10Q Q32011
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
_________________________
FORM 10-Q
(Mark One)
 
x
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
September 30, 2011
or
o
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended September 30, 2011
 
Commission File Number: 001-15204
 
Kingsway Financial Services Inc.
(Exact name of registrant as specified in its charter)
_________________________
Ontario, Canada
(State or other jurisdiction of
incorporation or organization)
 
Not Applicable (I.R.S. Employer
Identification No.)
45 St. Clair Avenue West, Suite 400 Toronto, Ontario M4V 1K9
(Address of principal executive offices and zip code)
1-416-848-1171
(Registrant's telephone number, including area code)
_________________________

Indicate by checkmark 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 ( 232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes x No o

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

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

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act). Yes o No x
The number of shares outstanding of the registrant's common stock as of March 27, 2012 was 52,595,828.





Table Of Contents
PART I - FINANCIAL INFORMATION
 
ITEM 1. FINANCIAL STATEMENTS
 
Condensed Consolidated Balance Sheets as of September 30, 2011 (unaudited) and December 31, 2010
 
Condensed Consolidated Statements of Operations for the Three and Nine Months Ended September 30, 2011 and 2010 (unaudited)
 
Condensed Consolidated Statements of Comprehensive Income (Loss) for the Three and Nine Months Ended September 30, 2011 and 2010 (unaudited)
 
Condensed Consolidated Statements of Cash Flows for the Nine Months Ended September 30, 2011 and 2010 (unaudited)
 
Notes to Condensed Consolidated Financial Statements (unaudited)
 
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
 
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
 
ITEM 4. CONTROLS AND PROCEDURES
 
PART II - OTHER INFORMATION
 
ITEM 1. LEGAL PROCEEDINGS
 
ITEM 1A. RISK FACTORS
 
ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS
 
ITEM 3. DEFAULTS UPON SENIOR SECURITIES
 
ITEM 4. RESERVED
 
ITEM 5. OTHER INFORMATION
 
ITEM 6. EXHIBITS
 
SIGNATURES
 




















2




PART I. FINANCIAL INFORMATION
Item 1. Financial Statements
Condensed Consolidated Balance Sheets
(in thousands, except per share data)
 
September 30, 2011

December 31, 2010

 
 (unaudited)

 
ASSETS
 
 
Investments:
 
 
Fixed maturities at fair value (amortized cost of $111,230 and $126,210, respectively)
$
114,823

$
127,863

Equity securities at fair value (cost of $2,781 and $92, respectively)
2,951

82

Investee at cost which approximates fair value
48,753

49,079

Other investments
487

490

Short-term investments at fair value (cost of $21,335 and $18,248, respectively)
21,335

18,249

Total investments
188,349

195,763

Cash and cash equivalents
82,462

140,567

Accrued investment income
1,660

1,957

Financed premiums, net of allowance for credit losses of $24 and $27, respectively
5,714

13,572

Accounts receivable, net of allowance for doubtful accounts of $3,623 and $4,760, respectively
44,047

46,395

Funds held in escrow

22,259

     Due from reinsurers and other insurers
555

7,651

     Deferred policy acquisition costs
9,339

13,952

Income taxes recoverable
12,389

17,991

Deferred income taxes

503

Property and equipment, net of accumulated depreciation of $27,189 and $28,743
13,369

13,961

Goodwill and intangible assets
42,149

42,467

     Other assets
1,152

2,541

TOTAL ASSETS
$
401,185

$
519,579

LIABILITIES AND STOCKHOLDERS’ EQUITY
 
 
 
 
 
LIABILITIES
 
 
Unpaid loss and loss adjustment expenses
$
132,200

$
174,708

Unearned premiums
42,780

66,879

LROC preferred units
8,829

13,076

Senior unsecured debentures
27,622

37,177

Subordinated indebtedness
17,218

40,480

Deferred income tax liability
2,653


     Notes payable
2,418


     Accounts payable and accrued liabilities
40,756

42,386

TOTAL LIABILITIES
$
274,476

$
374,706

STOCKHOLDERS’ EQUITY
 
 
Common stock, no par value; unlimited number authorized; 52,345,828 and 52,095,828 issued and outstanding at September 30, 2011 and December 31, 2010, respectively
$
296,489

$
296,139

     Additional paid-in capital
15,275

15,440

     Accumulated deficit
(194,181
)
(181,070
)
     Accumulated other comprehensive income
12,615

14,407

Stockholders' equity attributable to stockholders of Kingsway
130,198

144,916

Noncontrolling interests in consolidated subsidiaries
(3,489
)
(43
)
TOTAL STOCKHOLDERS' EQUITY
126,709

144,873

TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY
$
401,185

$
519,579

See accompanying notes to unaudited condensed consolidated financial statements.


3




Condensed Consolidated Statements of Operations
(in thousands, except per share data)
(Unaudited)
 
Three months ended September 30,
 
Nine months ended September 30,
 
 
2011

2010

2011

2010

Revenue:
 
 
 
 
  Net premiums earned
$
36,614

$
52,269

$
124,825

$
170,370

  Commission income
5,807

4,246

18,124

8,544

Net investment income
999

2,222

3,228

8,064

Net realized gains
104

6,028

102

6,513

Unrealized gain (loss) on fair value of debt
17,189

(7,351
)
25,821

(102,827
)
Miscellaneous income
3,472

528

1,426

7,163

Total revenues:
64,185

57,942

173,526

97,827

Expenses:
 
 
 
 
  Losses and loss adjustment expenses
$
33,329

$
47,432

$
109,349

$
144,382

  Commissions and premiums taxes
5,405

7,289

19,684

28,180

  General and administrative expenses
14,982

24,271

52,212

67,101

  Restructuring costs



4,898

Interest expense
1,874

2,920

5,610

12,612

Amortization of other intangible assets
18

1,190

54

3,274

Total expenses
55,608

83,102

186,909

260,447

Income (loss) before unusual item, equity in net income (loss) of investee and income taxes
8,577

(25,160
)
(13,383
)
(162,620
)
Gain on buy-back of debt
3

92

556

3,112

Gain on consolidation of debt

17,820


17,820

Equity in net income (loss) of investee
145


(384
)

Income (loss) from continuing operations before income taxes
8,725

(7,248
)
(13,211
)
(141,688
)
Income tax expense (benefit)
2,433

(1,534
)
2,292

(4,492
)
Income (loss) from continuing operations
$
6,292

$
(5,714
)
$
(15,503
)
$
(137,196
)
Loss from discontinued operations,
  net of taxes

(1,651
)

(3,938
)
(Loss) gain on disposal of discontinued operations, net of taxes (Note 5)


(1,293
)
30,354

Net income (loss)
$
6,292

$
(7,365
)
$
(16,796
)
$
(110,780
)
Attributable to:
 
 
 
 
Common stockholders
7,252

(8,283
)
(13,112
)
(111,698
)
Noncontrolling interests in consolidated subsidiaries
(960
)
918

(3,684
)
918

Total
$
6,292

$
(7,365
)
$
(16,796
)
$
(110,780
)
Earnings (loss) per share - continuing operations:
 
 
 
 
Basic and diluted:
$
0.12

$
(0.11
)
$
(0.30
)
$
(2.63
)
Earnings (loss) per share – net income (loss):
 
 
 
 
Basic and diluted:
$
0.12

$
(0.14
)
$
(0.32
)
$
(2.13
)
Weighted average shares outstanding (in ‘000s):
 
 
 
 
Basic and diluted:
52,346

52,062

52,283

52,090

See accompanying notes to unaudited condensed consolidated financial statements.







4






Condensed Consolidated Statements of Comprehensive Income (Loss)
(in thousands)
(unaudited)
 
Three months ended September 30,
 
Nine months ended September 30,
 
 
2011

2010

2011

2010

Comprehensive income (loss)
 
 
 
 
Net income (loss)
$
6,292

$
(7,365
)
$
(16,796
)
$
(110,780
)
Other comprehensive loss, net of taxes:
 
 
 
 
Change in unrealized gains (losses) on available-for securities:
 
 
 
 
Unrealized gains (losses) arising during the year, net of tax (1)
952

(1,763
)
2,115

7,835

Recognition of realized losses (gains) to net income (loss), net of tax (2)
44

(3,739
)
4

(1,942
)
Unrealized loss on translating financial statements of self-sustaining foreign operations
(6,698
)
(5,598
)
(1,833
)
(886
)
Equity in other comprehensive income (loss) of investee
114


(574
)

Recognition of currency translation gain on disposal of subsidiary



(34,075
)
Loss on cash flow hedge

(972
)
(1,267
)
(3,417
)
Other comprehensive loss
(5,588
)
(12,072
)
(1,555
)
(32,485
)
Comprehensive income (loss)
$
704

$
(19,437
)
$
(18,351
)
$
(143,265
)
Attributable to:
 
 
 
 
Shareholders of Kingsway
1,679

(21,611
)
(14,905
)
(145,439
)
Noncontrolling interests
(975
)
2,174

(3,446
)
2,174

Total
704

(19,437
)
(18,351
)
(143,265
)
 (1) Net of income tax benefit of nil for the three months ended September 30, 2011 ($26 year to date) and $673 for the three months ended September 30, 2010 ($3,195 year to date).
 
 (2) Net of income tax expense of nil for the three months ended September 30, 2011 ($16 year to date) and $1,926 for the three months ended September 30, 2010 ($1,000 year to date).
 
See accompanying notes to unaudited condensed consolidated financial statements


























5






Condensed Consolidated Statements of Cash Flows
(in thousands)
(unaudited)
 
Nine months ended September 30,
 
 
2011

2010

Cash provided by (used in):
 
 
Operating activities:
 
 
Net loss
$
(16,796
)
$
(110,780
)
Adjustments to reconcile net loss to net cash used in operating activities:
 
 
Loss (income) from discontinued operations
1,293

(26,416
)
Equity in net income (loss) of investee
384


Depreciation and amortization
1,725

6,637

Net realized gains
(102
)
(6,513
)
Deferred income taxes, net
3,422

(1,482
)
Amortization of bond premiums and discounts
666

3,868

Changes in operating assets and liabilities:
 
 
Accounts receivable, net
2,347

18,404

Due from reinsurers and other insurers
7,096

1,699

Deferred policy acquisition costs
4,613

7,003

Unpaid loss and loss adjustment expense
(42,508
)
(69,442
)
Unearned premiums
(24,099
)
(21,010
)
Other, net
4,171

(76,467
)
Net cash used in operating activities
(57,788
)
(274,499
)
Investing activities:
 
 
Proceeds from sale and maturities of investments
102,047

261,696

Purchase of investments
(94,056
)
(79,893
)
Financed premiums receivable, net
7,858

(1,530
)
Acquisition, net of cash acquired

(13,752
)
Net proceeds from sale of discontinued operations

253,553

Net purchases of property and equipment and other intangible assets
(815
)
(12,826
)
Net cash provided by investing activities
15,034

407,248

Financing activities:
 
 
Share capital
350

848

Contributed surplus
(165
)
(2,378
)
Subordinated indebtedness and loans payable
(20,844
)
(12,018
)
LROC preferred units
(4,247
)
13,571

Senior unsecured indebtedness
9,555

(66,927
)
Net cash used in financing activities
(15,351
)
(66,904
)
Net increase (decrease) in cash and cash equivalents
(58,105
)
65,845

Cash and cash equivalents at beginning of period
140,567

58,726

Cash and cash equivalents at end of period
$
82,462

$
124,571

See accompanying notes to unaudited condensed consolidated financial statements.






6


KINGSWAY FINANCIAL SERVICES INC.
Notes to Condensed Consolidated Financial Statements (Unaudited) September 30, 2011




NOTE 1 BUSINESS

Kingsway Financial Services Inc. (the "Company" or "Kingsway"), incorporated under the Business Corporations Act (Ontario) on September 19, 1989, is a financial services holding company which, through its subsidiaries, focuses on non-standard automobile insurance in the United States of America. The Company's primary businesses are the insuring of automobile risks for drivers who do not meet the criteria for coverage by standard automobile insurers.


NOTE 2 BASIS OF PRESENTATION
The accompanying unaudited interim condensed consolidated financial statements have been prepared in accordance with U.S. Generally Accepted Accounting Principles ("U.S. GAAP") for interim financial information and with the instructions to Form 10-Q and Article 10 of Regulation S-X. Accordingly, they do not include all of the information and notes required by U.S. GAAP for complete financial statements of the Company. In the opinion of management, all adjustments necessary for a fair presentation have been included and are of a normal recurring nature. Interim results are not necessarily indicative of the results that may be expected for the year.

The Company presented its consolidated financial statements for the year ended December 31, 2010 in accordance with Canadian Generally Accepted Accounting Principles (“Canadian GAAP”). The Canadian Accounting Standards Board required all publicly traded companies to present their financial statements in accordance with International Financial Reporting Standards ("IFRS") as the replacement for Canadian GAAP for fiscal years beginning on or after January 1, 2011. As a result, the Company presented its interim consolidated financial statements for the period ended September 30, 2011 in accordance with IFRS.

Effective July 1, 2011, the Company ceased to be a “foreign private issuer” as defined in Rule 3b-4 of the Securities Exchange Act of 1934, as amended (the “Exchange Act”), and became subject to the rules and regulations under the Exchange Act applicable to domestic issuers. As a result, the Company is required to prepare and file its consolidated financial statements included in our Annual Report on Form 10-K for the fiscal year ended December 31, 2011, whereas our Annual Reports were previously filed on Form 40-F. While we do not believe this change will impact the value of the Company, shareholders will now have to adapt to filings made pursuant to the Exchange Act. As required by Ontario Securities Commission National Instrument 51-102 Continuous Disclosure Obligations, the Company must restate its interim financial reports previously filed under IFRS in accordance with U.S. GAAP.

The accompanying interim condensed consolidated financial statements and footnotes should be read in conjunction with the audited consolidated financial statements and footnotes included within our Annual Report on Form 40-F ("2010 Annual Report") for the year ended December 31, 2010 prepared in accordance with Canadian GAAP. There are no differences in recognition, measurement, and disclosure between U.S. GAAP and Canadian GAAP applicable to the Company, except for the measurement of the Company's interest-bearing debt. Interest-bearing debt includes Linked Return of Capital ("LROC") preferred units, senior unsecured debentures, and subordinated indebtedness reported in the Company's condensed consolidated balance sheets. Under Canadian GAAP, the Company's interest-bearing debt was measured at amortized cost. Under IFRS, the Company elected to measure its interest-bearing debt at fair value. Under U.S. GAAP, the Company is continuing to measure its interest-bearing debt at fair value under its preexisting IFRS accounting policy.

The interim condensed consolidated financial statements include the accounts of the Company and its subsidiaries. All material intercompany transactions and balances have been eliminated in consolidation. The comparative figures in respect of 2010 were restated to reflect the adoption of U.S. GAAP.

The preparation of consolidated financial statements defined in conformity with U.S. GAAP requires management to make estimates and assumptions that affect application of policies and the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the consolidated financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. The critical accounting estimates and assumptions in the accompanying interim condensed consolidated financial statements include the provision for unpaid loss and loss adjustment expense, valuation of fixed maturities and equity securities, deferred tax asset valuation, provision for uncollectible insurance receivables, intangible asset valuation, deferred policy acquisition costs, goodwill recoverability, and fair value assumptions for debt obligations.


7


KINGSWAY FINANCIAL SERVICES INC.
Notes to Condensed Consolidated Financial Statements (Unaudited) September 30, 2011




The fair values of the Company's investments in fixed maturities and equity securities, LROC preferred units, senior unsecured debentures, and subordinated indebtedness are estimated using a fair value hierarchy to categorize the inputs it uses in valuation techniques. The fair value of the Company's investment in investee is based on quoted market prices. The carrying amounts reported in the condensed consolidated balance sheets approximate fair value for cash, short-term investments and certain other assets and other liabilities because of their short-term nature.

The Company's financial results contained herein are reported in U.S. dollars unless otherwise indicated.

NOTE 3 SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
There have been no material changes to our significant accounting policies as reported in our 2010 Annual Report. The following significant accounting policy is also applicable to the Company.

Noncontrolling interests
A noncontrolling interest arises where the Company owns less than 100% of the voting rights and economic interests in a subsidiary and is initially recognized at the proportionate share of the identifiable net assets of the subsidiary at the acquisition date and is subsequently adjusted for the noncontrolling interest's share of the acquiree's net income (losses) and changes in capital. The effects of transactions with noncontrolling interests are recorded in equity where there is no change of control.


NOTE 4 RECENTLY ISSUED ACCOUNTING STANDARDS
In October 2010, the Financial Accounting Standards Board ("FASB") issued Accounting Standards Update ("ASU") 2010-26, Financial Services-Insurance (Topic 944): Accounting for Costs Associated with Acquiring or Renewing Insurance Contracts. The amendments in ASU 2010-26 address diversity in practice regarding the interpretation of which costs relating to the acquisition of new or renewal insurance contracts qualify for deferral; they clarify which costs should be deferred and which costs should be expensed when incurred. The amendments in ASU 2010-26 become effective for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2011. The Company is in process of determining whether ASU 2010-26 will have a material effect on the consolidated financial statements.

In May 2011, the FASB issued ASU 2011-04, Fair Value Measurement (Topic 820): Amendments to Achieve Common Fair Value Measurement and Disclosure Requirements in U.S. GAAP and IFRS. ASU 2011-04 provides identical guidance with concurrently issued IFRS 13, Fair Value Measurements. Most of the changes in the new standard are clarifications of existing guidance, but it expands the disclosures about fair value measurements. It will require the categorization by level of the fair value hierarchy for items that are not measured at fair value in the statement of financial position but for which the fair value is required to be disclosed. In addition, for fair value measurements categorized as Level 3 within the fair value hierarchy, the valuation processes and sensitivity of the fair value measurements to changes in unobservable inputs shall be disclosed. This standard is effective for interim and annual periods beginning after December 15, 2011, and should be applied prospectively. Early adoption is not permitted. Other than enhanced disclosure requirements, the Company does not anticipate that the adoption of the new standard will have a material impact on the Company.

In June 2011, the FASB issued ASU 2011-05, Comprehensive Income (Topic 220): Presentation of Comprehensive Income. ASU 2011-05 will require companies to present the components of net income and comprehensive income in either one or two consecutive financial statements. Companies will no longer be permitted to present the components of other comprehensive income as part of the statement of changes in stockholders' equity. Reclassifications from other comprehensive income must be presented in both the consolidated statement of operations and the consolidated statement of other comprehensive income. This standard is effective for interim and annual periods beginning after December 15, 2011, and should be applied retrospectively. Early adoption is permitted. The Company does not anticipate that the adoption of ASU 2011-05 will have a material impact on the consolidated financial statements.

In September 2011, the FASB issued ASU 2011-08, Intangibles-Goodwill and Other (Topic 350): Testing Goodwill for Impairment. The standard is effective for the first interim or annual period beginning on or after December 15, 2011, with early adoption permitted. The standard amends Accounting Standards Codification Topic 350, Intangibles-Goodwill and Other, and gives companies the option to first perform a qualitative assessment to determine whether it is more likely than not that the fair value of a reporting unit is less than its carrying amount. Except for the option to perform the qualitative assessment, the Company does

8


KINGSWAY FINANCIAL SERVICES INC.
Notes to Condensed Consolidated Financial Statements (Unaudited) September 30, 2011


not anticipate that the adoption of the new standard will have a material impact on the Company.

NOTE 5 ACQUISITIONS AND DISCONTINUED OPERATIONS

(a)
Acquisitions

KLROC Trust:

KLROC Trust is an investment trust established under the laws of the Province of Ontario and is governed by a Declaration of Trust dated May 12, 2005, amended July 14, 2005. KLROC Trust was created to provide holders with exposure to a promissory note issued by Kingsway America Inc. ("KAI"), an affiliate of KFSI.

KLROC Trust commenced operations on July 14, 2005 and raised C$78,000,000 through the issuance of 3,120,000 preferred units (“LROC Units”) at C$25 per LROC preferred unit. In order to achieve its investment objectives, KLROC Trust used the net proceeds of C$74,141,236 of its initial public offering to subscribe for and purchase all of the limited partnership units of KL Limited Partnership (“KL LP”). In turn, KL LP used these proceeds for the payment of its purchase obligations under a Forward Purchase Agreement which KL LP entered into with the Bank of Nova Scotia (“the Counterparty”). Such proceeds were invested by the Counterparty in KN Trust.

KN Trust lent funds to Kingsway ROC GP (“ROC GP”) and combined with its partnership capital of C$8,250,000, ROC GP subscribed for common shares in Kingsway ROC LLC (“ROC LLC”) totaling C$82,087,781. With these proceeds, ROC LLC purchased a promissory note from KAI, with the principal amount of US $66,222,012 bearing interest at 7.37% per annum and due June 30, 2015.

Beginning in 2009, KFS Capital LLC ("KFS Capital"), an affiliate of KFSI, began purchasing LROC Units. The investments at that time were accounted for as available for sale securities as they were purchased primarily as an investment. As at June 30, 2010, KFSI held 833,715 LROC Units representing 26.7% of the issued and outstanding LROC units; therefore, the Company was not obligated to consolidate KLROC Trust. In July 2010, the Company purchased an additional 1,500,000 LROC Units and now beneficially owns and controls 74.8% of the issued and outstanding LROC Units. The Company has determined that the consolidated financial statements of KLROC Trust, which financial statements include the accounts of the other aforementioned entities, should be consolidated with the financial statements of the Company beginning July 23, 2010. As a result of consolidating KLROC Trust, the Company recorded a gain of $17.8 million in the third quarter related to the LROC Units held by KFS Capital. The gain arose from the difference between the carrying value of the debt held by KLROC Trust and the fair value of the LROC Units held by KFS Capital.

Assigned Risk Solutions Ltd. (formerly JBA Associates, Inc.):
Effective June 30, 2010, the Company made an investment in JBA Associates, Inc. (“JBA”) for approximately $16.3 million, following which the Company has a 100% interest in JBA. JBA is a managing general agency based in New Jersey that specializes in assigned risk automobile insurance. The acquisition allows the Company to benefit from its institutional knowledge of non-standard automobile and assigned risk business and expand in the agency market. Goodwill of $0.5 million was recognized related to the purchase. An intangible asset of $11.7 million was recognized related to retention of buyout customers and contract renewals. Subsequent to the acquisition, JBA was renamed Assigned Risk Solutions, Ltd.
Itasca Financial, LLC:
On January 4, 2010, KAI acquired certain assets of Itasca Financial, LLC, a property and casualty insurance industry advisory firm, owned and controlled by Mr. Larry Swets, a former director and current Chief Executive Officer and President of the Company. The consideration for the assets purchased is equal to $1.5 million cash and one million restricted common shares of the Company, payable in three annual installments. Goodwill of $2.5 million was recognized related to the purchase.
(b)
Discontinued Operations

American Service Insurance Company, Inc. (“American Service”), American Country Insurance Company (“American Country”), Southern United Fire Insurance Company (“Southern United”), and Jevco Insurance Company (“Jevco”), were disposed of in 2010 and have been classified as discontinued operations, and the results of their operations are reported separately in the condensed consolidated statements of operations for all periods presented.



9


KINGSWAY FINANCIAL SERVICES INC.
Notes to Condensed Consolidated Financial Statements (Unaudited) September 30, 2011



Summarized financial information for discontinued operations is shown below.
 
Three months ended September 30,
Nine months ended September 30,
 
2011

2010

2011

2010

Operations:
 
 
 
 
Revenue
$

$
8,297

$

$
126,695

(Loss) income from discontinued operations before taxes

(1,651
)

1,141

Income tax expense



5,079

Loss from discontinued operations before gain (loss) on disposal, net of taxes
$

$
(1,651
)
$

$
(3,938
)
Disposals:
 
 
 
 
(Loss) gain on disposal before income taxes
$

$

$
(1,670
)
$
29,380

Income tax benefit


(377
)
(974
)
(Loss) gain on disposal, net of taxes
$

$

$
(1,293
)
$
30,354

(Loss) gain from discontinued operations, net of taxes
$

$
(1,651
)
$
(1,293
)
$
26,416


American Country, American Service, and Southern United:
During 2010, Southern United was merged into American Service.
On December 31, 2010, the previously announced going-public transaction involving the Company's subsidiaries American Country and American Service by way of a reverse takeover of JJR VI Acquisition Corp. (“J6”) was completed. Upon completion of the transaction, J6 was renamed Atlas Financial Holdings Inc. (“Atlas”) and American Country and American Service became wholly-owned subsidiaries of Atlas. Total consideration to the Company as a result of the transaction was approximately $57.0 million, consisting of cash of $7.9 million, preferred shares of Atlas of $18.0 million, and common shares of Atlas of $31.1 million. As part of the transaction, a quota share agreement was put in place for 90% of up to $10.0 million of adverse claims development in excess of $1.0 million, based on the carried reserves of Atlas at September 30, 2010. The maximum obligation to the Company is $9.0 million.
As a result of disposal, the Company recognized an after-tax gain of nil in the third quarter of 2011 ($0.6 million year to date). The Company's revenues from discontinued operations relating to Atlas companies were nil and $8.3 million for the third quarters of 2011 and 2010 (nil and $41.8 million prior year to date), respectively. In total, the Company reported a loss from discontinued operations of nil and $4.1 million for the third quarters of 2011 and 2010 (income of $0.6 million and a loss of $14.5 million prior year to date), respectively.
Jevco:
On January 25, 2010, the Company entered into a definitive purchase agreement with The Westaim Corporation (“Westaim”) to sell all of the issued and outstanding shares of Jevco to Westaim. On March 29, 2010, after receipt of all required regulatory approvals, the sale was completed for a purchase price of C$263.3 million subject to certain future contingent adjustments. The contingent adjustments included up to C$20.0 million decrease in the purchase price relating to specific future adverse claims development to be determined at the end of 2012. On March 31, 2011 the Company settled the C$20.0 million contingent adjustments related to the Jevco transactions for C$17.8 million, recording pre-tax loss of $2.3 million.
As a result of the disposal of Jevco, the Company realized an after-tax loss of nil in the third quarter of 2011 ($1.9 million year to date) and an after-tax gain of nil in the third quarter of 2010 ($30.4 million prior year to date). The Company's revenues from discontinued operations relating to Jevco were nil for the third quarters of 2011 and 2010 (nil and $84.9 million prior year to date), respectively. In total, the Company reported a loss from discontinued operations relating to Jevco of nil for each of the third quarters of 2011 and 2010 ($1.9 million and income of $41.4 million prior year to date), respectively.




10


KINGSWAY FINANCIAL SERVICES INC.
Notes to Condensed Consolidated Financial Statements (Unaudited) September 30, 2011



(c)
Other

Hamilton Risk Management Company:
On March 30, 2011, KAI sold all of the issued and outstanding shares of its wholly owned subsidiary Hamilton Risk Management Company (“Hamilton”) and its subsidiaries, including Kingsway Amigo Insurance Company, to HRM Acquisition Corp., a wholly owned subsidiary of Acadia Acquisition Partners, L.P. (“Acadia”), in exchange for a $10.0 million senior promissory note due March 30, 2014, a $5.0 million junior promissory note due March 30, 2016, and a Class B partnership interest in Acadia, representing a 40% economic interest. An independent third party holds a Class A partnership interest in Acadia representing a 60% economic interest. KAI will act as the general partner of Acadia. As general partner, KAI has control of the policies and financial affairs of Hamilton; therefore, Kingsway will continue to consolidate the financial statements of Hamilton. During the second quarter of 2011, HRM Acquisition Corp. merged into Hamilton.













11


KINGSWAY FINANCIAL SERVICES INC.
Notes to Condensed Consolidated Financial Statements (Unaudited) September 30, 2011



NOTE 6 INVESTMENTS

The amortized cost, gross unrealized gains (losses), and estimated fair value of the Company's fixed maturities, equity securities, and short-term investments at September 30, 2011 and December 31, 2010 are summarized in the tables shown below:

 
September 30, 2011
 
 
Amortized Cost

Gross Unrealized Gains

Gross Unrealized Losses

 Fair Value

Fixed maturities:
 
 
 
 
U.S. government, government agencies and authorities
$
18,865

$
1,331

$

$
20,196

Canadian government
3,295

23


3,318

States municipalities and political subdivisions
19,468

914


20,382

Mortgage-backed
36,682

578

18

37,242

Asset-backed
2,319

24

2

2,341

Corporate
30,601

762

19

31,344

Total fixed maturities
$
111,230

$
3,632

$
39

$
114,823

Common stock
2,689

182

8

2,863

Preferred stock
92


4

88

Other investments
487



487

Short-term investments
21,335



21,335

Total investments
$
135,833

$
3,814

$
51

$
139,596


 
December 31, 2010
 
 
Amortized Cost

Gross Unrealized Gains

Gross Unrealized Losses

 Fair Value

Fixed maturities:
 
 
 
 
U.S. government, government agencies and authorities
$
23,201

$
1,138

$
3

$
24,336

Canadian government
2,882

17

21

2,878

States municipalities and political subdivisions
22,780

12

561

22,231

Mortgage-backed
41,550

594

83

42,061

Asset-backed
1,553

46


1,599

Corporate
34,244

695

181

34,758

Total fixed maturities
$
126,210

$
2,502

$
849

$
127,863

Preferred stock
92


10

82

Other investments
490



490

Short-term investments
18,248

1


18,249

Total investments
$
145,040

$
2,503

$
859

$
146,684






12


KINGSWAY FINANCIAL SERVICES INC.
Notes to Condensed Consolidated Financial Statements (Unaudited) September 30, 2011



The table below summarizes the Company's fixed maturities at September 30, 2011, by contractual maturity periods. Actual results may differ as issuers may have the right to call or prepay obligations, with or without penalties, prior to the contractual maturity of these obligations.
 
September 30, 2011
 
 
Amortized Cost

Fair Value

Due in one year or less
$
34,642

$
34,843

Due after one year through five years
59,697

62,290

Due after five years through ten years
6,280

6,742

Due after ten years
10,611

10,948

Total
$
111,230

$
114,823


Gross realized gains and losses on fixed maturities, equity securities, and short-term investments for the three and nine months ended September 30, 2011 and September 30, 2010 were as follows:
 
Three months ended September 30,
 
Nine months ended September 30,
 
 
2011

2010

2011

2010

Gross gains
110

6,028

114

6,613

Gross losses
(6
)

(12
)
(100
)
Total
104

6,028

102

6,513


The following tables highlight the aggregate unrealized loss position, by security type, of fixed maturities, equity securities, and short-term investments in an unrealized loss position as at September 30, 2011 and December 31, 2010. The tables segregate the holdings based on the period of time the securities have been continuously held in an unrealized loss position.

September 30, 2011
 
 
 
Less than 12 Months
Greater than 12 Months
Total
 
 
Fair Value
Unrealized Loss
Fair Value
Unrealized Loss
Fair Value
Unrealized Loss
Fixed maturities:
 
 
 
 
 
 
 
 
U.S. government, government agencies and authorities
$

$

$

$

$

$

 
Canadian government






 
States municipalities and political subdivisions






 
Mortgage-backed
10,355

(18
)


10,355

(18
)
 
Asset-backed
856

(2
)


856

(2
)
 
Corporate
2,787

(10
)
1

(9
)
2,788

(19
)
Total fixed maturities
 
$
13,998

$
(30
)
$
1

$
(9
)
$
13,999

$
(39
)
Common stock
 
414

(8
)


414

(8
)
Preferred stock
 


88

(4
)
88

(4
)
Short-term investments
 
21,000




21,000


Total
 
$
35,412

$
(38
)
$
89

$
(13
)
$
35,501

$
(51
)


13


KINGSWAY FINANCIAL SERVICES INC.
Notes to Condensed Consolidated Financial Statements (Unaudited) September 30, 2011


December 31, 2010
 
 
 
Less than 12 Months
Greater than 12 Months
Total
 
 
Fair Value
Unrealized Loss
Fair Value
Unrealized Loss
Fair Value
Unrealized Loss
Fixed maturities:
 
 
 
 
 
 
 
 
U.S. government, government agencies and authorities
$
1,604

$
(3
)
$

$

$
1,604

$
(3
)
 
Canadian government


866

(21
)
866

(21
)
 
States municipalities and political subdivisions
21,883

(561
)


21,883

(561
)
 
Mortgage-backed
11,911

(83
)


11,911

(83
)
 
Asset-backed






 
Corporate
3,491

(181
)


3,491

(181
)
Total fixed maturities
 
$
38,889

$
(828
)
$
866

$
(21
)
$
39,755

$
(849
)
Preferred stock
 


82

(10
)
82

(10
)
Total
 
$
38,889

$
(828
)
$
948

$
(31
)
$
39,837

$
(859
)

Management performs a quarterly analysis of the Company’s investment holdings to determine if declines in market value are other-than-temporary. The analysis includes some or all of the following procedures as deemed appropriate by management:

Identifying all security holdings in unrealized loss positions that have existed for at least six months or other circumstances that management believes may impact the recoverability of the security;
Obtaining a valuation analysis from third party investment managers regarding the intrinsic value of these holdings based on their knowledge, experience and other market based valuation techniques;
Reviewing the trading range of certain securities over the preceding calendar period;
Assessing if declines in market value are other-than-temporary for debt security holdings based on their investment grade credit ratings from third-party security rating agencies;
Assessing if declines in market value are other-than-temporary for any debt security holding with 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;
Assessing the Company’s ability and intent to hold these securities at least until the investment impairment is recovered.

The risks and uncertainties inherent in the assessment methodology utilized to determine declines in market value that are other than-temporary include, but may not be limited to, the following:
The opinion of professional investment managers could be incorrect;
The past trading patterns of individual securities 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 securities may not reflect future debt service capabilities and may not reflect a company’s unknown underlying financial problems.

As a result of the above analysis performed by management to determine declines in market value that are other-than-temporary, there were no write-downs for other-than-temporary impairments for the quarters and years ended September 30, 2011 and September 30, 2010.

Management has reviewed currently available information regarding other securities with estimated fair values that are less than their carrying amounts and believes that these unrealized losses are not other-than-temporary and are primarily due to temporary market and sector-related factors rather than to issuer-specific factors. The Company does not intend to sell those securities, and it is not likely that it will be required to sell those securities before recovery of its amortized cost.


14


KINGSWAY FINANCIAL SERVICES INC.
Notes to Condensed Consolidated Financial Statements (Unaudited) September 30, 2011



Net investment income for the three and nine months ended September 30, 2011 and September 30, 2010, respectively, is comprised as follows:
 
Three months ended September 30,
 
Nine months ended September 30,
 
 
2011

2010

2011

2010

Investment income
 
 
 
 
Interest from bonds
$
699

$
2,202

$
2,418

$
7,545

Interest from other
107

122

360

402

Dividends
240

35

704

563

Gross investment income
$
1,046

$
2,359

$
3,482

$
8,510

Investment expenses
(47
)
(137
)
(254
)
(446
)
Net investment income
$
999

$
2,222

$
3,228

$
8,064


As at September 30, 2011, fixed maturities and short-term investments with an estimated fair value of $28.9 million were on deposit with state and provincial regulatory authorities. Also, from time to time, the Company pledges securities to third parties to collateralize liabilities incurred under its insurance policies. At September 30, 2011, the amount of such pledged securities was $17.6 million.
The Company's investment in the preferred and restricted voting common stock of Atlas is accounted for under the equity method of accounting on a three-month lag basis and is reported as "investee" in the Company's condensed consolidated balance sheets. The carrying value, fair value and approximate voting and equity percentages based on the most recent publicly available data at June 30, 2011 and December 31, 2010, for the Company's investment in investee was:
 
June 30, 2011

December 31, 2010

Carrying amount
$
48,753

$
49,079

Fair Value
$
39,469

$
49,079

Approximate voting percentage
30
%
30
%
Approximate equity percentage
75
%
75
%

The fair value of the Company's investment in investee at June 30, 2011 is calculated based on the published closing price of Atlas at June 30, 2011. The fair value of the Company's investment in investee at December 31, 2010 approximates carrying value due to the investee not being actively traded at December 31, 2010.
Summarized financial information for Atlas at June 30, 2011 and December 31, 2010 is presented below:
 
June 30, 2011

December 31, 2010

Total assets
$
201,888

$
225,438

Total liabilities
$
142,922

$
165,269

Total revenue
$
10,533

$
59,973

Net income (loss)
$
193

$
(21,812
)











15


KINGSWAY FINANCIAL SERVICES INC.
Notes to Condensed Consolidated Financial Statements (Unaudited) September 30, 2011


NOTE 7 GOODWILL AND INTANGIBLE ASSETS
Goodwill and intangible assets are comprised as follows:
 
September 30, 2011

December 31, 2010

Goodwill
$
3,010

$
3,273

Intangible assets subject to amortization
 
 
     Agent relationships
18

73

Intangible assets not subject to amortization
 
 
     Insurance licenses
7,803

7,803

     Renewal rights
31,318

31,318

Goodwill and intangible assets
$
42,149

$
42,467


Effective January 1, 2011, the renewal rights intangible assets were deemed to have indefinite useful lives and, therefore, are no longer being amortized.   

NOTE 8 UNPAID LOSS AND LOSS ADJUSTMENT EXPENSES
The establishment of the estimated provision for unpaid loss and loss adjustment expenses is based on known facts and interpretation of circumstances and is therefore a complex and dynamic process influenced by a large variety of factors. These factors include the Company's experience with similar cases and historical trends involving claim payment patterns, loss payments, pending levels of unpaid claims, product mix or concentration, claims severity and claim frequency patterns.
Other factors include the continually evolving and changing regulatory and legal environment, actuarial studies, professional experience and expertise of the Company's claims departments' personnel and independent adjusters retained to handle individual claims, the quality of the data used for projection purposes, existing claims management practices including claims handling and settlement practices, the effect of inflationary trends on future claims settlement costs, court decisions, economic conditions and public attitudes.
Consequently, the process of establishing the estimated provision for unpaid claims is complex as it relies on the judgment and opinions of a large number of individuals, on historical precedent and trends, on prevailing legal, economic, social and regulatory trends and on expectations as to future developments. The process of determining the provision necessarily involves risks that the actual results will deviate, perhaps substantially, from the best estimates made.
The Company's evaluation of the adequacy of unpaid loss and loss adjustment expenses includes a re-estimation of the liability for unpaid loss and loss adjustment expenses relating to each preceding financial year compared to the liability that was previously established. The results of this comparison and the changes in the provision for unpaid loss and loss adjustment expenses, net of amounts recoverable from reinsurers, as of September 30, 2011 and December 31, 2010 were as follows:
 
September 30, 2011

December 31, 2010

Net balance - beginning of period
$
166,734

$
186,685

Incurred related to:
 
 

      Current year
106,192

200,279

      Prior years
3,157

14,402

Paid related to:
 
 

      Current year
(56,249
)
(122,956
)
      Prior years
(87,634
)
(111,676
)
Net balance - end of period
$
132,200

$
166,734

Plus reinsurance recoverable on unpaid loss and loss adjustment expenses

7,974

Balance - end of period
$
132,200

$
174,708






16


KINGSWAY FINANCIAL SERVICES INC.
Notes to Condensed Consolidated Financial Statements (Unaudited) September 30, 2011


NOTE 9 DEBT
Long term debt consists of the following instruments:
 
September 30, 2011
 
December 31, 2010
 
 
Principal

Fair Value

Principal

Fair Value

6% Senior unsecured debentures due 2012
$
1,608

1,600

$
12,547

12,233

7.5% Senior notes due 2014
26,966

26,022

26,966

24,944

LROC preferred units due 2015
18,753

8,829

19,764

13,076

Subordinated indebtedness
90,500

17,218

90,500

40,480

Total
$
137,827

53,669

$
149,777

90,733


Subordinated indebtedness mentioned above consists of the following trust preferred debt instruments:
Issuer
Principal

Issue date
Interest
Redemption date
Kingsway CT Statutory Trust I
15,000

12/4/2002
annual interest rate equal to LIBOR, plus 4.00% payable quarterly
12/4/2032
Kingsway CT Statutory Trust II
17,500

5/15/2003
annual interest rate equal to LIBOR, plus 4.10% payable quarterly
5/15/2033
Kingsway CT Statutory Trust III
20,000

10/29/2003
annual interest rate equal to LIBOR, plus 3.95% payable quarterly
10/29/2033
Kingsway DE Statutory Trust III
15,000

5/23/2003
annual interest rate equal to LIBOR, plus 4.20% payable quarterly
5/23/2033
Kingsway DE Statutory Trust IV
10,000

9/30/2003
annual interest rate equal to LIBOR, plus 3.85% payable quarterly
9/30/2033
Kingsway DE Statutory Trust VI
13,000

1/8/2004
annual interest rate equal to LIBOR, plus 4.00% payable quarterly
1/8/2034

During the first quarter of 2011, the Company gave notice to its Trust Preferred trustees of its intention to exercise its voluntary right to defer interest payments for up to 20 quarters, pursuant to the contractual terms of its outstanding Trust Preferred indentures, which permit interest deferral. This action does not constitute a default under the Company's Trust Preferred indentures or any of its other debt indentures.  At September 30, 2011, deferred interest payable of $2.7 million is included in accounts payable and accrued liabilities in the condensed consolidated balance sheet.  The cash interest due in 2016 is subject to changes in LIBOR over the deferral period.
Pursuant to the debt buyback initiatives, the Company has repurchased a substantial amount of its external debt. During the third quarter of 2011, Kingsway 2007 General Partnership purchased and canceled $0.2 million ($11.4 million year to date) par value of its senior unsecured debentures with a carrying value of $0.2 million ($11.4 million year to date) for $0.2 million ($10.8 million year to date) recording a gain of nil ($0.6 million year to date). During the third quarter of 2010, KAI and Kingsway 2007 General Partnership purchased and canceled $47.7 million ($143.3 million year to date) par value of its senior unsecured debentures with a carrying value of $45.0 million ($127.0 million prior year to date) for $44.9 million ($123.9 million prior year to date) recording a gain of $0.1 million ($3.1 million prior year to date).


17


KINGSWAY FINANCIAL SERVICES INC.
Notes to Condensed Consolidated Financial Statements (Unaudited) September 30, 2011


NOTE 10 INCOME TAXES

Income tax expense (benefit) varies from the amount that would result by applying the applicable Canadian income tax rate (28.25% for the three and nine month periods ending September 30, 2011 and 30.99% for the three and nine months periods ending September 30, 2010) to income (loss) from continuing operations before income taxes. The following table summarizes the differences:
 
Three months ended September 30,
 
Nine months ended September 30,
 
 
2011
2010
2011
2010
Provision for taxes at Canadian statutory income tax rate
$
2,465

$
(2,246
)
$
(3,732
)
$
(43,909
)
Valuation allowance
218

2,884

8,319

49,392

Foreign operations subject to different tax rates
71

(205
)
(1,139
)
(4,317
)
Change in tax rates and other
(321
)
(1,967
)
(1,156
)
(5,658
)
Income tax expense (benefit) for continuing operations
$
2,433

$
(1,534
)
$
2,292

$
(4,492
)


The Company maintains a valuation allowance for its gross deferred tax assets at September 30, 2011 and December 31, 2010. The Company's U.S. businesses have generated substantial operating losses during the last several years. These losses can be available to reduce income taxes that might otherwise be incurred on future taxable income. The Company's U.S. operations, however, remain challenged and, as a result, it is uncertain whether the Company will generate the taxable income necessary to utilize these losses or other reversing temporary differences. This uncertainty has caused management to place a full valuation allowance on its September 30, 2011 and December 31, 2010 U.S. operations net deferred tax asset. The company carries no deferred income tax asset at September 30, 2011 for its Canadian operations. The company carries a deferred tax liability of $2.7 million at September 30, 2011, all of which relates to indefinite life intangible assets.

As of September 30, 2011, the Company had no unrecognized tax benefits. The Company analyzed its tax positions in accordance with the provisions of ASC Topic 740, Income Taxes and has determined that there are currently no uncertain tax positions. The Company recognizes interest and penalties, if any, related to unrecognized tax benefits in income tax benefits.

The income taxes recoverable of $12.4 million and $18.0 million at September 30, 2011 and December 31, 2010, respectively, primarily relate to tax receivables of the Company's Canadian operations.


NOTE 11 NET LOSS PER SHARE

Net loss per share is based on the weighted average number of shares outstanding. Diluted weighted average shares is calculated by adjusting basic weighted average shares outstanding by all potentially dilutive stock options. Stock options outstanding of 1,594,500 and 2,433,850 as of September 30, 2011 and 2010, respectively, were not included in the computation of diluted earnings per share because the exercise price of the options was greater than the average market price of the common stock and thus the inclusion would have been anti-dilutive.



18


KINGSWAY FINANCIAL SERVICES INC.
Notes to Condensed Consolidated Financial Statements (Unaudited) September 30, 2011


NOTE 12 ACCUMULATED OTHER COMPREHENSIVE INCOME

Accumulated other comprehensive income is a component of stockholders' equity on the condensed consolidated balance sheets.

The table below details the components of accumulated other comprehensive income, net of tax, at September 30, 2011:

  
 
Balance at December 31, 2010
$
14,407

Changes in net unrealized gain on investments
1,856

Reclassification adjustment for realized gains
4

Changes in unrealized loss on translating financial statements of self-sustaining, foreign operation
(1,811
)
Equity in other comprehensive loss of investee
(574
)
Loss on cash flow hedge
(1,267
)
Balance at September 30, 2011
$
12,615





19


KINGSWAY FINANCIAL SERVICES INC.
Notes to Condensed Consolidated Financial Statements (Unaudited) September 30, 2011


NOTE 13 SEGMENTED INFORMATION
The Company's primary businesses are the insuring of automobile risks for drivers who do not meet the criteria for coverage by standard automobile insurers. Previously, the Company managed these businesses in two reportable segments, the United States and Corporate. As a result of implementing its corporate restructuring plan and exiting non-core businesses, the Company now manages its business in the following three segments: Underwriting, Agency and Non-underwriting, and Corporate and Other. Results for the Company's operating segments are based on the Company's internal financial reporting systems and are consistent with those followed in the preparation of the consolidated financial statements.
Segment revenues for the three and nine months ended September 30, 2011 and 2010 were:
 
Three months ended September 30,
 
Nine months ended September 30,
 
 
2011

2010

2011

2010

Revenues:
 
 
 
 
Underwriting:
 
 
 
 
   Net premiums earned
$
36,614

$
52,269

$
124,825

$
170,370

   Commission income




   Net investment income
589

1,775

2,319

6,724

Total Underwriting
37,203

54,044

127,144

177,094

Agency and Non-underwriting:
 
 
 
 
Net premiums earned




   Commission income
5,807

4,246

18,124

8,544

   Net investment income
9

12

33

12

Total Agency and Non-underwriting
5,816

4,258

18,157

8,556

Corporate and Other:
 
 
 
 
   Net premiums earned




   Commission income




   Net investment income
401

435

876

1,328

Total Corporate and Other
401

435

876

1,328

Total segment revenues
43,420

58,737

146,177

186,978

Net realized gains
104

6,028

102

6,513

Unrealized gain (loss) on fair value of debt
17,189

(7,351
)
25,821

(102,827
)
Miscellaneous income
3,472

528

1,426

7,163

Total revenues
$
64,185

$
57,942

$
173,526

$
97,827

















20


KINGSWAY FINANCIAL SERVICES INC.
Notes to Condensed Consolidated Financial Statements (Unaudited) September 30, 2011



Segment net loss for the three and nine months ended September 30, 2011 and 2010 were:

 
Three months ended September 30,
 
Nine months ended September 30,
 
 
2011

2010

2011

2010

Segment operating income (loss)
 
 
 
 
   Underwriting
$
(8,886
)
$
(13,150
)
$
(28,198
)
$
(36,006
)
   Agency and Non-underwriting
422

(1,698
)
1,553

(4,348
)
   Corporate and Other
(2,831
)
(7,629
)
(11,651
)
(25,293
)
Total segment operating loss
(11,295
)
(22,477
)
(38,296
)
(65,647
)
Net investment income
999

2,222

3,228

8,064

Net realized gains
104

6,028

102

6,513

Unrealized gain (loss) on fair value of debt
17,189

(7,351
)
25,821

(102,827
)
Miscellaneous income
3,472

528

1,426

7,163

Interest expense
(1,874
)
(2,920
)
(5,610
)
(12,612
)
Amortization of other intangible assets
(18
)
(1,190
)
(54
)
(3,274
)
Gain on buy-back of debt
3

92

556

3,112

Gain on consolidation of debt

17,820


17,820

Equity in net income (loss) of investee
145


(384
)

Income (loss) from continuing operations before income taxes
$
8,725

$
(7,248
)
$
(13,211
)
$
(141,688
)
Income tax expense (benefit)
2,433

(1,534
)
2,292

(4,492
)
Income (loss) from continuing operations
$
6,292

$
(5,714
)
$
(15,503
)
$
(137,196
)


Net premiums earned by line of business for the three and nine months ended September 30, 2011 and 2010 were:
 
Three months ended September 30,
 
Nine months ended September 30,
 
 
2011

2010

2011

2010

Underwriting segment:
 
 
 
 
Personal lines:
 
 
 
 
Non-standard automobile
$
33,910

$
50,281

$
116,695

$
159,038

Property (including liability)
4

5

12

16

Total personal lines
$
33,914

$
50,286

$
116,707

$
159,054

Commercial automobile
2,700

1,983

8,118

11,316

Total net premiums earned
$
36,614

$
52,269

$
124,825

$
170,370













21


KINGSWAY FINANCIAL SERVICES INC.
Notes to Condensed Consolidated Financial Statements (Unaudited) September 30, 2011



NOTE 14 FAIR VALUE OF FINANCIAL INSTRUMENTS

Fair value amounts represent estimates of the consideration that would currently be agreed upon between knowledgeable, willing parties who are under no compulsion to act. Fair value is best evidenced by quoted bid or ask price, as appropriate, in an active market. Where bid or ask prices are not available, such as in an illiquid or inactive market, the closing price of the most recent transaction of that instrument subject to appropriate adjustments as required is used. Where quoted market prices are not available, the quoted price of similar financial instruments or valuation models with observable market based inputs are used to estimate the fair value. These valuation models may use multiple observable market inputs, including observable interest rates, foreign exchange rates, index levels, credit spreads, equity prices, counterparty credit quality, corresponding market volatility levels, and option volatilities. Minimal management judgment is required for fair values calculated using quoted market prices or observable market inputs for models. Greater subjectivity is required when making valuation adjustments for financial instruments in inactive markets or when using models where observable parameters do not exist. Also, the calculation of estimated fair value is based on market conditions at a specific point in time and may not be reflective of future fair values. For the Company's financial instruments carried at cost or amortized cost, the book value is not adjusted to reflect increases or decreases in fair value due to market fluctuations, including those due to interest rate changes, as it is the Company's intention to hold them until there is a recovery of fair value, which may be to maturity.
The Company classifies its investments in fixed maturities and equity securities as available-for-sale and reports these investments at fair value. The Company's LROC preferred units, senior unsecured debentures, and subordinated indebtedness are measured and reported at fair value.
Fair values of short-term investments, fixed maturities, and equity securities are considered to approximate quoted market values based on the latest bid prices in active markets. Fair value of securities for which no active market exists are derived from quoted market prices of similar securities or other third party evidence.
The fair value of the LROC preferred units is based on quoted market prices, and the fair value of the subordinated debt is estimated using an internal model based on significant market observable inputs. The fair values of senior unsecured debentures, for which no active market exists, are derived from quoted market prices of similar instruments or other third-party evidence.
The Company employs a fair value hierarchy to categorize the inputs it uses in valuation techniques to measure the fair value. The extent of use of quoted market prices (Level 1), internal models using observable market information (Level 2) and internal models without observable market information (Level 3) in the valuation of the Company's financial assets and liabilities measured at fair value on a recurring basis as at September 30, 2011 and December 31, 2010 was as follows:
 
Assets at Fair Value
 
 
 
 
 
 
September 30, 2011
Quoted Prices in Active Markets (Level 1)

Significant Other Observable Inputs (Level 2)

Significant Unobservable Inputs (Level 3)

Total

Assets:
 
 
 
 
Fixed maturities
$

$
114,823

$

$
114,823

Equity securities
2,951



2,951

Other investments

487

 
487

Short-term investments

21,335



21,335

Total assets
$
2,951

$
136,645

$

$
139,596

 
 
 
 
 
Liabilities:
 
 
 
 
LROC preferred units
$
8,829

$

$

$
8,829

Senior unsecured debentures

27,622


27,622

Subordinated indebtedness

17,218


17,218

Total liabilities
$
8,829

$
44,840

$

$
53,669




22


KINGSWAY FINANCIAL SERVICES INC.
Notes to Condensed Consolidated Financial Statements (Unaudited) September 30, 2011


 
Assets at Fair Value
 
 
 
 
 
 
December 31, 2010
Quoted Prices in Active Markets (Level 1)

Significant Other Observable Inputs (Level 2)

Significant Unobservable Inputs (Level 3)

Total

Assets:
 
 
 
 
Fixed maturities
$

$
127,863

$

$
127,863

Equity securities
82



82

Other investments

490


490

Short-term investments

18,249


18,249

Total assets
$
82

$
146,602

$

$
146,684

 
 
 
 
 
Liabilities:
 
 
 
 
LROC preferred units
$
13,076

$

$

$
13,076

Senior unsecured debentures

37,177


37,177

Subordinated indebtedness

40,480


40,480

Total liabilities
$
13,076

$
77,657

$

$
90,733



NOTE 15 RELATED PARTY TRANSACTIONS

Related party transactions, including services provided to or received by the Company's subsidiaries, are carried out in the normal course of operations and are measured at the amount of consideration paid or received as established and agreed by the parties. Management believes that consideration paid for such services approximates fair value. Except where disclosed elsewhere in these consolidated financial statements, the following is a summary of related party transactions.
On January 4, 2010, the Company and its subsidiary KAI acquired certain assets of Itasca Financial, LLC, a property and casualty insurance industry advisory firm, owned and controlled by Mr. Swets, a former director and current Chief Executive Officer and President of the Company. The consideration for the assets purchased is equal to $1.5 million cash and one million restricted common shares of the Company. The value of the consideration paid was approximately $2.5 million at the time of close.
Subsequent to the transaction, certain employees of Itasca are now employees within the KAI group, including Mr. Swets, who was appointed Chief Executive Officer and President of Kingsway effective June 30, 2010.
In March 2010, the Company signed an agreement with American Physicians Assurance Corporation (“AP Assurance”) to provide investment management and investment accounting services to the Company, commencing April 1, 2010. Two of the members of the Company's Board of Directors sat on the board of AP Assurance in March 2010, making it a related party.
In the first quarter of 2010, in addition to a previously agreed retainer of C$0.2 million, the Board of Directors had decided to pay an additional $0.1 million to the Chairman of the Board. This additional payment was made in the second quarter of 2010.
In the second quarter of 2010, the Board of Directors had decided to pay an additional $0.1 million to the Chairman of the Board. The Company paid half of this additional amount in the second quarter of 2010. The remaining payment was made in the third quarter of 2010.
The additional payments to the Chairman of the Board in 2010 were due to his increased workload with respect to various matters confronting the Company.
In August 2011, the Company and its subsidiary, 1347 Advisors, LLC ("1347 Advisors") entered into a management services agreement with United Insurance Holdings Corp. (“United”). This agreement provides that 1347 Advisors will supply the services of an interim Chief Financial Officer to United, as well as certain strategy consulting, corporate development, corporate finance and actuarial services. Pursuant to the management services agreement, Hassan Baqar has been appointed interim Chief Financial Officer at United. Mr. Baqar is currently a Managing Director of 1347 Advisors as well as a Vice President of KAI. Mr. Larry Swets, Chief Executive Officer and President of Kingsway, also serves on the Board of Directors of United.


23


KINGSWAY FINANCIAL SERVICES INC.
Notes to Condensed Consolidated Financial Statements (Unaudited) September 30, 2011



NOTE 16 COMMITMENTS AND CONTINGENCIES

In connection with its operations, the Company and its subsidiaries are named as defendants in various actions for damages and costs allegedly sustained by the plaintiffs. While it is not possible to estimate the outcome of the various proceedings at this time, it is reasonably possible that some of the actions may have a material adverse effect on the Company's overall financial position.
In addition to the exposures outlined above, as discussed in detail in the 2010 Annual Report, in May 2009 the Company placed all of Lincoln General Insurance Company (“Lincoln”) into voluntary run-off, and subsequently on October 19, 2009, with the objective of protecting the interests of the Company's stakeholders, KAI, an indirect wholly owned subsidiary of the Company, disposed of its entire interest in its wholly owned subsidiary, Walshire Assurance Company (“Walshire”). Walshire was the sole shareholder of Lincoln. All of the stock of Walshire was donated to charities, and with this disposition Lincoln ceased being a member of the Kingsway group of companies. The disposition led to litigation with the Pennsylvania Insurance Department (“DOI”), as discussed in the 2010 Annual Report. On October 17, 2011 Kingsway reached a settlement and release ending all legal disputes with the DOI, and also completed the previously announced acquisition of minority interest in Walshire. At closing, Kingsway also obtained releases from Walshire, Lincoln, and the charities.


NOTE 17 SUBSEQUENT EVENTS
On October 6, 2011, A.M. Best & Co. (“A.M. Best”) announced the downgrade of several ratings of Kingsway long-term debt and operating subsidiaries. Following this action, Kingsway informed A.M. Best of its intention to cease participation in the interactive rating process of A.M. Best. As a result, A.M. Best announced on October 19, 2011 that it had withdrawn its ratings for all Kingsway entities.




24




Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations

Forward Looking Statements
Management's Discussion and Analysis includes “forward looking statements” that are subject to risks and uncertainties. Such forward looking statements relate to future events or future performance, but reflect Kingsway management’s current beliefs, based on information currently available. A number of factors could cause actual events, performance or results to differ materially from the events, performance and results discussed in the forward looking statements. For information identifying important factors that could cause actual results to differ materially from those anticipated in the forward looking statements, see Kingsway’s securities filings, including its 2010 Annual Report under the heading Risk Factors in the Management’s Discussion and Analysis section. The securities filings can be accessed on the Canadian Securities Administrators’ website at www.sedar.com, and on the EDGAR section of the U.S. Securities and Exchange Commission’s website at www.sec.gov or through the Company’s website at www.kingsway-financial.com. Except as expressly required by applicable securities law, the Company disclaims any intention or obligation to update or revise any forward looking statements whether as a result of new information, future events or otherwise.

Adoption of U.S. Generally Accepted Accounting Principles
The unaudited interim condensed consolidated financial statements have been prepared in accordance with U.S. Generally Accepted Accounting Principles ("U.S. GAAP") for interim financial information and follow disclosures required per Regulation S-X Rule 10-01, Interim Financial Statements, provided by SEC Guidance.
The Company presented its consolidated financial statements for the year ended December 31, 2010 in accordance with Canadian Generally Accepted Accounting Principles ("Canadian GAAP"). The Canadian Accounting Standards Board required all publicly traded companies to present their financial statements in accordance with International Financial Reporting Standards ("IFRS") as the replacement for Canadian GAAP for fiscal years beginning on or after January 1, 2011. As a result, the Company presented its interim consolidated financial statements for the period ended September 30, 2011 in accordance with IFRS. The transition date to IFRS was January 1, 2010 and accordingly all prior period results and balances in the September 30, 2011 interim consolidated financial statements and Management's Discussion and Analysis were restated from Canadian GAAP to comply with IFRS.
Effective July 1, 2011, the Company ceased to be a “foreign private issuer” as defined in Rule 3b-4 of the Securities Exchange Act of 1934, as amended (the “Exchange Act”), and became subject to the rules and regulations under the Exchange Act applicable to domestic issuers. As a result, the Company is required to prepare and file its consolidated financial statements included in our Annual Report on Form 10-K for the fiscal year ended December 31, 2011, whereas our Annual Reports were previously filed on Form 40-F. While we do not believe this change will impact the value of the Company, shareholders will now have to adapt to filings made pursuant to the Exchange Act. As required by Ontario Securities Commission National Instrument 51-102 Continuous Disclosure Obligations, the Company must restate the interim financial reports previously filed under IFRS in accordance with U.S. GAAP.
The Company is not required to refile its interim consolidated financial statements for 2011 with the SEC; however, the Company is required by Canadian Exchange Act rules to refile its quarterly reports for 2011 using Form 10-Q and financial statements prepared in accordance with U.S. GAAP.
The accounting policies set out in the interim condensed consolidated financial statements for the period ended September 30, 2011 have been consistently applied to all the periods presented. The comparative figures in respect of 2010 were restated to reflect the adoption of U.S. GAAP.
There was no significant impact of the transition to U.S. GAAP on the Company's internal controls, information technology systems and financial reporting expertise requirements. No financial covenants were impacted by the Company's conversion to U.S. GAAP.








25




Overview
Kingsway's primary continuing operations are the insuring of automobile risks in the United States for drivers who do not meet the criteria for coverage by standard automobile insurers. Kingsway conducts this business through its subsidiary companies, Mendota Insurance Company, Mendakota Insurance Company, KAI Advantage Auto, Inc., Assigned Risk Solutions and Kingsway Amigo Insurance Company (“Amigo”). For the three and nine months ended September 30, 2011, non-standard automobile insurance accounted for 83.7% and 86.3% of gross premiums written in the Company's continuing operations. The Company also owns wholly owned reinsurance subsidiaries domiciled in Bermuda and Barbados.

Acquisitions
On January 4, 2010, the Company and its subsidiary, Kingsway America Inc. ("KAI"), acquired certain assets of Itasca Financial, LLC (“Itasca”), a property and casualty insurance industry advisory firm, owned and controlled by Mr. Larry Swets, a former director and current Chief Executive Officer and President of the Company. The consideration for the assets purchased is equal to $1.5 million cash and one million restricted common shares of the Company, payable in three annual installments (refer to Note 5, "Acquisitions and Discontinued Operations" to the condensed consolidated financial statements (unaudited) for additional details). Goodwill of $2.5 million was recognized related to the purchase.
Effective June 30, 2010, the Company made an investment in JBA Associates, Inc. (“JBA”) for approximately $16.3 million, following which the Company has a 100% interest in JBA. JBA is a managing general agency based in New Jersey that specializes in assigned risk automobile insurance. The acquisition allows the Company to benefit from its institutional knowledge of non-standard automobile and assigned risk business and expand in the agency market. Goodwill of $0.5 million was recognized related to the purchase. An intangible asset of $11.7 million was recognized related to retention of buyout customers and contract renewals. Subsequent to the acquisition, JBA was renamed Assigned Risk Solutions, Ltd (“ARS”).
KLROC Trust is an investment trust established under the laws of the Province of Ontario and is governed by a Declaration of Trust dated May 12, 2005, amended July 14, 2005. KLROC Trust was created to provide holders with exposure to a promissory note issued by KAI, an affiliate of KFSI.

KLROC Trust commenced operations on July 14, 2005 and raised C$78,000,000 through the issuance of 3,120,000 preferred units (“LROC Units”) at C$25 per LROC preferred unit. In order to achieve its investment objectives, KLROC Trust used the net proceeds of C$74,141,236 of its initial public offering to subscribe for and purchase all of the limited partnership units of KL Limited Partnership (“KL LP”). In turn, KL LP used these proceeds for the payment of its purchase obligations under a Forward Purchase Agreement which KL LP entered into with the Bank of Nova Scotia (“the Counterparty”). Such proceeds were invested by the Counterparty in KN Trust.

KN Trust lent funds to Kingsway ROC GP (“ROC GP”) and combined with its partnership capital of C$8,250,000, ROC GP subscribed for common shares in Kingsway ROC LLC (“ROC LLC”) totaling C$82,087,781. With these proceeds, ROC LLC purchased a promissory note from KAI, with the principal amount of US $66,222,012 bearing interest at 7.37% per annum and due June 30, 2015.

Beginning in 2009, KFS Capital LLC ("KFS Capital"), an affiliate of KFSI, began purchasing LROC Units. The investments at that time were accounted for as available for sale securities as they were purchased primarily as an investment. As at June 30, 2010, KFSI held 833,715 LROC Units representing 26.7% of the issued and outstanding LROC units; therefore, the Company was not obligated to consolidate KLROC Trust. In July 2010, the Company purchased an additional 1,500,000 LROC Units and now beneficially owns and controls 74.8% of the issued and outstanding LROC Units. The Company has determined that the consolidated financial statements of KLROC Trust, which financial statements include the accounts of the other aforementioned entities, should be consolidated with the financial statements of the Company beginning July 23, 2010. As a result of consolidating KLROC Trust, the Company recorded a gain of $17.8 million in the third quarter related to the LROC Units held by KFS Capital. The gain arose from the difference between the carrying value of the debt held by KLROC Trust and the fair value of the LROC Units held by KFS Capital.

Discontinued Operations
During 2010, the Company disposed of:
Jevco Insurance Company (“Jevco”);
American Country Insurance Company (“American Country”); and
American Service Insurance Company, Inc. (“American Service”).



26




Each of the operations above is considered to be discontinued operations and is recorded as such in the statement of operations under the item “Income (loss) from discontinued operations, net of taxes”. In this Management Discussion and Analysis, unless otherwise disclosed, only continuing operating activities of Kingsway are included.
Change in Ownership
On March 30, 2011, KAI sold all of the issued and outstanding shares of its wholly owned subsidiary Hamilton Risk Management Company (“Hamilton”) and its subsidiaries, including Amigo, to HRM Acquisition Corp., a wholly owned subsidiary of Acadia Acquisition Partners, L.P. (“Acadia”), in exchange for a $10.0 million senior promissory note due March 30, 2014, a $5.0 million junior promissory note due March 30, 2016, and a Class B partnership interest in Acadia, representing a 40% economic interest. An independent third party holds a Class A partnership interest in Acadia representing a 60% economic interest. KAI will act as the general partner of Acadia. As general partner, KAI has control of the policies and financial affairs of Hamilton, therefore, Kingsway will continue to consolidate the financial statements of Hamilton. Subsequent to March 31, 2011, HRM Acquisition Corp. merged into Hamilton.
Competitive Factors
In order to stay competitive, Kingsway competes on a number of factors such as distribution strength, pricing and agency relationships, service, and market reputation. In our core non-standard automobile lines in the United States, our primary offerings are policies at the minimum prescribed limits in each state, typically not greater than $50,000 per occurrence.

At the same time, we compete with numerous smaller insurance companies in regional markets. The fragmented nature of the non-standard automobile markets in the United States means that many of our competitors are small companies with limited capital resources which have traditionally relied upon the support of reinsurers to supplement their capital. Like us, many of our competitors primarily serve the independent agency market. On the other hand, direct underwriters typically operate in standard lines of personal automobile and property insurance where they have certain competitive advantages over agency underwriters. These advantages include increased name recognition obtained through extensive media advertising, loyalty of the customer base to the insurer rather than to an independent agency and, potentially, reduced policy acquisition costs and increased customer retention.

From time to time, the niche non-standard market attracts competition from new entrants. In many cases, these entrants are looking for growth, and, as a result, price their insurance below the rates that we believe provide an acceptable premium for the related risk. We firmly believe that it is not in our best interest to compete solely on price. As a result, we occasionally experience a loss of market share during periods of intense price competition or “soft” market conditions.

Our underwriting philosophy stresses receiving an adequate premium and spread of risks for the business we accept. Rather than attempt to select individual risks, we seek to set premium rates at levels that should generate profitable underwriting. We regularly monitor premium adequacy both by territory and class of business and make adjustments as required. Typically, we do not reduce our pricing when competitors offer to underwrite certain classes of business at premium rates that we believe are below acceptable levels. Instead, we focus on maintaining our premium per risk rather than write a large number of risks at premiums that we believe would be inadequate and thus unprofitable. As a result, our premium volumes may be impacted.

As a normal part of operations, we regularly consider and implement initiatives to address adverse profitability trends in our business. These initiatives vary by jurisdiction but may include tightening of underwriting requirements, price increases, termination of underperforming programs, reduction in agent commissions, policy non-renewals (where permitted) and other administrative changes. In most U.S. jurisdictions, premium rates must be approved by the applicable regulatory authority. Once approved, an insurance company is prohibited from altering rates without regulatory approval for changes. In the United States, we market and distribute our products through a network of independent agents. We maintain an “open market” approach which enables these agents to place business with us with no minimum commitments and provides us with a broad, flexible and scalable distribution network. We believe that this approach is unique compared with the approach of many of the nonstandard automobile insurance companies.

Our strategy focuses on developing and maintaining strong relationships with our independent agents. We continually strive to provide excellent service in the markets in which we operate, communicating through a variety of channels as we look for opportunities to increase efficiency and reduce operating costs with our agents. Our agents generally have the authority to bind policies on our behalf, providing specified insurance coverages within our prescribed underwriting guidelines. These guidelines prescribe the kinds and amounts of coverage that may be written and the premium rates that may be charged for specified categories of risk. We do not delegate authority to settle or adjust claims, establish underwriting guidelines, develop rates or enter into other transactions or commitments through our independent agents.




27




Non-U.S. GAAP Financial Measures
The Company uses both U.S. GAAP and certain non-U.S. GAAP financial measures to assess performance. Securities regulators require that companies caution readers about non-U.S. GAAP financial measures that do not have a standardized meaning under U.S. GAAP and are unlikely to be comparable to similar measures used by other companies. Kingsway, like many insurance companies, analyzes performance based on underwriting ratios such as combined, expense and loss ratios. The loss ratio is derived by dividing the amount of net claims incurred by net premiums earned. The expense ratio is derived by dividing the sum of commissions and premium taxes and general and administrative expenses by net premiums earned. The combined ratio is the sum of the loss ratio and the expense ratio. A combined ratio below 100% demonstrates underwriting profit whereas a combined ratio over 100% demonstrates an underwriting loss. We believe that consistently delivering an underwriting profit is a key measure of performance of the underwriting business of a property and casualty insurance company. Although there is not a property and casualty industry defined standard that is consistently applied in calculating these ratios, the Company has historically included costs such as corporate office expenses and excluded premium finance revenues whereas other public companies have done otherwise in the calculation of their expense and combined ratios. Readers are therefore cautioned when comparing the Company's combined ratios to those of other public companies as they may not have been calculated on a comparable basis.

Summary of Results

The following information throughout the Management's Discussion & Analysis ("MD&A") presents the financial results as continuing operations unless otherwise specifically stated as discontinued operations.
The following table presents the Company's sources of net loss and combined ratios for the three and nine months ended September 30, 2011 and 2010:
 
Three months ended September 30,
 
Nine months ended September 30,
 
(in millions of dollars except per share values)
2011

2010

Change

2011

2010

Change

Gross premiums written
$
33.2

$
51.9

(36.0
)%
107.6

166.9

(35.5
)%
Operating loss - Underwriting segment
(8.9
)
(13.2
)
(32.6
)%
(28.2
)
(36.0
)
(21.7
)%
Operating loss - Agency and Non-underwriting and Corporate and Other segments
(2.4
)
(9.3
)
(74.2
)%
(10.1
)
(29.6
)
(65.9
)%
Net investment income
1.0

2.2

(54.5
)%
3.2

8.1

(60.5
)%
Net realized gains
0.1

6.0

(98.3
)%
0.1

6.5

(98.5
)%
Unrealized gain (loss) on fair value of debt
17.2

(7.4
)
(332.4
)%
25.8

(102.8
)
(125.1
)%
Miscellaneous income
3.5

0.5

600.0
 %
1.4

7.2

(80.6
)%
Interest expense
1.9

2.9

(34.5
)%
5.6

12.6

(55.6
)%
Amortization of other intangible assets

1.2

(100.0
)%
0.1

3.3

(97.0
)%
Gain on buy-back of debt

0.1

(100.0
)%
0.6

3.1

(80.6
)%
Income tax expense (benefit)
2.4

(1.5
)
(260.0
)%
2.3

(4.5
)
(151.1
)%
Income (loss) from continuing operations
6.3

(5.7
)
(210.5
)%
(15.5
)
(137.2
)
(88.7
)%
Net income (loss)
6.3

(7.4
)
(185.1
)%
(16.8
)
(110.8
)
(84.8
)%
Diluted earnings (loss) per share - continuing operations
0.12

(0.11
)
(209.1
)%
(0.30
)
(2.63
)
(88.6
)%
Diluted earnings (loss) per share - net income (loss)
0.12

(0.14
)
(185.7
)%
(0.32
)
(2.13
)
(85.0
)%
Book value per share
2.42

2.78

(12.9
)%
2.42

2.78

(12.9
)%
Combined ratio
146.7
%
151.1
%
(4.4
)%
145.2
%
143.5
%
1.7
 %


28




Premiums
 
Three months ended September 30,
 
Nine months ended September 30,
 
(in millions of dollars)
2011

2010

Change

2011

2010

Change

Gross premiums written
$
33.2

51.9

(36.0
)%
$
107.6

166.9

(35.5
)%
Net premiums written
$
30.9

49.5

(37.6
)%
$
100.7

159.5

(36.9
)%
Net premiums earned
$
36.6

52.3

(30.0
)%
$
124.8

170.4

(26.8
)%

The following table provides a breakdown of gross premiums written by line of business:
 
Three months ended September 30,
 
Nine months ended September 30,
 
(in millions of dollars)
2011
2010
2011
2010
Non-standard automobile
$
27.8

83.7
%
$
47.6

91.7
%
92.9

86.3
%
153.2

91.8
%
Property (including liability)
2.1

6.3
%
2.4

4.6
%
6.2

5.8
%
6.3

3.8
%
Total personal lines
$
29.9

90.0
%
$
50.0

96.3
%
99.1

92.1
%
159.5

95.6
%
Commercial automobile
3.3

10.0
%
1.9

3.7
%
8.5

7.9
%
7.4

4.4
%
Total gross premiums written
$
33.2

100.0
%
$
51.9

100.0
%
107.6

100.0
%
166.9

100.0
%

Gross premiums written decreased by 36.0% in the third quarter to $33.2 million (35.5% to $107.6 million year to date) from $51.9 million in the third quarter last year ($166.9 million prior year to date).
The Company also reported decreases in gross premiums written in non-standard automobile, its primary line of business, which decreased by 41.6% (39.4% year to date) in the third quarter compared to the same period last year. The significant reduction in premium volume is a reflection of the Company's strategy of discontinuing certain lines of business, terminating unprofitable business and increasing premium rates.
Non-standard automobile accounted for 83.7% of gross premiums written for the three months ended September 30, 2011 (86.3% year to date) compared to 91.7% for the three months ended September 30, 2010 (91.8% prior year to date).
Operating Results - Underwriting Segment
 
Three months ended September 30,
 
Nine months ended September 30,
 
(in millions of dollars)
2011

2010

Change

2011

2010

Change

Operating loss
$
(8.9
)
$
(13.2
)
(32.6
)%
$
(28.2
)
$
(36.0
)
(21.7
)%
Combined ratio
124.3
%
125.2
%
(0.9
)%
122.5
%
121.1
%
1.4
 %
Expense ratio
30.6
%
31.3
%
(0.7
)%
32.1
%
34.0
%
(1.9
)%
Loss ratio
93.7
%
93.9
%
(0.2
)%
90.4
%
87.1
%
3.3
 %

The operating loss for the Underwriting segment was $8.9 million for the quarter ($28.2 million year to date) compared to a loss of $13.2 million in the same quarter last year ($36.0 million prior to date). The operating results for the quarter ended September 30, 2011 continue to be negatively affected, though to a lesser extent than during the prior year period, by the performance of lines of business and programs which the Company has previously terminated. The Company continues to address its performance issues in its go-forward markets through rate and policy form actions; reductions in new business writings; claim department initiatives; and personnel changes.
Investment Income
 
Three months ended September 30,
 
Nine months ended September 30,
 
(in millions of dollars)
2011

2010

Change

2011

2010

Change

 
 
 
 
 
 
 
Net investment income
$
1.0

$
2.2

(54.5
)%
3.2

8.1

(60.5
)%
 
 
 
 
 
 
 

For the three months ended September 30, 2011, investment income, excluding net realized gains, was $1.0 million compared to $2.2 million for the same quarter of 2010, a 54.5% decrease (60.5% decrease to $3.2 million compared to $8.1 million million year to date). The decrease in investment income was primarily a result of decline in interest income on the fixed income securities portfolio due to lower yields as well as the smaller size of the portfolio as a result of reduction in premiums written.

29




Net Realized Gains
The table below presents a summary of the net realized gains for the three and nine months ended September 30, with comparative figures:
 
Three months ended September 30,
 
Nine months ended September 30,
 
(in millions of dollars)
2011

2010

Change

2011

2010

Change

Fixed maturities
$
0.1

$
6.0

(98.3
)%
0.1

6.5

(98.5
)%

For the three months ended September 30, 2011, net realized gains on sales from the securities portfolio were $0.1 million compared to net realized gains of $6.0 million for the three months ended September 30, 2010 ($0.1 million compared to $6.5 million prior year to date).
Unrealized Gain (Loss) on Fair Value of Debt
The unrealized gain on fair value of debt amounted to $17.2 million for the quarter ($25.8 million year to date) compared to an unrealized loss of $7.4 million in the same quarter last year ($102.8 million prior year to date) primarily due to decline in fair value of subordinated indebtedness. Under IFRS, the Company elected to measure its interest-bearing debt at fair value. Under U.S. GAAP, the Company measures its interest-bearing debt at fair value under the preexisting IFRS accounting policy.
Development on Unpaid Loss and Loss Adjustment Expenses
 
Three months ended September 30,
Nine months ended September 30,
(in millions of dollars)
2011

2010

2011

2010

Favourable (unfavourable) change in estimated unpaid loss and loss adjustment expenses for prior accident years (Note 1):
$
(1.5
)
$
1.9

$
(3.2
)
$
(5.9
)
As a % of net premiums earned (Note 2):
4.1
%
(3.6
)%
2.6
%
3.5
%
As a % of unpaid loss and loss adjustment expenses (Note 3):
0.9
%
(0.5
)%
1.8
%
1.6
%

Note 1 - Increase (decrease) in estimates for unpaid loss and loss adjustment expenses from prior accident years reflected in current financial year results
Note 2 - Increase (decrease) in current financial year reported combined ratio
Note 3 - Increase (decrease) compared to estimated unpaid loss and loss adjustment expenses at the end of the preceding fiscal year
The Company experienced estimated net unfavourable development on unpaid loss and loss adjustment expenses of $1.5 million for the quarter ($3.2 million year to date) resulting in an increase of 4.1% to the combined ratio for the quarter (2.6% year to date) compared with estimated net favourable development on unpaid loss and loss adjustment expenses of $1.9 million in the same quarter last year (net unfavourable development on unpaid loss and loss adjustment expenses of $5.9 million prior year to date). The unfavourable development in the quarter was primarily generated by the non-standard automobile and commercial lines of business.
During 2010, the Company moved responsibility for evaluating and setting reserves to an internal process, with the objective of increasing consistency and accountability relating to variability of reserves. Reserves were evaluated on a quarterly basis by the Company's actuaries, with the results then shared with Management, which was responsible for the final setting of reserves.
In the year-end full actuarial review process, a loss and loss adjustment expense reserve analysis is completed for each insurance subsidiary. Unpaid claims reserves, allocated loss adjustment expense reserves and unallocated loss adjustment expense reserves are separately analyzed by segment, line of business or coverage by accident year. A wide range of actuarial methods are utilized in order to appropriately measure ultimate loss and loss adjustment expense costs. Many of these methods are designed to properly address changes in claims settlement rate, changes in case reserve adequacy and other operational changes. These methods include Paid Loss Development, Incurred Loss Development, Paid Bornhuetter-Ferguson, Incurred Bornhuetter-Ferguson, Berquist-Sherman Paid Method, Berquist-Sherman Reported and frequency-severity method. Reasonability tests such as average outstanding reserves, ultimate loss trends and ultimate allocated loss adjustment expense to ultimate loss are also performed prior to selection of ultimate losses. Reserves are indicated by segment, line of business or coverage and are separated into case reserves, incurred but not reported ("IBNR") reserves and unallocated loss adjustment expense reserves.

30




Expenses
General and administrative expenses decreased 38.3% (22.2% year to date) to $15.0 million in the third quarter of 2011 ($52.2 million year to date) from $24.3 million ($67.1 million year to date) for the same period last year. This decline in general and administrative expenses is primarily the result of the Company's cost saving initiatives and resizing of its operations. Commissions and premium taxes declined 26.0% to $5.4 million in the third quarter of 2011 from $7.3 million for the same period last year (decline of 30.1% year to date to $19.7 million from $28.2 million prior year to date) due to significantly reduced premium volumes.
Interest Expense
Interest expense on external debt decreased 34.5% to $1.9 million in the third quarter of 2011, as compared to $2.9 million reported for the same period last year (decrease of 55.6% year to date to $5.6 mill