, under the ACP Re Credit Agreement (see Note 14, "Related Party Transactions" for additional information).

(c) Realized Gains and Losses

Proceeds from sales of equity securities and fixed maturities during the six months ended June 30, 2016 and 2015 were $188,397 and $114,496, respectively. For the three and six months ended June 30, 2016, the Company did not recognize any other-than-temporary impairment ("OTTI") loss. For the three and six months ended June 30, 2015, the Company recognized an OTTI loss of $1,467 and $2,483, respectively, on investments, based on the Company's qualitative and quantitative review.

The tables below indicate the gross realized gains and losses (including any OTTI) for the three and six months ended June 30, 2016 and 2015.

17
NATIONAL GENERAL HOLDINGS CORP.

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(In Thousands, Except Shares and Per Share Data)

Three Months Ended June 30, 2016
 
Gross Gains
 
Gross Losses
 
Net Gains (Losses)
Equity securities
 
$
262

 
$
(291
)
 
$
(29
)
Fixed maturities
 
5,653

 
(1,242
)
 
4,411

Total gross realized gains and losses
 
$
5,915

 
$
(1,533
)
 
$
4,382

NGHC
 
$
5,745

 
$
(1,504
)
 
$
4,241

Reciprocal Exchanges
 
170

 
(29
)
 
141

Total gross realized gains and losses
 
$
5,915

 
$
(1,533
)
 
$
4,382

Three Months Ended June 30, 2015
 
Gross Gains
 
Gross Losses
 
Net Gains (Losses)
Equity securities
 
$
5

 
$
—

 
$
5

Fixed maturities
 
2,466

 
(615
)
 
1,851

OTTI
 
—

 
(1,467
)
 
(1,467
)
Total gross realized gains and losses
 
$
2,471

 
$
(2,082
)
 
$
389

NGHC
 
$
2,415

 
$
(1,480
)
 
$
935

Reciprocal Exchanges
 
56

 
(602
)
 
(546
)
Total gross realized gains and losses
 
$
2,471

 
$
(2,082
)
 
$
389

Six Months Ended June 30, 2016
 
Gross Gains
 
Gross Losses
 
Net Gains (Losses)
Equity securities
 
$
704

 
$
(293
)
 
$
411

Fixed maturities
 
9,852

 
(2,264
)
 
7,588

Total gross realized gains and losses
 
$
10,556

 
$
(2,557
)
 
$
7,999

NGHC
 
$
10,386

 
$
(2,528
)
 
$
7,858

Reciprocal Exchanges
 
170

 
(29
)
 
141

Total gross realized gains and losses
 
$
10,556

 
$
(2,557
)
 
$
7,999

Six Months Ended June 30, 2015
 
Gross Gains
 
Gross Losses
 
Net Gains (Losses)
Equity securities
 
$
5

 
$
—

 
$
5

Fixed maturities
 
5,090

 
(1,036
)
 
4,054

OTTI
 
—

 
(2,483
)
 
(2,483
)
Total gross realized gains and losses
 
$
5,095

 
$
(3,519
)
 
$
1,576

NGHC
 
$
4,188

 
$
(2,759
)
 
$
1,429

Reciprocal Exchanges
 
907

 
(760
)
 
147

Total gross realized gains and losses
 
$
5,095

 
$
(3,519
)
 
$
1,576



18
NATIONAL GENERAL HOLDINGS CORP.

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(In Thousands, Except Shares and Per Share Data)

(d) Unrealized Gains and Losses

Unrealized gains (losses) on investments as of June 30, 2016 and December 31, 2015 consisted of the following:
 
 
June 30, 2016
 
December 31, 2015
Net unrealized loss on common stock
 
$
(16,003
)
 
$
(6,391
)
Net unrealized gain on preferred stock
 
(284
)
 
377

Net unrealized gain (loss) on fixed maturities
 
104,550

 
(23,066
)
Net unrealized loss on other
 
—

 
(20
)
Deferred income tax
 
(30,893
)
 
10,185

Net unrealized gain (loss), net of deferred income tax
 
$
57,370

 
$
(18,915
)
NGHC
 
$
48,859

 
$
(15,634
)
Reciprocal Exchanges
 
8,511

 
(3,281
)
Net unrealized gain (loss), net of deferred income tax
 
57,370

 
(18,915
)
Non-controlling interest
 
(8,511
)
 
3,281

NGHC net unrealized gain (loss), net of deferred income tax
 
$
48,859

 
$
(15,634
)
 
 
 
 
 
Six months ended June 30, 2016 and 2015:
 
June 30, 2016
 
June 30, 2015
NGHC net unrealized gain (loss), net of deferred income tax
 
$
64,493

 
$
(8,591
)
Non-controlling interest net unrealized gain (loss), net of deferred income tax
 
$
6,537

 
$
(3,138
)

(e) Gross Unrealized Losses

The tables below summarize the gross unrealized losses on equity securities and fixed maturities by length of time the security has continuously been in an unrealized loss position as of June 30, 2016 and December 31, 2015:
 
 
Less Than 12 Months
 
12 Months or More
 
Total
June 30, 2016
 
Fair
Market
Value
 
Unrealized
Losses
 
No. of
Positions
Held
 
Fair
Market
Value
 
Unrealized
Losses
 
No. of
Positions
Held
 
Fair
Market
Value
 
Unrealized
Losses
Common stock
 
$
45,129

 
$
(23,136
)
 
65

 
$
154

 
$
(20
)
 
3

 
$
45,283

 
$
(23,156
)
Preferred stock
 
7,957

 
(580
)
 
4

 
—

 
—

 
—

 
7,957

 
(580
)
States and political subdivision bonds
 
4,254

 
(10
)
 
11

 
5,763

 
(182
)
 
11

 
10,017

 
(192
)
Foreign government
 
1,913

 
(340
)
 
1

 
—

 
—

 
—

 
1,913

 
(340
)
Corporate bonds
 
129,782

 
(6,751
)
 
79

 
60,155

 
(10,837
)
 
29

 
189,937

 
(17,588
)
Residential mortgage-backed securities
 
1,162

 
(10
)
 
3

 
1,209

 
(50
)
 
3

 
2,371

 
(60
)
Commercial mortgage-backed securities
 
20,834

 
(305
)
 
7

 
28,114

 
(748
)
 
12

 
48,948

 
(1,053
)
Structured securities
 
99,167

 
(3,854
)
 
47

 
43,237

 
(2,249
)
 
21

 
142,404

 
(6,103
)
Total
 
$
310,198

 
$
(34,986
)
 
217

 
$
138,632

 
$
(14,086
)
 
79

 
$
448,830

 
$
(49,072
)
NGHC
 
$
291,501

 
$
(34,368
)
 
207

 
$
127,478

 
$
(13,642
)
 
65

 
$
418,979

 
$
(48,010
)
Reciprocal Exchanges
 
18,697

 
(618
)
 
10

 
11,154

 
(444
)
 
14

 
29,851

 
(1,062
)
Total
 
$
310,198

 
$
(34,986
)
 
217

 
$
138,632

 
$
(14,086
)
 
79

 
$
448,830

 
$
(49,072
)

19
NATIONAL GENERAL HOLDINGS CORP.

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(In Thousands, Except Shares and Per Share Data)

 
 
Less Than 12 Months
 
12 Months or More
 
Total
December 31, 2015
 
Fair
Market
Value
 
Unrealized
Losses
 
No. of
Positions
Held
 
Fair
Market
Value
 
Unrealized
Losses
 
No. of
Positions
Held
 
Fair
Market
Value
 
Unrealized
Losses
Common stock
 
$
39,490

 
$
(6,932
)
 
5

 
$
130