10-Q 1 form10-q.htm
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UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

 

FORM 10-Q

 

(Mark One)

 

QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

 

For the Quarterly Period Ended September 30, 2022

 

Or

 

TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

 

Commission File Number: 001-36366

 

FG Financial Group, Inc.

(Exact name of registrant as specified in its charter)

 

 

Delaware   46-1119100

(State or other jurisdiction of

incorporation or organization)

 

(I.R.S. Employer

Identification No.)

 

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

(Address of principal executive offices and zip code)

 

(847) 773-1665

(Registrant’s telephone number, including area code)

 

Not Applicable

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

 

 

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

 

Title of each class   Trading Symbol(s)   Name of each exchange on which registered
Common Stock, $0.001 par value per share   FGF   The Nasdaq Stock Market LLC
8.00% Cumulative Preferred Stock, Series A, $25.00 par value per share   FGFPP   The Nasdaq Stock Market LLC

 

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

 

Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit such files). Yes ☒ No ☐

 

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

 

Large accelerated filer ☐ Accelerated filer ☐ Non-accelerated filer Smaller Reporting Company  Emerging Growth Company 

 

If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. ☐

 

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

 

The number of shares outstanding of the registrant’s common stock as of November 9, 2022 was 9,394,040.

 

 

 

 

 

 

Table of Contents

 

PART I. FINANCIAL INFORMATION 3
   
ITEM 1. FINANCIAL STATEMENTS 3
   
ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS 25
   
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK 33
   
ITEM 4. CONTROLS AND PROCEDURES 33
   
PART II. OTHER INFORMATION 34
   
ITEM 1. LEGAL PROCEEDINGS 34
   
ITEM 1A. RISK FACTORS 34
   
ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS 34
   
ITEM 3. DEFAULTS UPON SENIOR SECURITIES 34
   
ITEM 4. MINE SAFETY DISCLOSURES 34
   
ITEM 5. OTHER INFORMATION 34
   
ITEM 6. EXHIBITS 34
   
SIGNATURES 35

 

2

 

 

PART I. FINANCIAL INFORMATION

 

ITEM 1. FINANCIAL STATEMENTS

 

FG FINANCIAL GROUP, INC.

Consolidated Balance Sheets

($ in thousands, except per share data)

 

  

September 30, 2022

  

December 31, 2021

 
   (unaudited)     
ASSETS          
Equity securities, at fair value (cost basis of $1,983 and $14,495, respectively)  $16   $1,421 
Other investments   22,008    14,040 
Cash and cash equivalents   9,647    15,542 
Deferred policy acquisition costs   1,920    786 
Reinsurance balances receivable   7,710    3,853 
Funds deposited for benefit of reinsured companies   6,679    4,442 
Other assets   943    745 
Total assets  $48,923   $40,829 
           
LIABILITIES          
Loss and loss adjustment expense reserves  $4,133   $2,133 
Unearned premium reserves   6,565    3,610 
Accounts payable   361    502 
Other liabilities   172    575 
Total liabilities  $11,231   $6,820 
           
Commitments and contingencies (Note 10)   -    - 
           
SHAREHOLDERS’ EQUITY          
Series A Preferred Shares, $25.00 par and liquidation value, 1,000,000 shares authorized; 894,580 shares issued and outstanding as of September 30, 2022 and December 31, 2021  $22,365   $22,365 
Common stock, $0.001 par value; 100,000,000 shares authorized; 9,394,040 and 6,497,205 shares issued and outstanding as of September 30, 2022 and December 31, 2021, respectively   9    6 
Additional paid-in capital   50,104    46,037 
Accumulated deficit   (34,786)   (34,399)
Total shareholders’ equity   37,692    34,009 
Total liabilities and shareholders’ equity  $48,923   $40,829 

 

See accompanying notes to consolidated financial statements

 

3

 

 

FG FINANCIAL GROUP, INC.

Consolidated Statements of Operations

($ in thousands, except per share data)

(Unaudited)

 

   2022   2021   2022   2021 
  

Three months ended

September 30,

  

Nine months ended

September 30,

 
   2022   2021   2022   2021 
Revenue:                    
Net premiums earned  $4,383   $1,099   $9,809   $2,221 
Net investment income (loss)   11,174    (1,299)   5,114    2,792 
Other income   214    67    266    146 
Total revenue   15,771    (133)   15,189    5,159 
                     
Expenses:                    
Net losses and loss adjustment expenses   2,406    1,058    5,798    1,893 
Amortization of deferred policy acquisition costs   1,109    202    2,427    633 
General and administrative expenses   2,001    3,000    6,009    6,698 
Total expenses   5,516    4,260    14,234    9,224 
                     
Income (loss) from continuing operations before income taxes   10,255    (4,393)   955    (4,065)
Income tax expense (benefit)                
Net income (loss) from continuing operations  $10,255   $(4,393)  $955   $(4,065)
Discontinued operations:                    
Gain from sale of the Maison Business, net of taxes               145 
Net income (loss)   10,255    (4,393)   955    (3,920)
Gain attributable to noncontrolling interests       569        1,235 
Dividends declared on Series A Preferred Shares   447    448    1,342    1,245 
Income (loss) attributable to FG Financial Group, Inc. common shareholders  $9,808   $(5,410)  $(387)  $(6,400)
                     
Basic and diluted net income (loss) per common share:                    
Continuing operations  $1.05   $(1.08)  $(0.05)  $(1.31)
Discontinued operations               0.03 
Basic and Diluted earning per share  $1.05   $(1.08)  $(0.05)  $(1.28)
                     
Weighted average common shares outstanding:                    
Basic and diluted   9,333,709    5,032,615    7,564,017    5,012,139 

 

See accompanying notes to consolidated financial statements

 

4

 

 

FG FINANCIAL GROUP, INC.

Consolidated Statements of Shareholders’ Equity

(Unaudited)

($ in thousands)

 

   Shares
Out-standing
   Amount   Shares
Out-standing
   Amount   Shares
Out-standing
   Amount   Paid-in
Capital
   Accumulated
Deficit
   to FG Financial Group, Inc.   Non-controlling Interests 
   Preferred Stock   Common Stock   Treasury Stock           Total Shareholders’ Equity attributable      
   Shares
Out-standing
   Amount   Shares
Out-standing
   Amount   Shares
Out-standing
   Amount   Paid-in
Capital
   Accumulated
Deficit
   to FG Financial Group, Inc.   Non-controlling Interests 
Balance, January 1, 2021   700,000   $17,500    4,988,310   $6    1,281,511   $(6,185)  $47,065   $(24,193)  $34,193   $ 
Stock based compensation           22,067                       177        177     
Dividends declared on Series A Preferred Shares ($0.50 per share)                               (350)   (350)    
Interests issued for contributed cash                                       657 
Net income (loss)                               34    34    (1)
Balance, March 31, 2021   700,000   $17,500    5,010,377   $6    1,281,511   $(6,185)  $47,242   $(24,509)  $34,054   $656 
                                                   
Series A Preferred Share issuance   194,580    4,865                    (648)       4,217     
Stock based compensation                           70        70     
Dividends declared on Series A Preferred Shares ($0.50 per share)                               (447)   (447)    
Net (loss) income                               (227)   (227)   667 
Balance, June 30, 2021   894,580   $22,365    5,010,377   $6    1,281,511   $(6,185)  $46,664   $(25,183)  $37,667   $1,323 
                                                   
Retirement of Treasury Stock               (1)   (1,281,511)   6,185    (6,184)            
Stock based compensation           41,094                129        129     
Dividends declared on Series A Preferred Shares ($0.50 per share)                               (448)   (448)    
Interests issued for contributed cash                                       3,490 
Net (loss) income                               (4,962)   (4,962)   569 
Balance, September 30, 2021   894,580   $22,365    5,051,471   $5       $   $40,609   $(30,593)  $32,386   $5,382 
                                                   
Balance, January 1, 2022   894,580   $22,365    6,497,205   $6       $   $46,037   $(34,399)  $34,009   $ 
Stock based compensation           30,796    1            62        63     
Dividends declared on Series A Preferred Shares ($0.50 per share)                               (447)   (447)    
Net loss                               (3,823)   (3,823)    
Balance, March 31, 2022   894,580   $22,365    6,528,001   $7       $   $46,099   $(38,669)  $29,802   $ 
                                                   
Common stock issuance           2,750,000    2            3,781        3,784     
Stock based compensation                           53        52     
Dividends declared on Series A Preferred Shares ($0.50 per share)                               (447)   (447)    
Net loss                               (5,478)   (5,478)    
Balance, June 30, 2022   894,580   $22,365    9,278,001   $9       $   $49,933   $(44,594)  $27,713   $ 
                                                   
Common stock issuance           71,770                106        106     
Stock based compensation           44,269                65        65     
Dividends declared on Series A Preferred Shares ($0.50 per share)                               (447)   (447)    
Net income                               10,255    10,255     
Balance, September 30, 2022   894,580   $22,365    9,394,040   $9       $   $50,104   $(34,786)  $37,692   $ 

 

See accompanying notes to consolidated financial statements

 

5

 

 

FG FINANCIAL GROUP, INC.

Consolidated Statements of Cash Flows

(Unaudited)

(in thousands)

 

   2022   2021 
   Nine months ended September 30, 
   2022   2021 
Cash flows from operating activities:          
Net income (loss)  $955   $(3,920)
Adjustments to reconcile net income (loss) to net cash used by operating activities:          
Net unrealized holding (gain) on equity investments   (10,521)   (2,670)
(Income) loss from equity method investments, net of distributions
received
   (2,880)   - 
Net realized loss on sale of equity investments   11,263    4 
Stock compensation expense   180    376 
Purchase of investments by consolidated investment
company subsidiary
       (6,479)
Changes in operating assets and liabilities:          
Current income taxes recoverable       1,724 
Reinsurance balances receivable   (3,857)   (3,364)
Amounts held on deposit with reinsured companies   (2,237)   (274)
Deferred policy acquisition costs   (1,134)   (1,017)
Other assets and receivables   (121)   (344)
Loss and loss adjustment expense reserves   2,000    1,344 
Unearned premium reserves   2,955    3,599 
Accounts payable and other liabilities   (544)   627 
Net cash used by operating activities   (3,941)   (10,394)
           
Cash flows from investing activities:          
Purchases of furniture and equipment   (77)   (10)
Purchases of equity method investments   (6,795)   (73)
Distribution from equity method investments   1,521     
Proceeds from sales of equity securities   664     
Return of capital – other investments   185    155 
Net cash (used) provided by investing activities   (4,502)   72 
           
Cash flows from financing activities:          
Payment of dividends on preferred shares   (1,341)   (1,245)
Proceeds from issuance of preferred stock, net       4,217 
Proceeds from issuance of common stock, net   3,889     
Cash contributions from non-controlling interests       4,147 
Net cash provided by financing activities   2,548    7,119 
           
Net decrease in cash and cash equivalents   (5,895)   (3,203)
Cash and cash equivalents at beginning of period   15,542    12,132 
Cash and cash equivalents at end of period  $9,647   $8,929 

 

See accompanying notes to consolidated financial statements.

 

6

 

 

FG FINANCIAL GROUP, INC.

Notes to Consolidated Financial Statements

 

Note 1. Nature of Business

 

FG Financial Group, Inc. (“FGF”, the “Company”, “we”, or “us”) is a reinsurance and asset management holding company. We focus on opportunistic collateralized and loss capped reinsurance, while allocating capital in partnership with Fundamental Global®, and from time to time, other strategic investors, to merchant banking activities. The Company’s principal business operations are conducted through its subsidiaries and affiliates. The Company also provides asset management services. From our inception in October 2012 through December 2019, we operated as an insurance holding company, writing property and casualty insurance throughout the states of Louisiana, Florida, and Texas. On December 2, 2019, we sold our three former insurance subsidiaries, and embarked upon our current strategy focused on reinsurance and asset management.

 

As of September 30, 2022, Fundamental Global GP, LLC, a private partnership focused on long-term strategic holdings (“FG”), and its affiliated entity, collectively beneficially owned approximately 60.0% of our 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 Insurance Business

 

On December 2, 2019, we completed the sale (“Asset Sale”) of our insurance subsidiaries to FedNat Holding Company for a combination of cash and FedNat common stock. As of September 30, 2022, the Company held 137,871 shares of FedNat common stock. On October 2, 2022, the Company sold the remaining FedNat common stock shares held for approximately $30,000 of net proceeds.

 

Current Business

 

Our strategy has evolved to focus on opportunistic collateralized and loss capped reinsurance, with capital allocation to merchant banking activities. As part of our refined focus, we have adopted the following capital allocation philosophy:

 

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

 

Currently, the business operates as a diversified holding company of insurance, reinsurance, asset management and our “Special purpose acquisition corporation (“SPAC”) Platform” businesses.

 

Insurance

 

We are in the process of establishing a Risk Retention Group (“RRG”) for the purpose of providing directors and officers insurance coverage to SPAC vehicles. We intend to provide 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.

 

Reinsurance

 

The Company’s wholly owned reinsurance subsidiary, FG Reinsurance Ltd. (“FGRe”), a Cayman Islands limited liability company, provides specialty property and casualty reinsurance. FGRe has been granted a Class B (iii) insurer license in accordance with the terms of The Insurance Act (as revised) of the Cayman Islands and underlying regulations thereto and is subject to regulation by the Cayman Islands Monetary Authority (the “Authority”). The terms of the license 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. FGRe participates in a Funds at Lloyds (“FAL”) syndicate covering risks written by the syndicate during the 2021 and 2022 calendar years. On April 1, 2021, FGRe entered its second reinsurance contract with a leading insurtech company that provides automotive insurance utilizing driver monitoring to predictively segment and price drivers. In addition to renewing this contract for a second year, the Company added a second agreement with the automotive insurance provider as of April 1, 2022. Beginning January 1, 2022, FGRe participates in a quota share reinsurance contact with a startup homeowners’ insurance company. On April 1, 2022, FGRe entered a homeowners’ property catastrophe excess of loss reinsurance contract with a specialty insurance company covering loss occurrences from named tropical storms arising out of the Atlantic. On July 1, 2022, FGRe entered a contract with a specialty insurance company that provides hired and non-owned automotive insurance. These agreements limit exposure by loss-caps stipulated within the reinsurance contracts.

 

Asset Management

 

Pursuant to the Investment Advisory Agreement, FG Strategic Consulting, LLC (“FGSC”) a wholly-owned subsidiary of the Company has agreed to provide investment advisory services to FedNat, including 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.

 

7

 

 

FG FINANCIAL GROUP, INC.

Notes to Consolidated Financial Statements

 

SPAC Platform

 

On December 21, 2020, we formed FG Management Solutions LLC (“FGMS”), formerly known as FG SPAC Solutions LLC, a Delaware company, to facilitate the launch of our “SPAC Platform”. Under the SPAC Platform, we provide various strategic, administrative, and regulatory support services to newly formed SPACs for a monthly fee. Additionally, the Company co-founded a partnership, FG Merchant Partners, LP (“FGMP”), formerly known as FG SPAC Partners, LP, 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. (“Fund”). As discussed in Note 4, the Company had consolidated the results of the Fund through November 30, 2021; however, effective December 1, 2021, the Company began accounting for its investment in the Fund under the equity method. The first transaction entered under the SPAC Platform occurred on January 11, 2021, by and among FGMS and Aldel Investors, LLC, the sponsor of Aldel Financial, Inc. (“Aldel”), a special purpose acquisition company which completed its business combination with Hagerty (NYSE: HGTY) on December 2, 2021. Under the services agreement between FGMS and Aldel Investors, LLC (the “Agreement”), FGMS provided accounting, regulatory, strategic advisory, and other administrative services to Aldel, which included assistance with negotiations with potential merger targets for the SPAC as well as assistance with the de-SPAC process.

 

In March and April 2022, the Company continued to build upon its SPAC Platform strategy. On March 3, 2022, FG Merger Corp. (“FG Merger”) (Nasdaq: FGMCU) announced the closing of an $80.5 million IPO in the United States, including the exercise of the over-allotment option granted to the underwriters in the offering. Similarly, on April 5, 2022, FG Acquisition Corp. (“FG Acquisition”) (TSX:FGAA.V), announced the closing of a $115 million IPO in Canada, including the exercise of the over-allotment option granted to the underwriters in the offering. The Company participated in the risk capital associated with the launch of the SPACs through its asset management business, specifically FG Special Situations Fund, LP. Mr. Cerminara, our Chairman, Larry G. Swets, Jr., our Director and Chief Executive Officer, and Hassan R. Baqar, our Executive Vice President and Chief Financial Officer, also hold financial interests in the SPACs and/or their sponsor companies. Additionally, Messrs. Cerminara, Swets, and Baqar are managers of the sponsor companies of FG Merger and FG Acquisition. Mr. Swets serves as Chairman of FG Merger, while Messrs. Baqar and Cerminara serve as Director and Senior Advisor of FG Merger, respectively. Mr. Swets serves as Chief Executive Officer and Director of FG Acquisition. Mr. Baqar serves as Chief Financial Officer, Secretary and Director of FG Acquisition. Mr. Cerminara serves as Chairman of FG Acquisition.

 

In the aggregate, the Company’s indirect exposure to FG Merger through its subsidiaries represents potential beneficial ownership of approximately 820,000 shares of FG Merger’s common stock, approximately 989,000 warrants with an $11.50 exercise price and 5-year expiration, and approximately 85,000 warrants with a $15.00 exercise price and 10-year expiration. The Company has invested approximately $2.6 million in FG Merger through its subsidiaries. The Company’s indirect exposure in FG Acquisition through its subsidiaries represents potential beneficial ownership of approximately 819,000 shares of FG Acquisition’s common stock, approximately 1,400,000 million warrants with an $11.50 exercise price and 5-year expiration (the “FGAC Warrants”), approximately 440,000 warrants with a $15 exercise price and 10-year expiration, and either (i) up to approximately an additional 1,600,000 FGAC Warrants, or (ii) up to approximately $2 million in cash, or (iii) a pro-rata combination of such FGAC Warrants and cash, based on certain adjustment provisions and the level of redemptions of FG Acquisition’s publicly traded warrants at the time of a business combination. The Company has invested approximately $3.4 million in FG Acquisition through its subsidiaries.

 

Merchant Banking

 

In Q3 2022, the Company announced the expansion of its growth strategy through the formation of a merchant banking division. Company plans to expand the addressable market beyond SPACs to encompass a larger universe of opportunities including reverse mergers and sponsoring startups. Company believes this offers enhanced flexibility to capitalize on asymmetric risk/reward opportunities.

 

Note 2. Significant Accounting Policies

 

Basis of Presentation

 

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

 

Consolidation Policies

 

The accompanying consolidated financial statements include the accounts of the Company and its subsidiaries. All significant intercompany balances and transactions have been eliminated upon consolidation.

 

The consolidated financial statements include the accounts of the Company and entities in which it is required to consolidate under either the Variable Interest Entity (“VIE”) or Voting Interest Entity (“VOE”) models. Both models require the reporting entity to identify whether it has a controlling financial interest in a legal entity and is therefore required to consolidate the legal entity. Under the VOE model, a reporting entity with ownership of a majority of the voting interest of a legal entity is generally considered to have a controlling financial interest. The VIE model was established for situations in which control may be demonstrated other than by the possession of voting rights in a legal entity and instead focuses on the power to direct the activities that most significantly impact the legal entity’s economic performance, as well as the rights to receive benefits and obligations to absorb losses that could potentially be significant to the legal entity.

 

The determination of whether a legal entity is consolidated under either model is reassessed where there is a substantive change in the governing documents or contractual arrangements of the entity, to the capital structure of the entity or in the activities of the entity. The Company continuously reassesses whether it should consolidate under either model.

 

In September 2020, the Company invested approximately $5.0 million to sponsor the launch of the Fund. The Fund, a VIE which the Company was required to consolidate through November 30, 2021, is considered an investment company for GAAP purposes and follows the accounting and reporting guidance in the Financial Accounting Standards Codification (“ASC”) Topic 946, Financial Services-Investment Companies, which includes the presentation of its investments at fair value. Beginning December 1, 2021, the Company has accounted for its investment in the Fund under the equity method of accounting.

 

See Note 4 for additional information regarding the Company’s consolidated investments.

 

8

 

 

FG FINANCIAL GROUP, INC.

Notes to Consolidated Financial Statements

 

Discontinued Operations

 

Due to the sale of all of the issued and outstanding equity of our previous insurance business 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 this business for approximately $145,000. This was related to a final true-up and settlement in the first quarter of 2021, for income taxes due to the Company under the sale agreement. The following table presents a reconciliation of the major classes of line items constituting pretax profit (loss) of discontinued operations to the after-tax profit (loss) of discontinued operations that are presented in the Company’s consolidated statement of operations for the three and nine months ended September 30, 2022 and 2021:

 

   2022   2021   2022   2021 
(in thousands) 

Three months ended

September 30,

  

Nine months ended

September 30,

 
   2022   2021   2022   2021 
Pre-tax gain (loss) on sale  $   $   $   $ 
Income tax benefit               145 
Net gain from sale of Maison Business  $   $   $   $145 

 

The Use of Estimates in the Preparation of Consolidated Financial Statements

 

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

 

Investments in Equity Securities

 

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

 

Other Investments

 

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

 

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

 

When we receive distributions from our equity method investments, we utilize the cumulative earnings approach. When classifying the related cash flows under this approach, the Company compares the cumulative distributions received, less distributions received in prior periods, with the Company’s cumulative equity in earnings. Cumulative distributions that do not exceed cumulative equity in earnings represent returns on investment and are classified as cash inflows from operating activities. Cumulative distributions in excess of cumulative equity in earnings represent returns on investment and are classified as cash inflows from investing activities.

 

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

 

Cash and Cash Equivalents

 

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

 

Pursuant to the Company’s insurance license, the Authority has required that FGRe hold a minimum capital requirement of $200,000 in cash in a bank in the Cayman Islands which holds an “A” license issued under the Banks and Trust Companies Act (2020 Revision).

 

9

 

 

FG FINANCIAL GROUP, INC.

Notes to Consolidated Financial Statements

 

Income Taxes

 

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

 

Concentration of Credit Risk

 

Financial instruments which potentially expose the Company to concentrations of credit risk include investments, cash, and deposits with reinsured companies. The Company maintains its cash with a major U.S. domestic banking institution which is insured by the Federal Deposit Insurance Corporation (“FDIC”) for up to $250,000. As of September 30, 2022 the Company held funds in excess of these FDIC insured amounts. The terms of these deposits are on demand to mitigate some of the associated risk. The Company has not incurred losses related to these deposits.

 

Premium Revenue Recognition

 

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

 

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

 

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

 

Policy Acquisition Costs

 

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

 

Funds Deposited for benefit of Reinsured Companies

 

“Funds Deposited for benefit of Reinsured Companies” on the Company’s consolidated balance sheets includes amounts held by cedents provided to support our reinsurance contracts. On November 12, 2020, FGRe, our Cayman Islands based reinsurance subsidiary, initially funded a trust account at Lloyd’s with approximately $2.4 million cash, to collateralize its obligations under a quota-share agreement with a FAL syndicate. The initial contract covered our quota-share percentage of all risks written by the syndicate for the 2021 calendar year. On November 30, 2021, we entered into an agreement with the same syndicate, slightly increasing our quota-share percentage of the risks the syndicate writes for the 2022 calendar year. This resulted in FGRe’s posting an additional $1.0 million in cash collateral to the account. In June 2022, FGRe received approximately $0.4 million in a partial return of initial collateral. During 2021, we also posted cash collateral in the approximate amount of $1.0 million, to support our automotive insurance quota-share agreement entered on April 1, 2021. We entered into an additional agreement with the same automotive insurance company on April 1, 2022, and in the third quarter of 2022, we posted additional collateral of approximately $0.2 million. In the third quarter of 2022, FGRe posted cash collateral of approximately $1.1 million and received approximately $1.5 million in premiums from the cedent, to support the homeowners’ property catastrophe excess of loss reinsurance contract that became effective April 1, 2022. The cash is held in a segregated account until such time that the Company’s liability for losses ascribed have been commuted, or all losses have been closed or settled for this contract. The named tropical storm season starts June 1, 2022 and ends November 30, 2022.

 

As of September 30, 2022, and December 31, 2021, the total cash collateral posted to support all of our reinsurance treaties was approximately $6.7 million and $4.4 million, respectively.

 

10

 

 

FG FINANCIAL GROUP, INC.

Notes to Consolidated Financial Statements

 

Loss and Loss Adjustment Expense Reserves

 

The Company maintains reserves equal to our estimated ultimate liability for losses and loss adjustment expense for reported and unreported claims from our reinsurance business. Loss and loss adjustment reserve estimates are based primarily on estimates derived from reports the Company has received from ceding companies. The Company then uses a variety of statistical and actuarial techniques to monitor reserve adequacy. When setting reserves, the Company considers many factors including: (1) the types of exposures and projected ultimate premium to be written by our cedants; (2) expected loss ratios by type of business; (3) actuarial methodologies which analyze loss reporting and payment experience, reports from ceding companies and historical trends; and (4) general economic conditions. The Company also engages independent actuarial specialists, at least annually, to assist management in establishing appropriate reserves. 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. The final settlement of losses may vary, perhaps materially, from the reserves recorded.

 

U.S. GAAP does not permit establishing loss reserves, which include case reserves and IBNR loss reserves, until the occurrence of an event which may give rise to a claim. As a result, only loss reserves applicable to losses incurred up to the reporting date are established, with no allowance for the establishment of loss reserves to account for expected future loss events.

 

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

 

Stock-Based Compensation

 

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

 

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

 

Based upon the Company’s historical forfeiture rates relating to stock options and RSUs, the Company has not made any adjustment to stock compensation expense for expected forfeitures as of September 30, 2022.

 

Fair Value of Financial Instruments

 

The carrying values of certain financial instruments, including cash, short-term investments, deposits held, accounts payable, and other liabilities approximate fair value due to their short-term nature. The Company measures the fair value of financial instruments in accordance with GAAP which defines fair value as the exchange price that would be received for an asset (or paid to transfer a liability) in the principal or most advantageous market for the asset (or liability) in an orderly transaction between market participants on the measurement date. GAAP also establishes a fair value hierarchy, which requires an entity to maximize the use of observable inputs and minimize the use of unobservable inputs when measuring fair value. See Note 4 for further information on the fair value of the Company’s financial instruments.

 

11

 

 

FG FINANCIAL GROUP, INC.

Notes to Consolidated Financial Statements

 

Earnings (Loss) Per Common Share

 

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

 

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

 

Note 3. Recently Adopted and Issued Accounting Standards

 

Accounting Standards Pending Adoption

 

ASU 2016-13: Financial Instruments – Credit Losses

 

In June 2016, the FASB issued ASU 2016-13: Financial Instruments – Credit Losses: Measurement of Credit Losses on Financial Instruments. ASU 2016-13 was issued to provide financial statement users with more useful information regarding the expected credit losses on financial instruments held as assets. Under current GAAP, financial statement recognition for credit losses on financial instruments is generally delayed until the occurrence of the loss was probable. The amendments of ASU 2016-13 eliminate this probable initial recognition threshold and instead reflect an entity’s current estimate of all expected credit losses. The amendments also broaden the information that an entity must consider in developing its expected credit loss estimates for those assets measured at amortized cost by using forecasted information instead of the current methodology which only considered past events and current conditions. Under ASU 2016-13, credit losses on certain types of financial instruments will be measured in a manner similar to current GAAP; however, the amendments require that credit losses be presented as an allowance against the financial instrument, rather than as a write-down. The amendments also allow the entity to record reversals of credit losses in current period net income, which is prohibited under current GAAP. The amendments in this update are effective for fiscal years beginning after December 15, 2019, including interim periods within those fiscal years, with early adoption permitted, however smaller reporting companies, like the Company, may delay adoption until January 2023. The Company is currently evaluating the impact of the adoption of ASU 2016-13 on its consolidated financial statements. We anticipate that the amounts we record as due to us from our cedant companies under our reinsurance contracts will be impacted by the adoption of ASU 2016-13, requiring us to record an allowance for any projected losses we may incur on these assets. The Company has begun evaluating their position by pooling contracts with shared risk characteristics, evaluating credit worthiness of the counterparties, and defining exposure through contract length, total reinsurance exposure, and collateralized position.

 

Note 4. Investments and Fair Value Disclosures

 

The following table summarizes the Company’s investments held at fair value as of September 30, 2022 and December 31, 2021:

 

(in thousands)                
As of September 30, 2022  Cost Basis  

Gross

Unrealized

Gains

  

Gross

Unrealized

Losses

  

Carrying

Amount

 
FedNat common stock  $1,983   $   $1,967   $16 
Total investments  $1,983   $   $1,967   $16 

 

As of December 31, 2021  Cost Basis  

Gross

Unrealized

Gains

  

Gross

Unrealized

Losses

  

Carrying

Amount

 
FedNat common stock  $14,495   $   $13,074   $1,421 
Total investments  $14,495   $   $13,074   $1,421 

 

FedNat Common Stock

 

As of September 30, 2022, the Company held 137,871 shares of FedNat Holding Company common stock (Nasdaq: FNHC). Of the total 1,773,102 shares of FedNat common stock which the Company had received as consideration for the Asset Sale, the Company has disposed of 1,635,231 shares. During the third quarter of 2022, the Company sold 217,500 shares of FedNat common stock on the open market. On October 2, 2022, the Company sold the remaining shares held of FedNat common stock for approximately $30,000 of net proceeds.

 

12

 

 

FG FINANCIAL GROUP, INC.

Notes to Consolidated Financial Statements

 

Deconsolidation of Subsidiary

 

The Company’s original investment in FG Special Situations Fund, LP (the “Fund”), a Delaware limited partnership, consisted of an investment as both a limited and general partner. At the time of the Company’s initial investment into the Fund, in September 2020, the Company had determined that its investment represented an investment in a variable interest entity (“VIE”) in which the Company was the primary beneficiary and as such, had consolidated the financial results of the Fund through November 30, 2021. At each reporting date, the Company evaluates whether it remains the primary beneficiary and continuously reconsiders that conclusion. On December 1, 2021, the Company no longer had the power to govern the financial and operating policies of the Fund, and accordingly derecognized the related assets, liabilities, and noncontrolling interests of the Fund as of that date. The Company did not receive any consideration in the deconsolidation of the Fund, nor did it record any gain or loss upon deconsolidation as the Company carried its investment at fair value. The assets and liabilities of the Fund, over which the Company lost control, were as follows:

 

As of December 1, 2021 (in thousands)    
Cash and cash equivalents  $100 
Investments in private placements   15,734 
Investments in public SPACs   22 
Other assets   18 
Other liabilities   (34)
Net assets deconsolidated  $15,840 

 

While the Company’s investments in the Fund are no longer consolidated, the Company has retained its interest in all of the investments held at the Fund. Accordingly, the Company has not presented its investment in the Fund as a discontinued operation. Effective December 1, 2021, the Company began accounting for its investment in the Fund via the equity method of accounting.

 

Equity Method Investments

 

Other investments on the Company’s Consolidated Balance Sheets consists of equity method investments, which as of September 30, 2022 includes our investment in FGMP and the Fund.

 

On January 4, 2021, FGMP was formed as a Delaware limited partnership to co-sponsor newly formed SPACs with their founders or partners. The Company is the sole managing member of the general partner of FGMP and holds a limited partner interest in FGMP directly and through its subsidiaries. FGMP participates as a co-sponsor of the SPACs launched under our SPAC Platform. For the nine months ended September 30, 2022, the Company has contributed $0.1 million into FGMP, and has recorded equity method gains of approximately $2.4 million. The carrying value of our investment in FGMP as of September 30, 2022 was approximately $4.9 million, all of which is in the form of undistributed earnings. Of the $4.9 million carrying value of our investment in FGMP, the Company may allocate up to approximately $1.0 million to incentivize and compensate individuals and entities for the successful merger of SPAC’s launched under our platform.

 

13

 

 

FG FINANCIAL GROUP, INC.

Notes to Consolidated Financial Statements

 

Certain investments held by our equity method investees are valued using Monte-Carlo simulation and option pricing models. Inherent in Monte-Carlo simulation and option pricing models are assumptions related to expected volatility and discount for lack of marketability of the underlying investment. Our investees estimate the volatility of these investments based on the historical performance of various broad market indices blended with various peer companies which they consider as having similar characteristics to the underlying investment, as well as consideration of price and volatility of relevant publicly traded securities such as SPAC warrants.

 

Equity method investments also include our investment in the Fund as of September 30, 2022. Until December 1, 2021, we had consolidated the Fund as a variable interest entity, however, effective December 1, 2021, we began accounting for this investment under the equity method of accounting. For the nine months ended September 30, 2022, the Company has contributed $6.7 million into the Fund, and has received distributions in the approximate amount of $3.3 million . The Company has recorded equity method gains from the Fund of approximately $3.6 million for the nine months ended September 30, 2022. As of September 30, 2022, the carrying value of our investment in the Fund was approximately $16.8 million.

 

Financial information for our investments accounted for under the equity method, in the aggregate, is as follows:

 

  

As of
September 30, 2022

   As of
December 31, 2021
 
(in thousands)          
Other investments  $33,762   $25,936 
Cash   130    72 
Other assets   39    16 
Total assets   33,931    26,024 
           
Accounts payable  $42   $19 
Other liabilities        
Total liabilities   42    19 

 

  

Nine months ended

September 30, 2022

  

Nine months ended

September 30, 2021

 
(in thousands)          
Net investment income (loss)  $8,170   $7,498 
General and administrative expenses   (95)   (143)
Net income (loss)   8,075    7,355 

 

Investments without Readily Determinable Fair Value

 

In addition to our equity method investments, other investments as listed on our balance sheet 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 $298,000 as of September 30, 2022. Both investments began returning capital to investors beginning in 2020. As of September 30, 2022, the Company has received approximately 62% of its initial $776,000 investment in these entities. There have been no upward or downward price adjustments to these investments for the nine months ended September 30, 2022 and 2021.

 

Impairment

 

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

 

14

 

 

FG FINANCIAL GROUP, INC.

Notes to Consolidated Financial Statements

 

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

 

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

 

  the opinions of professional investment managers and appraisers could be incorrect;
     
  the past operating performance and cash flows generated from the investee’s operations may not reflect their future performance; and
     
  the estimated fair values for investment for which observable market prices are not available are inherently imprecise.

 

We have not recorded an impairment on our investments for either of the nine months ended September 30, 2022 or 2021.

 

Net investment income (loss) for the three and nine months ended September 30, 2022 and 2021 is as follows:

 

   2022   2021   2022   2021 
($ in thousands)  Three Months Ended
September 30,
   Nine Months Ended
September 30,
 
   2022   2021   2022   2021 
Investment income (loss):                    
Realized loss on FedNat common stock  $(2,472)  $-   $(11,441)  $- 
Unrealized gain (loss) on FedNat common stock   2,448    (2,424)   10,521    (4,978)
Unrealized holding gain on private placement investments       4        5,120 
Equity method earnings   11,226    1,070    6,080    2,527 
Other   (28)   51    (46)   123 
Net investment income (loss)  $11,174   $(1,299)  $5,114   $2,792 

 

Fair Value Measurements

 

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

 

  Level 1 – inputs to the valuation methodology are quoted prices for identical assets or liabilities in active markets providing the most reliable measurement of fair value since it is directly observable.
     
  Level 2 – inputs to the valuation methodology which include quoted prices for similar assets or liabilities in active markets. These inputs are observable, either directly or indirectly, for substantially the full-term of the financial instrument.
     
  Level 3 - inputs to the valuation methodology which are unobservable and significant to the measurement of fair value.

 

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

 

15

 

 

FG FINANCIAL GROUP, INC.

Notes to Consolidated Financial Statements

 

We have valued our investment in FedNat at its last reported sales price as the shares are traded on a national exchange. They have been characterized in Level 1 of the fair value hierarchy.

 

Financial instruments measured, on a recurring basis, at fair value as of September 30, 2022 and December 31, 2021 in accordance with the guidance promulgated by the FASB are as follows.

 

(in thousands)                
                 
As of September 30, 2022  Level 1   Level 2   Level 3   Total 
FedNat common stock  $16   $   $   $16 
   $16   $   $   $16 
                     
As of December 31, 2021                    
FedNat common stock  $1,421   $   $   $1,421 
   $1,421   $   $   $1,421 

 

Note 5. Loss and Loss Adjustment Expense Reserves

 

A significant degree of judgment is required to determine amounts recorded in the Company’s 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 many 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 in-force treaties that may provide coverage and incur losses;
   
general forecasts, catastrophe and scenario modelling analyses and results shared by cedents;
   
reviews of industry insured loss estimates and market share analyses; and
   
management’s judgment.

 

16

 

 

FG FINANCIAL GROUP, INC.

Notes to Consolidated Financial Statements

 

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

 

the scope of coverage provided by the underlying policies, particularly 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.

 

Under the terms of certain 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 contracts, third quarter 2022 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 actual results through the second quarter 2022 as well as forecasts for the remainder of 2022 reported to us by the ceding companies. We have approximated third quarter 2022 results under our contracts based upon this historical and forecasted information.

 

While the Company believes its estimate of loss and loss adjustment expense reserves are adequate as of September 30, 2022, based on available information, actual losses may ultimately differ materially from the Company’s current estimates. The Company will continue to monitor the appropriateness of its assumptions as new information is provided.

 

A summary of changes in outstanding loss and loss adjustment expense reserves for the nine months ended September 30, 2022 and 2021, is as follows:

 

   2022   2021 
(in thousands)  Nine months ended September 30, 
   2022   2021 
Balance, beginning of period, gross of reinsurance  $2,133   $ 
Less: reinsurance recoverable on loss and LAE expense reserves        
Balance, beginning of period, net of reinsurance  $2,133   $ 
Incurred related to:        
Current year   4,984    1,893 
Prior year   814     
Paid related to:          
Current year   (2,568)   (549)
Prior years   (1,230)    
Balance, September 30, net of reinsurance  $4,133   $1,344 
Plus: reinsurance recoverable related to loss and LAE expense reserves        
Balance, September 30, gross of reinsurance  $4,133   $1,344 

 

Note 6. Income Taxes

 

A summary of income tax expense (benefit) is as follows:

 

   2022   2021 
(in thousands)  Nine months ended September 30, 
   2022   2021 
Current income tax benefit – from continuing operations  $   $ 
Current income tax benefit – from discontinued operations        
Total current income tax benefit        
           
Deferred income tax benefit – from continuing operations        
Deferred income tax benefit – from discontinued operations        
Total deferred income tax benefit        
           
Total income tax benefit – from continuing operations        
Total income tax benefit – from discontinued operations  $   $(145)
Total income tax benefit  $   $(145)

 

17

 

 

FG FINANCIAL GROUP, INC.

Notes to Consolidated Financial Statements

 

Actual income tax expense (benefit) differs from the income tax expense computed by applying the applicable effective federal and state tax rates to income before income tax expense as follows:

 

   2022   2021   2022   2021 
($ in thousands) 

Three months ended

September 30,

  

Nine months ended

September 30,

 
   2022   2021   2022   2021 
Provision for taxes at U.S, statutory marginal income tax rate of 21%  $2,154   $(923)  $201   $(854)
Valuation allowance for deferred tax assets deemed unrealizable   (2,168)   1,041    (219)   1,081 
Rate differential due to CARES Act                
Non-deductible expenses associated with the Share Repurchase Transaction   2        2    - 
Net operating loss carryback       -           
State income tax (net of federal benefit)       -        (114)
Noncontrolling interests        (119)        (259)
Share-based compensation   12         16     
Other       1         1 
Income tax expense (benefit)  $   $   $   $(145)

 

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. The Company’s gross deferred tax assets and liabilities are $7.9 million and $2.4 million as of September 30, 2022. The Company has recorded a valuation allowance against its deferred tax assets of $5.5 million, as of September 30, 2022, due to the uncertain nature surrounding our ability to realize these tax benefits in the future. Significant components of the Company’s net deferred tax assets are as follows:

 

           
(in thousands)    
  

As of

September 30, 2022

  

As of

December 31, 2021

 
Deferred income tax assets:          
Net operating loss carryforward  $3,981   $3,010 
Loss and loss adjustment expense reserves   48    25 
Unearned premium reserves   276    152 
Capital loss carryforward   2,929    1,114 
Share-based compensation   241    253 
Investments   413    1,692 
Other   3    3 
Deferred income tax assets  $7,891   $6,249 
Less: Valuation allowance   (5,496)   (5,715)
Deferred income tax assets net of valuation allowance  $2,395   $534 
           
Deferred income tax liabilities:          
Investments  $1,989   $369 
Other   3     
Deferred policy acquisition costs   403    165 
Deferred income tax liabilities  $2,395   $534 
           
Net deferred income tax asset (liability)  $   $ 

 

As of September 30, 2022, the Company had net operating loss carryforwards (“NOLs”) for federal income tax purposes of approximately $19.0 million, which will be available to offset future taxable income. Approximately $0.5 million expire on December 31, 2039, $0.1 million expire on December 31, 2040, and $1.6 million of the Company’s NOLs will expire on December 31, 2041. The remaining $16.8 million of the Company’s NOLs do not expire under current tax law. Additionally, the Company has approximately $2.9 million of capital loss carryforward that can only be used to offset capital gains and which will expire in December 2026 if not used prior.

 

As of September 30, 2022, the Company had no unrecognized tax benefits. The Company analyzed its tax positions in accordance with the provisions of Accounting Standards Codification Topic 740, Income Taxes, and has determined that there are currently no uncertain tax positions. The Company generally recognizes interest and penalties, if any, related to unrecognized tax benefits in income tax expense.

 

18

 

 

FG FINANCIAL GROUP, INC.

Notes to Consolidated Financial Statements

 

Note 7. Equity Incentive Plan Grants

 

On December 15, 2021, our shareholders approved the FG Financial Group, Inc. 2021 Equity Incentive Plan (the “2021 Plan”). The purpose of the 2021 Plan is to attract and retain directors, consultants, officers and other key employees of the Company and its subsidiaries and to provide to such persons incentives and rewards for superior performance. The 2021 Plan is administered by the Compensation and Management Resources Committee of the Board and has a term of ten years. The 2021 Plan awards may be in the form of stock options (which may be incentive stock options or nonqualified stock options), stock appreciation rights (or “SARs”), restricted shares, restricted stock units (“RSUs”), and other share-based awards, and provides for a maximum of 1,500,000 shares available for issuance.

 

As of September 30, 2022, the Company had 272,815 RSUs outstanding, 25,000 restricted shares, and 130,000 non-qualified stock options outstanding under its equity incentive plans.

 

RSUs Outstanding

 

The following table summarizes RSU activity for the nine months ended September 30, 2022 and 2021.

 

Restricted Stock Units  Number of Units  

Weighted

Average Grant Date Fair Value

 
Non-vested units, January 1, 2022   164,655   $4.35 
Granted   158,225    1.58 
Vested   (50,065)   4.81 
Forfeited        
Non-vested units, September 30, 2022   272,815   $2.66 
           
Non-vested units, January 1, 2021   148,486   $5.44 
Granted        
Vested   (63,161)   5.55 
Forfeited        
Non-vested units, September 30, 2021   85,325   $5.36 

 

On December 17, 2021, we issued a total of 83,329 RSUs to our non-employee directors. The RSUs vest in five equal annual installments, beginning with the first anniversary of the grant date, other than those RSUs granted to a former director. As the former director made himself available to serve on the Board but was not elected to do so at the Company’s 2021 annual meeting of shareholders, the Board accelerated the vesting of his RSUs, such that they all vested on January 1, 2022. This included 14,492 RSUs granted on December 17, 2021, as well as an additional 15,224 RSUs previously granted. On August 19, 2022, we issued a total of 158,225 RSUs to our non-employee directors. The RSUs vest in five equal annual installments, beginning with the first anniversary of the grant date.

 

Restricted Shares

 

On July 31, 2022, the Company issued 25,000 restricted shares under the 2021 Equity Incentive Plan to an employee of the Company. The restriction will be lifted on the first anniversary of the grant date.

 

Stock Options Outstanding

 

On January 12, 2021, in connection with Larry G. Swets, Jr.’s appointment as Chief Executive Officer, the Company entered into a Stock Option Agreement (the “Stock Option”) with Mr. Swets. The Stock Option entitles Mr. Swets to purchase up to 130,000 shares of the Company’s common stock at an exercise price of $3.38 per share. The Stock Option becomes vested and fully exercisable in 20% increments on each anniversary of the grant date, provided that Mr. Swets remains in the continuous service of the Company through each applicable vesting date and that the Company’s book value per share has increased by 15% or more as compared to the Company’s book value per share as of the fiscal year end prior. The Stock Option expires on January 11, 2031.

 

19

 

 

FG FINANCIAL GROUP, INC.

Notes to Consolidated Financial Statements

 

The Stock Option contains performance and service conditions that affect vesting. Pursuant to ASC Topic 718- Stock Compensation, these conditions have not been reflected in estimating the fair value of the award upon its grant date; however, the Company employed a Monte-Carlo model to estimate the likelihood of satisfaction of the required performance and service conditions. This resulted in a derived service period of approximately 3.3 years under the grant.

 

In estimating the fair value of the Stock Option, the Company estimated volatility based on the historical volatility of our stock. The risk-free interest rate is based on the U.S. Treasury Constant Maturity similar to the expected remaining life of the Stock Option. The expected life of the Stock Option is assumed to be equivalent to its contractual term. The dividend rate is based on our historical rate, which the Company anticipates will remain at zero. The following assumptions were used to determine the estimated fair value of the Stock Option:

 

Expected volatility   45.60%
Expected life (years)   10.00 
Risk-free interest rate   1.15%
Dividend yield   0.00%

 

The following table summarizes activity for stock options issued for the nine months ended September 30, 2022 and 2021.

 

Common Stock Options  Shares   Weighted Ave Exercise Price   Weighted Ave Remaining Contractual Term (yrs)   Weighted Ave Grant Date Fair Value   Aggregate Intrinsic Value 
Outstanding, January 1, 2022   130,000   $3.38    9.04   $1.88   $49,400 
Exercisable, January 1, 2022      $       $   $ 
Granted                       
Exercised                    
Cancelled                    
Outstanding, September 30, 2022   130,000   $3.38    8.29   $1.88   $ 
Exercisable, September 30, 2022      $       $   $ 
                          
Outstanding, January 1, 2021      $       $   $ 
Exercisable, January 1, 2021      $