News Column

NATIONAL GENERAL HOLDINGS CORP. - 10-Q - Management's Discussion and Analysis of Financial Condition and Results of Operations

August 11, 2014

The following discussion and analysis of our financial condition and results of operations should be read in conjunction with our condensed consolidated financial statements and related notes included elsewhere in this Form 10-Q. Note on Forward-Looking Statements This Form 10-Q contains certain forward-looking statements that are intended to be covered by the safe harbors created by The Private Securities Litigation Reform Act of 1995. When we use words such as "anticipate," "intend," "plan," "believe," "estimate," "expect," or similar expressions, we do so to identify forward-looking statements. Examples of forward-looking statements include the plans and objectives of management for future operations, including those relating to future growth of our business activities and availability of funds, and are based on current expectations that involve assumptions that are difficult or impossible to predict accurately and many of which are beyond our control. There can be no assurance that actual developments will be those anticipated by us. Actual results may differ materially from those expressed or implied in these statements as a result of significant risks and uncertainties, including, but not limited to, non-receipt of expected payments from insureds or reinsurers, changes in interest rates, a downgrade in the financial strength ratings of our insurance subsidiaries, the effect of the performance of financial markets on our investment portfolio, our ability to accurately underwrite and price our products and to maintain and establish accurate loss reserves, estimates of the fair value of our life settlement contracts, development of claims and the effect on loss reserves, accuracy in projecting loss reserves, the cost and availability of reinsurance coverage, the effects of emerging claim and coverage issues, changes in the demand for our products, our degree of success in integrating of acquired businesses, the effect of general economic conditions, state and federal legislation, regulations and regulatory investigations into industry practices, risks associated with conducting business outside the United States, developments relating to existing agreements, disruptions to our business relationships with Maiden Holdings, Ltd. ("Maiden"), AmTrust Financial Services, Inc. ("AmTrust"), ACP Re Ltd. ("ACP Re") or third party agencies, breaches in data security or other disruptions with our technology, heightened competition, changes in pricing environments, and changes in asset valuations. Additional information about these risks and uncertainties, as well as others that may cause actual results to differ materially from those projected, is contained in our filings with the SEC, including our Annual Report on Form 10-K for the year ended December 31, 2013, and our quarterly reports on Form 10-Q. The projections and statements in this report speak only as of the date of this report and we undertake no obligation to update or revise any forward-looking statement, whether as a result of new information, future developments or otherwise, except as may be required by law.



Overview

We are a specialty personal lines insurance holding company. Through our subsidiaries, we provide personal and commercial automobile insurance, homeowners insurance, supplemental health insurance products and other niche insurance products. We sell insurance products with a focus on underwriting profitability through a combination of our customized and predictive analytics and our technology driven low cost infrastructure. We manage our business through two segments: Property and Casualty ("P&C ") and Accident and Health ("A&H"). We transact business primarily through our fourteen regulated domestic insurance subsidiaries: Integon Casualty Insurance Company, Integon General Insurance Company, Integon Indemnity Corporation, Integon National Insurance Company ("Integon National"), Integon Preferred Insurance Company, New South Insurance Company, MIC General Insurance Corporation, National General Insurance Company, National General Assurance Company, National General Insurance Online, Inc., National Health Insurance Company, Personal Express Insurance Company, Imperial Fire and Casualty Insurance Company and National Automotive Insurance Company. Our insurance subsidiaries have been assigned an "A-" (Excellent) group rating by A.M. Best. The operating results of property and casualty insurance companies are subject to quarterly and yearly fluctuations due to the effect of competition on pricing, the frequency and severity of losses, the effect of weather and natural disasters on losses, general economic conditions, the general regulatory environment in states in which an insurer operates, state regulation of premium rates, changes in fair value of investments, and other factors such as changes in tax laws. The property and casualty industry has been highly cyclical with periods of high premium rates and shortages of underwriting capacity followed by periods of severe price competition and excess capacity. While these cycles can have a large impact on a company's ability to grow and retain business, we have sought to focus on niche markets and regions where we are able to maintain premium rates at generally consistent levels and maintain underwriting discipline throughout these cycles. We believe that the nature of our P&C insurance products, including their relatively low limits, the relatively short duration of time between when claims are reported and when they are settled, and the broad geographic distribution of our customers, have allowed us to grow and retain our business throughout these 44 -------------------------------------------------------------------------------- cycles. In addition, we have limited our exposure to catastrophe losses through reinsurance. With regard to seasonality, we tend to experience higher claims and claims expense in our P&C segment during periods of severe or inclement weather. We evaluate our operations by monitoring key measures of growth and profitability, including net loss ratio, net combined ratio (non-GAAP) and operating leverage. We target a net combined ratio (non-GAAP) of 95.0% or lower over the near term, and between 90% and 95% over the long term, while seeking to maintain optimal operating leverage in our insurance subsidiaries commensurate with our A.M. Best rating objectives. To achieve our targeted net combined ratio (non-GAAP) we continually seek ways to reduce our operating costs and lower our expense ratio. For the six months ended June 30, 2014, our annualized operating leverage (the ratio of net premiums earned to average total stockholders' equity) was 1.88x, which was within our planned target operating leverage of between 1.5x and 2.0x. Investment income is also an important part of our business. Because we often do not settle claims until several months or longer after we receive the original policy premiums, we are able to invest cash from premiums for significant periods of time. We invest our capital and surplus in accordance with state and regulatory guidelines. Our net investment income was $20.5 million and $13.7 million for the six months ended June 30, 2014 and 2013, respectively. We held 6.3% and 6.6% of total invested assets in cash and cash equivalents as of June 30, 2014 and December 31, 2013, respectively. Our most significant balance sheet liability is our unpaid loss and loss adjustment expense reserves ("LAE"). As of June 30, 2014 and December 31, 2013, our reserves, net of reinsurance recoverables, were $481.7 million and $308.4 million, respectively. We record reserves for estimated losses under insurance policies that we write and for LAE related to the investigation and settlement of policy claims. Our reserves for loss and LAE represent the estimated cost of all reported and unreported loss and LAE incurred and unpaid at any time based on known facts and circumstances. Our reserves, excluding life reserves, for loss and LAE incurred and unpaid are not discounted using present value factors. Our loss reserves are reviewed quarterly by internal actuaries and at least annually by our external actuaries. Reserves are based on estimates of the most likely ultimate cost of individual claims. These estimates are inherently uncertain. Judgment is required to determine the relevance of our historical experience and industry information under current facts and circumstances. The interpretation of this historical and industry data can be impacted by external forces, principally frequency and severity of future claims, the length of time needed to achieve ultimate settlement of claims, inflation of medical costs, insurance policy coverage interpretations, jury determinations and legislative changes. Accordingly, our reserves may prove to be inadequate to cover our actual losses. If we change our estimates, these changes would be reflected in our results of operations during the period in which they are made, with increases in our reserves resulting in decreases in our earnings.



Acquisitions

In July 2014, we reacquired Agent Alliance Insurance Company ("AAIC"), an Alabama-domiciled insurer focused on private passenger auto business in North Carolina which is also licensed as a surplus lines carrier in over 30 states, from ACP Re, Ltd. ("ACP Re") for a purchase price equal to AAIC's capital and surplus of approximately $17.0 million. Following our 2012 sale of AAIC to ACP Re, we had continued to reinsure 100% of its existing and renewal private passenger auto insurance. On June 27, 2014, we purchased certain assets of Imperial Management Corporation ("Imperial"), including its underwriting subsidiaries Imperial Fire & Casualty Insurance Company and National Automotive Insurance Company, its retail agency subsidiary ABC Insurance Agencies, and its managing general agency subsidiary RAC Insurance Partners. The purchase price was approximately $20.0 million. In connection with the Imperial transaction, we assumed certain debt of Imperial and Imperial Fire & Casualty Insurance Company (see Note 9, "Debt" to our condensed consolidated financial statements). On April 1, 2014, we purchased Personal Express Insurance Company ("Personal Express"), a California domiciled personal auto and home insurer from Sequoia Insurance Company, an affiliate of AmTrust Financial Services, Inc. ("AmTrust"). The purchase price was approximately $21.7 million, subject to certain adjustments. The Tower Transaction On January 3, 2014, ACP Re, Ltd. ("ACP Re"), a Bermuda reinsurer that is a subsidiary of The Michael Karfunkel 2005 Grantor Retained Annuity Trust (the "Karfunkel Trust"), entered into a merger agreement (the "Tower Merger Agreement") with Tower Group International, Ltd. ("Tower") pursuant to which ACP Re has agreed to acquire 100% of the outstanding stock of Tower and cause its subsidiary to merge into Tower (the "Merger"). The transactions contemplated by the Tower Merger Agreement are subject to certain regulatory and shareholder approvals. In connection with the Merger, the Company and AmTrust Financial Services, Inc. ("AmTrust") agreed, subject to the consummation of the Merger, to (a) acquire the renewal rights and certain other assets related to Tower's personal lines insurance 45

-------------------------------------------------------------------------------- operations and commercial lines insurance operations, respectively, (b) administer the run-off of Tower's historical personal lines claims and commercial lines claims at cost, (c) in their discretion, place personal lines business and commercial lines business with the Tower insurance companies, which they will exclusively manage and fully reinsure for a net 2% ceding fee payable to the Tower insurance companies, (d) retain the expirations on all business written by the Tower insurance companies through the Company and AmTrust, as managers, and (e) receive the agreement of the Tower insurance companies and ACP Re not to compete with respect to the personal lines business and commercial lines business. The Company also agreed to acquire the Attorneys-in-Fact which serve as insurance managers for the reciprocal exchanges managed by Tower from ACP Re for $7.5 million. Subject to the consummation of the Merger, the Company and AmTrust have agreed to provide ACP Re with financing in an aggregate principal amount of $125 million each. On July 22, 2014, a Special Committee of the Company's Board of Directors composed solely of independent directors (the "Special Committee") approved the terms of the Credit Agreement to be entered into among the Company, AmTrust and ACP Re upon consummation of the Merger. The $250 million loan will have a seven-year term, will bear interest at an annual rate of 7% and will contain restrictive covenants, including, without limitation, covenants relating to the value of ACP Re's assets, ACP Re's leverage ratio and fixed charge coverage ratio, as well as other typical limitations on ACP Re's activities. The loan will be secured by a security interest in the stock of ACP Re and its subsidiaries, the assets of ACP Re and certain of the assets of ACP Re's unregulated subsidiaries. In addition, effective upon the consummation of the Merger, a subsidiary of the Company, along with a subsidiary of AmTrust, as reinsurers, will enter into a $250 million aggregate stop loss reinsurance agreement with a subsidiary of Tower by which each, as reinsurers, will provide, severally, $125 million of stop loss coverage with respect to the run-off of the legacy Tower business (the "Stop-Loss"). ACP Re will enter into a reinsurance agreement (the "Retrocession") by which it reinsures the full amount of any payments that the Company and AmTrust would be obligated to make under the Stop Loss. The Stop Loss premium will be equal to $56 million, payable five years following the closing of the Merger. The Retrocession premium will be equal to the Stop Loss premium, less a fee of 5.5% of the Stop Loss premium to be retained by a subsidiary of the Company and a subsidiary of AmTrust. The Stop Loss coverage will attach in the event that paid losses and paid loss adjustment expenses by the Tower insurance companies exceed Tower's reserves as of the closing of the Merger. Through the Stop-Loss, our subsidiary will have direct exposure, and we will have indirect exposure, to Tower's historical commercial and personal lines business and reserves, subject to the reinsurance provided by the Retrocession. The Special Committee approved the terms of the Stop Loss and Retrocession. The Special Committee also approved the Company's entrance into an Amended and Restated Personal Lines Master Agreement with ACP Re (the "Amended and Restated Personal Lines Master Agreement"), which, in addition to the agreements previously described, provides that the Company will pay ACP Re contingent consideration in the form of an earnout (the "Contingent Payments"), payable semi-annually on the last day of January and July, of 3% of gross written premium of the Tower personal lines business written or assumed by the Company following the closing in connection with the transaction for a three-year period. The Contingent Payments to be made by the Company are capped at a total of $30 million, in the aggregate, over the three-year period. The parties entered into the Amended and Restated Personal Lines Master Agreement on July 23, 2014. Simultaneously, ACP Re and AmTrust entered into an Amended and Restated Commercial Lines Master Agreement that provides for contingent consideration payable by AmTrust to ACP Re on the same terms. The Tower transaction remains subject to regulatory approval and the consummation of the Merger. There is no assurance that regulatory approval for the transaction will be received or that modifications to the terms described above will not need to be made in order to obtain regulatory approval. In addition, Integon National, our wholly-owned subsidiary, has entered into a reinsurance agreement (the "Cut-Through Reinsurance Agreement") with several Tower subsidiaries. Under the Cut-Through Reinsurance Agreement, Integon National has reinsured on a 100% quota share basis with a cut-through endorsement all of Tower's new and renewal personal lines business after January 1, 2014 and has assumed 100% of Tower's unearned premium reserves with respect to in-force personal lines policies, in each case, net of reinsurance already in effect. The agreement is effective solely with respect to losses occurring on or after January 1, 2014 and has a duration of one year unless earlier terminated. We will pay a 20% ceding commission with respect to unearned premium assumed and a 22% ceding commission with respect to new and renewal business after January 1, 2014 and up to a 4% claims handling expense reimbursement to Tower on all Tower premium subject to the Cut-Through Reinsurance Agreement. We believe the Tower Transaction will add increased product offerings to our customers, agents and brokers. We expect that this transaction will permit us to introduce homeowners and umbrella coverage into our product offerings, allow us to bundle these coverages with our existing auto business and make our product offerings even more competitive. In addition, we expect this transaction will also add geographic expansion to our auto business. We believe that the additional premium we expect to assume under the Cut-Through Reinsurance Agreement, together with the unearned premium reserves that we assume, will provide us with the opportunity to significantly increase our earned premiums over time. 46

-------------------------------------------------------------------------------- Expectations Regarding Tower Transactions Set forth below are certain of our expectations regarding the Tower Transaction described above. We caution you that these expectations may not materialize and are not indicative of the actual results that we will achieve. Our expectations are based in large part on Tower's historical financial performance as reported in its public SEC and statutory filings. We have assumed the accuracy of this information in setting our expectations. There can be no assurance that the future performance of the Tower personal lines business will be comparable to its historical performance or that our expectations as to the level and profitability of the Tower personal lines business that we may have access to as a result of the Tower Transaction will be realized. Many factors and future developments may cause our actual results to differ materially and significantly from the information set forth below. See Item 1A, "Risk Factors" of our Annual Report on Form 10-K for the year ended December 31, 2013, and Part II, Item IA, "Risk Factors" of our Quarterly Report on Form 10-Q for the quarterly period ended March 31, 2014, and "Note on Forward-Looking Statements" of this Quarterly Report on Form 10-Q. As part of the Tower Transaction, we anticipate that we will have access to approximately $650 million of potential annual managed gross premium that we expect will be generated by the Tower personal lines companies. We expect to earn service and fee income only (and not bear underwriting risk) on approximately one-third of these premiums by providing management and administration services to the issuing companies which are structured as reciprocal insurers, and we expect our insurance companies to reinsure approximately two-thirds of these premiums, and utilize quota share and catastrophe reinsurance to reduce our exposure as necessary. Excluding the impact of catastrophic losses, we expect to target a loss ratio on these premiums within an approximate range of between 50% and 60%. Of course, there can be no assurance that we will complete the Tower Transaction in the manner currently planned or at all, or that the results of the Tower Transaction will match our expectations as to premium volume, profitability or otherwise. Principal Revenue and Expense Items Gross premium written. Gross premium written represents premium from each insurance policy that we write, including as a servicing carrier for assigned risk plans, during a reporting period based on the effective date of the individual policy, prior to ceding reinsurance to third parties. Net premium written. Net premium written is gross premium written less that portion of premium that we cede to third-party reinsurers under reinsurance agreements. The amount ceded under these reinsurance agreements is based on a contractual formula contained in the individual reinsurance agreement. Change in unearned premium. Change in unearned premium is the change in the balance of the portion of premium that we have written but have yet to earn during the relevant period because the policy is unexpired. Net earned premium. Net earned premium is the earned portion of our net premium written. We generally earn insurance premium on a pro rata basis over the term of the policy. At the end of each reporting period, premium written that is not earned is classified as unearned premium, which is earned in subsequent periods over the remaining term of the policy. Our policies typically have a term of six months or one year. For a six-month policy written on January 1, 2014, we would earn half of the premium in the first quarter of 2014 and the other half in the second quarter of 2014. Ceding commission income. Ceding commission income is a commission we receive based on the earned premium ceded to third-party reinsurers to reimburse us for our acquisition, underwriting and other operating expenses. We earn commissions on reinsurance premium ceded in a manner consistent with the recognition of the earned premium on the underlying insurance policies, generally on a pro-rata basis over the terms of the policies reinsured. The portion of ceding commission income which represents reimbursement of successful acquisition costs related to the underlying policies is recorded as an offset to acquisition and other underwriting expenses. The ceding commission ratio is equal to ceding commission income divided by net earned premium. Service and fee income. We currently generate policy service and fee income from installment fees, late payment fees, and other finance and processing fees related to policy cancellation, policy reinstatement, and non-sufficient fund check returns. These fees are generally designed to offset expenses incurred in the administration of our insurance business, and are generated as follows. Installment fees are charged to permit a policyholder to pay premiums in installments rather than in a lump sum. Late payment fees are charged when premiums are remitted after the due date and any applicable grace periods. Policy cancellation fees are charged to policyholders when a policy is terminated by the policyholder prior to the expiration of the policy's term or renewal term, as applicable. Reinstatement fees are charged to reinstate a policy that has lapsed, generally as a result of non-payment of premiums. Non-sufficient fund fees are charged when the customer's payment is returned by the financial institution. All fee income is recognized as follows. An installment fee is recognized at the time each policy installment bill is due. A late payment fee is recognized when the customer's payment is not received after the listed due date and any applicable grace period. A policy cancellation fee is recognized at the time the customer's policy is cancelled. A policy reinstatement fee is recognized 47 -------------------------------------------------------------------------------- when the customer's policy is reinstated. A non-sufficient fund fee is recognized when the customer's payment is returned by the financial institution. The amounts charged are primarily intended to compensate us for the administrative costs associated with processing and administering policies that generate insurance premium; however, the amounts of fees charged are not dependent on the amount or period of insurance coverage provided and do not entail any obligation to return any portion of those funds. The direct and indirect costs associated with generating fee income are not separately tracked. We also collect service fees in the form of commissions and general agent fees by selling policies issued by third-party insurance companies. We do not bear insurance underwriting risk with respect to these policies. Commission income and general agent fees are recognized, net of an allowance for estimated policy cancellations, at the date the customer is initially billed or as of the effective date of the insurance policy, whichever is later. The allowance for estimated third-party cancellations is periodically evaluated and adjusted as necessary. Net investment income and realized gains and (losses). We invest our statutory surplus funds and the funds supporting our insurance liabilities primarily in cash and cash equivalents, fixed-maturity and equity securities. Our net investment income includes interest and dividends earned on our invested assets. We report net realized gains and losses on our investments separately from our net investment income. Net realized gains occur when we sell our investment securities for more than their costs or amortized costs, as applicable. Net realized losses occur when we sell our investment securities for less than their costs or amortized costs, as applicable, or we write down the investment securities as a result of other-than-temporary impairment. We classify equity securities and our fixed-maturity securities as available-for-sale. We report net unrealized gains (losses) on those securities classified as available-for-sale separately within other comprehensive income. Loss and loss adjustment expenses. Loss and LAE represent our largest expense item and, for any given reporting period, include estimates of future claim payments, changes in those estimates from prior reporting periods and costs associated with investigating, defending and servicing claims. These expenses fluctuate based on the amount and types of risks we insure. We record loss and LAE related to estimates of future claim payments based on case-by-case valuations and statistical analyses. We seek to establish all reserves at the most likely ultimate exposure based on our historical claims experience. It is typical for our more serious bodily injury claims to take several years to settle, and we revise our estimates as we receive additional information about the condition of claimants and the costs of their medical treatment. Our ability to estimate loss and LAE accurately at the time of pricing our insurance policies is a critical factor in our profitability. Acquisition and other underwriting costs. Acquisition and other underwriting costs consist of policy acquisition and marketing expenses, salaries and benefits expenses. Policy acquisition expenses comprise commissions directly attributable to those agents, wholesalers or brokers that produce premiums written on our behalf and promotional fees directly attributable to our affinity relationships. Acquisition costs also include costs that are related to the successful acquisition of new or renewal insurance contracts including comprehensive loss underwriting exchange reports, motor vehicle reports, credit score checks, and policy issuance costs. General and administrative expense. General and administrative expense is composed of all other operating expenses, including various departmental salaries and benefits expenses for employees that are directly involved in the maintenance of policies, information systems, and accounting for insurance transactions, and other insurance expenses such as federal excise tax, postage, telephones and internet access charges, as well as legal and auditing fees and board and bureau charges. In addition, general and administrative expense includes those charges that are related to the amortization of tangible and intangible assets and non-insurance activities in which we engage. Interest expense. Interest expense represents amounts we incur on our outstanding indebtedness at the then-applicable interest rates. Income tax expense. We incur federal, state and local income tax expenses as well as income tax expenses in certain foreign jurisdictions in which we operate. Net operating expense. These expenses consist of the sum of general and administrative expense and acquisition and other underwriting costs less ceding commission income and service and fee income. Underwriting income. Underwriting income is a measure of an insurance company's overall operating profitability before items such as investment income, interest expense and income taxes. Underwriting income is calculated as net earned premium plus ceding commission income and service and fee income less loss and LAE, acquisition and other underwriting costs, and general and administrative expense. Equity in earnings (losses) from unconsolidated subsidiaries. This represents primarily our share in earnings or losses of our investment in four companies that own life settlement contracts, which includes the gain realized upon a mortality event and the change in fair value of the investments in life settlements as evaluated at the end of each reporting period. These unconsolidated 48 -------------------------------------------------------------------------------- subsidiaries determine the fair value of life settlement contracts based upon an estimate of the discounted cash flow of the anticipated death benefits incorporating a number of factors, such as current life expectancy assumptions, expected premium payment obligations and increased cost assumptions, credit exposure to the insurance companies that issued the life insurance policies and the rate of return that a buyer would require on the policies. The gain realized upon a mortality event is the difference between the death benefit received and the recorded fair value of that particular policy. Insurance Ratios Net loss ratio. The net loss ratio is a measure of the underwriting profitability of an insurance company's business. Expressed as a percentage, this is the ratio of loss and LAE incurred to net earned premiums. Net operating expense ratio (non-GAAP). The net operating expense ratio (non-GAAP) is one component of an insurance company's operational efficiency in administering its business. Expressed as a percentage, this is the ratio of net operating expense to net earned premium. Net combined ratio (non-GAAP). The net combined ratio (non-GAAP) is a measure of an insurance company's overall underwriting profit. This is the sum of the net loss and net operating expense ratio (non-GAAP). If the net combined ratio (non-GAAP) is at or above 100 percent, an insurance company cannot be profitable without investment income, and may not be profitable if investment income is insufficient. Net operating expense ratio and net combined ratio are considered non-GAAP financial measures under applicable SEC rules because a component of those ratios, net operating expense, is calculated by offsetting acquisition and other underwriting costs and general and administrative expense by ceding commission income and service and fee income, and is therefore a non-GAAP measure. Management uses net operating expense ratio (non-GAAP) and net combined ratio (non-GAAP) to evaluate financial performance against historical results and establish targets on a consolidated basis. Other companies may calculate these measures differently, and, therefore, their measures may not be comparable to those used by the Company's management. For a reconciliation showing the total amounts by which acquisition and other underwriting costs and general and administrative expense were offset by ceding commission income and service and fee income in the calculation of net operating expense, see "Results of Operations - Consolidated Results of Operations for the three and six months ended June 30, 2014 and 2013 (Unaudited)" below. Personal Lines Quota Share Effective March 1, 2010, Integon National entered into a 50% quota share reinsurance treaty (the "Personal Lines Quota Share"), pursuant to which Integon National ceded 50% of the gross premium written of its P&C business (excluding premium ceded to state-run reinsurance facilities) to a group of affiliated reinsurers consisting of a subsidiary of AmTrust, ACP Re and Maiden Insurance. Quota share reinsurance refers to reinsurance under which the insurer (the "ceding company," which under the Personal Lines Quota Share is Integon National) transfers, or cedes, a fixed percentage of liabilities, premium and related losses for each policy covered on a pro rata basis in accordance with the terms and conditions of the relevant agreement. The reinsurer pays the ceding company a ceding commission on the premiums ceded to compensate the ceding company for various expenses, such as underwriting and policy acquisition expenses, that the ceding company incurs in connection with the ceded business. The Personal Lines Quota Share provided that the reinsurers, severally, in accordance with their participation percentages, received 50% of our P&C gross premium written (excluding premium ceded to state-run reinsurance facilities) and assumed 50% of the related losses and allocated LAE. The participation percentages were: Maiden Insurance, 25%; ACP Re, 15%; and AmTrust, 10%. The Personal Lines Quota Share had an initial term of three years and was renewed through March 1, 2016. The Personal Lines Quota Share provided that the reinsurers pay a provisional ceding commission equal to 32.0% of ceded earned premium, net of premiums ceded by Integon National for inuring third-party reinsurance, subject to adjustment to a maximum of 34.5% if the loss ratio for the reinsured business is 60.0% or less and a minimum of 30.0% if the loss ratio is 64.5% or higher. The Personal Lines Quota Share provides for the net settlement of claims and the provisional ceding commission on a quarterly basis during the month following the end of each quarter. The net payments are based on earned premiums less paid losses and LAE less the provisional ceding commission for the quarter. The adjustment to the provisional ceding commission is calculated at the end of, and with respect to, each calendar year during the term of the Quota Share (an "adjustment period"), with the final adjustment period following termination of the Quota Share ending at the end of the run-off period. The adjusted commission rate, which is calculated and reported by the reinsurers to the Company within 30 days after the end of each adjustment period, is calculated by first determining the "actual loss ratio" for the adjustment period, which loss ratio is calculated in the same manner as the net loss ratio as disclosed in this filing with the SEC. The adjusted commission rate is set based on the actual loss ratio within a range between 30.0% and 34.5%, and varies inversely with a range of actual loss ratios between 60.0% and 64.5%, such that the adjusted commission rate will be higher than 32.0% if the actual loss ratio is lower than 62.5%, and lower than 32.0% if the actual loss ratio is higher than 62.5%, subject to the caps described above. The Company accrues any adjustments to the 49 -------------------------------------------------------------------------------- provisional ceding commission based on the loss experience of the ceded business on a quarterly basis. Remittance of any positive difference between the adjusted commission rate over the provisional ceding commission is paid by the reinsurer to the Company, and any negative difference is paid by the Company to the reinsurer within 12 months after the end of the final adjustment period (other than with respect to the initial year of the agreement with respect to which initial remittance was made 24 months after the end of the first adjustment period). Effective August 1, 2013, as permitted by the Personal Lines Quota Share, we terminated our cession of P&C premium to our quota share reinsurers and now retain 100% of such P&C gross premium written and related losses with respect to all new and renewal P&C policies bound after August 1, 2013. We will continue to cede 50% of P&C gross premium written and related losses with respect to policies in effect as of July 31, 2013 to the quota share reinsurers until the expiration of such policies. This retention of our P&C premium will provide us the opportunity to substantially increase our underwriting and investment income, while also increasing our exposure to losses. See Item 1A, "Risk Factors-Risks Relating to Our Insurance Operations-We have reduced our dependence on reinsurance and will retain a greater percentage of our premium writings, which increases our exposure to the underlying policy risks" of our Annual Report on Form 10-K for the year ended December 31, 2013. Critical Accounting Policies Our discussion and analysis of our results of operations, financial condition and liquidity are based upon our condensed consolidated financial statements, which have been prepared in accordance with U.S. generally accepted accounting principles. The preparation of these financial statements requires us to make estimates and judgments that affect the amounts of assets and liabilities, revenues and expenses and disclosure of contingent assets and liabilities as of the date of the financial statements. As more information becomes known, these estimates and assumptions could change, which would have an impact on actual results that may differ materially from these estimates and judgments under different assumptions. We have not made any changes in estimates or judgments that have had a significant effect on the reported amounts as previously disclosed in our Annual Report on Form 10-K for the year ended December 31, 2013. 50 --------------------------------------------------------------------------------



Results of Operations

Consolidated Results of Operations for the Three and Six Months Ended June 30, 2014 and 2013 (Unaudited) Three Months Ended Six Months Ended June 30, June 30, 2014 2013 2014 2013 (Amounts in Thousands) Gross premium written $ 468,473$ 330,689$ 1,114,615$ 688,302 Ceded premiums (related parties - three months $12,690; $147,401 and six months $42,967; $291,501) (49,917 ) (183,685 ) (128,574 ) (368,782 ) Net premium written $ 418,556$ 147,004$ 986,041$ 319,520 Change in unearned premiums (27,090 ) 7,546 (236,723 ) (12,814 ) Net earned premium $ 391,466$ 154,550$ 749,318$ 306,706 Ceding commission income (primarily related parties) 1,557 24,735 6,927 49,992 Service, fees and other income 38,486 31,406 75,192 58,668 Underwriting expenses: Loss and LAE 255,604 98,669



480,951 201,871

Acquisition costs and other underwriting costs 74,418 32,222



148,791 62,432

General and administrative 77,059 68,412 153,258 135,221 Total underwriting expenses $ 407,081$ 199,303$ 783,000$ 399,524 Underwriting income $ 24,428$ 11,388$ 48,437$ 15,842 Net investment income 11,321 7,181 20,535 13,654 Net realized gains (losses) on investments - (751 ) - 947 Other revenue 100 - 107 16 Equity in earnings (losses) of unconsolidated subsidiaries (2,610 ) 487 (1,487 ) (324 ) Interest expense (2,519 ) (573 ) (3,112 ) (916 ) Income before provision for income taxes $ 30,720$ 17,732$ 64,480$ 29,219 Provision for income taxes 424 3,782 7,760 7,553 Net income $ 30,296$ 13,950$ 56,720$ 21,666 Net income (loss) attributable to non-controlling interest 38 - 6 (44 ) Net income attributable NGHC $ 30,334$ 13,950$ 56,726$ 21,622 Net loss ratio 65.3 % 63.8 % 64.2 % 65.8 % Net operating expense ratio (non-GAAP) 28.5 % 28.8 % 29.4 % 29.0 % Net combined ratio (non-GAAP) 93.8 % 92.6 % 93.6 % 94.8 % Three Months Ended Six Months Ended June 30, June 30, Reconciliation of net operating expense ratio (non-GAAP): 2014 2013 2014 2013 (Amounts in Thousands) Total expenses $ 409,600$ 199,876$ 786,112$ 400,440 Less: Loss and loss adjustment expense 255,604 98,669 480,951 201,871 Less: Interest expense 2,519 573 3,112 916 Less: Ceding commission income 1,557 24,735 6,927 49,992 Less: Service, fees and other income 38,486 31,406 75,192 58,668 Net operating expense $ 111,434$ 44,493$ 219,930$ 88,993 Net earned premium $ 391,466$ 154,550 $



749,318 $ 306,706 Net operating expense ratio (non-GAAP) 28.5 % 28.8 % 29.4 % 29.0 %

51 -------------------------------------------------------------------------------- During 2013, we terminated the Personal Lines Quota Share on a run-off basis (the "Quota Share Runoff") pursuant to which we historically ceded 50% of our P&C gross premium written and related losses (excluding premium ceded to state-run reinsurance facilities) to our quota share reinsurers. Effective January 1, 2014, we entered into the Tower Cut-Through Reinsurance Agreement under which during the six months ended June 30, 2014 we assumed unearned premium relating to in-force personal lines business and under which we reinsured new and renewal personal lines policies written after January 1, 2014. During 2014, we also continued our expansion into the A&H segment ("A&H Expansion"). In April 2013, we acquired Euro Accident Health and Care Insurance Aktiebolag ("EHC"), a Swedish group life and health insurance provider focused on health. EHC operates as a Managing General Agent, which means that it is a registered insurance intermediary and as such operates as a non-risk bearing insurer. Commencing January 1, 2014, our European insurance subsidiary began reinsuring all business placed by EHC (the "EHC Business"). Commencing April 1, 2014, all new and renewal policies placed by EHC are underwritten by our European insurance subsidiaries. As a result of the Quota Share Runoff, the Tower Cut-Through Reinsurance Agreement, the A&H Expansion and the financial impact of the EHC Business, comparisons between our 2014 and 2013 results will be less meaningful. Consolidated Results of Operations for the Three Months Ended June 30, 2014 Compared with the Three Months Ended June 30, 2013 (Unaudited) Gross premium written. Gross premium written increased by $137.8 million from $330.7 million for the three months ended June 30, 2013 to $468.5 million for the three months ended June 30, 2014, due to an increase of $86.5 million in premiums received from the P&C segment primarily as a result of the Tower Cut-Through Reinsurance Agreement and an increase of $51.3 million in premiums received from the A&H segment primarily as a result of the EHC Business. Net premium written. Net premium written increased by $271.6 million from $147.0 million for the three months ended June 30, 2013 to $418.6 million for the three months ended June 30, 2014. Net premium written for the P&C segment increased by $220.3 million for the three months ended June 30, 2014 compared to the same period in 2013 primarily due to the Tower Cut-Through Reinsurance Agreement and the Quota Share Runoff. Primarily in connection with the EHC Business, net premium written for the A&H segment increased by $51.3 million. Net earned premium. Net earned premium increased by $236.9 million, or 153.3%, from $154.6 million for the three months ended June 30, 2013 to $391.5 million for the three months ended June 30, 2014. The increase by segment was: P&C - $216.2 million and A&H - $20.7 million. The increase was primarily attributable to the Tower Cut-Through Reinsurance Agreement, the Quota Share Runoff and the EHC Business. Ceding commission income. Ceding commission income decreased from $24.7 million for the three months ended June 30, 2013 to $1.6 million for the three months ended June 30, 2014, reflecting the Quota Share Runoff. Our ceding commission ratio decreased from 16.0% to 0.4%. Service and fee income. Service and fee income increased by $7.1 million, or 22.5%, from $31.4 million for the three months ended June 30, 2013 to $38.5 million for the three months ended June 30, 2014. The increase was primarily attributable to the increase of $4.1 million in service and fee income related to our A&H segment as a result of the A&H Expansion and the EHC Business and an increase of $3.0 million related to our P&C segment as a result of higher general agent fees. The components of service and fee income are as follows: Three Months Ended June 30, (amounts in thousands) 2014 2013 Change Installment fees $ 7,322$ 7,053$ 269 Commission revenue 14,878 10,527 4,351 General agent fees 7,842 4,967 2,875 Late payment fees 2,987 2,863 124 Finance and processing fees 3,369 3,826 (457 ) Other 2,088 2,170 (82 ) Total $ 38,486$ 31,406$ 7,080 Loss and loss adjustment expenses; net loss ratio. Loss and LAE increased by $156.9 million, or 159.1%, from $98.7 million for the three months ended June 30, 2013 to $255.6 million for the three months ended June 30, 2014, primarily reflecting the Quota Share Runoff as well as the Tower Cut-Through Reinsurance Agreement. The changes by segment were: P&C - increased $137.8 million and A&H -increased $19.1 million. Our net loss ratio increased from 63.8% for the three months ended June 30, 2013 to 65.3% for the three months ended June 30, 2014 primarily due to the A&H Expansion. 52 -------------------------------------------------------------------------------- Acquisition and other underwriting costs. Acquisition and other underwriting costs increased by $42.2 million, or 131.0%, from $32.2 million for the three months ended June 30, 2013 to $74.4 million for the three months ended June 30, 2014 primarily due to the Tower Cut-Through Reinsurance Agreement, Quota Share Runoff and A&H Expansion expenses. General and administrative expense. General and administrative expense increased by $8.7 million, or 12.6%, from $68.4 million for the three months ended June 30, 2013 to $77.1 million for the three months ended June 30, 2014 primarily as a result of A&H Expansion expenses. Net operating expense; net operating expense ratio (non-GAAP). Net operating expense increased by $66.9 million, or 150.5% from $44.5 million for the three months ended June 30, 2013 to $111.4 million for the three months ended June 30, 2014. The net operating expense ratio (non-GAAP) decreased to 28.5% in the three months ended June 30, 2014 from 28.8% in the three months ended June 30, 2013 primarily as a result of the lower expense ratio on policies reinsured under the Tower Cut-Through Reinsurance Agreement, partially offset by A&H Expansion expenses. Net investment income. Net investment income increased by $4.1 million, or 57.7%, from $7.2 million for the three months ended June 30, 2013 to $11.3 million for the three months ended June 30, 2014 primarily due to an increase in average invested assets related to our February 2014 common stock issuance, our May 2014 issuance of $250.0 million aggregate principal amount of 6.75% notes, and our June 2014$55.0 million preferred stock issuance. Net realized gains (losses) on investments. Net realized gains on investments increased by $0.8 million from a $0.8 million loss for the three months ended June 30, 2013 to $0.0 million for the three months ended June 30, 2014. Equity in earnings (losses) of unconsolidated subsidiaries. Equity in (losses) of unconsolidated subsidiaries, which primarily relates to our 50% interest in life settlement entities, increased by $3.1 million, from $0.5 million in earnings for the three months ended June 30, 2013 to $2.6 million in losses for the three months ended June 30, 2014, due to the change in fair market value of the life settlement contracts. Interest expense. Interest expense for the three months ended June 30, 2014 and 2013 was $2.5 million and $0.6 million, respectively, increasing primarily due to our May 2014 issuance of $250.0 million aggregate principal amount of 6.75% notes. Provision for income taxes. Income tax expense decreased by $3.4 million, or 88.8%, from $3.8 million for the three months ended June 30, 2013, reflecting an effective tax rate of 21.9%, to $0.4 million for the three months ended June 30, 2014, reflecting an effective tax rate of 1.3%. Income tax expense included a tax benefit of $9.0 million attributable to the reduction of the deferred tax liability associated with the equalization reserves of our Luxembourg reinsurers.



Consolidated Results of Operations for the Six Months Ended June 30, 2014 Compared with the Six Months Ended June 30, 2013 (Unaudited)

Gross premium written. Gross premium written increased by $426.3 million from $688.3 million for the six months ended June 30, 2013 to $1,114.6 million for the six months ended June 30, 2014, due to an increase of $342.8 million in premiums received from the P&C segment primarily as a result of the Tower Cut-Through Reinsurance Agreement and an increase of $83.5 million in premiums received from the A&H segment primarily as a result of the EHC Business. Net premium written. Net premium written increased by $666.5 million from $319.5 million for the six months ended June 30, 2013 to $986.0 million for the six months ended June 30, 2014. Net premium written for the P&C segment increased by $583.1 million for the six months ended June 30, 2014 compared to the same period in 2013 primarily due to the Tower Cut-Through Reinsurance Agreement and the Quota Share Runoff. Primarily in connection with the EHC Business, net premium written for the A&H segment increased by $83.4 million. Net earned premium. Net earned premium increased by $442.6 million, or 144.3%, from $306.7 million for the six months ended June 30, 2013 to $749.3 million for the six months ended June 30, 2014. The increase by segment was: P&C - $398.6 million and A&H - $44.0 million. The increase was primarily attributable to the Tower Cut-Through Reinsurance Agreement, the Quota Share Runoff and the EHC Business. Ceding commission income. Ceding commission income decreased from $50.0 million for the six months ended June 30, 2013 to $6.9 million for the six months ended June 30, 2014, reflecting the Quota Share Runoff. Our ceding commission ratio decreased from 16.3% to 0.9%. 53 -------------------------------------------------------------------------------- Service and fee income. Service and fee income increased by $16.5 million, or 28.2%, from $58.7 million for the six months ended June 30, 2013 to $75.2 million for the six months ended June 30, 2014. The increase was primarily attributable to the increase of $12.8 million in service and fee income related to our A&H segment as a result of the A&H Expansion and the EHC Business and an increase of $3.7 million related to our P&C segment as a result of higher general agent fees. The components of service and fee income are as follows: Six Months Ended June 30, (amounts in thousands) 2014 2013 Change Installment fees $ 14,205$ 17,063$ (2,858 ) Commission revenue 29,738 16,816 12,922 General agent fees 15,167 9,419 5,748 Late payment fees 5,485 5,444 41 Finance and processing fees 6,509 5,451 1,058 Other 4,088 4,475 (387 ) Total $ 75,192$ 58,668$ 16,524 Loss and loss adjustment expenses; net loss ratio. Loss and LAE increased by $279.1 million, or 138.2%, from $201.9 million for the six months ended June 30, 2013 to $481.0 million for the six months ended June 30, 2014, primarily reflecting the Quota Share Runoff as well as the Tower Cut-Through Reinsurance Agreement. The changes by segment were: P&C - increased $251.2 million and A&H -increased $27.8 million. Our net loss ratio decreased from 65.8% for the six months ended June 30, 2013 to 64.2% for the six months ended June 30, 2014 primarily due to a lower loss ratio experienced with respect to our Tower Cut-Through Reinsurance Agreement. Acquisition and other underwriting costs. Acquisition and other underwriting costs increased by $86.4 million, or 138.3%, from $62.4 million for the six months ended June 30, 2013 to $148.8 million for the six months ended June 30, 2014 primarily due to the Tower Cut-Through Reinsurance Agreement, Quota Share Runoff and A&H Expansion expenses. General and administrative expense. General and administrative expense increased by $18.1 million, or 13.3%, from $135.2 million for the six months ended June 30, 2013 to $153.3 million for the six months ended June 30, 2014 primarily as a result of A&H Expansion expenses. Net operating expense; net operating expense ratio (non-GAAP). Net operating expense increased by $130.9 million, or 147.1% from $89.0 million for the six months ended June 30, 2013 to $219.9 million for the six months ended June 30, 2014. The net operating expense ratio (non-GAAP) increased to 29.4% in the six months ended June 30, 2014 from 29.0% in the six months ended June 30, 2013 primarily as a result of A&H Expansion expenses. Net investment income. Net investment income increased by $6.8 million, or 50.4%, from $13.7 million for the six months ended June 30, 2013 to $20.5 million for the six months ended June 30, 2014 primarily due to an increase in average invested assets related to our February 2014 common stock issuance, our May 2014 issuance of $250.0 million aggregate principal amount of 6.75% notes and our June 2014$55.0 million preferred stock issuance. Net realized gains (losses) on investments. Net realized gains on investments decreased by $0.9 million from a $0.9 million gain for the six months ended June 30, 2013 to $0.0 million for the six months ended June 30, 2014 due to the decision to sell more securities during the six months ended June 30, 2013 than during the same period of the current year. Equity in earnings (losses) of unconsolidated subsidiaries. Equity in (losses) of unconsolidated subsidiaries, which primarily relates to our 50% interest in life settlement entities, increased $1.2 million, from $0.3 million in losses for the six months ended June 30, 2013 to $1.5 million in losses for the six months ended June 30, 2014, due to the change in fair market value of the life settlement contracts. Interest expense. Interest expense for the six months ended June 30, 2014 and 2013 was $3.1 million and $0.9 million, respectively, increasing primarily due to our May 2014 issuance of $250.0 million aggregate principal amount of 6.75% notes. Provision for income taxes. Income tax expense increased by $0.2 million, or 2.7%, from $7.6 million for the six months ended June 30, 2013, reflecting an effective tax rate of 25.6%, to $7.8 million for the six months ended June 30, 2014, reflecting an effective tax rate of 11.8%. Income tax expense included a tax benefit of $13.0 million attributable to the reduction of the deferred tax liability associated with the equalization reserves of our Luxembourg reinsurers. 54

-------------------------------------------------------------------------------- P&C Segment - Results of Operations for the Three and Six Months Ended June 30, 2014 and 2013 (Unaudited) Six Months Ended Three Months Ended June 30, June 30, 2014 2013 2014 2013 (Amounts in Thousands) Gross premium written $ 407,863$ 321,438$ 1,014,471$ 671,736 Ceded premiums (49,767 ) (183,615 ) (128,377 ) (368,707 ) Net premium written $ 358,096$ 137,823$ 886,094$ 303,029 Change in unearned premiums 3,527 7,546 (197,252 ) (12,813 ) Net earned premium $ 361,623$ 145,369$ 688,842$ 290,216 Ceding Commission Income (primarily related parties) 1,557 24,735 6,927 49,992 Service and fee income 23,389 20,363 45,062 41,413 Underwriting expenses: Loss and LAE 231,008 93,205 440,438 189,178 Acquisition costs and other underwriting costs 61,440



25,505 117,213 51,186

General and administrative 64,715 61,620 128,236 125,445 Total underwriting expenses $ 357,163$ 180,330$ 685,887$ 365,809 Underwriting income $ 29,406$ 10,137$ 54,944$ 15,812 Net loss ratio 63.9 % 64.1 % 63.9 % 65.2 % Net operating expense ratio (non-GAAP) 28.0 % 28.9 % 28.1 % 29.4 % Net combined ratio (non-GAAP) 91.9 % 93.0 % 92.0 % 94.6 % Six Months Ended Three Months Ended June 30, June 30, Reconciliation of net operating expense ratio (non-GAAP): 2014 2013 2014 2013 (Amounts in Thousands) Total underwriting expenses $ 357,163$ 180,330$ 685,887$ 365,809 Less: Loss and loss adjustment expense 231,008 93,205 440,438 189,178 Less: Ceding Commission Income 1,557 24,735 6,927 49,992 Less: Service, Fees and Other Income 23,389 20,363 45,062 41,413 Net operating expense $ 101,209$ 42,027$ 193,460$ 85,226 Net earned premium $ 361,623$ 145,369$ 688,842$ 290,216 Net operating expense ratio (non-GAAP) 28.0 % 28.9 % 28.1 % 29.4 % 55

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P&C Segment Results of Operations for the Three Months Ended June 30, 2014 Compared with the Three Months Ended June 30, 2013 (Unaudited)

Gross premium written. Gross premium written increased by $86.5 million, or 26.9%, from $321.4 million for the three months ended June 30, 2013 to $407.9 million for the three months ended June 30, 2014 primarily as a result of the Tower Cut-Through Reinsurance Agreement. Net premium written. Net premium written increased by $220.3 million from $137.8 million for the three months ended June 30, 2013 to $358.1 million for the three months ended June 30, 2014 primarily due to the Tower Cut-Through Reinsurance Agreement and the Quota Share Runoff. Net earned premium. Net earned premium increased by $216.2 million, or 148.8%, from $145.4 million for the three months ended June 30, 2013 to $361.6 million for the three months ended June 30, 2014 primarily as a result of the Tower Cut-Through Reinsurance Agreement and the Quota Share Runoff. Ceding commission income. Our ceding commission income decreased by $23.1 million, or 93.6%, from $24.7 million for the three months ended June 30, 2013 to $1.6 million for the three months ended June 30, 2014 reflecting the Quota Share Runoff. Our ceding commission ratio decreased from 17.0% for the three months ended June 30, 2013 to 0.4% for the three months ended June 30, 2014. Service and fee income. Service and fee income increased by $3.0 million, or 14.9%, from $20.4 million for the three months ended June 30, 2013 to $23.4 million for the three months ended June 30, 2014 as a result of higher general agent fees. Loss and loss adjustment expenses; net loss ratio. Loss and LAE increased by $137.8 million, or 147.8%, from $93.2 million for the three months ended June 30, 2013 to $231.0 million for the three months ended June 30, 2014 primarily reflecting the Quota Share Runoff as well as the Tower Cut-Through Reinsurance Agreement. Our net loss ratio decreased from 64.1% for the three months ended June 30, 2013 to 63.9% for the three months ended June 30, 2014 primarily due to a lower loss ratio experienced on policies reinsured under the Tower Cut-Through Reinsurance Agreement. Acquisition and other underwriting costs. Acquisition and other underwriting costs increased by $35.9 million from $25.5 million for the three months ended June 30, 2013 to $61.4 million for the three months ended June 30, 2014. The increase was primarily due to the Tower Cut-Through Reinsurance Agreement and Quota Share Runoff. General and administrative expense. General and administrative expense increased by $3.1 million, or 5.0%, from $61.6 million for the three months ended June 30, 2013 to $64.7 million for the three months ended June 30, 2014. Net operating expense; net operating expense ratio (non-GAAP). Net operating expense increased by $59.2 million, or 140.8%, from $42.0 million for the three months ended June 30, 2013 to $101.2 million for the three months ended June 30, 2014. The net operating expense ratio (non-GAAP) decreased from 28.9% for the three months ended June 30, 2013 to 28.0% for the three months ended June 30, 2014 primarily due to the lower expense ratio on policies reinsured under the Tower Cut-Through Reinsurance Agreement. Underwriting income. Underwriting income increased from $10.1 million for the three months ended June 30, 2013 to $29.4 million for the three months ended June 30, 2014 primarily as a result of the Tower Cut-Through Reinsurance Agreement and the Quota Share Runoff. The combined ratio for the three months ended June 30, 2014 decreased to 91.9% compared to 93.0% for the same period in 2013 primarily as the result of our lower net loss ratio and net operating expense ratio experienced on policies reinsured under the Tower Cut-Through Reinsurance Agreement.



P&C Segment Results of Operations for the Six Months Ended June 30, 2014 Compared with the Six Months Ended June 30, 2013 (Unaudited)

Gross premium written. Gross premium written increased by $342.8 million, or 51.0%, from $671.7 million for the six months ended June 30, 2013 to $1,014.5 million for the six months ended June 30, 2014 primarily as a result of the Tower Cut-Through Reinsurance Agreement. Net premium written. Net premium written increased by $583.1 million from $303.0 million for the six months ended June 30, 2013 to $886.1 million for the six months ended June 30, 2014 primarily due to the Tower Cut-Through Reinsurance Agreement and the Quota Share Runoff. 56 -------------------------------------------------------------------------------- Net earned premium. Net earned premium increased by $398.6 million, or 137.4%, from $290.2 million for the six months ended June 30, 2013 to $688.8 million for the six months ended June 30, 2014 primarily as a result of the Tower Cut-Through Reinsurance Agreement and the Quota Share Runoff. Ceding commission income. Our ceding commission income decreased by $43.1 million, or 86.1%, from $50.0 million for the six months ended June 30, 2013 to $6.9 million for the six months ended June 30, 2014 reflecting the Quota Share Runoff. Our ceding commission ratio decreased from 17.2% for the six months ended June 30, 2013 to 1.0% for the six months ended June 30, 2014. Service and fee income. Service and fee income increased by $3.7 million, or 8.8%, from $41.4 million for the six months ended June 30, 2013 to $45.1 million for the six months ended June 30, 2014 as a result of higher general agent fees. Loss and loss adjustment expenses; net loss ratio. Loss and LAE increased by $251.2 million, or 132.8%, from $189.2 million for the six months ended June 30, 2013 to $440.4 million for the six months ended June 30, 2014 primarily reflecting the Quota Share Runoff as well as the Tower Cut-Through Reinsurance Agreement. Our net loss ratio decreased from 65.2% for the six months ended June 30, 2013 to 63.9% for the six months ended June 30, 2014 primarily due to a lower loss ratio experienced on policies reinsured under the Tower Cut-Through Reinsurance Agreement. Acquisition and other underwriting costs. Acquisition and other underwriting costs increased by $66.0 million from $51.2 million for the six months ended June 30, 2013 to $117.2 million for the six months ended June 30, 2014. The increase was primarily due to the Tower Cut-Through Reinsurance Agreement and Quota Share Runoff. General and administrative expense. General and administrative expense increased by $2.8 million from $125.4 million for the six months ended June 30, 2013 to $128.2 million for the six months ended June 30, 2014. Net operating expense; net operating expense ratio (non-GAAP). Net operating expense increased by $108.2 million, or 127.0%, from $85.2 million for the six months ended June 30, 2013 to $193.5 million for the six months ended June 30, 2014. The net operating expense ratio (non-GAAP) decreased from 29.4% for the six months ended June 30, 2013 to 28.1% for the six months ended June 30, 2014 primarily due to the lower expense ratio on policies reinsured under the Tower Cut-Through Reinsurance Agreement. Underwriting income. Underwriting income increased from $15.8 million for the six months ended June 30, 2013 to $54.9 million for the six months ended June 30, 2014 primarily as a result of the Tower Cut-Through Reinsurance Agreement and the Quota Share Runoff. The combined ratio for the six months ended June 30, 2014 decreased to 92.0% compared to 94.6% for the same period in 2013 primarily as the result of our lower net loss ratio and net operating expense ratio experienced on policies reinsured under the Tower Cut-Through Reinsurance Agreement. 57

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A&H Segment - Results of Operations for the Three and Six Months Ended June 30, 2014 and 2013 (Unaudited)

Six Months Ended Three Months Ended June 30, June 30, 2014 2013 2014 2013 (Amounts in Thousands) Gross premium written $ 60,610$ 9,251$ 100,144$ 16,566 Ceded premiums (150 ) (70 ) (197 ) (75 ) Net premium written $ 60,460$ 9,181$ 99,947$ 16,491 Change in unearned premiums (30,617 ) - (39,471 ) (1 ) Net earned premium $ 29,843$ 9,181$ 60,476$ 16,490 Service and fee income 15,097 11,043 30,130 17,255 Underwriting expenses: Loss and LAE 24,596



5,464 40,513 12,693

Acquisition costs and other underwriting costs 12,978



6,717 31,578 11,246

General and administrative 12,344 6,792 25,022 9,776 Total underwriting expenses $ 49,918$ 18,973$ 97,113$ 33,715 Underwriting income (loss) $ (4,978 )$ 1,251$ (6,507 )$ 30 Net loss ratio 82.4 % 59.5 % 67.0 % 77.0 % Net operating expense ratio (non-GAAP) 34.3 % 26.9 % 43.8 % 22.8 % Net combined ratio (non-GAAP) 116.7 % 86.4 % 110.8 % 99.8 % Six Months Ended Three Months Ended June 30, June 30, Reconciliation of net operating expense ratio (non-GAAP): 2014 2013 2014 2013 (Amounts in Thousands) Total underwriting expenses $ 49,918$ 18,973$ 97,113$ 33,715 Less: Loss and loss adjustment expense 24,596 5,464 40,513 12,693 Less: Service, Fees and Other Income 15,097 11,043 30,130 17,255 Net operating expense $ 10,225$ 2,466$ 26,470$ 3,767 Net earned premium $ 29,843$ 9,181$ 60,476$ 16,490 Net operating expense ratio (non-GAAP) 34.3 %



26.9 % 43.8 % 22.8 %

A&H Segment Results of Operations for the Three Months Ended June 30, 2014 Compared with the Three Months Ended June 30, 2013 (Unaudited)

Gross premium written. Gross premium written increased by $51.3 million, from $9.3 million for the three months ended June 30, 2013 to $60.6 million for the three months ended June 30, 2014 primarily as a result of the EHC Business. Net premium written. Net premium written increased by $51.3 million, from $9.2 million for the three months ended June 30, 2013 to $60.5 million for the three months ended June 30, 2014 primarily as a result of the EHC Business. Net earned premium. Net earned premium increased by $20.7 million, from $9.2 million for the three months ended June 30, 2013 to $29.8 million for the three months ended June 30, 2014 primarily as a result of the EHC Business. Service and fee income. Service and fee income increased by $4.1 million, or 36.7%, from $11.0 million for the three months ended June 30, 2013 to $15.1 million for the three months ended June 30, 2014 as a result of the A&H Expansion and the EHC Business. 58 -------------------------------------------------------------------------------- Loss and loss adjustment expenses; net loss ratio. Loss and LAE increased by $19.1 million, from $5.5 million for the three months ended June 30, 2013 to $24.6 million for the three months ended June 30, 2014. Our net loss ratio increased from 59.5% for the three months ended June 30, 2013 to 82.4% for the three months ended June 30, 2014. The loss ratio in the three months ended June 30, 2014 was higher due to the A&H Expansion. Acquisition and other underwriting costs. Acquisition and other underwriting costs increased by $6.3 million from $6.7 million for the three months ended June 30, 2013 to $13.0 million for the three months ended June 30, 2014 primarily as a result of A&H Expansion expenses. General and administrative expense. General and administrative expense increased by $5.5 million from $6.8 million for the three months ended June 30, 2013 to $12.3 million for the three months ended June 30, 2014 primarily as a result of A&H Expansion expenses. Net operating expense; net operating expense ratio (non-GAAP). Net operating expense increased by $7.8 million from $2.5 million for the three months ended June 30, 2013 to $10.2 million for the three months ended June 30, 2014. The net operating expense ratio (non-GAAP) increased from 26.9% for the three months ended June 30, 2013 to 34.3% for the three months ended June 30, 2014 primarily as a result of the A&H Expansion expenses. Underwriting income. Underwriting income decreased from income of $1.3 million for the three months ended June 30, 2013 to a loss of $5.0 million for the three months ended June 30, 2014. The combined ratio for the three months ended June 30, 2014 increased to 116.7% compared to 86.4% for the same period in 2013. The combined ratio was higher due to the A&H Expansion.



A&H Segment - Results of Operations for the Six Months Ended June 30, 2014 and 2013 (Unaudited)

Gross premium written. Gross premium written increased by $83.5 million, from $16.6 million for the six months ended June 30, 2013 to $100.1 million for the six months ended June 30, 2014 primarily as a result of the EHC Business. Net premium written. Net premium written increased by $83.4 million, from $16.5 million for the six months ended June 30, 2013 to $99.9 million for the six months ended June 30, 2014 primarily as a result of the EHC Business. Net earned premium. Net earned premium increased by $44.0 million, from $16.5 million for the six months ended June 30, 2013 to $60.5 million for the six months ended June 30, 2014 primarily as a result of the EHC Business. Service and fee income. Service and fee income increased by $12.8 million, or 74.6%, from $17.3 million for the six months ended June 30, 2013 to $30.1 million for the six months ended June 30, 2014 as a result of the EHC Business and the A&H Expansion. Loss and loss adjustment expenses; net loss ratio. Loss and LAE increased by $27.8 million, from $12.7 million for the six months ended June 30, 2013 to $40.5 million for the six months ended June 30, 2014. Our net loss ratio decreased from 77.0% for the six months ended June 30, 2013 to 67.0% for the six months ended June 30, 2014. The loss ratio in the six months ended June 30, 2014 was positively affected by the EHC Business in 2014. Acquisition and other underwriting costs. Acquisition and other underwriting costs increased by $20.4 million from $11.2 million for the six months ended June 30, 2013 to $31.6 million for the six months ended June 30, 2014 primarily as a result of A&H Expansion expenses. General and administrative expense. General and administrative expense increased by $15.2 million from $9.8 million for the six months ended June 30, 2013 to $25.0 million for the six months ended June 30, 2014 primarily as a result of A&H Expansion expenses. Net operating expense; net operating expense ratio (non-GAAP). Net operating expense increased by $22.7 million from $3.8 million for the six months ended June 30, 2013 to $26.5 million for the six months ended June 30, 2014. The net operating expense ratio (non-GAAP) increased from 22.8% for the six months ended June 30, 2013 to 43.8% for the six months ended June 30, 2014 primarily as a result of the A&H Expansion expenses. Underwriting income. Underwriting loss increased from $0.0 million for the six months ended June 30, 2013 to a loss of $6.5 million for the six months ended June 30, 2014. The combined ratio for the six months ended June 30, 2014 increased to 110.8% compared to 99.8% for the same period in 2013. The combined ratio was higher due to the A&H Expansion, partially offset by the positive effects of the EHC Business in 2014. 59 -------------------------------------------------------------------------------- Investment Portfolio Our investment strategy emphasizes, first, the preservation of capital and, second, maximization of an appropriate risk-adjusted return. We seek to maximize investment returns using investment guidelines that stress prudent allocation among cash and cash equivalents, fixed-maturity securities and, to a lesser extent, equity securities. Cash and cash equivalents include cash on deposit, commercial paper, pooled short-term money market funds and certificates of deposit with an original maturity of 90 days or less. Our fixed-maturity securities include obligations of the U.S. Treasury or U.S. government agencies, obligations of U.S. and Canadian corporations, mortgages guaranteed by the Federal National Mortgage Association, the Government National Mortgage Association, the Federal Home Loan Mortgage Corporation, Federal Farm Credit entities, and asset-backed securities and commercial mortgage obligations. Our equity securities include preferred stock of U.S. and Canadian corporations. The annualized average yield on our investment portfolio was 3.42% and 3.31% for the six months ended June 30, 2014 and 2013, respectively, and the average duration of the portfolio was 5.31 and 4.94 years as of June 30, 2014 and June 30, 2013, respectively. The cost or amortized cost, fair value, and gross unrealized gains and losses on available-for-sale securities were as follows: Gross Cost or Gross Unrealized Unrealized June 30, 2014 Amortized Cost Gains



Losses Fair Value

(amounts in thousands) Equity securities: Common stock $ 15,542 $ 628 $ (907 )$ 15,263 Preferred stock 5,045 3 (175 ) 4,873 Fixed maturities: U.S. Treasury and Federal agencies 190,920 1,160 (169 ) 191,911 States and political subdivisions bonds 152,667 3,039 (908 ) 154,798 Residential mortgage-backed securities 386,005



8,474 (1,907 ) 392,572

Corporate bonds 699,501



39,742 (1,198 ) 738,045

Asset-backed other securities 999 - - 999 Foreign government 6,233 - (14 ) 6,219 Commercial mortgage-backed securities 21,544 834 - 22,378 Subtotal $ 1,478,456$ 53,880$ (5,278 )$ 1,527,058 Less: Securities pledged 62,637 555 (39 ) 63,153 Total $ 1,415,819$ 53,325$ (5,239 )$ 1,463,905 Gross Cost or Gross Unrealized Unrealized December 31, 2013 Amortized Cost Gains Losses Fair Value (amounts in thousands) Equity securities: Common stock $ 1,939 $ - $ - $ 1,939 Preferred stock 5,000 - (652 ) 4,348 Fixed maturities: U.S. Treasury and Federal agencies 30,655 920 - 31,575 States and political subdivisions bonds 101,105



1,681 (3,202 ) 99,584

Residential mortgage-backed securities 272,820



4,136 (7,527 ) 269,429

Corporate bonds 477,442



21,397 (7,044 ) 491,795

Commercial mortgage-backed securities 8,179 - (51 ) 8,128 Subtotal $ 897,140$ 28,134$ (18,476 )$ 906,798 Less: Securities pledged 133,013 3,884 (2,975 ) 133,922 Total $ 764,127$ 24,250$ (15,501 )$ 772,876 60

-------------------------------------------------------------------------------- The decrease in gross unrealized losses from $15.5 million at December 31, 2013 to $5.2 million at June 30, 2014 resulted from fluctuations in market interest rates. The tables below summarize the credit quality of our fixed-maturity and preferred securities as of June 30, 2014 and December 31, 2013, as rated by Standard and Poor's. Percentage of Fixed-Maturity Cost or Amortized and Preferred June 30, 2014 Cost Fair Value Securities (amounts in thousands) U.S. Treasury $ 190,920$ 191,911 12.7 % AAA 412,446 419,914 27.8 % AA, AA+, AA- 218,790 223,807 14.8 % A, A+, A- 284,584 301,488 19.9 % BBB, BBB+, BBB- 304,730 319,659 21.1 % BB+ and lower 51,444 55,016 3.7 % Total $ 1,462,914$ 1,511,795 100.0 % Percentage of Fixed-Maturity Cost or Amortized and Preferred December 31, 2013 Cost Fair Value Securities (amounts in thousands) U.S. Treasury $ 30,656 $ 31,575 3.5 % AAA 69,893 69,616 7.7 % AA, AA+, AA- 377,956 374,479 41.4 % A, A+, A- 170,879 181,621 20.1 % BBB, BBB+, BBB- 207,764 210,336 23.2 % BB+ and lower 38,053 37,232 4.1 % Total $ 895,201$ 904,859 100.0 %



The tables below summarize the investment quality of our corporate bond holdings and industry concentrations as of June 30, 2014 and December 31, 2013.

% of AA+, BBB+, Corporate AA, BBB, BB+ or Fair Bonds June 30, 2014 AAA AA- A+,A,A- BBB- Lower Value Portfolio (amounts in thousands) Corporate Bonds: Financial Institutions 1.7 % 8.7 % 28.2 % 9.3 % 1.8 % $ 366,192 49.7 % Industrials - % 2.7 % 7.1 % 32.2 % 3.6 % 336,833 45.6 % Utilities/Other - % - % 1.6 % 1.8 % 1.3 % 35,020 4.7 % 1.7 % 11.4 % 36.9 % 43.3 % 6.7 % $ 738,045 100.0 % 61

--------------------------------------------------------------------------------

% of AA+, BBB+, Corporate AA, BBB, BB+ or Fair Bonds December 31, 2013 AAA AA- A+,A,A- BBB- Lower Value Portfolio (amounts in thousands) Corporate Bonds: Financial Institutions 2.5 % 12.1 % 28.7 % 13.9 % 0.5 % $ 283,766 57.7 % Industrials - % 1.8 % 4.7 % 26.7 % 4.3 % 184,649 37.5 % Utilities/Other - % - % 0.7 % 2.2 % 1.9 % 23,380 4.8 % 2.5 % 13.9 % 34.1 % 42.8 % 6.7 % $ 491,795 100.0 % The cost or amortized cost and fair value of available-for-sale debt securities held as of June 30, 2014, by contractual maturity, are shown in the table below. Actual maturities may differ from contractual maturities because some borrowers may have the right to call or prepay obligations with or without call or prepayment penalties. June 30, 2014 Cost or Amortized Cost Fair Value (amounts in thousands) Due in one year or less $ 11,840 $ 11,950 Due after one year through five years 298,690



306,268

Due after five years through ten years 644,233 676,029 Due after ten years 95,557 97,725 Mortgage-backed securities 407,549 414,950 Total $ 1,457,869 $ 1,506,922 Gross Unrealized Losses. The tables below summarize the gross unrealized losses of fixed-maturity and equity securities by the length of time the security had continuously been in an unrealized loss position as of June 30, 2014 and December 31, 2013: Less Than 12 Months 12 Months or More Total Fair No. of Fair No. of Fair Market Unrealized Positions Market Unrealized Positions Market Unrealized June 30, 2014 Value Losses Held Value Losses Held Value Losses (amounts in thousands) Common stock $ 1,033$ (907 ) 1 $ - $ - - $ 1,033$ (907 ) Preferred stock - - - 4,828 (175 ) 1 4,828 (175 ) U.S. Government 166,971 (169 ) 2 - - - 166,971 (169 ) States and political subdivisions 18,807 (215 ) 7 11,470 (693 ) 11 30,277 (908 ) Residential Mortgage-backed 126,116 (1,877 ) 11 2,063 (30 ) 3 128,179 (1,907 ) Commercial Mortgage-backed - - - - - - - - Foreign government 6,221 (14 ) 1 - - - 6,221 (14 ) Corporate bonds 25,773 (125 ) 12 36,593 (1,073 ) 17 62,366 (1,198 ) Total $ 344,921$ (3,307 ) 34 $ 54,954$ (1,971 ) 32 $ 399,875$ (5,278 ) 62

-------------------------------------------------------------------------------- Less Than 12 Months 12 Months or More Total Fair No. of Fair No. of Fair Market Unrealized Positions Market



Unrealized Positions Market Unrealized December 31, 2013 Value Losses Held Value

Losses Held Value Losses (amounts in thousands) Preferred stock $ 4,348$ (652 ) 1 $ - $ - - $ 4,348$ (652 ) States and political subdivisions 32,770 (2,622 ) 18 2,600 (580 ) 2 35,370 (3,202 ) Residential Mortgage-backed 176,491 (7,527 ) 6 - - - 176,491 (7,527 ) Commercial Mortgage-backed 8,128 (51 ) 2 - - - 8,128 (51 ) Corporate bonds 128,362 (4,051 ) 39 41,673 (2,993 ) 9 170,035 (7,044 ) Total $ 350,099$ (14,903 ) 66 $ 44,273$ (3,573 ) 11 $ 394,372$ (18,476 ) There were 66 and 77 securities at June 30, 2014 and December 31, 2013, respectively, that account for the gross unrealized loss, none of which we deemed to be OTTI. Significant factors influencing our determination that none of the securities were OTTI included the magnitude of unrealized losses in relation to cost, the nature of the investment and management's intent not to sell these securities and our determination that it was more likely than not that we would not be required to sell these investments before anticipated recovery of fair value to our cost basis. Restricted Cash and Investments. In order to conduct business in certain states, we are required to maintain letters of credit or assets on deposit to support state-mandated insurance regulatory requirements and certain third party agreements. We also utilize trust accounts to collateralize business with our reinsurance counterparties. Assets held on deposit or in trust accounts are primarily in the form of cash or certain high-grade securities. The fair values of our restricted assets as of June 30, 2014 and December 31, 2013 are as follows: June 30, 2014 December 31, 2013 (amounts in thousands) Restricted cash $ 13,034 $ 1,155 Restricted investments - fixed maturities at fair value 44,079 42,092 Total restricted cash and investments $ 57,113 $ 43,247 Other. We enter into reverse repurchase and repurchase agreements, which are accounted for as either collateralized lending or borrowing transactions and are recorded at contract amounts which approximate fair value. For the collateralized borrowing transactions (i.e., repurchase agreements), we receive cash or securities that we invest or hold in short-term or fixed-income securities. As of June 30, 2014, we had collateralized borrowing transaction principal outstanding of $60.1 million at interest rates between 0.14% and 0.45%. As of December 31, 2013, we had collateralized borrowing transaction principal outstanding of $109.6 million at interest rates between 0.37% and 0.44%. Interest expense associated with the repurchase borrowing agreements for the three and six months ended June 30, 2014 was $0.1 million and $0.1 million, respectively. Interest expense associated with the repurchase borrowing agreements for the three and six months ended June 30, 2013 was $0.1 million and $0.2 million, respectively. We had approximately $63.2 million and $133.9 million of collateral pledged in support for these agreements as of June 30, 2014 and December 31, 2013, respectively. Investment in Entities Holding Life Settlement Contracts A life settlement contract is a contract between the owner of a life insurance policy and a third party who obtains the ownership and beneficiary rights of the underlying life insurance policy. During 2010, we formed Tiger Capital LLC ("Tiger") with a subsidiary of AmTrust for the purpose of acquiring certain life settlement contracts. In 2011, we formed AMT Capital Alpha, LLC ("AMT Alpha") with a subsidiary of AmTrust for the purpose of acquiring additional life settlement contracts. In the first quarter of 2013, we acquired a 50% interest in AMT Capital Holdings, S.A. ("AMTCH"), the other 50% of which is owned by AmTrust. Additionally, in December 2013, we formed AMT Capital Holdings II, S.A. ("AMTCH II") with AmTrust for the purpose of acquiring additional life settlement contracts. We have a 50% ownership interest in each of Tiger, AMT Alpha, AMTCH and AMTCH II (collectively, the "LSC Entities"). The LSC Entities may also acquire premium finance loans made in connection with the borrowers' purchase of life insurance policies that are secured by the policies, which are in default at the time of purchase. The LSC Entities acquire 63 -------------------------------------------------------------------------------- the underlying policies through the borrowers' voluntary surrender of the policy in satisfaction of the loan or foreclosure. A third party serves as the administrator for two of the life settlement contract portfolios, for which it receives an administrative fee. The third-party administrator is eligible to receive a percentage of profits after certain time and performance thresholds have been met. The LSC Entities account for investments in life settlements in accordance with ASC 325-30, "Investments in Insurance Contracts", which states that an investor shall elect to account for its investments in life settlement contracts by using either the investment method or the fair value method. The election is made on an instrument by instrument basis and is irrevocable. The LSC Entities have elected to account for these investments using the fair value method. As no comparable market pricing is available, the LSC Entities determine fair value based upon their estimate of the discounted cash flow related to policies (net of the reserves for improvements in mortality, the possibility that the high net worth individuals represented in the portfolio may have access to better health care, the volatility inherent in determining the life expectancy of insureds with significant reported health impairments, the possibility that the issuer of the policy or a third party will contest the payment of the death benefit payable to the LSC Entities, and the future expenses related to the administration of the portfolio), which incorporates current life expectancy assumptions, premium payments, the credit exposure to the insurance company that issued the life settlement contracts and the rate of return that a buyer would require on the contracts. As of June 30, 2014, we have a 50% ownership interest in the LSC Entities that hold certain life settlement contracts, and the fair value of these contracts owned by the LSC Entities is $276.2 million, with our proportionate interest being $138.1 million. Total capital contributions of approximately $21.8 million and $10.8 million were made to the LSC Entities during the six months ended June 30, 2014 and 2013, respectively, for which we contributed approximately $10.9 million and $6.2 million in those same periods. The LSC Entities used the contributed capital to pay premiums and purchase policies. As of June 30, 2014, the face value amounts of the 288 life insurance policies disclosed in the table below was approximately $1.8 billion. During the six months ended June 30, 2014, upon the voluntary surrender of the underlying life insurance policies in satisfaction of the remaining defaulted premium finance loans, the LSC Entities became the owner and beneficiary under the underlying life insurance policies with respect to such loans. As of June 30, 2014, the LSC Entities owned no premium finance loans. The following table describes details of our investment in LSC Entities as of June 30, 2014. This table shows the gross amounts for the portfolio of life insurance policies owned by the LSC Entities, in which we and AmTrust each own a 50% interest. (amounts in thousands, except number of life Number of settlement contracts) Life Settlement Expected Maturity Term in Years Contracts Fair Value(1) Face Value June 30, 2014 0 - 1 - $ - $ - 1 - 2 3 17,688 25,000 2 - 3 7 41,209 68,000 3 - 4 2 5,370 15,000 4 - 5 9 16,942 43,000 Thereafter 267 194,990 1,695,209 Total 288 $ 276,199$ 1,846,209



(1) The LSC Entities determined the fair value as of June 30, 2014 based on 222

policies out of 288 policies, as the LSC Entities assigned no value to 66

of the policies as of June 30, 2014. The LSC Entities estimate the fair

value of a life insurance policy using a cash flow model with an

appropriate discount rate. In some cases, the cash flow model calculates

the value of an individual policy to be negative, and therefore the fair

value of the policy is zero as no liability exists when a negative value is

calculated. The LSC Entities are not contractually bound to pay the premium

on its life settlement contracts and, therefore, would not pay a willing

buyer to assume title of these contracts. Additionally, certain of the LSC

Entities' acquired policies were structured to have low premium payments at

inception of the policy term, which later escalate greatly towards the tail

end of the policy term. At the current time, the LSC Entities expense all

premiums paid, even on policies with zero fair value. Once the premium

payments escalate, the LSC Entities may allow the policies to lapse. In the

event that death benefits are realized in the time frame between initial

acquisition and premium escalation, it is a benefit to cash flow of the LSC

Entities. 64

-------------------------------------------------------------------------------- For these contracts where the LSC Entities determined the fair value to be negative and therefore assigned a fair value of zero, the table below details the amount of premiums paid and the death benefits received during the twelve months preceding June 30, 2014. June



30, 2014 Number of policies with a negative value from discounted cash flow model as of period end

66

Premiums paid for the preceding twelve month period for period ended $ 7,342 Death benefit received $ 3,012



Premiums to be paid by the LSC Entities, in which we have 50% ownership interests, for each of the five succeeding fiscal years to keep the life insurance policies in force as of June 30, 2014, are as follows:

Premiums (amounts in thousands) Due on Life Settlement Contracts 2014 $ 41,008 2015 43,688 2016 61,031 2017 39,847 2018 38,984 Thereafter 552,485 $ 777,043 For additional information about the fair value of the life settlement contracts, see Note 5, "Equity Investments in Unconsolidated Subsidiaries". For additional information about the risks inherent in determining the fair value of the portfolio of life insurance policies, see Item 1A, "Risk Factors-Risks Relating to Our Business Generally-A portion of our financial assets consists of life settlement contracts that are subject to certain risks" of our Annual Report on Form 10-K for the year ended December 31, 2013. Liquidity and Capital Resources We are organized as a holding company with fourteen domestic insurance company subsidiaries, various foreign insurance and reinsurance subsidiaries, as well as various other non-insurance subsidiaries. Our principal sources of operating funds are premiums, service and fee income, investment income and proceeds from sales and maturities of investments. Our primary uses of operating funds include payments of claims and operating expenses. Currently, we pay claims using cash flow from operations and invest our excess cash primarily in fixed-maturity and, to a lesser extent, equity securities. Except as set forth below, we expect that projected cash flows from operations, as well as the net proceeds from our debt and equity issuances, will provide us with sufficient liquidity to fund our anticipated growth by providing capital to increase the surplus of our insurance subsidiaries, as well as to pay claims and operating expenses, and to pay interest and principal on debt and debt facilities and other holding company expenses for the foreseeable future. However, if our growth attributable to potential acquisitions, internally generated growth, or a combination of these factors, exceeds our expectations, we may have to raise additional capital. If we cannot obtain adequate capital on favorable terms or at all, we may be unable to support future growth or operating requirements and, as a result, our business, financial condition and results of operations could be adversely affected. To support our current and future policy writings, especially in light of the termination of the Personal Lines Quota Share Agreement, the Cut-Through Reinsurance Agreement and the Tower Transactions, we have raised substantial capital using a combination of debt and equity, and we may raise additional capital over the next twelve months. We may generate liquidity through the issuance of debt or equity securities or financing through borrowings under credit facilities, or a combination thereof. During the second quarter of 2014, we closed the sale of $250.0 million aggregate principal amount of our 6.75% notes due 2024 (the "6.75% Notes") to certain purchasers in a private placement. A portion of the net proceeds from the issuance was used to pay off the outstanding balance on our previous credit agreement of approximately $59.2 million and our loans payable to ACP Re, an affiliated company, of approximately $18.7 million. We expect to use the remaining net proceeds from the issuance (i) to fund the agreement by the Company to provide ACP Re with financing in connection with its acquisition of Tower Group International, Ltd. and (ii) for general corporate purposes. In addition, during the second quarter of 65 -------------------------------------------------------------------------------- 2014, we entered into a $135.0 million credit agreement under which we had borrowed $0.0 million as of June 30, 2014. The proceeds of borrowings under the credit agreement may be used for working capital, acquisitions and general corporate purposes. Also during the second quarter of 2014, we issued 2,200,000 shares of 7.50% Non-Cumulative Preferred Stock. The net proceeds we received from the issuance was approximately $53.2 million, after deducting the issuance expenses payable by us. See "6.75% Notes due 2024", Preferred Stock" and "Revolving Credit Agreements" below. Our insurance subsidiaries are subject to statutory and regulatory restrictions imposed on insurance companies by their states of domicile which limit the amount of cash dividends or distributions that they may pay to us unless special permission is received from the insurance regulator of the relevant domiciliary state. The aggregate limit imposed by the various domiciliary states of our insurance subsidiaries was approximately $97.1 million and $61.1 million as of June 30, 2014 and December 31, 2013, respectively, taking into account dividends paid in the prior twelve month periods. During the six months ended June 30, 2014 and 2013, there were $1.0 million and $0.0 million, respectively, of dividends and return of capital paid by the insurance subsidiaries to National General Management Corp. ("Management Corp.") or the Company. We forecast claim payments based on our historical experience. We seek to manage the funding of claim payments by actively managing available cash and forecasting cash flows on both a short-term and long-term basis. Cash payments for claims were $343.5 million and $203.2 million in the six months ended June 30, 2014 and 2013, respectively. Historically, we have funded claim payments from cash flow from operations (principally premiums), net of amounts ceded to our third party reinsurers. We presently expect to maintain sufficient cash flow from operations to meet our anticipated claim obligations and operating and capital expenditure needs. Our cash and investment portfolio has increased from $1,116.7 million at December 31, 2013 to $1,785.8 million at June 30, 2014. We do not anticipate selling securities in our investment portfolio to pay claims or to fund operating expenses. Should circumstances arise that would require us to do so, we may incur losses on such sales, which would adversely affect our results of operations and financial condition and could reduce investment income in future periods. Pursuant to an amended and restated management services agreement dated as of January 1, 2012 between Management Corp., on one hand, and certain of our other direct and indirect subsidiaries, on the other hand, such subsidiaries have delegated to Management Corp. underwriting duties, claims services, actuarial services, policyholder services, accounting, information technology and certain other administrative functions. The subsidiaries that are party to this agreement pay to Management Corp. a quarterly fee calculated as a percentage of the premium written by each such subsidiary, plus reimbursement for certain expenses. During the six months ended June 30, 2014, Management Corp. was paid approximately $13.8 million in management fees. Pursuant to a tax allocation agreement by and among us and certain of our direct and indirect subsidiaries, we compute and pay federal income taxes on a consolidated basis. Each subsidiary party to this agreement computes and pays to us its respective share of the federal income tax liability primarily based on separate return calculations. The LSC Entities in which we own a 50% interest also purchase life settlement contracts that require the LSC Entities to make premium payments on individual life insurance policies in order to keep the policies in force. We seek to manage the funding of premium payments required. We presently expect to maintain sufficient cash flow to make future capital contributions to the LSC Entities to permit them to make future premium payments. The following table is a summary of our statement of cash flows: (amounts in thousands) Six Months Ended June



30,

2014



2013

Cash and Cash equivalents provided by (used in): Operating activities $ 234,226$ 39,917 Investing activities (544,807 ) (93,056 ) Financing activities 348,707 101,572



Net Increase in Cash and Cash Equivalents $ 38,126$ 48,433

Comparison of the Six Months Ended June 30, 2014 and 2013

Net cash provided by operating activities was approximately $234.2 million for the six months ended June 30, 2014, compared with $39.9 million used by operating activities for the same period in 2013. For the six months ended June 30, 2014, net cash provided by operating activities increased $194.3 million from the comparable period in 2013, primarily as a result of the Tower Cut-Through Reinsurance Agreement and the Quota Share Runoff. 66 -------------------------------------------------------------------------------- Net cash used in investing activities was $544.8 million for the six months ended June 30, 2014, compared with net cash used in investing activities of $93.1 million for the six months ended June 30, 2013. For the six months ended June 30, 2014, net cash used in investing activities increased primarily due to an increase of $259.7 million in the purchases of fixed maturity investments, an decrease of $85.2 million in the purchases of short term investments and a decrease of $147.8 million in the proceeds from the sale of fixed maturity investments, partially offset by a $27.8 million increase in the proceeds from the sale of short-term investments and a decrease of $7.0 million in cash used for acquisitions. Net cash provided by financing activities was $348.7 million for the six months ended June 30, 2014, compared with net cash provided by financing activities of $101.6 million for the six months ended June 30, 2013. For the six months ended June 30, 2014, cash provided by financing activities increased versus the comparable period in 2013 primarily due to: (i) the May 2014 sale of our $250.0 million aggregate principal amount of 6.75% Notes; and (ii) the June 2014 issuance of 2,200,000 shares of 7.50% Non-Cumulative Preferred Stock, partially offset by a decrease in the proceeds from the issuance of common stock.



Other Material Changes in Financial Position

(amounts in thousands) June 30, 2014 December 31, 2013 Selected Assets: Premiums receivable, net $ 658,961 $ 449,252 Goodwill and Intangible assets $ 181,208 $



156,915

Selected Liabilities: Loss and loss expense reserves $ 1,386,111 $



1,259,241

Unearned premium $ 751,322 $



476,232

Ceded reinsurance premium payable $ 43,601 $



93,534

Accounts Payable and accrued expenses $ 239,391 $



91,143

Deferred income taxes and income taxes payable $ 46,566 $

26,463

During the six months ended June 30, 2014, premiums receivable, net increased $209.7 million from December 31, 2013 primarily due to the Tower Cut-Through Reinsurance Agreement, the EHC Reinsurance Agreement, Personal Express and Imperial acquisitions and the Quota Share Runoff. Goodwill and intangible assets increased $24.3 million compared to December 31, 2013 due to the acquisitions of Anticimex Reinsurance S.A., Personal Express and Imperial and its subsidiaries. Loss and loss expense reserves increased $126.9 million compared to December 31, 2013 primarily due to the Tower Cut-Through Reinsurance Agreement, the EHC Reinsurance Agreement, Imperial and the Quota Share Runoff. Unearned premium increased $275.1 million compared to December 31, 2013 primarily due to the Tower Cut-Through Reinsurance Agreement, EHC Reinsurance, Personal Express, Imperial and Quota Share Runoff. Accounts payable and accrued expenses increased $148.2 million compared to December 31, 2013 primarily due to the Tower Cut-Through Reinsurance Agreement and the EHC Reinsurance Agreement. Deferred income taxes and income taxes payable increased $20.1 million primarily due to the acquisition of Anticimex Reinsurance SA and the corresponding deferred tax liability associated with the acquired equalization reserves as well as the increase in taxable income year over year. Ceded reinsurance premium payable decreased $49.9 million primarily due to the Quota Share Runoff. All other balances remained within the expected range. Reinsurance Our insurance subsidiaries utilize reinsurance agreements to transfer portions of the underlying risk of the business we write to various affiliated and third-party reinsurance companies. Reinsurance does not discharge or diminish our obligation to pay claims covered by the insurance policies we issue; however, it does permit us to recover certain incurred losses from our reinsurers and our reinsurance recoveries reduce the maximum loss that we may incur as a result of a covered loss event. We believe it is important to ensure that our reinsurance partners are financially strong and they generally carry at least an A.M. Best rating of ''A-'' (Excellent) at the time we enter into our reinsurance agreements. We also enter reinsurance relationships with third-party captives formed by agents as a mechanism for sharing risk and profit. The total amount, cost and limits relating to the reinsurance coverage we purchase may vary from year to year based upon a variety of factors, including the availability of quality reinsurance at an acceptable price and the level of risk that we choose to retain for our own account. As of July 1, 2014, our new reinsurance program went into effect with respect to excess of loss catastrophic and casualty reinsurance for protection against catastrophic and other large losses. The property catastrophe program provides a total of $550 67

-------------------------------------------------------------------------------- million in coverage in excess of a $50 million retention, with one reinstatement and the casualty program provides $45 million in coverage in excess of a $5 million retention. For a more detailed description of our reinsurance arrangements, see ''Reinsurance'' in ''Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations'' in our Annual Report on Form 10-K for the year ended December 31, 2013. 6.75% Notes due 2024



On May 23, 2014, we sold $250.0 million aggregate principal amount of our 6.75% Notes due 2024 to certain purchasers in a private placement.

The 6.75% Notes bear interest at a rate equal to 6.75% per year, payable semiannually in arrears on May 15th and November 15th of each year, beginning on November 15, 2014. The 6.75% Notes are our general unsecured obligations and rank equally in right of payment with our other existing and future senior unsecured indebtedness and senior in right of payment to any of our indebtedness that is contractually subordinated to the 6.75% Notes. The 6.75% Notes are also effectively subordinated to any of our existing and future secured indebtedness to the extent of the value of the collateral securing such indebtedness and are structurally subordinated to the existing and future indebtedness of our subsidiaries (including trade payables). The 6.75% Notes mature on May 15, 2024, unless earlier redeemed or purchased by us. The Indenture contains customary covenants, such as reporting of annual and quarterly financial results, and restrictions on certain mergers and consolidations. The Indenture also includes covenants relating to the incurrence of debt if our consolidated leverage ratio would exceed 0.35 to 1.00, a limitation on liens, a limitation on the disposition of stock of certain of our subsidiaries and a limitation on transactions with certain of our affiliates. The net proceeds we received from the issuance was approximately $245.0 million, after deducting the issuance expenses. We used a portion of the net proceeds from the issuance to repay all amounts outstanding under (A) the credit agreement, dated as of February 20, 2013, by and among us, JPMorgan Chase Bank, N.A., as Administrative Agent, Key Bank National Association, as Syndication Agent, and First Niagara Bank, N.A., as Documentation Agent, and (B) our promissory note to ACP Re, Ltd ("ACP Re").



Interest expense on the 6.75% Notes for the three and six months ended June 30, 2014 was $1.7 million and $1.7 million, respectively.

Preferred Stock

On June 25, 2014, we issued 2,200,000 shares of 7.50% Non-Cumulative Preferred Stock ("Series A Preferred Stock"). Dividends on the Series A Preferred Stock when, as and if declared by our Board of Directors or a duly authorized committee of the Board, will be payable on the liquidation preference amount of $25.00 per share, on a non-cumulative basis, quarterly in arrears on the 15th day of January, April, July and October of each year (each, a "dividend payment date"), commencing on October 15, 2014, at an annual rate of 7.50%. Dividends on the Series A Preferred Stock are not cumulative. Accordingly, in the event dividends are not declared on the Series A Preferred Stock for payment on any dividend payment date, then those dividends will not accumulate and will not be payable. If we have not declared a dividend before the dividend payment date for any dividend period, we will have no obligation to pay dividends for that dividend period, whether or not dividends on the Series A Preferred Stock are declared for any future dividend payment. The net proceeds we received from the issuance was approximately $53.2 million, after deducting the underwriting discount and issuance expenses.



Revolving Credit Agreements

During the first quarter of 2013, we entered into a credit agreement to establish a secured $90.0 million line of credit with JPMorgan Chase, N.A. Interest payments were required to be paid monthly on any unpaid principal and bore interest at a rate of LIBOR plus 250 basis points. The credit agreement had a maturity date of February 20, 2016. The outstanding balance on the line of credit of $59.2 million was repaid and the credit facility was terminated in the second quarter of 2014 in connection with the issuance of the 6.75% Notes. On May 30, 2014, we entered into a $135.0 million credit agreement (the "Credit Agreement"), among JPMorgan Chase Bank, N.A., as Administrative Agent, KeyBank National Association as Syndication Agent, and Associated Bank, National 68 -------------------------------------------------------------------------------- Association and First Niagara Bank, N.A., as Co-Documentation Agents. The credit facility is a revolving credit facility with a letter of credit sublimit of $10.0 million and an expansion feature not to exceed $50.0 million. The Credit Agreement contains certain restrictive covenants customary for facilities of this type (subject to negotiated exceptions and baskets), including restrictions on indebtedness, liens, acquisitions and investments, restricted payments and dispositions. There are also financial covenants that require us to maintain a minimum consolidated net worth, a maximum consolidated leverage ratio, a minimum fixed charge coverage ratio, a minimum risk-based capital and a minimum statutory surplus. The Credit Agreement also provides for customary events of default, with grace periods where customary, including failure to pay principal when due, failure to pay interest or fees within three business days after becoming due, failure to comply with covenants, breaches of representations and warranties, default under certain other indebtedness, certain insolvency or receivership events affecting us and our subsidiaries, the occurrence of certain material judgments, or a change in control. Upon the occurrence and during the continuation of an event of default, the administrative agent, upon the request of the requisite percentage of the lenders, may terminate the obligations of the lenders to make loans and to issue letters of credit under the Credit Agreement, declare our obligations under the Credit Agreement to become immediately due and payable and/or exercise any and all remedies and other rights under the Credit Agreement. The Credit Agreement has a maturity date of May 30, 2018. Borrowings under the Credit Agreement bear interest at either the Alternate Base Rate ("ABR") or LIBOR. ABR borrowings (which are borrowings bearing interest at a rate determined by reference to the ABR) under the Credit Agreement will bear interest at (x) the greatest of (a) the prime rate in effect on such day, (b) the federal funds effective rate on such day plus 0.5 percent or (c) the adjusted LIBOR for a one-month interest period on such day plus 1 percent, plus (y) a margin that is adjusted on the basis of our consolidated leverage ratio. Eurodollar borrowings under the Credit Agreement will bear interest at the adjusted LIBOR for the interest period in effect plus a margin that is adjusted on the basis of our consolidated leverage ratio. Fees payable by us under the Credit Agreement include a letter of credit participation fee (the margin applicable to Eurodollar borrowings), a letter of credit fronting fee with respect to each letter of credit (0.125%) and a commitment fee on the available commitments of the lenders (a range of 0.20% to 0.30% based on our consolidated leverage ratio, and which rate was 0.25% as of June 30, 2014). As of June 30, 2014, there was no outstanding balance on the line of credit. Interest expense for our existing and repaid lines of credit for the three and six months ended June 30, 2014 was $0.7 million and $1.1 million, respectively. Interest expense for our existing and repaid lines of credit for the three and six months ended June 30, 2013 was $0.3 million and $0.4 million, respectively. We were in compliance with all covenants under the Credit Agreement as of June 30, 2014.



Imperial-related Debt

In connection with the Imperial transaction, we assumed $3.5 million in principal amount of Senior Notes due 2034 ("Imperial-related Notes") previously issued by Imperial Management Corporation. The notes bear interest at an annual rate equal to LIBOR plus 3.95%, payable quarterly. The notes are redeemable by us at a redemption price equal to 100% of their principal amount plus accrued interest. In addition, Imperial Fire and Casualty Insurance Company is the issuer of $5.0 million principal amount of Surplus Notes due 2034 ("Surplus Notes"). The notes bear interest at an annual rate equal to LIBOR plus 4.05%, payable quarterly. The notes are redeemable by us at a redemption price equal to 100% of their principal amount. (See Note 6, "Acquisitions and Disposals" to our condensed consolidated financial statements). Securities Sold (Purchased) Under Agreements to Repurchase (Sell), at Contract Value We enter into reverse repurchase and repurchase agreements, which are accounted for as either collateralized lending or borrowing transactions and are recorded at contract amounts which approximate fair value. For the collateralized borrowing transactions (i.e., repurchase agreements), we receive cash or securities that we invest or hold in short-term or fixed-income securities. As of June 30, 2014, we had collateralized borrowing transaction principal outstanding of $60.1 million at interest rates of 0.14% and 0.45%. As of December 31, 2013, we had collateralized borrowing transaction principal outstanding of $109.6 million at interest rates between 0.37% and 0.44%. Interest expense associated with the repurchase borrowing agreements for the three and six months ended June 30, 2014 was $0.1 million and $0.1 million, respectively. Interest expense associated with the repurchase borrowing agreements for the three and six months ended June 30, 2013 was $0.1 million and $0.2 million, respectively. We had approximately $63.2 million and $133.9 million of collateral pledged in support for these agreements as of June 30, 2014 and December 31, 2013, respectively. 69



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Deferred Purchase Obligations In the first quarter of 2013, we paid the third and final deferred payment related to the March 1, 2010 acquisition of our P&C insurance business. At the original closing, we paid an amount equal to the estimated net tangible book value less (i) the purchase price discount amount and (ii) $90.0 million. The balance of the purchase price was payable in three equal annual installments of $30.0 million plus interest at a rate of 2.28% to be made on the first, second and third anniversaries of the closing date. On April 15, 2013, we acquired Euro Accident Health & Care Insurance Aktiebolag ("EHC") for an initial purchase price of approximately $23.6 million. The transaction also includes a deferred purchase price arrangement whereby, once EBITDA (including EBITDA of a Company affiliate which underwrites products sold by EHC) when combined with EHC's equity at closing exceeds the initial purchase price, the seller will be entitled to receive an amount corresponding to 50% of the EHC's EBITDA (including EBITDA of a Company affiliate which underwrites products sold by EHC) for each of the fiscal years 2015, 2016, 2017 and 2018. We estimate the total purchase price including the deferred arrangement will be approximately $42.8 million. EHC is a limited liability company incorporated and registered under the laws of Sweden and primarily administers accident and health business in that region.


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Source: Edgar Glimpses


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