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TMCNet:  FEDERATED NATIONAL HOLDING CO - 10-K - MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

[March 17, 2014]

FEDERATED NATIONAL HOLDING CO - 10-K - MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

(Edgar Glimpses Via Acquire Media NewsEdge) OVERVIEW Federated National Holding Company ("FNHC", "Company", "we", "us"), formerly known as 21st Century Holding Company is an insurance holding company that controls substantially all steps in the insurance underwriting, distribution and claims processes through our subsidiaries and our contractual relationships with our independent agents and general agents. We changed our name on September 11, 2012, pursuant to approval received at our annual shareholders' meeting, from 21st Century Holding Company so that our parent company and other subsidiary companies' names are consistent with our primary insurance subsidiary and the name under which we have been writing insurance for more than 20 years.


We are authorized to underwrite, and/or place through our wholly owned subsidiaries, homeowners' multi-peril ("homeowners"), commercial general liability, federal flood, personal auto and various other lines of insurance in Florida and various other states. We market and distribute our own and third-party insurers' products and our other services through a network of independent agents.

Our insurance subsidiary is Federated National Insurance Company ("FNIC"). FNIC is licensed as an admitted carrier in Florida. An admitted carrier is an insurance company that has received a license from the state department of insurance giving the company the authority to write specific lines of insurance in that state. These companies are also bound by rate and form regulations, and are strictly regulated to protect policyholders from a variety of illegal and unethical practices, including fraud. Admitted carriers are also required to financially contribute to the state guarantee fund, which is used to pay for losses if an insurance carrier becomes insolvent or unable to pay the losses due their policyholders. Through contractual relationships with a network of approximately 3,600 independent agents, of which approximately 1,800 actively sell and service our products, FNIC is authorized to underwrite homeowners', commercial general liability, fire, allied lines and personal and commercial automobile insurance in Florida. FNIC is licensed as an admitted carrier in Alabama, Louisiana, Georgia and Texas and underwrites commercial general liability insurance in those states, homeowners' insurance in Louisiana and personal automobile insurance in Georgia and Texas.

FNIC is licensed as a non-admitted carrier in Arkansas, Kentucky, Missouri, Nevada, Oklahoma, South Carolina and Tennessee and can underwrite commercial general liability insurance in all of these states. A non-admitted carrier, sometimes referred to as a "excess and surplus lines" carrier, is permitted to do business in a state and, although it is strictly regulated to protect policyholders from a variety of illegal and unethical practices, including fraud, non-admitted carriers are subject to considerably less regulation with respect to policy rates and forms. Non-admitted carriers are not required to financially contribute to and benefit from the state guarantee fund, which is used to pay for losses if an insurance carrier becomes insolvent or unable to pay the losses due their policyholders.

In January 2011, we merged FNIC and our other wholly owned insurance subsidiary, American Vehicle Insurance Company ("American Vehicle"), with FNIC continuing the operations of both entities. In connection with this merger, the Company, FNIC and American Vehicle entered into a Consent Order with the Florida OIR pursuant to which we agreed to certain restrictions on our business operations.

The Consent Order was amended in February 2013 to lessen or eliminate certain of the original requirements, due to FNIC's statutory underwriting profit during 2012. See "Regulation- Consent Order." We internally process claims made by our insureds through our wholly owned claims adjusting company, Federated National Adjusting, Inc. ("FNA"). Our agents have no authority to settle claims or otherwise exercise control over the claims process. Furthermore, we believe that the retention of independent adjusters, in addition to the employment of salaried claims personnel, results in reduced ultimate loss payments, lower LAE and improved customer service for our claimants and policyholders. We also employ an in-house Litigation Manager to cost effectively manage claims-related litigation and to monitor our claims handling practices for efficiency and regulatory compliance.

Until June 2011, we offered premium financing to our own and third-party insureds through our wholly owned subsidiary, Federated Premium Finance, Inc.

("Federated Premium").

Federated National Underwriters, Inc. ("FNU"), formerly known as Assurance Managing General Agents, a wholly owned subsidiary of the Company, acts as FNIC's exclusive managing general agent in Florida and is also licensed as a managing general agent in the States of Alabama, Georgia, Louisiana, Mississippi, Missouri, North Carolina, Nevada, South Carolina, Texas and Virginia. FNU has contracted with several unaffiliated insurance companies to sell commercial general liability, workers compensation, personal umbrella, inland marine and other various lines of insurance through FNU's existing network of agents.

- 37 --------------------------------------------------------------------------------- Table of Contents Federated National Holding Company Management's Discussion and Analysis of Financial Condition and Results of Operations FNU earns commissions and fees for providing policy administration, marketing, accounting and analytical services, and for participating in the negotiation of reinsurance contracts. FNU earns a $25 per policy fee, and traditionally a 6% commission fee from its affiliate, FNIC. During the fourth quarter of 2010, FNU, pursuant to the Consent Order as discussed above, reduced its fee to earn amounts varying between 2% and 4%, which we anticipate will return to 6% at an unknown future date with approval from the Florida OIR. A formal agreement reflecting this fee modification was executed during January 2011.

The homeowner policy provides FNU the right to cancel any policy within a period of 90 days from the policy's inception with 25 days' notice, or after 90 days from policy inception with 95 days' notice, even if the risk falls within our underwriting criteria.

Although we are authorized to underwrite the various lines described above, our business is primarily underwriting homeowners' policies. During 2013, 89.6%, 4.3%, 2.6% and 3.5% of the premiums we underwrote were for homeowners', commercial general liability, federal flood, and personal automobile insurance, respectively. During 2013, $29.7 million or 13.6% of the $218.3 million of homeowners' premiums we underwrote were produced under an agency agreement with Ivantage Select Agency, Inc. ("ISA"), an affiliate of Allstate Insurance Company, that grants Allstate agents the authority to offer certain FNU products. The $29.7 million of homeowners' premiums produced under this agreement with ISA represents 25.5% of the total increase in the sale of homeowners' policies during 2013, compared with 2012. This network of agents began writing for FNIC in March 2013. During 2012, 85.3%, 7.8%, 4.4% and 2.5% of the premiums we underwrote were for homeowners', commercial general liability, federal flood, and personal automobile insurance, respectively.

During the years ended December 31, 2013, 2012 or 2011, we did not experience any weather-related catastrophic events such as the hurricanes that occurred in Florida during 2005 and 2004. We are not able to predict how hurricanes or other insurable events will affect our future results of operations and liquidity.

Loss and loss adjustment expenses ("LAE") are affected by a number of factors, many of which are partially or entirely beyond our control, including the following.

· the nature and severity of the loss; · weather-related patterns; · the availability, cost and terms of reinsurance; · underlying settlement costs, including medical and legal costs; · legal and political factors such as legislative initiatives and public opinion; · macroeconomic issues.

Our business, results of operations and financial condition are subject to fluctuations due to a variety of factors. Abnormally high severity or frequency of claims in any period could have a material adverse effect on us. When our estimated liabilities for unpaid losses and LAE are less than the actuarially determined amounts, we increase the expense in the current period. Conversely, when our estimated liabilities for unpaid losses and LAE are greater than the actuarially determined amounts, we decrease the expense in the current period.

We have entered into a Coexistence Agreement effective August 30, 2013 (the "Coexistence Agreement") with Federated Mutual Insurance Company ("Federated Mutual") in response to correspondence received from Federated Mutual's counsel alleging that our use of the name "Federated" infringed certain federal trademarks held by Federated Mutual. Although we believe that we have meritorious defenses to this allegation, we sought to avoid litigation and therefore negotiated and entered into the Coexistence Agreement. Under the Coexistence Agreement, among other things, we may continue to use "Federated" until at least August 30, 2020, after which time we have agreed to either cease using "Federated" in commerce or otherwise adopt and use trade names that are not confusingly similar to Federated Mutual's trademarks. During this period, we continue to develop our brand under the "FedNat" name, which is the name by which agents generally know us.

Our goal in our reinsurance strategy is to equalize the liquidity requirements imposed by most severe insurable events and by all other insurable events we manage in the normal course of business. Please see "Reinsurance Agreements" under "Item 1. Business" for a more detailed description of our reinsurance agreements and strategy.

- 38 --------------------------------------------------------------------------------- Table of Contents Federated National Holding Company Management's Discussion and Analysis of Financial Condition and Results of Operations Overview of Premium Growth Gross premiums written increased $123.9 million, or 103.7%, to $243.4 million for 2013, compared with $119.5 million for 2012. Florida homeowners' represents 94% and Texas private passenger automobile represents the remaining 6% of the increased premium volume. We believe that our growth in 2013 reflects management's efforts over several years. Our success today reflects our goal to be an agent-friendly carrier that provides exceptional service. We have invested in our agent relationships and our staff, have created easy to use systems for the agent, and increased our relevance to the agents' operations by providing insurance products that meet their market needs.

Our homeowner business contributed $116.5 million or 94.0% of the increased gross written premiums during the year ended December 31, 2013. This increase was the result of: · policyholders continuing to renew their FNIC homeowners' policy, · a "flight to quality" in the market by agents who seek quality carriers to place their business, · and supporting a marketing team dedicated to promoting the quality and quantity of products and services that we offer.

During 2013, approximately 85% of our policyholders renewed their policies. This high retention rate reflects the confidence that the policyholder and his agent have in our financial stability and strength. Additionally, policyholders have told agents that our professional staff adjusts claims quickly and fairly.

CRITICAL ACCOUNTING POLICIES The preparation of financial statements in conformity with Generally Accepted Accounting Principles ("GAAP") requires management to make estimates and assumptions about future events that affect the amounts reported in the financial statements and accompanying notes. Future events and their effects cannot be determined with absolute certainty. Therefore, the determination of estimates requires the exercise of judgment. Actual results inevitably will differ from those estimates, and such differences may be material to the financial statements.

The most significant accounting estimates inherent in the preparation of our financial statements include estimates associated with management's evaluation of the determination of (i) liability for unpaid losses and LAE, (ii) the amount and recoverability of amortization of Deferred Policy Acquisition Costs ("DPAC"), and (iii) estimates for our reserves with respect to finance contracts, premiums receivable and deferred income taxes. Various assumptions and other factors underlie the determination of these significant estimates, which are described in greater detail in Footnote 2 in this Form 10-K.

Except as described below, we believe that in 2013 there were no significant changes in those critical accounting policies and estimates. Senior management has reviewed the development and selection of our critical accounting policies and estimates and their disclosure in this Form 10-K with the Audit Committee of our Board of Directors.

The process of determining significant estimates is fact-specific and takes into account factors such as historical experience, current and expected economic conditions, and in the case of unpaid losses and LAE, an actuarial valuation.

Management regularly reevaluates these significant factors and makes adjustments where facts and circumstances dictate. In selecting the best estimate, we utilize various actuarial methodologies. Each of these methodologies is designed to forecast the number of claims we will be called upon to pay and the amounts we will pay on average to settle those claims. In arriving at our best estimate, our actuaries consider the likely predictive value of the various loss development methodologies employed in light of underwriting practices, premium rate changes and claim settlement practices that may have occurred, and weight the credibility of each methodology. Our actuarial methodologies take into account various factors, including, but not limited to, paid losses, liability estimates for reported losses, paid allocated LAE, salvage and other recoveries received, reported claim counts, open claim counts and counts for claims closed with and without payment for loss.

Accounting for loss contingencies pursuant to Financial Accounting Standards Board ("FASB") issued guidance involves the existence of a condition, situation or set of circumstances involving uncertainty as to possible loss that will ultimately be resolved when one or more future event(s) occur or fail to occur.

Additionally, accounting for a loss contingency requires management to assess each event as probable, reasonably possible or remote. Probable is defined as the future event or events are likely to occur. Reasonably possible is defined as the chance of the future event or events occurring is more than remote but less than probable, while remote is defined as the chance of the future event or events occurring is slight. An estimated loss in connection with a loss contingency shall be recorded by a charge to current operations if both of the following conditions are met: First, the amount can be reasonably estimated, and second, the information available prior to issuance of the financial statements indicates that it is probable that a liability has been incurred at the date of the financial statements. It is implicit in this condition that it is probable that one or more future events will occur confirming the fact of the loss or incurrence of a liability.

- 39 --------------------------------------------------------------------------------- Table of Contents Federated National Holding Company Management's Discussion and Analysis of Financial Condition and Results of Operations FASB issued guidance addresses accounting and reporting for (a) investments in equity securities that have readily determinable fair values and (b) all investments in debt securities. The guidance requires that these securities be classified into one of three categories: Held-to-maturity, Trading, or Available-for-sale securities.

Investments classified as held-to-maturity include debt securities wherein the Company's intent and ability are to hold the investment until maturity. The accounting treatment for held-to-maturity investments is to carry them at amortized cost without consideration to unrealized gains or losses. Investments classified as trading securities include debt and equity securities bought and held primarily for the sale in the near term. The accounting treatment for trading securities is to carry them at fair value with unrealized holding gains and losses included in current period operations. Investments classified as available-for-sale include debt and equity securities that are not classified as held-to-maturity or as trading security investments. The accounting treatment for available-for-sale securities is to carry them at fair value with unrealized holding gains and losses excluded from earnings and reported as a separate component of shareholders' equity, namely "Other Comprehensive Income".

Overview of Management's Loss Reserving Process The Company's loss reserves can generally be categorized into two distinct groups. One group is short-tail classes of business consisting principally of property risks in connection with homes and automobiles. The other group is long-tail casualty classes of business which include primarily commercial general liability and to a much lesser extent, homeowner and automobile liability. For operations writing short-tail coverages our loss reserves were generally geared toward determining an expected loss ratio for current business rather than maintaining a reserve for the outstanding exposure.

Estimations of ultimate net loss reserves for long-tail casualty classes of business is a more complex process and depends on a number of factors including class and volume of business involved. Experience in the more recent accident years of long-tail casualty classes of business shows limited statistical credibility in reported net losses because a relatively low proportion of net losses would be reported claims and expenses and even smaller percentage would be net losses paid. Therefore, incurred but not yet reported ("IBNR") would constitute a relatively high proportion of net losses.

Additionally, the different methodologies are utilized the same, regardless of the line of business. However, the final selection of ultimate loss and LAE is certain to vary by both line of business and by accident period maturity. There is no prescribed combination of line of business, accident year maturity, and methodologies; consistency in results of the different methodologies and reasonableness of the result are the primary factors that drive the final selection of ultimate loss and LAE.

Methods Used to Estimate Loss and LAE Reserves The methods we use for our short-tail business do not differ from the methods we use for our long-tail business. The Incurred and Paid Development Methods intrinsically recognize the unique development characteristics contained within the historical experience of each material short-tail and long-tail line of business. The Incurred and Paid Cape Cod Methods reflect similar historical development unique to each material short-tail and long-tail line of business.

We apply the following general methods in projecting loss and LAE reserves: · Paid and Incurred Loss Development Method · Paid and Incurred Bornhuetter-Ferguson Incurred Method · Frequency / Severity Method - 40 --------------------------------------------------------------------------------- Table of Contents Federated National Holding Company Management's Discussion and Analysis of Financial Condition and Results of OperationsDescription of Ultimate Loss Estimation Methods The estimated Ultimate Loss and Defense and Cost Containment Expense ("DCCE") is based on an analysis by line of business, coverage and by accident quarter performed using data as of December 31, 2013. The analysis relies primarily on four actuarial methods: Incurred Loss and DCCE Development Method, Paid Loss and DCCE Development Method, Bornhuetter-Ferguson Incurred Method, and Bornhuetter-Ferguson Paid Method. Each method relies on company experience, and, where relevant, the analysis includes comparisons to industry experience. The following is a description of each of these methods: Incurred Loss and DCCE Development Method - This reserving method is based on the assumption that the historical incurred loss and DCCE development pattern as reflected by the Company is appropriate for estimating the future loss & DCCE development. Incurred paid plus case amounts separated by accident quarter of occurrence and at quarterly evaluations are used in this analysis. Case reserves do not have to be adequately stated for this method to be effective; they only need to have a fairly consistent level of adequacy at all stages of maturity.

Historical "age-to-age" loss development factors were calculated to measure the relative development of an accident quarter from one maturity point to the next.

Loss and DCCE development factors ("LDF") are selected based on a review of the historical relationships between incurred loss & DCCE at successive valuations and based on industry patterns. The LDFs are multiplied together to derive cumulative LDF's that, when multiplied by actual incurred loss and DCCE, produce estimates of ultimate loss and DCCE.

Paid Loss & DCCE Development Method - This method is similar to the Incurred Loss & DCCE Development Method only paid loss & DCCE and paid patterns are substituted for the incurred loss & DCCE and incurred patterns.

Bornhuetter-Ferguson Incurred Method - This reserving method combines estimated initial expected unreported loss & DCCE with the actual loss & DCCE to yield the ultimate loss & DCCE estimate. Expected unreported loss & DCCE are equal to expected total loss & DCCE times the expected unreported percentage of loss & DCCE for each policy year. The incurred loss & DCCE emergence pattern used to determine the unreported percentages in our projections is based on the selected LDF's from the Incurred Loss & DCCE Development Method described above. The estimate of initial expected total loss & DCCE is based on the historical loss ratio for more mature accident years. While this approach reduces the independence of the Bornhuetter-Ferguson Method from the loss & DCCE development methods for older policy years, it is used primarily for estimating ultimate loss & DCCE for more recent, less mature, policy years.

Bornhuetter-Ferguson Paid Method - This method is similar to the Bornhuetter-Ferguson Incurred Method only paid loss & DCCE and paid patterns are substituted for the incurred loss & DCCE and incurred patterns.

We select an estimate of ultimate loss & DCCE for each accident quarter after considering the results of each projection method for the quarter and the relative maturity of the quarter (the time elapsed between the start of the quarter and December 31, 2013). Reserves for unpaid losses & DCCE for each quarter are the differences between these ultimate estimates and the amount already paid. The reserves for each quarter and each coverage are summed, and the result is the overall estimate of unpaid losses & DCCE liability for the company.

We also produce an estimate of unpaid Adjusting and Other Expense ("A&O"), as a reserve is required under Statutory Accounting Principles ("SAP") even if this expense has been pre-paid or with an unconsolidated affiliate. Although we do not prepay for A&O, the majority of the A&O incurred is with an affiliated company and eliminated under the accounting principles for consolidation. The unpaid A&O is added to unpaid losses & DCCE, resulting in total unpaid losses and LAE.

The validity of the results from using a loss development approach can be affected by many conditions, such as internal claim department processing changes, a shift between single and multiple claim payments, legal changes, or variations in a company's mix of business from year to year. Also, since the percentage of losses paid for immature years is often low, development factors can be volatile. A small variation in the number of claims paid can have a leveraging effect that could lead to significant changes in estimated ultimate values. Accordingly, our reserves are estimates because there are uncertainties inherent in the determination of ultimate losses. Court decisions, regulatory changes and economic conditions can affect the ultimate cost of claims that occurred in the past as well as create uncertainties regarding future loss cost trends. We compute our estimated ultimate liability using the most appropriate principles and procedures applicable to the lines of business written. However, because the establishment of loss reserves is an inherently uncertain process, we cannot be certain that ultimate losses will not exceed the established loss reserves and have a material adverse effect on our results of operations and financial condition.

- 41 --------------------------------------------------------------------------------- Table of Contents Federated National Holding Company Management's Discussion and Analysis of Financial Condition and Results of Operations Frequency / Severity Method - This method separately estimates the two components of ultimate losses (the frequency, or number of claims and the severity, or cost per claim) and then combines the resulting estimates in a multiplicative fashion to estimate ultimate losses. The approach is valuable because sometimes there is more inherent stability in the frequency and severity data when viewed separately than in the total losses.

We developed reported claim counts to ultimate levels using the development approach. The mechanics of this approach are the same as we described previously for paid and incurred losses. The validity of the results of this method depends on the stability of claim reporting and settlement rates. Then we developed accident year incurred severities (incurred losses divided by reported claim counts) to ultimate levels using the development approach.

We trended these severities to accident year 2013 levels. Trend rates were selected based on a review of historical severities. Selected severity was chosen based on judgment considering the developed severities and the trended severities, considering industry benchmarks for each segment. The loss & ALAE, claim count and severity triangles are evaluated as of 12 months, 24 months, 36 months etc. We selected loss development factors based on the loss development history, to the extent credible, and supplemented with industry data where appropriate.

A key assumption underlying the estimation of the reserve for loss and LAE is that past experience serves as the most reliable estimator of future events.

This assumption may materially affect the estimates when the insurance market, the regulatory environment, the legal environment, the economic environment, the book of business, the claims handling department, or other factors (known or unknown) have varied over time during the experience period and / or will vary (expectedly or unexpectedly) in the future. Changes in estimates, or differences between estimates and amounts ultimately paid, are reflected in the operating results of the period during which such adjustments are made. Therefore, the ultimate liability for unpaid losses and LAE will likely differ from the amount recorded at December 31, 2013.

The following describes the extent of our procedures for determining the reserve for loss and LAE on both an annual and interim reporting basis: Annually - Our policy is to select a single point estimate that best reflects our in-house actuarial determination for unpaid losses and LAE. Our independent actuarial firm, examining the exact same data set, will independently select a point estimate which determines a high point and low point range. Both processes rely on objective and subjective determinations. If our point estimate falls within the range determined from the point estimate of our actuary, then the Company's policy has been that no adjustments by management would be required. In consideration thereof, the company does not have a policy for adjusting the liability for unpaid losses and LAE to an amount that is different than an amount set forth within the range determined by our independent actuary, although the reserve level ultimately determined by us may not be the mid-point of our independent actuary's range. Further, there can be no assurances that our actual losses will be within our actuary's range. Our independent actuary's report expressly states that the report is based on assumptions developed from its own analysis and based on information provided by management and that notwithstanding its analysis, there is a significant risk of material adverse deviation from its range.

Interim - During 2013 our interim approach was very similar to the annual process noted above.

A number of other actuarial assumptions are generally made in the review of reserves for each class of business.

For each class of business, expected ultimate loss ratios for each accident year are estimated based on loss reserve development patterns. The expected loss ratio generally reflects the projected loss ratio from prior accident years, adjusted for the loss trend and the effect of rate changes and other quantifiable factors on the loss ratio.

In practice there are factors that change over time; however, many (such as inflation) are intrinsically reflected in the historical development patterns, and others typically do not materially affect the estimate of the reserve for unpaid losses and LAE. Therefore, no specific adjustments have been incorporated for such contingencies projecting future development of losses and LAE. There are no key assumptions as of December 31, 2013 premised on future emergence inconsistent with historical loss reserve development patterns.

- 42 --------------------------------------------------------------------------------- Table of Contents Federated National Holding Company Management's Discussion and Analysis of Financial Condition and Results of Operations The table below distinguishes total loss reserves between IBNR, as discussed above, and case estimates for specific claims as established by routine claims management.

Reserves for unpaid Reinsurance loss and LAE net of Recoverable reinsurance on Unpaid recoverable as of Case Loss Case LAE Total Case IBNR Reserves Loss and Loss December 31, 2013 Reserves Reserves Reserves (Including LAE) Expenses Net Reserves (Dollars in Thousands) Homeowners' $ 10,106 $ 1,292 $ 11,398 $ 23,749 $ 25 $ 35,122 Commercial General Liability 2,404 1,099 3,503 13,366 - 16,869 Automobile 5,037 3,211 8,248 752 2,717 6,283 Total $ 17,547 $ 5,602 $ 23,149 $ 37,867 $ 2,742 $ 58,274 Reserves for unpaid Reinsurance loss and LAE net of Recoverable reinsurance on Unpaid recoverable as of Case Loss Case LAE Total Case IBNR Reserves Loss and Loss December 31, 2012 Reserves Reserves Reserves (Including LAE) Expenses Net Reserves (Dollars in Thousands) Homeowners' $ 6,295 $ 1,430 $ 7,725 $ 8,855 $ 141 $ 16,439 Commercial General Liability 1,197 1,509 2,706 22,677 77 25,306 Automobile 3,456 133 3,589 4,259 3,285 4,563 Fire 5 7 12 83 - 95 Inland Marine - - - 2 - 2 Total $ 10,953 $ 3,079 $ 14,032 $ 35,876 $ 3,503 $ 46,405 Our reported results, financial position and liquidity would be affected by likely changes in key assumptions that determine our net loss reserves. The table below illustrates the change to equity that would occur as a result of a change in loss and LAE reserves, net of reinsurance.

Years Ended December 31, 2013 2012 Change in Adjusted loss Adjusted loss loss and LAE and LAE and LAE reserves, net reserves, net Percentage reserves, net Percentage of of change in equity of change in equity reinsurance reinsurance (1) reinsurance (1) (Dollars in Thousands) -10.0 % 52,447 3.6 % 41,764 4.5 % -7.5 % 53,903 2.7 % 42,925 3.4 % -5.0 % 55,360 1.8 % 44,085 2.3 % -2.5 % 56,817 0.9 % 45,245 1.1 % Base 58,274 - 46,405 - 2.5 % 59,731 -0.9 % 47,565 -1.1 % 5.0 % 61,188 -1.8 % 48,725 -2.3 % 7.5 % 62,644 -2.7 % 49,885 -3.4 % 10.0 % 64,101 -3.6 % 51,045 -4.5 % (1) Net of tax - 43 --------------------------------------------------------------------------------- Table of Contents Federated National Holding Company Management's Discussion and Analysis of Financial Condition and Results of Operations For the year ended December 31, 2013, our actuarial firm determined range of statutory loss and LAE reserves on a net basis range from a low of $51.5 million to a high of $60.9 million, with a best estimate of $55.5 million. The Company's net loss and LAE reserves are carried on a statutory basis at $54.0 million, and on a GAAP consolidated basis at $61.0 million which when netted with our $2.7 million reinsurance recoverable totals $58.3 million. The Company's statutory point estimate for its reserves as of December 31, 2013 is 2.6% below our actuary's best estimate, which reflects management's current analysis of the status and expected timing of our anticipated claims, our analysis of expected weather patterns in the regions in which we sell policies, our re-focus of our business growth efforts to areas outside of South Florida, and other factors.

We are required to review the contractual terms of all our reinsurance purchases to ensure compliance with FASB issued guidance. The guidance establishes the conditions required for a contract with a reinsurer to be accounted for as reinsurance and prescribes accounting and reporting standards for those contracts. Contracts that do not result in the reasonable possibility that the reinsurer may realize a significant loss from the insurance risk assumed generally do not meet the conditions for reinsurance accounting and must be accounted for as deposits. The guidance also requires us to disclose the nature, purpose and effect of reinsurance transactions, including the premium amounts associated with reinsurance assumed and ceded. It also requires disclosure of concentrations of credit risk associated with reinsurance receivables and prepaid reinsurance premiums.

Please see Footnote 2 of the Notes to Consolidated Financial Statements for additional discussions regarding critical accounting policies.

RECENT ACCOUNTING PRONOUNCEMENTS See Note 2(n), "Summary of Significant Accounting Policies - Recent Accounting Pronouncements" in the Notes to the Condensed Consolidated Financial Statements for a discussion of recent accounting pronouncements and their effect, if any, on the Company.

ANALYSIS OF FINANCIAL CONDITION As of December 31, 2013 Compared with December 31, 2012 Total Investments Total investments increased $90.6 million, or 69.7%, to $220.7 million as of December 31, 2013, compared with $130.1 million as of December 31, 2012. This increase reflected the $123.9 million increase in gross premiums written compared with 2012 and the $28.1 million in net proceeds from the Company's November 2013 offering. The excess cash was invested primarily in the bond portfolio.

FASB issued guidance addresses accounting and reporting for (a) investments in equity securities that have readily determinable fair values and (b) all investments in debt securities. We account for our investment securities consistent with FASB issued guidance that requires our securities to be classified into one of three categories: (i) held-to-maturity, (ii) trading securities or (iii) available-for-sale.

Investments classified as held-to-maturity include debt securities wherein the Company's intent and ability are to hold the investment until maturity and are carried at amortized cost without consideration to unrealized gains or losses.

Investments classified as trading securities include debt and equity securities bought and held primarily for sale in the near term and are carried at fair value with unrealized holding gains and losses included in current period operations. Investments classified as available-for-sale include debt and equity securities that are not classified as held-to-maturity or as trading security investments and are carried at fair value with unrealized holding gains and losses excluded from earnings and reported as a separate component of shareholders' equity, namely "Other Comprehensive Income." The debt and equity securities that are available for sale and carried at fair value represent 97% of total investments as of December 31, 2013, compared with 94% as of December 31, 2012.

We did not hold any trading investment securities during 2013.

As of December 31, 2013 and 2012, our investments consisted primarily of corporate bonds held in various industries, municipal bonds and United States government bonds. As of December 31, 2013, 83% of our debt portfolio was in diverse industries and 17% is in United States government bonds. As of December 31, 2013, approximately 91% of our equity holdings were in equities related to diverse industries and 9% were in mutual funds. As of December 31, 2012, 69% of our debt portfolio was in diverse industries and 31% is in United States government bonds. As of December 31, 2012, approximately 87% of our equity holdings were in equities related to diverse industries and 13% were in mutual funds.

- 44 --------------------------------------------------------------------------------- Table of Contents Federated National Holding Company Management's Discussion and Analysis of Financial Condition and Results of Operations Below is a summary of net unrealized gains at December 31, 2013 and December 31, 2012 by category.

Unrealized (Losses) and Gains December 31, December 31, 2013 2012 (Dollars in Thousands) Debt securities: United States government obligations and authorities $ (213 ) $ 567 Obligations of states and political subdivisions 180 201 Corporate 467 3,760 International (33 ) 106 401 4,634 Equity securities: Common stocks 9,161 1,887 Total debt and equity securities $ 9,562 $ 6,521 The net unrealized gain of $9.6 million is inclusive of $1.6 million of unrealized losses. The $1.6 million of unrealized losses is inclusive of $0.1 million unrealized losses from equity securities and $1.5 million unrealized losses from debt securities.

The $0.1 million of unrealized losses from equity securities is from common stocks and mutual funds held in diverse industries as of December 31, 2013.

The Company evaluated the near-term prospects in relation to the severity and duration of the impairment. Based on this evaluation and the Company's ability and intent to hold these investments for a reasonable period of time sufficient for a forecasted recovery of fair value, the Company does not consider these investments to be other-than-temporarily impaired at December 31, 2013.

The $1.5 million of unrealized losses from debt securities is primarily related to US government obligations and obligations of states and political subdivisions. The Company does not expect to settle at prices less than the amortized cost basis. The Company does not consider these investments to be other-than-temporarily impaired at December 31, 2013 because we neither currently intend to sell these investments nor consider it likely that we will be required to sell these investments before recovery of the amortized cost basis.

The FASB issued guidance also addresses the determination as to when an investment is considered impaired, whether that impairment is other-than temporary, and the measurement of an impairment loss. The Company's policy for the valuation of temporarily impaired securities is to determine impairment based on the analysis of the following factors.

· rating downgrade or other credit event (eg., failure to pay interest when due); · length of time and the extent to which the fair value has been less than amortized cost; · financial condition and near term prospects of the issuer, including any specific events which may influence the operations of the issuer such as changes in technology or discontinuance of a business segment; · prospects for the issuer's industry segment; · intent and ability of the Company to retain the investment for a period of time sufficient to allow for anticipated recovery in market value; · historical volatility of the fair value of the security.

- 45 --------------------------------------------------------------------------------- Table of Contents Federated National Holding Company Management's Discussion and Analysis of Financial Condition and Results of Operations Pursuant to FASB issued guidance, the Company records the unrealized losses, net of estimated income taxes that are associated with that part of our portfolio classified as available-for-sale through the shareholders' equity account titled "Other Comprehensive Income". Management periodically reviews the individual investments that comprise our portfolio in order to determine whether a decline in fair value below our cost either is other-than temporarily or permanently impaired. Factors used in such consideration include, but are not limited to, the extent and length of time over which the market value has been less than cost, the financial condition and near-term prospects of the issuer and our ability and intent to keep the investment for a period sufficient to allow for an anticipated recovery in market value.

In reaching a conclusion that a security is either other-than-temporarily or permanently impaired we consider such factors as the timeliness and completeness of expected dividends, principal and interest payments, ratings from nationally recognized statistical rating organizations such as Standard and Poor's ("S&P") and Moody's Investors Service, Inc. ("Moody's"), as well as information released via the general media channels. During 2013, in connection with the process, we have not charged any investment losses to operations. During 2012, in connection with the process, we have charged to operations $44,000 of investment losses.

As of December 31, 2013 and December 31, 2012, respectively, all of our securities are in good standing and not impaired, except as noted above, as defined by FASB issued guidance.

The following table summarizes, by type, our investments as of December 31, 2013 and 2012.

December 31, 2013 December 31, 2012 Carrying Percent Carrying Percent Amount of Total Amount of Total (Dollars in Thousands) Debt securities, at market: United States government obligations and authorities $ 27,209 12.33 % $ 27,392 21.06 % Obligations of states and political subdivisions 52,064 23.59 % 3,939 3.03 % Corporate 91,941 41.66 % 67,313 51.74 % International 3,698 1.68 % 3,111 2.39 % 174,912 79.26 % 101,755 78.22 % Debt securities, at amortized cost: United States government obligations and authorities 4,630 2.10 % 6,016 4.62 % Corporate 2,475 1.12 % 1,203 0.92 % International 109 0.05 % 140 0.11 % 7,214 3.27 % 7,359 5.65 % Total debt securities 182,126 82.53 % 109,114 83.87 % Equity securities, at market: 38,584 17.47 % 20,982 16.13 % Total investments $ 220,710 100.00 % $ 130,096 100.00 % Debt securities are carried on the balance sheet at market. At December 31, 2013 and 2012, debt securities had the following quality ratings by S&P and for securities not assigned a rating by S&P, Moody's or Fitch ratings were used.

December 31, 2013 December 31, 2012 Carrying Percent Carrying Percent Amount of Total Amount of Total (Dollars in Thousands) AAA $ 24,904 13.67 % $ 10,967 10.05 % AA 67,374 36.99 % 38,733 35.50 % A 46,338 25.44 % 31,774 29.12 % BBB 42,979 23.60 % 27,640 25.33 % Not rated 531 0.30 % - 0.00 % $ 182,126 100.00 % $ 109,114 100.00 % - 46 --------------------------------------------------------------------------------- Table of Contents Federated National Holding Company Management's Discussion and Analysis of Financial Condition and Results of Operations The following table summarizes, by maturity, the debt securities as of December 31, 2013 and 2012.

December 31, 2013 December 31, 2012 Carrying Percent Carrying Percent Amount of Total Amount of Total (Dollars in Thousands) Matures In: One year or less $ 5,180 2.84 % $ 2,938 2.70 % One year to five years 113,561 62.35 % 51,439 47.14 % Five years to 10 years 62,511 34.32 % 37,111 34.01 % More than 10 years 874 0.49 % 17,626 16.15 % Total debt securities $ 182,126 100.00 % $ 109,114 100.00 % As December 31, 2013, the duration of the bond portfolio was approximately 3.9 years.

As of December 31, 2013 and December 31, 2012, we have classified $7.2 million and $7.4 million, respectively, of our bond portfolio as held-to-maturity. We classify bonds as held-to-maturity to support securitization of credit requirements.

During 2013 we reclassified $150,000 of our bond portfolio to available-for-sale from held-to-maturity. During 2012, we did not re-classify any of our bond portfolio between available-for-sale and held-to-maturity.

Two reinsurers require FNIC to maintain securities with a fair market value of $4.6 million. As of December 31, 2013, FNIC maintained fully funded trust agreements that totaled $4.9 million in favor of the reinsurers. As of December 31, 2012, FNIC maintained fully funded trust agreements that totaled $4.8 million in favor of the reinsurers.

During April 2006, American Vehicle finalized a $15.0 million irrevocable letter of credit in conjunction with the 100% Quota Share Reinsurance Agreement with Republic Underwriters Insurance Company ("Republic") which was terminated in April 2007. During 2010, the letter of credit in favor of Republic was replaced by a fully funded trust agreement. As of December 31, 2013 and 2012 respectively, the amount held in trust was $1.0 million.

Cash and Short-Term Investments Cash and short-term investments, which include cash, certificates of deposits, and money market accounts, increased $20.3 million, or 96.0%, to $41.4 million as of December 31, 2013, compared with $21.1 million as of December 31, 2012.

The increase in cash and short-term investments is for a planned reinsurance payment. We evaluate our asset class allocation on an ongoing basis continually adjust based on economic and business risk.

Prepaid Reinsurance Premiums Prepaid reinsurance premiums increased $0.6 million, or 7.8%, to $7.6 million as of December 31, 2013, compared with $7.0 million as of December 31, 2012 due to the amortization of our payment patterns. We believe concentrations of credit risk associated with our prepaid reinsurance premiums are not significant.

Premiums Receivable, Net of Allowance for Credit Losses Premiums receivable, net of allowance for credit losses, increased $14.4 million, or 179.4%, to $22.4 million as of December 31, 2013, compared with $8.0 million as of December 31, 2012.

Our homeowners' insurance premiums receivable increased $13.4 million, or 226.4%, to $19.4 million as of December 31, 2013, compared with $6.0 million as of December 31, 2012, resulting from the increase to gross premiums written during 2013 compared with 2012.

Our commercial general liability insurance premiums receivable decreased $0.2 million, or 33.5%, to $0.3 million as of December 31, 2013, compared with $0.5 million as of December 31, 2012.

Premiums receivable in connection with our automobile line of business increased $1.1 million, or 69.5%, to $2.8 million as of December 31, 2013, compared with $1.7 million as of December 31, 2012.

- 47 --------------------------------------------------------------------------------- Table of Contents Federated National Holding Company Management's Discussion and Analysis of Financial Condition and Results of OperationsOur allowance for credit losses remained unchanged at $0.1 million as of December 31, 2013, compared with $0.1 million as of December 31, 2012.

Years Ended December 31, 2013 2012 (Dollars in Thousands) Allowance for credit losses at beginning of year $ 69 $ 73 Additions charged to bad debt expense 250 161 Write-downs charged against the allowance (176 ) (165 ) Allowance for credit losses at end of year $ 143 $ 69 Reinsurance Recoverable, Net Reinsurance recoverable, net, decreased $0.8 million, or 21.7%, to $2.7 million as of December 31, 2013, compared with $3.5 million as of December 31, 2012. The change is due to the payment patterns by our reinsurers, as influenced by the diminishing catastrophe related claims. All amounts are current and deemed collectable. We believe concentrations of credit risk associated with our reinsurance recoverables, net, are not significant.

DPAC DPAC increased $8.2 million, or 97.0%, to $16.7 million as of December 31, 2013, compared with $8.5 million as of December 31, 2012. The change is due to the deferral of the actual policy acquisition costs, including commissions, payroll and premium taxes, less commissions earned on reinsurance ceded and policy fees earned, in conjunction with the increase to gross premiums written during 2013 compared with 2012. An analysis of deferred acquisition costs follows.

Years Ended December 31, 2013 2012 (Dollars in Thousands) Balance, beginning of year $ 8,479 $ 7,718 Acquisition costs deferred 29,676 14,016 Amortization expense during year (21,447 ) (13,255 ) Balance, end of year $ 16,708 $ 8,479 - 48 --------------------------------------------------------------------------------- Table of Contents Federated National Holding Company Management's Discussion and Analysis of Financial Condition and Results of Operations Deferred Income Taxes, Net Deferred income taxes, net, decreased $3.3 million, or 76.8%, to $1.0 million as of December 31, 2013, compared with $4.3 million as of December 31, 2012.

Deferred income taxes, net, is comprised of approximately $11.0 million and $10.0 million of deferred tax assets, net of approximately $10.0 million and $5.7 million of deferred tax liabilities as of December 31, 2013 and December 31, 2012. The change in the net deferred tax asset is primarily due to the increase in the deferred tax liability related to deferred acquisition costs, net.

Years Ended December 31, 2013 2012 Deferred tax assets: Unpaid losses and loss adjustment expenses $ 1,157 $ 1,725 Unearned premiums 6,864 2,629 Discount on advance premiums 243 167 Allowance for credit losses 59 31 Allowance for impairments 21 91 FIGA Guaranty Assessment - 306 Depreciation & amortization 149 366 Reserve for claims settlements 1,844 809 NOL Carryforward 73 3,259 AMT credit - 253 Flow-through income or loss 4 - Stock option expense per ASC 718 550 432 Total deferred tax assets 10,964 10,068 Deferred tax liabilities: Deferred acquisition costs, net (6,287 ) (3,191 ) Dividends Collected vs. Earned (6 ) (18 ) Regulatory assessments (67 ) (67 ) Unrealized Gain on investment securities (3,598 ) (2,454 ) Total deferred tax liabilities (9,958 ) (5,730 ) Net deferred tax asset $ 1,006 $ 4,338 Property, Plant and Equipment, net Property, plant and equipment, net increased $0.3 million, or 64.8%, to $0.9 million as of December 31, 2013, compared with $0.6 million as of December 31, 2012. The change is due primarily to investments in information technology.

Other Assets Other assets increased $0.5 million, or 20.1%, to $3.2 million as of December 31, 2013, compared with $2.7 million as of December 31, 2012. Major components of other assets are shown in the following table; the accrued interest income receivable is primarily investment related.

December 31, 2013 December 31, 2012 (Dollars in Thousands) Accrued interest income receivable $ 1,684 $ 966 Deposits 327 249 Prepaid expenses 812 478 Receivable for investments sold - 598 Other 371 367 Total $ 3,194 $ 2,658 - 49 --------------------------------------------------------------------------------- Table of Contents Federated National Holding Company Management's Discussion and Analysis of Financial Condition and Results of Operations Unpaid Losses and LAE Unpaid losses and LAE increased $11.1 million, or 22.3%, to $61.0 million as of December 31, 2013, compared with $49.9 million as of December 31, 2012, in conjunction with the increase to net premiums earned during 2013 compared with 2012. The composition of unpaid losses and LAE by product line is as follows.

December 31, 2013 December 31, 2012 Case Bulk Total Case Bulk Total (Dollars in Thousands) (Dollars in Thousands) Homeowners' $ 11,399 $ 19,623 $ 31,022 $ 8,276 $ 6,637 $ 14,913 Commercial General Liability 3,503 13,231 16,734 2,956 22,310 25,266 Automobile 8,259 5,001 13,260 3,643 6,086 9,729 Total $ 23,161 $ 37,855 $ 61,016 $ 14,875 $ 35,033 $ 49,908 Please see "Liability for Unpaid Losses and LAE" under "Item 1. Business" for a discussion of the factors that affect unpaid losses and LAE.

Unearned Premium Unearned premiums increased $69.3 million, or 117.5%, to $128.3 million as of December 31, 2013, compared with $59.0 million as of December 31, 2012. The change was due to a $68.0 million increase in unearned homeowners' insurance premiums, a $0.4 million increase in unearned flood insurance premiums, a $0.5 million increase in unearned commercial general liability premiums and a $0.4 million increase in unearned automobile insurance premiums. Generally, as is in this case, an increase in unearned premium directly relates to an increase in written premium on a rolling twelve-month basis.

Premium Deposits and Customer Credit Balances Premium deposits and customer credit balances increased $1.3 million, or 56.0%, to $3.8 million as of December 31, 2013, compared with $2.5 million as of December 31, 2012. Premium deposits are monies received on policies not yet in-force as of December 31, 2013.

Income Taxes Payable Income taxes payable increased to $2.4 million as of December 31, 2013, compare with nothing as of December 31, 2012, in conjunction with the increase to income before provision for income tax expense, net of estimated tax payments made during 2013.

Bank Overdraft Bank overdraft increased $0.2 million, or 3.6%, to $6.2 million as of December 31, 2013, compared with $6.0 million as of December 31, 2012. The bank overdraft relates primarily to losses and LAE disbursements paid but not presented for payment by the policyholder or vendor. The change relates to the timing of presentation of claims checks to the issuing bank.

Accounts Payable and Accrued Expenses Accounts payable and accrued expenses increased $3.9 million, or 146.7%, to $6.5 million as of December 31, 2013, compared with $2.6 million as of December 31, 2012. The $3.9 million change includes increases of $1.6 million for commissions, $0.8 million for the remittance of recouped assessments, $0.6 million for payroll, $0.6 million for premium taxes and $0.3 million for dividends.

- 50 --------------------------------------------------------------------------------- Table of Contents Federated National Holding Company Management's Discussion and Analysis of Financial Condition and Results of Operations Results of Operations Year Ended December 31, 2013 Compared with Year Ended December 31, 2012 Effective January 26, 2011, FNIC merged with and into American Vehicle, and the resulting entity changed its name to "Federated National Insurance Company".

Gross Premiums Written Gross premiums written increased $123.9 million, or 103.7%, to $243.4 million for 2013, compared with $119.5 million for 2012. The following table denotes gross premiums written by major product line. The increase in gross premiums written during 2013 is primarily due to the increase in the sale of homeowners' policies. During 2013, our improved underwriting, risk management and product distribution enabled us to write more policies than in prior years.

Years Ended December 31, 2013 2012 (Dollars in Thousands) Amount Percentage Amount Percentage Homeowners' $ 218,349 89.72 % $ 101,832 85.24 % Commercial General Liability 10,362 4.26 % 9,338 7.82 % Federal Flood 6,213 2.55 % 5,293 4.43 % Automobile 8,449 3.47 % 2,996 2.51 % Gross written premiums $ 243,373 100.00 % $ 119,459 100.00 % The increase in the sale of homeowners' policies by $116.5 million, or 114.4%, to $218.3 million in 2013, compared with $101.8 million in 2012, is gross of reinsurance costs and net of Florida's mandated homeowners' wind mitigation discounts. We offer premium discounts for wind mitigation efforts by policyholders, as required by Florida law. As of December 31, 2013, 80.3% of our in-force homeowners' policyholders were receiving wind mitigation credits totaling approximately $216.8 million (a 50.1% reduction of in-force premium), while 72.7% of our in-force homeowners' policyholders were receiving wind mitigation credits totaling approximately $61.1 million, (a 37.4 % reduction of in-force premium), as of December 31, 2012.

During 2013, $29.7 million or 13.6% of the $218.3 million of homeowners' premiums we underwrote were produced under an agency agreement with Ivantage Select Agency, Inc. ("ISA"), an affiliate of Allstate Insurance Company, that grants Allstate agents the authority to offer certain FNU products. The $29.7 million of homeowners' premiums produced under this agreement with ISA represents 25.5% of the total increase in the sale of homeowners' policies during 2013, compared with 2012. This network of agents began writing for FNIC in March 2013.

During 2013 and 2012, the change to the cumulative wind mitigation credits afforded our policyholders totaled $155.7 million and $29.6 million, respectively.

These premium discounts have had a significant effect on both written and earned premium. Wind mitigation credits are 50.1% of the pre-credit premium, or $216.8 million, as of December 31, 2013, as compared with 37.4% of the pre-credit premium, or $61.1 million, as of December 31, 2012.

Our in-force homeowners' policies increased by approximately 55,300, or approximately 91%, to approximately 116,400 as of December 31, 2013, as compared with approximately 61,100 as of December 31, 2012.

Premium rates charged to our homeowner insurance policyholders are continually evaluated to assure that they meet the expectation that they are actuarially sound and produce a reasonable level of profit (neither excessive nor inadequate). Premium rates are regulated and approved by the Florida OIR. In 2013 our voluntary program rate indications did not indicate the need for adjustment. In 2012 we were approved for a 4.8% and 0.9% rate increase on our voluntary property book of homeowners' business. In 2011 our voluntary rate increase of 20% was approved.

Similarly, for the policies we assumed from Citizens Property Insurance Corporation ("Citizens") in 2009, we received approval for a 14.8% increase in 2013 and a 14.1% rate increase in 2012. In 2011 we received approval for a 13.9% increase. Our voluntary program was 97.7%, 90.0%, and 79.2% of the total homeowner program, for the years ending December 31, 2013, 2012, and 2011, respectively.

- 51 --------------------------------------------------------------------------------- Table of Contents Federated National Holding Company Management's Discussion and Analysis of Financial Condition and Results of Operations Our earnings can also be impacted by our ratings, such as the rating of FNIC by Demotech, Inc. ("Demotech"). FNIC's rating as of December 31, 2013 was "A" ("Exceptional"). For more information regarding our rating and the impact of a change or withdrawal of our rating, please see "Business-Regulation-Industry Rating Services." The Company's sale of commercial general liability policies increased by $1.1 million to $10.4 million for 2013, compared with $9.3 million for 2012. The primary factor for this increase has been renewal retention combined with new business growth.

The following table sets forth the amounts and percentages of our gross premiums written in connection with our commercial general liability program by state.

Years Ended December 31, 2013 2012 Amount Percentage Amount Percentage (Dollars in Thousands) State Florida $ 9,572 92.37 % $ 8,639 92.52 % Louisiana 150 1.45 % 217 2.32 % Texas 547 5.28 % 426 4.56 % Other 93 0.90 % 56 0.60 % Total $ 10,362 100.00 % $ 9,338 100.00 % We are required to report write-your-own flood premiums on a direct and 100% ceded basis.

The Company's sale of auto insurance policies increased by $5.4 million to $8.4 million for 2013, compared with $3.0 million for 2012. The primary factor for this increase has been renewal retention combined with new Texas business growth for which 2013 was the first full year of operations.

Gross Premiums Ceded Gross premiums ceded increased to $82.7 million for 2013, compared with $51.1 million for 2012. Gross premiums ceded relating to our homeowners', commercial general liability, write-your-own flood and automobile programs totaled $69.7 million, $0.5 million, $6.2 million and $6.3 million for 2013. Gross premiums ceded relating to our homeowners', commercial general liability, write-your-own flood and automobile programs totaled $43.3 million, $0.5 million, $5.3 million and $2.0 million for 2012.

The increased homeowners' gross premiums ceded is due to an additional 75.7% of reinsurance coverage purchased for the 2013-2014 season as compared with the 2012 - 2013 season.

Increase in Prepaid Reinsurance Premiums The increase in prepaid reinsurance premiums was $13.1 million in 2013, compared with $2.1 million in 2012. The benefit to written premium is associated with the timing of our reinsurance payments measured against the term of the underlying reinsurance policies.

Increase in Unearned Premiums The increase in unearned premiums was $69.3 million for 2013, compared with $11.1 million in 2012. The 2013 charge to written premium was due to a $68.0 million increase in unearned homeowners' insurance premiums, a $0.4 million increase in unearned flood premiums, a $0.5 million increase in unearned commercial general liability premiums and a $0.4 million increase in unearned automobile insurance premiums during 2013. These changes are a result of differences in written premium volume during this period as compared with the same period last year. See "Gross Premiums Written" above.

- 52 --------------------------------------------------------------------------------- Table of Contents Federated National Holding Company Management's Discussion and Analysis of Financial Condition and Results of Operations Net Premiums Earned Net premiums earned increased $45.0 million, or 75.8%, to $104.4 million for 2013, compared with $59.4 million for 2012. The following table denotes net premiums earned by product line.

Years Ended December 31, 2013 2012 Amount Percentage Amount Percentage (Dollars in Thousands) Homeowners' $ 92,793 88.89 % $ 49,209 82.90 % Commercial General Liability 9,432 9.04 % 9,196 15.49 % Automobile 2,156 2.07 % 954 1.61 % Net premiums earned $ 104,381 100.00 % $ 59,359 100.00 % The $43.6 million increase in homeowners' net premiums earned is due to a $116.5 million increase in gross written premium as discussed, a $26.4 million increase in gross premiums ceded and a $46.5 million increase in the net change to prepaid reinsurance premiums and unearned premium.

The $0.2 million increase in commercial general liability net premiums earned is a result of a $1.0 million increase in gross written premium, a less than $0.1 million decrease in gross premiums ceded and a $0.8 million increase in the net change to unearned premium.

The $1.2 million increase in automobile net premiums earned is a result of a $5.5 million increase in gross written premium as discussed, a $4.3 million increase in gross premiums ceded and a less than $0.1 million decrease in the net change to prepaid reinsurance premiums and unearned premium.

Commission Income Commission income increased $1.2 million, or 92.2%, to $2.6 million for 2013, compared with $1.4 million for 2012. The primary sources of our commission income are our managing general agent services, write-your-own flood premiums and our independent insurance agency, Insure-Link, Inc. ("Insure-Link").

Direct Written Policy Fees Direct written policy fees increased $4.2 million, or 208.8%, to $6.2 million for 2013, compared with $2.0 million for 2012. The change is attributed to the increase in gross premiums written during this same period.

Net Investment Income Net investment income decreased $0.5 million, or 12.7%, to $3.3 million for 2013, compared with $3.8 million for 2012.

Our investment yield, net and gross of investment expenses, excluding equities and including cash, was 1.8% and 2.0%, respectively, for 2013. Our investment yield, net and gross of investment expenses, excluding equities and including cash, was 2.5% and 2.8%, respectively, for 2012.

Our investment yield, net and gross of investment expenses measured against debt securities, excluding equities and cash, was 2.1% and 2.4%, respectively, for 2013. The primary reason for our lower investment yield in 2013 pertained to selling higher yielding and longer duration bonds, purchasing shorter duration and lower yielding bonds to protect our bond portfolio against principal erosion. Our investment yield, net and gross of investment expenses measured against debt securities, excluding equities and cash, was 2.6% and 2.9%, respectively, for 2012.

See also "Analysis of Financial Condition As of December 31, 2013 Compared with December 31, 2012 - Investments" for a further discussion on our investment portfolio.

- 53 --------------------------------------------------------------------------------- Table of Contents Federated National Holding Company Management's Discussion and Analysis of Financial Condition and Results of Operations \ Net Realized Investment Gains Net realized investment gains were $2.9 million for 2013, compared with $1.1 million for 2012. Specifically, net realized gains for equity securities were $2.2 million for 2013, compared with net realized losses of $0.3 million for 2012. For debt securities, net realized gains were $0.7 million for 2013, compared with $1.4 million for 2012. Our managers are authorized to sell securities at their discretion. During 2013, our equity managers took advantage of prevailing market opportunities and sold equities to lock in gains.

FASB has issued guidance regarding when an investment is considered impaired, whether that impairment is other-than temporary, and the measurement of an impairment loss. Management periodically reviews the individual investments that comprise our portfolio in order to determine whether a decline in fair value below our cost either is other-than temporarily or permanently impaired. During 2013, pursuant to guidelines prescribed in FASB issued guidance, we have not charged to operations any investment losses. During 2012, pursuant to guidelines prescribed in FASB issued guidance, we charged to operations, realized investment losses of $44,000. In reaching a conclusion that a security is either other than temporarily or permanently impaired we consider such factors as the timeliness and completeness of expected dividends, principal and interest payments, ratings from nationally recognized statistical rating organizations such as S&P and Moody's, as well as information released via the general media channels.

The table below depicts the net realized investment gains by investment category during 2013 and 2012.

Years Ended December 31, 2013 2012 (Dollars in Thousands) Realized gains: Debt securities $ 1,690 $ 1,783 Equity securities 2,858 1,403 Total realized gains 4,548 3,186 Realized losses: Debt securities (1,001 ) (391 ) Equity securities (666 ) (1,723 ) Total realized losses (1,667 ) (2,114 )Net realized gains on investments $ 2,881 $ 1,072 Other Income Other income increased $0.9 million, or 177.3%, to $1.4 million for 2013, compared with $0.5 million for 2012. The increase is primarily due to the recoupment of assessments previously expensed in connection with the Florida Insurance Guaranty Association ("FIGA").

Losses and LAE Losses and LAE, our most significant expense, represent actual payments made and changes in estimated future payments to be made to or on behalf of our policyholders, including expenses required to settle claims and losses. We revise our estimates based on the results of analysis of estimated future payments to be made. This process assumes that experience, adjusted for the effects of current developments and anticipated trends, is an appropriate basis for predicting future events.

Losses and LAE increased by $26.2 million, or 86.7%, to $56.4 million for 2013, compared with $30.2 million for 2012. The overall change includes a $26.7 million increase in our homeowners' program, a $2.5 million decrease in our commercial general liability program and a $2.0 million increase in connection with our automobile program.

The increase to losses and LAE for 2013, compared with 2012, reflects the additional reserves we added in response to the substantial increase in the number of policies we wrote during 2013. The increase to losses and LAE was more than offset by the increase to net premiums earned during this same period.

- 54 --------------------------------------------------------------------------------- Table of Contents Federated National Holding Company Management's Discussion and Analysis of Financial Condition and Results of OperationsThe composition of unpaid losses and LAE by product line is as follows.

December 31, 2013 December 31, 2012 Case Bulk Total Case Bulk Total (Dollars in Thousands) (Dollars in Thousands) Homeowners' $ 11,399 $ 19,623 $ 31,022 $ 8,276 $ 6,637 $ 14,913 Commercial General Liability 3,503 13,231 16,734 2,956 22,310 25,266 Automobile 8,259 5,001 13,260 3,643 6,086 9,729 Total $ 23,161 $ 37,855 $ 61,016 $ 14,875 $ 35,033 $ 49,908 Please see "Liability for Unpaid Losses and LAE" under "Item 1 Business" for a further discussion of the factors that affect unpaid losses and LAE.

Management revises its estimates based on the results of its analysis. This process assumes that experience, adjusted for the effects of current developments and anticipated trends, is an appropriate basis for estimating the ultimate settlement of all claims. There is no precise method for subsequently evaluating the impact of any specific factor on the adequacy of the reserves, because the eventual redundancy or deficiency is affected by multiple factors.

Because of our process, reserves were increased by approximately $11.1 million during 2013. This overall change includes a $16.1 million increase in reserves for our homeowners' program, a $3.5 million increase in reserves for our automobile program and an $8.5 million decrease in reserves for our commercial general liability program.

Our loss ratio is computed as losses and LAE divided by net premiums earned. A lower loss ratio generally results in higher operating income. Our loss ratio for 2013 was 54.0% compared with 50.9% for the same period in 2012. The increase to our loss ratio is due to the $26.2 million increase in losses and LAE measured against the $45.0 million increase in net premium earned during 2013 as compared with the same period in 2012.

The table below reflects the loss ratios by product line.

Years Ended December 31, 2013 2012 Homeowners' 56.27 % 51.86 % Commercial General Liability 5.49 % 32.86 % Automobile 170.79 % 175.08 % All lines 54.04 % 50.89 % Operating and Underwriting Expenses Operating and underwriting expenses increased $4.5 million, or 44.8%, to $14.5 million for 2013, compared with $10.0 million for 2012. The change is primarily due to a $2.5 million increase in premium tax expense, a $0.5 million increase in postage, a $0.9 million increase in surveys and underwriting reports, a $0.2 million increase in rent, a $0.2 million increase in computer service fees and a $0.2 million increase in other general expenses.

Salaries and Wages Salaries and wages increased $1.8 million, or 20.7%, to $10.2 million for 2013, compared with $8.4 million for 2012 and is primarily due to an increased number of employees. The charge to operations for stock-based compensation, in accordance with FASB guidance, was approximately $0.4 million during 2013, compared with approximately $0.3 million for 2012.

Amortization of Deferred Policy Acquisition Costs Amortization of deferred policy acquisition costs increased $8.1 million, or 61.8%, to $21.4 million for 2013, compared with $13.3 million for 2012, which corresponds to the increase in net premiums earned during this same period.

Amortization of deferred policy acquisition costs, consists of the actual policy acquisition costs, including commissions, payroll and premium taxes, less commissions earned on reinsurance ceded and policy fees earned.

- 55 --------------------------------------------------------------------------------- Table of Contents Federated National Holding Company Management's Discussion and Analysis of Financial Condition and Results of OperationsProvision for Income Tax Expense The provision for income tax expense was $6.5 million for 2013, compared with $2.4 million for 2012. The effective rate for income taxes was 33.8% for 2013, compared with 36.1% for 2012.

Net Income Net income increased $8.4 million, or 195.1%, to $12.7 million for 2013, compared with $4.3 million for 2012.

Results of Operations Year Ended December 31, 2012 Compared with Year Ended December 31, 2011 Effective January 26, 2011, FNIC merged with and into American Vehicle, and the resulting entity changed its name to "Federated National Insurance Company".

Gross Premiums Written Gross premiums written increased $21.2 million, or 21.6%, to $119.5 million for 2012, compared with $98.3 million for 2011. The following table denotes gross premiums written by major product line. This increase reflected primarily an increase in the sale of homeowners' policies.

Years Ended December 31, 2012 2011 (Dollars in Thousands) Amount Percentage Amount Percentage Homeowners' $ 101,832 85.24 % $ 80,402 81.82 % Commercial General Liability 9,338 7.82 % 10,125 10.30 % Federal Flood 5,293 4.43 % 4,468 4.55 % Automobile 2,996 2.51 % 3,274 3.33 % Gross written premiums $ 119,459 100.00 % $ 98,269 100.00 % The increase in the sale of homeowners' policies by $21.4 million, or 26.7%, to $101.8 million in 2012, compared with $80.4 million in 2011, is gross of reinsurance costs and net of Florida's mandated homeowners' wind mitigation discounts. We offer premium discounts for wind mitigation efforts by policyholders, as required by Florida law. As of December 31, 2012, 72.7% of our in-force homeowners' policyholders were receiving wind mitigation credits totaling approximately $61.1 million (a 37.4% reduction of in-force premium), while 63.5% of our in-force homeowners' policyholders were receiving wind mitigation credits totaling approximately $31.5 million, (a 28.6 % reduction of in-force premium), as of December 31, 2011.

During 2012 and 2011, the change to the cumulative wind mitigation credits afforded our policyholders totaled $29.6 million and $4.2 million, respectively.

These premium discounts have had a significant effect on both written and earned premium. Wind mitigation credits are 37.4% of the pre-credit premium, or $61.1 million, as of December 31, 2012, as compared with 28.6% of the pre-credit premium, or $31.5 million, as of December 31, 2011.

Our in-force homeowners' policies increased by approximately 17,300, or approximately 40%, to approximately 61,100 as of December 31, 2012, as compared with approximately 43,800 as of December 31, 2011.

We received approval from the Florida OIR in 2010 for a premium rate increase for our voluntary homeowners' program within the State of Florida. That premium rate increase averaged approximately 20.2% and was implemented for policies with effective dates as soon as permitted following approval. In addition, in 2010 we received approval from the Florida OIR for a premium rate increase of approximately 15% for homeowners policies assumed from Citizens in Florida beginning July 2010. In February 2012, we received approval from the Florida OIR of a 14.1% rate increase. That rate increase, together with our 2011 rate increase for our voluntary property book of homeowners' business averaged 20.2% statewide, and our assumed property book of homeowners' business, averaged 13.9% statewide.

- 56 --------------------------------------------------------------------------------- Table of Contents Federated National Holding Company Management's Discussion and Analysis of Financial Condition and Results of Operations Our earnings can also be impacted by our ratings, such as the rating of FNIC by Demotech. FNIC's rating as of December 31, 2012 was "A" ("Exceptional"). For more information regarding our rating and the impact of a change or withdrawal of our rating, please see "Business-Regulation-Industry Rating Services." The Company's sale of commercial general liability policies decreased by $0.8 million to $9.3 million for 2012, compared with $10.1 million for 2011. The primary factor for this decrease has been improvements to our underwriting standards and our decision to restrict underwriting authority within specific commercial general liability classes and geographic areas.

The following table sets forth the amounts and percentages of our gross premiums written in connection with our commercial general liability program by state.

Years Ended December 31, 2012 2011 Amount Percentage Amount Percentage (Dollars in Thousands) State Florida $ 8,639 92.52 % $ 8,606 84.99 % Louisiana 217 2.32 % 916 9.05 % Texas 426 4.56 % 534 5.28 % Other 56 0.60 % 69 0.68 % Total $ 9,338 100.00 % $ 10,125 100.00 % We are required to report write-your-own flood premiums on a direct and 100% ceded basis.

The Company's sale of auto insurance policies decreased to $3.0 million for 2012, compared with $3.3 million for 2011. The Company's sale of auto insurance included new and renewal policies in 2012 and only renewal policies in 2011.

Gross Premiums Ceded Gross premiums ceded increased to $51.1 million for 2012, compared with $46.3 million for 2011. Gross premiums ceded relating to our homeowners', commercial general liability, write-your-own flood and automobile programs totaled $43.3 million, $0.5 million, $5.3 million and $2.0 million for 2012. Gross premiums ceded relating to our homeowners', write-your-own flood and automobile programs totaled $40.3 million, $4.5 million and $1.5 million for 2011. The increase to gross premiums ceded relating to our homeowners' program is due to higher gross premium written, net of a reduced marginal cost of reinsurance purchased from the Florida Hurricane Catastrophe Fund ("FHCF"). We are required to report write-your-own flood premiums on a direct and 100% ceded basis.

Increase (Decrease) in Prepaid Reinsurance Premiums The increase in prepaid reinsurance premiums was $2.1 million in 2012, compared with a $2.7 million decrease in 2011. The benefit to written premium is associated with the timing of our reinsurance payments measured against the term of the underlying reinsurance policies.

Increase in Unearned Premiums The increase in unearned premiums was $11.1 million for 2012, compared with $0.8 million for 2011. The 2012 charge to written premium was due to a $10.9 million increase in unearned homeowners' insurance premiums, a $0.5 million increase in unearned flood premiums, a $0.1 million decrease in unearned automobile premiums and a $0.2 million decrease in unearned commercial general liability premiums during 2012. These changes are a result of differences in written premium volume during this period as compared with the same period last year. See "Gross Premiums Written" above.

- 57 --------------------------------------------------------------------------------- Table of Contents Federated National Holding Company Management's Discussion and Analysis of Financial Condition and Results of Operations Net Premiums Earned Net premiums earned increased $10.9 million, or 22.3%, to $59.4 million for 2012, compared with $48.5 million for 2011. The following table denotes net premiums earned by product line.

Years Ended December 31, 2012 2011 Amount Percentage Amount Percentage (Dollars in Thousands) Homeowners' $ 49,209 82.90 % $ 35,785 73.75 % Commercial General Liability 9,196 15.49 % 10,632 21.91 % Automobile 954 1.61 % 2,106 4.34 % Net premiums earned $ 59,359 100.00 % $ 48,523 100.00 % The $13.4 million increase in homeowners' net premiums earned is due to a $21.4 million increase in gross written premium as discussed, a $3.1 million increase in gross premiums ceded and a $4.9 million increase in the net change to prepaid reinsurance premiums and unearned premium.

The $1.4 million decrease in commercial general liability net premiums earned is a result of a $0.8 million decrease in gross written premium, reflecting the impact our decision to restrict underwriting authority within specific commercial general liability classes and geographic areas. The change is also a result of a $0.4 million increase in gross premiums ceded and a $0.2 million decrease in the net change to unearned premium.

The $1.1 million decrease in automobile net premiums earned is a result of a $0.3 million decrease in gross written premium as discussed, a $0.4 million increase in gross premiums ceded and a $0.4 million decrease in the net change to prepaid reinsurance premiums and unearned premium.

Commission Income Commission income increased $0.4 million, or 38.5%, to $1.4 million for 2012, compared with $1.0 million for 2011. The primary sources of our commission income are our managing general agent services, write-your-own flood premiums and our independent insurance agency, Insure-Link.

Direct Written Policy Fees Direct written policy fees increased $0.4 million, or 26.8%, to $2.0 million for 2012, compared with $1.6 million for 2011. The change is attributed to the increase in gross premiums written during this same period.

Net Investment Income Net investment income decreased $0.3 million, or 6.4%, to $3.8 million for 2012, compared with $4.1 million for 2011. Our investment yield, net and gross of investment expenses, excluding equities and including cash, was 2.5% and 2.8%, respectively, for 2012. Our investment yield, net and gross of investment expenses, excluding equities and including cash, was 2.9% and 3.1%, respectively, for 2011.

Our investment yield, net and gross of investment expenses measured against debt securities, excluding equities and cash, was 2.6% and 2.9%, respectively, for 2012. The primary reason for our lower investment yield in 2012 was the result of the Federal Reserve's activity in the bond market, which pushed up bond prices and lowered yields. Our investment yield, net and gross of investment expenses measured against debt securities, excluding equities and cash, was 3.1% and 3.4%, respectively, for 2011.

See also "Analysis of Financial Condition As of December 31, 2012 Compared with December 31, 2011 - Investments" for a further discussion on our investment portfolio.

- 58 --------------------------------------------------------------------------------- Table of Contents Federated National Holding Company Management's Discussion and Analysis of Financial Condition and Results of OperationsNet Realized Investment Gains Net realized investment gains were $1.1 million for 2012, compared with $2.7 million for 2011. Specifically, net realized losses for equity securities were $0.3 million for 2012 and 2011. For debt securities, net realized gains were $1.4 million for 2012, compared with $3.0 million for 2011. During 2011, the Company, because of the actions taken by the Federal Reserve to maintain a low interest rate environment, realized significant gains in the fixed income portfolio.

FASB has issued guidance regarding when an investment is considered impaired, whether that impairment is other-than temporary, and the measurement of an impairment loss. Management periodically reviews the individual investments that comprise our portfolio in order to determine whether a decline in fair value below our cost either is other-than temporarily or permanently impaired. During 2012, pursuant to guidelines prescribed in FASB issued guidance, we have charged to operations, realized investment losses of $44,000. The charges relate to common stock held in diverse industries; during 2011, pursuant to guidelines prescribed in FASB issued guidance, we charged to operations, realized investment losses of $0.8 million. In reaching a conclusion that a security is either other than temporarily or permanently impaired we consider such factors as the timeliness and completeness of expected dividends, principal and interest payments, ratings from nationally recognized statistical rating organizations such as S&P and Moody's, as well as information released via the general media channels.

The table below depicts the net realized investment gains by investment category during 2012 and 2011.

Years Ended December 31, 2012 2011 (Dollars in Thousands) Realized gains: Debt securities $ 1,783 $ 3,569 Equity securities 1,403 1,240 Total realized gains 3,186 4,809 Realized losses: Debt securities (391 ) (595 ) Equity securities (1,723 ) (1,489 ) Total realized losses (2,114 ) (2,084 )Net realized gains on investments $ 1,072 $ 2,725 Other Income Other income decreased $1.1 million, or 68.3%, to $0.5 million for 2012, compared with $1.6 million for 2011. Sources of other income for 2012 include the reconciliation of outstanding checks in connection with our accounting for unclaimed property and the recovery of a receivable written off in a prior year.

Sources of other income for 2011 include the reconciliation of outstanding checks in connection with our accounting for unclaimed property and the final recognition of our gain on the sale of our Lauderdale Lakes property.

Losses and LAE Losses and LAE, our most significant expense, represent actual payments made and changes in estimated future payments to be made to or on behalf of our policyholders, including expenses required to settle claims and losses. We revise our estimates based on the results of analysis of estimated future payments to be made. This process assumes that experience, adjusted for the effects of current developments and anticipated trends, is an appropriate basis for predicting future events.

Losses and LAE decreased by $0.7 million, or 2.2%, to $30.2 million for 2012, compared with $30.9 million for 2011. The overall change includes a $4.8 million increase in our homeowners' program, a $3.4 million decrease in our commercial general liability program and a $2.1 million decrease in connection with our automobile program.

- 59 - -------------------------------------------------------------------------------- Table of Contents The composition of unpaid losses and LAE by product line is as follows.

December 31, 2012 December 31, 2011 Case Bulk Total Case Bulk Total (Dollars in Thousands) (Dollars in Thousands) Homeowners' $ 8,276 $ 6,637 $ 14,913 $ 8,795 $ 10,652 $ 19,447 Commercial General Liability 2,956 22,310 25,266 4,225 27,717 31,942 Automobile 3,643 6,086 9,729 3,533 5,061 8,594 Total $ 14,875 $ 35,033 $ 49,908 $ 16,553 $ 43,430 $ 59,983 Please see "Liability for Unpaid Losses and LAE" under "Item 1 Business" for a discussion of the factors that affect unpaid losses and LAE.

Management revises its estimates based on the results of its analysis. This process assumes that experience, adjusted for the effects of current developments and anticipated trends, is an appropriate basis for estimating the ultimate settlement of all claims. There is no precise method for subsequently evaluating the impact of any specific factor on the adequacy of the reserves, because the eventual redundancy or deficiency is affected by multiple factors.

Because of our process, reserves were decreased by approximately $10.1 million during 2012. This overall change includes a $4.5 million decrease in reserves for our homeowners' program, a $6.7 million decrease in reserves for our commercial general liability program and a $1.1 million increase in reserves for our automobile program. The decreases are due to favorable experience based in part on enhanced underwriting and claim processing techniques.

Our loss ratio is computed as losses and LAE divided by net premiums earned. A lower loss ratio generally results in higher operating income. Our loss ratio for 2012 was 50.9% compared with 63.7% for the same period in 2011. The favorable decrease to our loss ratio is due to the $0.7 million decrease in losses and LAE measured against the $10.9 million increase in net premium earned during 2012 as compared with the same period in 2011.

The table below reflects the loss ratios by product line.

Years Ended December 31, 2012 2011 Homeowners' 51.86 % 57.79 % Commercial General Liability 32.86 % 60.11 % Automobile 175.08 % 181.67 % All lines 50.89 % 63.67 % Operating and Underwriting Expenses Operating and underwriting expenses increased $0.1 million, or 0.8%, to $10.0 million for 2012, compared with $9.9 million for 2011.

Salaries and Wages Salaries and wages increased $0.4 million, or 5.4%, to $8.4 million for 2012, compared with $8.0 million for 2011. The charge to operations for stock-based compensation, in accordance with FASB guidance, was approximately $0.3 million during 2012, compared with approximately $0.2 million for 2011.

Amortization of Deferred Policy Acquisition Costs Amortization of deferred policy acquisition costs, increased $1.0 million, or 7.4%, to $13.3 million for 2012, compared with $12.3 million for 2011. Policy acquisition costs - amortization, consists of the actual policy acquisition costs, including commissions, payroll and premium taxes, less commissions earned on reinsurance ceded and policy fees earned.

Provision for Income Tax Expense (Benefit) The provision for income tax expense was $2.4 million for 2012, compared with a benefit of $0.6 million for 2011. The effective rate for income taxes was 36.1% for 2012, compared with 57.0% for 2011. The 2011 57.0% effective rate reflects the true-up of the 2010 tax return permanent differences.

- 60 --------------------------------------------------------------------------------- Table of Contents Federated National Holding Company Management's Discussion and Analysis of Financial Condition and Results of Operations Net Income (Loss) As a result of the foregoing, the Company's net income for 2012 was $4.3 million, compared with net loss of $0.4 million for 2011.

CONTRACTUAL OBLIGATIONS A summary of long-term contractual obligations as of December 31, 2013 follows.

The amounts represent estimates of gross undiscounted amounts payable over time.

(Dollars in Thousands) Contractual Obligations Total 2014 2015 2016 2017 Thereafter Unpaid Losses and LAE $ 61,016 $ 36,219 $ 14,589 $ 6,712 $ 2,343 $ 1,153 Operating leases 1,356 392 400 408 156 - Total $ 62,372 $ 36,611 $ 14,989 $ 7,120 $ 2,499 $ 1,153 LIQUIDITY AND CAPITAL RESOURCES In 2013, our primary sources of capital included proceeds from the sale of investment securities, increased unearned premiums, issuance of common stock, increased unpaid losses and LAE, increased accounts payable and accrued expenses, increased income taxes payable and decreased deferred income tax expense. Additional sources of capital included amortization of investment premium discount, net, increased premium deposits and customer credit balances, exercised stock options, decreased reinsurance recoverable, net, non-cash compensation, depreciation and amortization, increased bank overdraft and a tax benefit related to non-cash compensation. Because we are a holding company, we are largely dependent upon fees and commissions from our subsidiaries for cash flow.

In 2013, 2012 and 2011, net cash provided by operating activities was $79.7 million, $1.5 million and $4.1 million, respectively.

In 2013, operations generated $106.3 million of gross cash flow, due to a $69.3 million increase in unearned premiums, an $11.1 million increase in unpaid losses and LAE, a $3.8 million increase in accounts payable and accrued expenses, a $2.4 million increase in income taxes payable and a $2.2 million decrease in deferred income tax expense. Additional sources of cash included $1.8 million of amortization of investment premium discount, net, a $1.4 million increase in premium deposits and customer credit balances, a $0.8 million decrease in reinsurance recoverable, net, $0.3 million non-cash compensation, $0.3 million depreciation and amortization and a $0.2 million increase in bank overdraft, all in conjunction with $12.7 million of net income.

In 2013, operations used $26.6 million of gross cash flow primarily due to a $14.3 million increase in premiums receivable, an $8.2 million increase in policy acquisition costs, net of amortization and $2.9 million of net realized investment gains. Additional uses of cash included a $0.6 million increase in prepaid reinsurance premiums, a $0.5 million increase in other assets and a $0.1 million decrease in recovery for uncollectible premiums receivable.

In 2013, net cash used by investing activities was $87.1 million. In 2012 and 2011, net cash provided and used by investing activities was $4.3 million and $5.2 million, respectively. Our available-for-sale investment portfolio is highly liquid as it consists entirely of readily marketable securities. In 2013, investing activities generated $106.2 million and used $193.3 million.

In 2013, net cash provided by financing activities was $27.7 million. In 2012 and 2011, net cash provided by financing activities was less than $0.1 million.

In 2013, the sources of cash in connection with financing activities included $27.9 million from issuance of common stock, $0.9 million from exercised stock options and a $0.1 million tax benefit related to non-cash compensation. In 2013, the use of cash in connection with financing activities was $1.2 million of dividends paid.

We offer direct billing in connection with our homeowners' and commercial general liability programs. Direct billing is an agreement in which the insurance company accepts from the insured, as a receivable, a promise to pay the premium, as opposed to requiring the full amount of the policy at policy inception, either directly from the insured or from a premium finance company.

The advantage of direct billing a policyholder by the insurance company is that we are not reliant on a credit facility, but remain able to charge and collect interest from the policyholder.

- 61 --------------------------------------------------------------------------------- Table of Contents Federated National Holding Company Management's Discussion and Analysis of Financial Condition and Results of Operations As discussed above, we have experienced significant growth, as evidenced by the 103.7% increase in gross premiums written during the twelve months of 2013 as compared with the same period in 2012 and the 91.0% increase in the number of our in-force homeowners' policies during 2013.

We believe that our current capital resources will be sufficient to meet currently anticipated working capital requirements. There can be no assurances, however, that such will be the case. We continue to evaluate our liquidity and the possibility that we may require additional working capital.

GAAP differs in some respects from reporting practices prescribed or permitted by the Florida OIR. FNIC's statutory capital and surplus was $76.9 million and $52.1 million as of December 31, 2013 and 2012, respectively. FNIC's statutory net income was $3.6 million, $6.6 million and $0.8 million for 2013, 2012 and 2011, respectively. FNIC's statutory non-admitted assets were nearly nothing and nearly nothing as of December 31, 2013 and 2012, respectively.

As of December 31, 2013, 2012, and 2011, we did not have any relationships with unconsolidated entities or financial partnerships, such as entities often referred to as "structured finance" or "special purpose" entities, which were established for the purpose of facilitating off-balance-sheet arrangements or other contractually narrow or limited purposes. As such, management believes that we currently are not exposed to any financing, liquidity, market or credit risks that could arise if we had engaged in transactions of that type requiring disclosure herein.

IMPACT OF INFLATION AND CHANGING PRICES The consolidated financial statements and related data presented in this Annual Report have been prepared in accordance with GAAP, which requires the measurement of financial position and operating results in terms of historical dollars without considering changes in the relative purchasing power of money over time due to inflation. Our primary assets and liabilities are monetary in nature. As a result, interest rates have a more significant impact on performance than the effects of general levels of inflation. Interest rates do not necessarily move in the same direction or with the same magnitude as the inflationary effect on the cost of paying losses and LAE.

Insurance premiums are established before we know the amount of losses and LAE and the extent to which inflation may affect such expenses. Consequently, we attempt to anticipate the future impact of inflation when establishing rate levels. While we attempt to charge adequate premiums, we may be limited in raising premium levels for competitive and regulatory reasons. Inflation may also affect the market value of our investment portfolio and the investment rate of return. Any future economic changes that result in prolonged and increasing levels of inflation could cause increases in the dollar amount of incurred losses and LAE and thereby materially adversely affect future liability requirements.

- 62 --------------------------------------------------------------------------------- Table of Contents Federated National Holding Company Management's Discussion and Analysis of Financial Condition and Results of OperationsSELECTED QUARTERLY FINANCIAL DATA (Unaudited) Year Ended December 31, 2013 (Dollars in Thousands except EPS) First Second Third Fourth Quarter Quarter Quarter Quarter Revenue: Net premiums earned $ 18,261 $ 23,742 $ 27,315 $ 35,063 Other revenue 3,607 4,436 4,605 4,708 Total revenue 21,868 28,178 31,920 39,771 Expenses: Losses and LAE 9,323 12,821 14,439 19,827 Other expenses 8,813 11,302 12,695 13,299 Total expenses 18,136 24,123 27,134 33,126 Income before provision for income tax expense 3,732 4,055 4,786 6,645 Provision for income tax expense 1,397 1,511 1,504 2,079 Net income $ 2,335 $ 2,544 $ 3,282 $ 4,566 Basic net income per share $ 0.29 $ 0.32 $ 0.41 $ 0.48 Fully diluted net income per share $ 0.29 $ 0.31 $ 0.39 $ 0.46 Weighted average number of common shares outstanding 7,983 8,020 8,067 9,391 Weighted average number of common shares outstanding (assuming dilution) 8,127 8,274 8,346 9,731 - 63 --------------------------------------------------------------------------------- Table of Contents Federated National Holding Company Management's Discussion and Analysis of Financial Condition and Results of Operations Year Ended December 31, 2012 (Dollars in Thousands except EPS) First Second Third Fourth Quarter Quarter Quarter Quarter Revenue: Net premiums earned $ 12,818 $ 14,693 $ 15,088 $ 16,760 Other revenue 1,925 2,130 2,173 3,060 Total revenue 14,743 16,823 17,261 19,820 Expenses: Losses and LAE 5,728 7,136 8,049 9,296 Other expenses 7,370 7,347 8,109 8,864 Total expenses 13,098 14,483 16,158 18,160 Income before provision for income tax expense 1,645 2,340 1,103 1,660 Provision for income tax expense 573 918 353 591 Net income $ 1,072 $ 1,422 $ 750 $ 1,069 Basic net income per share $ 0.13 $ 0.18 $ 0.09 $ 0.13 Fully diluted net income per share $ 0.13 $ 0.18 $ 0.09 $ 0.13 Weighted average number of common shares outstanding 7,946 7,947 7,949 7,965 Weighted average number of common shares outstanding (assuming dilution) 7,962 7,994 8,042 8,096 OFF BALANCE SHEET TRANSACTIONS For the years ended December 31, 2013 and 2012, we had no off balance sheet transactions.

- 64 --------------------------------------------------------------------------------- Table of Contents Federated National Holding Company

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