You should read the following discussion in conjunction with our consolidated financial statements and related notes and information included elsewhere in this Quarterly Report on Form 10-Q and in our Annual Report for the year ended
December 31, 2020on Form 10-K filed with the Securities and Exchange Commission("SEC") on March 18, 2021.
Caution regarding forward-looking statements
This Quarterly Report on Form 10-Q contains forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended (the "Securities Act"), and Section 21E of the Securities Exchange Act of 1934, as amended (the "Exchange Act"). These statements are therefore entitled to the protection of the safe harbor provisions of these laws. These statements may be identified by the use of forward-looking terminology such as "anticipate," "believe," "budget," "can," "contemplate," "continue," "could," "envision," "estimate," "expect," "evaluate," "forecast," "goal," "guidance," "indicate," "intend," "likely," "may," "might," "outlook," "plan," "possibly," "potential," "predict," "probable," "probably," "pro-forma," "project," "seek," "should," "target," "view," "will," "would," "will be," "will continue," "will likely result" or the negative thereof or other variations thereon or comparable terminology. In particular, discussions and statements regarding the Company's future business plans and initiatives are forward-looking in nature. We have based these forward-looking statements on our current expectations, assumptions, estimates, and projections. While we believe these to be reasonable, such forward-looking statements are only predictions and involve a number of risks and uncertainties, many of which are beyond our control. These and other important factors may cause our actual results, performance, or achievements to differ materially from any future results, performance or achievements expressed or implied by these forward-looking statements, and may impact our ability to implement and execute on our future business plans and initiatives. You should be aware that many of the risks listed below were, and may continue to be, exacerbated by the COVID-19 pandemic. Management cautions that the forward-looking statements in this Quarterly Report on Form 10-Q are not guarantees of future performance, and we cannot assume that such statements will be realized or the forward-looking events and circumstances will occur. Factors that might cause such a difference include, without limitation: risks associated with our limited business operations since the closing of the Asset Sale; risks associated with our inability to identify and realize business opportunities, and the undertaking of any new such opportunities, following the Asset Sale; our ability to spend or invest the net proceeds from the Asset Sale in a manner that yields a favorable return; general conditions in the global economy, including the impact of health and safety concerns from the current COVID-19 pandemic and the impact of governmental measures taken in response thereto; the uncertainty and difficulty in predicting the ultimate impact of the COVID-19 pandemic on our business; our lack of operating history or established reputation in the reinsurance industry; our inability to obtain or maintain the necessary approvals to operate reinsurance subsidiaries; risks associated with operating in the reinsurance industry, including inadequately priced insured risks, credit risk associated with brokers we may do business with, and inadequate retrocessional coverage; our inability to execute on our investment and investment management strategy, including our strategy to invest in real estate assets; potential loss of value of investments; risk of becoming an investment company; fluctuations in our short-term results as we implement our new business strategy; risks of not being unable to attract and retain qualified management and personnel to implement and execute on our business and growth strategy; failure of our information technology systems, data breaches and cyber-attacks; our ability to establish and maintain an effective system of internal controls; our limited operating history as a publicly traded company; the requirements of being a public company and losing our status as a smaller reporting company or becoming an accelerated filer; any potential conflicts of interest between us and our controlling stockholders and different interests of controlling stockholders; potential conflicts of interest between us and our directors and executive officers; the impact of the COVID-19 pandemic on the business of FedNat Holding Company; continued volatility or further decline in the value of the shares of FedNat Holding Company common stock received by us as consideration in the Asset Sale or limitations and restrictions with respect to our ownership of such shares; risks of being a minority stockholder of FedNat Holding Company; risks associated with our related party transactions and investments; and risks associated with our inability to continue to satisfy the listing standards of the Nasdaq following completion of the Asset Sale. Our expectations and future plans and initiatives may not be realized. If one of these risks or uncertainties materialize, or if our underlying assumptions prove incorrect, actual results may vary materially from those expected, estimated or projected. You are cautioned not to place undue reliance on forward-looking statements. The forward-looking statements are made only as of the date hereof and do not necessarily reflect our outlook at any other point in time. We do not undertake and specifically decline any obligation to update any such statements or to publicly announce the results of any revisions to any such statements to reflect new information, future events or developments. 28
FG FINANCIAL GROUP, INC.Overview FG Financial Group, Inc.("FGF", the "Company", "we", or "us") is a reinsurance and investment management holding company focused on opportunistic collateralized and loss capped reinsurance, while allocating capital in partnership with Fundamental Global® to SPAC and SPAC sponsor-related businesses. Our principal business operations are conducted through our subsidiaries and affiliates. We were incorporated on October 2, 2012in the State of Delawareunder the name Maison Insurance Holdings, Inc., and changed our legal name to 1347 Property Insurance Holdings, Inc.on November 19, 2013. On March 31, 2014, we completed an initial public offering of our common stock. Prior to the offering, we were a wholly owned subsidiary of Kingsway America Inc., which, in turn, is a wholly owned subsidiary of Kingsway Financial Services Inc., or KFSI, a publicly owned Delawareholding company. From our inception through December 2, 2019, we operated as an insurance holding company, writing property and casualty insurance throughout the states of Louisiana, Floridaand Texasthrough our subsidiaries. On December 2, 2019, we sold our three insurance subsidiaries, and embarked on a new strategy focused on insurance, reinsurance, real estate, and asset management. Accordingly, on December 14, 2020, our shareholders approved a change in our corporate name to FG Financial Group, Inc., to better align with this new business strategy. As of September 30, 2021, Fundamental Global GP, LLC, a privately owned investment management company, and its affiliates, or "FG," beneficially owned approximately 60% of our outstanding shares of common stock. D. Kyle Cerminara, Chairman of our Board of Directors, serves as Chief Executive Officer, Co-Founder and Partner of FG. Sale of the Maison Business On December 2, 2019, we completed the sale of all of the issued and outstanding equity of three of the Company's then wholly-owned subsidiaries, Maison Insurance Company("Maison"), Maison Managers Inc.("MMI") and ClaimCor, LLC("ClaimCor" and, together with Maison and MMI, the "Maison Business" or the "Insurance Companies"), to FedNat Holding Company, a Floridacorporation ("FedNat"), pursuant to the terms and conditions of the Equity Purchase Agreement, dated as of February 25, 2019(the "Purchase Agreement"), by and among the Company and each of Maison, MMI and ClaimCor, on the one hand, and FedNat, on the other hand (the "Asset Sale"). As consideration for the Asset Sale, FedNat paid the Company $51.0 million, consisting of $25.5 millionin cash and $25.5 millionin FedNat's common stock, or 1,773,102 shares of FedNat common stock. In addition, upon the closing of the Asset Sale, $18.0 millionof outstanding surplus note obligations payable by Maison to the Company, plus all accrued but unpaid interest, was repaid to
the Company. On
December 31, 2019, the shares of FedNat common stock issued to the Company in connection with the Asset Sale were registered under the Securities Act of 1933, as amended (the "Securities Act"), pursuant to the terms of the Registration Rights Agreement entered into by the Company and FedNat at the closing of the Asset Sale. In addition to the Registration Rights Agreement, the Company and FedNat entered into a Standstill Agreement, a Reinsurance Capacity Right of First Refusal Agreement (the "Reinsurance Agreement"), and an Investment Advisory Agreement at the closing of the Asset Sale. Standstill Agreement
The Standstill Agreement imposes certain limitations and restrictions with respect to the voting securities of FedNat (including shares of FedNat common stock) that are owned or held beneficially or of record by the Company. Under the Standstill Agreement, the Company has agreed to vote all of the voting securities of FedNat beneficially owned by the Company in accordance with the recommendation of the board of directors of FedNat with respect to any matter that is before the stockholders of FedNat for a vote by such stockholders. The Standstill Agreement imposes limitations on the sale of voting securities of FedNat held by the Company and restricts the Company from taking certain actions as a holder of voting securities of FedNat. The Standstill Agreement expires on
December 2, 2024.
For insurance regulatory purposes, the Company has waived any rights it may
must exercise control over FedNat.
FG FINANCIAL GROUP, INC.
Reinsurance capacity Right of first refusal agreement
The Reinsurance Agreement provides the Company with a right of first refusal to sell reinsurance coverage to the insurance company subsidiaries of FedNat, providing reinsurance on up to 7.5% of any layer in FedNat's catastrophe reinsurance program, subject to the annual reinsurance limit of
$15.0 million, on the terms and subject to the conditions set forth in the Reinsurance Agreement. All reinsurance sold by the Company pursuant to the right of first refusal, if any, will be memorialized in an agreement in such form and subject to such terms and conditions as are customary in the property and casualty insurance industry. The Reinsurance Agreement is assignable by the Company subject to conditions set forth in the agreement. The term of the Reinsurance Agreement is five years, expiring on December 2, 2024. As of September 30, 2021, the Company has not provided any reinsurance coverage to FedNat under the Reinsurance Agreement. Investment Advisory Agreement
Pursuant to the Investment Advisory Agreement,
FG Strategic Consulting, LLC("FGSC"), a wholly-owned subsidiary of the Company, was formed to provide investment advisory services to FedNat, which include identifying, analyzing and recommending potential investments, advising as to existing investments and investment optimization, recommending investment dispositions, and providing advice regarding macro-economic conditions. In exchange for providing the investment advisory services, FedNat has agreed to pay FGSC an annual fee of $100,000. The term of the Investment Advisory Agreement is five years, expiring on December 2, 2024. Current Business
Our strategy has evolved to focus on opportunistic collateralized and loss capped reinsurance, while allocating capital to special purpose acquisition companies ("SPACs") and SPAC sponsor-related businesses. Accordingly, in the first quarter 2021, we have launched our "SPAC Platform," as further discussed below. As part of our refined focus, we have adopted the following capital allocation philosophy:
“Increase intrinsic value per share with a long-term goal using
research, by allocating capital to asymmetric risk / reward opportunities. “
Historically, the Company has operated a real estate business through its subsidiary,
FGI Metrolina Property Income Fund, LP, however, the Company does not anticipate that its real estate business will be a significant component of its future business plans. Reinsurance The Company has formed a wholly-owned reinsurance subsidiary, FG Reinsurance Ltd.("FGRe"), a Cayman Islandslimited liability company, to provide specialty property and casualty reinsurance. FGRe has been granted a Class B (iii) insurer license in accordance with the terms of The Insurance Law, 2010 and underlying regulations thereto and is subject to regulation by the Cayman Islands Monetary Authority(the "Authority"). The terms of the license require FGRe to receive a capital infusion in the amount of $5.0 million, which the Company effected in July 2020via the transfer of 156,000 shares of FedNat common stock from the Company along with approximately $3.3 millionin cash. The terms of the insurer license also require advance approval from the Authority should FGRe wish to enter into any reinsurance agreements which are not fully collateralized to their aggregate exposure limit. In November 2020, FGRe entered into its first reinsurance transaction, effective January 1, 2021, through a Funds at Lloyds syndicate ("FAL"). The maximum loss exposure in the transaction is approximately $2.9 millionand covers all risks written by the syndicate during the 2021 calendar year. On November 12, 2020, FGRe initially funded a trust account at Lloyd'swith approximately $2.4 millionin cash to collateralize its obligations under the contract. Effective April 1, 2021FGRe entered into its second reinsurance contract with a leading insurtech company that provides automotive insurance utilizing driver monitoring to predictively segment and price drivers. FGRe's exposure is limited by a loss-cap stipulated within the quota-share
FG FINANCIAL GROUP, INC.Asset Management FGSC serves as an investment advisor to FedNat under the investment advisory agreement entered into at the closing of the Asset Sale. The Company has also formed Fundamental Global Asset Management, LLC("FGAM"), a joint venture with a wholly owned subsidiary of FG, to sponsor investment advisors that will manage private funds ranging the full spectrum of alternative equities, fixed income, private equity and real estate. In September 2020, the joint venture sponsored the launch of FG Special Situations Fundvia an investment of $5.0 million. Approximately $4.0 millionof this investment represented the sponsorship of our first special purpose acquisition company, or "SPAC". Insurance FGRe is currently in the process of establishing and seeking regulatory approvals for a Risk Retention Group("RRG") to be domiciled in the State of Vermontfor the purpose of providing directors and officers insurance coverage to special purpose acquisition vehicles. The Company expects to obtain the necessary regulatory approvals for the RRG in the fourth quarter of 2021. FGRe also anticipates providing capital, along with other participants, to facilitate the underwriting of such insurance coverage. The Company will focus on fee income derived from originating, underwriting, and servicing the insurance business, while mitigating our financial risk with external reinsurance partners. SPAC Platform
December 21, 2020, we formed FG SPAC Solutions LLC("FGSS"), a Delawarecompany, to facilitate the launch of our "SPAC Platform". Under the SPAC Platform, we plan to provide various strategic, administrative, and regulatory support services to newly formed SPACs for a monthly fee. The Company co-founded a partnership, FG SPAC Partners, LP("FGSP") to participate as a co-sponsor for newly formed SPACs. The Company also participates in the risk capital investments associated with the launch of such SPACs through its Asset Management business, specifically FG Special Situations Fund, LP. The first transaction entered into under the SPAC Platform occurred on January 11, 2021, by and among FGSS and Aldel Investors, LLC, the sponsor of Aldel Financial, Inc. ("Aldel"), a special purpose acquisition company which consummated its initial public offering on April 12, 2021. Under the services agreement between FGSS and Aldel Investors, LLC(the "Agreement"), FGSS has agreed to provide certain accounting, regulatory, strategic advisory, and other administrative services to Aldel, which include assistance with negotiations with a potential merger target for the SPAC as well as assistance with the de-SPAC process. Additional information regarding our formation of FGSS and our SPAC Platform can be found in Note 10 - Related Party Transactions under the heading "Formation of FG
Impact of the coronavirus pandemic (COVID-19)
We continue to monitor the recent outbreak of the novel coronavirus (COVID-19)
on our operations.
Given the ongoing and dynamic nature of the circumstances, it is difficult to predict the full impact of the COVID-19 pandemic on our business. Adverse events such as health-related concerns about working in our offices, the inability to travel and other matters affecting the general work environment have negatively impacted and could continue to harm our business and our business strategy. The extent to which our operations and investments may continue to be impacted by the COVID-19 pandemic will depend largely on future developments, which are highly uncertain and cannot be accurately predicted, including new developments concerning the severity of the pandemic and actions by government authorities to contain the pandemic or treat its impact. Furthermore, the impacts of a potential worsening of global economic conditions and the continued disruptions to and volatility in the financial markets remain unknown. In the event of a major disruption caused by the pandemic, we may lose the services of our employees, experience system interruptions or face challenges accessing the capital or credit markets, which could lead to diminishment of our business operations. Any of the foregoing could harm our business and delay the implementation of our business strategy.
Critical accounting estimates and assumptions
Critical accounting policies are those that require us to make significant judgments, estimates or assumptions that affect amounts reported in our financial statements or the notes thereto. We base our judgments, estimates and assumptions on current facts, historical experience and various other factors that we believe to be reasonable and prudent. Actual results may differ materially from these estimates. The business and economic uncertainty resulting from the novel coronavirus (COVID-19) pandemic has made such estimates and assumptions difficult to calculate. Set forth below is a summary of what we believe to be our most critical accounting policies and estimates. 31
FG FINANCIAL GROUP, INC.Discontinued Operations
Due to the sale of all of the issued and outstanding equity of Maison, MMI and ClaimCor on
December 2, 2019, these operations have been classified as discontinued operations in the Company's financial statements presented herein. For the nine months ended September 30, 2021, we recognized a gain from the sale of the Maison Business of approximately $145,000. This was related to a final true-up and settlement in the current quarter, for income taxes due to the Company under the sale agreement. Valuation of Investments
The Company's equity securities are recorded at fair value using observable inputs such as quoted prices in both active and inactive markets, quoted prices in active markets for similar instruments, benchmark interest rates, broker quotes and other relevant inputs. Certain of the Company's equity securities do not trade on established markets and are thus valued using unobservable inputs and other valuation approaches such as an income or market approach and are accordingly classified as Level 3 valuation inputs under the fair value hierarchy established by the
Financial Accounting and Standards Board. Due to the inherent uncertainty of valuations, the fair values reflected in the financial statements as of the measurement date may differ materially from: 1) values that would have been used had a readily available market existed for these investments; and 2) the values that may ultimately be realized upon sale of the investments.
Any change in the estimated fair value of its investments could impact the amount of unrealized gain or loss the Company has recorded, which could change the amount the Company has recorded for its investments and on its consolidated balance sheets and statements of income.
Gains and losses realized on the disposition of investments are determined on the basis of
on a first in, first out basis and credited or charged to the consolidated accounts
statement of operations and comprehensive income.
The Company performs a quarterly analysis of its investment portfolio to
determine if declines in market value are other than temporary. Further away
information regarding its detailed analysis and the factors taken into account in
the establishment of a lasting depreciation on an investment is discussed
in Note 4 – Investments, of the appendix to the consolidated financial statements.
Variable Interest Entities The determination of whether or not to consolidate a variable interest entity under GAAP requires a significant amount of judgment concerning the degree of control over an entity by its holders of variable interests. To make these judgments, management has conducted an analysis, on a case-by-case basis, of whether we are the primary beneficiary and are therefore required to consolidate the entity. Upon the occurrence of certain events, such as modifications to organizational documents and investment management agreements, management will reconsider its conclusion regarding the status of an entity as a variable interest entity.
Valuation of Net Deferred Taxes
The provision for income taxes is calculated based on the expected tax treatment of transactions recorded in the Company's consolidated financial statements. In determining its provision for income taxes, the Company interprets tax legislation in a variety of jurisdictions and makes assumptions about the expected timing of the reversal of deferred income tax assets and liabilities and the valuation of net deferred income taxes. The ultimate realization of the deferred income tax asset balance is dependent upon the generation of future taxable income during the periods in which the Company's temporary differences reverse and become deductible. A valuation allowance is established when it is more likely than not that all or a portion of the deferred income tax asset balance will not be realized. In determining whether a valuation allowance is needed, management considers all available positive and negative evidence affecting specific deferred income tax asset balances, including the Company's past and anticipated future performance, the reversal of deferred income tax liabilities, and the availability of tax planning strategies. To the extent a valuation allowance is established in a period, an expense must be recorded within the income tax provision in the consolidated statements of income and comprehensive income. 32
FG FINANCIAL GROUP, INC.
Recognition of premium income
The Company participates in a quota share contract under a Funds at Lloyds ("FAL") transaction and estimates the ultimate premiums for the contract period. These estimates are based on information received from the ceding companies, whereby premiums are recorded as written in the same periods in which the underlying insurance contracts are written and are based on cession statements from cedents. These statements are received quarterly, in arrears and thus for any reporting lag, premiums written are estimated based on the portion of the ultimate estimated premiums relating to the risks underwritten during the lag period. Premium estimates are reviewed by management periodically. Such review includes a comparison of actual reported premiums to expected ultimate premiums. Based on management's review, the appropriateness of the premium estimates is evaluated, and any adjustments to these estimates are recorded in the period in which they are determined. Changes in premium estimates, including premiums receivable, are not unusual and may result in significant adjustments in any period. A significant portion of amounts included in the caption "Reinsurance balances receivable" in the Company's consolidated balance sheets represent estimated premiums written, net of commissions, brokerage, and loss and loss adjustment expense, and are not currently due based on the terms of the underlying contracts. Premiums written are generally recognized as earned over the contract period in proportion to the risk covered. Additional premiums due on a contract that has no remaining coverage period are earned in full when written. Unearned premiums represent the unexpired portion of reinsurance provided. Policy Acquisition Costs
Policy acquisition costs are costs that vary with, and are directly related to, the successful production of new and renewal business, and consist principally of commissions, taxes, and brokerage expenses. If the sum of a contract's expected losses and loss expenses and deferred acquisition costs exceeds associated unearned premiums and expected investment income, a premium deficiency is determined to exist. In this event, deferred acquisition costs are written off to the extent necessary to eliminate the premium deficiency. If the premium deficiency exceeds deferred acquisition costs, then a liability is accrued for the excess deficiency. There were no premium deficiency adjustments recognized during the periods presented herein.
Losses and provisions for loss adjustment costs
Loss and loss adjustment expense reserve estimates are based on estimates derived from reports received from ceding companies. These estimates are periodically reviewed by the Company's management and adjusted as necessary. Since reserves are estimates, the final settlement of losses may vary from the reserves established and any adjustments to the estimates, which may be material, are recorded in the period they are determined. Loss estimates may also be based upon actuarial and statistical projections, an assessment of currently available data, predictions of future developments, estimates of future trends and other factors. The final settlement of losses may vary, perhaps materially, from the reserves recorded. All adjustments to the estimates are recorded in the period in which they are determined.
U.S.GAAP does not permit establishing loss reserves, which include case reserves and IBNR loss reserves, until the occurrence of an event which may give rise to a claim. As a result, only loss reserves applicable to losses incurred up to the reporting date are established, with no allowance for the establishment of loss reserves to account for expected future loss events. Generally, the Company obtains regular updates of premium and loss related information for the current and historical periods, which are utilized to update the initial expected loss ratio. We also experience lag between (i) claims being reported by the underlying insured to the Company's cedent and (ii) claims being reported by the Company's cedent to the Company. This lag may impact the Company's loss reserve estimates. Client reports have pre-determined due dates (for example, thirty days after each month end). As a result, the lag depends in part upon the terms of the specific contract. The timing of the reporting requirements is designed so that the Company receives premium and loss information as soon as practicable once the client has closed its books. Accordingly, there should be a short lag in such reporting. Additionally, most of the contracts that have the potential for large single event losses have provisions that such loss notifications are provided to the Company immediately upon the occurrence of an event. 33 FG FINANCIAL GROUP, INC.
Stock-based compensation expense
The Company uses the fair-value method of accounting for stock-based compensation awards granted. The Company determines the fair value of the stock options on their grant date using the Black-Scholes option pricing model and determines the fair value of restricted stock units ("RSUs") on their grant date using the fair value of the Company's common stock on the date the RSUs were issued (for those RSU which vest solely based upon the passage of time), as well as using multiple
Monte Carlosimulations for those RSUs with market-based vesting conditions. The fair value of these awards is recorded as compensation expense over the requisite service period, which is generally the expected period over which the awards will vest, with a corresponding increase to additional paid-in capital. When the stock options are exercised, or correspondingly, when the RSUs vest, the amount of proceeds together with the amount recorded in additional paid-in capital is recorded in shareholders' equity.
New accounting statements
See Note 3 - "Recently Adopted and Issued Accounting Standards" to the consolidated financial statements included in Part I, Item 1 of this report for a discussion of recent accounting pronouncements and their effect, if any,
on the Company.
Financial situation analysis
The following table summarizes the Company’s investments in equity securities such as
Gross Gross Unrealized Unrealized ($ in thousands) Cost Basis Gains Losses Carrying Amount As of
September 30, 2021FNHC common stock $ 20,751$ - $ 17,187$ 3,564 SPAC investments 19 - - 19 Private placements 10,469 5,120 - 15,589 Total equity securities $ 31,239 $ 5,120 $ 17,187$ 19,172 As of December 31, 2020FNHC common stock $ 20,751$ - $ 12,209$ 8,542 Private placements 4,012 - - 4,012 Total equity securities $ 24,763$ - $ 12,209$ 12,554 FedNat Common Stock On December 2, 2019, the Company received 1,773,102 shares of FedNat Holding Company common stock (Nasdaq: FNHC), along with $25.5 millioncash as consideration for the Asset Sale. On July 14, 2020, the Company transferred 156,000 shares of FedNat common stock to FGRe, a wholly-owned subsidiary of the Company, as a capital contribution for no consideration, and, on September 15, 2020, the Company transferred 330,231 shares of FedNat common stock to the Hale Parties as further discussed in Note 10 - "Related Party Transactions". Following the transactions, the Company directly holds 1,286,871 shares of FedNat common stock. As of November 10, 2021, the estimated fair value of the 1,442,871 shares of FedNat common stock held in the aggregate by the Company and its subsidiary was $3.2 million. SPAC Investments SPAC investments consist of the public equity of newly formed special purpose acquisition companies held by the Fund. The investments typically consist of one share of common stock of the SPAC, along with one-half of one redeemable warrant entitling the holder to purchase one share of common stock at an exercise price of $11.50per share, although the number of warrants and/or the exercise price of the warrant may vary. The investments are typically issued by the SPAC as a combined unit consisting of both the common stock and warrant at a price of $10.00per unit however the offering price may also vary. Following the initial public offering of the SPAC, these units are separated into individual shares of common stock and warrants. The SPAC investments which we have purchased trade on either of the Nasdaq Stock Marketor New York Stock Exchange. 34 FG FINANCIAL GROUP, INC. Private Placements
Private placements typically consist of the private equity and risk capital associated with the sponsorship of SPACs and are also held by the Fund. In
September 2020, the Company invested $5.0 millioninto its joint venture, Fundamental Global Asset Management, LLC("FGAM"), to capitalize FG Special Situations Fund Advisor, LLC(the "Advisor"), a Delawarelimited liability company formed on September 2, 2020, and to sponsor the launch of the Fund. FGAM has invested in the Fund through the Fund's general partner and the Advisor, both of which are ultimately controlled by Mr. Cerminara, the Chairman of the Company's Board of Directors. Of the initial $5.0 millioninvestment, approximately $4.0 millionwas used by FG New America Investors, LLC(the "Sponsor") as part of a total $8.6 millionof risk capital used to launch FG New America Acquisition Corp("FGNA"), a special purpose acquisition company which consummated its initial public offering on October 2, 2020. On July 20, 2021, FGNA completed its definitive business combination with Opportunity Financial, LLCand began operating as OppFi Inc. ("OppFi"), with OppFi's common stock trading on the NYSE under the ticker symbol "OPFI". The Fund's specific investment consists of both class A and class A-1 interests of the Sponsor. On July 15, 2021, the Sponsor entered into a sponsor forfeiture agreement with FGNA and Opportunity Financial, LLC, under which the Sponsor agreed to forfeit a portion of FGNA Class B common stock as well as a portion of warrants to purchase FGNA Class A common stock which the Sponsor previously held. As a result, as of July 20, 2021, the class A and class A-1 interests represent a potential beneficial ownership of approximately 0.86 million common shares of OppFi as well as approximately 0.36 million warrants to purchase common shares of OppFi at a price of $11.50per share. The class A and class A-1 interests have not been registered under the Securities Act of 1933, as amended, and are not transferrable except as provided for in the operating agreement of the Sponsor. The Company has determined that its investment in the Fund represents an investment in a variable interest entity ("VIE") in which the Company is the primary beneficiary and as such, has consolidated the financial results of the Fund as of September 30, 2021. At each reporting date, the Company assesses whether it is the primary beneficiary and will consolidate or deconsolidate accordingly. For the nine months ended September 30, 2021, the Company invested an additional $1.65 millioninto the Fund and the Fund also received outside investment of approximately $4.1 million, resulting in the presentation of noncontrolling interests in the Company's consolidated balance sheet as of September 30, 2021. A portion of this additional investment was used by the Fund to sponsor its second SPAC via an investment of $1.65 millionin Aldel Investors, LLC, the sponsor of Aldel Financial, Inc. (NYSE: ADF). Of the total $1.65 millionthe Fund invested in Aldel, $1.0 millionwas allocated to the Company, with the remaining $0.65 millionallocated to noncontrolling interests. On August 17, 2021, Aldel entered into a business combination agreement with The Hagerty Group, LLC, a specialty vehicle and marine insurer ("Hagerty"). Under the agreement, Aldel has agreed to acquire all of Hagerty' s limited liability company interests, for $3 billion, less certain transaction expenses, in aggregate consideration, consisting of Aldel and Hagerty equity securities and up to $500 millionin cash. The Company's investment in Aldel Investors, LLC, through the Fund represents a beneficial interest in approximately 286,000
Aldel shares. Additionally, in the third quarter 2021, the Fund invested approximately
$4.8 millionin a private placement not related to the sponsorship of a SPAC, but which instead seeks to benefit from the underlying publicly traded stock which it owns. Of the total $4.8 millioninvested by the Fund, approximately $1.5 millionhas been allocated to the Company. Other Investments
Other investments consist, in part, of equity investments made in privately held companies accounted for under the equity method. Equity method investments include our investment of
$4.0 millionin FGI Metrolina Property Income Fund, LP("Metrolina"), which invests in real estate through a real estate investment trust which is wholly owned by Metrolina. The Company, a limited partner of Metrolina, does not have a controlling interest, but exerts significant influence over the entity's operating and financial policies as it owns an economic interest of approximately 52% as of September 30, 2021. We have recorded equity method earnings from our investment in Metrolina of approximately $137,000and $61,000and for each of the nine months ended September 30, 2021and 2020, respectively. The carrying value of our investment in Metrolina as of September 30, 2021was approximately $4.83 million. In the third quarter, 2021, Metrolina announced it would be liquidating and returning capital to its investors. Accordingly, on November 11, 2021, we received approximately $4.4 millionin cash back from the Fund, representing our initial investment of $4.0 millionplus approximately $0.4 millionin distributed earnings. We anticipate receiving additional earnings from Metrolina in the fourth quarter of 2021, based upon the final net asset value calculated by Metrolina as of November 30, 2021. Equity method investments also include our investment in FG SPAC Partners, LP("FGSP"). On January 4, 2021, FGSP was formed as a Delawarelimited partnership to co-sponsor newly formed SPACs with their founders or partners. The Company is the sole managing member of the general partner of FGSP and holds an approximate 49% limited partner interest in FGSP directly and through its subsidiaries. Certain of our directors and officers also hold limited partner interests in FGSP. Mr. Swetsholds a limited partner interest through Itasca Financial LLC, an advisory and investment firm for which Mr. Swetsis managing member. Mr. Baqaralso holds a limited partner interest through Sequoia Financial LLC, an advisory firm for which Mr. Baqaris managing member. Mr. Cerminaraalso holds a limited partner interest through Fundamental Global, LLC, a holding company for which Mr. Cerminarais the manager and one of the members. We have recorded equity method earnings from our investment in FGSP of approximately $2.39 millionfor the nine months ended September 30, 2021. The carrying value of our investment in FGSP as of September 30, 2021was approximately $2.46 million, representing $2.39 millionin undistributed earnings. 35 FG FINANCIAL GROUP, INC.On January 11, 2021, FGSP purchased 1,075,000 founder shares from Aldel, for total consideration of $4,674. On March 25, 2021, FGSP entered into a forfeiture agreement with Aldel whereby FGSP agreed to transfer 575,000 of these founder shares back to Aldel at no cost. Concurrent with Aldel's initial public offering, on April 12, 2021, FGSP also purchased 650,000 warrants at a price of $0.10per warrant, each exercisable to purchase one share of Aldel's Class A common stock at an exercise price of $15.00per share (the "OTM Warrants"), for a purchase price of $65,000. In addition, as discussed above, the Company, through the Fund, has invested $1.0 millionin the risk capital of Aldel Investors, LLC, which represent beneficial ownership of approximately 286,000 Aldel founder shares. Altogether, the Company's investment represents beneficial interests of approximately 533,000 Aldel founder shares and approximately 321,000 OTM Warrants. Our Chief Executive Officer and Director, Larry G. Swets, serves as senior advisor to Aldel. Hassan R. Baqar, our Chief Financial Officer effective August 6, 2021, serves as a director and chief financial officer of Aldel. The Chairman of our Board of Directors, D. Kyle Cerminaraserves as
a director of Aldel. Other investments also consist of equity we have purchased in a limited partnership and a limited liability company for which there does not exist readily determinable fair values. The Company accounts for these investments at their cost, minus impairment, if any, plus or minus changes resulting from observable price changes in orderly transactions for identical or similar investment of the same issuer. Any profit distributions the Company receives on these investments are included in net investment income. The Company's total investment in these two entities was approximately
$483,000as of September 30, 2021. For the nine months ended September 30, 2021and 2020, the Company has received profit distributions of $73,000and $42,000on these investments, respectively, which has been included in income. Furthermore, both investments began the process of returning capital back to its investors in 2020. As of September 30, 2021, the Company has received approximately 38% of its initial $776,000investment back from these investments.
We did not record any depreciation on our investments for any of the nine
Funds deposited with reinsured companies
November 12, 2020, FGRe, our Cayman Islandsbased reinsurance subsidiary, initially funded a trust account at Lloyd'swith approximately $2.4 millionin cash, to collateralize its obligations under our quota share agreement. The quota share agreement became effective January 1, 2021. As of September 30, 2021, the balance in the trust account was $2.7 million. On October 20, 2021, we posted additional collateral in the amount of approximately $1.0 million, to support our automotive insurance quota-share agreement entered into on April 1, 2021.
Current income taxes recoverable
Current income taxes recoverable were approximately
$0as of September 30, 2021, compared to approximately $1.7 millionas of December 31, 2020, representing the estimate of both the Company's state and federal income taxes receivable as of each date. In the third quarter, 2021 we received a refund on our federal taxes in the amount of approximately $1.5 millionassociated with a carryback refund request filed for our 2018, 2017 and 2014 tax years.
Reinsurance balances receivable
Reinsurance balances receivable were
$3.4 millionas of September 30, 2021compared to $0as of December 31, 2020and represent net amounts due to the Company under our quota share agreements. As the Company estimates the ultimate premiums, loss expenses and other costs associated with these contracts, based on information received by us from the ceding companies, a significant portion of this balance is based on estimates and may not ultimately be collected by the Company. 36 FG FINANCIAL GROUP, INC.Net Deferred Taxes
Deferred income taxes reflect the net tax effects of temporary differences between carrying amounts of assets and liabilities for financial reporting purposes, as compared to the amounts used for income tax purposes. As of
September 30, 2021, the Company has gross net deferred tax assets of approximately $5.3 million; however the Company has recorded a valuation allowance against all of its deferred tax assets due to the uncertain nature surrounding our ability to realize these tax benefits in the future, resulting in a net deferred tax asset of $0as of September 30, 2021. Significant components of the Company's net deferred taxes are as follows: September 30, 2021 December 31, 2020 Deferred income tax assets: Net operating loss carryforward $ 2,824 $ 1,143 Share-based compensation 221 216 Investments 2,085 2,570 Unearned premium reserves 151 - Other 21 5 Deferred income tax assets 5,302 3,934 Less: Valuation allowance (5,015 ) (3,934 ) Deferred income tax assets net of valuation allowance $ 287 $ - Deferred income tax liabilities: Deferred policy acquisition costs $ 214 $ - Other 73 - Deferred income tax liabilities $ 287 $ - Net deferred income tax asset (liability) $
- $ -
September 30, 2021, the Company had net operating loss carryforwards ("NOLs") for federal income tax purposes of approximately $13.4 million, which may be available to offset future taxable income. The Company's NOLs expire as follows: $0.5 millionin 2039, $0.1 millionin 2040, and $1.2 millionin 2041. The remaining $11.6 millionin NOLs do not expire under current tax law.
Losses and provisions for loss adjustment costs
A significant degree of judgment is required to determine amounts recorded in the consolidated financial statements for the provision for loss and loss adjustment expense ("LAE") reserves. The process for establishing this provision reflects the uncertainties and significant judgmental factors inherent in predicting future results of both known and unknown loss events. The process of establishing the provision for loss and LAE reserves relies on the judgment and opinions of a large number of individuals, including the opinions of the Company's management, as well as the management of ceding companies and their actuaries. The COVID-19 pandemic is unprecedented, and the Company does not have previous loss experience on which to base the associated estimate for loss and loss adjustment expenses. In estimating losses, the Company may assess any of the following:
? a review of existing treaties that may provide cover and cause losses;
? general forecasts, analyzes and modeling results of catastrophes and scenarios
shared by the ceding companies;
? reviews of industry insured loss estimates and market share analyzes; and
? management's judgement.
The significant assumptions that served as the basis for the Company’s estimates
reserves for losses related to the COVID-19 pandemic and claims settlement costs include:
? the extent of coverage offered by the underlying policies, especially those
that provide for business interruption coverage; ? the regulatory, legislative, and judicial actions that could influence contract interpretations across the insurance industry; ? the extent of economic contraction caused by the COVID-19 pandemic and associated actions; and ? the ability of the cedents and insured to mitigate some or all of their losses. 37
FG FINANCIAL GROUP, INC.Under the terms of our quota share agreements, and due to the nature of claims and premium reporting, a lag exists between (i) claims being reported by the underlying insured to the Company's cedent and (ii) claims being reported by the Company's cedent to the Company. This lag may impact the Company's loss reserve estimates. The reports we receive from our cedents have pre-determined due dates. In the case of the Company's FAL contract, third quarter 2021 premium and loss information will not be made available to the Company until subsequent to the filing of this quarterly report. Thus, our third quarter results, including the loss and loss adjustment expense reserves presented herein, have been based upon a combination of first and second quarter actual results as well as full-year forecasts reported to us by the ceding companies for which we used to approximate third quarter results. The Company obtains regular updates of premium and loss related information for the current and historical periods, which are utilized to update the initial expected loss ratios on our reinsurance contracts.
Although the Company believes that its estimate of losses and claims settlement costs
the reserves are sufficient at
actual losses may ultimately differ materially from the Company’s current losses
estimates. The Company will continue to monitor the relevance of its
assumptions as new information is provided.
A summary of changes in outstanding loss and loss adjustment expense reserves for the nine months ended
September 30, 2021is as follows. There was no activity with respect to loss and loss adjustment expense reserves for the nine months ended September 30, 2020. (in thousands) 2021
January 1, gross of reinsurance $
Less reinsurance recoverable on loss and LAE expense reserves
January 1, net of reinsurance
- Incurred related to: Current year 1,893 Prior years - Paid related to: Current year (549 ) Prior years - Balance,
September 30, net of reinsurance
Plus recoverable reinsurance related to losses and provisions for LAE charges
September 30, gross of reinsurance $ 1,344Shareholders' Equity Share Repurchase Transaction On September 15, 2020, the Company entered into a Share Repurchase and Cooperation Agreement (the "Share Repurchase Agreement") with Hale Partnership Capital Management, LLCand certain of its affiliates (collectively, the "Hale Parties"), which, prior to the transaction, owned more than 18% of the Company's outstanding common stock (the "Share Repurchase Transaction"). Pursuant to the Share Repurchase Agreement, the Company agreed to purchase all of the 1,130,152 shares of the Company's common stock, owned, of record or beneficially, by the Hale Parties, in exchange for an aggregate of approximately $2.8 millionin cash and 330,231 shares of FedNat common stock previously owned by the Company (the "FedNat Shares") having an estimated fair value of approximately $2.7 millionon September 15, 2020. As acknowledged by the Hale Parties in the Share Repurchase Agreement, that certain Standstill Agreement, dated December 2, 2019, by and between FedNat Holding Company and the Company, imposes certain restrictions in respect of the FedNat Shares transferred by the Company to the Hale Parties. FedNat Holding Company is not party to, or a third-party beneficiary of, the agreement. As the total consideration paid in the Share Repurchase Transaction exceeded the fair value of the treasury shares repurchased by the Company, the Company recorded a charge of approximately $0.2 millionto general and administrative expense for the year ended December 31, 2020, representing the estimated fair value of the rights conveyed to the Company pursuant to the standstill provisions in the agreement. The fair value of the 1,130,152 shares of Company common stock, or approximately $5.2 million, was recorded to treasury stock.
8.00% Cumulative Preferred Shares, Series A
May 21, 2021, we completed the underwritten public offering of an additional 194,580 shares of our preferred stock designated as 8.00% Cumulative Preferred Stock, Series A, par value $25.00per share (the "Series A Preferred Stock"), for gross proceeds of approximately $4.9 million, before deducting underwriting commissions and offering expenses. This included the exercise in full by the underwriters of their over-allotment option to purchase up to an additional 25,380 shares, bringing the total number of Series A Preferred Stock shares outstanding to 894,580 as of September 30, 2021. 38 FG FINANCIAL GROUP, INC.Dividends on the Series A Preferred Stock are cumulative from the date of original issue and are payable quarterly on the 15th day of March, June, September and December of each year, when, as and if declared by our Board of Directors or a duly authorized committee thereof. Dividends are payable out of amounts legally available therefor at a rate equal to 8.00% per annum per $25.00of stated liquidation preference per share, or $2.00per share of Series A Preferred Stock per year. Our Board of Directors declared the third quarter 2021 dividend on the shares of Series A Preferred Stock on November 12, 2021. The Series A Preferred Stock is not redeemable prior to February 28, 2023. On and after that date, the Series A Preferred Stock will be redeemable at our option, for cash, in whole or in part, at a redemption price of $25.00per share of Series A Preferred Stock, plus all accumulated and unpaid dividends to, but not including, the date of redemption. The Series A Preferred Stock has no stated maturity and is not subject to any sinking fund or mandatory redemption. The affirmative vote of the holders of at least two-thirds of the outstanding shares of Series A Preferred Stock and each other class or series of voting parity stock will be required at any time for us to authorize, create or issue any class or series of our capital stock ranking senior to the Series A Preferred Stock with respect to the payment of dividends or the distribution of assets on liquidation, dissolution or winding up, to amend any provision of our Certificate of Incorporation so as to materially and adversely affect any rights of the Series A Preferred Stock or to take certain other actions. The Series A Preferred Stock shares trade on the Nasdaq Stock Marketunder the symbol "FGFPP". Common Stock
October 28, 2021, we closed the underwritten public offering of 652,174 shares of our common stock at a public offering price of $4.00per share. Furthermore, on November 3, 2021, the underwriters exercised their over-allotment option, closing on the sale of an additional 97,826 shares of our common stock under the same terms. The issuance, including the exercise of the over-allotment, resulted in approximately $2.5 millionin net proceeds to us, after deducting underwriting commissions and other offering expenses. On October 29, 2021, the Company announced the commencement of its previously announced rights offering to holders of its common stock. Pursuant to the terms of the rights offering, the Company distributed, to each holder of its common stock, one non-transferable subscription right to purchase 0.15 share of common stock, at a price of $4.00per whole share, for each share held as of 5:00 p.m. Eastern Timeon October 25, 2021, the record date for the rights offering. The subscription rights may be exercised at any time during the subscription period, which commenced on October 29, 2021. The rights will expire if they are not exercised by 5:00 p.m., Eastern Time, on November 29, 2021, unless the Company extends the rights offering subscription period. The Company will not issue any fractional shares of the Company's common stock in the rights offering, and subscription rights will be rounded down to the nearest whole number of shares. Stockholders are entitled to purchase, in total, up to 757,720 shares of common stock, for potential gross proceeds to the Company of approximately $3.0 million. The Company intends to use the net proceeds from this offering for working capital and other general corporate purposes. Equity Award Letter Agreement On January 18, 2021, Company and the Company's Chief Executive Officer, Larry G. Swets, Jr., entered into an Equity Award Letter Agreement (the "Letter Agreement"), pursuant to which the Company agreed to grant Mr. Swetsa future award (the "Future Award") of 370,000 stock options, restricted shares or restricted stock units, subject to the approval of an amended and/or new equity plan, among other conditions. Specifically, under the Letter Agreement, no such Future Award may be granted until there is a determination by the Compensation Committee of the specific vesting and other terms of the award, and an amended and/or new equity plan, in a form to be prepared and reviewed by the Board of Directors of the Company (the "Board"), has been approved by the Board and stockholders of the Company that authorizes a sufficient number of shares of common stock to make such Future Award. 39 FG FINANCIAL GROUP, INC.
Withdrawal of shares from the Treasury
August 19, 2021, the Board approved the retirement of all 1,281,511 common stock treasury shares owned by the Company. Accordingly, these shares have been classified as authorized, but unissued shares on the Company's balance sheet as of September 30, 2021.