UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q


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


For the quarterly period ended	June 30, 2017


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


For the transition period from		to
Commission File Number	001-36712

STATE NATIONAL COMPANIES, INC.

(Exact name of registrant as specified in its charter)


Delaware		26-0017421
(State or other jurisdiction of incorporation or organization)		(I.R.S. Employer Identification No.)

1900 L. Don Dodson Drive, Bedford, Texas		76021
(Address of principal executive offices)		(Zip Code)

(817) 265-2000

(Registrant’s telephone number, including area code)

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

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

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


Large accelerated filer ☐	Accelerated filer ☒
Non-accelerated filer ☐ (Do not check if a smaller reporting company)	Smaller reporting company ☐
	Emerging growth company ☒

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

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

Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date.


Class		Outstanding at August 08, 2017
(Common stock, $.001 par value)		42,173,561 Shares

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STATE NATIONAL COMPANIES, INC.

INDEX


		Page No.
Part I - Financial Information

Item 1	Unaudited Condensed Consolidated Financial Statements
	Condensed Consolidated Balance Sheets – June 30, 2017 (unaudited) and December 31, 2016	1

	Unaudited Condensed Consolidated Statements of Income – six months ended June 30, 2017 and 2016	3

	Unaudited Condensed Consolidated Statements of Comprehensive Income – six months ended June 30, 2017 and 2016	4

	Unaudited Condensed Consolidated Statements of Shareholders’ Equity – six months ended June 30, 2017 and twelve months ended December 31, 2016	5

	Unaudited Condensed Consolidated Statements of Cash Flows – six months ended June 30, 2017 and 2016	6

	Notes to Unaudited Condensed Consolidated Financial Statements	7

Item 2	Management’s Discussion and Analysis of Financial Condition and Results of Operations	22

Item 3	Quantitative and Qualitative Disclosures About Market Risk	36

Item 4	Controls and Procedures	38

Part II - Other Information

Item 1	Legal Proceedings	39

Item 1A	Risk Factors	39

Item 2	Unregistered Sales of Equity Securities and Use of Proceeds	40

Item 3	Defaults Upon Senior Securities	40

Item 4	Mine Safety Disclosures	40

Item 5	Other Information	40

Item 6	Exhibits	40

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PART I - FINANCIAL INFORMATION

Item 1: Unaudited Condensed Consolidated Financial Statements

STATE NATIONAL COMPANIES, INC.

CONDENSED CONSOLIDATED BALANCE SHEETS

($ in thousands)


	June 30,		December 31,
	2017		2016
		(Unaudited)
Assets
Investments:
Fixed-maturity securities – available-for-sale, at fair value (amortized cost – $377,101, $329,994, respectively)	$	382,518	$	332,107
Equity securities – available-for-sale, at fair value (cost – $2,036, $3,271, respectively)		2,134		3,224
Total investments		384,652		335,331

Cash and cash equivalents		47,979		91,698
Restricted cash and investments		16,746		2,958
Accounts receivable from agents, net		120,214		35,964
Reinsurance recoverable on paid losses		1,972		1,430
Deferred acquisition costs		1,106		1,194
Reinsurance recoverables		2,607,559		2,342,864
Property and equipment, net (includes land held for sale – $1,034, $1,034, respectively)		16,876		16,163
Interest receivable		2,333		2,112
Income taxes receivable		174		329
Deferred income taxes, net		28,202		28,858
Goodwill and intangible assets, net		14,539		12,588
Other assets		6,656		5,248
Total assets	$	3,249,008	$	2,876,737

The accompanying notes are an integral part of these unaudited condensed consolidated financial statements.

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STATE NATIONAL COMPANIES, INC.

CONDENSED CONSOLIDATED BALANCE SHEETS (continued)

($ in thousands, except for share and per share information)


	June 30,		December 31,
	2017		2016
		(Unaudited)
Liabilities
Unpaid losses and loss adjustment expenses	$	1,858,105	$	1,703,706
Unearned premiums		787,051		680,691
Allowance for policy cancellations		54,541		66,418
Deferred ceding fees		39,385		32,226
Accounts payable to agents		2,121		2,639
Accounts payable to insurance companies		94,259		14,871
Debt, net		43,804		43,783
Other liabilities		49,256		36,023
Total liabilities		2,928,522		2,580,357

Shareholders’ equity
Common stock, $.001 par value (150,000,000 shares authorized; 42,173,561 and 41,924,440 shares issued at June 30, 2017 and December 31, 2016, respectively)		42		42
Preferred stock, $.001 par value (10,000,000 shares authorized; no shares issued and outstanding at June 30, 2017 and December 31, 2016)		—		—
Additional paid-in capital		231,654		229,297
Retained earnings		85,910		66,230
Accumulated other comprehensive income		2,880		811
Total shareholders’ equity		320,486		296,380
Total liabilities and shareholders’ equity	$	3,249,008	$	2,876,737

The accompanying notes are an integral part of these unaudited condensed consolidated financial statements.

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STATE NATIONAL COMPANIES, INC.

UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF INCOME

($ in thousands, except for per share information)


	Three Months Ended				Six Months Ended
	June 30,		June 30,		June 30,		June 30,
	2017		2016		2017		2016

Revenues:
Premiums earned	$	33,934	$	28,916	$	70,442	$	60,593
Commission income		322		305		598		626
Ceding fees		20,998		16,917		38,643		33,161
Net investment income		2,288		2,100		4,439		4,140
Realized net investment gains (losses)		523		282		2,399		(356)
Other income		530		459		1,061		915
		58,595		48,979		117,582		99,079

Expenses:
Losses and loss adjustment expenses		16,135		13,743		34,966		28,832
Commissions		1,703		1,130		3,277		2,827
Taxes, licenses, and fees		914		804		1,866		1,506
General and administrative		18,618		17,148		37,746		34,142
Interest expense		612		553		1,200		1,090
Total expenses		37,982		33,378		79,055		68,397

Income (loss) before income taxes		20,613		15,601		38,527		30,682

Income taxes:
Current tax expense (benefit)		8,551		6,137		14,260		10,491
Deferred tax expense (benefit)		(1,173)		(524)		(458)		533
		7,378		5,613		13,802		11,024
Net income (loss)	$	13,235	$	9,988	$	24,725	$	19,658

Net income (loss) per share attributable to common shareholders:
Basic earnings per share	$	0.32	$	0.24	$	0.59	$	0.46
Diluted earnings per share		0.31		0.24		0.58		0.46

Dividends, per share	$	0.06	$	0.06	$	0.12	$	0.12

The accompanying notes are an integral part of these unaudited condensed consolidated financial statements.

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STATE NATIONAL COMPANIES, INC.

UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME

($ in thousands)


	Three Months Ended				Six Months Ended
	June 30,		June 30,		June 30,		June 30,
	2017		2016		2017		2016

Net income (loss)	$	13,235	$	9,988	$	24,725	$	19,658

Other comprehensive income (loss), net of tax:
Unrealized gains (losses) on securities:
Unrealized holding gains (losses)		2,055		3,943		3,563		8,515
Tax effect on unrealized holding (gains) losses		(719)		(1,380)		(1,247)		(2,980)
Less: reclassification adjustments for realized (gains) losses included in net income		(109)		(95)		(380)		54
Tax effect on reclassification adjustments for realized gains (losses) included in net income		38		33		133		(19)
Other comprehensive income (loss)		1,265		2,501		2,069		5,570

Total comprehensive income (loss)	$	14,500	$	12,489	$	26,794	$	25,228

The accompanying notes are an integral part of these unaudited condensed consolidated financial statements.

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STATE NATIONAL COMPANIES, INC.

unaudited condensed Consolidated Statements of Shareholders’ Equity

($ in thousands)


							Accumulated
			Additional				Other
	Common		Paid-In		Retained		Comprehensive
	Stock		Capital		Earnings		Income		Total

Balance at December 31, 2015	$	43	$	224,719	$	37,322	$	1,373	$	263,457
Stock-based compensation expense		—		4,578		—		—		4,578
Dividends declared		—		—		(10,139)		—		(10,139)
Repurchase of common stock		(1)		—		(10,030)		—		(10,031)
Net income (loss)		—		—		49,077		—		49,077
Other comprehensive income (loss), net of tax		—		—		—		(562)		(562)
Balance at December 31, 2016		42		229,297		66,230		811		296,380
Stock-based compensation expense		—		2,357		—		—		2,357
Dividends declared		—		—		(5,045)		—		(5,045)
Net income (loss)		—		—		24,725		—		24,725
Other comprehensive income (loss), net of tax		—		—		—		2,069		2,069
Balance at June 30, 2017	$	42	$	231,654	$	85,910	$	2,880	$	320,486

The accompanying notes are an integral part of these unaudited condensed consolidated financial statements.

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STATE NATIONAL COMPANIES, INC.

UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

($ in thousands)


	Six Months Ended
	June 30,		June 30,
	2017		2016

Operating activities
Net cash provided by (used in) operating activities	$	9,629	$	15,239

Investing activities
Purchase of investments		(68,796)		(47,010)
Proceeds from sale of investments		34,493		25,260
Proceeds from maturities and principal receipts		19,459		10,856
Proceeds from dispositions of property and equipment		18		48
Purchase of property and equipment		(1,509)		(555)
Acquisition of consolidated subsidiaries, net of cash obtained		(31,980)		—
Net cash provided by (used in) investing activities		(48,315)		(11,401)

Financing activities
Dividends paid		(5,033)		(2,552)
Repurchase of common stock		—		(7,424)
Net cash provided by (used in) financing activities		(5,033)		(9,976)

Net change in cash and cash equivalents		(43,719)		(6,138)
Cash and cash equivalents at beginning of period		91,698		51,770
Cash and cash equivalents at end of period	$	47,979	$	45,632

The accompanying notes are an integral part of these unaudited condensed consolidated financial statements.

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1. Summary of Significant Accounting Policies

Description of Business

State National Companies, Inc. (the “Company”) refers to a group of companies that conducts insurance-related activities along two major segments. The Company’s Program Services segment generates fee income, in the form of ceding fees, by offering issuing carrier capacity to both specialty general agents and other producers (“GAs”), who sell, control, and administer books of insurance business that are supported by third parties that assume reinsurance risk. Substantially all of the underwriting risk associated with the Program Services segment is ceded to unaffiliated, highly rated reinsurance companies or other reinsurers that provide collateral. The Company’s Lender Services segment generates premiums primarily from the sale of collateral protection insurance (“CPI”), which insures automobiles or other vehicles held as collateral for loans made by credit unions, banks and specialty finance companies.

Principles of Consolidation

The consolidated financial statements include the accounts of the Company and its wholly owned subsidiaries. All intercompany accounts and transactions have been eliminated in consolidation. The Company includes the results of operations of an acquired business in its consolidated financial statements from the date of the acquisition.

Basis of Presentation

The unaudited condensed consolidated financial statements have been prepared in accordance with U.S. generally accepted accounting principles (“GAAP”) and include the accounts of the Company and all subsidiaries. All significant intercompany accounts and transactions have been eliminated in consolidation. Certain footnote disclosures normally included in financial statements prepared in accordance with GAAP have been condensed or omitted pursuant to rules and regulations of the Securities and Exchange Commission (“SEC”) for interim financial reporting. These unaudited condensed consolidated financial statements should be read in conjunction with the audited consolidated financial statements for the years ended December 31, 2016 and 2015.

The interim financial data as of June 30, 2017 and 2016 is unaudited. However, in the opinion of the Company’s management (“Management”), the interim data includes all adjustments, consisting of normal recurring adjustments, necessary to fairly state the results for the interim period. The results of operations for the period ended June 30, 2017 and 2016 are not necessarily indicative of the operating results to be expected for the full year.

Refer to “Summary of Significant Accounting Policies” in the consolidated financial statements for the three years in the period ended December 31, 2016 for information on accounting policies that we consider critical in preparing consolidated financial statements.

Estimates

The preparation of financial statements in conformity with GAAP requires Management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the dates of the financial statements and the reported amounts of revenues and expenses during the reporting periods. Actual results could differ materially from these estimates.

Earnings Per Share

The computation of earnings per share is based upon the weighted average number of common shares outstanding during the period plus the effect of common shares potentially issuable (in periods in which they have a dilutive effect).

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Income Taxes

For any uncertain tax positions not meeting the “more likely than not” recognition threshold, accounting standards require recognition, measurement, and disclosure in the financial statements. There were no uncertain tax positions at June 30, 2017 and December 31, 2016.

Stock-Based Compensation

Compensation expense for stock-based payments is recognized based on the measurement-date fair value for awards that will settle in shares. Compensation expense for restricted stock grants and stock option awards that contain a service condition are recognized on a straight line pro rata basis over the vesting period. For restricted stock awards that contain a performance condition, the expense is recognized based on the awards expected to vest and the cumulative expense is adjusted whenever the estimate of the number of awards to vest changes. An estimation of future forfeitures of stock-based awards is incorporated into the determination of compensation expense. See Note 8 — “Stock-based Payments” for related disclosures.

Recent Accounting Pronouncements

In May 2014, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update (“ASU”) 2014-09, “Revenue from Contracts with Customers (Topic 606)” which replaces most existing GAAP revenue recognition guidance to a five-step revenue recognition model. The FASB has updated the guidance to include the following ASU’s:

ASU 2015-14—“Revenue from Contracts with Customers (Topic 606): Deferral of the Effective Date”;

ASU 2016-08—“Revenue from Contracts with Customers (Topic 606): Principal versus Agent Considerations (Reporting Revenue Gross versus Net)”;

ASU 2016-10—“Revenue from Contracts with Customers (Topic 606): Identifying Performance Obligations and Licensing”;

ASU 2016-11—“Revenue Recognition (Topic 605) and Derivatives and Hedging (Topic 815): Rescission of SEC Guidance Because of Accounting Standards Updates 2014-09 and 2014-16 Pursuant to Staff Announcements at March 3, 2016 EITF Meeting (SEC Update)”;

ASU 2016-12—“Revenue from Contracts with Customers (Topic 606): Narrow-Scope Improvements and Practical Expedients”; and

ASU 2016-20—“Technical Corrections and Improvements to Topic 606, Revenue from Contracts with Customers”

The new guidance excludes insurance contracts that are recognized under Topic 944 “Financial Services—Insurance”; however, income related to our agency operations will be recognized under the new guidance. The model provides for an analysis of transactions to determine when or how revenue is recognized and requires additional disclosures sufficient to describe the nature, amount, timing, and uncertainty of revenue and cash flows for these transactions. The Company has the option to choose to apply the guidance using either the full retrospective or a modified retrospective approach. The standards are effective for annual periods beginning after December 15, 2017, including interim reporting periods within that period. The Company has assessed its revenue streams to identify those contracts that are clearly excluded from the scope of the new standard and those that may be subject to the new standard. The Company will continue to evaluate the impact these ASUs will have on our financial results and disclosures and which adoption option to apply, but does not anticipate such impact to be material to the Company’s financial position or cash flows.

In January 2016, the FASB issued ASU 2016-01, “Recognition and Measurement of Financial Assets and Financial Liabilities” (Sub-Topic 825-10). The amendment in this update supersedes the guidance to classify equity securities with readily determinable fair value into different categories (either trading or available-for-sale) and requires equity securities to be measured at fair value and changes in the fair value to be recognized through net income instead of other comprehensive income. This ASU is effective for annual and interim reports beginning after December 15, 2017. Since the Company’s current position in equities is less than 1% of our current investment portfolio as of June 30, 2017, the

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Company does not anticipate that the guidance will have a material impact to the Company’s financial statements or cash flows.

In February 2016, the FASB issued ASU 2016-02, “Leases” (Topic 842) that requires lessees to recognize the assets and liabilities related to leases on the balance sheet. The FASB is issuing this update to increase transparency and comparability among organizations by recognizing lease assets and lease liabilities on the balance sheet and disclosing key information about leasing arrangements. This ASU is effective for annual and interim periods beginning after December 15, 2018. Early adoption is permitted. The Company does not plan to early adopt and is currently evaluating what impact this ASU will have on financial results and disclosures.

In June 2016, the FASB issued ASU 2016-13, “Financial Instruments—Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments.” The standard will replace today’s “incurred loss” approach with an “expected loss” model for instruments measured at amortized cost and require entities to record allowances for available-for-sale (AFS) debt securities rather than reduce the carrying amount, as they do today under the other-than-temporary impairment (OTTI) model. It also simplifies the accounting model for purchased credit-impaired debt securities and loans. This ASU is effective for annual and interim periods beginning after December 15, 2019. The Company will be evaluating what impact this ASU will have on financial results and disclosures.

In August 2016, the FASB issued ASU 2016-15, “Statement of Cash Flows (Topic 230): Classification of Certain Cash Receipts and Cash Payments.” This ASU amends guidance related to debt prepayment or extinguishment costs, settlement of zero-coupon debt instruments or other debt instruments with coupon rates that are insignificant in relation to the effective interest rate of the borrowing, contingent consideration payments made after a business combination, proceeds from the settlement of insurance claims and corporate-owned life insurance, distributions received from equity method investees and beneficial interests in securitization transactions. The guidance will generally be applied retrospectively and is effective for public business entities for fiscal years beginning after December 15, 2017, and interim periods within those years. The Company does not expect financial results and disclosures to be significantly impacted by this ASU.

In November 2016, the FASB issued ASU 2016-18, “Statement of Cash Flows (Topic 230): Restricted Cash.” The amendments require entities to show the changes in the total of cash, cash equivalents, restricted cash and restricted cash equivalents in the statement of cash flows. As a result, entities will no longer present transfers between cash and cash equivalents and restricted cash and restricted cash equivalents in the statement of cash flows. This ASU is effective for annual and interim periods beginning after December 15, 2017. The Company will be evaluating what impact this ASU will have on disclosures.

In January 2017, the FASB issued ASU 2017-01, “Business Combinations (Topic 805): Clarifying the Definition of a Business.” Under the new guidance, if substantially all of the fair value of the gross assets acquired is concentrated in a single identifiable asset or a group of similar identifiable assets, then the transferred assets and activities do not constitute a business. The guidance also requires a business to include at least one substantive process and narrows the definition of outputs by more closely aligning it with how outputs are described in ASC 606. The ASU is effective for public business entities for fiscal years beginning after December 15, 2017, and interim periods within those years. The ASU will be applied prospectively to any transactions occurring within the period of adoption. Early adoption is permitted, including for interim or annual periods in which the financial statements have not been issued or made available for issuance. The Company does not plan to early adopt and will be evaluating what impact this ASU will have on financial results and disclosures.

In January 2017, the FASB issued ASU 2017-04, “Intangibles – Goodwill and Other (Topic 350): Simplifying the Test for Goodwill Impairment.” The new guidance eliminates the requirement to calculate the implied fair value of goodwill under step two of the current goodwill impairment test, to measure a goodwill impairment charge. Instead, entities will record an impairment charge based on the excess of a reporting unit’s carrying amount over its fair value based on step one of the current goodwill impairment test. The standard will be applied prospectively and is effective for annual and interim impairment tests performed in periods beginning after December 15, 2019, for public business entities. The Company will be evaluating what impact this ASU will have on disclosures.

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In March 2017, the FASB issued ASU 2017-08, “Premium Amortization on Purchased Callable Debt Securities.” The amendments in this update shorten the amortization period for certain callable debt securities held at a premium. Specifically, the amendments require the premium to be amortized to the earliest call date. This ASU is effective for annual and interim periods beginning after December 15, 2018. The Company will be evaluating what impact this ASU will have on disclosures.

In May 2017, the FASB issued ASU 2017-09, “Compensation—Stock Compensation (Topic 718): Scope of Modification Accounting.” The amendments in this update provide guidance about which changes to the terms or conditions of a share-based payment award require an entity to apply modification accounting. Modification accounting is not needed if the fair value, vesting conditions and classification of the modified award are the same as the original award immediately before the original award is modified. This ASU is effective for annual and interim periods beginning after December 15, 2017. The Company does not expect financial results and disclosures to be significantly impacted by this ASU.

2. Investments

The following table summarizes information on the amortized cost, gross unrealized gains and losses, and the fair value of investment securities by class:


	As of June 30, 2017
	Cost or		Gross		Gross
	Amortized		Unrealized		Unrealized		Fair
($ in thousands)	Cost		Gains		Losses		Value

Fixed-maturity securities
Government	$	35,370	$	104	$	(92)	$	35,382
Government agency		870		16		(2)		884
State and municipality		58,602		1,501		(36)		60,067
Industrial and miscellaneous		173,526		4,735		(1,583)		176,678
Residential mortgage-backed		56,783		579		(454)		56,908
Commercial mortgage-backed		49,102		423		(245)		49,280
Redeemable preferred stock		2,848		560		(89)		3,319
Total fixed-maturity securities		377,101		7,918		(2,501)		382,518

Equity securities
Non-redeemable preferred stock		2,032		348		(252)		2,128
Common stock		4		2		—		6
Total equity securities		2,036		350		(252)		2,134
Total investments	$	379,137	$	8,268	$	(2,753)	$	384,652

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	As of December 31, 2016
	Cost or		Gross		Gross
	Amortized		Unrealized		Unrealized		Fair
($ in thousands)	Cost		Gains		Losses		Value

Fixed-maturity securities
Government	$	28,020	$	87	$	(102)	$	28,005
Government agency		1,522		18		(2)		1,538
State and municipality		57,885		508		(183)		58,210
Industrial and miscellaneous		147,761		3,765		(2,111)		149,415
Residential mortgage-backed		51,237		536		(697)		51,076
Commercial mortgage-backed		40,410		300		(327)		40,383
Redeemable preferred stock		3,159		503		(182)		3,480
Total fixed-maturity securities		329,994		5,717		(3,604)		332,107

Equity securities
Non-redeemable preferred stock		3,267		304		(350)		3,221
Common stock		4		—		(1)		3
Total equity securities		3,271		304		(351)		3,224
Total investments	$	333,265	$	6,021	$	(3,955)	$	335,331

Investment securities are exposed to various risks such as interest rate, market, and credit risk. Fair values of securities fluctuate based on the magnitude of changing market conditions; significant changes in market conditions could materially affect the portfolio fair value in the near term.

The following tables show the gross unrealized losses and fair value, aggregated by investment category and length of time that individual securities have been in a continuous unrealized loss position:


	As of June 30, 2017
	Less than 12 Months				12 Months or More				Total
	Fair		Unrealized		Fair		Unrealized		Fair		Unrealized
($ in thousands)	Value		Losses		Value		Losses		Value		Losses

Fixed-maturity securities
Government	$	19,084	$	(92)	$	—	$	—	$	19,084	$	(92)
Government agency		527		(2)		—		—		527		(2)
State and municipality		4,775		(34)		351		(2)		5,126		(36)
Industrial and miscellaneous		43,332		(841)		4,320		(742)		47,652		(1,583)
Residential mortgage-backed		32,831		(361)		2,991		(93)		35,822		(454)
Commercial mortgage-backed		20,325		(204)		747		(41)		21,072		(245)
Redeemable preferred stock		284		(60)		29		(29)		313		(89)
Total fixed-maturity securities		121,158		(1,594)		8,438		(907)		129,596		(2,501)

Equity securities
Non-redeemable preferred stock		185		(75)		93		(177)		278		(252)
Total equity securities		185		(75)		93		(177)		278		(252)
	$	121,343	$	(1,669)	$	8,531	$	(1,084)	$	129,874	$	(2,753)

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	As of December 31, 2016
	Less than 12 Months				12 Months or More				Total
	Fair		Unrealized		Fair		Unrealized		Fair		Unrealized
($ in thousands)	Value		Losses		Value		Losses		Value		Losses

Fixed-maturity securities
Government	$	19,371	$	(102)	$	—	$	—	$	19,371	$	(102)
Government agency		538		(2)		—		—		538		(2)
State and municipality		21,523		(183)		—		—		21,523		(183)
Industrial and miscellaneous		52,995		(1,485)		2,784		(626)		55,779		(2,111)
Residential mortgage-backed		29,776		(535)		3,338		(162)		33,114		(697)
Commercial mortgage-backed		18,673		(293)		773		(34)		19,446		(327)
Redeemable preferred stock		2,207		(171)		135		(11)		2,342		(182)
Total fixed-maturity securities		145,083		(2,771)		7,030		(833)		152,113		(3,604)

Equity securities
Non-redeemable preferred stock		570		(312)		42		(38)		612		(350)
Common stock		3		(1)		—		—		3		(1)
Total equity securities		573		(313)		42		(38)		615		(351)
	$	145,656	$	(3,084)	$	7,072	$	(871)	$	152,728	$	(3,955)

The determination that a security has incurred an other-than-temporary decline in fair value and the associated amount of any loss recognition requires the judgment of Management and a regular review of the Company’s investments. Management reviewed all securities with unrealized losses in accordance with the Company’s impairment policy described in Note 1 — “Summary of Significant Accounting Policies” in the consolidated financial statements for each of the three years in the period ended December 31, 2016. Management believes that the temporary impairments are primarily the result of a combination of widening credit spreads, and higher underlying Treasury rates, and that despite the wider credit spreads and higher rates, the securities are only temporarily impaired due to the strength of the issuing entities’ balance sheets, as well as their available liquidity options. For structured securities, future cash flow projections were used to determine potential impairment. For those securities where cash flow projections showed less than 100% principal recovery, a net present value test was done to determine any credit related losses. There were 231 securities in an unrealized loss position at June 30, 2017. Approximately 95% of these investments are investment-grade at June 30, 2017. We do not intend to sell or believe we will be required to sell any of our temporarily-impaired fixed maturities before recovery of their amortized cost basis. Management has the intent and ability to hold the equity securities in an unrealized loss position until the recovery of their fair value. Therefore, Management does not consider these investments to be other-than-temporarily impaired at June 30, 2017.

Proceeds from sales of investments in fixed-maturity, equity and short-term securities for the six months ended June 30, 2017 and 2016 were $34.5 million and $25.3 million, respectively.

The Company holds convertible securities with embedded derivatives. The embedded derivative is bifurcated from the host contract if all of the following criteria are met: the combined instrument is not accounted for in its entirety at fair value with changes in fair value recorded in earnings; the terms of the embedded derivative are not clearly and closely related to the economic characteristics of the host contract; and a separate instrument with the same terms as the embedded derivative would qualify as a derivative instrument. These embedded derivatives are presented together with the host contract and carried at estimated fair value. Changes in the estimated fair value of the embedded derivatives are reflected in “Realized net investment gains (losses)” in the condensed consolidated statements of income, while changes in the estimated fair value of the underlying fixed maturity securities are reflected in “Unrealized holding gains (losses)” in the condensed consolidated statements of comprehensive income.

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The following table presents the Company’s gross realized gains (losses) for the periods ended:


	Three Months Ended				Six Months Ended
	June 30,		June 30,		June 30,		June 30,
($ in thousands)	2017		2016		2017		2016

Realized gains:
Fixed-maturity securities	$	751	$	518	$	2,553	$	1,012
Equity securities		—		(1)		5		76
Gross realized gains		751		517		2,558		1,088
Realized losses:
Fixed-maturity securities		(282)		(157)		(423)		(410)
Equity securities		(1)		—		(2)		(98)
Other-than-temporary impairment losses on fixed-maturity securities		—		(1)		—		(90)
Gross realized losses		(283)		(158)		(425)		(598)
Change in fair value of embedded derivatives		55		(77)		266		(846)
Net realized investment gains (losses)	$	523	$	282	$	2,399	$	(356)

The Company had six non-cash exchanges of investment securities for the six months ended June 30, 2017 and two non-cash exchanges for the six months ended June 30, 2016. Non-cash consideration received for these exchanges was $1.5 million and $747 thousand for the six months ended June 30, 2017 and June 30, 2016. Gains of $148 thousand and $96 thousand were recognized on these exchanges and are reflected in “Realized net investment gains (losses)” on the condensed consolidated statements of income.

The following schedule details the maturities of the Company’s available-for-sale fixed-maturity securities:


	As of June 30, 2017
($ in thousands)	Amortized Cost		Fair Value

Due in one year or less	$	15,189	$	15,480
Due after one year through five years		131,408		133,826
Due after five years through ten years		109,947		111,383
Due after ten years		14,672		15,642
Residential mortgage-backed securities		56,783		56,907
Commercial mortgage-backed securities		49,102		49,280
	$	377,101	$	382,518

Expected maturities may differ from contractual maturities because certain borrowers have the right to call or prepay obligations with or without call or prepayment penalties.

The Company’s investment portfolio includes approximately $0.7 million of mortgage-backed securities collateralized by subprime residential loans, which represent approximately 0.18% of the Company’s total investments as of June 30, 2017. The Company does not own mortgage derivatives.

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Net investment income for the periods ended, consists of the following:


	Three Months Ended				Six Months Ended
	June 30,		June 30,		June 30,		June 30,
($ in thousands)	2017		2016		2017		2016

Interest on investments	$	2,440	$	2,186	$	4,725	$	4,335
Dividends		83		123		186		239
Gross investment income		2,523		2,309		4,911		4,574
Investment expenses		(235)		(209)		(472)		(434)
Net investment income	$	2,288	$	2,100	$	4,439	$	4,140

The Company’s insurance subsidiaries are required to maintain deposits in various states where they are licensed to operate. These deposits consist of fixed-maturity securities at fair values totaling $80.5 million and $77.0 million at June 30, 2017 and December 31, 2016, respectively.

3. Income Tax Provision

The Company computes its provision for income taxes in interim periods by applying its estimated annual effective tax rate against income (loss) before income taxes for the period. In addition, non-recurring or discrete items are recorded during the period in which they occur. The magnitude of the impact that discrete items have on the Company’s quarterly effective tax rate is dependent on the level of income in the period. A reconciliation of federal income tax expense computed by applying the federal statutory tax rate to income (loss) before income taxes for the periods ended is as follows:


	Six Months Ended
	June 30, 2017				June 30, 2016
			Effective				Effective
($ in thousands)	Amount		Tax Rate		Amount		Tax Rate

Expected tax expense (benefit)	$	13,485	35.0	%	$	10,739	35.0	%
Tax-exempt income		(256)	(0.7)			(199)	(0.7)
State income taxes		722	1.9			522	1.7
Other		(149)	(0.4)			(38)	(0.1)
Total income tax expense (benefit)	$	13,802	35.8	%	$	11,024	35.9	%

4. Reinsurance

Through unaffiliated general agents, the Company’s insurance subsidiaries write property and casualty lines of business in the Program Services segment. This business is written and reinsured pursuant to quota share and excess of loss reinsurance contracts and general agency agreements that are typically tripartite agreements executed by the Company’s insurance subsidiaries, the reinsurer, and the general agent. Substantially all of the underwriting risk associated with this business is borne by the reinsurer. As compensation for writing this business, the Company’s insurance subsidiaries receive ceding fees from the producers and, accordingly, the related ceding fees receivable are reflected as “Accounts receivable from agents, net”. Typically, if the producer defaults on its obligation to pay these fees (or any other amount due), the reinsurer is obligated to make the payment under the guarantee contained in the tripartite contracts. The Company recently entered into a limited number of large programs, in which certain qualifying criteria were met, where the Company retains the risk associated with such obligations. In these instances, the net premiums receivable are also reflected as “Accounts receivable from agents, net”, and the net premiums payable to the reinsurers are reflected as “Accounts payable to insurance companies”.

Through our Lender Services segment, the Company is party to a reinsurance agreement in which it cedes 30% of certain CPI policies to CUMIS Insurance Society, Inc. (“CUNA Mutual”) and receives a ceding commission related to these policies.

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The Company’s insurance subsidiaries remain liable for unearned premiums and unpaid losses and loss adjustment expenses with respect to reinsurance ceded should the reinsurer be unable to meet its obligations. Management considers the possibility of a reinsurer becoming unable to meet its obligations as remote due to the reinsurers’ financial stability, A.M. Best Company rating, size, security funds available, and other factors as appropriate. Following is a summary of these balances:


	June 30,		December 31,
($ in thousands)	2017		2016

Ceded unearned premiums	$	762,117	$	651,938
Ceded loss and loss adjustment expense reserves		1,845,442		1,690,926
Total reinsurance recoverables		2,607,559		2,342,864
Secured reinsurance recoverables		(1,745,177)		(1,678,243)
Unsecured reinsurance recoverables

State National Companies, Inc. 10-Q