Quarterly Report (10-q)

UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q


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


For the quarterly period ended	September 30, 2015


☐	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 or a smaller reporting company. See the definition of “large accelerated filer”, “accelerated filer” and “smaller reporting 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 ☐

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 November 12, 2015
(Common stock, $.001 par value)		44,488,190 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 – September 30, 2015 (unaudited) and December 31, 2014	1

	Unaudited Condensed Consolidated Statements of Income – nine months ended September 30, 2015 and 2014	3

	Unaudited Condensed Consolidated Statements of Comprehensive Income – nine months ended September 30, 2015 and 2014	4

	Unaudited Condensed Consolidated Statements of Shareholders’ Equity – nine months ended September 30, 2015 and twelve months ended December 31, 2014	5

	Unaudited Condensed Consolidated Statements of Cash Flows – nine months ended September 30, 2015 and 2014	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	42

Item 4:	Controls and Procedures	44

Part II - Other Information

Item 1:	Legal Proceedings	44

Item 1A:	Risk Factors	44

Item 2:	Unregistered Sales of Equity Securities and Use of Proceeds	44

Item 3:	Defaults Upon Senior Securities	44

Item 4:	Mine Safety Disclosures	44

Item 5:	Other Information	44

Item 6:	Exhibits	44

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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)


	September 30,		December 31,
	2015		2014
Assets		(Unaudited)
Investments:
Fixed-maturity securities – available-for-sale, at fair value (amortized cost – $328,271, $305,019, respectively)	$	331,478	$	309,911
Equity securities – available-for-sale, at fair value (cost – $5,594, $1,419, respectively)		6,443		2,642
Total investments		337,921		312,553

Cash and cash equivalents		47,732		38,348
Restricted cash and investments		3,716		6,597
Accounts receivable from agents, net		25,988		18,528
Reinsurance recoverable on paid losses		1,046		1,200
Deferred acquisition costs		957		1,036
Reinsurance recoverables		1,842,427		1,656,534
Property and equipment, net (includes land held for sale – $1,034, $1,034, respectively)		17,367		18,397
Interest receivable		1,985		1,795
Deferred income taxes, net		28,822		23,864
Goodwill and intangible assets, net		6,139		6,683
Other assets		4,522		6,229
Total assets	$	2,318,622	$	2,091,764

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)


	September 30,		December 31,
	2015		2014
Liabilities		(Unaudited)
Unpaid losses and loss adjustment expenses	$	1,301,173	$	1,209,905
Unearned premiums		575,935		480,124
Allowance for policy cancellations		56,927		55,500
Deferred ceding fees		29,446		23,612
Accounts payable to agents		2,124		2,448
Accounts payable to insurance companies		4,437		4,399
Subordinated debentures		44,500		44,500
Income taxes payable		2,920		1,762
Other liabilities		31,556		28,642
Total liabilities		2,049,018		1,850,892

Shareholders’ equity
Common stock, $.001 par value (150,000,000 shares authorized; 44,488,190 and 44,247,102 shares issued at September 30, 2015 and December 31, 2014, respectively)		44		44
Preferred stock, $.001 par value (10,000,000 shares authorized; no shares issued and outstanding at September 30, 2015 and December 31, 2014)		—		—
Additional paid-in capital		223,429		220,577
Retained earnings		43,303		16,108
Accumulated other comprehensive income		2,828		4,143
Total shareholders’ equity		269,604		240,872
Total liabilities and shareholders’ equity	$	2,318,622	$	2,091,764

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				Nine Months Ended
	September 30,		September 30,		September 30,		September 30,
	2015		2014		2015		2014
Revenues:
Premiums earned	$	30,156	$	25,599	$	85,145	$	69,585
Commission income		340		405		1,074		1,167
Ceding fees		18,837		12,167		49,360		33,025
Net investment income		2,008		1,183		5,961		3,401
Realized net investment gains (losses)		(571)		291		880		1,186
Other income		381		926		1,228		3,137
Total revenues		51,151		40,571		143,648		111,501

Expenses:
Losses and loss adjustment expenses		14,773		10,695		40,955		29,009
Commissions		1,207		1,209		3,964		2,438
Taxes, licenses, and fees		910		823		2,185		2,053
General and administrative		14,456		14,813		46,649		42,321
Founder special compensation		—		—		—		17,914
Offering-related expenses		—		1,101		—		8,230
Contract modification expense		—		—		—		17,800
Interest expense		510		580		1,515		1,728
Total expenses		31,856		29,221		95,268		121,493

Income (loss) before income taxes		19,295		11,350		48,380		(9,992)

Income taxes:
Current tax expense (benefit)		8,864		752		21,878		4,505
Deferred tax expense (benefit)		(1,965)		3,639		(4,250)		(18,663)
		6,899		4,391		17,628		(14,158)
Net income (loss)	$	12,396	$	6,959	$	30,752	$	4,166

Net income (loss) per share attributable to common shareholders:
Basic earnings per share	$	0.28	$	0.16	$	0.70	$	0.11
Diluted earnings per share		0.28		0.16		0.70		0.11

Dividends, per share	$	0.06	$	—	$	0.08	$	0.48

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				Nine Months Ended
	September 30,		September 30,		September 30,		September 30,
	2015		2014		2015		2014

Net income (loss)	$	12,396	$	6,959	$	30,752	$	4,166

Other comprehensive income (loss), net of tax:
Unrealized gains (losses) on securities:
Unrealized holding gains (losses) during the period		370		(1,236)		(1,393)		2,358
Tax effect on unrealized holding gains (losses) during the period		(130)		432		491		(813)
Less: reclassification adjustments for realized gains (losses) included in net income		393		(225)		(630)		(962)
Tax effect on reclassification adjustments for realized gains (losses) included in net income		(137)		80		217		337
Other comprehensive income (loss)		496		(949)		(1,315)		920

Total comprehensive income (loss)	$	12,892	$	6,010	$	29,437	$	5,086

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		Treasury		Comprehensive
	Stock		Capital		Earnings		Stock		Income		Total

Balance at December 31, 2013	$	41	$	24,367	$	128,830	$	(10,000)	$	2,116	$	145,354
Retirement of treasury stock		(7)		(9,993)		—		10,000		—		—
Issuance of common stock		31		289,291		—		—		—		289,322
Costs directly attributable to the issuance of common stock		—		(1,578)		—		—		—		(1,578)
Redemption of existing common stock		(21)		(190,574)		—		—		—		(190,595)
Stock-based compensation expense		—		2,012		—		—		—		2,012
Conversion from S corporation to C corporation tax status		—		107,052		(107,052)		—		—		—
Dividends declared		—		—		(16,683)		—		—		(16,683)
Net income		—		—		11,013		—		—		11,013
Other comprehensive income, net of tax		—		—		—		—		2,027		2,027
Balance at December 31, 2014		44		220,577		16,108		—		4,143		240,872
Stock-based compensation expense		—		2,852		—		—		—		2,852
Dividends declared		—		—		(3,557)		—		—		(3,557)
Net income		—		—		30,752		—		—		30,752
Other comprehensive loss, net of tax		—		—		—		—		(1,315)		(1,315)
Balance at September 30, 2015	$	44	$	223,429	$	43,303	$	—	$	2,828	$	269,604

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)


	Nine Months Ended
	September 30,		September 30,
	2015		2014
Operating activities
Net cash provided by (used in) operating activities	$	40,843	$	3,634

Investing activities
Purchase of investments		(73,598)		(101,619)
Proceeds from sale of investments		22,141		12,624
Proceeds from maturities and principal receipts		23,734		19,063
Proceeds from dispositions of property and equipment		448		987
Purchase of property and equipment		(644)		(1,715)
Net cash provided by (used in) investing activities		(27,919)		(70,660)

Financing activities
Dividends paid		(3,540)		(16,240)
Proceeds from issuances of common stock		—		289,322
Costs directly attributable to the issuance of common stock		—		(1,578)
Redemption of existing common stock		—		(190,595)
Net cash provided by (used in) financing activities		(3,540)		80,909

Net change in cash and cash equivalents		9,384		13,883
Cash and cash equivalents at beginning of period		38,348		69,431
Cash and cash equivalents at end of period	$	47,732	$	83,314

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

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STATE NATIONAL COMPANIES, INC.

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

1. Summary of Significant Accounting Policies

Description of Business

State National Companies, Inc. (the Company) refers to a group of companies that conduct 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 risk associated with the program business is ceded to unaffiliated, highly rated reinsurance companies or other reinsurers that provide collateral. The Company’s Lender Services segment involves the writing and insuring of lines of insurance marketed to lending institutions, primarily collateral protection insurance (CPI) policies.

Basis of Presentation

The unaudited condensed consolidated financial statements included herein 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, 2014 and 2013.

The interim financial data as of September 30, 2015 and 2014 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 September 30, 2015 and 2014 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 years ended December 31, 2014, 2013 and 2012 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). Earnings per share have been adjusted to reflect a 736 for 1 stock split in the form of a stock dividend on June 23, 2014.

Income Taxes

Prior to June 25, 2014, the Company had elected for its parent company to be taxed for federal income tax purposes as a “Subchapter S corporation” under the Internal Revenue Code. At that time, the Company completed a private placement of common stock, which resulted in the termination of its Subchapter S corporation status. Prior to this change in tax status, deferred income taxes were recorded only on the Company’s insurance subsidiaries (and their immediate parent)

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STATE NATIONAL COMPANIES, INC.

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(continued)

to reflect the tax consequences on future years of differences between the tax bases of assets and liabilities and their financial reporting amounts at each year-end. Prior to June 25, 2014, all other entities included in the consolidated group filed under Subchapter S Corporation status; therefore, no provision for income taxes had been recorded for these entities. On June 25, 2014, the Company recorded a net deferred income tax benefit related to this change in tax status to reflect the tax consequences on future years of differences between the tax bases of assets and liabilities and their financial reporting amounts.

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 September 30, 2015 and December 31, 2014.

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. See Note 7 — “Stock-based Payments” for related disclosures.

Minimum Ceding Fees

Minimum ceding fees are fees the Company receives pursuant to contractual minimum premium requirements for certain programs where either significant premium capacity is reserved for that program or where the expected premium volume is not reasonably assured. For those programs where a minimum applies, the ceding fees are considered as two distinct pieces: 1) “premium related fees,” which are earned as the associated gross written premium is earned, typically pro rata on an annual basis; and (2) “capacity fees,” which are determined based on the shortfall, if any, between the program’s contractual annual premium minimum and the amount of premium estimated to be written in the contract year, which fees are earned ratably in each quarter.

Minimum ceding fees earned are based on estimates of annual premiums to be written for those programs that are subject to minimum premium levels and related ceding fees. These estimates are based upon various assumptions made regarding the production plans for the underlying program. These assumptions are reviewed by Management and the amount of annual premiums expected to be written are re-estimated as needed. As actual premiums emerge and revisions are made to earlier estimates, minimum ceding fees are earned or reversed and are reflected in current operations.

Investments

The Company invests in convertible securities that have embedded derivatives. Derivatives embedded within non-derivative instruments, such as options embedded in convertible fixed maturity securities, are bifurcated from the host instrument when the embedded derivative meets the criteria for bifurcation. However, for reporting purposes, 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” 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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STATE NATIONAL COMPANIES, INC.

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(continued)

Recent Accounting Pronouncements

In May 2014, the FASB issued an accounting standards update (ASU 2014-09), “Revenue from Contracts with Customers” (Topic 606). The core guidance of the ASU presents a comprehensive revenue recognition model that requires a company to recognize revenue to depict the transfer of goods or services to a customer at an amount that reflects the consideration it expects to receive in exchange for those goods or services. The ASU provides a five-step analysis of transactions to determine when and 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. In August 2015, the FASB issued ASU 2015-14 to defer the effective date to annual reporting periods beginning after December 15, 2017, including interim reporting periods within that period. Earlier application is permitted only as of annual reporting periods beginning after December 15, 2016, including interim reporting periods within that reporting period. As insurance contracts are excluded from this ASU, the Company is currently evaluating what impact, if any, this ASU will have on financial results and disclosures and which adoption method to apply.

In June 2014, the FASB issued an accounting standards update (ASU 2014-12), “Compensation – Stock Compensation” (Topic 718). The main provision of this ASU requires that a performance target that affects vesting and that could be achieved after the requisite service period be treated as a performance condition. Compensation cost should be recognized in the period in which it becomes probable that the performance target will be achieved and should represent the compensation cost attributable to the period(s) for which the requisite service has already been rendered. If the performance target becomes probable of being achieved before the end of the requisite service period, the remaining unrecognized compensation cost should be recognized prospectively over the remaining requisite service period. This ASU is effective for annual reporting periods beginning after December 15, 2015 and interim periods within those annual periods. The Company awarded performance based stock compensation on March 30, 2015. The Company expects the impact of this pronouncement to be minimal.

In April 2015, the FASB issued an accounting standards update (ASU 2015-03), “Interest – Imputation of Interest” (Topic 835). The new guidance requires that debt issuance costs related to a recognized debt liability be presented in the balance sheet as a direct deduction from the carrying amount of that debt liability, consistent with debt discounts. The guidance in ASU 2015-03 does not address presentation or subsequent measurement of debt issuance costs related to line-of-credit arrangements. The FASB therefore issued ASU 2015-15 “Interest—Imputation of Interest (Subtopic 835-30): Presentation and Subsequent Measurement of Debt Issuance Costs Associated with Line-of-Credit Arrangements,” which clarified that the SEC staff would not object to an entity deferring and presenting debt issuance costs as an asset and subsequently amortizing the deferred debt issuance costs ratably over the term of the line-of-credit arrangement, regardless of whether there are any outstanding borrowings on the line-of-credit arrangement. For public business entities, the guidance is effective for annual and interim periods beginning after December 15, 2015. Early adoption is permitted. The Company does not plan to early adopt and expects the impact of this pronouncement to be minimal.

In May 2015, the FASB issued an accounting standards update (ASU 2015-09), “Disclosures about Short-Duration Contracts” (Topic 944) intended to make targeted improvements to disclosure requirements for insurance companies that issue short-duration contracts. The amendments in this update are expected to increase transparency of significant estimates made in measuring those liabilities, improve comparability by requiring consistent disclosure of information, and provide financial statement users with additional information to facilitate analysis of the amount, timing, and uncertainty of cash flows arising from contracts issued by insurance entities and the development of loss reserve estimates. This ASU will be effective for annual periods beginning after December 15, 2015, and interim periods within annual periods beginning after December 15, 2016. The Company is currently evaluating what impact this ASU will have on disclosures.

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STATE NATIONAL COMPANIES, INC.

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(continued)

In June 2015, the FASB issued an accounting standards update (ASU 2015-10), “Technical Corrections and Improvements.” The amendments in this update represent changes to clarify the codification, correct unintended application of guidance, or make minor improvements to the codification that are not expected to have a significant effect on current accounting practice or create a significant administrative cost to most entities. Additionally, some of the amendments will make the codification easier to understand and easier to apply by eliminating inconsistencies, providing needed clarifications, and improving the presentation of guidance in the codification. This ASU will be effective for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2015. Early adoption is permitted. The Company does not plan to early adopt and expects the impact of this pronouncement to be minimal.

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:


	Cost or		Gross		Gross
September 30, 2015	Amortized		Unrealized		Unrealized		Fair
($ in thousands)	Cost		Gains		Losses		Value

Fixed-maturity securities
Government	$	13,044	$	256	$	—	$	13,300
Government agency		2,287		48		(1)		2,334
State and municipality		68,137		1,470		(24)		69,583
Industrial and miscellaneous		131,774		1,644		(1,833)		131,585
Residential mortgage-backed		87,666		1,789		(445)		89,010
Commercial mortgage-backed		22,573		352		(25)		22,900
Redeemable preferred stock		2,790		16		(40)		2,766
Total fixed-maturity securities		328,271		5,575		(2,368)		331,478

Equity securities
Non-redeemable preferred stock		5,556		522		(63)		6,015
Common stock		38		391		(1)		428
Total equity securities		5,594		913		(64)		6,443
Total investments	$	333,865	$	6,488	$	(2,432)	$	337,921

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STATE NATIONAL COMPANIES, INC.

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(continued)


	Cost or		Gross		Gross
December 31, 2014	Amortized		Unrealized		Unrealized		Fair
($ in thousands)	Cost		Gains		Losses		Value

Fixed-maturity securities
Government	$	13,896	$	195	$	(49)	$	14,042
Government agency		2,325		57		(9)		2,373
State and municipality		61,179		1,200		(27)		62,352
Industrial and miscellaneous		108,125		2,582		(460)		110,247
Residential mortgage-backed		96,610		1,825		(764)		97,671
Commercial mortgage-backed		22,483		339		(27)		22,795
Redeemable preferred stock		401		30		—		431
Total fixed-maturity securities		305,019		6,228		(1,336)		309,911

Equity securities
Non-redeemable preferred stock		1,407		806		—		2,213
Common stock		12		417		—		429
Total equity securities		1,419		1,223		—		2,642
Total investments	$	306,438	$	7,451	$	(1,336)	$	312,553

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.

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STATE NATIONAL COMPANIES, INC.

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(continued)

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:


	Less than 12 Months				12 Months or More				Total
September 30, 2015	Fair		Unrealized		Fair		Unrealized		Fair		Unrealized
($ in thousands)	Value		Losses		Value		Losses		Value		Losses

Fixed-maturity securities
Government agency	$	566	$	(1)	$	—	$	—	$	566	$	(1)
State and municipality		3,356		(13)		372		(11)		3,728		(24)
Industrial and miscellaneous		46,156		(1,673)		1,037		(160)		47,193		(1,833)
Residential mortgage-backed		6,724		(57)		13,852		(388)		20,576		(445)
Commercial mortgage-backed		1,913		(25)		210		—		2,123		(25)
Redeemable preferred stock		1,183		(6)		201		(34)		1,384		(40)
Total fixed-maturity securities	$	59,898	$	(1,775)	$	15,672	$	(593)	$	75,570	$	(2,368)

Equity securities
Non-redeemable preferred stock		2,036		(63)		—		—		2,036		(63)
Common stock		24		(1)		—		—		24		(1)
Total equity securities		2,060		(64)		—		—		2,060		(64)
	$	61,958	$	(1,839)	$	15,672	$	(593)	$	77,630	$	(2,432)


	Less than 12 Months				12 Months or More				Total
December 31, 2014	Fair		Unrealized		Fair		Unrealized		Fair		Unrealized
($ in thousands)	Value		Losses		Value		Losses		Value		Losses

Fixed-maturity securities
Government	$	522	$	(2)	$	3,094	$	(47)	$	3,616	$	(49)
Government agency		—		—		685		(9)		685		(9)
State and municipality		4,164		(10)		2,001		(17)		6,165		(27)
Industrial and miscellaneous		34,433		(418)		2,637		(42)		37,070		(460)
Residential mortgage-backed		15,491		(94)		19,428		(670)		34,919		(764)
Commercial mortgage-backed		2,528		(14)		694		(13)		3,222		(27)
Total fixed-maturity securities	$	57,138	$	(538)	$	28,539	$	(798)	$	85,677	$	(1,336)

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 the years ended December 31, 2014, 2013 and 2012. Management believes that the temporary impairments are primarily the result of interest rate fluctuations, current conditions in the capital markets, and the impact of those conditions on market liquidity and prices. There were 148 securities in an unrealized loss position at September 30, 2015. Over 83% of these investments were investment-grade at September 30, 2015. The Company does not intend to sell the securities, and it is not more likely than not that the Company will be required to sell these securities before recovery of their amortized cost. 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 September 30, 2015.

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STATE NATIONAL COMPANIES, INC.

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(continued)

Proceeds from sales of investments in fixed-maturity, equity and short-term securities for the nine months ended September 30, 2015 and 2014 were $22.1 million and $12.6 million, respectively.

The following table presents the Company’s gross realized gains (losses) for the periods ended September 30:


	Three Months Ended				Nine Months Ended
	September 30,		September 30,		September 30,		September 30,
($ in thousands)	2015		2014		2015		2014
Realized gains:
Fixed-maturity securities	$	126	$	298	$	1,948	$	1,188
Equity securities		(55)		4		359		33
Gross realized gains		71		302		2,307		1,221
Realized losses:
Fixed-maturity securities		(690)		(11)		(1,407)		(33)
Equity securities		48		—		(20)		(2)
Gross realized losses		(642)		(11)		(1,427)		(35)
Net realized investment gains (losses)	$	(571)	$	291	$	880	$	1,186

The Company had four non-cash exchanges of investment securities for the nine months ended September 30, 2015 and two non-cash exchanges for the nine months ended September 30, 2014. Non-cash consideration received for these exchanges was $1.6 million for the nine months ended September 30, 2015 and September 30, 2014. Gains of $72 thousand and $289 thousand were recognized on these exchanges and are reflected in “Realized net investment gains” in the condensed consolidated statements of income.

The following schedule details the maturities of the Company’s fixed-maturity securities, available-for-sale, as of September 30, 2015:


			Fair
($ in thousands)	Amortized Cost		Value

Due in one year or less	$	6,911	$	6,950
Due after one year through five years		96,434		97,233
Due after five years through ten years		95,499		96,364
Due after ten years		19,188		19,021
Residential mortgage-backed securities		87,666		89,010
Commercial mortgage-backed securities		22,573		22,900
	$	328,271	$	331,478

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 $1.1 million of mortgage-backed securities collateralized by subprime residential loans, which represent approximately 0.33% of the Company’s total investments as of September 30, 2015. The Company does not own mortgage derivatives.

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STATE NATIONAL COMPANIES, INC.

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(continued)

Net investment income for the periods ended September 30, consists of the following:


	Three Months Ended				Nine Months Ended
	September 30,		September 30,		September 30,		September 30,
($ in thousands)	2015		2014		2015		2014

Interest on investments	$	2,087	$	1,287	$	6,256	$	3,687
Dividends		77		32		176		93
Gross investment income		2,164		1,319		6,432		3,780
Investment expenses		(156)		(136)		(471)		(379)
Net investment income	$	2,008	$	1,183	$	5,961	$	3,401

The Company’s insurance subsidiaries, State National Insurance Company, Inc. (SNIC), National Specialty Insurance Company (NSIC) and United Specialty Insurance Company (USIC) are required to maintain deposits in various states where they are licensed to operate. These deposits consisted of fixed-maturity securities at fair values totaling $53.7 million and $36.9 million at September 30, 2015 and December 31, 2014, 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” 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. Net loss related to embedded derivatives was $0.4 million for the three month period ended as of September 30, 2015. Net gain related to embedded derivatives was $0.7 million for the nine month period ended as of September 30, 2015.

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. Prior to the private placement, the Company computed its income tax provision using a 34.3% federal statutory tax rate as its taxable income was within the graduated rates of 34.0% to 35.0%. Prior to June 25, 2014, such a provision applied only to the Company’s insurance subsidiaries and their parent company, State National Intermediate Holdings, Inc. (SNIH). The Company’s other entities, including the ultimate parent company, previously qualified for Subchapter S Corporation status for federal income tax purposes. On June 25, 2014, the Company completed a private placement of common stock, which resulted in the termination of its Subchapter S corporation status. As a result, the Company is taxed as a C corporation and the Company revised its estimated annual effective tax rate to reflect a change in the federal statutory rate from 34.3% to 35.0%. The “exclusion of Subchapter S income” reflects the effect of the lack of income tax expense recorded for the Subchapter S entities for the period ended

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STATE NATIONAL COMPANIES, INC.

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(continued)

June 25, 2014. A reconciliation of federal income tax expense computed by applying the federal statutory tax rate to income (loss) before income taxes for the nine month periods ended September 30 is as follows:


	2015				2014
			Effective				Effective
($ in thousands)	Amount		Tax Rate		Amount		Tax Rate
Expected tax expense (benefit)	$	16,933	35.0	%	$	(3,497)	35.0	%
Exclusion of Subchapter S income		—	—			8,497	(85.0)
Change in tax status		—	—			(19,517)	195.3
Change in federal statutory rate		—	—			(76)	0.8
Tax-exempt income		(347)	(0.7)			(110)	1.1
State income taxes		1,234	2.6			395	(4.0)
Other		(192)	(0.5)			150	(1.5)
Total income tax expense	$	17,628	36.4	%	$	(14,158)	141.7	%

4. Reinsurance

Through unaffiliated general agents, SNIC, NSIC, and USIC 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 tripartite agreements executed by SNIC, NSIC, or USIC, the reinsurer, and the general agent. Substantially all of the risk associated with this business is borne by the reinsurer. As compensation for writing this business, SNIC, NSIC, and USIC receive ceding fees from the producers and, accordingly, the related ceding fees receivable are reflected as accounts receivable from agents. 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 contracts.

SNIC and NSIC write business in the Lender Services segment through an affiliated general agent. The Company is party to a reinsurance agreement in which it cedes a percentage of certain CPI policies to CUMIS Insurance Society, Inc. (CUNA Mutual) and receives a ceding commission related to these policies.

The Company earns minimum ceding fees on certain programs based on estimates of annual premiums to be written for those programs that are subject to minimum premium levels and related ceding fees. The company re-estimated its 2015 annual projection for such programs during the third quarter 2015, which resulted in an additional $1.9 million of capacity fees earned for the three and nine month periods ended September 30, 2015.

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STATE NATIONAL COMPANIES, INC.

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(continued)

SNIC, NSIC, and USIC 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:


	September 30,		December 31,
($ in thousands)	2015		2014
Ceded unearned premiums	$	553,269	$	456,754
Ceded loss and loss adjustment expense reserves		1,289,158		1,199,780
Total reinsurance recoverables		1,842,427		1,656,534
Secured reinsurance recoverables		(1,504,639)		(1,209,032)
Unsecured reinsurance recoverables	$	337,788	$	447,502

The fair value of the collateral held by SNIC, NSIC and USIC is approximately 180% of the secured reinsurance recoverables as of September 30, 2015.

5. Fair Value Measurements

Assets and liabilities reported in the condensed consolidated financial statements at fair value are required to be classified according to a fair value hierarchy that prioritizes the use of inputs used in valuation methodologies into three levels. The hierarchy gives the highest ranking to fair values determined using unadjusted quoted prices in active markets for identical assets and liabilities (Level 1) and the lowest ranking to fair values determined using methodologies and models with unobservable inputs (Level 3). An asset’s or liability’s classification is based on the lowest level input that is significant to its measurement. For example, a Level 3 fair value measurement may include inputs that are both observable (Level 1 and 2) and unobservable (Level 3). The levels of the fair value hierarchy are as follows:

Level 1: Inputs are quoted prices for identical assets or liabilities in active markets that are accessible at the measurement date.

Level 2: Inputs include quoted prices for similar assets or liabilities in active markets, quoted prices from those willing to trade in markets that are not active, or other inputs that are observable or can be corroborated by market data for the term of the instrument. These inputs include market interest rates and volatilities, spreads, and yield curves.

Level 3: Inputs are unobservable. Unobservable inputs reflect the Company’s own assumptions about the assumptions market participants would use in pricing the asset or liability based on the best information available in the circumstances.

A description of the Company’s valuation techniques used to measure its assets at fair value is as follows:

Available-for-sale, fixed-maturity securities: All fixed-maturity investments are currently reported at fair value utilizing Level 2 inputs. For these securities, the Company obtains fair value measurements from either an independent pricing service using quoted prices or from its third-party investment managers. These Level 2 inputs are valued by either the pricing service or the investment managers utilizing observable data that may

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STATE NATIONAL COMPANIES, INC.

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(continued)

include dealer quotes, market spreads, cash flows, yield curves, live trading levels, trade execution data, market consensus, prepayment speeds, credit information, and the security’s terms and conditions, among other things.

Available-for-sale equity securities: Equity securities are reported at fair value utilizing Level 2 inputs. For these securities, the Company obtains fair value measurements from an independent pricing service using quoted prices or from its third-party investment managers.

Embedded derivatives: The Company invests in convertible securities that have embedded derivatives. Embedded derivatives are recorded at estimated fair value with changes in estimated fair value reported in the condensed consolidated statements of net income. The estimated fair value of the embedded derivatives is calculated by the Company’s third-party investment managers.

Management has reviewed the processes used by the pricing services and has determined that they result in fair values consistent with requirements for Level 2 investment securities. Based on an analysis of the inputs, the Company’s investments measured at fair value on a recurring basis have been categorized as follows:


September 30, 2015
($ in thousands)	Level 1		Level 2		Level 3		Total

Fixed-maturity securities
Government	$	—	$	13,300	$	—	$	13,300
Government agency		—		2,334		—		2,334
State and municipality		—		69,583		—		69,583
Industrial and miscellaneous		—		131,585		—		131,585
Residential mortgage-backed		—		89,010		—		89,010
Commercial mortgage-backed		—		22,900		—		22,900
Redeemable preferred stock		—		2,766		—		2,766
Total fixed-maturity securities		—		331,478		—		331,478

Equity securities
Non-redeemable preferred stock		—		6,015		—		6,015
Common stock		—		428		—		428
Total equity securities		—		6,443		—		6,443
Total investments	$	—	$	337,921	$	—	$	337,921

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STATE NATIONAL COMPANIES, INC.

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(continued)


December 31, 2014
($ in thousands)	Level 1		Level 2		Level 3		Total

Fixed-maturity securities
Government	$	—	$	14,042	$	—	$	14,042
Government agency		—		2,373		—		2,373
State and municipality		—		62,352		—		62,352
Industrial and miscellaneous		—		110,247		—		110,247
Residential mortgage-backed		—		97,671		—		97,671
Commercial mortgage-backed		—		22,795		—		22,795
Redeemable preferred stock		—		431		—		431
Total fixed-maturity securities		—		309,911		—		309,911

Equity securities
Non-redeemable preferred stock		—		2,213		—		2,213
Common stock		—		429		—		429
Total equity securities		—		2,642		—		2,642
Total investments	$	—	$	312,553	$	—	$	312,553

At September 30, 2015, the fair value of embedded derivatives included in Level 2 securities was $8.3 million.

There was no Level 3 activity including gains or losses recognized, purchases, or sales transaction during the periods ending September 30, 2015 and December 31, 2014.

Transfers between levels are recognized at the end of the reporting period. There were no transfers between Level 1, Level 2, and Level 3 at September 30, 2015 and December 31, 2014.

6. 401(k) Profit-Sharing Plan and Trust

The Company has a 401(k) profit-sharing plan for employees that covers all officers and employees who are at least 18 years of age. Effective January 1, 2015, the Company is required to make a matching contribution of 100% of the first 1% and 50% of the next 5% of employees’ contributions. For employee contributions made prior to January 1, 2015, the Company was required to make matching contributions of 50% of employees’ contributions, limited to 6% of eligible employees’ compensation. Also, the Company may make additional matching and profit-sharing contributions that are discretionary and are determined at the end of each plan year. The employer contribution expense included in general and administrative expenses for the three months ended September 30, 2015 was $226 thousand (2014 - $212 thousand) and the nine months ended September 30, 2015 was $901 thousand (2014 - $836 thousand).

7. Stock-based Payments

On May 29, 2014, the Company’s shareholders approved the 2014 Long-Term Incentive Plan (2014 Plan), which provides for an aggregate of 4.4 million shares of common stock that may be issued to employees and non-employee directors. Awards under the 2014 Plan may be in the form of stock options (including incentive stock options that meet the requirements of Section 422 of the Internal Revenue Code and non-statutory stock options), restricted stock, restricted stock units, stock appreciation rights and performance units. On June 25, 2014, the Company made grants of non-qualified stock options to certain officers and employees to purchase an aggregate of 2,783,873 shares of common stock. In addition

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STATE NATIONAL COMPANIES, INC.

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(continued)

to the grants of non-qualified stock options, the Company made grants of 12,000 shares of restricted stock to non-employee directors. These non-qualified stock options and restricted stock grants are classified as equity based awards and will be recognized on a straight line basis over the vesting period of 3 years and 1 year, respectively.

The fair value of each stock option grant is established on the grant date using the Black-Scholes option pricing model with the following weighted-average assumptions. The expected volatility is 32.96%, based on historical volatility of similar entities that are publicly traded for a period equal to the expected term. The estimated term of the options, all of which expire ten years after the grant date, is 5.5 years based on expected behavior of the group of option holders. The assumed risk-free interest rate is 1.85%, based on rates for U.S. Treasury Notes with maturity dates corresponding to the estimated term of the options on the date of grant. The assumed dividend yield was 0.40% and no forfeitures are expected.

On July 9, 2014 the Company granted 38,500 shares of common stock to employees under the 2014 Plan. The fair value of the shares was determined based on the most recent trading price of the stock.

On March 30, 2015, the Company awarded 230,060 shares of performance-based restricted stock to certain officers under the 2014 Plan. The fair value of the shares was determined based on the most recent trading price of the stock as of the grant date. These restricted stock grants are classified as equity based awards and will vest based on achievement of performance objectives over one, two and three year performance periods.

On June 25, 2015, the Company granted 11,028 shares of restricted stock to non-employee directors. These restricted stock grants are classified as equity awards and will be recognized on a straight line basis over a 1 year vesting period.

8. Concentration of Risk

The Company maintains cash and cash equivalents in accounts with financial institutions in excess of the amount insured by the Federal Deposit Insurance Corporation. The Company monitors the financial stability of these institutions regularly, and Management does not believe there is significant credit risk associated with deposits in excess of federally insured amounts.

A significant portion of the Company’s writings occurs in California, Texas, New York and Florida. Five reinsurers represent approximately 50% of the Company’s unsecured ceded balances at September 30, 2015.

9. Commitments and Contingencies

The Company is involved in various legal proceedings incidental to its normal business activities. Management of the Company does not anticipate that the outcome of such legal actions will have a material effect on the Company’s consolidated financial position or results of operations.

SNIC, NSIC, and USIC are subject to assessments from various insurance regulatory agencies related to insurance company insolvencies. Management is not aware of any material assessments for which notice has not yet been received. However, to the extent that such assessments are made, the Company has the contractual right to recover these amounts from the underlying reinsurers.

In July 2009, the Company formed a Collateral Protection Alliance (the Alliance) with CUMIS Insurance Society, Inc., a subsidiary of CUNA Mutual, to administer and write CPI business for CUNA Mutual’s customers. The Alliance includes an agency agreement and a reinsurance agreement whereby the Company cedes a portion of the business back to CUNA

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STATE NATIONAL COMPANIES, INC.

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(continued)

Mutual. In connection with the Alliance, the Company has a purchase option and CUNA Mutual has a put option, whereby the Company is obligated to purchase CUNA Mutual’s right to participate in future program business at a specified price in the event of termination of the Alliance. The terms of the Alliance with CUNA Mutual were modified on May 19, 2014 whereby CUNA Mutual’s quota share percentage under the reinsurance agreement was reduced; the Alliance was extended through July 31, 2018 with an automatic three-year renewal (subject to the right of either party to give notice of nonrenewal); the termination rights for each party were modified, and the purchase price calculation was modified. In consideration of these changes, State National paid contract modification expense of $17.8 million.

10. Earnings Per Share

We have adopted the provisions of ASC 260, “Earnings Per Share,” requiring presentation of both basic and diluted earnings per share. Earnings per share have been adjusted to reflect a 736 for 1 stock split in the form of a stock dividend on June 23, 2014. A reconciliation of the numerators and denominators of the basic and diluted per share calculations is presented below:


	Three Months Ended				Nine Months Ended
	September 30,		September 30,		September 30,		September 30,
($ in thousands, except for per share amounts)	2015		2014		2015		2014

Numerator for both basic and diluted earnings per share:
Net income (loss)	$	12,396	$	6,959	$	30,752	$	4,166

Denominator for both basic and diluted earnings per share:
Weighted-average common shares outstanding		44,247,102		44,231,336		44,239,410		37,748,716

Dilutive effect of outstanding securities (determined using the treasury stock method)		725		206,223		4,837		73,274

Weighted-average common shares outstanding and potential common shares outstanding		44,247,827		44,437,559		44,244,247		37,821,990

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STATE NATIONAL COMPANIES, INC.

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(continued)

11. Segment Information

The following is business segment information for the periods indicated:


	Three Months Ended				Nine Months Ended
	September 30,		September 30,		September 30,		September 30,
($ in thousands)	2015		2014		2015		2014
Revenues:
Program	$	18,841	$	12,168	$	49,350	$	33,010
Lender		30,873		26,321		87,332		71,705
Corporate		1,437		2,082		6,966		6,786
Consolidated revenues	$	51,151	$	40,571	$	143,648	$	111,501

Income (loss) before income taxes:
Program	$	14,895	$	9,100	$	38,293	$	24,893
Lender		5,522		4,385		12,614		(8,237)
Corporate		(1,122)		(2,135)		(2,527)		(26,648)
Consolidated income (loss) before income taxes	$	19,295	$	11,350	$	48,380	$	(9,992)

The following table summarizes the financial assets of the Company’s segments as of the periods indicated:


	September 30,		December 31,
($ in thousands)	2015		2014
Assets:
Program	$	1,868,690	$	1,677,971
Lender		15,253		16,270
Corporate		434,679		397,523
	$	2,318,622	$	2,091,764

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

Forward-Looking and Other Statements

Various statements contained in this Form 10-Q are forward-looking statements made pursuant to the Safe Harbor Provisions of the Private Securities Litigation Reform Act of 1995. These forward-looking statements may include projections and estimates concerning the timing and success of specific projects and the Company’s future production, revenues, income and capital spending. The Company’s forward-looking statements are generally, but not always, accompanied by words such as “estimate,” “believe,” “expect,” “will,” “plan,” “target,” “could” or other words that convey the uncertainty of future events or outcomes.

There can be no assurance that actual developments will be those anticipated by us, and therefore you are cautioned not to place undue reliance on the Company’s forward-looking statements. 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, our ability to recover from our capacity providers, the cost and availability of reinsurance coverage, challenges to our use of issuing carrier or fronting arrangements by regulators or changes in state or federal insurance or other statutes or regulations, our dependence on a limited number of business partners, potential regulatory scrutiny of lender-placed automobile insurance, level of new car sales, availability of credit for vehicle purchases and other factors affecting automobile financing, our ability to compete effectively, a downgrade in the financial strength ratings of our insurance subsidiaries, our ability to accurately underwrite and price our products and to maintain and establish accurate loss reserves, changes in interest rates or other changes in the financial markets, the effects of emerging claim and coverage issues, changes in the demand for our products, the effect of general economic conditions, breaches in data security or other disruptions with our technology, and changes in pricing or other competitive environments.

Forward-looking statements involve inherent risks and uncertainties that are difficult to predict and many of which are beyond the Company’s control. The Company cautions readers that various factors could cause its actual financial and operational results to differ materially from those indicated by forward-looking statements made from time-to-time in news releases, reports, proxy statements, registration statements, and other written communications, as well as oral statements made from time to time by representatives of the Company. These and other important factors, including those contained in Item 1A, "Risk Factors” in the 2014 Annual Report on Form 10-K, may cause our actual results, performance or achievements to differ materially from any future results, performance or achievements expressed or implied by these forward-looking statements. The forward-looking statements contained in this Form 10-Q speak only as of the date hereof, and the Company undertakes no obligation to publicly 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 leading specialty provider of property and casualty insurance operating in two niche markets across the United States. In our Program Services segment, we leverage our “A” (Excellent) A.M. Best rating, expansive licenses and reputation to provide access to the U.S. property and casualty insurance market in exchange for ceding fees. In our Lender Services segment, we specialize in providing collateral protection insurance, or CPI, which insures personal automobiles and other vehicles held as collateral for loans made by credit unions, banks and specialty finance companies.

Our Program Services segment generates significant fee income, in the form of ceding fees, by offering issuing carrier (“fronting”) 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. These reinsurers are domestic and foreign insurers and institutional risk investors (“capacity providers”) that want to access specific lines of U.S. property and casualty insurance business. Issuing carrier arrangements refer to our business in which we write insurance on behalf of a capacity provider and then reinsure the risk under these policies with the capacity provider in exchange for ceding fees. We reinsure substantially all of the underwriting and operating risks in connection with our fronting arrangements to our capacity providers. As such, this segment generates very large gross premiums with no net premiums (except for the run-off of the retained business as described below). In many cases, we hold significant collateral to secure the associated reinsurance recoverables. Furthermore, since the funds related to settling balances

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(premiums, commissions and losses) between the GAs and the reinsurers do not flow through the Company, no receivables or payables are reflected in the Company’s financial statements for these amounts. In exchange for providing our insurance capacity, licensing and rating to our GA and insurer clients, we receive ceding fees averaging in excess of 5% of gross written premiums.

Our Lender Services segment generates premiums primarily from providing collateral protection insurance, or CPI, to our credit union, bank and specialty finance company clients. Lenders purchase CPI to provide coverage for automobiles or other vehicles of borrowers who do not uphold their obligation to insure the collateral underlying the loan. Our lender clients pay us directly for CPI and then add the cost of CPI to the borrower’s loan. Our CPI business is fully vertically integrated: we manage all aspects of the CPI business cycle, including sales and marketing, policy issuance, policy administration, underwriting and claims handling.

Factors Affecting Our Operating Results

Trending Market Opportunities. We believe that macroeconomic conditions will provide us with growth opportunities in each of our business segments. Increasing automobile sales and credit availability should expand lenders’ loan portfolios to improve our Lender Services results. Increased capital in the reinsurance market coupled with a decline in reinsurance rates is causing reinsurers to review options for accessing the primary market, which should create demand for our fronting services in our Program Services segment.

In our Lender Services business, we believe that organic growth from our existing lender clients will be driven by overall growth in lenders’ portfolios as a result of rising automobile sales, higher average auto loan sizes and increasing credit availability resulting in increased premium writings. We expect that new sales from our alliance with CUNA Mutual and potential new business from banks and specialty finance companies will also produce additional premiums.

We believe that the increased role of capital market alternatives to reinsurance, including the capitalization of hedge fund-backed reinsurers and the availability of capital in the off-shore reinsurance market, should drive demand for our Program Services, as these firms typically do not have direct access to the U.S. insurance market. This increased demand is contributing to an increase in new programs sold. The Company sold sixteen new programs for the first nine months of 2015 compared to seven new programs for the same period in 2014.

We currently have a significant program with an institutional risk investor, Nephila Capital Ltd. (“Nephila”). Nephila is a hedge fund with approximately $10 billion in assets under management that participates in the market for catastrophe exposed property business. In 2014, we entered into an agreement with Nephila under which we have granted Nephila the exclusive right to produce U.S. catastrophe exposed property insurance during 2015 and 2016. This agreement was amended in November 2015 to extend the term of State National’s exclusive relationship with Nephila through 2019. In exchange for the continued exclusive right to produce such catastrophe exposed property insurance via State National, Nephila has agreed to pay State National contractual minimum ceding fees through 2019. The prior agreement between the two companies, entered into in 2014, required Nephila to pay State National minimum ceding fees of $15 million in 2015, $19.5 million in 2016 and $5 million in 2017. Under the terms of the amended agreement, the minimum ceding fees are $15 million in 2015, $14 million in 2016, $10 million in 2017, $12.5 million in 2018 and $15 million in 2019. This equates to an additional $27 million of contractual minimum ceding fees and three more years of exclusivity. The minimum ceding fees are subject to State National maintaining its “A” A.M. Best rating and potential reductions to the extent that State National is unable to provide production year capacity or is otherwise constrained from writing premium. Also, under certain circumstances, Nephila may terminate the exclusivity, which would reduce the contractual minimum ceding fees to a total of $32.5 million for 2016 through 2019. In the event of such a termination, State National would have the ability to write the catastrophe exposed property business for other capacity providers. The timing and actual amount of gross premiums written for Nephila will impact the timing and amount of ceding fees earned each period under this program. See “—Principal Revenue and Expense Items—Minimum ceding fees.” For the nine months ended September 30, 2015, ceding fees earned for this program were $9.7 million, comprised of premium related fees of $2.2 million and capacity fees of $7.5 million. This program began writing in the second quarter of 2014 and ceding fees were minimal through the third quarter of 2014.

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In addition, downgrades of insurance companies create increased demand for our fronting services. For example, we currently have a large active program with certain subsidiaries of Meadowbrook Insurance Group, Inc. (MIG), including Century Surety Company, Star Insurance Company and Savers Property & Casualty Insurance Company. This A.M. Best rating-sensitive book of business came to us in August of 2013 after A.M. Best downgraded the rating of the MIG insurance subsidiaries from “A-” to “B++”. For the nine months ended September 30, 2015, we earned ceding fees of $11.0 million compared to $10.7 million for the nine months ended September 30, 2014. On July 7, 2015, Meadowbrook announced completion of the acquisition of Meadowbrook by Fosun International Limited. It is unknown if Meadowbrook will seek to terminate our fronting arrangement.

Alliance with CUNA Mutual. The Company’s alliance with CUNA Mutual that began in 2009 provides us access to a wider array of clients and added significant additional scale to our CPI business. Prior to July 1, 2014, this business was subject to a 50% quota share agreement with CUNA Mutual. In May 2014, we amended the alliance agreement to increase our retention of the business subject to the alliance to 70% from 50% for business written on or after July 1, 2014, and in exchange made payments to CUNA Mutual totaling $17.8 million. In addition, the term of the alliance has been extended at least through July 31, 2018. For the nine months ended September 30, 2015, we generated net earned premiums of $43.0 million through the alliance with CUNA Mutual ($11.3 million of which was related to the amendment of the alliance agreement) compared to $28.2 million for the nine months ended September 30, 2014.

Run-off of the Retained Business. In the past, the Company has participated on a quota share basis to a limited extent in certain programs in the Program Services segment. From 2007 until 2011, California had required USIC to retain 10% of the risks written. After this requirement was lifted in early 2012, the Company reinsured to inception the retained business under most of the active contracts, but others continue to run-off. The Company has no active retained contracts and has no present intention of participating in future contracts. We refer to this business as “the run-off of the retained business.” As of September 30, 2015, we had net reserves of $4.1 million related to this business.

Subchapter S Corporation Status. Prior to the completion of a private placement on June 25, 2014, we elected for our parent company to be taxed for federal income tax purposes as a “Subchapter S corporation” under the Internal Revenue Code and our subsidiaries (other than our insurance subsidiaries and intermediate holding company) to be pass-through entities for federal income tax purposes. As a result, prior to the completion of the private placement, the income for our parent company and pass-through subsidiaries was not subject to, and we did not pay, U.S. federal income taxes, and no provision or liability for federal or state income tax for our parent company and pass-through subsidiaries has been included in our consolidated financial statements. The tax provision, assets and liabilities that are reflected in our consolidated financial statements for periods prior to the completion of the private placement, represent those for our insurance subsidiaries, SNIC, NSIC, and USIC, and their intermediate holding company, State National Intermediate Holdings, Inc. (“SNIH”), as those entities were “C” Corporations. Despite the Subchapter S corporation status, the impact of taxes on our parent company are included in the financial statements in that our shareholders were provided with the cash to pay the taxes that passed through to the shareholders. Prior to the completion of the private placement, we made periodic cash distributions to our shareholders that have included amounts necessary for them to pay their estimated personal U.S. federal income tax liabilities relating to the items of our income, gain, deductions and losses that pass through to them. Upon the completion of the private placement, our parent company’s status as a Subchapter S corporation terminated and our parent company became a “C” Corporation for U.S. tax purposes and became subject to a combined federal and state corporate income tax rate between approximately 35% and 38%. We invest a portion of our investment portfolio in tax-exempt municipal securities, which investment may have the effect of lowering our effective tax rate.

Founder Special Compensation. Prior to the completion of the private placement, we paid special compensation to our co-founders and principal executive officers, Lonnie Ledbetter and Terry Ledbetter, in recognition of their service to our Company. We refer to these payments as “founder special compensation.” Founder special compensation payments were discretionary and determined by the Company’s owners in the first or second quarter of the year in which they were made, based on current period considerations including capital position, estimated capital needs and liquidity, and earnings for the prior year. We paid founder special compensation in the aggregate amount of $17.9 million for the nine months ended September 30, 2014. Following the completion of the private placement in June 2014, we ceased paying founder special compensation.

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Seasonality of Our Business. Our Lender Services segment typically experiences seasonal fluctuations in written premium. The fourth quarter tends to generate the greatest amount of written premium, whereas the first quarter of the year tends to generate the least. We believe this trend follows loan delinquency patterns for the industry. We generally do not experience seasonality in our Program Services segment.

Principal Revenue and Expense Items

Premiums earned. Premiums earned are the earned portion of our net premiums written, which are predominately CPI premiums. As the CPI product is not a traditional insurance product, the premium recognition is likewise different. First, we do not record premiums until we collect them from our accounts since they have the right to waive the placement of insurance on any of their loans. Our premium notice cycles range from 45 to 65 days. Therefore, we earn premiums for such notice periods at the time they are written. Next, there is a high level of policy cancellations since borrowers often purchase insurance at the traditional rates that provides protection for them in addition to their lender. Due to this high level of policy cancellations, we split the premium into two pieces: (1) an allowance for future cancellations and (2) premiums that we expect to earn, which we refer to as “stick premiums.” We earn stick premiums on a pro rata basis over the terms of the policies. The CPI premiums written as presented in this document reflect the effects of the allowance for policy cancellations including any adjustments related to re-estimation of the allowance. As such, our recorded CPI premiums written are those that we expect to earn while those that are expected to cancel are included in the allowance for policy cancellations. At the end of each reporting period, stick premium written that is not earned is classified as unearned premium, which is earned in subsequent periods over the remaining terms of the policies. Our policies typically have a term of one year, although the average duration of our CPI policies is typically less than six months due to policy cancellations.

Ceding fees. Ceding fees are fees we receive in the Program Services segment in exchange for providing access to the U.S. property and casualty insurance market and are based on the gross premiums we write on behalf of our GA and capacity provider clients. We earn ceding fees in a manner consistent with the recognition of the gross earned premium on the underlying insurance policies, generally on a pro-rata basis over the terms of the policies reinsured, which policies often have a one year term.

Minimum ceding fees. Minimum ceding fees are fees we receive pursuant to contractual minimum premium requirements for certain of our programs where either significant premium capacity is reserved for that program or where the expected premium volume is not reasonably assured. For those programs where a minimum applies, the ceding fees are considered as two distinct pieces (1) “premium related fees,” which are earned as the associated gross written premium is earned, typically pro rata on an annual basis; and (2) “capacity fees,” which are determined based on the shortfall, if any, between the program’s contractual annual premium minimum and the amount of premium that we estimate will be written in the contract year, which fees are earned ratably in each quarter.

At the end of each quarter during the program contract year, we adjust the capacity fee based upon the re-estimated or actual amount of gross premiums that we expect will be written or that were written for that program for the full contract year. If the estimated annual gross written premiums fall below the minimum contract level in a given period, capacity fees associated with the estimated premium shortfall for that period are earned in that period. If the estimated annual gross written premiums equal or exceed the required minimum level for a given period, no capacity fees are recognized for that period, and the premium related fees are earned as the associated gross written premium is earned. In connection with our re-estimation process, if in a subsequent period we increase our estimate of the amount of gross premiums that we expect will be written under a program for the full contract year, we will reverse a portion of the capacity fees earned in a prior period. Conversely, to the extent that we decrease our estimate of gross premiums, we will recognize capacity fees associated with the additional shortfall in the current period.

Loss and loss adjustment expenses. Loss and loss adjustment expenses (“LAE”) include claims paid, estimates of future claim payments, changes in those estimates from prior reporting periods and costs associated with investigating, defending and servicing claims. We record loss and LAE related to estimates of future claim payments based on historical experience. We seek to establish all reserves at the most likely ultimate exposure based on our historical claims experience. We revise our estimates as we receive additional information about claims and the total costs of settlement.

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Commissions. Commission expenses are primarily related to our Lender Services segment. A significant portion of these amounts are paid to financial institutions as a means to reimburse the financial institution for costs associated with operating a CPI program. These commissions are partially offset by a 21% ceding commissions received under our quota reinsurance agreement with CUNA Mutual and the reimbursement we received from CUNA Mutual for a portion of the direct commission expense. The ceding commission compensates us for expenses, such as underwriting and policy acquisition expenses, that we incur in connection with the writing of the ceded business.

General and administrative expense. General and administrative expense is composed of all other operating expenses, including various departmental salaries and benefits expenses for employees. General and administrative expenses also include expenses related to our office space, postage, telephone and information technology charges, as well as legal and auditing fees and corporate travel. In addition, general and administrative expense includes those charges that are related to the amortization of tangible and intangible assets.

Stock-based compensation expense. 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 awards that are settled in equity are recognized on a straight line pro rata basis over the vesting period. Stock-based compensation expense was approximately $2.9 million and $1.2 million for the nine months ended September 30, 2015 and September 30, 2014, respectively. Upon completion of the private placement, the Company made grants of non-qualified stock options to certain officers to purchase an aggregate of 2,783,873 shares of our common stock. In addition to the grants of non-qualified stock options, the Company made grants of 12,000 shares of restricted stock to our non-employee directors and 38,500 shares of stock to our employees. These non-qualified stock options and restricted stock grants are classified as equity-based awards and will be recognized on a straight-line basis over the vesting period of 3 years and 1 year, respectively. The stock grants made to employees were expensed at their fair value and had no vesting or performance requirements. On March 30, 2015, the Company made grants of 230,060 shares of restricted stock to certain officers. These restricted stock grants are classified as equity-based awards and will be recognized based on achievement of performance objectives over one, two and three year performance periods. On June 25, 2015, the Company granted 11,028 shares of restricted stock to our non-employee directors. These restricted stock grants are classified as equity awards and will be recognized on a straight-line basis over a 1 year vesting period.

Other Measures and Ratios

Non-GAAP Measures

Adjusted pre-tax income. Adjusted pre-tax income is considered a non-GAAP financial measure because it reflects adjustments to pre-tax income, which is the most directly comparable measure calculated in accordance with GAAP, for the amount of founder special compensation and the non-recurring offering related expenses and contract modification expense related to the amendment to our alliance with CUNA Mutual, as applicable. The Company’s management (Management) believes this measure is helpful to investors because it provides comparability in evaluating core financial performance between periods. Management uses adjusted pre-tax income to evaluate core financial performance against historical results without the effect of these items.

Adjusted net income. Adjusted net income is considered a non-GAAP financial measure because it reflects adjustments to net income, which is the most directly comparable measure calculated in accordance with GAAP for the pro forma provision for income taxes as if the Company had been treated as a C Corporation for each period presented and the exclusion (net of tax benefit) of the increase in the Company’s deferred tax asset as a result of the conversion to the C Corporation status, the amount of founder special compensation and the non-recurring offering related expenses and contract modification expense related to the amendment to our alliance agreement with CUNA Mutual, as applicable. Management believes this measure is helpful to investors because it provides comparability in evaluating core financial performance between periods. Management uses adjusted net income to evaluate core financial performance against historical results without the effect of these items.

For a reconciliation of these non-GAAP financial measures, see “Management’s Discussion and Analysis of Financial Condition and Results of Operation—Results of Operations—Consolidated Results of Operations.”

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Program Services Ratios

Program gross expense ratio. The program gross expense ratio is a measure of our ability to earn increasing amounts of ceding fees with only minimal incremental expense in our Program Services business. Expressed as a percentage, this is the ratio of general and administrative expense incurred to gross written premium. Our GAs and capacity providers are responsible for providing all underwriting, policy administration, claims handling and other traditional insurance company services. As a result, we are able to produce significant premium volume with only minimal operating expenses. In addition, our fixed costs are a large component of the operating expenses while the incremental costs are small and are dependent upon the size and complexity of the programs being supported. For the nine months ended September 30, 2015 and 2014, our ratio of operating expenses to gross premiums written, or program gross expense ratio, was 1.1% and 1.2%, respectively. Our objective is to produce a gross expense ratio in a range of 1.0% to 1.5%.

Gross operating leverage. Gross operating leverage is the ratio of gross premiums written (including our Lender Services segment) to shareholder’s equity. A significant portion of our capital is used to support the gross premium produced in our Program Services segment. We retain virtually no risk other than the credit risk of the capacity providers. We maintain strict credit underwriting standards, broad indemnification agreements and collateral requirements. Using this efficient model, we are able to generate significant gross written premiums on a relatively small amount of capital compared to our peers.

Lender Services Insurance Ratios

Net loss ratio. The net loss ratio is a measure of the underwriting profitability of our Lender Services segment. Expressed as a percentage, this is the ratio of net loss and LAE incurred to net premiums earned. For the nine months ended September 30, 2015 and 2014, our net loss ratio was 45.7% and 41.5%, respectively.

Net expense ratio. The net expense ratio is a component of our operational efficiency in administering our Lender Services segment. Expressed as a percentage, this is the ratio of net expenses (commissions, taxes, licenses, and fees and general and administrative) to net premiums earned. Our expense ratio is higher than most traditional insurance products due to the labor and systems intensive processes involved in monitoring the insurance statuses for the loan portfolios of our Lender Services clients. For the nine months ended September 30, 2015 and 2014, our net expense ratio was 42.1% and 47.8%, respectively.

Net combined ratio. The net combined ratio is a measure of the overall profitability of our Lender Services segment. This is the sum of the net loss ratio and the net expense ratio. For the nine months ended September 30, 2015 and 2014, our net combined ratio was 87.8% and 89.3%, respectively. Our objective is to price our products to achieve a net combined ratio between 85% to 90%.

Financial Ratios

Return on equity. One of the key financial measures that we use to evaluate our operating performance is return on equity. We calculate return on equity by dividing net income by the average GAAP equity. Our overall financial objective is to produce a return on equity of at least 15% over the long-term.

Financial leverage ratios. Our financial leverage ratio at September 30, 2015 was 16.5%, as compared to 18.5% at December 31, 2014. Our objective is to maintain a financial leverage ratio in the range of 20% to 40%.

Critical Accounting Estimates

Our consolidated financial statements include amounts that, either by their nature or due to the requirements of generally accepted accounting principles in the U.S. (GAAP), are determined using estimates and assumptions. We base our estimates on past experience and other assumptions that we believe are reasonable under the circumstances. While we believe that the amounts included in our consolidated financial statements reflect our best judgment, actual amounts

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could ultimately materially differ from those currently presented. We believe the items that require the most subjective and complex estimates are: unpaid losses and loss adjustment expense reserves, allowance for policy cancellations, unearned premium reserve, reinsurance recoverable, valuation of our investment portfolio and assessment of other-than-temporary impairments (OTTI) and minimum ceding fees.

There were no significant changes to our critical accounting policies and estimation processes during the nine months ended September 30, 2015. Our critical accounting policies and estimation processes are described in our audited consolidated financial statements and the related notes in the Company’s 2014 Annual Report on Form 10-K.

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Consolidated Results of Operations	Three Months Ended				Nine Months Ended
	September 30,				September 30,
($ in thousands)	2015		2014		2015		2014

Revenues:
Premiums earned	$	30,156	$	25,599	$	85,145	$	69,585
Commission income		340		405		1,074		1,167
Ceding fees		18,837		12,167		49,360		33,025
Net investment income		2,008		1,183		5,961		3,401
Realized net investment gains (losses)		(571)		291		880		1,186
Other income		381		926		1,228		3,137
Total revenues		51,151		40,571		143,648		111,501

Expenses:
Losses and loss adjustment expenses		14,773		10,695		40,955		29,009
Commissions		1,207		1,209		3,964		2,438
Taxes, licenses, and fees		910		823		2,185		2,053
General and administrative		14,456		14,813		46,649		42,321
Founder special compensation		—		—		—		17,914
Offering-related expenses		—		1,101		—		8,230
Contract modification expense		—		—		—		17,800
Interest expense		510		580		1,515		1,728
Total expenses		31,856		29,221		95,268		121,493

Income (loss) before income taxes		19,295		11,350		48,380		(9,992)

Income taxes:
Current tax expense (benefit)		8,864		752		21,878		4,505
Deferred tax expense (benefit)		(1,965)		3,639		(4,250)		(18,663)
		6,899		4,391		17,628		(14,158)
Net income (loss)	$	12,396	$	6,959	$	30,752	$	4,166


Adjusted pre-tax income (loss)	$	19,295	$	12,451	$	48,380	$	33,952
Reconciliation of adjusted pre-tax income (loss):
Pre-tax income (loss)	$	19,295	$	11,350	$	48,380	$	(9,992)
Plus: Founder special compensation (1)		—		—		—		17,914
Plus: Offering-related expenses (2)		—		1,101		—		8,230
Plus: Contract modification expense (3)		—		—		—		17,800
Adjusted pre-tax income (loss)	$	19,295	$	12,451	$	48,380	$	33,952


Adjusted net income (loss)	$	12,396	$	7,634	$	30,752	$	20,796
Reconciliation of adjusted net income (loss):
Net income (loss)	$	12,396	$	6,959	$	30,752	$	4,166
Plus (less): Provision for income taxes to reflect change to C corporation status (4)		—		—		—		4,193
Less: Recognition of deferred tax asset upon conversion to C corporation (5)		—		—		—		14,480
Plus: Founder special compensation (1) (6)		—		—		—		10,973
Plus: Offering-related expenses (2) (6)		—		675		—		5,041
Plus: Contract modification expense (3) (6)		—		—		—		10,903
Adjusted net income (loss)	$	12,396	$	7,634	$	30,752	$	20,796

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(1)

We made special compensation payments to our co-founders and principal executive officers, Lonnie Ledbetter and Terry Ledbetter in recognition of their service to our Company. We refer to these payments as “founder special compensation.” Following the completion of the private placement, we ceased paying founder special compensation.

(2)

Offering-related expenses are non-recurring expenses related to the Company’s private placement of common stock in 2014.

(3)

In connection with the 2014 amendment to the alliance agreement with CUNA Mutual, we paid CUNA Mutual $17.8 million. As a result, we recorded non-recurring contract modification expense of $17.8 million.

(4)

Upon the completion of the private placement, our parent company’s status as a Subchapter S corporation terminated and our consolidated income became fully subject to U.S. federal income taxes. This adjustment represents estimated income taxes as if the Company had been treated as a C Corporation for each period presented.

(5)

As a result of the Company’s conversion to a C Corporation, the deferred tax asset increased by approximately $14.5 million primarily due to the effects of eliminating deferred tax balances on the insurance subsidiaries related to intercompany transactions. This excludes the tax effect related to contract modification expense of $6.7 million.

(6)

Founder special compensation, offering-related expenses, and contract modification expense are shown net of the estimated statutory federal and state income taxes for each period presented.

Consolidated Results of Operations for the Three Months Ended September 30, 2015 compared with the Three Months Ended September 30, 2014

Premiums earned. Premiums earned increased by $4.6 million, or 17.8%, from $25.6 million for the three months ended September 30, 2014 to $30.2 million for the three months ended September 30, 2015. This increase was due to an increase in Lender Services premiums earned, $1.9 million of which is related to the amendment of the CUNA Mutual alliance agreement. Factors contributing to this increase in premiums earned are new sales and growth in the loan portfolios of existing accounts driven by rising automobile sales and higher average auto loan sizes.

Ceding fees. Ceding fees increased by $6.6 million, or 54.8%, from $12.2 million for the three months ended September 30, 2014 to $18.8 million for the three months ended September 30, 2015, due to an increase in Program gross earned premium and capacity fees. Program gross earned premium increased from $217.0 million for the three months ended September 30, 2014 to $258.6 million for the three months ended September 30, 2015. Two large existing programs and a new program experienced growth in 2015 totaling $1.4 million. In addition, Nephila began writing business in second quarter 2014 with minimal premium writings for the three months ended September 30, 2014 compared to the business written for the three months ended September 30, 2015. Ceding fees earned for Nephila for the three months ended September 30, 2015 were $4.6 million, consisting of premium related fees of $0.8 million and capacity fees of $3.8 million ($1.9 million of which is attributable to the re-estimation of gross written premium expected from Nephila for 2015 from $150 million to $100 million).

Investment income. Investment income increased by $0.8 million, from $1.2 million for the three months ended September 30, 2014 to $2.0 million for the three months ended September 30, 2015, in part due to the timing of investing the net proceeds of the private placement.

Realized net investment gains. Realized net investment gains decreased by $0.9 million, from a gain of $0.3 million for the three months ended September 30, 2014 to a loss of $0.6 million for the three months ended September 30, 2015. The loss for the three months ended September 30, 2015 is primarily a result of market volatility during the quarter, which impacted the value of our convertible securities.

Other income. Other income decreased by $0.5 million, from $0.9 million for the three months ended September 30, 2014 to $0.4 million for the three months ended September 30, 2015. This decrease is primarily related to termination of a tenant lease in November 2014.

Losses and loss adjustment expenses. Losses and LAE increased by $4.1 million, from $10.7 million for the three months ended September 30, 2014 to $14.8 million for the three months ended September 30, 2015, which is partly the result of increased exposure due to higher earned premiums and an increase in claim frequency and severity. A

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strengthening economy, an aging automobile fleet, and easier access to credit have contributed to an increase in vehicle sales, resulting in higher loan balances which are the bases upon which we pay claims.

Commissions. Commission expense remained flat for the three months ended September 30, 2015 compared to the three months ended September 30, 2014 despite an increase in premiums earned for the same time period. This is primarily due to additional CPI business ceded to CUNA Mutual. This growth resulted in increases in ceding commissions that offset increases in direct commissions related to the growth in premiums earned.

Offering-related expenses. Offering-related expenses decreased $1.1 million related to non-recurring expenses associated with the private offering of the Company’s stock in 2014.

Current tax expense (benefit). Current tax expense increased by $8.1 million, from $0.8 million for the three months ended September 30, 2014 to $8.9 million for the three months ended September 30, 2015, primarily due to the benefit recorded in 2014 related to the amendment of the CUNA Mutual alliance agreement.

Deferred tax expense (benefit). Deferred tax benefit increased $5.6 million, from an expense of $3.6 million for the three months ended September 30, 2014 to a benefit of $2.0 million for the three months ended September 30, 2015, primarily due to the expense recorded in 2014 related to the amendment of the CUNA Mutual alliance agreement.

Consolidated Results of Operations for the Nine Months Ended September 30, 2015 compared with the Nine Months Ended September 30, 2014

Premiums earned. Premiums earned increased by $15.5 million, or 22.4%, from $69.6 million for the nine months ended September 30, 2014 to $85.1 million for the nine months ended September 30, 2015. This increase was due to an increase in Lender Services premiums earned, $9.1 million of which is related to the amendment of the CUNA Mutual alliance agreement. Factors contributing to this increase in premiums earned are new sales and growth in the loan portfolios of existing accounts driven by rising automobile sales and higher average auto loan sizes.

Ceding fees. Ceding fees increased by $16.4 million, or 49.5%, from $33.0 million for the nine months ended September 30, 2014 to $49.4 million for the nine months ended September 30, 2015, due to an increase in Program gross earned premium and capacity fees. Program gross earned premiums increased from $592.2 million for the nine months ended September 30, 2014 to $745.4 million for the nine months ended September 30, 2015. Two large existing programs and a new program experienced growth in 2015 totaling $4.2 million. In addition, Nephila began writing business in second quarter 2014 with minimal premium writings for the nine months ended September 30, 2014 compared to the business written for the nine months ended September 30, 2015. Ceding fees earned for Nephila were $9.7 million, consisting of premium related fees of $2.2 million and capacity fees of $7.5 million for the nine months ended September 30, 2015.

Investment income. Investment income increased by $2.6 million, from $3.4 million for the nine months ended September 30, 2014 to $6.0 million for the nine months ended September 30, 2015, in part due to an increase in investment holdings as a result of the net proceeds of the private placement.

Other income. Other income decreased by $1.9 million, from $3.1 million for the nine months ended September 30, 2014 to $1.2 million for the nine months ended September 30, 2015. This decrease is primarily related to termination of a tenant lease in November 2014.

Losses and loss adjustment expenses. Losses and LAE increased by $12.0 million, or 41.2%, from $29.0 million for the nine months ended September 30, 2014 to $41.0 million for the nine months ended September 30, 2015, which is partly the result of increased exposure due to higher earned premiums and an increase in claim frequency and severity. A strengthening economy, an aging automobile fleet, and easier access to credit have contributed to an increase in vehicle sales, resulting in higher loan balances which are the bases upon which we pay claims.

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Lender Services premiums earned and a reduction to ceding commissions as a result of the amendment to the CUNA Mutual alliance agreement.

General and administrative expense. General and administrative expense increased by $4.3 million or 10.2%, from $42.3 million for the nine months ended September 30, 2014 to $46.6 million for the nine months ended September 30, 2015, primarily due to stock-based compensation, salaries and expenses associated with being a public company.

Founder special compensation. Founder special compensation decreased by $17.9 million as of September 30, 2015 compared to September 30, 2014. We ceased paying founder special compensation following the completion of the private placement in June 2014.

Offering-related expenses. Offering-related expenses decreased $8.2 million related to non-recurring expenses associated with the private offering of the Company’s stock in 2014.

Contract modification expense. Contract modification expense decreased by $17.8 million. In connection with the 2014 amendment to the alliance agreement with CUNA Mutual, we paid CUNA Mutual $17.8 million. As a result, we recorded non-recurring contract modification expense of $17.8 million for the period ended September 30, 2014.

Current tax expense (benefit). Current tax expense increased by $17.4 million, from $4.5 million for the nine months ended September 30, 2014 to $21.9 million for the nine months ended September 30, 2015, primarily due to the conversion of the Company’s tax status from a Subchapter S Corporation to a C Corporation on June 25, 2014.

Deferred tax expense (benefit). Deferred tax benefit decreased $14.4 million, from $18.7 million for the nine months ended September 30, 2014 to $4.3 million for the nine months ended September 30, 2015, primarily due to the conversion of the Company’s tax status from a Subchapter S Corporation to a C Corporation on June 25, 2014.


Program Services Segment — Results of Operations	Three Months Ended						Nine Months Ended
	September 30,						September 30,
($ in thousands)	2015			2014			2015			2014

Revenues:
Premiums earned	$	4		$	1		$	(10)		$	(15)
Ceding fees		18,837			12,167			49,360			33,025
Total revenues		18,841			12,168			49,350			33,010

Expenses:
Losses and loss adjustment expenses		1,090			266			2,057			113
Commissions		—			1			2			(1)
Taxes, licenses, and fees		(1)			4			8			3
General and administrative		2,857			2,797			8,990			8,002
Total expenses		3,946			3,068			11,057			8,117

Income (loss) before income taxes	$	14,895		$	9,100		$	38,293		$	24,893

Program gross expense ratio		1.0	%		1.1	%		1.1	%		1.2	%
Gross premiums written	$	280,975		$	257,175		$	842,033		$	693,260
Gross premiums earned	$	258,621		$	217,000		$	745,407		$	592,248

Program Services Segment Results of Operations for the Three Months Ended September 30, 2015 compared with the Three Months Ended September 30, 2014

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months ended September 30, 2014 to $258.6 million for the three months ended September 30, 2015. Two large existing programs and a new program experienced growth in 2015 totaling $1.4 million. In addition, Nephila began writing business in second quarter 2014 with minimal premium writings for the three months ended September 30, 2014 compared to the business written for the three months ended September 30, 2015. Ceding fees earned for Nephila for the three months ended September 30, 2015 were $4.6 million, consisting of premium related fees of $0.8 million and capacity fees of $3.8 million ($1.9 million of which is attributable to the re-estimation of gross written premium expected from Nephila for 2015 from $150 million to $100 million).

Losses and loss adjustment expenses. Losses and LAE incurred in the run-off of the retained business increased by $0.8 million from $0.3 million for the three months ended September 30, 2014 to $1.1 million for the three months ended September 30, 2015. The increase in losses and LAE for the three months ended September 30, 2015, was related to reserve strengthening on run-off programs.

Program Services Segment Results of Operations for the Nine months Ended September 30, 2015 compared with the Nine months Ended September 30, 2014

Losses and loss adjustment expenses. Losses and LAE incurred in the run-off of the retained business increased by $2.0 million from $0.1 million for the nine months ended September 30, 2014 to $2.1 million for the nine months ended September 30, 2015. The increase in losses and LAE for the nine months ended September 30, 2015, was related to reserve strengthening on run-off programs.

General and administrative expense. General and administrative expense increased by $1.0 million, or 12.3%, from $8.0 million for the nine months ended September 30, 2014 to $9.0 million for the nine months ended September 30, 2015. The increase was primarily related to stock-based compensation and is partially offset by a small decrease in compensation expense.

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Lender Services Segment — Results of Operations


	Three Months Ended						Nine Months Ended
	September 30,						September 30,
($ in thousands)	2015			2014			2015			2014

Revenues:
Premiums earned	$	30,152		$	25,598		$	85,155		$	69,600
Commission income		340			405			1,074			1,167
Other income		381			318			1,103			938
Total revenues		30,873			26,321			87,332			71,705

Expenses:
Losses and loss adjustment expenses		13,683			10,429			38,898			28,896
Commissions		1,207			1,208			3,962			2,439
Taxes, licenses, and fees		911			819			2,177			2,050
General and administrative		9,550			9,480			29,681			28,757
Contract modification expense		—			—			—			17,800
Total expenses		25,351			21,936			74,718			79,942

Income (loss) before income taxes	$	5,522		$	4,385		$	12,614		$	(8,237)


Adjusted pre-tax income (loss)	$	5,522		$	4,385		$	12,614		$	9,563
Reconciliation of adjusted pre-tax income (loss):
Pre-tax income (loss)	$	5,522		$	4,385		$	12,614		$	(8,237)
Plus: Contract modification expense (1)		—			—			—			17,800
Adjusted pre-tax income (loss)	$	5,522		$	4,385		$	12,614		$	9,563


Net loss ratio		45.4	%		40.7	%		45.7	%		41.5	%
Net expense ratio		38.7	%		45.0	%		42.1	%		47.8	%
Net combined ratio		84.1	%		85.7	%		87.8	%		89.3	%

Gross premiums written	$	40,522		$	34,688		$	102,635		$	89,978
Net premiums written	$	33,039		$	29,097		$	84,452		$	69,787

(1)

Lender Services Segment Results of Operations for the Three Months Ended September 30, 2015 compared with the Three Months Ended September 30, 2014

Premiums earned. Premiums earned increased by $4.6 million, or 17.8%, from $25.6 million for the three months ended September 30, 2014 to $30.2 million for the three months ended September 30, 2015, $1.9 million of which is related to the amendment of the CUNA Mutual alliance agreement. Factors contributing to this increase in premiums earned are new sales and growth in the loan portfolios of existing accounts driven by rising automobile sales and higher average auto loan sizes.

Losses and loss adjustment expenses. Losses and LAE increased by $3.3 million, from $10.4 million for the three months ended September 30, 2014 to $13.7 million for the three months ended September 30, 2015, which is partly the result of increased exposure due to higher earned premiums and an increase in claim frequency and severity. A

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Lender Services Segment Results of Operations for the Nine months Ended September 30, 2015 compared with the Nine months Ended September 30, 2014

Premiums earned. Premiums earned increased by $15.6 million, or 22.3%, from $69.6 million for the nine months ended September 30, 2014 to $85.2 million for the nine months ended September 30, 2015, $9.1 million of which is related to the amendment of the CUNA Mutual alliance agreement. Factors contributing to this increase in premiums earned are new sales and growth in the loan portfolios of existing accounts driven by rising automobile sales and higher average auto loan sizes.

Losses and loss adjustment expenses. Losses and LAE increased by $10.0 million, or 34.6%, from $28.9 million for the nine months ended September 30, 2014 to $38.9 million for the nine months ended September 30, 2015, which is partly the result of increased exposure due to higher earned premiums and an increase in claim frequency and severity. A strengthening economy, an aging automobile fleet, and easier access to credit have contributed to an increase in vehicle sales, resulting in higher loan balances which are the bases upon which we pay claims.

Commissions. Commission expense increased by $1.6 million from $2.4 million for the nine months ended September 30, 2014 to $4.0 million for the nine months ended September 30, 2015, primarily due to the increase in Lender Services premiums earned and a reduction to ceding commissions as a result of the amendment to the CUNA Mutual alliance agreement.

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Corporate Segment — Results of Operations	Three Months Ended				Nine Months Ended
	September 30,				September 30,
($ in thousands)	2015		2014		2015		2014

Revenues:
Net investment income	$	2,008	$	1,183	$	5,961	$	3,401
Realized net investment gains (losses)		(571)		291		880		1,186
Other income		—		608		125		2,199
Total revenues		1,437		2,082		6,966		6,786

Expenses:
General and administrative		2,049		2,536		7,978		5,562
Founder special compensation		—		—		—		17,914
Offering-related expenses		—		1,101		—		8,230
Interest expense		510		580		1,515		1,728
Total expenses		2,559		4,217		9,493		33,434

Income (loss) before income taxes		(1,122)		(2,135)		(2,527)		(26,648)

Income tax expense (benefit)		6,899		4,391		17,628		(14,158)

Net income (loss)	$	(8,021)	$	(6,526)	$	(20,155)	$	(12,490)


Adjusted pre-tax income (loss)	$	(1,122)	$	(1,034)	$	(2,527)	$	(504)
Reconciliation of adjusted pre-tax income (loss):
Pre-tax income (loss)	$	(1,122)	$	(2,135)	$	(2,527)	$	(26,648)
Plus: Founder special compensation (1)		—		—		—		17,914
Plus: Offering-related expenses (2)		—		1,101		—		8,230
Adjusted pre-tax income (loss)	$	(1,122)	$	(1,034)	$	(2,527)	$	(504)

(1)

(2)

Offering-related expenses are non-recurring expenses related to the Company’s private placement of common stock in 2014.

Corporate Segment Results of Operations for the Three Months Ended September 30, 2015 compared with the Three Months Ended September 30, 2014

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Other income. Other income decreased by $0.6 million for the three months ended September 30, 2015 related to termination of a tenant lease in November 2014.

General and administrative expense. General and administrative expense decreased by $0.5 million, from $2.5 million for the three months ended September 30, 2014 to $2.0 million for the three months ended September 30, 2015, primarily due to bonuses.

Offering-related expenses. Offering-related expenses decreased $1.1 million related to non-recurring expenses associated with the private offering of the Company’s stock in 2014.

Income tax expense. Income tax expense increased by $2.5 million, from $4.4 million for the three months ended September 30, 2014 to $6.9 million for the three months ended September 30, 2015, primarily resulting from a $7.9 million increase in net income before taxes.

Corporate Segment Results of Operations for the Nine Months Ended September 30, 2015 compared with the Nine Months Ended September 30, 2014

Other income. Other income decreased by $2.1 million, from $2.2 million for the nine months ended September 30, 2014 to $0.1 million for the nine months ended September 30, 2015. This decrease is primarily related to termination of a tenant lease in November 2014.

General and administrative expense. General and administrative expense increased by $2.4 million, from $5.6 million for the nine months ended September 30, 2014 to $8.0 million for the nine months ended September 30, 2015, primarily due to an increase in stock-based compensation, bonuses and expenses associated with being a public company.

Offering-related expenses. Offering-related expenses decreased $8.2 million related to non-recurring expenses associated with the private offering of the Company’s stock in 2014.

Income tax expense. Income tax expense increased by $31.8 million, from a benefit of $14.2 million for the nine months ended September 30, 2014 to an expense of $17.6 million for the nine months ended September 30, 2015, primarily resulting from the conversion of the Company’s tax status from a Subchapter S Corporation to a C Corporation.

Investment Portfolio

Our investment strategy emphasizes, first, the preservation of capital and, second, the generation of an appropriate risk-adjusted return. We seek to generate 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 and short-term money market funds. As of September 30, 2015, the tax adjusted yield on our fixed maturity and equity securities was 2.7%. Convertible securities represent 12.1% of the portfolio at September 30, 2015, an increase from 5.3% at December 31, 2014. Management increased the convertible portfolio because convertible securities offer the potential for participation in the growth of the equity markets with greater down side protection. The average duration, excluding convertible securities, was 4 years and included 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

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Mortgage Corporation, Federal Farm Credit entities, and asset-backed securities and commercial mortgage obligations. Our equity securities include preferred stock and common stock of U.S. corporations. Our investment portfolio is managed by Asset Allocation & Management Company, LLC and AAM Advisors, Inc. (collectively, “AAM”). AAM operates under written investment guidelines approved by our board of directors. We pay AAM an investment management fee based on the market value of assets under management.

For each period specified below, the cost, fair value, and gross unrealized gains and losses on available-for-sale securities were as follows:


	Cost or		Gross		Gross
September 30, 2015	Amortized		Unrealized		Unrealized		Fair
($ in thousands)	Cost		Gains		Losses		Value

Total fixed-maturity securities	$	328,271	$	5,575	$	(2,368)	$	331,478
Total equity securities		5,594		913		(64)		6,443
Total investments	$	333,865	$	6,488	$	(2,432)	$	337,921

	Cost or		Gross		Gross
December 31, 2014	Amortized		Unrealized		Unrealized		Fair
($ in thousands)	Cost		Gains		Losses		Value

Total fixed-maturity securities	$	305,019	$	6,228	$	(1,336)	$	309,911
Total equity securities		1,419		1,223		—		2,642
Total investments	$	306,438	$	7,451	$	(1,336)	$	312,553

The table below summarizes the credit quality of our fixed-maturity securities as of September 30, 2015, as rated by Standard and Poor’s.


					Percentage of
	Amortized		Fair		Fixed-Maturity
($ in thousands)	Cost		Value		Securities

U.S. Treasury	$	13,044	$	13,300		4.01%
AAA		155,345		157,451		47.50%
AA, AA+, AA-		65,607		66,695		20.12%
A, A+, A-		36,401		36,974		11.15%
BBB, BBB+, BBB-		40,282		39,685		11.97%
BB+ and lower		17,592		17,373		5.25%
Total	$	328,271	$	331,478		100.00%

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The amortized cost and fair value of available-for-sale debt securities held as of September 30, 2015, 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.


			Fair
($ in thousands)	Amortized Cost		Value

Due in one year or less	$	6,911	$	6,950
Due after one year through five years		96,434		97,233
Due after five years through ten years		95,499		96,364
Due after ten years		19,188		19,021
Residential mortgage-backed securities		87,666		89,010
Commercial mortgage-backed securities		22,573		22,900
	$	328,271	$	331,478

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 for each year or shorter period specified below:


	Less than 12 Months				12 Months or More				Total
September 30, 2015	Fair		Unrealized		Fair		Unrealized		Fair		Unrealized
($ in thousands)	Value		Losses		Value		Losses		Value		Losses

Total fixed-maturity securities	$	59,898	$	(1,775)	$	15,672	$	(593)	$	75,570	$	(2,368)
Total equity securities		2,060		(64)		—		—		2,060		(64)
Total investments	$	61,958	$	(1,839)	$	15,672	$	(593)	$	77,630	$	(2,432)

	Less than 12 Months				12 Months or More				Total
December 31, 2014	Fair		Unrealized		Fair		Unrealized		Fair		Unrealized
($ in thousands)	Value		Losses		Value		Losses		Value		Losses

Total fixed-maturity securities	$	57,138	$	(538)	$	28,539	$	(798)	$	85,677	$	(1,336)
Total equity securities		—		—		—		—		—		—
Total investments	$	57,138	$	(538)	$	28,539	$	(798)	$	85,677	$	(1,336)

There were 148 and 143 securities at September 30, 2015 and December 31, 2014, respectively, that account for the gross unrealized loss, none of which we deemed to be other-than-temporarily impaired. Management believes that the temporary impairments are primarily the result of interest rate fluctuations, current conditions in the capital markets, and the impact of those conditions on market liquidity and prices. The Company does not intend to sell the securities, and it is not more likely than not that the Company will be required to sell these securities before recovery of their amortized cost. 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.

We are required to maintain deposits in various states where the insurance subsidiaries are licensed to operate. These deposits are fixed maturity securities at fair values totaling $53.7 million and $36.9 million at September 30, 2015 and December 31, 2014, respectively. The increase in the amounts on deposit at September 30, 2015 is primarily due to an increase in the required deposits for workers’ compensation business.

Fair value of financial instruments. ASC 820, “Fair Value Measurements and Disclosures”, provides a definition of fair value, establishes a framework for measuring fair value, and requires expanded disclosures about fair value measurements. The standard applies when GAAP requires or allows assets or liabilities to be measured at fair value; therefore, it does not expand the use of fair value in any new circumstance. Investments measured at fair value on a recurring basis at September 30, 2015 and December 31, 2014 are all considered level 2 investments.

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Liquidity

We are organized as a holding company with three domestic insurance company subsidiaries, as well as a wholly-owned subsidiary that operates in an agency capacity. Our principal sources of operating funds are premiums, ceding fees, investment income and proceeds from sales and maturities of investments. Our primary uses of operating funds include payments of claims and operating expenses. We pay claims using cash flow from operations and invest our excess cash primarily in fixed-income securities. We expect that projected cash flows from operations, as well as the net proceeds from the private placement that we contributed to our insurance subsidiaries, will provide us with sufficient liquidity to fund our anticipated growth, as well as to pay claims and operating expenses, and to pay interest on debt facilities, finance our stock buyback plan 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 in the near term. 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. We may generate liquidity through the issuance of debt or equity securities or financing through borrowings under credit facilities, or a combination thereof.

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 $21.6 million and $15.6 million as of December 31, 2014 and 2013, respectively. In addition, we are able to generate substantial cash flow outside of our regulated insurance subsidiaries through intercompany agency and management agreements between our insurance subsidiaries and our agency, TBA. TBA functions as a managing general agent for SNIC and NSIC in connection with the Lender Services segment, overseeing the underwriting of the CPI business. In addition, under the management agreement TBA provides business development, financial monitoring and other oversight functions to all of our insurance subsidiaries.

The following table is a summary of our consolidated statements of cash flows:


	Nine Months Ended
	September 30,
($ in thousands)	2015		2014

Cash and cash equivalents provided by (used in):
Operating activities	$	40,843	$	3,634
Investing activities		(27,919)		(70,660)
Financing activities		(3,540)		80,909
Net change in cash and equivalents	$	9,384	$	13,883

Comparison of Nine Months Ended September 30, 2015 and 2014

Net cash provided by (used in) operating activities was $37.2 million higher for the nine months ended September 30, 2015 compared to the nine months ended September 30, 2014. The increase is primarily due to nonrecurring cash expenditures for the nine months ended September 30, 2014 related to founder special compensation, amendment to the CUNA Mutual alliance agreement and offering-related expenses. Also, contributing to the increase is an increase in ceding fees and the change to the Company’s retention related to the CUNA Mutual Alliance agreement to 70% from 50%.

Net cash provided by (used in) in investing activities decreased $42.8 million from $70.7 million for nine months ended September 30, 2014 to $27.9 million for the nine months ended September 30, 2015. This decrease is primarily due to investing cash received from the private placement in 2014.

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Net cash provided by (used in) financing activities decreased $84.4 million for the nine months ended September 30, 2015 compared to the nine months ended September 30, 2014 primarily due to the 2014 private placement and redemption of common shares of existing shareholders. This was offset by a decrease in dividends paid of $12.7 million. The decrease in dividends is primarily related to payments in the first and second quarters of 2014 to the founding shareholders for the payment of estimated taxes of the S corporation.

Other Material Changes in Financial Position


	September 30,		December 31,
($ in thousands)	2015		2014
Selected Assets:
Accounts receivable from agents, net	$	25,988	$	18,528
Reinsurance recoverable on paid losses		1,046		1,200
Reinsurance recoverables		1,842,427		1,656,534
Goodwill and intangible assets, net		6,139		6,683
Deferred income taxes, net		28,822		23,864

Selected Liabilities:
Unpaid losses and loss adjustment expenses	$	1,301,173	$	1,209,905
Unearned premiums		575,935		480,124
Allowance for policy cancellations		56,927		55,500
Deferred ceding fees		29,446		23,612
Subordinated debentures		44,500		44,500
Other liabilities		31,556		28,642

Accounts receivable from agents, net. During the nine months ended September 30, 2015, accounts receivable from agents increased $7.5 million from December 31, 2014, as a result of growth in Program Services business due to the addition of new programs and expansion of existing programs. This balance reflects ceding fees and premium taxes receivable from agents.

Reinsurance recoverables, unpaid losses and loss adjustment expenses and unearned premiums. As of September 30, 2015, we held $2.7 billion in collateral securing $1.5 billion in reinsurance recoverables. In addition, we had $337.8 million of unsecured reinsurance recoverables, of which $331.4 million related to the Program Services segment and $6.4 million related to our quota share reinsurance with CUNA Mutual, an A.M. Best “A” rated carrier. During the nine months ended September 30, 2015, reinsurance recoverables increased $185.9 million from December 31, 2014, which was primarily a result of the increase in gross premiums written for Program Services business due to the addition of new programs and expansion of existing programs. These factors also caused an increase in the corresponding unearned premiums and the unpaid losses and loss adjustment expenses of $95.8 million and $91.3 million, respectively.

Allowance for policy cancellations. As of September 30, 2015, the allowance for policy cancellations increased by $1.4 million from December 31, 2014, primarily due to higher CPI premiums (gross of cancellations) written in the most recent three months of 2015 compared to the last three months of 2014. On a quarterly basis, we review our estimates for allowance for policy cancellations to determine whether further adjustments are appropriate. Any resulting adjustments are included in the current period’s operating results. The allowance for policy cancellations for the nine months ended September 30, 2015 and September 30, 2014 included upward revisions to prior year estimates of $0.8 million and $4.2 million, respectively. Because of the interplay between the allowance for policy cancellations and the related unearned premium reserve, changes in the allowance for policy cancellations are partially offset by related changes in the unearned premium reserve and amounts ceded to reinsurers. After taking into account the associated changes in unearned premium and amounts ceded to reinsurers, the net impact to the balance sheet and the corresponding reduction in net income from the revised estimates for the nine months ended September 30, 2015 and 2014 was approximately $0.5 million and $2.2 million, respectively.

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Capital Resources

The Company has three statutory business trusts that were formed between 2002 and 2004, for the sole purpose of issuing $44.5 million of trust preferred securities in private offering transactions. The trusts used the proceeds from these offerings, together with the equity proceeds received upon their initial formation from TBA, an indirect wholly-owned subsidiary of State National, to purchase variable-rate subordinated debentures issued by TBA. All voting securities of the trusts are owned by TBA, and the debentures are the sole assets of the trusts. The trusts meet the obligations of the trust preferred securities with the interest and principal paid on the debentures. These trusts’ interest rates range from 3.80% to 4.10% plus the 3-month LIBOR. The three month LIBOR at September 30, 2015, was 0.33%.

Item 3. Quantitative and Qualitative Disclosures About Market Risk

Liquidity Risk

Liquidity risk represents our potential inability to meet all payment obligations when they become due. We maintain sufficient cash and marketable securities to fund claim payments and operations.

Credit Risk

We are exposed to credit risk from potential losses arising principally from the financial condition of our third party reinsurers, and also from potential losses in our investment portfolio. Although our third party reinsurers are obligated to reimburse us to the extent we cede risk to them, we are ultimately liable to our policyholders on all risks we have ceded. As a result, reinsurance contracts do not limit our ultimate obligations to pay claims covered under the insurance policies we issue and we might not collect amounts recoverable from our reinsurers. We address this credit risk generally by either (1) selecting reinsurers that have an A.M. Best rating of “A-” (Excellent) or better, have $300 million in surplus and are a Texas or Delaware (for USIC) authorized reinsurer at the time we enter into the agreement, or (2) requiring that the reinsurer post substantial collateral to secure the reinsured risks. Security can take the form of collateral (in the form of security posted with a trustee pursuant to a related agreement, or evergreen letter of credit), or guaranty by a related third party that we believe has the ability to pay. The security amount is a function of the policyholder liabilities (unearned premiums, loss and LAE reserves or other amounts that is more representative of the amounts at risk). Excess security is required when a reinsurer does not meet the above financial requirements to provide a “cushion” for inadequate estimates of policyholder liabilities. Unless there is some mitigating factor, we control the ability to set policyholder liability amounts for security purposes.

Security is also immediately required if a reinsurer falls below the benchmark rating during the term of a reinsurance agreement. Existing security may be increased if a reinsurer is downgraded during the term of a reinsurance agreement or experiences a significant loss in policyholder surplus.

Collateral levels are reviewed weekly on each reinsurer on which security is required. Collateral calculations are adjusted as monthly activity reports are received on individual programs and as collateral account balance information is available. Collateral is collected for estimated policyholder liabilities a quarter in advance at the end of each calendar quarter.

We also evaluate the credit risk of our investment portfolio. The primary measure we utilize to mitigate credit risk (the risk of principal default on the securities in which we invest) involves the credit quality of our portfolio. Over 70% of our portfolio is rated AA- or higher (rated by Standard & Poor’s), which is consistent with the guidelines provided to our asset managers. Additionally, our investment committee reviews the portfolio on a quarterly basis and discusses any securities which have been downgraded in the previous quarter.

Market Risk

The risk of underperformance in the market is addressed by having a quality asset manager administering our portfolio. Additionally, our portfolio is diversified to eliminate exposure to any one particular segment. Finally, as the

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bulk of our assets support either our surplus or short tailed lines of business, investment performance is a relatively small portion of our profits relative to other property and casualty companies.

The investment policy is reviewed periodically and updated to meet current needs. However, the primary goal and philosophy of the policy is to be conservative in nature to provide preservation of principal and provide necessary liquidity.

Interest Rate Risk

This is a two-fold risk involving loss of market value due to a rising interest rate environment coupled with a need to liquidate those securities to provide liquidity for operations. Our exposure to extreme shifts in interest rates is mitigated to some extent by selecting a duration target for the portfolio which is relatively short (i.e., approximately four years). The exposure to actually selling underwater securities to gain liquidity is managed by maintaining a laddered portfolio whereby we have securities maturing over the next few years. Further mitigation is provided by maintaining the convexity (i.e., how the duration of a bond changes as the interest rate changes) of the portfolio at relatively low levels.

We had fixed-maturity securities with a fair value of $331.5 million and an amortized cost of $328.3 million as of September 30, 2015 that are subject to interest rate risk. Interest rate risk is the risk that we may incur losses due to adverse changes in interest rates. Fluctuations in interest rates have a direct impact on the market valuation of our fixed-maturity securities. In the management of this risk, the characteristics of duration, credit and variability of cash flows are critical elements.

The table below summarizes the interest rate risk associated with our fixed-maturity securities by illustrating the sensitivity of the fair value of our fixed-maturity securities as of September 30, 2015 to selected hypothetical changes in interest rates, and the associated impact on our shareholders’ equity. We anticipate that we will continue to meet our obligations out of income. We classify our fixed-maturity securities and equity securities as available-for-sale. Temporary changes in the fair value of our fixed-maturity securities impact the carrying value of these securities and are reported in our shareholders’ equity as a component of other comprehensive income, net of deferred taxes. The selected scenarios in the table below are not predictions of future events, but rather are intended to illustrate the effect such events may have on the fair value and carrying value of our fixed-maturity securities and on our shareholders’ equity, each as of September 30, 2015.


Hypothetical Change	Fair		Estimated Change in		Total
in Interest Rates	Value		Fair Value		Return %
($ in thousands)
300 basis point increase	$	292,768	$	(38,710)	-11.68	%
200 basis point increase		305,487		(25,991)	-7.84	%
100 basis point increase		318,484		(12,994)	-3.92	%
No change		331,478		—	—
100 basis point decrease		344,066		12,588	3.80	%
200 basis point decrease		356,194		24,716	7.46	%
300 basis point decrease		368,468		36,990	11.16	%

Changes in interest rates would affect the fair market value of our fixed-rate debt instruments but would not have an impact on our earnings or cash flow. As of September 30, 2015, we had $44.5 million of debt instruments. A fluctuation of 100 basis points in interest on our variable-rate debt instruments, which are tied to LIBOR, would affect our earnings and cash flows by $0.4 million before income tax, on an annual basis, but would not affect the fair market value of the variable-rate debt.

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Item 4:Controls and Procedures

Under the supervision and with the participation of our Management, including our chief executive officer and chief financial officer, we have evaluated the effectiveness of our disclosure controls and procedures (as defined in Rule 13a-15(e) under the Securities Exchange Act of 1934, as amended (the “Exchange Act”)) as of the end of the period covered by this report. Based on that evaluation, our chief executive officer and chief financial officer concluded that our disclosure controls and procedures were effective as of the end of the period covered by this report to provide reasonable assurance that information we are required to disclose in reports that are filed or submitted under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in the Securities and Exchange Commission’s rules and forms. We note that the design of any system of controls is based in part upon assumptions about the likelihood of future events, and there can be no assurance that any design will succeed in achieving the stated goals under all potential future conditions.

There were no changes in our internal control over financial reporting (as defined in Exchange Act Rule 13a-15(f)) as of the end of the period covered by this report that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

PART II - OTHER INFORMATION

Item 1:Legal Proceedings

We are routinely involved in legal proceedings arising in the ordinary course of business, in particular in connection with claims adjudication with respect to our policies. We believe that there is no individual case pending that is likely to have a material adverse effect on our financial condition or results of operations.

Item 1A:Risk Factors

There have been no material changes to the Risk Factors described in Item 1A, "Risk Factors” in the Company’s Annual Report on Form 10-K for the fiscal year ended December 31, 2014.

Item 2:Unregistered Sales of Equity Securities and Use of Proceeds

None.

Item 3:Defaults Upon Senior Securities

None.

Item 4:Mine Safety Disclosures

Not applicable.

Item 5:Other Information

None.

Item 6:Exhibits

The information required by this item is set forth on the exhibit index which follows the signature page of this report.

Available Information

Our company website address is www.statenational.com. We use our website as a channel of distribution for important company information. Important information, including press releases, investor presentations and

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financial information regarding our company, is routinely posted on and accessible on the Investor Relations subpage of our website, which is accessible by clicking on the tab labeled “Investor Relations” on our website home page. We also use our website to expedite public access to time-critical information regarding our company in advance of or in lieu of distributing a press release or a filing with the Securities and Exchange Commission disclosing the same information. Therefore, investors should look to the Investor Relations subpage of our website for important and time-critical information. Visitors to our website can also register to receive automatic e-mail notifications alerting them when new information is made available on the Investor Relations subpage of our website. In addition, we make available on the Investor Relations subpage of our website (under the link “Financial Information” and then “SEC Filings”), free of charge, our annual reports on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K, ownership reports on Forms 3, 4 and 5 and any amendments to those reports as soon as practicable after we electronically file such reports with the Securities and Exchange Commission. Further, copies of our Amended and Restated Certificate of Incorporation and Amended and Restated Bylaws, our Code of Business Conduct and Ethics and the charters for the Audit, Compensation and Nominating and Corporate Governance Committees of our Board of Directors are also available through the Investor Relations subpage of our website (under the link “Corporate Governance”).

Additionally, the public may read and copy any of the materials we file with the Securities and Exchange Commission at the Securities and Exchange Commission’s Public Reference Room at 100 F Street, NE, Room 1580, Washington, D.C. 20549. Information on the operation of the Public Reference Room may be obtained by calling the Securities and Exchange Commission at (800) SEC-0330. Our electronically filed reports can also be obtained on the Securities and Exchange Commission’s internet site at http://www.sec.gov.

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SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.


		STATE NATIONAL COMPANIES, INC.



Date:	November 12, 2015		/s/ Terry Ledbetter
			Terry Ledbetter
			President and Chief Executive Officer



Date:	November 12, 2015		/s/ David Hale
			David Hale
			Chief Operating Officer and Chief Financial Officer

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INDEX TO EXHIBITS


Exhibit Number		Exhibit Description

31.1		Certification of Chief Executive Officer Pursuant to Rule 13a-14(a)/15d-14(a)
31.2		Certification of Chief Financial Officer Pursuant to Rule 13a-14(a)/15d-14(a)
32.1		Certification of Periodic Financial Report Pursuant to 18 U.S.C. Section 1350 (furnished herewith)
101.INS		XBRL Instance Document
101.SCH		XBRL Taxonomy Extension Schema Document
101.CAL		XBRL Taxonomy Extension Calculation Linkbase Document
101.LAB		XBRL Taxonomy Extension Label Linkbase Document
101.PRE		XBRL Taxonomy Extension Presentation Linkbase Document
101.DEF		XBRL Taxonomy Extension Definition Linkbase Document

Exhibit 31.1

STATE NATIONAL COMPANIES, INC.

CERTIFICATION

Pursuant to Rule 13a – 14(a) / 15d-14(a)

I, Terry Ledbetter, certify that:

I have reviewed this quarterly report on Form 10-Q of State National Companies, Inc.;

Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report;

Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report;

The registrant’s other certifying officer and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) and we have:

Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared;

[Omitted pursuant to Exchange Act Rules 13a-14(a) and 15d-15(a).]

Evaluated the effectiveness of the registrant’s disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and

Disclosed in this report any change in the registrant’s internal control over financial reporting that occurred during the registrant’s most recent fiscal quarter (the registrant’s fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonably likely to materially affect, the registrant’s internal control over financial reporting; and

The registrant’s other certifying officer and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant’s auditors and the audit committee of the registrant’s board of directors (or persons performing the equivalent functions):

All significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant’s ability to record, process, summarize and report financial information; and

Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant’s internal control over financial reporting.


Date:November 12, 2015	/s/ Terry Ledbetter

	Terry Ledbetter
	President and Chief Executive Officer

Exhibit 31.2

STATE NATIONAL COMPANIES, INC.

CERTIFICATION

Pursuant to Rule 13a – 14(a) / 15d-14(a)

I, David Hale, certify that:

I have reviewed this quarterly report on Form 10-Q of State National Companies, Inc.;

[Omitted pursuant to Exchange Act Rules 13a-14(a) and 15d-15(a).]

Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant’s internal control over financial reporting.


Date:November 12, 2015	/s/ David Hale

	David Hale
	Chief Operating Officer and Chief Financial Officer

Exhibit 32.1

CERTIFICATION PURSUANT TO 18 U.S.C. § 1350,

AS ADOPTED PURSUANT TO § 906

OF THE SARBANES-OXLEY ACT OF 2002

In connection with the filing of the Quarterly Report on Form 10-Q of State National Companies, Inc., a Delaware corporation (the “Company”), for the quarter ended September 30, 2015, as filed with the Securities and Exchange Commission on the date hereof (the “Report”), each of the undersigned officers of the Company certifies, pursuant to 18 U.S.C. § 1350, as adopted pursuant to § 906 of the Sarbanes-Oxley Act of 2002, that, to such officer’s knowledge:

1. The Report fully complies with the requirements of section 13(a) or 15(d) of the Securities Exchange Act of 1934; and

2. The information contained in the Report fairly presents, in all material respects, the financial condition and results of operations of the Company as of the dates and for the periods expressed in the Report.


Date: November 12, 2015	/s/ Terry Ledbetter
	Terry Ledbetter
	President and Chief Executive Officer


Date: November 12, 2015	/s/ David Hale
	David Hale
	Chief Operating Officer and Chief Financial Officer

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