kins_10q.htm


UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
 
FORM 10-Q
 
(Mark one)
þ
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
 
For the quarterly period ended September 30, 2011
 
OR
 
o
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
 
For the transition period from _________to _________

Commission File Number 0-1665

KINGSTONE COMPANIES, INC.
(Exact name of registrant as specified in its charter)
 
Delaware   36-2476480
(State or other jurisdiction of incorporation or organization)
 
(I.R.S. Employer Identification Number)
 
1154 Broadway
Hewlett, NY 11557
(Address of principal executive offices)

(516) 374-7600
(Registrant’s telephone number, including area code)
 
 (Former Name, if Changed Since Last Report)
 
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 þ No o

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

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer or a smaller reporting company. See definition of  “accelerated filer and large accelerated filer” in Rule 12b-2 of the Exchange Act. (Check one):
 
Large accelerated filer
o
Non-accelerated filer
o
Accelerated filer o Smaller reporting company þ
(Do not check if a smaller reporting company)      

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

As of November 12, 2011, there were 3,838,386 shares of the registrant’s common stock outstanding.
 


 
 

 
KINGSTONE COMPANIES, INC.
INDEX
 
     
PAGE
           
PART I — FINANCIAL INFORMATION
   
4
 
Item 1.
 Financial Statements
   
4
 
 
 Condensed Consolidated Balance Sheets at September 30, 2011 (Unaudited) and December 31, 2010
   
4
 
 
 Condensed Consolidated Statements of Operations and Comprehensive Income  for the three months and nine months ended September 30, 2011 (Unaudited) and 2010 (Unaudited)
   
5
 
 
 Condensed Consolidated Statement of Stockholders’ Equity for the nine months ended September 30, 2011 (Unaudited)
   
6
 
 
 Condensed Consolidated Statements of Cash Flows for the nine months ended September 30, 2011 (Unaudited) and 2010  (Unaudited)
   
7
 
 
 Notes to Condensed Consolidated Financial Statements  (Unaudited)
   
9
 
Item 2.
 Management’s Discussion and Analysis of Financial Condition and Results of Operations
   
32
 
Item 3.
 Quantitative and Qualitative Disclosures About Market Risk
   
50
 
Item 4.
 Controls and Procedures
   
50
 
           
PART II — OTHER INFORMATION
   
51
 
Item 1 .
Legal Proceedings
   
51
 
Item 1A.
Risk Factors
   
51
 
Item 2.
Unregistered Sales of Equity Securities and Use of Proceeds
   
51
 
Item 3.
Defaults Upon Senior Securities
   
51
 
Item 4.
Reserved
   
51
 
Item 5.
Other Information
   
51
 
Item 6.
Exhibits
   
52
 
  Signatures        
 
       
 
EXHIBIT 31(a)
EXHIBIT 31(b)
EXHIBIT 32
EXHIBIT 101.INS XBRL Instance Document
EXHIBIT 101.SCH XBRL Taxonomy Extension Schema
EXHIBIT 101.CAL XBRL Taxonomy Extension Calculation Linkbase
EXHIBIT 101.DEF XBRL Taxonomy Extension Definition Linkbase
EXHIBIT 101.LAB XBRL Taxonomy Extension Label Linkbase
EXHIBIT 101.PRE XBRL Taxonomy Extension Presentation Linkbase

 
2

 

Forward-Looking Statements
 
This Quarterly Report contains forward-looking statements as that term is defined in the federal securities laws.  The events described in forward-looking statements contained in this Quarterly Report may not occur.  Generally these statements relate to business plans or strategies, projected or anticipated benefits or other consequences of our plans or strategies, projected or anticipated benefits from acquisitions to be made by us, or projections involving anticipated revenues, earnings or other aspects of our operating results.  The words "may," "will," "expect," "believe," "anticipate," "project," "plan," "intend," "estimate," and "continue," and their opposites and similar expressions are intended to identify forward-looking statements.  We caution you that these statements are not guarantees of future performance or events and are subject to a number of uncertainties, risks and other influences, many of which are beyond our control, that may influence the accuracy of the statements and the projections upon which the statements are based.  Factors which may affect our results include, but are not limited to, the risks and uncertainties discussed in Item 7 of our Annual Report on Form 10-K for the year ended December 31, 2010 under “Factors That May Affect Future Results and Financial Condition”.
 
Any one or more of these uncertainties, risks and other influences could materially affect our results of operations and whether forward-looking statements made by us ultimately prove to be accurate.  Our actual results, performance and achievements could differ materially from those expressed or implied in these forward-looking statements.  We undertake no obligation to publicly update or revise any forward-looking statements, whether from new information, future events or otherwise.
 
 
3

 
 
PART I.  FINANCIAL INFORMATION
 


ITEM 1.   FINANCIAL STATEMENTS.
KINGSTONE COMPANIES, INC. AND SUBSIDIARIES
Condensed Consolidated Balance Sheets
 
   
September 30,
   
December 31,
 
   
2011
      2010*  
   
(unaudited)
         
Assets
             
   Fixed-maturity securities, held to maturity, at amortized cost (fair value of $771,281 at September 30, 2011 and
      $606,398 at December 31, 2010)
  $ 606,234     $ 605,424  
   Fixed-maturity securities, available for sale, at fair value (amortized cost of $17,588,998 at September 30, 2011 and
      $16,277,052 at December 31, 2010)
    17,951,642        16,339,101  
   Equity securities, available-for-sale, at fair value (cost of $4,119,319 at September 30, 2011 and $2,825,015 at
      December 31, 2010)
     4,143,257        2,983,035  
     Total investments
    22,701,133       19,927,560  
   Cash and cash equivalents
    3,031,068       326,620  
   Premiums receivable, net of provision for uncollectible amounts
    6,038,333       5,001,886  
   Receivables - reinsurance contracts
    685,316       1,174,729  
   Reinsurance receivables, net of provision for uncollectible amounts
    25,643,556       20,720,194  
   Notes receivable-sale of business
    400,417       705,019  
   Deferred acquisition costs
    4,415,056       3,619,001  
   Intangible assets, net
    3,779,600       4,136,386  
   Property and equipment, net of accumulated depreciation
    1,633,152       1,585,029  
   Other assets
    625,444       1,486,249  
 Total assets
  $ 68,953,075     $ 58,682,673  
                 
Liabilities
               
  Loss and loss adjustment expenses
  $ 21,373,562     $ 17,711,907  
  Unearned premiums
    21,101,548       17,277,332  
  Advance premiums
    637,357       410,574  
  Reinsurance balances payable
    2,922,815       1,106,897  
  Deferred ceding commission revenue
    3,857,820       3,219,513  
  Notes payable and capital lease obligations (includes payable to related parties of $378,000 at September 30, 2011 and $785,000 at December 31, 2010)
    747,000       1,460,997  
  Accounts payable, accrued expenses and other liabilities
    2,321,323       2,553,031  
  Income taxes payable
    194,621       -  
  Deferred income taxes
    1,652,724       1,998,557  
Total liabilities
    54,808,770       45,738,808  
                 
Commitments and Contingencies
               
                 
Stockholders' Equity
               
   Common stock, $.01 par value; authorized 10,000,000 shares; issued 4,643,122 shares;outstanding 3,838,386 shares
    46,432       46,432  
   Preferred stock, $.01 par value; authorized 1,000,000 shares;-0- shares issued and outstanding
    -       -  
   Capital in excess of par
    13,719,484       13,633,913  
   Accumulated other comprehensive income
    255,145       145,247  
   Retained earnings
    1,286,502       281,531  
      15,307,563       14,107,123  
Treasury stock, at cost, 804,736 shares
    (1,163,258 )     (1,163,258 )
Total stockholders' equity
    14,144,305       12,943,865  
                 
Total liabilities and stockholders' equity
  $ 68,953,075     $ 58,682,673  
 
* derived from audited financial information
 
See accompanying notes to condensed consolidated financial statements.

 
4

 
 
KINGSTONE COMPANIES, INC. AND SUBSIDIARIES
Condensed Consolidated Statements of Operations and Comprehensive Income (Unaudited)
 
   
For the Three Months Ended
   
For the Nine Months Ended
 
   
September 30,
   
September 30,
 
   
2011
   
2010
   
2011
   
2010
 
Revenues
                       
Net premiums earned
  $ 3,937,189     $ 3,065,289     $ 10,822,137     $ 7,905,350  
Ceding commission revenue
    2,307,390       2,231,493       7,347,832       6,413,774  
Net investment income
    172,039       154,679       510,173       435,882  
Net realized gain on investments
    196,574       84,054       357,006       228,803  
Other income
    228,615       214,606       693,188       664,091  
Total revenues
    6,841,807       5,750,121       19,730,336       15,647,900  
                                 
Expenses
                               
Loss and loss adjustment expenses
    2,933,531       1,907,917       7,307,925       4,518,253  
Commission expense
    1,596,281       1,287,268       4,472,924       3,647,371  
Other underwriting expenses
    1,734,137       1,580,827       5,045,051       4,112,889  
Other operating expenses
    260,149       428,401       863,114       1,345,208  
Depreciation and amortization
    144,122       155,258       457,264       463,746  
Interest expense
    23,577       46,258       108,249       138,560  
Interest expense - mandatorily redeemable preferred stock
    -       -       -       74,706  
Total expenses
    6,691,797       5,405,929       18,254,527       14,300,733  
                                 
Income from continuing operations before taxes
    150,010       344,192       1,475,809       1,347,167  
Income tax (benefit) expense
    (69,559 )     128,278       355,685       564,388  
Income from continuing operations
    219,569       215,914       1,120,124       782,779  
Income from discontinued operations, net of taxes
    -       16,234       -       40,082  
Net income
    219,569       232,148       1,120,124       822,861  
                                 
        Gross unrealized investment holding gains (losses) arising during period
    (166,793 )     523,690       166,513       560,337  
        Income tax benefit (expense) related to items of other comprehensive income (loss)
    56,710       (178,055 )     (56,614 )     (190,515 )
 Comprehensive income
  $ 109,486     $ 577,783     $ 1,230,023     $ 1,192,683  
                                 
Basic and diluted earnings per common share:
                               
Income from continuing operations
  $ 0.06     $ 0.06     $ 0.29     $ 0.24  
Income from discontinued operations
  $ -     $ -     $ -     $ 0.01  
Income per common share
  $ 0.06     $ 0.06     $ 0.29     $ 0.25  
                                 
Weighted average common shares outstanding
                               
Basic
    3,838,386       3,833,798       3,838,386       3,292,145  
Diluted
    3,918,763       3,833,798       3,921,289       3,292,145  
 
See accompanying notes to condensed consolidated financial statements.
 
 
5

 

KINGSTONE COMPANIES, INC. AND SUBSIDIARIES
Condensed Consolidated Statement of Stockholders' Equity
Nine months ended September 30, 2011 (unaudited)
 
                                 
Accumulated
                         
                           
Capital
   
Other
                         
   
Common Stock
   
Preferred Stock
   
in Excess
   
Comprehensive
   
Retained
   
Treasury Stock
       
   
Shares
   
Amount
   
Shares
   
Amount
   
of Par
   
Income
   
Earnings
   
Shares
   
Amount
   
Total
 
Balance, December 31, 2010
    4,643,122     $ 46,432       -     $ -     $ 13,633,913     $ 145,247     $ 281,531       804,736     $ (1,163,258 )   $ 12,943,865  
Stock-based payments
    -       -       -       -       85,571       -       -       -       -       85,571  
Dividends
                                                    (115,153 )                     (115,153 )
Net income
    -       -       -       -       -       -       1,120,124       -       -       1,120,124  
Net unrealized gains on securities available for sale, net of income tax
    -       -       -       -       -       109,899       -       -       -       109,899  
Balance, September 30, 2011
    4,643,122     $ 46,432       -     $ -     $ 13,719,484     $ 255,145     $ 1,286,502       804,736     $ (1,163,258 )   $ 14,144,305  
 
See accompanying notes to condensed consolidated financial statements.
 
 
6

 
 
KINGSTONE COMPANIES, INC. AND SUBSIDIARIES
Condensed Consolidated Statements of Cash Flows (Unaudited)
Nine months ended September  30,
 
   
2011
   
2010
 
             
Cash flows provided by operating activities:
           
Net income
  $ 1,120,124     $ 822,861  
Adjustments to reconcile net income to net cash provided by operations:
               
    Gain on sale of investments
    (357,006 )     (228,803 )
    Depreciation and amortization
    457,264       463,746  
    Amortization of bond premium, net
    162,990       54,810  
    Stock-based payments
    85,571       326,573  
    Deferred income taxes
    (402,447 )     (36,197 )
(Increase) decrease in assets:
               
    Short term investments
    -       225,336  
    Premiums receivable, net
    (1,036,447 )     (795,761 )
    Receivables - reinsurance contracts
    489,413       (1,015,489 )
    Reinsurance receivables, net
    (4,923,362 )     (32,328 )
    Deferred acquisition costs
    (796,055 )     (677,169 )
    Other assets
    860,804       (142,389 )
Increase (decrease) in liabilities:
               
    Loss and loss adjustment expenses
    3,661,655       624,918  
    Unearned premiums
    3,824,216       3,127,590  
    Advance premiums
    226,783       110,262  
    Reinsurance balances payable
    1,815,918       (92,772 )
    Deferred ceding commission revenue
    638,307       (96,230 )
    Income taxes payable
    194,621       -  
    Accounts payable, accrued expenses and other liabilities
    (231,708 )     (512,401 )
Net cash provided by operating activities of continuing operations
    5,790,641       2,126,557  
    Operating activities of discontinued operations
    -       (26,000 )
Net cash flows provided by operating activities
    5,790,641       2,100,557  
                 
Cash flows used in investing activities:
               
Purchase - fixed-maturity securities held to maturity
    -       (106,205 )
Purchase - fixed-maturity securities available for sale
    (4,372,917 )     (4,449,040 )
Purchase - equity securities
    (2,570,333 )     (1,968,273 )
Sale or maturity - fixed-maturity securities available for sale
    3,034,295       2,616,788  
Sale - equity securities
    1,362,700       1,202,909  
Recovery of loss from failed bank
    133,211       -  
Collections of notes receivable and accrued interest - Sale of businesses
    304,602       364,067  
Other investing activities
    (148,601 )     (5,820 )
Net cash flows used in investing activities
    (2,257,043 )     (2,345,574 )
                 
Cash flows (used in) provided by financing activities:
               
Proceeds from long term debt (includes $200,000 from related parties in 2010)
    -       400,000  
Principal payments on long-term debt (includes $407,000 to related parties in 2011)
    (713,997 )     (18,268 )
Dividends paid
    (115,153 )     -  
Net cash flows (used in) provided by financing activities
    (829,150 )     381,732  
 
See accompanying notes to condensed consolidated financial statements.
 
 
7

 
 
 KINGSTONE COMPANIES, INC. AND SUBSIDIARIES
Condensed Consolidated Statements of Cash Flows (Unaudited)
Nine months ended September  30,
 
   
2011
   
2010
 
             
Increase in cash and cash equivalents
  $ 2,704,448     $ 136,715  
Cash and cash equivalents, beginning of period
    326,620       625,320  
Cash and cash equivalents, end of period
  $ 3,031,068     $ 762,035  
                 
Supplemental disclosures of cash flow information:
               
Cash paid for income taxes
  $ 458,871     $ 501,102  
Cash paid for interest
  $ 172,964     $ 296,782  
                 
Supplemental Schedule of Non-Cash Investing and Finacing Activities:
               
Mandatorily redeemable preferred stock exchanged for common stock
    -     $ 1,299,231  
 
 
See accompanying notes to condensed consolidated financial statements.
 
 
8

 

KINGSTONE COMPANIES, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)

Note 1 – Basis of Presentation and Nature of Business
 
Kingstone Companies, Inc. (referred to herein as "Kingstone" or the “Company”), through its subsidiary Kingstone Insurance Company (“KICO”), offers property and casualty insurance products to small businesses and individuals in New York State.
 
The accompanying unaudited condensed consolidated financial statements included in this report have been prepared in accordance with accounting principles generally accepted in the United States (“GAAP”) for interim financial information and the instructions to Securities and Exchange Commission (“SEC”) Form 10-Q and Article 8-03 of SEC Regulation S-X. The principles for condensed interim financial information do not require the inclusion of all the information and footnotes required by generally accepted accounting principles for complete financial statements. Therefore, these financial statements should be read in conjunction with the consolidated financial statements as of and for the year ended December 31, 2010 and notes thereto included in the Company’s Annual Report on Form 10-K filed on March 31, 2011. The accompanying condensed consolidated financial statements have not been audited by an independent registered public accounting firm in accordance with standards of the Public Company Accounting Oversight Board (United States) but, in the opinion of management, such financial statements include all adjustments, consisting only of normal recurring adjustments, necessary for a fair statement of the Company’s financial position and results of operations. The results of operations for the nine months ended September 30, 2011 may not be indicative of the results that may be expected for the year ending December 31, 2011.
 
Note 2 – Accounting Policies and Basis of Presentation
 
Use of Estimates
 
The preparation of financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the consolidated financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates.
 
Reclassification
 
The Company has reclassified certain amounts in its 2010 statements of consolidated operations and cash flows to conform to the 2011 presentation. None of these reclassifications had an effect on the Company’s consolidated net earnings, total stockholders’ equity or cash flows.
 
Principles of Consolidation

The consolidated financial statements consist of Kingstone and its wholly-owned subsidiaries. Subsidiaries include KICO and its subsidiaries, CMIC Properties, Inc. (“CMIC Properties”) and 15 Joys Lane, LLC (“15 Joys Lane”), which together own the land and building from which KICO operates. All material intercompany transactions have been eliminated in consolidation.
 
 
9

 
 
Accounting Pronouncements
 
In October 2010, the FASB issued new guidance concerning the accounting for costs associated with acquiring or renewing insurance contracts. This guidance generally follows the model of that for loan origination costs. Under the new guidance, only direct incremental costs associated with successful insurance contract acquisitions or renewals are deferrable. The Company adopted this guidance retrospectively effective January 1, 2011. The adoption of this guidance did not have a material impact on the Company’s results of operations, financial position or liquidity.

In April 2011, the FASB issued ASU No. 2011-03, “Reconsideration of Effective Control for Repurchase Agreements” (“ASU 2011-03”). ASU 2011-03 provides amendments to Accounting Standards Codification (“ASC”) No. 860 “Transfers and Servicing”, which remove from the assessment of effective control (1) the criterion requiring the transferor to have the ability to repurchase or redeem the financial assets on substantially the agreed terms, even in the event of default by the transferee, and (2) the collateral maintenance implementation guidance related to that criterion. The amendments in this update are effective prospectively for transactions or modifications of existing transactions that occur on or after the beginning of the first interim or annual reporting period beginning on or after December 15, 2011, with early adoption not permitted.

In May 2011, the FASB issued ASU No. 2011-04, “Amendments to Achieve Common Fair Value Measurement and Disclosure Requirements in U.S. GAAP and IFRS” (“ASU 2011-04”). ASU 2011-04 provides amendments to ASC No. 820 “Fair Value Measurement”, which results in a consistent definition of fair value and common requirements for measurement of and disclosure of fair value between U.S. GAAP and IFRS. Some of the amendments clarify the FASB’s intent about the application of existing fair value measurement requirements, while others change a particular principle or requirement for measuring fair value or for disclosing information about fair value measurements. The amendments in this update are effective prospectively during interim and annual periods beginning after December 15, 2011, with early adoption not permitted.

In June 2011, the FASB issued ASU No. 2011-05, “Presentation of Comprehensive Income” (“ASU 2011-05”). ASU 2011-05 provides amendments to ASC No. 220 “Comprehensive Income”, which require an entity to present the total of comprehensive income, the components of net income, and the components of other comprehensive income either in a single continuous statement of comprehensive income or in two separate but consecutive statements. The amendments in this update are effective retrospectively for fiscal years and interim periods within those years, beginning after December 15, 2011, with early adoption permitted. The Company has not elected to early adopt ASU 2011-05.

In September 2011, the FASB issued amended guidance on testing goodwill for impairment. This guidance is providing the option to first assess qualitative factors, such as macroeconomic conditions and industry and market considerations, to determine whether it is more likely than not that the fair value of a reporting unit is less than its carrying amount. If indicated by the qualitative assessment, then it is necessary to perform the two−step goodwill impairment test. If the option is not elected, the guidance requiring the two−step goodwill impairment test is unchanged. The new guidance is effective for annual and interim goodwill impairment tests performed for fiscal years beginning after December 15, 2011, with early adoption permitted. The impact of adoption is not expected to be material to the Company’s results of operations and financial position.

The Company has determined that all other recently issued accounting pronouncements will not have a material impact on its consolidated financial position, results of operations and cash flows, or do not apply to its operations. 

 
10

 
 
Note 3 – Investments 

Available for Sale Securities

The amortized cost and fair value of investments in available for sale fixed-maturity securities, equities and short term investments as of September 30, 2011 and December 31, 2010 are summarized as follows:

   
September 30, 2011
 
  
 
Cost or
   
Gross
   
Gross Unrealized Losses
         
Unrealized
 
   
Amortized
   
Unrealized
   
Less than 12
   
More than 12
   
Fair
   
Gains/
 
 Category
 
Cost
   
Gains
   
Months
   
Months
   
Value
   
(Losses)
 
   
(unaudited)
 
Fixed-Maturity Securities:
                                   
U.S. Treasury securities and obligations of U.S. government corporations and agencies
  $ 499,815     $ 49,398     $ -     $ -     $ 549,213     $ 49,398  
                                                 
Political subdivisions of States, Territories and Possessions
    6,133,143       288,099       -       -       6,421,242       288,099  
                                                 
Corporate and other bonds industrial and miscellaneous
    10,956,040       271,758       (221,751 )     (24,860 )     10,981,187       25,147  
Total fixed-maturity securities
    17,588,998       609,255       (221,751 )     (24,860 )     17,951,642       362,644  
                                                 
Equity Securities:
                                               
Preferred stocks
    1,268,171       26,616       (91,915 )     -       1,202,872       (65,299 )
Common stocks
    2,851,148       209,110       (119,873 )     -       2,940,385       89,237  
Total equity securities
    4,119,319       235,726       (211,788 )     -       4,143,257       23,938  
                                                 
Total
  $ 21,708,317     $ 844,981     $ (433,539 )   $ (24,860 )   $ 22,094,899     $ 386,582  
 
 
11

 

   
December 31, 2010
 
  
 
Cost or
   
Gross
   
Gross Unrealized Losses
         
Unrealized
 
   
Amortized
   
Unrealized
   
Less than 12
   
More than 12
   
Fair
   
Gains/
 
 Category
 
Cost
   
Gains
   
Months
   
Months
   
Value
   
(Losses)
 
 Fixed-Maturity Securities:
                                   
U.S. Treasury securities and obligations of U.S. government corporations and agencies
  $ 1,000,572     $ 42,085     $ -     $ -     $ 1,042,657     $ 42,085  
                                                 
Political subdivisions of States, Territories and Possessions
    7,278,663       79,791       (86,234 )     (12,995 )     7,259,225       (19,438 )
                                                 
Corporate and other bonds industrial and miscellaneous
    7,997,817       176,999       (137,597 )     -       8,037,219       39,402  
Total fixed-maturity securities
    16,277,052       298,875       (223,831 )     (12,995 )     16,339,101       62,049  
                                                 
Equity Securities:
                                               
Preferred stocks
    824,569       29,934       (6,333 )     -       848,170       23,601  
Common stocks
    2,000,446       188,783       (54,364 )     -       2,134,865       134,419  
Total equity securities
    2,825,015       218,717       (60,697 )     -       2,983,035       158,020  
                                                 
Total
  $ 19,102,067     $ 517,592     $ (284,528 )   $ (12,995 )   $ 19,322,136     $ 220,069  

A summary of the amortized cost and fair value of the Company’s available for sale investments in fixed-maturity securities by contractual maturity as of September 30, 2011 and December 31, 2010 is shown below:

 
12

 
 
   
September 30, 2011
   
December 31, 2010
 
   
Amortized
         
Amortized
       
 Remaining Time to Maturity
 
Cost
   
Fair Value
   
Cost
   
Fair Value
 
   
(unaudited)
             
Less than one year
  $ 301,268     $ 303,207     $ 263,098     $ 253,385  
One to five years
    6,495,249       6,671,967       6,868,952       6,997,694  
Five to ten years
    9,506,527       9,615,351       7,132,079       7,118,405  
More than 10 years
    1,285,954       1,361,117       2,012,923       1,969,617  
Total
  $ 17,588,998     $ 17,951,642     $ 16,277,052     $ 16,339,101  
 
The actual maturities may differ from contractual maturities because certain borrowers have the right to call or prepay obligations with or without penalties.

Held to Maturity Securities

The amortized cost and fair value of investments in held to maturity fixed-maturity securities as of September 30, 2011 and December 31, 2010 are summarized as follows:
 
    September 30, 2011  
    Cost or     Gross    
Gross Unrealized Losses
          Unrealized  
   
Amortized
   
Unrealized
   
Less than 12
   
More than 12
   
Fair
   
Gains/
 
 Category
 
Cost
   
Gains
   
Months
   
Months
   
Value
   
(Losses)
 
   
(unaudited)
 
U.S. Treasury securities
  $ 606,234     $ 165,047     $ -     $ -     $ 771,281     $ 165,047  
 
    December 31, 2010
  
 
Cost or
   
Gross
   
Gross Unrealized Losses
         
Unrealized
 
   
Amortized
   
Unrealized
   
Less than 12
   
More than 12
   
Fair
   
Gains/
 
 Category
 
Cost
   
Gains
   
Months
   
Months
   
Value
   
(Losses)
 
                                     
U.S. Treasury securities
  $ 605,424     $ 974     $ -     $ -     $ 606,398     $ 974  
 
All held to maturity securities are held in trust pursuant to the New York State Insurance Department’s minimum funds requirement.

Contractual maturities of all held to maturity securities are greater than ten years.

 
13

 
 
Investment Income

Major categories of the Company’s net investment income are summarized as follows:
 
   
Three months ended
   
Nine months ended
 
   
September 30,
   
September 30,
 
   
2011
   
2010
   
2011
   
2010
 
   
(unaudited)
   
(unaudited)
 
Income
             
 
   
 
 
Fixed-maturity securities
  $ 170,083     $ 140,953     $ 526,583     $ 395,676  
Equity securities
    44,089       41,176       114,387       100,702  
Cash and cash equivalents
    2,552       61       4,775       4,878  
Other
    8       13       (3,307 )     34  
Total
    216,732       182,203       642,438       501,290  
Expenses
                               
Investment expenses
    44,693       27,524       132,265       65,408  
Net investment income
  $ 172,039     $ 154,679     $ 510,173     $ 435,882  
 
Proceeds from the sale and maturity of fixed-maturity securities were $3,034,295 and $2,616,788 for the nine months ended September 30, 2011 and 2010.

Proceeds from the sale of equity securities were $1,362,700 and $1,202,909 for the nine months ended September 30, 2011 and 2010, respectively.

The Company’s gross realized gains and losses on investments are summarized as follows:
 
   
Three months ended
   
Nine months ended
 
   
September 30,
   
September 30,
 
   
2011
   
2010
   
2011
   
2010
 
Fixed-maturity securities
                       
Gross realized gains
  $ 51,805     $ 37,601     $ 139,107     $ 133,598  
Gross realized losses
    -       -       (1,983 )     (18,562 )
      51,805       37,601       137,124       115,036  
                                 
Equity securities
                               
Gross realized gains
    11,558       64,210       147,375       148,462  
Gross realized losses
    -       (17,757 )     (60,704 )     (34,695 )
      11,558       46,453       86,671       113,767  
                                 
Cash and short term investments (1)
    133,211       -       133,211       -  
                                 
Net realized gains
  $ 196,574     $ 84,054     $ 357,006     $ 228,803  
 
(1) Realized gain on cash and short term investments is a partial recovery from the FDIC of an amount previously written off in 2009 due to the failure of Waterfield Bank.

 
14

 
 
Impairment Review
 
The Company regularly reviews its fixed-maturity securities and equity securities portfolios to evaluate the necessity of recording impairment losses for other-than-temporary declines (“OTTI”) in the fair value of investments. In evaluating potential impairment, management considers, among other criteria: (i) the current fair value compared to amortized cost or cost, as appropriate; (ii) the length of time the security’s fair value has been below amortized cost or cost; (iii) specific credit issues related to the issuer such as changes in credit rating, reduction or elimination of dividends or non-payment of scheduled interest payments; (iv) management’s intent and ability to retain the investment for a period of time sufficient to allow for any anticipated recovery in value to cost; and (v) current economic conditions.
 
OTTI losses are recorded in the condensed consolidated statement of operations and comprehensive income as net realized losses on investments and result in a permanent reduction of the cost basis of the underlying investment. The determination of OTTI is a subjective process and different judgments and assumptions could affect the timing of loss realization. There are 42 securities at September 30, 2011 that account for the gross unrealized loss. The Company determined that none of the unrealized losses were deemed to be OTTI for its portfolio of fixed maturity investments and equity securities for the nine months ended September 30, 2011 and 2010.  Significant factors influencing the Company’s determination that unrealized losses were temporary included the magnitude of the unrealized losses in relation to each security’s cost, the nature of the investment and management’s intent and ability to retain the investment for a period of time sufficient to allow for anticipated recovery of fair value to the Company’s cost basis.

The Company held securities with unrealized losses representing declines that were considered temporary at September 30, 2011 as follows:
 
   
September 30, 2011
 
   
Less than 12 months
   
12 months or more
   
Total
 
  
             
No. of
               
No. of
   
Aggregate
       
   
Fair
   
Unrealized
   
Positions
   
Fair
   
Unrealized
   
Positions
   
Fair
   
Unrealized
 
 Category
 
Value
   
Losses
   
Held
   
Value
   
Losses
   
Held
   
Value
   
Losses
 
   
(unaudited)
 
Fixed-Maturity Securities:
                                           
U.S. Treasury securities and obligations of U.S. government corporations and agencies
  $ -     $ -       -     $ -     $ -       -     $ -     $ -  
                                                                 
Political subdivisions of States, Territories and Possessions
    -       -       -       -       -       -       -       -  
 
                                                               
Corporate and other bonds industrial and miscellaneous
    4,131,740       (221,751 )     1       375,140       (24,860 )     22       4,506,880       (246,611 )
                                                                 
Total fixed-maturity securities
  $ 4,131,740     $ (221,751 )     1     $ 375,140     $ (24,860 )     22     $ 4,506,880     $ (246,611 )
                                                                 
Equity Securities:
                                                               
Preferred stocks
  $ 719,322     $ (91,915 )     6     $ -     $ -       -     $ 719,322     $ (91,915 )
Common stocks
    947,280       (119,873 )     13       -       -       -       947,280       (119,873 )
                                                                 
Total equity securities
  $ 1,666,602     $ (211,788 )     19     $ -     $ -       -     $ 1,666,602     $ (211,788 )
                                                                 
Total
  $ 5,798,342     $ (433,539 )     20     $ 375,140     $ (24,860 )     22     $ 6,173,482     $ (458,399 )
 
 
15

 
 
Note 4 – Fair Value Measurements

The Company follows GAAP guidance regarding fair value measurements. The valuation technique used to fair value the financial instruments is the market approach which uses prices and other relevant information generated by market transactions involving identical or comparable assets.
 
This guidance establishes a three-level hierarchy that prioritizes the inputs to valuation techniques used to measure fair value. The fair value hierarchy gives the highest priority to quoted prices in active markets for identical assets or liabilities (Level 1) and the lowest priority to unobservable inputs (Level 3). If the inputs used to measure the assets or liabilities fall within different levels of the hierarchy, the classification is based on the lowest level input that is significant to the fair value measurement of the asset or liability. Classification of assets and liabilities within the hierarchy considers the markets in which the assets and liabilities are traded, including during period of market disruption, and the reliability and transparency of the assumptions used to determine fair value. The hierarchy requires the use of observable market data when available. The levels of the hierarchy and those investments included in each are as follows:
 
Level 1—Inputs to the valuation methodology are quoted prices (unadjusted) for identical assets or liabilities traded in active markets. Included are those investments traded on an active exchange, such as the NASDAQ Global Select Market, U.S. Treasury securities and obligations of U.S. government agencies, together with municipal bonds, corporate debt securities that are generally investment grade.
 
Level 2—Inputs to the valuation methodology include quoted prices for similar assets or liabilities in active markets, quoted prices for identical or similar assets or liabilities in markets that are not active, inputs other than quoted prices that are observable for the asset or liability and market-corroborated inputs.
 
Level 3—Inputs to the valuation methodology are unobservable for the asset or liability and are significant to the fair value measurement. Material assumptions and factors considered in pricing investment securities and other assets may include appraisals, projected cash flows, market clearing activity or liquidity circumstances in the security or similar securities that may have occurred since the prior pricing period. Included in this valuation methodology are the real estate assets owned by the Company that are utilized in its operations.
 
The availability of observable inputs varies and is affected by a wide variety of factors. When the valuation is based on models or inputs that are less observable or unobservable in the market, the determination of fair value requires significantly more judgment. The degree of judgment exercised by management in determining fair value is greatest for investments categorized as Level 3. For investments in this category, the Company considers prices and inputs that are current as of the measurement date. In periods of market dislocation, as characterized by current market conditions, the observability of prices and inputs may be reduced for many instruments. This condition could cause a security to be reclassified between levels.
 
 
16

 
 
The Company’s investments are allocated among pricing input levels at September 30, 2011 and December 31, 2010 as follows:
 
   
September 30, 2011
 
($ in thousands)
 
Level 1
   
Level 2
   
Level 3
   
Total
 
   
(unaudited)
 
Fixed-maturity investments available for sale
                       
U.S. Treasury securities and obligations of U.S. government corporations and agencies
  $ 549     $ -     $ -     $ 549  
                                 
Political subdivisions of States, Territories and Possessions
    5,044       1,378       -       6,422  
                                 
Corporate and other bonds industrial and miscellaneous
    10,453       528       -       10,981  
Total fixed maturities
    16,046       1,906       -       17,952  
Equity investments
    4,143       -       -       4,143  
Short term investments
    -       -       -       -  
Total investments
  $ 20,189     $ 1,906     $ -     $ 22,095  
 
   
December 31, 2010
 
 ($ in thousands)
 
Level 1
   
Level 2
   
Level 3
   
Total
 
                         
 Fixed-maturity investments
                       
U.S. Treasury securities and obligations of U.S. government corporations and agencies
  $ 1,043     $ -     $ -     $ 1,043  
                                 
Political subdivisions of States, Territories and Possessions
    5,351       1,908       -       7,259  
                                 
Corporate and other bonds industrial and miscellaneous
    8,037       -       -       8,037  
Total fixed maturities
    14,431       1,908       -       16,339  
Equity investments
    2,983       -       -       2,983  
Total investments
  $ 17,414     $ 1,908     $ -     $ 19,322  
 
 
17

 
 
Note 5 – Fair Value of Financial Instruments

GAAP requires all entities to disclose the fair value of financial instruments, both assets and liabilities recognized and not recognized in the balance sheet, for which it is practicable to estimate fair value. The Company uses the following methods and assumptions in estimating its fair value disclosures for financial instruments:
 
Equity and fixed income investments:  Fair value disclosures for investments are included in “Note 3 - Investments.”

Cash and cash equivalents: The carrying values of cash and cash equivalents approximate their fair values because of the short maturity of these instruments.

Premiums receivable, reinsurance receivables:  The carrying values reported in the accompanying condensed consolidated balance sheets for these financial instruments approximate their fair values due to the short term nature of the assets.

Notes receivable: The carrying amount of notes receivable related to the sale of businesses approximates fair value because of the recently negotiated interest rates based on term of the loan, risk and guaranty.

Real Estate: The fair value of the land and building included in property and equipment, which is used in the Company’s operations, approximates the carrying value. The fair value was based on an appraisal prepared using the sales comparison approach.

Reinsurance balances payable:  The carrying value reported in the condensed consolidated balance sheets for these financial instruments approximates fair value.

Notes payable (including related parties): The Company estimates that the carrying amount of notes payable approximates fair value because of the recently negotiated interest rates based on term of the loan, risk and guaranty.

The estimated fair values of the Company’s financial instruments are as follows:
 
   
September 30, 2011
   
December 31, 2010
 
   
Carrying Value
   
Fair Value
   
Carrying Value
   
Fair Value
 
   
(unaudited)
             
Fixed-maturity investments held to maturity
  $ 606,234     $ 771,281     $ 605,424     $ 606,398  
Cash and cash equivalents
    3,031,068       3,031,068       326,620       326,620  
Premiums receivable
    6,038,333       6,038,333       5,001,886       5,001,886  
Receivables - reinsurance contracts
    685,316       685,316       1,174,729       1,174,729  
Reinsurance receivables
    25,643,556       25,643,556       20,720,194       20,720,194  
Notes receivable-sale of business
    400,417       400,417       705,019       705,019  
Real estate, net of accumulated depreciation
    1,515,916       1,510,000       1,437,787       1,510,000  
Reinsurance balances payable
    2,922,815       2,922,815       1,106,897       1,106,897  
Notes payable (including related parties)
    747,000       747,000       1,460,997       1,460,997  

 
18

 
 
Note 6 – Notes Receivable-Sale of Businesses
 
Retail Business
 
New York Stores: On April 17, 2009, the Company’s wholly-owned subsidiaries that owned and operated 16 Retail Business locations in New York State sold substantially all of their assets, including their book of business (the “New York Assets”). The purchase price for the New York Assets was approximately $2,337,000, of which approximately $1,786,000 was paid at closing.  Promissory notes in the aggregate original principal amount of approximately $551,000 (the “New York Notes”) were also delivered at the closing.  On April 1, 2011 the purchaser of the New York Assets paid in advance the balance of the New York Notes in the amount of $138,762.
 
Pennsylvania Stores:  Effective June 30, 2009, the Company sold all of the outstanding stock of the subsidiary that operated the three remaining Pennsylvania stores (the “Pennsylvania Stock”).  The purchase price for the Pennsylvania Stock was approximately $397,000 which was paid by delivery of two promissory notes (the “Pennsylvania Notes”), one in the approximate principal amount of $238,000 and payable with interest at the rate of 9.375% per annum in 120 equal monthly installments, and the other in the approximate principal amount of $159,000 and payable with interest at the rate of 6% per annum in 60 monthly installments commencing August 10, 2011 (with interest only being payable prior to such date). Effective August 10, 2011, the Pennsylvania Notes were restructured into one note with a principal balance of $361,625. The restructured note provides for interest at the rate of 8.63% per annum and is payable in 102 equal monthly installments of $5,015. There was no gain or loss recorded on the restructuring of the Pennsylvania Notes.
 
Franchise Business
 
Effective May 1, 2009, the Company sold all of the outstanding stock of the subsidiaries that operated the DCAP franchise business (collectively, the “Franchise Stock”).  The purchase price for the Franchise Stock was $200,000 which was paid by delivery of a promissory note in such principal amount (the “Franchise Note”).  As of March 31, 2011, the terms of the Franchise Note called for installments of $50,000 on May 15, 2009, $50,000 on May 1, 2010, both of which were paid, and $100,000 plus accrued interest on May 1, 2011 and provides for interest at the rate of 5.25% per annum. On May 1, 2011, the Franchise Note was amended. Under the amended Franchise Note, the payment due on May 1, 2011 was reduced to a principal payment only of $75,000. The remaining balance of $25,000 plus accrued interest of $12,797 is due on May 1, 2012.  A principal of the buyer is the son-in-law of Morton L. Certilman, one of the Company’s principal shareholders at the time.
 
Notes receivable arising from the sale of businesses as of September 30, 2011 and December 31, 2010 consists of:
 
   
September 30, 2011
   
December 31, 2010
 
   
Total
   
Current
         
Total
   
Current
       
   
Note
   
Maturities
   
Long-Term
   
Note
   
Maturities
   
Long-Term
 
   
(unaudited)
                   
Sale of NY stores
  $ -     $ -     $ -     $ 211,536     $ 211,536     $ -  
Sale of Pennsylvania stores
    359,210       30,368       328,842       375,211       28,730       346,481  
Sale of Franchise business
    37,797       37,797       -       100,000       100,000       -  
      397,007       68,165       328,842       686,747       340,266       346,481  
Accrued interest
    3,410       3,410       -       18,272       18,272       -  
Total
  $ 400,417     $ 71,575     $ 328,842     $ 705,019     $ 358,538     $ 346,481  
 
 
19

 
 
Note 7 – Property and Casualty Insurance Activity
 
Earned Premiums

Premiums written, ceded and earned are as follows:

   
Direct
   
Assumed
   
Ceded
   
Net
 
                         
Nine months ended September 30, 2011 (unaudited)
   
 
   
 
   
 
 
 Premiums written
  $ 30,502,800     $ 6,289     $ (18,099,446 )   $ 12,409,643  
 Change in unearned premiums
    (3,823,593 )     1,611       2,234,476       (1,587,506 )
 Premiums earned
  $ 26,679,207     $ 7,900     $ (15,864,970 )   $ 10,822,137  
                                 
Nine months ended September 30, 2010 (unaudited)
                         
 Premiums written
  $ 24,969,119     $ 9,572     $ (14,529,432 )   $ 10,449,259  
 Change in unearned premiums
    (3,126,232 )     (1,360 )     583,683       (2,543,909 )
 Premiums earned
  $ 21,842,887     $ 8,212     $ (13,945,749 )   $ 7,905,350  
                                 
Three months ended September 30, 2011 (unaudited)
                         
 Premiums written
  $ 10,382,641     $ 3,409     $ (6,119,576 )   $ 4,266,474  
 Change in unearned premiums
    (909,125 )     (41 )     579,881       (329,285 )
 Premiums earned
  $ 9,473,516     $ 3,368     $ (5,539,695 )   $ 3,937,189  
                                 
Three months ended September 30, 2010 (unaudited)
                         
 Premiums written
  $ 8,375,776     $ 6,436     $ (5,015,905 )   $ 3,366,307  
 Change in unearned premiums
    (595,995 )     (3,432 )     298,409       (301,018 )
 Premiums earned
  $ 7,779,781     $ 3,004     $ (4,717,496 )   $ 3,065,289  
 
Premium receipts in advance of the policy effective date are recorded as advance premiums. The balance of advance premiums was approximately $637,000 and $411,000 as of September 30, 2011 (unaudited) and December 31, 2010, respectively.

 
20

 
 
Loss and Loss Adjustment Expenses

The following table provides a reconciliation of the beginning and ending balances for unpaid losses and loss adjustment expenses (“LAE”):

 
   
Nine months ended
 
   
September 30,
 
   
2011
   
2010
 
   
(unaudited)
 
Balance at beginning of period
  $ 17,711,907     $ 16,513,318  
Less reinsurance recoverables
    (10,431,415 )     (10,512,203 )
Net balance, beginning of period
    7,280,492       6,001,115  
                 
Incurred related to:
               
Current year
    6,742,201       4,211,203  
Prior years
    565,724       307,050  
Total incurred
    7,307,925       4,518,253  
                 
Paid related to:
               
Current year
    2,414,171       1,960,235  
Prior years
    2,608,709       1,725,204  
Total paid
    5,022,880       3,685,439  
  
               
Net balance at end of period
    9,565,537       6,833,929  
Add reinsurance recoverables
    11,808,025       10,304,307  
Balance at end of period
  $ 21,373,562     $ 17,138,236  
 
Incurred losses and LAE are net of reinsurance recoveries under reinsurance contracts of $7,035,191 and $6,588,317 for the nine months ended September 30, 2011 and 2010.

Prior year incurred loss and LAE development is based upon numerous estimates by line of business and accident year. The Company’s management continually monitors claims activity to assess the appropriateness of carried case and IBNR reserves, giving consideration to Company and industry trends.

 
21

 
 
Loss and loss adjustment expense reserves

The reserving process for loss adjustment expense reserves provides for the Company’s best estimate at a particular point in time of the ultimate unpaid cost of all losses and loss adjustment expenses incurred, including settlement and administration of losses, and is based on facts and circumstances then known and including losses that have been incurred but not yet been reported. The process includes using actuarial methodologies to assist in establishing these estimates, judgments relative to estimates of future claims severity and frequency, the length of time before losses will develop to their ultimate level and the possible changes in the law and other external factors that are often beyond the Company’s control. The loss ratio projection method is used to estimate loss reserves. The process produces carried reserves set by management based upon the actuaries’ best estimate and is the result of numerous best estimates made by line of business, accident year, and loss and loss adjustment expense. The amount of loss and loss adjustment expense reserves for reported claims is based primarily upon a case-by-case evaluation of coverage, liability, injury severity, and any other information considered pertinent to estimating the exposure presented by the claim. The amounts of loss and loss adjustment expense reserves for unreported claims are determined using historical information by line of insurance as adjusted to current conditions. Since this process produces loss reserves set by management based upon the actuaries’ best estimate, there is no explicit or implicit provision for uncertainty in the carried loss reserves.
 
Due to the inherent uncertainty associated with the reserving process, the ultimate liability may differ, perhaps substantially, from the original estimate. Such estimates are regularly reviewed and updated and any resulting adjustments are included in the current year’s results. Reserves are closely monitored and are recomputed periodically using the most recent information on reported claims and a variety of statistical techniques. Specifically, on at least a quarterly basis, the Company reviews, by line of business, existing reserves, new claims, changes to existing case reserves and paid losses with respect to the current and prior years.
 
Reinsurance
 
The Company’s reinsurance treaties for both its Personal Lines business, which primarily consists of homeowners’ policies, and Commercial Lines business, other than commercial auto were renewed as of July 1, 2011. The treaties are renewed annually; the terms of the treaties effective July 1, 2011 are as follows:
 
Personal Lines

Personal Lines business, which includes homeowners, dwelling fire and canine legal liability insurance, is reinsured under a 75% quota share treaty which provides coverage up to $700,000 per occurrence. An excess of loss contract provides $1,500,000 of coverage in excess of the $700,000 included under the 75% quota share treaty for a total coverage up to $2,200,000 per occurrence. Personal umbrella policies are reinsured under a 90% quota share treaty limiting the Company to a maximum of $100,000 per occurrence for the first $1,000,000 of coverage. The second $1,000,000 of coverage is 100% reinsured. 

Commercial Lines

General liability commercial policies written by the Company, except for commercial auto policies, are reinsured under a 60% quota share treaty, which provides coverage up to $700,000 per occurrence.  An excess of loss contract provides $1,500,000 of coverage in excess of the $700,000 included under the 60% quota share treaty for a total coverage up to $2,200,000 per occurrence.

 
22

 
 
Commercial Auto

Commercial auto policies are covered by an excess of loss reinsurance contract which provides $1,750,000 of coverage in excess of $250,000 for a total coverage up to $2,000,000 per occurrence.

Catastrophe Reinsurance

A total of $54,000,000 of catastrophe reinsurance coverage has been obtained, whereby the Company retains $500,000 per occurrence.

The Company’s reinsurance program is structured to enable it to reflect significant reductions in premiums written and earned and also provides income as a result of ceding commissions earned pursuant to the quota share reinsurance contracts. This structure has enabled the Company to significantly grow its premium volume while maintaining regulatory capital and other financial ratios generally within or below the expected ranges used for regulatory oversight purposes. The Company’s participation in reinsurance arrangements does not relieve the Company from its obligations to policyholders.

Ceding Commission Revenue
 
The Company earns ceding commissions under its quota share reinsurance agreements based on a sliding scale of commission rates and ultimate treaty year loss ratios on the policies reinsured under each of these agreements. The sliding scale includes minimum and maximum commission rates in relation to specified ultimate loss ratios.  The commission rate and ceding commissions earned increases when the estimated ultimate loss ratio decreases and, conversely, the commission rate and ceding commissions earned decreases when the estimated ultimate loss ratio increases.
 
As of September 30, 2011 and 2010, the Company’s estimated ultimate loss ratios attributable to these contracts are lower than the contractual ultimate loss ratios at which provisional ceding commissions are earned. Accordingly, the Company has recorded contingent ceding commissions earned in addition to the provisional ceding commissions earned.

Ceding commission revenue consists of the following:
 
   
Three months ended
   
Nine months ended
 
   
September 30,
   
September 30,
 
   
2011
   
2010
   
2011
   
2010
 
   
(unaudited)
   
(unaudited)
 
Provisional ceding commissions earned
  $ 1,763,930     $ 1,547,878     $ 5,048,609     $ 4,771,366  
Contingent ceding commissions earned
    543,460       683,615       2,299,223       1,642,408  
    $ 2,307,390     $ 2,231,493     $ 7,347,832     $ 6,413,774  
 
 
23

 
 
Note 8 – Notes Payable and Capital Lease Obligations
 
Notes payable and capital lease obligations consist of:
 
   
September 30, 2011
   
December 31, 2010
 
         
Less
               
Less
       
   
Total
   
Current
   
Long-Term
   
Total
   
Current
   
Long-Term
 
   
Debt
   
Maturities
   
Debt
   
Debt
   
Maturities
   
Debt
 
         
(unaudited)
                         
Capital lease obligation
  $ -     $ -     $ -     $ 10,997     $ 10,997     $ -  
Notes payable (includes payable to related parties of $378,000 at September 30, 2011 and $785,000 at December 31, 2010)
    747,000       -       747,000       1,450,000       1,450,000       -  
    $ 747,000     $ -     $ 747,000     $ 1,460,997     $ 1,460,997     $ -  
 
Notes Payable
 
From June 2009 through January 2010, the Company borrowed $1,450,000 (including $785,000 from related parties as disclosed below) and issued promissory notes in such aggregate principal amount (the “2009 Notes”).  The 2009 Notes provide for interest at the rate of 12.625% per annum through the maturity date of July 10, 2011. During the quarter the ended June 30, 2011, the Company prepaid $703,000 (including $407,000 to related parties) of the principal amount of the 2009 Notes. In June 2011, the remaining note holders agreed to extend the maturity date for a period of three years from July 10, 2011 to July 10 2014, and effective July 11, 2011, reduce the interest rate from 12.625% to 9.5% per annum. The remaining 2009 Notes, as extended, can be prepaid without premium or penalty.
 
Interest expense on the 2009 Notes for the nine months ended and three months ended September 30, 2011 was approximately $108,000 and $24,000, respectively. Interest expense on the 2009 Notes for the nine months ended and three months ended September 30, 2010 was approximately $133,000 and $46,000, respectively.
 
 
24

 
 
Related party balances as of September 30, 2011 and principal prepayments for the nine months ended September 30, 2011 under the 2009 Notes are as follows:
 
   
Balance
    Less    
Balance
 
   
December 31,
   
Principal
   
September 30,
 
   
2010
   
Prepayments
   
2011
 
Barry Goldstein IRA
  $ 150,000     $ 60,000     $ 90,000  
A limited liability company owned by Mr. Goldstein, along with Sam Yedid and Steven Shapiro (who are both directors of KICO)
    120,000       120,000       -  
Jay Haft, a director of the Company
    50,000       20,000       30,000  
A member of the family of Michael Feinsod, a director of the Company
    100,000       40,000       60,000  
Mr. Yedid and members of his family
    295,000       139,000       156,000  
A member of the family of Floyd Tupper, a director of KICO
    70,000       28,000       42,000  
Total related party transations
  $ 785,000     $ 407,000     $ 378,000  

Interest expense on related party borrowings for the nine months and three months ended September 30, 2011 was approximately $57,000 and $12,000, respectively. Interest expense on related party borrowings for the nine months and three months ended September 30, 2010 was approximately $71,000 and $24,000, respectively.
 
Note 9 – Preferred Stock
 
In accordance with GAAP guidance for accounting for certain financial instruments with characteristics of both liabilities and equity, the Company recorded previously issued Preferred Stock as a liability.  All of the preferred stock was exchanged for common stock effective June 30, 2010. For the nine months ended September 30, 2011 and 2010, the preferred dividends have been classified as interest expense of $-0- and $74,706 (including $65,274 to related parties), respectively. For the three months ended September 30, 2011 and 2010, the preferred dividends have been classified as interest expense of $-0- and $-0-, respectively.

 
25

 
 
Note 10 – Stockholders’ Equity
 
Dividend Declared

The Company’s Board of Directors approved a quarterly dividend on November 10, 2011 of $.03 per share payable in cash on December 15, 2011 to stockholders of record as of November 30, 2011.

Other Equity Compensation

The results of operations for the nine months ended September 30, 2011 and 2010 include other share-based stock compensation expense totaling $-0- and $143,129, respectively. The results of operations for the three months ended September 30, 2011 and 2010 include other share-based stock compensation expense totaling $-0- and $10,000, respectively. For the nine months ended September 30, 2010, other equity compensation consists of: (a) 50,000 shares granted to the Company’s chief executive officer pursuant to an amended employment agreement dated March 24, 2010, and (b) 12,466 shares granted to directors. The fair value of stock grants is as follows:
 
   
Three months ended
   
Three months ended
   
Nine months ended
   
Nine months ended
 
   
September 30, 2011
   
September 30, 2010
   
September 30, 2011
   
September 30, 2010
 
   
(unaudited)
   
(unaudited)
   
(unaudited)
   
(unaudited)
 
                                                 
Grant
 
Shares
   
Fair Value
   
Shares
   
Fair Value
   
Shares
   
Fair Value
   
Shares
   
Fair Value
 
Chief Executive Officer
    -     $ -       -     $ -       -     $ -       50,000     $ 112,000  
Directors
    -       -       4,588       10,000       -       -       12,466       31,129  
      -     $ -       4,588     $ 10,000       -     $ -       62,466     $ 143,129  
 
The fair value of stock grants has been included in the Condensed Consolidated Statement of Operations and Comprehensive Income within other operating expenses.

 
26

 
 
Stock Options

In December 2005, the Company’s shareholders ratified the adoption of the 2005 Equity Participation Plan (the “2005 Plan”), which provides for the issuance of incentive stock options, non-statutory stock options and restricted stock. Under the 2005 Plan, a maximum of 300,000 shares of Common Stock were permitted to be issued pursuant to options granted and restricted stock issued.  In March 2010, the Board of Directors of the Company increased the number of shares of Common Stock authorized to be issued pursuant to the 2005 Plan to 550,000, subject to stockholder approval.  In June 2010, the stockholders approved the increase to 550,000 shares.  Incentive stock options granted under the 2005 Plan expire no later than ten years from date of grant (except no later than five years for a grant to a 10% stockholder). The Board of Directors or the Stock Option Committee will determine the expiration date with respect to non-statutory options, and the vesting provisions for restricted stock, granted under the 2005 Plan.
 
The results of operations for the nine months and three months ended September 30, 2011 include share-based stock option compensation expense totaling approximately $86,000 and $21,000, respectively.  The results of operations for the nine months and three months ended September 30, 2010 include share-based stock option compensation expense totaling approximately $183,000 and $45,000, respectively. Share-based compensation expense related to stock options is net of estimated forfeitures of 21% for the nine months and three months ended September 30, 2011. Share-based compensation expense related to stock options is net of estimated forfeitures of 23% for the nine months and three months ended September 30, 2010.  Such amounts have been included in the Condensed Consolidated Statements of Operations and Comprehensive Income within other operating expenses.
 
Stock option compensation expense in 2011 and 2010 is the estimated fair value of options granted amortized on a straight-line basis over the requisite service period for the entire portion of the award. The weighted average estimated fair value of stock options granted during the nine months ended September 30, 2010 was $2.04 per share. The fair value of options at the grant date was estimated using the Black-Scholes option-pricing method. No stock options were granted during the nine months ended September 30, 2011. The following weighted average assumptions were used for grants during the nine months ended September 30, 2010:

Dividend Yield
0.00%
Volatility
101.25%
Risk-Free Interest Rate
2.62%
Expected Life
5 years
 
 
27

 
 
A summary of option activity under the Company’s 1998 Stock Option Plan (terminated in November, 2008) and the 2005 Plan as of September 30, 2011, and changes during the nine months then ended, is as follows:
 
Stock Options
 
Number of Shares
   
Weighted Average Exercise Price per Share
   
Weighted Average Remaining Contractual Term
   
Aggregate Intrinsic Value
 
                         
Outstanding at January 1, 2011
    393,865     $ 2.32       3.28     $ 463,465  
                                 
Granted
          $ -       -     $ -  
Exercised
    -     $ -       -     $ -  
Forfeited
    -     $ -       -     $ -  
                                 
Outstanding at September 30, 2011
    393,865     $ 2.32       2.53     $ 455,588  
                                 
Vested and Exercisable at September 30, 2011
    269,432     $ 2.26       2.17     $ 329,293  
 
The aggregate intrinsic value of options outstanding and options exercisable at September 30, 2011 is calculated as the difference between the exercise price of the underlying options and the market price of the Company’s Common Stock for the options that had exercise prices that were lower than the $3.48 closing price of the Company’s Common Stock on September 30, 2011.  No stock options were exercised in the nine months ended September 30, 2011 and 2010.
 
As of September 30, 2011, the fair value of unamortized compensation cost related to unvested stock option awards was approximately $75,000. Unamortized compensation cost as of September 30, 2011 is expected to be recognized over a remaining weighted-average vesting period of 1.21 years.
 
 
28

 
 
Note 11 – Income Taxes

The Company files a consolidated U.S. Federal Income Tax return that includes all wholly-owned subsidiaries. State tax returns are filed on a consolidated or separate basis depending on applicable laws. The company records adjustments related to prior year’s taxes during the period when they are identified, generally when the tax returns are filed.   The effect of these adjustments on the current and prior periods (during which the differences originated) is evaluated based upon quantitative and qualitative factors and are considered in relation to the financial statements taken as a whole for the respective periods. The Company has evaluated this year’s amounts in relation to the current and prior reporting periods and determined that a restatement of those prior reporting periods is not appropriate. The Company’s effective tax rate from continuing operations for the nine months and three months ended September 30, 2011 was 24.1% and 41.9%, respectively. A reconciliation of the Federal statutory rate to our effective rate from continuing operations is as follows:
 
   
For the Three Months Ended
   
For the Nine Months Ended
 
   
September 30,
   
September 30,
 
   
2011
   
2010
   
2011
   
2010
 
                                                 
 Computed expected tax expense
  $ 51,003       34.0 %   $ 117,025       34.0 %   $ 501,775       34.0 %   $ 458,036       34.0 %
 State taxes, net of Federal benefit
    (10,225 )     (6.8 )     10,164       3.0       (24,976 )     (1.7 )     24,932       1.9  
 Permanent differences
    (70,835 )     (47.2 )     (12,773 )     2.6       (88,153 )     (6.0 )     46,756       4.5  
 True-up of prior year taxes
    (72,960 )     (48.6 )     -       -       (50,886 )     (3.5 )     -       -  
 Other
    33,458       22.3       13,862       (2.3 )     17,926       1.2       34,664       1.6  
 Total tax
  $ (69,559 )     (46.4 )%   $ 128,278       37.3 %   $ 355,686       24.1 %   $ 564,388       41.9 %
 
Deferred tax assets and liabilities are determined using the enacted tax rates applicable to the period the temporary differences are expected to be recovered. Accordingly, the current period income tax provision can be affected by the enactment of new tax rates. The net deferred income taxes on the balance sheet reflect temporary differences between the carrying amounts of the assets and liabilities for financial reporting purposes and income tax purposes, tax effected at a various rates depending on whether the temporary differences are subject to Federal taxes, State taxes, or both. Significant components of the Company’s deferred tax assets and liabilities are as follows:
 
   
September 30,
   
December 31,
 
   
2011
   
2010
 
   
(unaudited)
       
Deferred tax asset:
       
 
 
    Net operating loss carryovers
  $ 383,403     $ 253,564  
    Claims reserve discount
    247,454       188,074  
    Unearned premium
    664,933       551,966  
    Loss and loss adjustment expenses
    -       39,100  
    Reinsurance recoverable
    -       13,600  
    Deferred ceding commission revenue
    1,311,659       1,094,634  
    Accrued expenses
    -       56,800  
    Other
    47,447       -  
Total deferred tax assets
    2,654,896       2,197,738  
                 
Deferred tax liability:
               
    Investment in KICO
    1,169,000       1,169,000  
    Deferred acquisition costs
    1,501,119       1,230,460  
    Intangibles
    1,285,064       1,406,371  
    Depreciation and amortization
    195,443       204,287  
    Reinsurance recoverable
    20,400       -  
    Net unrealized appreciation of securities - available for sale
    108,730       109,497  
    Investment income
    27,864       42,348  
    Other
    -       34,332  
Total deferred tax liabilities
    4,307,620       4,196,295  
                 
Net deferred income tax liability
  $ (1,652,724 )   $ (1,998,557 )

Under GAAP guidance for the “Accounting for Uncertainty in Income Taxes”, the Company had no material unrecognized tax benefit and no adjustments to liabilities or operations were required. Additionally, Accounting for Uncertainty in Income Taxes, provides guidance on the recognition of interest and penalties related to income taxes. There were no interest or penalties related to income taxes that have been accrued or recognized as of and for the nine months and three months ended September 30, 2011 and 2010. If any had been recognized these would be reported in income tax expense.

 
29

 
 
IRS Tax Audit

In July 2011, the Company received a notice that its Federal income tax return for the year ended December 31, 2009 has been selected for examination by the Internal Revenue Service. The audit commenced in September 2011. The final results of this audit are unknown, although management is confident in the tax assertions made in the tax return.

Note 12 – Net Income Per Common Share
 
For the nine months and three months ended September 30, 2011 there were 269,432 vested options with an exercise price below the average market price of the Company’s Common Stock during the period. For the nine months ended September 30, 2011 the inclusion of 83,788 net shares of Common Stock assumed to issued upon the exercise of such options in the computation of diluted earnings per share would have been anti-dilutive for such period, and as a result, the weighted average number of shares of Common Stock used in the calculation of basic and diluted earnings per common share have not been adjusted for the effect of such options.
 
For the nine months and three months ended September 30, 2010 there were 204,716 and 157,500 vested options with an exercise price below the average market price of the Company’s shares of Common Stock during the period. For the nine months and three months ended September 30, 2010 the inclusion of 51,289 net shares of Common Stock and 20,608 net shares of Common Stock, respectively, assumed to issued upon the exercise of such options in the computation of diluted earnings per share would have been anti-dilutive for both periods, and as a result, the weighted average number of shares of Common Stock used in the calculation of basic and diluted earnings per common share have not been adjusted for the effects of such options.
 
The reconciliation of the weighted average number of shares of Common Stock used in the calculation of basic and diluted earnings per common share for the three months ended September 30, 2011 follows:
 
Weighted average number of shares outstanding
    3,838,386  
Effect of dilutive securities, common share equivalents
    74,650  
         
Weighted average number of shares outstanding, used for computing diluted earnings per share
    3,913,036  
 
Note 13 – Commitments and Contingencies

Legal Proceedings

From time to time, the Company is involved in various legal proceedings in the ordinary course of business. For example, to the extent a claim asserted by a third party in a law suit against one of the Company’s insureds covered by a particular policy, the Company may have a duty to defend the insured party against the claim. These claims may relate to bodily injury, property damage or other compensable injuries as set forth in the policy. Such proceedings are considered in estimating the liability for loss and LAE expenses. The Company is not subject to any other pending legal proceedings that management believes are likely to have a material adverse effect on the financial statements.

 
30

 
 
Note 14 – Discontinued Operations
 
On April 17, 2009, the Company’s wholly-owned subsidiaries that owned and operated its former network of retail brokerage outlets in New York State sold substantially all of their assets, including the book of business (the “New York Assets”). As additional consideration, the Company was entitled to receive through September 30, 2010 an additional amount equal to 60% of the net commissions derived from the book of business of six New York retail locations that were closed in 2008. Income from discontinued operations for the nine months ended September 30, 2011 and 2010 includes approximately $-0- and $40,000, respectively, of income from additional consideration from the sale of the New York Assets. Income from discontinued operations for the three months ended September 30, 2011 and 2010 includes approximately $-0- and $16,000, respectively, of income from additional consideration from the sale of the New York Assets.

Note 15 – Subsequent Event
 
On November 10, 2011, KICO’s board of directors approved a cash dividend of $175,000 to the Company, which was paid on November 11, 2011. Payment of the cash dividend will have no effect on the Company’s consolidated net earnings, total stockholders’ equity or cash flows.
 
 
31

 
 
ITEM 2.  MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS.
 
Overview
 
We offer property and casualty insurance products to small businesses and individuals in New York State through our subsidiary, Kingstone Insurance Company (“KICO”).

We derive 98% of our revenue from KICO, which includes revenues from earned premiums, ceding commissions from quota share reinsurance, investment income and net realized and unrealized gains and losses on investment securities.  Earned premiums represent premiums received from insureds, which are recognized as revenue over the period of time that insurance coverage is provided (i.e., ratably over the life of the policy). A significant period of time normally elapses between the receipt of insurance premiums and the payment of insurance claims. During this time, KICO invests the premiums, earns investment income and generates net realized and unrealized investment gains and losses on investments.

Our expenses include the insurance underwriting expenses of KICO and other operating expenses. Insurance companies incur a significant amount of their total expenses from policyholder losses, which are commonly referred to as claims. In settling policyholder losses, various loss adjustment expenses (“LAE”) are incurred such as insurance adjusters’ fees and litigation expenses. In addition, insurance companies incur policy acquisition expenses, such as commissions paid to producers and premium taxes, and other expenses related to the underwriting process, including their employees’ compensation and benefits.

Other operating expenses include the corporate expenses of our holding company, Kingstone Companies, Inc. These expenses include executive employment costs, legal, auditing and consulting fees, occupancy costs related to our corporate office and other costs directly associated with being a public company.

We utilize the following key measures in analyzing the results of our insurance underwriting business:
 
Net loss ratio.  The net loss ratio is a measure of the underwriting profitability of an insurance company’s business. Expressed as a percentage, this is the ratio of net losses and loss adjustment expenses (“LAE”) incurred to net premiums earned.
 
Net underwriting expense ratio.  The net underwriting expense ratio is a measure of an insurance company’s operational efficiency in administering its business. Expressed as a percentage, this is the ratio of the sum of acquisition costs (the most significant being commissions paid to our producers) and other underwriting expenses less ceding commission revenue less other income to net premiums earned.
 
Net combined ratio.  The net combined ratio is a measure of an insurance company’s overall underwriting profit. This is the sum of the net loss and net underwriting expense ratios. If the net combined ratio is at or above 100 percent, an insurance company cannot be profitable without investment income, and may not be profitable if investment income is insufficient.
 
Underwriting Income. Underwriting income is net pre-tax income attributable to our insurance underwriting business except for net investment income, net realized gains from investments, and depreciation and amortization (net premiums earned less expenses included in combined ratio). Underwriting income is a measure of an insurance company’s overall operating profitability before items such as investment income, depreciation and amortization, interest expense and income taxes.
 
 
32

 
 
Critical Accounting Policies
 
Our condensed consolidated financial statements include the accounts of Kingstone Companies, Inc. and all majority-owned and controlled subsidiaries. The preparation of financial statements in conformity with accounting principles generally accepted in the United States requires our management to make estimates and assumptions in certain circumstances that affect amounts reported in our consolidated financial statements and related notes. In preparing these financial statements, our management has utilized information available including our past history, industry standards and the current economic environment, among other factors, in forming its estimates and judgments of certain amounts included in the consolidated financial statements, giving due consideration to materiality. It is possible that the ultimate outcome as anticipated by our management in formulating its estimates inherent in these financial statements might not materialize. However, application of the critical accounting policies below involves the exercise of judgment and use of assumptions as to future uncertainties and, as a result, actual results could differ from these estimates. In addition, other companies may utilize different estimates, which may impact comparability of our results of operations to those of companies in similar businesses.
 
We believe that the most critical accounting policies relate to the reporting of reserves for loss and LAE, including losses that have occurred but have not been reported prior to the reporting date, amounts recoverable from third party reinsurers, deferred policy acquisition costs, deferred income taxes, the impairment of investment securities, intangible assets and the valuation of stock based compensation. See Note 2 to the Consolidated Financial Statements - “Accounting Policies and Basis of Presentation” for information related to updated accounting policies.
 
 
33

 
 
Consolidated Results of Operations
 
Nine Months Ended September 30, 2011 Compared to Nine Months Ended September 30, 2010
 
The following table summarizes the changes in the results of our operations (in thousands) for the periods indicated:
 
   
Nine months ended September 30,
 
($ in thousands)
 
2011
   
2010
   
Change
   
Percent
 
Revenues
                       
 Direct written premiums
  $ 30,503     $ 24,969     $ 5,534       22.2 %
 Net written premiums
    12,410       10,449       1,960       18.8 %
 Change in net unearned premiums
    (1,588 )     (2,544 )     956       (37.6 )%
 Net premiums earned
    10,822       7,905       2,917       36.9 %
 Ceding commission revenue (1)
    7,348       6,414       934       14.6 %
 Net investment income
    510       436       74       17.0 %
 Net realized gain on investments
    357       229       128       55.9 %
 Other income
    693       664       29       4.4 %
 Total revenues
    19,730       15,648       4,082       26.1 %
                                 
Expenses
                               
 Loss and loss adjustment expenses
                               
 Direct loss and loss adjustment expenses
    14,343       11,107       3,237       29.1 %
 Less: ceded loss and loss adjustment expenses
    (7,035 )     (6,588 )     (447 )     6.8 %
 Net loss and loss adjustment expenses (1)
    7,308       4,518       2,790       61.7 %
 Commission expense
    4,473       3,647       826       22.6 %
 Other underwriting expenses
    5,045       4,113       932       22.7 %
 Other operating expenses
    863       1,345       (482 )     (35.8 )  %
 Depreciation and amortization
    457       464       (7 )     (1.5 )  %
 Interest expense
    108       139       (31 )     (22.3 )  %
 Interest expense - mandatorily redeemable preferred stock
    -       75       (75 )     (100.0 )  %
 Total expenses
    18,254       14,301       3,953       27.6 %
                                 
 Income from continuing operations before taxes
    1,476       1,347       129       9.6 %
 Provision for (benefit from) income tax
    356       564       (208 )     (36.9 )  %
 Income from continuing operations
    1,120       783       337       43.0 %
 Income from discontinued operations, net of taxes
    -       40       (40 )     (100.0 )  %
Net income
  $ 1,120     $ 823     $ 297       36.1 %
                                 
Percent of total revenues:
                               
 Net premiums earned
    54.9 %     50.5 %                
 Ceding commission revenue
    37.2 %     41.0 %                
 Net investment income
    2.6 %     2.8 %                
 Net realized gains on investments
    1.8 %     1.5 %                
 Other income
    3.5 %     4.2 %                
      100.0 %     100.0 %                
                                 
Net loss ratio excluding the effect of catastrophes
    63.6 %     57.2 %                
Net catastrophe loss
    3.9 %     0.0 %                
Net loss ratio
    67.5 %     57.2 %              
 
 
(1) Includes net catastrophe losses and net loss adjustment expenses for the nine months ended September 30, 2011of $422,000 incurred from August 27, 2011 to August 29, 2011 from Tropical Storm Irene. Catastrophe losses incurred from Tropical Storm Irene decreased our ceded loss ratio which reduced our contingent ceding commission revenue by $493,000. We define a “catastrophe” as an event that involves multiple first party policyholders, or an event that produces a number of claims in excess of a preset, per-event threshold of average claims in a specific area, occurring within a certain amount of time constituting the event.  Catastrophes are caused by various natural events including high winds, excessive rain, winter storms, tornadoes, hailstorms, wildfires, tropical storms, and hurricanes. 
 
 
34

 
Direct written premiums during the nine months ended September 30, 2011 (“2011”) were $30,503,000 compared to $24,969,000 during the nine months ended September 30, 2010 (“2010”). The increase of $5,534,000 or 22.2% was primarily due to an increase in policies in-force during 2011 as compared to 2010. Policies in-force increased by 19.7% as of September 30, 2011 compared to September 30, 2010. In addition to the increase of policies in-force, we are also writing more policies which have higher premiums.
 
Net written premiums increased $1,960,000, or 18.8%, to $12,410,000 in 2011 from $10,449,000 in 2010. The increase in net written premiums resulted from an increase in direct written premiums in 2011 compared to direct written premiums in 2010. Net written premiums grew at a lower rate than direct written premiums (18.8% compared to 22.2%) due to a greater increase in premiums written in lines of business that are subject to quota share treaties compared to lines of business that are not subject to quota share treaties.
 
Net premiums earned increased $2,917,000, or 36.9%, to $10,822,000 in 2011 from $7,905,000 in 2010. As premiums written earn ratably primarily over a twelve month period, the increase was a result of higher net written premiums for the twelve months ended September 30, 2011 compared to the twelve months ended September 30, 2010.
 
Ceding commission revenue was $7,348,000 in 2011 compared to $6,414,000 in 2010. The increase of $934,000 or 14.6% was due to the increase in the amount of premiums ceded and more favorable ceding commission rates, offset by the effects of Tropical Storm Irene on our ceded net loss ratio which reduced our contingent ceding commission revenue by $493,000. Our quota share reinsurance treaty, which expired June 30, 2011, contained a provision which limited the maximum contingent ceding commission that could be paid to us, with the unused benefit carried forward to the current treaty year which began July 1, 2011. The carryover amount was recognized effective July 1, 2011, and resulted in an additional $136,000 to our contingent ceding commission revenue. Ceding commission revenue also increased as a result of decreases in ceded loss ratios on prior year’s quota share treaties.
 
Net investment income was $510,000 in 2011 compared to $436,000 in 2010. The increase of $74,000 or 17.0% was due to an increase in average invested assets in 2011 as compared to 2010, offset by an adjustment to amortization of bond premium in 2011.  The increase in cash and invested assets resulted primarily from increased operating cash flows. The tax equivalent investment yield, excluding cash, was 5.07% and 5.77% at September 30, 2011 and 2010, respectively.
 
Net realized gains on investments were $357,000 in 2011 compared to $229,000 in 2010. The increase of $128,000 or 55.9% was due to a $133,000 FDIC recovery from a failed bank which was included in other than temporary impaired losses in 2009.
 
 
35

 
 
Net loss and loss adjustment expenses were $7,308,000 in 2011 compared to $4,518,000 in 2010. The net loss ratio was 67.5% in 2011 compared to 57.2% in 2010. The increase of 10.3 percentage points in our net loss ratio for 2011 as compared to 2010 is primarily due to the effects of Tropical Storm Irene in August 2011 and an increase in losses in our commercial auto line of business, which is not subject to a quota share treaty in 2011. As a result of Tropical Storm Irene, which we define as a catastrophe, we incurred $422,000 of losses and loss adjustment expenses (net of reinsurance recoverable of $1,266,000), and added 3.9 percentage points to our net loss ratio.
 
Commission expense was $4,473,000 in 2011 or 14.7% of direct written premiums. Commission expense was $3,647,000 in 2010 or 14.6% of direct written premiums. The increase of $826,000 or 22.6% is due to the 22.2% increase in direct written premiums in 2011 as compared to 2010.
 
Other underwriting expenses were $5,045,000 in 2011 compared to $4,113,000 in 2010. The $932,000 increase in other underwriting expenses was primarily due to expenses directly related to the increase in direct written premiums and additional employment costs due to the hiring of additional staff needed to service our growth in written premiums. The net underwriting expense ratio was 46.6% in 2011 as compared to 52.0% in 2010.
 
Other operating expenses, related to the corporate expenses of our holding company, were $863,000 in 2011 compared to $1,345,000 in 2010. The $482,000 decrease in 2011 was primarily due to decreases in professional fees, executive employment costs, and amortization of stock options. The reduction of professional fees in 2011 was due to the elimination of the additional costs incurred in 2010 stemming from the acquisition of KICO on July 1, 2009. The reduction of executive employment costs is due to share-based bonus compensation to our Chief Executive Officer in 2010, which was incurred pursuant to his amended employment agreement dated March 24, 2010. No such share-based bonus compensation was incurred in 2011. The reduction in amortization of stock options decreased as a result of more stock options being fully vested prior to 2011.
 
Interest expense was $108,000 in 2011 compared to $139,000 in 2010. The $31,000 decrease in interest expense was due to the $703,000 partial redemption of our 2009 Notes during the quarter ended June 30, 2011, and effective July 11, 2011, a reduction in the interest rate from 12.625% to 9.5%.
 
Interest expense on mandatorily redeemable preferred stock was $-0- in 2011 compared to $75,000 in 2010.  The reduction was due to the exchange of all of the outstanding preferred stock into common stock on June 30, 2010, which resulted in the elimination of additional related interest expense as of that date.
 
Income tax expense in 2011 was $356,000, which resulted in an effective tax rate of 24.1%. Income tax expense in 2010 was $564,000, which resulted in an effective tax rate of 41.9%. The decrease in our effective tax rate resulted primarily from a change to tax exempt permanent differences in 2011 from taxable permanent differences in 2010 and the true-up of our 2010 income tax liability. Permanent differences in 2011 had less of an impact on the effective tax rate due to a lower percentage of permanent differences to book income compared to 2010.
 
Net income was $1,120,000 in 2011 compared to $823,000 in 2010. The increase in net income of $297,000 was due to the circumstances that caused the increases in our net premiums earned and ceding commission revenue, increase in net realized gains and a decrease in other operating expenses, offset by increases in our net loss ratio and other underwriting expenses, as described above.
 
 
36

 
 
Three Months Ended September 30, 2011 Compared to Three Months Ended September 30, 2010
 
The following table summarizes the changes in the results of our operations (in thousands) for the periods indicated:
 
   
Three months ended September 30,
 
($ in thousands)
 
2011
   
2010
   
Change
   
Percent
 
Revenues
                       
 Direct written premiums
  $ 10,383     $ 8,376     $ 2,007       24.0 %
 Net written premiums
    4,267       3,366       900       26.7 %
 Change in net unearned premiums
    (330 )     (301 )     (29 )     9.6 %
 Net premiums earned
    3,937       3,065       871       28.4 %
 Ceding commission revenue (1)
    2,308       2,232       76       3.4 %
 Net investment income
    172       155       17       11.0 %
 Net realized gain on investments
    197       84       113       134.5 %
 Other income
    228       215       13       6.0 %
 Total revenues
    6,842       5,751       1,090       19.0 %
                                 
Expenses
                               
 Loss and loss adjustment expenses
                               
 Direct loss and loss adjustment expenses
    6,555       4,490       2,065       46.0 %
 Less: ceded loss and loss adjustment expenses
    (3,621 )     (2,582 )     (1,039 )     40.3 %
 Net loss and loss adjustment expenses (1)
    2,934       1,908       1,026       53.8 %
 Commission expense
    1,596       1,287       309       24.0 %
 Other underwriting expenses
    1,734       1,581       153       9.7 %
 Other operating expenses
    260       428       (168 )     (39.3 )  %
 Depreciation and amortization
    144       156       (12 )     (7.7 )  %
 Interest expense
    24       47       (23 )     (48.9 )  %
 Total expenses
    6,692       5,407       1,285       23.8 %
                                 
 Income from continuing operations before taxes
    150       344       (195 )     (56.5 )  %
 Provision for (benefit from) income tax
    (70 )     128       (198 )     (154.7 )  %
 Income from continuing operations
    220       216       3       1.5 %
 Income from discontinued operations, net of taxes
    -       16       (16 )     (100.0 )  %
Net income
  $ 220     $ 232     $ (13 )     (5.5 )  %
                                 
Percent of total revenues:
                               
 Net premiums earned
    57.5 %     53.3 %                
 Ceding commission revenue
    33.7 %     38.8 %                
 Net investment income
    2.5 %     2.7 %                
 Net realized gains on investments
    2.9 %     1.5 %                
 Other income
    3.3 %     3.7 %                
      100.0 %     100.0 %                
                                 
Net loss ratio excluding the effect of catastrophes
    63.8 %     62.2 %                
Net catastrophe loss
    10.7 %     0.0 %                
Net loss ratio
    74.5 %     62.2 %                
 
(1) Includes net catastrophe losses and net loss adjustment expenses for the three months ended September 30, 2011of $422,000 incurred from August 27, 2011 to August 29, 2011 from Tropical Storm Irene. Catastrophe losses incurred from Tropical Storm Irene decreased our ceded loss ratio which reduced our contingent ceding commission revenue by $493,000. We define a “catastrophe” as an event that involves multiple first party policyholders, or an event that produces a number of claims in excess of a preset, per-event threshold of average claims in a specific area, occurring within a certain amount of time constituting the event.  Catastrophes are caused by various natural events including high winds, excessive rain, winter storms, tornadoes, hailstorms, wildfires, tropical storms, and hurricanes. 
 
 
37

 
 
Direct written premiums during the three months ended September 30, 2011 (“Q3 2011”) were $10,383,000 compared to $8,376,000 during the three months ended September 30, 2010 (“Q3 2010”). The increase of $2,007,000 or 24.0% was primarily due to an increase in policies in-force during Q2 2011 as compared to Q2 2010. Policies in-force increased by 19.7% as of September 30, 2011 compared to September 30, 2010. In addition to the increase of policies in-force, we are also writing more policies which have higher premiums.
 
Net written premiums increased $900,000, or 26.7%, to $4,267,000 in Q3 2011 from $3,366,000 in Q3 2010. The increase in net written premiums resulted from an increase in direct written premiums in Q3 2011 compared to direct written premiums in Q3 2010. Net written premiums grew at a greater rate than direct written premiums (26.7% compared to 24.0%) due to a reduction effective July 1, 2011 in the quota share percentage on our commercial lines from 75% to 60%.
 
Net premiums earned increased $871,000, or 28.4%, to $3,937,000 in Q3 2011 from $3,065,000 in Q3 2010. As premiums written earn ratably primarily over a twelve month period, the increase was a result of higher net written premiums for the twelve months ended September 30, 2011 compared to the twelve months ended September 30, 2010.
 
Ceding commission revenue was $2,308,000 in Q3 2011 compared to $2,232,000 in Q3 2010. The increase of $76,000 or 3.4% was due to the increase in the amount of premiums ceded and more favorable ceding commission rates, offset by the effects of Tropical Storm Irene on our ceded net loss ratio which reduced our contingent ceding commission revenue by $493,000. Our quota share reinsurance treaty, which expired June 30, 2011, contained a provision which limited the maximum contingent ceding commission that could be paid to us, with the unused benefit carried forward to the current treaty year which began July 1, 2011. The carryover amount was recognized effective July 1, 2011, and resulted in an additional $136,000 to our contingent ceding commission revenue. Increases in ceded loss ratios on prior year’s quota share treaties had the effect of decreasing Ceding commission revenue in Q3.
 
Net investment income was $172,000 in Q3 2011 compared to $155,000 in Q3 2010. The increase of $17,000 or 11.0% was due to an increase in average invested assets in Q3 2011 as compared to Q3 2010.  The increase in cash and invested assets resulted primarily from increased operating cash flows. The tax equivalent investment yield, excluding cash, was 5.07% and 5.77% at September 30, 2011 and 2010, respectively.
 
Net realized gains on investments were $197,000 in 2011 compared to $84,000 in 2010. The increase of $113,000 or 134.5% was primarily due to a $133,000 FDIC recovery from a failed bank which was included in other than temporary impaired losses in 2009.
 
Net loss and loss adjustment expenses were $2,934,000 in Q3 2011 compared to $1,908,000 in Q3 2010. The net loss ratio was 74.5% in Q3 2011 compared to 62.2% in Q3 2010. The increase of 12.3 percentage points in our net loss ratio for 2011 as compared to 2010 is primarily due to the effects of Tropical Storm Irene in August 2011 and an increase in losses in our commercial auto line of business, which is not subject to a quota share treaty in 2011. As a result of Tropical Storm Irene, which we define as a catastrophe, we incurred $422,000 of losses and loss adjustment expenses (net of reinsurance recoverable of $1,266,000), and added 10.7 percentage points to our net loss ratio.
 
Commission expense was $1,596,000 in Q3 2011 or 15.4% of direct premiums written. Commission expense was $1,287,000 in Q3 2010 or 15.4% of direct written premiums. The increase of $309,000 or 24.0% is due to the 24.0% increase in direct written premiums in Q3 2011 as compared to Q3 2010.
 
 
38

 
 
Other underwriting expenses were $1,734,000 in Q3 2011 compared to $1,581,000 in Q3 2010. The $153,000 increase in other underwriting expenses was primarily due to expenses directly related to the increase in direct written premiums and additional employment costs due to the hiring of additional staff needed to service our growth in written premiums. The net underwriting expense ratio was 44.0% in Q3 2011 as compared to 51.6% in Q3 2010.
 
Other operating expenses, related to the corporate expenses of our holding company, were $260,000 in Q3 2011 compared to $428,000 in Q3 2010. The $168,000 decrease in Q3 2011 was primarily due to decreases in salaries and amortization of stock options. The decrease in salaries is due a change in allocation of our executive salaries to corporate expenses and a reduction of the accrued bonus to our CEO based on the formula calculated pursuant to his amended employment agreement date March 24, 2010. The reduction in amortization of stock options decreased as a result of more stock options being fully vested prior to Q3 2011.
 
Interest expense was $24,000 in Q3 2011 compared to $47,000 in Q3 2010. The $23,000 decrease in interest expense was due to the $703,000 partial redemption of our 2009 Notes during the quarter ended June 30, 2011, and effective July 11, 2011, a reduction in the interest rate from 12.625% to 9.5%.
 
Income tax benefit in Q3 2011 was $70,000, which resulted in an effective tax rate of (46.4)%. Income tax expense in Q3 2010 was $128,000, which resulted in an effective tax rate of 37.3%.
 
Net income was $220,000 in Q3 2011 compared to $232,000 in Q3 2010. The decrease in net income of $13,000 was due to the circumstances that caused the increases in our net loss ratio and other underwriting expenses, offset by increases in our net premiums earned and ceding commission revenue, increase in realized gains, decrease in other operating expenses, and increase in tax benefit, as described above.
 
 
39

 
 
Insurance Underwriting Business on a Standalone Basis
 
Our insurance underwriting business reported on a standalone basis for the periods indicated is as follows:
 
   
Three months ended
   
Nine months ended
 
   
September 30,
   
September 30,
 
   
2011
   
2010
   
2011
   
2010
 
                         
Revenues
                       
 Net premiums earned
 
$
3,937,189
   
$
3,065,289
   
$
10,822,137
   
$
7,905,350
 
 Ceding commission revenue
   
2,307,390
     
2,231,493
     
7,347,832
     
6,413,774
 
 Net investment income
   
172,039
     
154,679
     
510,173
     
435,882
 
 Net realized gain on investments
   
196,574
     
84,054
     
357,006
     
228,803
 
 Other income
   
109,452
     
82,498
     
307,511
     
244,666
 
 Total revenues
   
6,722,644
     
5,618,013
     
19,344,659
     
15,228,475
 
                                 
Expenses
                               
 Loss and loss adjustment expenses
   
2,933,531
     
1,907,917
     
7,307,925
     
4,518,253
 
 Commission expense
   
1,596,281
     
1,287,268
     
4,472,924
     
3,647,371
 
 Other underwriting expenses
   
1,734,137
     
1,580,827
     
5,045,051
     
4,112,889
 
 Depreciation and amortization
   
144,122
     
154,475
     
452,503
     
461,076
 
 Total expenses
   
6,408,071
     
4,930,488
     
17,278,403
     
12,739,590
 
                                 
 Income from operations
   
314,573
     
687,525
     
2,066,256
     
2,488,885
 
 Income tax expense
   
30,295
     
209,426
     
601,939
     
820,036
 
Net income
 
$
284,278
   
$
478,100
   
$
1,464,317
   
$
1,668,850
 
 
 
 
40

 
 
An analysis of our direct, assumed and ceded earned premiums, loss and loss adjust expenses, and loss ratios is shown below:
 
   
Direct
   
Assumed
   
Ceded
   
Net
 
                         
Nine months ended September 30, 2011
                       
 Written premiums
  $ 30,502,800     $ 6,289     $ (18,099,446 )   $ 12,409,643  
 Unearned premiums
    (3,823,593 )     1,611       2,234,476       (1,587,506 )
 Earned premiums
  $ 26,679,207     $ 7,900     $ (15,864,970 )   $ 10,822,137  
                                 
     Loss and loss adjustment expenses exluding the effect of catastrophes
  $ 12,639,123     $ 15,704     $ (5,768,974 )   $ 6,885,853  
 Catastrophe loss
    1,688,289       -       (1,266,217 )     422,072  
 Loss and loss adjustment expenses
  $ 14,327,412     $ 15,704     $ (7,035,191 )   $ 7,307,925  
                                 
 Loss ratio excluding the effect of catastrophes
    47.4 %     198.8 %     36.4 %     63.6 %
 Catastrophe loss
    6.3 %     0.0 %     8.0 %     3.9 %
 Loss ratio
    53.7 %     198.8 %     44.3 %     67.5 %
                                 
Nine months ended September 30, 2010
                               
 Written premiums
  $ 24,969,119     $ 9,572     $ (14,529,432 )   $ 10,449,259  
 Unearned premiums
    (3,126,232 )     (1,360 )     583,683       (2,543,909 )
 Earned premiums
  $ 21,842,887     $ 8,212     $ (13,945,749 )   $ 7,905,350  
                                 
     Loss and loss adjustment expenses exluding the effect of catastrophes
  $ 11,095,027     $ 11,543     $ (6,588,317 )   $ 4,518,253  
 Catastrophe loss
    -       -       -       -  
 Loss and loss adjustment expenses
  $ 11,095,027     $ 11,543     $ (6,588,317 )   $ 4,518,253  
                                 
 Loss ratio excluding the effect of catastrophes
    50.8 %     140.6 %     47.2 %     57.2 %
 Catastrophe loss
    0.0 %     0.0 %     0.0 %     0.0 %
 Loss ratio
    50.8 %     140.6 %     47.2 %     57.2 %
                                 
Three months ended September 30, 2011
                               
 Written premiums
  $ 10,382,641     $ 3,409     $ (6,119,576 )   $ 4,266,474  
 Unearned premiums
    (909,125 )     (41 )     579,881       (329,285 )
 Earned premiums
  $ 9,473,516     $ 3,368     $ (5,539,695 )   $ 3,937,189  
                                 
     Loss and loss adjustment expenses exluding the effect of catastrophes
  $ 4,857,144     $ 9,649     $ (2,355,334 )   $ 2,511,459  
 Catastrophe loss
    1,688,289       -       (1,266,217 )     422,072  
 Loss and loss adjustment expenses
  $ 6,545,433     $ 9,649     $ (3,621,551 )   $ 2,933,531  
                                 
 Loss ratio excluding the effect of catastrophes
    51.3 %     286.5 %     42.5 %     63.8 %
 Catastrophe loss
    17.8 %     0.0 %     22.9 %     10.7 %
 Loss ratio
    69.1 %     286.5 %     65.4 %     74.5 %
                                 
Three months ended September 30, 2010
                               
 Written premiums
  $ 8,375,776     $ 6,436     $ (5,015,905 )   $ 3,366,307  
 Unearned premiums
    (595,995 )     (3,432 )     298,409       (301,018 )
 Earned premiums
  $ 7,779,781     $ 3,004     $ (4,717,496 )   $ 3,065,289  
                                 
     Loss and loss adjustment expenses exluding the effect of catastrophes
  $ 4,482,894     $ 6,825     $ (2,581,802 )   $ 1,907,917  
 Catastrophe loss
    -       -       -       -  
 Loss and loss adjustment expenses
  $ 4,482,894     $ 6,825     $ (2,581,802 )   $ 1,907,917  
                                 
 Loss ratio excluding the effect of catastrophes
    57.6 %     227.2 %     54.7 %     62.2 %
 Catastrophe loss
    0.0 %     0.0 %     0.0 %     0.0 %
 Loss ratio
    57.6 %     227.2 %     54.7 %     62.2 %
 
 
41

 
 
Key Measures
 
The key measures for our insurance underwriting business for the periods indicated are as follows:
 
   
Three months ended
   
Nine months ended
 
   
September 30,
   
September 30,
 
   
2011
   
2010
   
2011
   
2010
 
Net premiums earned
  $ 3,937,189     $ 3,065,289     $ 10,822,137     $ 7,905,350  
Ceding commission revenue (1)
    2,307,390       2,231,493       7,347,832       6,413,774  
Other income
    109,452       82,498       307,511       244,666  
                                 
Loss and loss adjustment expenses (2)
    2,933,531       1,907,917       7,307,925       4,518,253  
                                 
Acquistion costs and other underwriting expenses:
                               
 Commission expense
    1,596,281       1,287,268       4,472,924       3,647,371  
 Other underwriting expenses
    1,734,137       1,580,827       5,045,051       4,112,889  
 Total acquistion costs and other underwriting expenses
    3,330,418       2,868,095       9,517,975       7,760,260  
                                 
Underwriting income
  $ 90,082     $ 603,268     $ 1,651,580     $ 2,285,277  
                                 
Key Measures:
                               
 Net loss ratio excluding the effect of catastrophes
    63.8 %     62.3 %     63.6 %     57.2 %
 Effect of catastrophe loss on loss ratio (2)
    10.7 %     0.0 %     3.9 %     0.0 %
 Net loss ratio
    74.5 %     62.3 %     67.5 %     57.2 %
                                 
         Net underwriting expense ratio excluding the effect of catastrophes
    10.7 %     18.1 %     12.7 %     13.9 %
         Effect of catastrophe loss on net underwriting expense ratio (1) (2)
    12.5 %     0.0 %     4.6 %     0.0 %
 Net underwriting expense ratio
    23.2 %     18.1 %     17.2 %     13.9 %
                                 
         Net combined ratio excluding the effect of catastrophes
    74.5 %     80.3 %     76.3 %     71.1 %
         Effect of catastrophe loss on net combined ratio (1) (2)
    23.2 %     0.0 %     8.5 %     0.0 %
 Net combined ratio
    97.7 %     80.3 %     84.7 %     71.1 %
                                 
 Reconciliation of net underwriting expense ratio:
                               
        Acquisition costs and other underwriting expenses
  $ 3,330,418     $ 2,868,095     $ 9,517,975     $ 7,760,260  
 Less: Ceding commission revenue (1)
    (2,307,390 )     (2,231,493 )     (7,347,832 )     (6,413,774 )
 Less: Other income
    (109,452 )     (82,498 )     (307,511 )     (244,666 )
   
  $ 913,576     $ 554,104     $ 1,862,632     $ 1,101,820  
                                 
 Net earned premium
  $ 3,937,189     $ 3,065,289     $ 10,822,137     $ 7,905,350  
 
(1) The effect of catastrophes reduced contingent ceding commission revenue by $492,870 for the three months and nine months ended September 30, 2011. A provision in our quota share reinsurance treaty, which expired June 30, 2011, limited the maximum contingent ceding commission that could be paid to us, with the unused benefit carried forward to the current treaty year which began July 1, 2011. The carry forward of the unused benefit resulted in additional contingent ceding commission revenue of approximately $136,000 for the three months and nine months ended September 30, 2011.
 
(2) Includes net catastrophe losses and net loss adjustment expenses for the three months ended September 30, 2011of $422,072.
 
 
42

 
 
Investments
 
Portfolio Summary
 
The following table presents a breakdown of the amortized cost, aggregate fair value and unrealized gains and losses by investment type as of September 30, 2011 and December 31, 2010:

Available for Sale Securities
 
   
September 30, 2011
 
                                     
  
 
Cost or
   
Gross
   
Gross Unrealized Losses
   
Aggregate
   
% of
 
   
Amortized
   
Unrealized
   
Less than 12
   
More than 12
   
Fair
   
Fair
 
 Category
 
Cost
   
Gains
   
Months
   
Months
   
Value
   
Value
 
   
(unaudited)
 
U.S. Treasury securities and obligations of U.S. government corporations and agencies
  $ 499,815     $ 49,398     $ -     $ -     $ 549,213       2.5 %
                                                 
Political subdivisions of States, Territories and Possessions
    6,133,143       288,099       -       -       6,421,242       29.1 %
                                                 
Corporate and other bonds industrial and miscellaneous
    10,956,040       271,758       (221,751 )     (24,860 )     10,981,187       49.7 %
 Total fixed-maturity securities
    17,588,998       609,255       (221,751 )     (24,860 )     17,951,642       81.2 %
Equity Securities
    4,119,319       235,726       (211,788 )     -       4,143,257       18.8 %
 Total
  $ 21,708,317     $ 844,981     $ (433,539 )   $ (24,860 )   $ 22,094,899       100.0 %

   
December 31, 2010
 
                                     
  
 
Cost or
   
Gross
   
Gross Unrealized Losses
   
Aggregate
   
% of
 
   
Amortized
   
Unrealized
   
Less than 12
   
More than 12
   
Fair
   
Fair
 
 Category
 
Cost
   
Gains
   
Months
   
Months
   
Value
   
Value
 
U.S. Treasury securities and obligations of U.S. government corporations and agencies
  $ 1,000,572     $ 42,085     $ -     $ -     $ 1,042,657       5.4 %
                                                 
Political subdivisions of States, Territories and Possessions
    7,278,663       79,791       (86,234 )     (12,995 )     7,259,225       37.6 %
                                                 
Corporate and other bonds industrial and miscellaneous
    7,997,817       176,999       (137,597 )     -       8,037,219       41.6 %
 Total fixed-maturity securities
    16,277,052       298,875       (223,831 )     (12,995 )     16,339,101       84.6 %
Equity Securities
    2,825,015       218,717       (60,697 )     -       2,983,035       15.4 %
 Total
  $ 19,102,067     $ 517,592     $ (284,528 )   $ (12,995 )   $ 19,322,136       100.0 %

 
43

 
 
Held to Maturity Securities
 
    September 30, 2011  
     Cost or      Gross      Gross Unrealized Losses           % of  
   
Amortized
   
Unrealized
   
Less than 12
   
More than 12
   
Fair
   
Fair
 
 Category
 
Cost
   
Gains
   
Months
   
Months
   
Value
   
Value
 
   
(unaudited)
 
                                     
 U.S. Treasury securities
  $ 606,234     $ 165,047     $ -     $ -     $ 771,281       100.0 %
 
    December 31, 2010  
    Cost or     Gross     Gross Unrealized Losses           % of  
   
Amortized
   
Unrealized
   
Less than 12
   
More than 12
   
Fair
   
Fair
 
 Category
 
Cost
   
Gains
   
Months
   
Months
   
Value
   
Value
 
                                     
 U.S. Treasury securities
  $ 605,424     $ 974     $ -     $ -     $ 606,398       100.0 %
 
 
44

 
 
Credit Rating of Fixed-Maturity Securities
 
The table below summarizes the credit quality of our fixed-maturity securities available for sale as of September 30, 2011 and December 31, 2010 as rated by Standard and Poor’s.
 
   
September 30, 2011
   
December 31, 2010
 
         
Percentage of
         
Percentage of
 
   
Fair Market
   
Fair Market
   
Fair Market
   
Fair Market
 
   
Value
   
Value
   
Value
   
Value
 
   
(unaudited)
             
Rating
                       
U.S. Treasury securities
  $ 549,213       3.1 %   $ 1,042,657       6.4 %
AAA
    3,952,158       22.0 %     4,229,483       25.9 %
AA
    3,794,815       21.1 %     3,698,610       22.6 %
    4,705,163       26.2 %     4,770,488       29.2 %
BBB
    4,950,293       27.6 %     2,597,863       15.9 %
Total
  $ 17,951,642       100.00 %   $ 16,339,101       100.0 %
 
The table below summarizes the average duration by type of fixed-maturity security available for sale as well as detailing the average yield as of September 30, 2011 and December 31, 2010:
 
   
September 30, 2011
   
December 31, 2010
 
         
Weighted
         
Weighted
 
         
Average
         
Average
 
   
Average
   
Duration in
   
Average
   
Duration in
 
 Category
 
Yield %
   
Years
   
Yield %
   
Years
 
U.S. Treasury securities and obligations of U.S. government corporations and agencies
    2.75 %     18.1       3.27 %     14.1  
                                 
Political subdivisions of States, Territories and Possessions
    3.89 %     5.6       4.24 %     6.9  
                                 
Corporate and other bonds industrial and miscellaneous
    5.12 %     6.8       5.20 %     7.6  
 
 
45

 
 
Fair Value Consideration
 
 As disclosed in Note 5 to the Condensed Consolidated Financial Statements, with respect to “Fair Value Measurements,” we define fair value under GAAP guidance as the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants (an “exit price”). This GAAP guidance establishes a fair value hierarchy that distinguishes between inputs based on market data from independent sources (“observable inputs”) and a reporting entity’s internal assumptions based upon the best information available when external market data is limited or unavailable (“unobservable inputs”). The fair value hierarchy in GAAP prioritizes fair value measurements into three levels based on the nature of the inputs. Quoted prices in active markets for identical assets have the highest priority (“Level 1”), followed by observable inputs other than quoted prices including prices for similar but not identical assets or liabilities (“Level 2”), and unobservable inputs, including the reporting entity’s estimates of the assumption that market participants would use, having the lowest priority (“Level 3”). As of September 30, 2011 and December 31, 2010, 91% and 90%, respectively of the investment portfolio recorded at fair value was priced based upon quoted market prices. As of September 30, 2011 and December 31, 2010, 9% and 10%, respectively, of the investment portfolio recorded at fair value was priced based upon observable inputs other than quoted prices.
 
As more fully described in Note 3 to our Consolidated Financial Statements, “Investments—Impairment Review,” we completed a detailed review of all our securities in a continuous loss position as of September 30, 2011 and December 31, 2010, and concluded that the unrealized losses in these asset classes are the result of a decrease in value due to technical spread widening and broader market sentiment, rather than fundamental collateral deterioration, and are temporary in nature.
 
The table below summarizes the gross unrealized losses of our fixed-maturity securities available for sale and equity securities by length of time the security has continuously been in an unrealized loss position as of September 30, 2011 and December 31, 2010:
 
 
46

 

   
September 30, 2011
 
   
Less than 12 months
   
12 months or more
   
Total
 
  
             
No. of
               
No. of
   
Aggregate
       
   
Fair
   
Unrealized
   
Positions
   
Fair
   
Unrealized
   
Positions
   
Fair
   
Unrealized
 
 Category
 
Value
   
Losses
   
Held
   
Value
   
Losses
   
Held
   
Value
   
Losses
 
   
(unaudited)
 
Fixed-Maturity Securities:
                                           
U.S. Treasury securities and obligations of U.S. government corporations and agencies
  $ -     $ -       -     $ -     $ -       -     $ -     $ -  
                                                                 
Political subdivisions of States, Territories and Possessions
    -       -       -       -       -       -       -       -  
                                                                 
Corporate and other bonds industrial and miscellaneous
    4,131,740       (221,751 )     1       375,140       (24,860 )     22       4,506,880       (246,611 )
                                                                 
Total fixed-maturity securities
  $ 4,131,740     $ (221,751 )     1     $ 375,140     $ (24,860 )     22     $ 4,506,880     $ (246,611 )
                                                                 
Equity Securities:
                                                               
Preferred stocks
  $ 719,322     $ (91,915 )     6     $ -     $ -       -     $ 719,322     $ (91,915 )
Common stocks
    947,280       (119,873 )     13       -       -       -       947,280       (119,873 )
                                                                 
Total equity securities
  $ 1,666,602     $ (211,788 )     19     $ -     $ -       -     $ 1,666,602     $ (211,788 )
                                                                 
Total
  $ 5,798,342     $ (433,539 )     20     $ 375,140     $ (24,860 )     22     $ 6,173,482     $ (458,399 )
 
 
47

 

   
December 31, 2010
 
   
Less than 12 months
   
12 months or more
   
Total
 
  
             
No. of
               
No. of
   
Aggregate
       
   
Fair
   
Unrealized
   
Positions
   
Fair
   
Unrealized
   
Positions
   
Fair
   
Unrealized
 
 Category
 
Value
   
Losses
   
Held
   
Value
   
Losses
   
Held
   
Value
   
Losses
 
                                                 
Fixed-Maturity Securities:
                                           
Political subdivisions of States, Territories and Possessions
  $ 2,870,728     $ (86,234 )     11     $ 1,119,244     $ (12,995 )     4     $ 3,989,972     $ (99,229 )
                                                                 
Corporate and other bonds industrial and miscellaneous
    4,113,912       (137,597 )     20       -       -       -       4,113,912       (137,597 )
                                                                 
Total fixed-maturity securities
  $ 6,984,640     $ (223,831 )     31     $ 1,119,244     $ (12,995 )     4     $ 8,103,884     $ (236,826 )
                                                                 
Equity Securities:
                                                               
Preferred stocks
  $ 363,670     $ (6,333 )     9     $ -     $ -       -     $ 363,670     $ (6,333 )
Common stocks
    690,634       (54,364 )     16       -       -       -       690,634       (54,364 )
Total equity securities
  $ 1,054,304     $ (60,697 )     25     $ -     $ -       -     $ 1,054,304     $ (60,697 )
                                                                 
Total
  $ 8,038,944     $ (284,528 )     56     $ 1,119,244     $ (12,995 )     4     $ 9,158,188     $ (297,523 )
 
 
48

 
 
There are 42 securities at September 30, 2011 that account for the gross unrealized loss, none of which is deemed by us to be other than temporarily impaired. There were 60 securities at December 31, 2010 that account for the gross unrealized loss, none of which were deemed by us to be other than temporarily impaired. Significant factors influencing our determination that unrealized losses were temporary included the magnitude of the unrealized losses in relation to each security’s cost, the nature of the investment and management’s intent not to sell these securities and it being not more likely than not that we will be required to sell these investments before anticipated recovery of fair value to our cost basis.
 
Liquidity and Capital Resources
 
Cash Flows
 
The primary sources of cash flow is from our insurance underwriting subsidiary, KICO, which are direct premiums written, ceding commissions from our quota share reinsurers, loss payments by our reinsurers, investment income and proceeds from the sale or maturity of investments. Funds are used by KICO for ceded premium payments to reinsurers, which are paid on a net basis after subtracting losses paid on reinsured claims and reinsurance commissions. KICO also uses funds for loss payments and loss adjustment expenses on our net business, commissions to producers, salaries and other underwriting expenses as well as to purchase investments and fixed assets.
 
On July 1, 2009, we completed the acquisition of 100% of the issued and outstanding common stock of KICO (formerly known as Commercial Mutual Insurance Company (“CMIC”)) pursuant to the conversion of CMIC from an advance premium cooperative to a stock property and casualty insurance company. Pursuant to the plan of conversion, we acquired a 100% equity interest in KICO. In connection with the plan of conversion of CMIC, we agreed with the Insurance Department that for a period of two years following the effective date of conversion of July 1, 2009, no dividend would be paid by KICO to us without the approval of the Insurance Department. As of June 30, 2011, no such request had been made by us to the Insurance Department. The first dividend of $175,000 was paid on August 12, 2011 by KICO to us. On November 10, 2011, KICO’s board of directors approved a cash dividend of $175,000 to us, which was paid on November 11, 2011. We have also agreed with the Insurance Department that certain intercompany transactions between KICO and us must be filed with the Insurance Department 30 days prior to implementation and not disapproved by the Insurance Department.
 
The primary sources of cash flow for our holding company operations are in connection with the fee income we receive from the premium finance loans and collection of principal and interest income from the notes received by us upon the sale of businesses that were included in our discontinued operations. Effective July 1, 2011, as discussed above, we may also receive cash dividends from KICO, subject to statutory restrictions. If the aforementioned is insufficient to cover our holding company cash requirements, we will seek to obtain additional financing.
 
We prepaid $703,000 of our notes payable during the quarter ended June 30, 2011. As of September 30, 2011, the outstanding principal balance of our notes payable was $747,000; such notes bear interest at the rate of 9.5% and mature on July 10, 2014. We believe that our present cash flows as described above will be sufficient on a short-term basis and over the next 12 months to fund our company-wide working capital requirements.
 
Our reconciliation of net income to cash provided by (used in) operations is generally influenced by the collection of premiums in advance of paid losses, the timing of reinsurance, issuing company settlements and loss payments.
 
 
49

 
 
Cash flow and liquidity are categorized into three sources: (1) operating activities; (2) investing activities; and (3) financing activities, which are shown in the following table:
 
Nine Months Ended September 30,
 
2011
   
2010
 
             
Cash flows provided by (used in):
           
 Operating activities
  $ 5,790,641     $ 2,100,557  
 Investing activities
    (2,257,043 )     (2,345,574 )
 Financing activities
    (829,150 )     381,732  
Net increase in cash and cash equivalents
    2,704,448       136,715  
Cash and cash equivalents, beginning of period
    326,620       625,320  
Cash and cash equivalents, end of period
  $ 3,031,068     $ 762,035  
 
The increase in cash flows provided by operating activities in 2011 was primarily a result of the fluctuations in the operating activities of KICO, described above, as affected by the growth in its operations.
 
 The decrease in cash flows used in investing activities is a result of the increase in net investments of fixed-maturity securities and equity securities, resulting from positive cash flow for operations.
 
We used in financing activities in 2011, in comparison to cash being provided by financing activities in 2010, as a result of the $714,000 prepayment of notes payable in 2011, compared to $400,000 of proceeds from notes payable received in 2010, and a dividend payment of $115,000 in 2011 compared to no such payment in  2010.
 
Off-Balance Sheet Arrangements
 
We have no off-balance sheet arrangements that have or are reasonably likely to have a current or future effect on our financial condition, changes in financial condition, revenues or expenses, results of operations, liquidity, capital expenditures or capital resources that is material to investors.
 

ITEM  3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK.
 
Not applicable

ITEM  4. CONTROLS AND PROCEDURES.

Evaluation of Disclosure Controls and Procedures

We maintain disclosure controls and procedures (as defined in Exchange Act Rule 13a-15(e)) that are designed to assure that information required to be disclosed in our Exchange Act reports is recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and forms, and that such information is accumulated and communicated to management, including our Chief Executive Officer and Chief Financial Officer, as appropriate, to allow timely decisions regarding required disclosures.
 
As required by Exchange Act Rule 13a-15(b), as of the end of the period covered by this Quarterly Report, under the supervision and with the participation of our principal executive officer and principal financial officer, we evaluated the effectiveness of our disclosure controls and procedures.  Based on this evaluation, our Chief Executive Officer and Chief Financial Officer concluded that our disclosure controls and procedures were effective as of September 30, 2011.
 
Changes in Internal Control over Financial Reporting

There was no change in our internal control over financial reporting during our most recently completed fiscal quarter that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.
 
 
50

 

PART II.  OTHER INFORMATION
 
 
ITEM 1.  LEGAL PROCEEDINGS.

NONE

ITEM 1A. RISK FACTORS.

NOT APPLICABLE

ITEM 2.  UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS.
 
NONE

ITEM 3.  DEFAULTS UPON SENIOR SECURITIES.

NONE

ITEM 4.  RESERVED.
 

ITEM 5.  OTHER INFORMATION.

NONE
 
51

 
 

ITEM 6.  EXHIBITS.
 
 2(a)    
Asset Purchase Agreement, dated as of March 27, 2009, by and among NII BSA LLC, Barry Scott Agency, Inc., DCAP Accurate, Inc. and DCAP Group, Inc.1
   
 2(b)    
Stock Purchase Agreement, dated as of May 1, 2009, by and between Stuart Greenvald and Abraham Weinzimer and DCAP Group, Inc.2
   
 2(c)    
Stock Purchase Agreement, dated as of June 30, 2009, between Barry Lefkowitz and Blast Acquisition Corp.3
   
 3(a)    
Restated Certificate of Incorporation4
   
 3(b)    
Certificate of Amendment of Certificate of Incorporation filed July 1, 20095
   
 3(c)    
Certificate of Designation of Series A Preferred Stock6
   
 3(d)    
Certificate of Designation of Series B Preferred Stock7
   
 3(e)    
Certificate of Designation of Series C Preferred Stock8
 
1 Denotes document filed as an exhibit to our Annual Report on Form 10-K for the year ended December 31, 2008 and incorporated herein by reference.
 
2 Denotes document filed as an exhibit to our Current Report on Form 8-K for an event dated May 6, 2009 and incorporated herein by reference.
 
3 Denotes document filed as an exhibit to our Current Report on Form 8-K for an event dated June 30, 2009 and incorporated herein by reference.
 
4 Denotes document filed as an exhibit to our Quarterly Report on Form 10-QSB for the period ended September 30, 2004 and incorporated herein by reference.
 
5 Denotes document filed as an exhibit to our Quarterly Report on Form 10-Q for the period ended June 30, 2009 and incorporated herein by reference.
 
6 Denotes document filed as an exhibit to our Current Report on Form 8-K for an event dated May 28, 2003 and incorporated herein by reference.
 
7 Denotes document filed as an exhibit to our Annual Report on Form 10-KSB for the year ended December 31, 2006 and incorporated herein by reference.
 
8 Denotes document filed as an exhibit to our Quarterly Report on Form 10-QSB for the period ended March 31, 2008 and incorporated herein by reference.
 
 
52

 
 
 3(f)    
Certificate of Designation of Series D Preferred Stock9
   
 3(g)    
Certificate of Designation of Series E Preferred Stock10
   
 3(h)    
By-laws, as amended11
   
 31(a)    
Rule 13a-14(a)/15d-14(a) Certification of Principal Executive Officer as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
   
 31(b)    
Rule 13a-14(a)/15d-14(a) Certification of Principal Financial Officer as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
   
 32    
Certification of Chief Executive Officer and Chief Financial Officer Certification of Chief Executive Officer and Chief Financial Officer Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
   
 101.INS
XBRL Instance Document.
   
 101.SCH
XBRL Taxonomy Extension Schema.
   
 101.CAL
XBRL Taxonomy Extension Calculation Linkbase.
   
 101.DEF
XBRL Taxonomy Extension Definition Linkbase.
   
 101.LAB
XBRL Taxonomy Extension Label Linkbase.
   
 101.PRE
XBRL Taxonomy Extension Presentation Linkbase.

9 Denotes document filed as an exhibit to our Quarterly Report on Form 10-Q for the period ended September 30, 2008 and incorporated herein by reference.
 
10 Denotes document filed as an exhibit to our Current Report on Form 8-K for an event dated May 12, 2009 and incorporated herein by reference.
 
11 Denotes document filed as an exhibit to our Current Report on Form 8-K for an event dated November 5, 2009 and incorporated herein by reference.

 
53

 
 
SIGNATURES
 
In accordance with the requirements of the Exchange Act, the registrant caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
 
  KINGSTONE COMPANIES, INC.  
       
Dated:  November 14, 2011
By:
/s/ Barry B. Goldstein  
    Barry B. Goldstein   
    President   
       
       
  By: /s/ Victor Brodsky  
    Victor Brodsky  
    Chief Financial Officer  
 
 
 
 
54