Heritage Insurance 10Q 2022 Q3 Quarterly report

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON D.C. 20549

Form 10-Q

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

For the quarterly period ended September 30, 2022

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

Commission File Number

001-36462

Heritage Insurance Holdings, Inc.

(Exact name of Registrant as specified in its charter)

Delaware

45-5338504

(State of Incorporation)

(IRS Employer

Identification No.)

1401 N. Westshore Blvd

Tampa, FL 33607

(Address, including zip code, of principal executive offices)

(727) 362-7200

(Registrant’s telephone number, including area code)

Securities registered pursuant to Section 12(b) of the Act:


Title of each class	Trading Symbol(s)	Name of each exchange on which registered
Common Stock, par value $0.0001 per share	HRTG	New York Stock Exchange

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 every Interactive Data File required to be submitted 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 such files). Yes ☒ No ☐

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


Large accelerated filer	☐	Accelerated filer	☒	Emerging growth company	☐
Non-accelerated filer	☐	Smaller reporting company	☐

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

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

The aggregate number of shares of the Registrant’s Common Stock outstanding on November 7, 2022 was 25,876,390.

HERITAGE INSURANCE HOLDINGS, INC.

Table of Contents


		Page
PART I – FINANCIAL INFORMATION
Item 1 Unaudited Financial Statements
Condensed Consolidated Balance Sheets: September 30, 2022 (unaudited) and December 31, 2021		2
Condensed Consolidated Statements of Operations and Other Comprehensive Loss: Three and Nine Months Ended September 30, 2022 and 2021 (unaudited)		3
Condensed Consolidated Statements of Stockholders’ Equity: Three and Nine Months Ended September 30, 2022 and 2021(unaudited)		4
Condensed Consolidated Statements of Cash Flows: Nine Months Ended September 30, 2022 and 2021(unaudited)		6
Notes to Unaudited Condensed Consolidated Financial Statements		8
Item 2 Management’s Discussion and Analysis of Financial Condition and Results of Operations		29
Item 3 Quantitative and Qualitative Disclosures about Market Risk		41
Item 4 Controls and Procedures		42
PART II – OTHER INFORMATION
Item 1 Legal Proceedings		43
Item 1A Risk Factors		43
Item 2 Unregistered Sales of Equity Securities and Use of Proceeds		43
Item 5 Other Information		43
Item 6 Exhibits		44
Signatures		46

FORWARD-LOOKING STATEMENTS

Statements in this Quarterly Report on Form 10-Q (“Form 10-Q”) or in documents incorporated by reference that are not historical facts are “forward-looking statements” within the meaning of the Private Securities Litigation Reform Act of 1995. These forward-looking statements include statements about (i) our ability to meet our investment objectives and to manage and mitigate market risk with respect to our investments; (ii) the expected positive impact of our strategic initiatives on our future financial results, including focus on profitability, exposure management, rate adequacy and our ability to create value for our shareholders; (iii) our ability to achieve consistent long-term quarterly earnings and drive shareholder value; (iv) expected continued changes in our portfolio to reduce exposure and generate long term returns; (v) the expected benefits of excess and surplus insurance products; (vi) expected losses from Hurricane Ian (vii) the adequacy of our reinsurance program and our ability to diversify risk and safeguard our financial position; (viii) business and risk management strategies, including acquisitions, strategic investments and risk diversification; (ix) our estimates with respect to tax and accounting matters including the impact on our financial statements; (x) future dividends, if any; (xi) our expectations related to our financing activities; (xii) the sufficiency of our liquidity to pay our insurance company affiliates’ claims and expenses, as well as to satisfy commitments in the event of unforeseen events; (xiii) the sufficiency of our capital resources, together with cash provided from our operations, to meet currently anticipated working capital requirements and the source of funds needed to fund our business and risk management strategies; (xiv) the potential effects of the seasonality of our business, including effects on our reinsurance business and financial results; (xv) our ability to successfully mitigate the effects of inflation on our business; (xvi) our intentions with respect to our credit risk investments; (xvii) the future impact of the COVID-19 pandemic; and (xviii) the potential effects of our current legal proceedings.

These statements are based on current expectations, estimates and projections about the industry and market in which we operate, and management’s beliefs and assumptions. Without limiting the generality of the foregoing, words such as “may,” “will,” “expect,” “believe,” “anticipate,” “intend,” “could,” “would,” “estimate,” or “continue” or the negative variations thereof or comparable terminology are intended to identify forward-looking statements. Forward-looking statements are not guarantees of future performance and involve certain known and unknown risks and uncertainties that could cause actual results to differ materially from those expressed or implied by such statements. The risks and uncertainties include, without limitation:

•

the possibility that actual losses may exceed reserves;

•

the concentration of our business in coastal states, which could be impacted by hurricane losses or other significant weather-related events such as northeastern winter storms;

•

our exposure to catastrophic weather events;

•

inherent uncertainty of our models and our reliance on such models as a tool to evaluate risk;

•

the fluctuation in our results of operations;

•

increased costs of reinsurance, non-availability of reinsurance, non-collectability of reinsurance and our ability to obtain reinsurance on terms and at a cost acceptable to us;

•

increased competition, competitive pressures, and market conditions;

•

our failure to accurately assess and price the risks we underwrite;

•

continued and increase impact of abusive and unwarranted claims;

•

our failure to identify suitable business acquisitions, effectively manage our growth and integrate acquired companies;

•

our failure to execute our diversification strategy;

•

our reliance on independent agents to write insurance policies for us on a voluntary basis and our ability to attract and retain agents;

•

the failure of our claims department to effectively manage or remediate claims;

•

low renewal rates and failure of such renewals to meet our expectations;

•

our inability to maintain our financial stability rating;

•

our ability to access sufficient liquidity or obtain additional financing to fund our operations and expand our business;

•

our inability to generate investment income;

•

effects of emerging claim and coverage issues relating to legal, judicial, environmental and social conditions;

•

the failure of our risk mitigation strategies or loss limitation methods;

•

lack of effectiveness of exclusions and loss limitation methods in the insurance policies we assume or write;

•

the regulation of our insurance operations;

•

changes in regulations and our failure to meet increased regulatory requirements, including minimum capital and surplus requirements;

•

climate change, health crisis, severe weather conditions and other catastrophe events;

•

litigation or regulatory actions;

•

regulation limiting rate increases or that require us to participate in loss sharing or assessments;

•

the terms of our indebtedness and our inability to comply with the financial and other covenants of our debt facilities;

•

our ability to maintain effective internal controls over financial reporting;

•

certain characteristics of our common stock;

•

the continued and potentially prolonged impact of COVID-19 on the economy, demand for our products and our operations, including measures taken by the governmental authorities to address COVID-19, which may precipitate or exacerbate other risks and/or uncertainties;

•

disruptions to our independent distribution agency channel;

•

failure of our information technology systems or those of our key service providers and unsuccessful development and implementation of new technologies;

•

a lack of redundancy in our operations;

•

our failure to attract and retain qualified employees and independent agents or our loss of key personnel; and

•

the impact of macroeconomic and geopolitical conditions, including the impact of supply chain constraints, inflationary pressures, labor availability and the conflict between Russia and Ukraine.

Additional risks and uncertainties not currently known to us or that we currently deem to be immaterial also may materially adversely affect our business, financial condition or operating results.

These forward-looking statements are subject to numerous risks, uncertainties and assumptions about us described in our filings with the Securities and Exchange Commission (the “SEC”). The forward-looking statements we make in our Form 10-Q are valid only as of the date of our Form 10-Q and may not occur in light of the risks, uncertainties and assumptions that we describe from time to time in our filings with the SEC. A detailed discussion of these and other risks and uncertainties that could cause actual results and events to differ materially from our forward-looking statements is included in the section entitled “Risk Factors” in Part I, Item 1A in our Annual Report on Form 10-K for the year ended December 31, 2021. Except as required by applicable law, we undertake no obligation and disclaim any obligation to publicly update or revise any forward-looking statements, whether as a result of new information, future events or otherwise.

PART I – FINANCIAL INFORMATION

Item 1 – Financial Statements

HERITAGE INSURANCE HOLDINGS, INC.

Condensed Consolidated Balance Sheets

(Amounts in thousands, except per share and share amounts)


	September 30, 2022			December 31, 2021
ASSETS	(unaudited)
Fixed maturities, available-for-sale, at fair value (amortized cost of $704,365 and $675,245)	$	633,192		$	669,354
Equity securities, at fair value, (cost $1,514 and $1,415)		1,514			1,415
Other investments, net		17,084			23,929
Total investments		651,790			694,698
Cash and cash equivalents		297,548			359,337
Restricted cash		6,265			5,415
Accrued investment income		3,517			3,167
Premiums receivable, net		76,126			71,925
Reinsurance recoverable on paid and unpaid claims, net of allowance for credit losses of $45		866,625			269,391
Prepaid reinsurance premiums		381,368			265,873
Income tax receivable		13,760			11,739
Deferred income tax asset, net		14,637			—
Deferred policy acquisition costs, net		100,649			93,881
Property and equipment, net		22,784			17,426
Right-of-use lease asset, net		25,218			27,753
Intangibles, net		51,163			55,926
Goodwill		—			91,959
Other assets		11,133			12,272
Total Assets	$	2,522,583		$	1,980,762
LIABILITIES AND STOCKHOLDERS' EQUITY
Unpaid losses and loss adjustment expenses	$	1,209,352		$	590,166
Unearned premiums		651,913			590,419
Reinsurance payable		278,298			191,728
Long-term debt, net		121,283			120,757
Deferred income tax liability, net		—			9,426
Advance premiums		37,855			24,504
Accrued compensation		8,067			8,014
Lease liability		28,901			31,172
Accounts payable and other liabilities		69,217			71,525
Total Liabilities	$	2,404,886		$	1,637,711

Commitments and contingencies (Note 17)
Stockholders’ Equity:
Common stock, $0.0001 par value, 50,000,000 shares authorized, 25,923,930 shares issued and 25,898,930 outstanding at September 30, 2022 and 26,803,511 shares issued and 26,753,511 outstanding at December 31, 2021		3			3
Additional paid-in capital		334,246			332,797
Accumulated other comprehensive loss, net of taxes		(54,573	)		(4,573	)
Treasury stock, at cost, 11,890,599 and 10,536,737 shares at September 30, 2022 and December 31, 2021		(130,286	)		(123,557	)
Retained (deficit) earnings		(31,693	)		138,381
Total Stockholders' Equity		117,697			343,051
Total Liabilities and Stockholders' Equity	$	2,522,583		$	1,980,762

See accompanying notes to unaudited condensed consolidated financial statements.

HERITAGE INSURANCE HOLDINGS, INC.

Condensed Consolidated Statements of Operations and Other Comprehensive Loss

(Unaudited)

(Amounts in thousands, except per share and share amounts)


	For the Three Months Ended September 30,						For the Nine Months Ended September 30,
	2022			2021			2022			2021
REVENUES:
Gross premiums written	$	304,501		$	274,178		$	952,981		$	886,059
Change in gross unearned premiums		3,458			20,231			(61,442	)		(35,593	)
Gross premiums earned		307,959			294,409			891,539			850,466
Ceded premiums earned		(148,266	)		(131,964	)		(420,645	)		(399,323	)
Net premiums earned		159,693			162,445			470,894			451,143
Net investment income		2,887			1,548			7,050			3,797
Net realized losses		(3	)		(6	)		(121	)		(926	)
Other revenue		2,916			3,421			10,049			10,835
Total revenues		165,493			167,408			487,872			464,849
EXPENSES:
Losses and loss adjustment expenses		155,849			129,632			397,409			328,376
Policy acquisition costs, net of ceding commission income (1)		39,194			35,984			115,826			109,183
General and administrative expenses, net of ceding commission income(2)		17,758			17,169			54,947			52,490
Goodwill impairment		—			—			91,959			—
Total expenses		212,801			182,785			660,141			490,049
Operating Loss		(47,308	)		(15,377	)		(172,269	)		(25,200	)
Interest expense, net		2,027			2,150			5,750			5,953
Loss before income taxes		(49,335	)		(17,527	)		(178,019	)		(31,153	)
Benefit for income taxes		(1,095	)		(1,117	)		(11,155	)		(5,644	)
Net loss	$	(48,240	)	$	(16,410	)	$	(166,864	)	$	(25,509	)
OTHER COMPREHENSIVE LOSS
Change in net unrealized losses on investments		(17,471	)		(1,344	)		(65,403	)		(8,316	)
Reclassification adjustment for net realized investment losses (gains)		3			6			121			(96	)
Income tax expense related to items of other comprehensive losses		4,089			310			15,282			1,950
Total comprehensive loss	$	(61,619	)	$	(17,438	)	$	(216,864	)	$	(31,971	)
Weighted average shares outstanding
Basic		26,369,265			27,938,028			26,536,700			27,902,814
Diluted		26,369,265			27,938,028			26,536,700			27,902,814
Loss per share
Basic	$	(1.83	)	$	(0.59	)	$	(6.29	)	$	(0.91	)
Diluted	$	(1.83	)	$	(0.59	)	$	(6.29	)	$	(0.91	)

(1)

Policy acquisition costs includes $11.7 million and $34.9 million of ceding commission income for the three and nine months ended September 30, 2022 and $12.0 million and $35.2 million for the three and nine months of September 30, 2021, respectively.

(2)

General and administration includes $3.8 million and $11.5 million of ceding commission income for the three and nine months ended September 30, 2022 and $4.0 million and $11.6 million for the three and nine months ended September 30, 2021, respectively.

See accompanying notes to unaudited condensed consolidated financial statements.

HERITAGE INSURANCE HOLDINGS, INC.

Condensed Consolidated Statements of Stockholders’ Equity

(Unaudited)

(Amounts in thousands, except share amounts)


	Common Shares			Par Value		Additional Paid-In Capital			Retained (Deficit) Earnings			Treasury Shares			Accumulated Other Comprehensive Loss			Total Stockholders' Equity
Balance at December 31, 2021		26,753,511		$	3	$	332,797		$	138,381		$	(123,557	)	$	(4,573	)	$	343,051
Net unrealized change in investments, net of tax		—			—		—			—			—			(24,321	)		(24,321	)
Shares tendered for income taxes withholding		(9,849	)		—		(89	)		—			—			—			(89	)
Restricted stock vested		25,000			—		—			—			—			—			—
Issued restricted stock		397,176			—		—			—			—			—			—
Stock-based compensation on restricted stock		—			—		505			—			—			—			505
Stock buy-back		(721,118	)		—		—			—			(5,000	)		—			(5,000	)
Cash dividends declared ($0.06 per common stock)		—			—		—			(1,621	)		—			—			(1,621	)
Net loss		—			—		—			(30,759	)		—			—			(30,759	)
Balance at March 31, 2022		26,444,720		$	3	$	333,213		$	106,001		$	(128,557	)	$	(28,894	)	$	281,766
Net unrealized change in investments, net of tax		—			—		—			—			—			(12,300	)		(12,300	)
Adjustment to shares tendered for income taxes withholding		—			—		31			—			—			—			31
Issued restricted stock		99,376			—		—			—			—			—			—
Stock-based compensation on restricted stock		—			—		503			—			—			—			503
Cash dividends declared ($0.06 per common stock)		—			—		—			(1,588	)		—			—			(1,588	)
Net loss		—			—		—			(87,866	)		—			—			(87,866	)
Balance at June 30, 2022		26,544,096		$	3	$	333,747		$	16,547		$	(128,557	)	$	(41,194	)	$	180,546
Net unrealized change in investments, net of tax		—			—		—			—			—			(13,379	)		(13,379	)
Adjustment to shares tendered for income taxes withholding		—			—		—			—			—			—			—
Forfeiture on restricted stock		(12,422	)		—		—			—			—			—			—
Stock-based compensation on restricted stock		—			—		499			—			—			—			499
Stock buy-back		(632,744	)		—		—			—			(1,729	)		—			(1,729	)
Cash dividends declared ($0.06 per common stock)		—			—		—			—			—			—			—
Net loss		—			—		—			(48,240	)		—			—			(48,240	)
Balance at September 30, 2022		25,898,930		$	3	$	334,246		$	(31,693	)	$	(130,286	)	$	(54,573	)	$	117,697


	Common Shares			Par Value		Additional Paid-In Capital			Retained Earnings			Treasury Shares			Accumulated Other Comprehensive (Loss) Income			Total Stockholders' Equity
Balance at December 31, 2020		27,748,606		$	3	$	331,867		$	219,782		$	(115,365	)	$	6,057		$	442,344
Net unrealized change in investments, net of tax		—			—		—			—			—			(8,202	)		(8,202	)
Shares tendered for income taxes withholding		(12,500	)		—		(127	)		—			—			—			(127	)
Restricted stock vested		25,000			—		—			—			—			—			—
Issued restricted stock		143,817			—		—			—			—			—			—
Stock-based compensation on restricted stock		—			—		260			—			—			—			260
Cash dividends declared ($0.06 per common stock)		—			—		—			(1,679	)		—			—			(1,679	)
Net loss		—			—		—			(5,148	)		—			—			(5,148	)
Balance at March 31, 2021		27,904,923		$	3	$	332,000		$	212,955		$	(115,365	)	$	(2,145	)	$	427,448
Net unrealized change in investments, net of tax		—			—		—			—			—			2,768			2,768
Restricted stock vested		—			—		—			—			—			—			—
Stock-based compensation on restricted stock		—			—		287			—			—			—			287
Issued restricted stock		42,018			—		—			—			—			—			—
Cash dividends declared ($0.06 per common stock)		—			—		—			(1,680	)		—			—			(1,680	)
Net loss		—			—		—			(3,950	)		—			—			(3,950	)
Balance at June 30, 2021		27,946,941		$	3	$	332,287		$	207,325		$	(115,365	)	$	623		$	424,873
Net unrealized change in investments, net of tax		—			—		—			—			—			(1,028	)		(1,028	)
Shares tendered for income taxes withholding		(6,473	)		—		(45	)		—			—			—			(45	)
Restricted stock vested		10,267			—		—			—			—			—			—
Stock-based compensation on restricted stock		—			—		320			—			—			—			320
Stock buy-back		(148,109	)		—		—			—			(1,005	)		—			(1,005	)
Cash dividends declared ($0.06 per common stock)		—			—		—			(1,680	)		—			—			(1,680	)
Net loss		—			—		—			(16,410	)		—			—			(16,410	)
Balance at September 30, 2021		27,802,626		$	3	$	332,562		$	189,235		$	(116,370	)	$	(405	)	$	405,025

See accompanying notes to unaudited condensed consolidated financial statements.

HERITAGE INSURANCE HOLDINGS, INC.

Condensed Consolidated Statements of Cash Flows

(Unaudited)

(Amounts in thousands)


	For the Nine Months Ended September 30,
	2022			2021
OPERATING ACTIVITIES
Net loss	$	(166,864	)	$	(25,509	)
Adjustments to reconcile net loss to net cash (used in) provided by operating activities:
Stock-based compensation		1,507			866
Bond amortization and accretion		2,561			3,018
Amortization of original issuance discount on debt		919			1,454
Goodwill impairment		91,959			—
Depreciation and amortization		6,233			6,345
Allowance for bad debt		10			106
Net realized investment losses (gains)		121			(96	)
Net change for unrealized losses in other investments		—			1,022
Deferred income taxes, net		(8,781	)		(2,862	)
Changes in operating assets and liabilities:
Accrued investment income		(350	)		(305	)
Premiums receivable, net		(4,211	)		2,488
Prepaid reinsurance premiums		(115,495	)		(92,354	)
Reinsurance recoverable on paid and unpaid claims		(597,234	)		8,663
Income taxes receivable, net		(2,021	)		(3,266	)
Deferred policy acquisition costs, net		(6,768	)		(6,160	)
Right of use leased asset		2,535			(22,192	)
Other assets		1,139			(1,676	)
Lease incentives		1,622			2,622
Unpaid losses and loss adjustment expenses		619,186			(23,195	)
Unearned premiums		61,494			35,686
Reinsurance payable		86,570			162,812
Accrued interest		(160	)		(15	)
Accrued compensation		53			105
Advance premiums		13,351			15,073
Operating lease liabilities		(2,271	)		23,809
Other liabilities		(585	)		(13,667	)
Net cash (used in) provided by operating activities		(15,480	)		72,772
INVESTING ACTIVITIES
Fixed maturity securities sales, maturities and paydowns		56,334			147,406
Purchases in other investments		(7,500	)		—
Fixed maturity securities purchases		(88,137	)		(258,548	)
Return of capital in other investments		14,345			1,684
Equity securities reinvestments of dividends		(99	)		—
Leasehold improvements		(3,539	)		(2,622	)
Proceeds from sale of assets		—			45
Cost of property and equipment acquired		(4,911	)		(892	)
Net cash used in investing activities		(33,507	)		(112,927	)
FINANCING ACTIVITIES
Repayment of term note		(2,625	)		(3,750	)
Mortgage loan payments		(240	)		(228	)
Draw from credit facility		25,000			—
Proceeds from term loan facility		—			2,781
Repurchase of convertible notes		(22,529	)		—
Purchase of treasury stock		(6,729	)		(1,005	)
Tax withholdings on share-based compensation awards		(58	)		(171	)
Dividends paid		(4,771	)		(5,029	)
Net cash used in financing activities		(11,952	)		(7,402	)
Decrease in cash, cash equivalents, and restricted cash		(60,939	)		(47,557	)
Cash, cash equivalents and restricted cash, beginning of period		364,752			446,383
Cash, cash equivalents and restricted cash, end of period	$	303,813		$	398,826
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION
Income taxes paid	$	6,222		$	489
Interest paid	$	4,245		$	4,214

Reconciliation of cash, cash equivalents, and restricted cash to condensed consolidated balance sheets.



	September 30, 2022		December 31, 2021
	(In thousands)
Cash and cash equivalents	$	297,548	$	359,337
Restricted cash		6,265		5,415
Total	$	303,813	$	364,752

Restricted cash primarily represents funds held to meet regulatory requirements in certain states in which the Company operates.

See accompanying notes to unaudited condensed consolidated financial statements.

HERITAGE INSURANCE HOLDINGS, INC.

Notes to Unaudited Condensed Consolidated Financial Statements

NOTE 1. BASIS OF PRESENTATION AND SIGNIFICANT ACCOUNTING POLICIES

Basis of Presentation

The condensed consolidated financial statements include the accounts of Heritage Insurance Holdings, Inc. (together with its subsidiaries, the “Company”). These statements have been prepared in accordance with generally accepted accounting principles for interim financial information and with the instructions to Form 10-Q and Article 10 of Regulation S-X. Certain financial information that is normally included in annual consolidated financial statements prepared in accordance with GAAP, but that is not required for interim reporting purposes, has been omitted. In the opinion of the Company’s management, all material intercompany transactions and balances have been eliminated and all adjustments consisting of normal recurring accruals which are necessary for a fair statement of the financial condition and results of operations for the interim periods have been reflected. The accompanying interim condensed consolidated financial statements and related footnotes should be read in conjunction with the Company’s audited consolidated financial statements and related footnotes included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2021 filed on March 14, 2022 (the “2021 Form 10-K”).

Significant accounting policies

Income Taxes

During a third quarter assessment of the Company's deferred tax position, a valuation allowance of $10.7 million was recorded against the Company's deferred tax asset as of September 30, 2022. Based on the Internal Revenue Code (“IRC”) Section 953(d) election made for Osprey Re, the Company's captive reinsurer domiciled in Bermuda, the Company concluded a valuation allowance for its net deferred tax assets was necessary because those net deferred tax assets can only be applied to offset future taxable income of Osprey Re. Based on current available evidence, management does not believe there will be sufficient future Osprey Re taxable income over the next year in order to realize those net deferred tax assets. In the event Osprey Re recognizes future taxable income, the proportionate amount of the net operating loss carryforward will be used and an equivalent amount of the valuation allowance will reverse.

Changes to Significant Accounting Policies

The accounting policies of the Company are set forth in Note 1 to condensed consolidated financial statements contained in the Company’s 2021 Form 10-K.

Reclassification

Certain prior year amounts reported on the condensed consolidated statements of cashflows have been reclassified to conform to the current year presentation.

Accounting Pronouncements adopted

In August 2020, the FASB issued ASU 2020-06, "Accounting for Convertible Instruments and Contracts in an Entity's Own Equity" . The ASU i)simplifies the accounting for convertible debt and convertible preferred stock by reducing the number of accounting models, and amends certain disclosures, ii) amends and simplifies the derivative scope exception guidance for contracts in an entity's own equity, including share-based compensation, and iii) amends the diluted earnings per share calculations for convertible instruments and contracts in an entity's own equity. The if-converted method will be the only permissible method for computing the dilutive effect of the convertible debt instruments. Interest expense no longer includes amortization of debt discount. The Company adopted the guidance of ASU 2020-06 on January 1, 2022, reporting no material impact to the Company's consolidated condensed financial statements or disclosures.

Accounting Pronouncements not yet adopted

In March 2022, the FASB issued ASU 2022-02, “2022-02 Financial Instruments-Credit Losses” (Topic 326): Troubled Debt Restructurings and Vintage Disclosures (“ASU 2022-02”). ASU 2022-02 requires that an entity disclose current-period gross write-offs by year of origination for financing receivables and net investments in leases. ASU 2022-02 is effective for annual periods beginning after December 15, 2022, including interim periods within those periods. Early adoption is permitted. The Company will adopt ASU 2022-02 during the first quarter of 2023 and will provide the required disclosures, if determined to be material.

The Company has documented the summary of its significant accounting policies in its Notes to the Audited Consolidated Financial Statements annual report on Form 10-K. There have been no material changes to the Company’s accounting policies since the filing of that report.

No other new accounting pronouncements issued but not yet effective have had, or are expected to have, a material impact on the Company’s results of operations or financial position.

NOTE 2. INVESTMENTS

Securities Available-for-Sale

The amortized cost, gross unrealized gains and losses, and fair value of the Company’s debt securities available-for-sale are as follows for the periods presented:


September 30, 2022	Cost or Adjusted / Amortized Cost		Gross Unrealized Gains		Gross Unrealized Losses		Fair Value
Debt Securities Available-for-sale	(In thousands)
U.S. government and agency securities (1)	$	118,629	$	11	$	4,354	$	114,286
States, municipalities and political subdivisions		105,221		1		13,037		92,185
Special revenue		290,424		47		34,153		256,318
Industrial and miscellaneous		190,091		44		19,732		170,403
Total	$	704,365	$	103	$	71,276	$	633,192

(1)

Includes securities at September 30, 2022 with a carrying amount of $26.4 million that were pledged as collateral for the advance agreement entered into with a financial institution in 2018. The Company is permitted to withdraw or exchange any portion of the pledged collateral over the minimum requirement at any time.


December 31, 2021		Cost or Adjusted / Amortized Cost		Gross Unrealized Gains		Gross Unrealized Losses		Fair Value
Debt Securities Available-for-sale	(In thousands)
U.S. government and agency securities (1)		$	73,923	$	184	$	282	$	73,825
States, municipalities and political subdivisions			106,727		242		1,270		105,699
Special revenue			291,005		1,084		3,520		288,569
Hybrid securities			99		—		—		99
Industrial and miscellaneous			203,491		636		2,965		201,162
Total		$	675,245	$	2,146	$	8,037	$	669,354

(1)

Includes securities at December 31, 2021 with a carrying amount of $22.5 million that were pledged as collateral for the advance agreement entered into with a financial institution in 2018. The Company is permitted to withdraw or exchange any portion of the pledged collateral over the minimum requirement at any time.

Net Realized (Losses)Gains

The following table presents net realized (losses) gains on the Company’s debt securities available-for-sale for the three and nine months ended September 30, 2022 and 2021, respectively:


	2022					2021
Three Months Ended September 30,	Gains (Losses)			Fair Value at Sale		Gains (Losses)			Fair Value at Sale
	(In thousands)
Debt Securities Available-for-Sale
Total realized gains	$	—		$	50	$	2		$	3,470
Total realized losses		(3	)		110		(8	)		226
Net realized (losses) and gains	$	(3	)	$	160	$	(6	)	$	3,696


	2022					2021
Nine Months Ended September 30,	Gains (Losses)			Fair Value at Sale		Gains (Losses)			Fair Value at Sale
	(In thousands)
Debt Securities Available-for-Sale
Total realized gains	$	32		$	2,451	$	106		$	24,265
Total realized losses		(153	)		6,206		(10	)		1,043
Net realized (losses) and gains	$	(121	)	$	8,657	$	96		$	25,308

As of September 30, 2021, the Company recorded on its condensed consolidated statement of operations in net realized (losses) gains an impairment of approximately $1.0 million on its REIT investment which is excluded from the table above.

The table below summarizes the Company’s debt securities at September 30, 2022 by contractual maturity periods. Actual results may differ as issuers may have the right to call or prepay obligations, with or without penalties, prior to the contractual maturity of those obligations.


	At September 30, 2022
	Cost or Amortized Cost		Percent of Total			Fair Value		Percent of Total
Maturity dates:						(In thousands)
Due in one year or less	$	95,442		14	%	$	93,586		15	%
Due after one year through five years		342,738		49	%		313,712		50	%
Due after five years through ten years		199,300		28	%		165,917		26	%
Due after ten years		66,885		9	%		59,977		9	%
Total	$	704,365		100	%	$	633,192		100	%

Net Investment Income

The following table summarizes the Company’s net investment income by major investment category for the three and nine months ended September 30, 2022 and 2021, respectively:


	Three Months Ended September 30,				Nine Months Ended September 30,
	2022		2021		2022		2021
	(In thousands)				(In thousands)
Debt securities	$	2,992	$	1,986	$	7,695	$	5,164
Equity securities		—		—		—		—
Cash and cash equivalents		273		17		433		72
Other investments		135		514		447		1,101
Net investment income		3,400		2,517		8,575		6,337
Less: Investment expenses		513		969		1,525		2,540
Net investment income, less investment expenses	$	2,887	$	1,548	$	7,050	$	3,797

The following tables present, for all debt securities available-for-sale in an unrealized loss position (including securities pledged) and for which no credit loss allowance been established to date, the aggregate fair value and gross unrealized loss by length of time the security has continuously been in an unrealized loss position at September 30, 2022 and December 31, 2021, respectively:


	Less Than Twelve Months						Twelve Months or More
September 30, 2022	Number of Securities		Gross Unrealized Losses		Fair Value		Number of Securities		Gross Unrealized Losses		Fair Value
Debt Securities Available-for-sale
U.S. government and agency securities		93	$	4,023	$	98,801		5	$	331	$	8,911
States, municipalities and political subdivisions		61		5,166		39,273		64		7,871		47,766
Special revenue		378		15,277		121,001		153		18,876		103,038
Industrial and miscellaneous		190		7,376		98,431		103		12,356		66,066
Total fixed maturity securities		722	$	31,842	$	357,506		325	$	39,434	$	225,781


	Less Than Twelve Months						Twelve Months or More
December 31, 2021	Number of Securities		Gross Unrealized Losses		Fair Value		Number of Securities		Gross Unrealized Losses		Fair Value
Debt Securities Available-for-sale
U.S. government and agency securities		43	$	282	$	57,420		—	$	—	$	—
States, municipalities and political subdivisions		98		1,270		80,972		—		—		—
Special revenue		253		3,485		195,450		14		35		1,214
Industrial and miscellaneous		191		2,387		146,746		18		578		11,598
Total fixed maturity securities		585	$	7,424	$	480,588		32	$	613	$	12,812

The Company completes a detailed analysis each quarter to assess whether the decline in the fair value of any investment below its cost basis is the result of a credit loss. All available-for-sale securities with unrealized losses are reviewed. The Company considers

many factors in completing its quarterly review of securities with unrealized losses for credit-related impairment to determine whether a credit loss exists, including the extent to which fair value is below cost, the implied yield to maturity, rating downgrades of the security and whether or not the issuer has failed to make scheduled principal or interest payments. The Company also takes into consideration information about the financial condition of the issuer and industry factors that could negatively impact the capital markets.

If the decline in fair value of an available-for-sale security below its amortized cost is considered to be the result of a credit loss, the Company compares the estimated present value of the cash flows expected to be collected to the amortized cost of the security. For the three and nine months ending September 30, 2022, management concluded that the decline in the fair value was not a result of credit losses but rather as a direct result from the increase in the market interest rates. Therefore, the Company did not have an allowance for credit losses as of September 30, 2022 or December 31, 2021.

Quarterly, the Company considers whether it intends to sell an available-for-sale security or if it is more likely than not that it will be required to sell the security before recovery of its amortized costs. In these instances, a decline in fair value is recognized in net income based on the fair value of the security at the time of assessment, resulting in a new cost basis for the security.

Other Investments

Non-Consolidating Variable Interest Entities (“VIEs”)

The Company makes passive investments in limited partnerships (“LPs”), which are accounted for using the equity method, with income reported in earnings. The Company also makes passive investments in a Real Estate Investment Trust (“REIT”) and an Insurtech company, which are accounted for using the measurement alternative method, which is reported at cost less impairment (if any), plus or minus changes from observable price changes.

The following table summarizes the carrying value and maximum loss exposure of the Company’s non-consolidated VIEs at September 30, 2022 and December 31, 2021:


	As of September 30, 2022				As of December 31, 2021
	Carrying Value		Maximum Loss Exposure		Carrying Value		Maximum Loss Exposure
	(in thousands)
Investments in non-consolidated VIEs - Equity Method	$	3,517	$	3,517	$	3,852	$	3,852
Investments in non-consolidated VIEs - Amortized Cost	$	8,490	$	8,490	$	15,000	$	15,000
Investments in non-consolidated VIEs - Measure Alternative	$	5,077	$	5,077	$	5,077	$	5,077
Total non-consolidated VIEs	$	17,084	$	17,084	$	23,929	$	23,929

No agreements exist requiring the Company to provide additional funding to any of the non-consolidated VIEs in excess of the Company’s initial investment.

NOTE 3. FAIR VALUE OF FINANCIAL MEASUREMENTS

Fair value is determined based on the exchange price that would be received to sell an asset or paid to transfer a liability in the principal or most advantageous market for the asset or liability in an orderly transaction between market participants at the measurement date.

The Company is required to use an established hierarchy for fair value measurements based upon the inputs to the valuation and degree to which they are observable or not observable in the market. The three levels in the hierarchy are as follows:

•

Level 1 – Unadjusted quoted prices are available in active markets for identical assets/liabilities as of the reporting date.

•

Level 2 – Valuations based on observable inputs, such as quoted prices for similar assets or liabilities at the measurement date; quoted prices in the markets that are not active; or other inputs that are observable, either directly or indirectly.

•

Level 3 – Pricing inputs are unobservable and significant to the overall fair value measurement, and the determination of fair value requires significant management judgment or estimation.

The highest priority is assigned to Level 1 inputs and the lowest priority to Level 3 inputs. The Company did not hold any Level 3 assets or liabilities as of September 30, 2022 or December 31, 2021.

The following table presents information about the Company’s assets measured at fair value on a recurring basis. The Company assesses the levels for the investments at each measurement date, and transfers between levels are recognized on the actual date of the

event or change in circumstances that caused the transfer in accordance with the Company’s accounting policy regarding the recognitions of transfers between levels of the fair value hierarchy.

The tables below present the balances of the Company’s invested assets measured at fair value on a recurring basis:


September 30, 2022	Total		Quoted Prices in Active Markets for Identical Assets (Level 1)		Significant Other Observable Inputs (Level 2)		Significant Unobservable Inputs (Level 3)
Invested Assets:	(in thousands)
Debt Securities Available-for-sale
U.S. government and agency securities	$	114,286	$	—	$	114,286	$	—
States, municipalities and political subdivisions		92,185		—		92,185		—
Special revenue		256,318		—		256,318		—
Industrial and miscellaneous		170,403		—		170,403		—
Total investments	$	633,192	$	—	$	633,192	$	—


December 31, 2021	Total		Quoted Prices in Active Markets for Identical Assets (Level 1)		Significant Other Observable Inputs (Level 2)		Significant Unobservable Inputs (Level 3)
Invested Assets:	(in thousands)
Debt Securities Available-for-sale
U.S. government and agency securities	$	73,825	$	364	$	73,461	$	—
States, municipalities and political subdivisions		105,699		—		105,699		—
Special revenue		288,569		—		288,569		—
Hybrid securities		99		—		99		—
Industrial and miscellaneous		201,162		—		201,162		—
Total investments	$	669,354	$	364	$	668,990	$	—

Financial Instruments excluded from the fair value hierarchy

The carrying value of premium receivables and accounts payable, accrued expense, revolving loans and borrowings under the Company’s senior secured credit facility approximate their fair value. The rate at which revolving loans and borrowings under the Company’s senior secured credit facility bear interest resets periodically at market interest rates.

Non-recurring fair value measurements

The Company determines the fair value of the goodwill and intangible assets using a combination of a discounted cash flow approach and market approaches, which contain significant unobservable inputs and therefore are considered a Level 3 fair value measurement. The unobservable inputs in the analysis generally include future cash flow projections and a discount rate.

For the year ended December 31, 2021, the Company recorded a goodwill impairment following its annual valuation review of approximately $61 million. In the second quarter of 2021, the Company recognized an impairment in other investments of approximately $1.0 million based on the estimated fair value of the Company's ownership interest. During the second quarter of 2022, Management concluded that it had a full impairment of its remaining goodwill and that the carrying value of $92.0 million should be written off based on the following factors: (i) disruptions in the equity markets, specifically for property and casualty insurance companies, largely due to recent weather-related catastrophe events; (ii) elevated loss ratios for property insurers in the Company's markets; and (iii) the Company's market cap was below book value.

NOTE 4. OTHER COMPREHENSIVE LOSS

The following table is a summary of other comprehensive loss and discloses the tax impact of each component of other comprehensive loss for the three and nine months ended September 30, 2022 and 2021, respectively:


	For the Three Months Ended September 30,
	2022									2021
	Pre-tax			Tax			After-tax			Pre-tax			Tax			After-tax
	(in thousands)
Other comprehensive loss
Change in unrealized losses on investments, net	$	(17,471	)	$	4,090		$	(13,381	)	$	(1,344	)	$	311		$	(1,033	)
Reclassification adjustment of realized losses (gains) included in net loss		3			(1	)		2			6			(1	)		5
Effect on other comprehensive loss	$	(17,468	)	$	4,089		$	(13,379	)	$	(1,338	)	$	310		$	(1,028	)


	For the Nine Months Ended September 30,
	2022									2021
	Pre-tax			Tax			After-tax			Pre-tax			Tax		After-tax
	(in thousands)
Other comprehensive loss
Change in unrealized losses on investments, net	$	(65,403	)	$	15,310		$	(50,093	)	$	(8,316	)	$	1,928	$	(6,388	)
Reclassification adjustment of realized losses (gains) included in net loss		121			(28	)		93			(96	)		22		(74	)
Effect on other comprehensive loss	$	(65,282	)	$	15,282		$	(50,000	)	$	(8,412	)	$	1,950	$	(6,462	)

NOTE 5. LEASES

The Company has entered into operating and financing leases primarily for real estate and vehicles. The Company will determine whether an arrangement is a lease at inception of the agreement. The operating leases have terms of one to ten years, and often include one or more options to renew. These renewal terms can extend the lease term from two to ten years and are included in the lease term when it is reasonably certain that the Company will exercise the option. The Company considers these options in determining the lease term used in establishing the Company’s right-of-use assets and lease obligations. The Company’s lease agreements do not contain any material residual value guarantees or material restrictive covenants.

Because the rate implicit in each operating lease is not readily determinable, the Company uses its incremental borrowing rate to determine present value of the lease payments. The Company used the implicit rates within the finance leases.

Components of the Company’s lease costs for the three and nine months ended September 30, 2022 and 2021 were as follows (in thousands):


	Three Months Ended September 30, 2022		Three Months Ended September 30, 2021
Amortization of ROU assets - Finance leases	$	651	$	647
Interest on lease liabilities - Finance leases		244		263
Variable lease cost (cost excluded from lease payments)		287		112
Operating lease cost (cost resulting from lease payments)		350		339
Total lease cost	$	1,532	$	1,361


	Nine Months Ended September 30, 2022		Nine Months Ended September 30, 2021
Amortization of ROU assets - Finance leases	$	1,943	$	1,321
Interest on lease liabilities - Finance leases		739		524
Variable lease cost (cost excluded from lease payments)		713		373
Operating lease cost (cost resulting from lease payments)		1,055		1,018
Total lease cost	$	4,450	$	3,236

Supplemental cash flow information and non-cash activity related to the Company’s operating and financing leases were as follows (in thousands):


	At September 30, 2022		At September 30, 2021
Finance lease - Operating cash flows	$	737	$	31
Finance lease - Financing cash flows	$	1,540	$	100

Operating lease - Operating cash flows (fixed payments)	$	1,188	$	1,123
Operating lease - Operating cash flows (liability reduction)	$	942	$	840

Supplemental balance sheet information related to the Company’s operating and financing leases as of September 30, 2022 were as follows (in thousands):


	Balance Sheet Classification	September 30, 2022		December 31, 2021
Right-of-use assets - operating	Right-of-use lease asset, net	$	4,437	$	5,035
Right-of-use assets - finance	Right-of-use lease asset, net	$	20,781	$	22,718
Lease liability - operating	Lease liability	$	5,821	$	6,551
Lease liability - finance	Lease liability	$	23,080	$	24,621

Weighted-average remaining lease term and discount rate for the Company’s operating and financing leases for the periods presented below were as follows:


	September 30, 2022			September 30, 2021
Weighted average lease term - Finance leases	8.37 yrs.			9.34 yrs.
Weighted average lease term - Operating leases	5.68 yrs.			6.40 yrs.
Weighted average discount rate - Finance leases		4.2	%		4.2	%
Weighted average discount rate - Operating leases		5.4	%		5.3	%

Maturities of lease liabilities by fiscal year for the Company’s operating and financing leases were as follows (in thousands):


	September 30, 2022
2022 remaining	$	1,161
2023		4,592
2024		4,263
2025		3,970
2026		3,990
Thereafter		16,225
Total lease payments		34,201
Less: imputed interest		(5,300	)
Present value of lease liabilities	$	28,901

NOTE 6. PROPERTY AND EQUIPMENT, NET

Property and equipment, net consisted of the following at September 30, 2022 and December 31, 2021:


	September 30, 2022			December 31, 2021
	(In thousands)
Land	$	2,582		$	2,582
Building		10,141			10,141
Computer hardware and software		12,089			7,204
Office furniture and equipment		1,381			1,355
Tenant and leasehold improvements		10,172			8,255
Vehicle fleet		720			720
Total, at cost		37,085			30,257
Less: accumulated depreciation and amortization		(14,301	)		(12,831	)
Property and equipment, net	$	22,784		$	17,426

Depreciation and amortization expense for property and equipment was approximately $544,900 and $736,000 for the three months ended September 30, 2022 and 2021, respectively and $1.5 million and $1.6 million for the nine months ended September 30, 2022 and 2021, respectively. The Company’s real estate consists of 15 acres of land, two buildings with a gross area of 88,378 square feet and a parking garage.

NOTE 7. GOODWILL AND OTHER INTANGIBLE ASSETS

Goodwill and Intangible Assets

At September 30, 2022 and December 31, 2021, goodwill was $0 and $92.0 million and intangible assets were $51.2 million and $55.9 million, respectively. The Company has determined the useful life of the other intangible assets to range between 2.5-15 years. Intangible assets include $1.3 million relating to insurance licenses which is classified as an indefinite lived intangible and is subject to annual impairment testing concurrent with goodwill.


	Goodwill
	(in thousands)
Balance as of December 31, 2021	$	91,959
Goodwill acquired	—
Impairment		(91,959	)
Balance as of September 30, 2022	$	—

Management tests goodwill and other intangible assets for impairment annually during the fourth quarter, or more frequently should events or changes in circumstances indicate that goodwill or the Company’s other intangible assets might be impaired. During the second quarter of 2022, management determined a triggering event occurred for which it deemed an interim evaluation of goodwill was appropriate and concluded the remaining balance of its goodwill was fully impaired. The carrying value of $92.0 million was written off based on the following factors: (i) disruptions in the equity markets, specifically for property and casualty insurance companies, largely due to recent weather-related catastrophe events; (ii) elevated loss ratios for property insurers in the Company’s markets; and (iii) the Company’s market cap was below book value. These factors reduced the Company’s previously modeled fair value of the Company and resulted in a $92.0 million goodwill impairment charge, as of the second quarter of 2022, most of which was not tax deductible.

Other Intangible Assets

The Company’s intangible assets consist of brand, agent relationships, renewal rights, customer relations, trade names, non-competes and insurance licenses.

Amortization expense of the Company’s intangible assets for three months ended September 30, 2022 and 2021 was $1.6 million and for the nine months ended September 30, 2022 and 2021 was $4.8 million. No impairment in the value of amortizing or non-amortizing intangible assets was recognized during the three and nine months ended September 30, 2022 or 2021.

Estimated annual pretax amortization of intangible assets for each of the next five years and thereafter is as follows (in thousands):


Year	Amount
2022 - remaining	$	1,588
2023	$	6,351
2024	$	6,351
2025	$	6,315
2026	$	6,114
Thereafter	$	23,129
Total	$	49,848

NOTE 8. LOSS PER SHARE

The following table sets forth the computation of basic and diluted loss per share (“EPS”) for the periods indicated.


	Three Months Ended September 30,						Nine Months Ended September 30,
	2022			2021			2022			2021
Basic loss per share:
Net loss attributable to common stockholders (000's)	$	(48,240	)	$	(16,410	)	$	(166,864	)	$	(25,509	)
Weighted average shares outstanding		26,369,265			27,938,028			26,536,700			27,902,814
Basic loss per share:	$	(1.83	)	$	(0.59	)	$	(6.29	)	$	(0.91	)

Diluted loss per share:
Net loss attributable to common stockholders (000's)	$	(48,240	)	$	(16,410	)	$	(166,864	)	$	(25,509	)
Weighted average shares outstanding		26,369,265			27,938,028			26,536,700			27,902,814
Total weighted average dilutive shares		26,369,265			27,938,028			26,536,700			27,902,814
Diluted loss per share:	$	(1.83	)	$	(0.59	)	$	(6.29	)	$	(0.91	)

The Company had 196,914 and 2,677,355 antidilutive shares as of September 30, 2022 and 2021, respectively. The convertible notes were excluded from the computations because the conversion price on these notes was greater than the average market price of our common shares during each of the respective periods, and therefore, would be anti-dilutive to earnings per share under the "if converted" method under the guidance of ASU 2020-06, adopted by the Company on January 1, 2022.

NOTE 9. DEFERRED REINSURANCE CEDING COMMISSION

The Company defers reinsurance ceding commission income, which is amortized over the effective period of the related insurance policies. For the three months ended September 30, 2022 and 2021, the Company allocated ceding commission income of $11.7 million and $12.0 million to policy acquisition costs and $3.8 million and $4.0 million to general and administrative expense, respectively. For the nine months ended September 30, 2022 and 2021, the Company allocated ceding commission income of $34.9 million and $35.2 million to policy acquisition costs and $11.5 million and $11.6 million to general and administrative expense, respectively.

The table below depicts the activity regarding deferred reinsurance ceding commission, included in accounts payable and other liabilities during the three and nine months ended September 30, 2022 and 2021.


	Three Months Ended September 30,						Nine Months Ended September 30,
	2022			2021			2022			2021
	(In thousands)
Beginning balance of deferred reinsurance ceding commission income	$	38,529		$	39,940		$	40,405		$	39,995
Ceding commission deferred		17,046			17,659			46,110			48,447
Less: ceding commission earned		(15,486	)		(15,978	)		(46,426	)		(46,821	)
Ending balance of deferred reinsurance ceding commission income	$	40,089		$	41,621		$	40,089		$	41,621

NOTE 10. DEFERRED POLICY ACQUISITION COSTS

The Company defers certain costs in connection with written policies, called deferred policy acquisition costs (“DPAC”), which are amortized over the effective period of the related insurance policies.

The Company anticipates that its DPAC will be fully recoverable in the near term. The table below depicts the activity regarding DPAC for the three and nine months ended September 30, 2022 and 2021.


	Three Months Ended September 30,						Nine Months Ended September 30,
	2022			2021			2022			2021
	(In thousands)
Beginning Balance	$	99,468		$	95,967		$	93,881		$	89,265
Policy acquisition costs deferred		39,194			47,976			139,028			144,380
Amortization		(38,013	)		(48,518	)		(132,260	)		(138,220	)
Ending Balance	$	100,649		$	95,425		$	100,649		$	95,425

NOTE 11. INCOME TAXES

The Company files a consolidated federal income tax return. Deferred federal income taxes reflect the future tax consequences of differences between the tax basis of assets and liabilities and their financial reporting amounts at each year end. The Company accounts for income taxes under the asset and liability method, which requires the recognition of deferred taxes for temporary differences between the financial statement and tax return basis of assets and liabilities.

Deferred tax assets generally represent items that can be used as a tax deduction or credit in future years for which the Company has already recorded the tax benefit in its income statement. Deferred tax liabilities generally represent tax expense recognized in the Company's financial statements for which payment has been deferred or expenditures for which the Company has already taken a deduction in its tax return but have not yet been recognized in its financial statements. Under GAAP the Company is required to evaluate the recoverability of its deferred tax assets and establish a valuation allowance if necessary to reduce its deferred tax assets to an amount that is more likely than not to be realized. Significant judgment is required in determining whether valuation allowances should be established, as well as the amount of such allowances.

The Company establishes or adjusts valuation allowances for deferred tax assets when it estimates that it is more likely than not that future taxable income will be insufficient to realize the value of the deferred tax assets. The Company evaluates all significant available positive and negative evidence as part of its analysis. Negative evidence includes the existence of losses in recent years. Positive evidence includes the forecast of future taxable income and tax-planning strategies that would result in the realization of deferred tax assets. The underlying assumptions its uses in forecasting future taxable income require significant judgment and take into account the Company's recent performance. The ultimate realization of deferred tax assets depends on the generation of future taxable income during the periods in which temporary differences are deductible or creditable. If actual experience differs from these estimates and assumptions, the recognized deferred tax asset value may not be fully realized, resulting in an increase to income tax expense in its results of operations.

As of September 30, 2022. the Company recognized a valuation allowance of $10.7 million against the net deferred tax assets generated at its foreign domiciled captive reinsurer, Osprey Re. The Company can only realize those net deferred tax assets to the extent Osprey Re contributes future taxable income to the consolidated group. Management believes there is not sufficient evidence at the current time to realize the Osprey Re net deferred tax assets within the next calendar year. The valuation allowance is accounted for as an increase to income tax expense for the quarter. Osprey Re’s future taxable income can be used to apply against its net deferred tax assets to reduce taxable income and the valuation allowance will decrease proportionately resulting in a reduction of income tax expense. Changes in tax laws and rates may affect recorded deferred tax assets and liabilities and its effective tax rate in the future.

For the three months ended September 30, 2022 and 2021, the Company recorded a tax benefit of $1.1 million and $1.1 million, respectively, which corresponds to effective tax rates of 2.2% and 6.4%, respectively. For the nine months ended September 30, 2022 and 2021, the Company recorded an income tax benefit of $11.2 million and $5.6 million, respectively, which corresponds to effective tax rates of 6.3% and 18.1%, respectively. The effective tax rates for the three and nine months ended September 30, 2022 were impacted by the mostly non-deductible goodwill impairment charge taken in the second quarter of 2022 described in Note 7. Goodwill and Other Intangible Assets as well as the valuation allowance described above. Effective tax rates are dependent upon components of pre-tax earnings and the related tax effects. The effective tax rate for each period was also affected by various permanent tax differences, including disallowed executive compensation deductions which was further limited in 2018 and future years upon the enactment of H.R.1, commonly referred to as the Tax Cuts and Jobs Act (“Tax Act”). Additionally, the state effective income tax rate can also fluctuate as a result of changes in the geographic dispersion of the Company’s business. Finally, the effective tax rate can fluctuate throughout the year as estimates used in the tax provision for each quarter are updated as more information becomes available throughout the year.

The table below summarizes the significant components of the Company’s net deferred asset (liability):



	September 30, 2022			December 31, 2021
Deferred tax assets:	(In thousands)
Unearned premiums	$	13,454		$	15,805
Unearned commission		9,384			9,459
State net operating loss		1,490			1,222
Tax-related discount on loss reserve		4,799			3,872
Stock-based compensation		455			84
Accrued expenses		1,481			1,182
Leases		841			792
Unrealized losses		17,195			1,913
Federal net operating loss carryforward		15,752			—
Other		416			472
Valuation allowance		(10,650	)		—
Total deferred tax asset		54,617			34,801
Deferred tax liabilities:
Deferred acquisition costs		23,561			21,977
Prepaid expenses		118			177
Property and equipment		1,221			1,504
Note discount		225			187
Basis in purchased investments		666			34
Basis in purchased intangibles		—			14,550
Internal revenue code 481(a)-Accounting method change		1,104			4,416
Amortization of goodwill		11,459			—
Other		1,626			1,382
Total deferred tax liabilities		39,980			44,227
Net deferred tax asset (liability)	$	14,637		$	(9,426	)

As of September 30, 2022, the Company has a gross operating loss carryforward for federal and state income tax purposes of $20.7 million and $45.8 million, respectively, which will expire after 2042. The statute of limitations related to the Company’s federal and state income tax returns remains open from the Company’s filings for 2018 through 2021.

Osprey Re, our reinsurance affiliate, based in Bermuda, made an irrevocable election under IRC Section 953(d) to be treated as a domestic insurance company for U.S. Federal income tax purposes. As a result of this election, the Company's reinsurance subsidiary is subject to United States income tax as if it were a U.S. corporation. Furthermore, limitations may be imposed on the ability to utilize Osprey Re’s deferred tax assets to the extent it has not contributed income to the consolidated group during its inclusion in the consolidated group.

NOTE 12. REINSURANCE

Overview

In order to limit the Company’s potential exposure to individual risks and catastrophic events, the Company purchases significant reinsurance from third party reinsurers. Purchasing reinsurance is an important part of the Company’s risk strategy, and premiums ceded to reinsurers is one of the Company’s largest costs. The Company has strong relationships with reinsurers, which it attributes to its management’s industry experience, disciplined underwriting, and claims management capabilities. For each of the twelve months beginning June 1, 2021 and 2022, the Company purchased reinsurance from the following sources: (i) the Florida Hurricane Catastrophe Fund, a state-mandated catastrophe fund (“FHCF”) for Florida policies only, (ii) private reinsurers, all of which were rated “A-” or higher by A.M. Best Company, Inc. (“A.M. Best”) or Standard & Poor’s Financial Services LLC (“S&P”) or were fully collateralized, and (iii) the Company’s wholly-owned reinsurance subsidiary, Osprey Re Ltd. (“Osprey”). Additionally, for the 2022 hurricane season, the Company purchased a portion of the Company's catastrophe excess of loss reinsurance program from Citrus Re Ltd. (“Citrus Re), a Bermuda special purpose insurer formed in 2014, through the 2022-1 notes, which cover catastrophe losses incurred for specific states. In addition to purchasing excess of loss catastrophe reinsurance, the Company also purchased quota share, property per risk and facultative reinsurance. The Company’s quota share program limits its exposure on catastrophe and non-catastrophe losses and provides ceding commission income. The Company’s per risk programs limit its net exposure in the event of a severe non-catastrophe loss impacting a single location or risk. The Company also utilizes facultative reinsurance to supplement its per risk reinsurance program where the Company capacity needs dictate.

Purchasing a sufficient amount of reinsurance to cover catastrophic losses from single or multiple events or significant non-catastrophe losses is an important part of the Company’s risk strategy. Reinsurance involves transferring, or “ceding”, a portion of the risk exposure on policies the Company writes to another insurer, known as a reinsurer. To the extent that the Company’s reinsurers are

unable to meet the obligations they assume under the Company’s reinsurance agreements, the Company remains liable for the entire insured loss.

The Company’s reinsurance agreements are prospective contracts. The Company records an asset, prepaid reinsurance premiums, and a liability, reinsurance payable, for the entire contract amount upon commencement of the Company’s new reinsurance agreements. The Company generally amortizes its catastrophe reinsurance premiums ratably over the 12-month contract period, which is June 1 through May 31. Its quota share reinsurance is amortized over the 12-month contract period and may be purchased on a calendar or fiscal year basis.

In the event that the Company incurs losses and loss adjustment expenses recoverable under its reinsurance program, the Company records amounts recoverable from its reinsurers on paid losses plus an estimate of amounts recoverable on unpaid losses. The estimate of amounts recoverable on unpaid losses is a function of its liability for unpaid losses associated with the reinsured policies; therefore, the amount changes in conjunction with any changes to its estimate of unpaid losses. As a result, a reasonable possibility exists that an estimated recovery may change significantly in the near term from the amounts included in the Company’s condensed consolidated financial statements.

The Company’s insurance regulators require all insurance companies, like us, to have a certain amount of capital and reinsurance coverage in order to cover losses and loss adjustment expenses upon the occurrence of a catastrophic event. The Company’s reinsurance program provides reinsurance in excess of its state regulator requirements, which are based on the probable maximum loss that it would incur from an individual catastrophic event estimated to occur once in every 100 years based on its portfolio of insured risks. The nature, severity and location of the event giving rise to such a probable maximum loss differs for each insurer depending on the insurer’s portfolio of insured risks, including, among other things, the geographic concentration of insured value within such portfolio. As a result, a particular catastrophic event could be a one-in-100-year loss event for one insurance company while having a greater or lesser probability of occurrence for another insurance company. The Company also purchases reinsurance coverage to protect against the potential for multiple catastrophic events occurring in the same year. The Company shares portions of its reinsurance program coverage among its insurance company affiliates.

2022-2023 Reinsurance Program

Catastrophe Excess of Loss Reinsurance

Effective June 1, 2022, the Company entered into catastrophe excess of loss reinsurance agreements covering Heritage Property & Casualty Insurance Company (“Heritage P&C”), Zephyr Insurance Company (“Zephyr”) and Narragansett Bay Insurance Company (“NBIC”). The catastrophe reinsurance programs are allocated among traditional reinsurers, the Florida Hurricane Catastrophe Fund (“FHCF”), Citrus Re Ltd., and Osprey Re Ltd (“Osprey”), the Company’s captive reinsurer. The FHCF covers Florida risks only and the Company elected to participate at 90% for the 2022 hurricane season. Osprey Re will provide reinsurance for a portion of the Heritage P&C, NBIC and Zephyr programs. The Company’s third-party reinsurers are either rated “A-” or higher by A.M. Best or S&P or are fully collateralized, to reduce credit risk. Osprey Re is fully collateralized.

The reinsurance program, which is segmented into layers of coverage, protects the Company for excess property catastrophe losses and loss adjustment expenses. The 2022-2023 reinsurance program provides first event coverage up to $1.3 billion for Heritage P&C, first event coverage up to $1.2 billion for NBIC, and first event coverage up to $780.0 million for Zephyr. The Company’s first event retention in a 1 in 100-year event would include retention for the respective insurance company as well as any retention by Osprey. The first event maximum retention up to a 1 in 100-year event for each insurance company subsidiary is as follows: Heritage P&C – $40.0 million, of which $35.0 million would be ceded to Osprey; NBIC – $30.0 million of which $30.0 million would be ceded to Osprey in a shared contract with Zephyr; and Zephyr – $40.0 million, of which $30.0 million would be ceded to Osprey in a shared contract with NBIC.

The Company is responsible for all losses and loss adjustment expenses in excess of the Company's reinsurance program. For second or subsequent catastrophic events, the Company’s total available coverage depends on the magnitude of the first event, as the Company may have coverage remaining from layers that were not previously fully exhausted. An aggregate of $3.2 billion of limit purchased in 2022 includes reinstatement through the purchase of reinstatement premium protection. The amount of coverage, however, will be subject to the severity and frequency of such events.

The Company's estimated net cost for the 2022-2023 catastrophe excess of loss reinsurance programs was approximately $359.5 million. This cost estimate is based on projected exposures for which there is a true up as of August 31, 2022.

Additionally, the Company placed an occurrence contract for business underwritten by NBIC which covers all catastrophe losses excluding named storms, on December 31, 2021, expiring December 31, 2022. The limit on the contract is $20.0 million with a retention of $20.0 million and has one reinstatement available.

The Company placed an aggregate contract for the Company’s business underwritten by NBIC which covers all catastrophe losses excluding named storms, on December 1, 2021, expiring March 31, 2022. The limit on the contract is $20.0 million with an aggregate retention of $21.0 million, with a $21.0 million per occurrence cap, and a $1.0 million franchise deductible.

Net Quota Share Reinsurance

The Company’s Net Quota Share coverage is proportional reinsurance, which applies to business underwritten by NBIC, for which certain of the Company’s other reinsurance (property catastrophe excess of loss and the second layer of the general excess of loss) inures to the quota share program. An occurrence limit of $20.0 million for catastrophe losses is in effect on the quota share program, subject to certain aggregate loss limits that vary by reinsurer. The amount and rate of ceding commissions slide, within a prescribed minimum and maximum, depending on loss performance. The Net Quota Share program was renewed on December 31, 2021 ceding 50.0% of the net premiums and losses and 5% of the prior year quota share is in run off.

Per Risk Coverage

For losses arising from business underwritten by Heritage P&C and losses arising from commercial residential business underwritten by NBIC, excluding losses from named storms, the Company purchased property per risk coverage for losses and loss adjustment expenses in excess of $1.0 million per claim. The limit recovered for an individual loss is $9.0 million and total limit for all losses is $27.0 million. There are two reinstatements available with additional premium due based on the amount of the layer exhausted. For losses arising from commercial residential business underwritten by NBIC, the Company also purchased property per risk coverage for losses and loss adjustments expenses in excess of $750,000 per claim. The limit recovered for an individual loss is $250,000 and total limit for all losses is $750,000. There are two reinstatements available with additional premium due based on the amount of the layer exhausted.

In addition, the Company purchased facultative reinsurance for losses in excess of $10.0 million for any properties it insured where the total insured value exceeded $10.0 million. This coverage applies to losses arising from business underwritten by Heritage P&C and losses arising commercial residential business underwritten by NBIC, excluding losses from named storms.

General Excess of Loss

The Company’s general excess of loss reinsurance protects business underwritten by NBIC and Zephyr multi-peril policies from single risk losses. For the contract period of July 1, 2021 through June 30, 2022, the coverage is in two layers in excess of the Company’s retention of the first $500,000 of loss. The first layer is $250,000 excess $500,000 for property and casualty losses and the second layer for property losses is $2.75 million excess $750,000. The second layer for casualty losses is $1.25 million excess $750,000. For the contract period of July 1, 2022 through June 30, 2023, the coverage for property losses is $2.75 million excess $750,000 and for casualty losses is $1.25 million excess $750,000.

In addition, the Company purchased facultative reinsurance for losses underwritten by NBIC in excess of $3.5 million.

For a detailed discussion of the Company’s 2021-2022 Reinsurance Program please refer to Part II, Item 8, “Financial Statements and Supplementary Data” and “Note 12. Reinsurance” in the Company’s 2021 Form 10-K.

Effect of Reinsurance

The Company’s reinsurance arrangements had the following effect on certain items in the condensed consolidated statement of income for the three and nine months ended September 30, 2022 and 2021:


	Three Months Ended September 30,						Nine Months Ended September 30,
	2022			2021			2022			2021
	(In thousands)						(In thousands)
Premium written:
Direct	$	304,501		$	274,178		$	952,981		$	886,059
Ceded		(60,885	)		(53,505	)		(536,139	)		(491,677	)
Net	$	243,616		$	220,673		$	416,842		$	394,382
Premiums earned:
Direct	$	307,959		$	294,409		$	891,539		$	850,466
Ceded		(148,266	)		(131,964	)		(420,645	)		(399,323	)
Net	$	159,693		$	162,445		$	470,894		$	451,143
Loss and Loss Adjustment Expenses
Direct	$	809,993		$	195,099		$	1,147,243		$	483,382
Ceded		(654,144	)		(65,467	)		(749,834	)		(155,006	)
Net	$	155,849		$	129,632		$	397,409		$	328,376

NOTE 13. RESERVE FOR UNPAID LOSSES

The Company determines the reserve for unpaid losses on an individual-case basis for all incidents reported. The liability also includes amounts which are commonly referred to as incurred but not reported, or “IBNR”, claims as of the balance sheet date. The

Company estimates its IBNR reserves by projecting its ultimate losses using industry accepted actuarial methods and then deducting actual loss payments and case reserves from the projected ultimate losses. Hurricane Ian struck Florida as a strong Category 4 hurricane on September 28, 2022. Gross catastrophe losses from Hurricane Ian are estimated to be of $655.4 million with net retained losses of $40.0 million. Gross losses from Hurricane Irma caused an increase in the ending balance as indicated below.

The table below summarizes the activity related to the Company’s reserve for unpaid losses:


	Three Months Ended September 30,						Nine Months Ended September 30,
	2022			2021			2022		2021
	(In thousands)
Balance, beginning of period	$	553,909		$	625,979		$	590,166	$	659,341
Less: reinsurance recoverable on unpaid losses		235,239			366,879			301,757		397,688
Net balance, beginning of period		318,670			259,100			288,409		261,653
Incurred related to:
Current year		156,855			130,425			395,921		331,374
Prior years		(1,006	)		(793	)		1,489		(2,998	)
Total incurred		155,849			129,632			397,410		328,376
Paid related to:
Current year		70,914			75,508			170,255		171,128
Prior years		24,088			27,273			136,047		132,950
Total paid		95,002			102,781			306,302		304,078
Net balance, end of period		379,517			285,951			379,517		285,951
Plus: reinsurance recoverable on unpaid losses		829,835			350,195			829,835		350,195
Balance, end of period	$	1,209,352		$	636,146		$	1,209,352	$	636,146

As of September 30, 2022, the Company reported $379.5 million in unpaid losses and loss adjustment expenses, net of reinsurance which included $266.8 million attributable to IBNR net of reinsurance recoverable, or 70.34% of net reserves for unpaid losses and loss adjustment expenses.

NOTE 14. LONG-TERM DEBT

Convertible Senior Notes

In August 2017 and September 2017, the Company issued in aggregate $136.8 million of 5.875% Convertible Senior Notes (“Convertible Notes”) maturing on August 1, 2037, unless earlier repurchased, redeemed or converted. Interest is payable semi-annually in arrears, on February 1, and August 1 of each year.

As of September 30, 2022, the Company had $885,000 of the Convertible Notes outstanding, net of $21.1 million of Convertible Notes held by an insurance company subsidiary. For each of the nine-month periods ended September 30, 2022 and 2021, the Company made interest payments, net of affiliated Convertible Notes of approximately $1.0 million and $1.3 million, on the Convertible Notes, respectively.

Holders of the 5.875% Convertible Senior Notes due 2037 (the “Notes”) issued by the Company had an optional put right, pursuant to the indenture governing the Notes, to require the Company to repurchase the aggregate principal amount of Notes that are validly tendered. The Company received notice from the Depositary for the Notes that, on July 29, 2022, $10,895,000 aggregate principal amount of the Notes has been validly tendered in accordance with the terms of the indenture and the Company’s notice with respect to the optional put right of the Notes, and the Company directed the trustee to cancel the Notes tendered. Prior to this transaction, the outstanding balance as of September 30, 2022 of non-affiliated Notes was $11.8 million. On August 1, 2022, the Company made payments for the principal amount of the Notes tendered and unpaid interest in the aggregate amounts of $10.9 million and $320,041, respectively. The Company used $10.0 million from its revolving credit facility to replenish the cash used to pay the $10.9 million for the purchase of the tendered Notes.

In January 2022, the Company reacquired and retired $11.7 million of its outstanding Convertible Senior Notes. Payment was made in cash and the Convertible Notes were retired at the time of repurchase. In addition, the Company expensed $242,700 which represents the proportionate amount of the unamortized issuance and debt discount costs associated with this repurchase.

Senior Secured Credit Facility

The Company is party to a five-year, $150.0 million credit agreement (as amended from time to time, the “Credit Agreement”) with a syndicate of lenders.

On November 7, 2022, the Company and its subsidiary guarantors entered into an amendment to the Credit Agreement to, among other things, (i) decrease the revolving credit facility from $75 million to $50 million, (ii) establish a new $25 million term loan facility to refinance loans outstanding under the existing revolving credit facility and to pay fees, costs and expenses related

thereto, (iii) reduce, from $50 million to $25 million, the aggregate amount of potential future increases to the revolving credit facility commitments and/or term loan commitments, (iii) modify the amortization of the existing term loan facility and new term loan facility to 10% per annum, paid quarterly, and (iii) increase the applicable margin for loans under the Credit Agreement to a range from 2.75% to 3.25% per annum for SOFR loans (plus a 0.10% credit adjustment spread) and based on a leverage ratio (an increase from the prior range of 2.50% to 3.00%). The Seventh Amendment also modified certain financial covenants in the Credit Agreement which may limit the Company’s flexibility in connection with future financing transactions and in the allocation of capital in the future, including the Company’s ability to pay dividends and make stock repurchases, and contribute capital to its insurance subsidiaries that are not parties to the Credit Agreement. For additional information regarding the changes to the financial covenants in the Credit Agreement, refer to Part II, Item 5, “Other Information” in this Quarterly Report on Form 10-Q.

The Credit Agreement, as amended, provides for (1) a five-year senior secured term loan facility in an aggregate principal amount of $100 million (the “Term Loan Facility”) and (2) a five-year senior secured revolving credit facility in an aggregate principal amount of $50 million (inclusive of a sublimit for the issuance of letters of credit equal to the unused amount of the revolving credit facility and a sublimit for swingline loans equal to the lesser of $25 million and the unused amount of the revolving credit facility) (the “Revolving Credit Facility” and together with the Term Loan Facility, the “Credit Facilities”).

Term Loan Facility. As amended by the Seventh Amendment, the principal amount of the Term Loan Facility amortizes in quarterly installments, which began with the close of the fiscal quarter ending March 31, 2019, in an amount equal to $1.9 million per quarter, payable quarterly, decreasing to $875,000 per quarter commencing with the quarter ending December 31, 2021, and increasing to $2.4 million per quarter commencing with the quarter ending December 31, 2022, with the remaining balance payable at maturity. The Term Loan Facility matures on July 28, 2026. As of September 30, 2022, there was $66.5 million in aggregate principal outstanding on the Term Loan Facility and as of November 7, 2022, after giving effect to the additional term loan advance that was used to refinance amounts outstanding under the Revolving Credit Facility and to pay fees, costs and expenses related thereto, there was $73.9 million in aggregate principal outstanding on the Term Loan Facility.

For the nine months ended September 30, 2022, the Company made principal and interest payments of approximately $2.6 million and $1.7 million, respectively and for the comparable period of 2021, the Company made interest payments of approximately $1.5 million on the Term Loan Facility.

On May 4, 2022, the Company and its subsidiary guarantors amended the Credit Agreement dated as of December 14, 2018 (as amended to date, the “Credit Agreement”) by entering into the Sixth Amendment to Credit Agreement (the “Sixth Amendment”) with the lenders party to the Credit Agreement, and Regions Bank, as administrative agent and collateral agent.

Pursuant to the Sixth Amendment, the consolidated fixed charge coverage ratio included in the Credit Agreement will be calculated based on the Company’s consolidated tangible net worth, rather than the Company’s consolidated net worth as was required under the existing Credit Agreement. Specifically, the Sixth Amendment provides that, effective as of March 31, 2022 and for future fiscal quarters, the Company’s consolidated tangible net worth, which is gross of accumulated other comprehensive income, as of the end of a fiscal quarter may not be less than the sum of (1) $162,333,750, plus (2) 25% of the sum of the positive consolidated net income of the Company and its subsidiaries with respect to each full fiscal quarter, plus (3) 100% of the net cash proceeds of certain equity issuance transactions of the Company and its subsidiaries. All other material terms of the Credit Agreement remained unchanged.

Revolving Credit Facility. The Revolving Credit Facility allows for borrowings of up to $50 million inclusive of a sublimit for the issuance of letters of credit equal to the unused amount of the Revolving Credit Facility and a sublimit for swingline loans equal to the lesser of $25 million and the unused amount of the Revolving Credit Facility. As of September 30, 2022, we had $25.0 million in borrowings and a $22.6 million letters of credit outstanding under the Revolving Credit Facility. In connection with the incurrence of additional amounts under the Term Loan Facility pursuant to the Seventh Amendment, the borrowings under the Revolving Credit Facility were repaid in full.

At our option, borrowings under the Credit Facilities bear interest at rates equal to either (1) a rate determined by reference to SOFR, plus an applicable margin and a credit adjustment spread equal to 0.10% or (2) a base rate determined by reference to the highest of (a) the “prime rate” of Regions Bank, (b) the federal funds rate plus 0.50%, and (c) the adjusted term SOFR in effect on such day for an interest period of one month plus 1.00%, plus an applicable margin.

The Credit Agreement contains, among other things, covenants, representations and warranties and events of default customary for facilities of this type. The Company is required to maintain, as of each fiscal quarter (1) a maximum consolidated leverage ratio of 2.50 to 1.00, stepping down to 2.25 to 1.00 as of the second quarter of 2024 and 2.00 to 1.00 as of the second quarter of 2025, (2) a minimum consolidated fixed charge coverage ratio of 1.20 to 1.00 and (3) a minimum consolidated net worth for the Company and its subsidiaries, which is required to be not less than $100 million plus 50% of positive quarterly net income (including its subsidiaries and regulated subsidiaries) plus the net cash proceeds of any equity transactions. Events of default include, among other events, (i) nonpayment of principal, interest, fees or other amounts; (ii) failure to perform or observe certain covenants set forth in the Credit Agreement; (iii) breach of any representation or warranty; (iv) cross-default to other indebtedness; (v) bankruptcy and insolvency defaults; (vi) monetary judgment defaults and material nonmonetary judgment defaults; (vii) customary ERISA defaults; (viii) a

change of control of the Company; and (ix) failure to maintain specified catastrophe retentions in each of the Company’s regulated insurance subsidiaries.

In addition to paying interest on outstanding borrowings under the Revolving Credit Facility, we are required to pay a quarterly commitment fee based on the unused portion of the Revolving Credit Facility, which is determined by our consolidated leverage ratio

At September 30, 2022, the effective interest rate on for the Term Loan Facility and Revolving Credit Facility was 5.88% and 5.69%, respectively. The Company monitors the rates prior to the reset date which allows it to establish if the payment is monthly or quarterly payment based on the most beneficial rate used to calculate the interest payment.

Mortgage Loan

In October 2017, the Company and its subsidiary, Skye Lane Properties LLC, jointly obtained a commercial real estate mortgage loan in the amount of $12.7 million, bearing interest of 4.95% per annum and maturing on October 30, 2027. On October 30, 2022, the interest rate shall adjust to an interest rate equal to the annualized interest rate of the United States 5-year Treasury Notes as reported by Federal Reserve on a weekly average basis plus 3.10%. The Company makes monthly principal and interest payments toward the loan. For each of the respective nine-month periods ended September 30, 2022 and 2021, the Company made principal and interest payments of approximately $670,000 on the mortgage loan.

FHLB Loan Agreements

In December 2018, a subsidiary of the Company received a 3.094% fixed interest rate cash loan of $19.2 million from the Federal Home Loan Bank (“FHLB”) Atlanta. In connection with the loan agreement, the subsidiary became a member of FHLB. Membership in the FHLB required an investment in FHLB’s common stock which was purchased in December 2018 and valued at $1.4 million. Additionally, the transaction required the acquired FHLB common stock and certain other investments to be pledged as collateral. As of September 30, 2022, the fair value of the collateralized securities was $26.4 million and the equity investment in FHLB common stock was $1.2 million. For each of the nine-month periods ended September 30, 2022, and 2021, the Company made quarterly interest payments as per the terms of the loan agreement of approximately $450,500. As of September 30, 2022, and December 31, 2021, the Company also holds other common stock from FHLB Des Moines, and FHLB Boston valued at $319,100 and $215,900, respectively.

The following table summarizes the Company’s long-term debt and credit facilities as of September 30, 2022 and December 31, 2021:


	September 30, 2022		December 31, 2021
	(in thousands)
Convertible debt	$	885	$	23,413
Mortgage loan	$	11,281	$	11,521
Credit loan facility	$	66,500	$	69,125
Revolving credit facility	$	25,000	$	—
FHLB loan agreement	$	19,200	$	19,200
Total principal amount	$	122,866	$	123,259
Deferred finance costs	$	1,583	$	2,502
Total long-term debt	$	121,283	$	120,757

After giving effect to Seventh Amendment, as of the date of this report, the Company was in compliance with the applicable terms of all its covenants and other requirements under the Credit Agreement, Convertible Notes indenture, cash borrowings and other loans. The Company’s ability to secure future debt financing depends, in part, on its ability to remain in such compliance.

The covenants and other requirements under the revolving agreement represent the most restrictive provisions that the Company is subject to with respect to its long-term debt.

The schedule of principal payments on long-term debt as of September 30, 2022 is as follows:


Year	Amount
	(In thousands)
2022 remaining	$	957
2023		23,039
2024		4,292
2025		5,624
2026		78,331
Thereafter		10,623
Total	$	122,866

NOTE 15. ACCOUNTS PAYABLE AND OTHER LIABILITIES

Accounts payable and other liabilities consist of the following as of September 30, 2022 and December 31, 2021:


Description	September 30, 2022		December 31, 2021
	(In thousands)
Deferred reinsurance ceding commission	$	40,089	$	40,406
Accounts payable and other payables		11,057		10,086
Accrued interest and issuance costs		575		735
Accrued dividends		72		1,634
Premium tax		1,523		871
Other liabilities		30		195
Commission payables		15,871		17,598
Total other liabilities	$	69,217	$	71,525

NOTE 16. STATUTORY ACCOUNTING AND REGULATIONS

State laws and regulations, as well as national regulatory agency requirements, govern the operations of all insurers such as the Company’s insurance subsidiaries. The various laws and regulations require that insurers maintain minimum amounts of statutory surplus and risk-based capital, restrict insurers’ ability to pay dividends, restrict the allowable investment types and investment mixes, and subject the Company’s insurers to assessments.

The Company’s insurance subsidiaries Heritage P&C, NBIC, Zephyr, and Pawtucket Insurance Company (“PIC”) must maintain capital and surplus ratios or balances as determined by the regulatory authority of the states in which they are domiciled. Heritage P&C is required to maintain capital and surplus equal to the greater of $15 million or 10% of their respective liabilities. Zephyr is required to maintain a deposit of $750,000 in a federally insured financial institution. NBIC is required to maintain capital and surplus of $3.0 million. The combined statutory surplus for Heritage P&C, Zephyr, NBIC and PIC was $261.4 million at September 30, 2022 and $302.1 million at December 31, 2021. State law also requires the Company’s insurance subsidiaries to adhere to prescribed premium-to-capital surplus ratios, and risk-based capital requirements with which the Company is in compliance. At September 30, 2022, the Company’s insurance subsidiaries met the financial and regulatory requirements of each of the states in which they conduct business.

NOTE 17. COMMITMENTS AND CONTINGENCIES

The Company is involved in claims-related legal actions arising in the ordinary course of business. The Company accrues amounts resulting from claims-related legal actions in unpaid losses and loss adjustment expenses during the period that it determines an unfavorable outcome becomes probable and it can estimate the amounts. Management makes revisions to its estimates based on its analysis of subsequent information that the Company receives regarding various factors, including: (i) per claim information; (ii) company and industry historical loss experience; (iii) judicial decisions and legal developments in the awarding of damages; and (iv) trends in general economic conditions, including the effects of inflation.

NOTE 18. RELATED PARTY TRANSACTIONS

From time to time the Company has been party to various related party transactions involving certain of its officers, directors and significant stockholders, including as set forth below. The Company has entered into each of these arrangements without obligation to continue its effect in the future and the associated expense was immaterial to its results of operations or financial position as of September 30, 2022 and 2021.

•

In July 2019, the Board of Directors appointed Mark Berset to the Board of Directors of the Company. Mr. Berset is also the Chief Executive Officer of Comegys Insurance Agency, Inc. (“Comegys”), an independent insurance agency that writes policies for Company. The Company pays commission to Comegys based upon standard industry rates consistent with those provided to the Company’s other insurance agencies. There are no arrangements or understandings between Mr. Berset and any other persons with respect to his appointment as a director. For the three months ended September 30, 2022 and 2021, the Company paid agency commission to Comegys of approximately $53,735 and $53,900, respectively. For the nine months ended September 30, 2022 and 2021, the Company paid agency commission to Comegys of approximately $549,988 and $595,700, respectively.

NOTE 19. EMPLOYEE BENEFIT PLANS

The Company provides a 401(k) plan for substantially all employees. The Company provides a matching contribution of 100% on the first 3% of employees’ contribution and 50% on the next 2% of the employees’ contribution to the plan. The maximum match

is 4%. For the three and nine months ended September 30, 2022, the contributions made to the plan on behalf of the participating employees were approximately $276,090 and $1.0 million, respectively. For the three and nine months ended September 30, 2021, the contributions made to the plan on behalf of the participating employees were approximately $293,000 and $985,000, respectively.

Effective September 1, 2021, the Company terminated its self-insured healthcare plan and enrolled in a flex healthcare plan which allows employees the choice of three medical plans with a range of coverage levels and costs. For the nine months ended September 30, 2022 and 2021, the Company incurred medical premium costs including the new 2021-2022 healthcare premiums, of $3.4 million and $2.6 million, respectively. As of September 30, 2022 and December 31, 2021, the Company had $0 million and $1.4 million of unapplied insurance premiums and additional liability recorded for unpaid claims, respectively.

NOTE 20. EQUITY

The total amount of authorized capital stock consists of 50,000,000 shares of common stock and 5,000,000 shares of preferred stock. As of September 30, 2022, the Company had 25,898,930 shares of common stock outstanding, 11,890,599 treasury shares of common stock and 715,454 unvested restricted common stock with accrued dividends reflecting total paid-in capital of $334.2 million as of such date.

As more fully disclosed in the Company’s audited consolidated financial statements for the year ended December 31, 2021, there were, 26,753,511 shares of common stock outstanding, 10,536,737 treasury shares of common stock and 283,092 unvested shares of restricted common stock, representing $332.8 million of additional paid-in capital.

Common Stock

Holders of common stock are entitled to one vote for each share held on all matters subject to a vote of stockholders, subject to the rights of holders of any outstanding preferred stock. Accordingly, holders of a majority of the shares of common stock entitled to vote in any election of directors may elect all of the directors standing for election, subject to the rights of holders of any outstanding preferred stock. Holders of common stock will be entitled to receive ratably any dividends that the board of directors may declare out of funds legally available therefor, subject to any preferential dividend rights of outstanding preferred stock. Upon the Company’s liquidation, dissolution or winding up, the holders of common stock will be entitled to receive ratably its net assets available after the payment of all debts and other liabilities and subject to the prior rights of holders of any outstanding preferred stock. Holders of common stock have no preemptive, subscription, redemption or conversion rights. There is no redemption or sinking fund provisions applicable to the common stock. All outstanding shares of the Company’s capital stock are fully paid and non-assessable.

Stock Repurchase Program

On December 19, 2021, the Board of Directors established a new share repurchase program plan to commence upon December 31, 2021, for the purpose or repurchasing up to an aggregate of $25.0 million of Common Stock, through the open market or in such other manner as will comply with the terms of applicable federal and state securities laws and regulations, including without limitation, Rule 10b-18 under the Securities Act at any time or from time to time on or prior to December 31, 2022 (the "New Share Repurchase Plan"). For the nine months ended September 30, 2022, the Company repurchased in aggregate 1,353,862 shares of its common stock under its repurchase programs for $6.7 million.

At September 30, 2022, the Company has the capacity under the New Share Repurchase Plan to repurchase $18.3 million of its common shares until December 31, 2022.

Dividends

On March 4, 2022, the Company announced that its Board of Directors declared a $0.06 per share quarterly dividend payable on April 6, 2022 to stockholders of record as of March 17, 2022.

On May 5, 2022, the Company announced that its Board of Directors declared a $0.06 per share quarterly dividend payable on July 5, 2022 to stockholders of record as of June 14, 2022.

On August 3, 2022, the Board of Directors elected to allocate the $0.06 per share typically used to pay a quarterly dividend to shareholders to repurchase common stock totaling $1.7 million. The Board of Directors re-evaluates dividend distribution on a quarterly basis and will make a determination, in part, based on the current stock trading price as compared to book value.

The declaration and payment of any future dividends will be subject to the discretion of the Board of Directors and will depend on a variety of factors including the Company’s financial condition and results of operations and the limitations under the Company’s debt facilities.

NOTE 21. STOCK-BASED COMPENSATION

Common, Restricted and Performance-based Stock

The Company has adopted the Heritage Insurance Holdings, Inc., Omnibus Incentive Plan (the “Plan”) effective on May 22, 2014. The Plan authorized 2,981,737 shares of common stock for issuance under the Plan for future grants. The Plan allows for a variety of equity awards including stock options, restricted stock awards and performance-based awards.

At September 30, 2022 there were 386,603 shares available for grant under the Plan. The Company recognizes compensation expense under ASC 718 for its stock-based payments based on the fair value of the awards.

Effective January 1, 2022, the Board of Directors approved the recommendations made by the Compensation Committee to revise the non-employee director compensation policy to provide that: (i) each non‐ employee director of the Company is entitled to an annual cash fee of $125,000, payable quarterly; (ii) each member of a committee of the Board is entitled to an additional annual cash fee of $2,500; (iii) each chair of a committee of the Board is entitled to an additional $5,000 annual cash fee; (iv) the chair of the Board, to the extent the chair is a non‐employee director, is entitled to an additional annual cash fee of $20,000; and (v) each non‐employee director of the Company is granted annually a number of shares of restricted stock with a value equal to $40,000 at the date of issuance, a grant date of the date of the annual meeting of stockholders of the Company and which restricted stock will vest on the earlier of the one‐year anniversary of the date of issuance and the day immediately prior to the date of the following year’s annual meeting of stockholders of the Company.

During the first quarter of 2022, the Company awarded 3,636 shares and 115,327 shares of time-based restricted stock with at the time of grant a fair value of $5.50 and $6.72 per share, respectively to certain employees. The time-based restricted stock will vest in two and three year equal installments on December 27, 2022, 2023 and 2024, respectively. In addition, during the first quarter of 2022, the Company awarded 10,909 shares and 245,536 shares of performance-based restricted stock with at the time grant a fair value of $5.50 and $6.72 per share, respectively. The performance-based restricted stock has a three-year performance period beginning on January 1, 2022 and ending on December 31, 2024 and will vest following the end of the performance period but no later than March 5, 2025.

In January 2022, the Company awarded to non-employee directors in aggregate 21,768 shares of restricted stock with a fair value at the time of grant of $5.88 per share. The awards will vest on the date of the next annual meeting of the Company's stockholders that occurs after the award date, provided the member remains on the Board until such date. The Company's annual shareholders meeting was held on June 23, 2022, at which time the restricted stock was effectively vested.

In June 2022, the Company awarded to non-employee directors in aggregate 99,376 shares of restricted stock with a fair value at the time of grant of $3.22 per share. The awards will vest on the earlier of the one year anniversary of the grant date and the date immediately prior to the date of the next annual meeting of the Company's stockholders that occurs after the award date, provided the member remains on the Board until such date.

For the performance-based restricted stock the numbers of shares that will be earned at the end of the performance period is subject to decrease based on the results of the performance condition.

The Plan authorizes the Company to grant stock options at exercise prices equal to the fair market value of the Company’s stock on the dates the options are granted. The Company has not granted any stock options since 2015 and all unexercised stock options have since been forfeited.

Restricted Stock

The Company has also granted shares of its common stock subject to certain restrictions under the Plan. Restricted stock awards granted to employee’s vest in equal installments generally over a two to five year period from the grant date subject to the recipient’s continued employment. The fair value of restricted stock awards is estimated by the market price at the date of grant and amortized on a straight-line basis to expense over the period of vesting. Recipients of restricted stock awards granted prior to 2021 have the right to receive dividends; dividends accrue but are not paid until vesting for recipients of restricted stock awards granted 2021 and thereafter.

Restricted stock activity for the nine months ended September 30, 2022 is as follows:


				Weighted-Average
				Grant-Date Fair
	Number of shares			Value per Share
Non-vested, at December 31, 2021		283,092		$	9.32
Granted - Performance-based restricted stock		256,445			6.67
Granted - Time-based restricted stock		240,107			5.18
Vested		(41,919	)		4.81
Canceled and surrendered		(22,271	)		4.40
Non-vested, at September 30, 2022		715,454		$	7.40

Awards are being amortized to expense over the two to five-year vesting period. For the three months ended September 30, 2022 and 2021, the Company recognized $499,000 and $320,000 of compensation expense, respectively. The Company recognized $1.5 million and $867,000 of compensation expense for the nine months ended September 30, 2022 and 2021, respectively. For the nine months ended September 30, 2022, 51,768 shares of restricted stock were vested and released, all of which had been granted to employees. Of the shares released to employees, 9,849 shares were withheld by the Company to cover withholding taxes of $58,000. For the comparable period of 2021, 40,267 shares were vested and released of which 18,973 shares were withheld by the Company to cover withholding taxes of $171,000.

At September 30, 2022, there was approximately $1.2 million unrecognized expense related to time-based non-vested restricted stock and an additional $1.4 million for performance-based restricted stock, which is expected to be recognized over the remaining restriction periods as described in the table below. For the comparable period in 2021, there was $2.1 million of unrecognized expense.

Additional information regarding the Company’s outstanding non-vested time-based restricted stock and performance-based restricted stock at September 30, 2022 is as follows:


Grant date	Restricted shares unvested		Share Value at Grant Date Per Share		Remaining Restriction Period (Years)
February 12, 2018		25,000		16.35		0.75
April 24, 2020		127,837		10.43		2.00
September 21, 2020		37,349		10.71		2.00
January 4, 2021		62,906		6.89		2.00
March 3, 2022		14,545		5.50		2.88
March 16, 2022		360,863		6.72		2.88
June 23, 2022		86,954		3.22		1.00
		715,454

NOTE 22. SUBSEQUENT EVENTS

The Company performed an evaluation of subsequent events through the date the condensed consolidated financial statements were issued and determined there were no recognized or unrecognized subsequent events that would require an adjustment or additional disclosure in the condensed consolidated financial statements as of September 30, 2022.

On November 7, 2022, Heritage Insurance Holdings, Inc. and its subsidiary guarantors (together, the “Company”) amended that certain Credit Agreement dated as of December 14, 2018 (as amended to date, the “Credit Agreement”) by entering into the Seventh Amendment to the Credit Agreement (the “Seventh Amendment”) with the lenders party to the Credit Agreement, and Regions Bank, as administrative agent, collateral agent, swingline lender and issuing bank.

The Seventh Amendment amended the Credit Agreement to, among other things, (i) decrease the revolving credit facility from $75 million to $50 million, (ii) establish a new $25 million term loan facility to refinance loans outstanding under the existing revolving credit facility and to pay fees, costs and expenses related thereto, (iii) reduce, from $50 million to $25 million, the aggregate amount of potential future increases to the revolving credit facility commitments and/or term loan commitments, (iii) modify the amortization of the existing term loan facility and new term loan facility to 10% per annum, paid quarterly, and (iii) increase the applicable margin for loans under the Credit Agreement to a range from 2.75% to 3.25% per annum for SOFR loans (plus a 0.10% credit adjustment spread) and based on a leverage ratio (an increase from the prior range of 2.50% to 3.00%).

The Seventh Amendment also modifies certain financial covenants in the Credit Agreement which may limit the Company’s flexibility in connection with future financing transactions and in the allocation of capital in the future. Specifically, starting in the first quarter of 2023, the Seventh Amendment amends certain financial covenants as follows: (1) require additional leverage ratios under the Consolidated Leverage Ratio covenant (as defined in the Credit Agreement) after the initial step down to 2.50x in the second quarter of 2023 not to exceed 2.25x as of the second quarter of 2024 and 2.00x as of the second quarter of 2025, (2) apply all (A) Restricted Payments (as defined in the Credit Agreement) and (B) fee forgiveness & other capital contributions to the Company’s regulated insurance companies that are not a party to the Credit Agreement (“Non-credit Parties”) that exceed $38 million, when calculating (i) Consolidated Tangible Net Worth (as defined in the Credit Agreement) which is required to be not less than $100 million plus 50% of positive quarterly net income (including its subsidiaries and regulated subsidiaries) plus the net cash proceeds of any equity transactions and (ii) Consolidated Fixed Charge Ratio (as defined in the Credit Agreement) which is required to be 1.20x. The Seventh Amendment also (A) eliminates the current $10 million basket available to the Company to pay dividends to its shareholders or to repurchase its securities, (B) provides for a dividend of up to $2.0 million in the fourth quarter of 2024 under certain conditions and (C) restricts future dividends based on maintenance of certain financial ratios, including Consolidated Tangible

Net Worth. As a result, going forward, dividends and stock repurchases may be limited or restricted entirely and the Company’s ability to contribute capital to its insurance subsidiaries that are not parties to the Credit Agreement may be limited.

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

You should read the following discussion in conjunction with our condensed consolidated financial statements and related notes and other information included elsewhere in this Quarterly Report on Form 10-Q and in our Annual Report on Form 10-K for the year ended December 31, 2021 (“2021 Form 10-K”). Unless the context requires otherwise, as used in this Form 10-Q, the terms “we”, “us”, “our”, “the Company”, “our Company”, and similar references refer to Heritage Insurance Holdings, Inc., a Delaware corporation, and its subsidiaries.

Overview

We are a super-regional property and casualty insurance holding company that primarily provides personal and commercial residential insurance products across our multi-state footprint. We provide personal residential insurance in Alabama, California, Connecticut, Delaware, Florida, Georgia, Hawaii, Maryland, Massachusetts, Mississippi, New Jersey, New York, North Carolina, Rhode Island, South Carolina, and Virginia and commercial residential insurance in Florida, New Jersey, and New York. We provide personal residential insurance in Florida on both an admitted and non-admitted basis and in California on a non-admitted basis. As a vertically integrated insurer, we control or manage substantially all aspects of risk management, underwriting, claims processing and adjusting, actuarial rate making and reserving, customer service, and distribution. Our financial strength ratings are important to us in establishing our competitive position and can impact our ability to write policies.

Trends

Inflation, Underwriting and Pricing

We continue to address rising reinsurance and loss costs in the property insurance sector through continued implementation of increased rates, resulting in an increase in the average premium per policy of 13.6% for the quarter ended September 30, 2022 as compared to the prior year quarter. New rates, which are subject to approval by our regulators, become effective when a policy is written or renewed, and the premium is earned pro rata over the policy period of one year. As a result of this timing, it can take up to twenty-four months for the complete impact of a rate change to be fully earned in our financial statements. For that reason, we account for inflation in our rate indications and filings with our regulators.

We invest in data analytics, using software and experienced personnel, to continuously evaluate our underwriting criteria and manage exposure to catastrophe and other losses. our retention has remained steadily in the range of 90% despite the rate increases we have implemented, in large part due to a challenging property insurance market in many of the regions in which we operate. Weather losses and a higher cost of reinsurance have impacted these markets. While we believe our rates are generally competitive with private market insurers operating in our space, we are focused on managing exposure and achieving rate adequacy throughout the book of business.

We continue to experience rising inflation in the form of increased labor and material costs, which drive up claim costs throughout all states in which we conduct business. Our Florida personal lines market is also seeing claim costs impacted by litigated claims, which substantially increases loss costs thereby driving up rates for the insurance buying public. Our response to this phenomenon is a combination of raising rates and reducing exposure. Since that time the claims abuse has extended throughout much of Florida, generated from assignment of benefits, excessive roof claims, and unwarranted litigated claims which far exceeds levels experienced in other states. Correspondingly, our exposure reduction plan expanded to personal lines business throughout the state of Florida.

Our industry experienced higher reinsurance costs and more constrained availability for catastrophe excess of loss reinsurance in the Spring 2022 renewals. We anticipate continued cost increases and availability constraints for the 2023 renewal season. As described herein, we are carefully managing exposure by reducing new business written in certain geographies, non-renewing unprofitable business in compliance with regulatory requirements, increasing rates, and narrowing our underwriting requirements.

While we see improvement in the geographic distribution of our business, which is becoming more rate adequate, our Florida loss costs have continued to increase from a combination of adverse weather and exacerbation of losses on weather and other claims resultant from the litigated claims environment. Recent legislative changes have been made in Florida in each of the last three years, which we believe is making some progress toward reducing losses from abusive claim reporting practices.

The table below shows reductions in Florida policy count and total insured value (“TIV”) of 17.6% and 10.3%, respectively, from the prior year quarter. During this period, Florida premium in force declined by only 2.6% as rate increases dampened the impact of the reduction in policy count. For markets outside of Florida, the premiums-in-force increased at a much larger rate than the increases in policies in force and TIV, primarily due to rate increases.


		At September 30,
		2022			2021		% Change
Policies in force:
Florida			188,383			228,572		-17.6	%
Other States			352,989			352,714		0.1	%
Total			541,372			581,286		-6.9	%

Premiums in force:
Florida	$		569,589,537	$		584,994,491		-2.6	%
Other States			672,812,875			589,527,230		14.1	%
Total	$		1,242,402,412	$		1,174,521,721		5.8	%

Total Insured Value:
Florida	$		102,784,056,201	$		114,537,338,974		-10.3	%
Other States			304,657,398,158			284,498,624,168		7.1	%
Total	$		407,441,454,359	$		399,035,963,142		2.1	%

Strategic Profitability Initiatives

The following provides an update to the Company’s strategic initiatives that we expect will enable Heritage to achieve consistent long-term quarterly earnings and drive shareholder value. The Supplemental Information table included in this earnings release demonstrates progress made since third quarter 2021.

•

Generate underwriting profit though rate adequacy and more selective underwriting.

Premiums-in-force of $1.24 billion are up 5.8% from the prior year quarter, while policy count is down 6.9%, driven by higher rates.

Average premium per policy throughout the book increased 13.6% over the prior year quarter.

Continued focus on tightening underwriting criteria while also restricting new business written in over-concentrated markets or products.

•

Optimize capital allocation toward products and geographies that maximize long-term returns.

Reduction of policy count for Florida personal lines product is a key focus and will continue if meaningful legislation to reduce abusive claims practices does not occur. Florida PRES policies in force intentionally declined by 18.8% as compared to the prior year period.

Continued offering of Florida commercial lines product with 18.2% growth in annual premium while value TIV increased only 4.2%.

•

Improve portfolio diversity.

Diversification efforts led to a premium in-force growth of 14.1% in other States other than Florida.

Overall premium-in-force increase of 5.8%, despite an 8.5% reduction in Florida admitted personal lines business.

TIV in other states improved to 74.8%, compared to 71.3% as of the third quarter of 2021.

Recent Developments

Economic and Market Factors

We continue to monitor the effects of general changes in economic and market conditions on our business. As a result of general supply chain disruptions and inflationary pressures, we have experienced, and may continue to experience, increased cost of materials and labor needed for repairs and to otherwise remediate claims.

Goodwill Impairment Charge

We evaluate goodwill and other intangible assets for impairment annually, or whenever events or changes in circumstances indicate that it is likely that the carrying amount of goodwill and other intangible assets may exceed the implied fair value. Any impairment is charged to operations in the period that the impairment is identified. The evaluation of goodwill impairment requires considerable management judgment and includes a review of a variety of factors as described below. Any adverse change in these factors could have a significant impact on the recoverability of goodwill and could have a material impact on our financial results. During the second quarter of 2022, we concluded it was appropriate to perform an interim evaluation of goodwill for potential impairment given a variety of market factors as described below. As a result of the analysis, we impaired the entire amount of remaining goodwill, which reduced our carrying value of goodwill from $92.0 million to $0 based on the following factors: (i) disruptions in the equity markets, specifically for property and casualty insurance companies, largely due to recent weather-related catastrophe events; (ii) elevated loss ratios for property insurers in our markets; and (iii) trading of our stock below book value. These

factors reduced our previously modeled fair value of the Company and resulted in a $92.0 million non-cash goodwill impairment charge, most of which is not tax deductible.

Third Quarter 2022 Financial Results

The discussion of our financial condition and results of operations that follows provides information that will assist the reader in understanding our consolidated financial statements, the changes in certain key items in those financial statements from year to year, including certain key performance indicators such as net combined ratio, net expense ratio and net loss ratio, and the primary factors that accounted for those changes, as well as how certain accounting principles, policies and estimates affect our consolidated financial statements. This discussion should be read in conjunction with our consolidated financial statements and the related notes that appear elsewhere in this document.

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Third quarter net loss of $48.2 million or $1.83 per diluted share, compared to a net loss of $16.4 million or $0.59 per diluted share in the prior year quarter, driven primarily by current accident year weather losses including a $40 million net retention for Hurricane Ian. In addition the Company recorded a $10.7 million valuation allowance against our net deferred tax asset related to certain tax elections made by Osprey Re, our captive reinsurer domiciled in Bermuda.

•

Gross premiums written of $304.5 million, up 11.1% from $274.2 million in the prior year quarter, reflecting a 4.8% rate related increase in Florida, despite a policy count reduction of approximately 40,000, and 15.4% growth in other states primarily due to rate increases. Rate increases continued to meaningfully benefit written premiums throughout the book of business.

•

Gross premiums earned of $308.0 million, up 4.6% from $294.4 million in the prior year quarter, reflecting higher gross premiums written over the last twelve months driven by higher average premium per policy.

•

Net earned premiums of $159.7 million, down 1.7% from $162.4 million in the prior year quarter, reflecting a 12.4% increase in contract year reinsurance cost with higher ceded premium outpacing the increase in gross earned premiums for the quarter.

•

Net current accident year weather losses of $63.8 million, up 24.2% from $51.4 million in the prior year quarter. Current accident year catastrophe weather losses are $40.0 million up 150.5% from $16.0 million in the prior year quarter. The catastrophe loss for the current quarter represents our $40.0 million retention for Hurricane Ian. Current accident year other weather losses are $23.8 million, down 32.8% from $35.4 million in the prior year quarter.

•

Ceded premium ratio of 48.1%, up 3.3 points from 44.8% in the prior year quarter driven by a higher cost of the 2022-2023 catastrophe excess of loss program, stemming from both higher costs and higher TIV.

•

Net loss ratio of 97.6%, 17.8 points higher than the prior year quarter of 79.8%, driven by higher losses incurred and slightly lower net earned premium than the prior year quarter.

•

Net expense ratio of 35.7%, up 3.0 points from the prior year quarter amount of 32.7%, mostly driven by the reduction of net earned premium from the prior year quarter, with a small portion of the increase related to higher underwriting costs associated with an increase in gross premiums written.

•

Net combined ratio of 133.3%, up 20.8 points from 112.5% in the prior year quarter, driven by a higher net loss ratio and net expense ratio as described above.

•

Effective tax rate was 2.2% compared to 6.4% in the prior year quarter, driven by the impact of permanent differences in relation to the pre-tax loss each quarter, as well as a $10.7 million valuation allowance as described above in the current period quarter.

Results of Operations

Comparison of the three months ended September 30, 2022 and 2021

Revenue


	For the Three Months Ended September 30,
(Unaudited)	2022			2021			$ Change			% Change
	(in thousands)
REVENUE:
Gross premiums written	$	304,501		$	274,178		$	30,323			11.1	%
Change in gross unearned premiums		3,458			20,231			(16,773	)		(82.9	)%
Gross premiums earned		307,959			294,409			13,550			4.6	%
Ceded premiums earned		(148,266	)		(131,964	)		(16,302	)		12.4	%
Net premiums earned		159,693			162,445			(2,752	)		(1.7	)%
Net investment income		2,887			1,548			1,339			86.5	%
Net realized losses		(3	)		(6	)		3			(50.0	)%
Other revenue		2,916			3,421			(505	)		(14.8	)%
Total revenue	$	165,493		$	167,408		$	(1,916	)		(1.1	)%

Total revenue

Total revenue was $165.5 million in the third quarter of 2022, down 1.1% from $167.4 million in the prior year quarter. The decrease primarily stems from lower net premiums earned, driven by higher reinsurance costs, partly offset by an increase in investment income, as described in detail below.

Gross premiums written

Gross premiums written were $304.5 million, up 11.1% from $274.2 million the prior year quarter, reflecting a 4.8% growth in Florida and 15.4% growth in other states, primarily from increased rates as well as a small increase in policy count in states outside of Florida. Rate increases continued to meaningfully benefit written premiums throughout the book of business.

Premiums-in-force were $1.24 billion in the third quarter of 2022, up 5.8% from third quarter 2021, while policies-in-force were down 6.9%. The increase in premiums-in-force reflects the impact of rate increases more than offsetting the premiums associated with the reduction in policies-in-force. The reduction in policies-in-force from the third quarter of 2021 reflects our exposure management initiatives.

Gross premiums earned

Gross premiums earned were $308.0 million in the third quarter of 2022, up 4.6% from $294.4 million in the prior year quarter. The increase reflects higher gross premiums written over the last twelve months, which is primarily related to higher rates on a smaller book of business based on policy count.

Ceded premiums earned

Ceded premiums earned were $148.3 million in the third quarter of 2022, up 12.4% from $132.0 million in the prior year quarter. The growth results primarily from higher reinsurance costs due to market conditions and higher TIV, as well as higher ceded premium for our net quota share reinsurance program, driven by growth in our northeast business.

Net premiums earned

Net premiums earned were $159.7 million in the third quarter of 2022, down 1.7% from $162.4 million in the prior year quarter, reflecting a 12.4% increase in contract year reinsurance cost with higher ceded premium outpacing the increase in gross earned premiums for the quarter.

Net investment income

Net investment income, inclusive of realized investment gains and unrealized gains on equity securities, was $2.9 million in the third quarter 2022, compared to a net investment gain of $1.5 million in the prior year quarter. The increase is driven by a higher interest rate environment compared to the prior year quarter.

Other revenue

Other revenue was $2.9 million in the third quarter of 2022, down by 14.8% from $3.4 million in the prior year quarter, driven primarily by a decline in policy fee income associated with the reduction of policies in force.


	For the Three Months Ended September 30,
(Unaudited)	2022		2021		$ Change		% Change
OPERATING EXPENSES:	(in thousands)
Losses and loss adjustment expenses	$	155,849	$	129,632	$	26,217		20.2	%
Policy acquisition costs		39,194		35,984		3,210		8.9	%
General and administrative expenses		17,758		17,169		589		3.4	%
Total operating expenses		212,801		182,785		30,017		16.4	%

Total operating expenses

Total operating expenses were up $30.0 million, or 16.4% in the third quarter of 2022. As described below, the driver was primarily from the increase in losses and loss adjustment expenses as well as an increase in acquisition costs.

Losses and loss adjustment expenses

Losses and loss adjustment expenses (“LAE”) were $155.8 million in the third quarter of 2022, up from $129.6 million in the prior year quarter driven by higher weather and attritional losses. Net current accident year weather losses were $63.8 million, up 24.2% from $51.4 million in the prior year quarter. Current accident year weather losses include $40.0 million of net current accident quarter catastrophe losses from Hurricane Ian, up from $16.0 million in the prior year quarter, and $23.8 million of other weather losses, down from $35.4 million in the prior year quarter.

Policy acquisition costs

Policy acquisition costs were $39.2 million in the third quarter of 2022, up 8.9% from $36.0 million in the prior year quarter. The increase is primarily attributable to growth of 11.1% in gross premiums written.

General and administrative expenses

General and administrative expenses were $17.8 million in the third quarter of 2022, up 3.4% from $17.2 million in the prior year quarter, driven primarily by compensation related items.


	For the Three Months Ended September 30,
(Unaudited)	2022			2021			$ Change			% Change
	(in thousands, except per share and share amounts)
Operating loss	$	(47,308	)	$	(15,377	)	$	(31,931	)		207.7	%
Interest expense, net		2,027			2,150			(123	)		(5.7	)%
Loss before income taxes		(49,335	)		(17,527	)		(31,809	)		181.5	%
Benefit for income taxes		(1,095	)		(1,117	)		23			(2.0	)%
Net loss	$	(48,240	)	$	(16,410	)	$	(31,831	)		194.0	%
Basic net loss per share	$	(1.83	)	$	(0.59	)	$	(1.24	)		210.2	%
Diluted net loss per share	$	(1.83	)	$	(0.59	)	$	(1.24	)		210.2	%

Net loss

Third quarter 2022 net loss was $48.2 million ($1.83 loss per share), down from net loss of $16.4 million ($0.59 loss per share) in the prior year quarter, driven primarily from the increase in net losses and loss adjustment expenses incurred as described above and the relatively small benefit for income taxes as described below.

Interest expense, net

Net interest expense was $2.0 million in the third quarter of 2022, slightly down from $2.2 million in the prior year quarter mostly due to a reduction in debt discount associated with the repurchase of convertible notes in the second quarter of 2022.

Benefit for income taxes

Benefit for income taxes was $1.1 million in third quarter 2022 compared to $1.1 million in the prior year quarter. The effective tax rate in third quarter 2022 was impacted by the impact of permanent tax differences on projected results of operations for the calendar year as well as impacts to the effective tax rate, which can also fluctuate throughout the year as estimates used in the quarterly tax provision are updated with additional information. The effective tax rate was 2.2% compared to 6.4% in the prior year quarter, driven by the impact of permanent differences in relation to the pre-tax loss each quarter, as well as a $10.7 million valuation allowance in the current period quarter. The valuation allowance was recorded against our deferred tax asset related to our captive

reinsurer, Osprey Re, for which net operating losses can only be used to offset income at Osprey Re due to the 953(d) election made when Osprey Re was formed. This was accounted for as an increase of income tax expense for the quarter.

Ratios


	For the Three Months Ended September 30,
(Unaudited)	2022			2021
Ceded premium ratio		48.1	%		44.8	%

Net loss and LAE ratio		97.6	%		79.8	%
Net expense ratio		35.7	%		32.7	%
Net combined ratio		133.3	%		112.5	%

Net combined ratio

The net combined ratio was 133.3% in the third quarter of 2022, up 20.8 points from 112.5% in the prior year quarter. The increase stems primarily from the increase in the net loss and LAE ratio, as described below.

Ceded premium ratio

The ceded premium ratio was 48.1% in the third quarter of 2022, up 3.3 points from 44.8% in the prior year quarter, reflecting a higher cost of the 2022-2023 catastrophe excess of loss program, stemming from both higher costs and higher TIV, driving the growth in ceded premiums earned to outpace the growth in gross premiums earned described above.

Net loss and LAE ratio

The net loss and LAE ratio was 97.6% in the third quarter of 2022, up 17.8 points from 79.8% in the prior year quarter, driven by higher weather and attritional losses. Net current accident year weather losses of $63.8 million, up 24.2% from $51.4 million in the prior year quarter. Current accident year weather losses include $40.0 million of net current accident quarter catastrophe losses from Hurricane Ian, up from $16.0 million in the prior year quarter, and $23.8 million of other weather losses, down from $35.4 million in the prior year quarter.

Net expense ratio

The net expense ratio was 35.7% in the third quarter of 2022, up 3.0 points from 32.7% in the prior year quarter. This was driven by higher underwriting costs associated with the growth in gross premiums written.

Results of Operations

Comparison of the Nine Months Ended September 30, 2022 and 2021


	For the Nine Months Ended September 30,
	2022			2021			$ Change			% Change
(Unaudited)	(in thousands)
REVENUE:
Gross premiums written	$	952,981		$	886,059		$	66,922			7.6	%
Change in gross unearned premiums		(61,442	)		(35,593	)		(25,849	)		72.6	%
Gross premiums earned		891,539			850,466			41,073			4.8	%
Ceded premiums earned		(420,645	)		(399,323	)		(21,322	)		5.3	%
Net premiums earned		470,894			451,143			19,751			4.4	%
Net investment income		7,050			3,797			3,253			85.7	%
Net realized losses		(121	)		(926	)		805			(86.9	)%
Other revenue		10,049			10,835			(786	)		(7.3	)%
Total revenue	$	487,872		$	464,849		$	23,022			5.0	%

Total revenue

Total revenue was $487.9 million for the nine months ended September 30, 2022, up 5.0% from $464.8 million in the prior year period. The increase primarily stems from higher net premiums earned and investment income, as described below.

Gross premiums written

Gross premiums written were $953.0 million for the nine months ended September 30. 2022, up 7.6% from $886.1 million in the prior year period. We experienced growth of 13.1% outside of Florida and 1.8% growth in Florida. Growth throughout our book of business was largely driven by rate increases resulting in a higher average premium per policy.

Premiums-in-force were $1.24 billion in the third quarter of 2022, up 5.8% from third quarter 2021, while policies-in-force were down 6.9%, with the difference largely stemming from rate increases. The reduction in policies-in-force from the third quarter of 2021 reflects our exposure management initiatives.

Gross premiums earned

Gross premiums earned were $891.5 million for the nine months ended September 30. 2022, up 7.0% from $850.5 million in the prior year period. The increase reflects higher gross premiums written over the preceding twelve months, driven primarily by higher rates.

Ceded premiums earned

Ceded premiums earned were $420.6 million for the nine months ended September 30, 2022, up 5.3% from $399.3 million in the prior year period. The increase is attributable to the higher cost of the current year catastrophe excess of loss contract for which the impact was partly offset by a $18 million ceded premium on the severe convective storm contract included in the prior year amount.

Net premiums earned

Net premiums earned were $470.9 million for the nine months ended September 30, 2022, up 4.4% from $451.1 million in the prior year period. On a year-to-date basis, growth in gross premiums earned exceeded the growth in ceded premiums earned. However, on a quarter-to-date basis, the growth in ceded premiums earned exceeded the growth in gross premiums earned. This relates primarily to the cost of our severe convective storm reinsurance contract in 2021, which was fully earned by the second quarter of 2021.

Net investment income

Net investment income, inclusive of realized investment gains and unrealized gains on equity securities, was $6.9 million for the nine months ended September 30, 2022, compared to $2.9 million in the prior year period. The increase is primarily due to higher balances in our fixed income portfolio than the prior nine-month period, coupled with a higher interest rate environment.

Other revenue

Other revenue was $10.0 million for the nine months ended September 30, 2022, down 7.3% from $10.8 million in the prior year period, driven primarily by a decline in policy fee income associated with the reduction of policies in force.


	For the Nine Months Ended September 30,
(Unaudited)	2022		2021		$ Change		% Change
OPERATING EXPENSES:	(in thousands)
Losses and loss adjustment expenses	$	397,409	$	328,376	$	69,033		21.0	%
Policy acquisition costs		115,826		109,183		6,643		6.1	%
General and administrative expenses		54,947		52,490		2,457		4.7	%
Goodwill impairment		91,959		—		91,959	NM
Total operating expenses		660,141		490,049		170,092		34.7	%

NM -Not meaningful

Total operating expenses

Total operating expenses were $660.1 million for the nine months ended September 30, 2022, up 34.7% from $490.0 million in the prior year period, primarily due to the $92.0 million pre-tax goodwill impairment charge taken in the second quarter of 2022, and a $69.0 million increase in losses and loss adjustment expenses detailed below.

Losses and loss adjustment expenses

Losses and LAE were $397.4 million for the nine months ended September 30, 2022, up 21.0% from $328.4 million in the prior year period driven by higher weather and attritional losses. Net current accident year weather losses were $165.7 million, up 40.1% from $118.3 million in the prior year period. Current accident year catastrophe weather losses were $117.1 million, up from $55.8 million in the prior year period, with current accident year other weather losses of $48.6 million, down from $62.5 million in the prior year period. Net current accident year catastrophe weather losses include a $40.0 million retention for Hurricane Ian.

Policy acquisition costs

Policy acquisition costs were $115.8 million for the nine months ended September 30, 2022, up 6.1% from $109.2 million in the prior year period. The increase is primarily attributable to growth in gross premiums written.

General and administrative expenses

General and administrative expenses were $54.7 million for the nine months ended September 30, 2022, up 4.7% from $52.5 million in the prior year period. The increase is primarily attributable to a $1.5 million state tax credit recorded in the prior year period.

Goodwill impairment

As a result of our analysis for goodwill impairment performed during the second quarter of 2022, we impaired the entire amount of remaining goodwill, reducing our carrying value of goodwill from $92.0 million to $0. See the section titled “Goodwill Impairment Charge” above for more detail on our goodwill impairment charge.


	For the Nine Months Ended September 30,
(Unaudited)	2022			2021			$ Change			% Change
	(in thousands, except per share and share amounts)
Operating loss	$	(172,269	)	$	(25,200	)	$	(147,069	)	NM
Interest expense, net		5,750			5,953			(203	)		(3.4	)%
Loss before income taxes		(178,019	)		(31,153	)		(146,866	)		471.4	%
Benefit for income taxes		(11,155	)		(5,644	)		(5,511	)		97.6	%
Net loss	$	(166,864	)	$	(25,509	)	$	(141,355	)	NM
Basic net loss per share	$	(6.29	)	$	(0.91	)	$	(5.37	)	NM
Diluted net loss per share	$	(6.29	)	$	(0.91	)	$	(5.37	)	NM

NM -Not meaningful

Net loss

Net loss for the nine months ended September 30, 2022 was $166.9 million ($6.29 loss per share), compared to a net loss of $25.5 million ($0.91 loss per share) in the prior year period. The year-over-year change primarily stems from a $90.8 million (net of a $1.2 million tax deductible portion) non-cash goodwill impairment charge, as described above, coupled with an underwriting loss generated for the nine-month period driven by higher weather and attritional losses over the prior period, which includes a net retention of $40.0 million related to Hurricane Ian, as described above. Additionally, the benefit for income taxes was lower than our statutory rate, as described below.

Interest expense, net

Net interest expense was $5.8 million for the nine months ended September 30, 2022, slightly down from the prior year period.

Benefit for income taxes

Benefit for income taxes was $11.2 million for the nine months ended September 30, 2022 compared to $5.6 million in the prior year period. The effective tax rate was 6.3% for the nine months ended September 30, 2022 compared to 18.1% for the prior year period. The effective tax rate for the nine months ended September 30, 2022 was impacted by the mostly non-deductible goodwill impairment charge as described above as well as a valuation allowance of $10.7 million recorded against our deferred tax asset, related to our captive reinsurer, Osprey Re, related to the IRC Section 953(d) election made when Osprey Re was formed. As a result of this election, net operating losses for Osprey Re may only be used to offset taxable income at Osprey Re.

The impact of permanent tax differences on projected results of operations for the calendar year also impacts the effective tax rate, which can also fluctuate throughout the year as estimates used in the quarterly tax provision are updated with additional information.

Ratios


	For the Nine Months Ended September 30,
(Unaudited)	2022			2021
Ceded premium ratio		47.2	%		47.0	%

Net loss and LAE ratio		84.4	%		72.8	%
Net expense ratio		36.3	%		35.8	%
Net combined ratio		120.7	%		108.6	%

Net combined ratio

The net combined ratio was 120.7% for the nine-month period ended September 30, 2022, up 12.1 points from 108.6% in the prior year period. The increase primarily stems from a higher net loss and LAE ratio as well as a small increase in the net expense ratio, as described below.

Ceded premium ratio

The ceded premium ratio was 47.2% for the nine-month period ended September 30, 2022, relatively flat from 47.0% in the prior year period. The cost of the current year catastrophe excess of loss contract was higher than the prior year but the impact was partly offset by a $18 million ceded premium on the severe convective storm contract included in the prior year amount.

Net loss and LAE ratio

The net loss and LAE ratio was 84.4% for the nine-month period ended September 30, 2022, up 11.6 points from 72.8% in the prior year period, driven by higher weather and attritional losses, including the $40 million retention for Hurricane Ian, compared to the prior year period, which was partly offset by the 4.4% increase in net premiums earned.

Net expense ratio

The net expense ratio was 36.3% for the nine-month period ended September 30, 2022, slightly up from 35.8% in the prior year period, driven by a lower PAC ratio.

Liquidity and Capital Resources

Our principal sources of liquidity include cash flows generated from operations, existing cash and cash equivalents, our marketable securities balances and borrowings available under our credit facilities. As of September 30, 2022, we had $297.5 million of cash and cash equivalents and $651.8 million in investments, compared to $359.3 million and $694.7 million, respectively, as of December 31, 2021. The decrease in cash and cash equivalents was primarily due to the timing of reinsurance payments for our catastrophe excess of loss program as well as timing of reinsurance recoveries. The decrease in investments is due to the unrealized losses on the Company’s available-for-sale fixed income securities portfolio. The unrealized losses resulted from the continued decline in bond prices throughout 2022 as a result of the higher interest rate environment. The Company’s fixed income portfolio average credit rating is A+ with a duration of 3.4 years at September 30, 2022.

We generally hold substantial cash balances to meet seasonal liquidity needs including amounts to pay quarterly reinsurance installments as well as meet the collateral requirements of Osprey, our captive reinsurance company, which is required to maintain a collateral trust account equal to the risk that it assumes from our insurance company affiliates.

We believe that our sources of liquidity are adequate to meet our cash requirements for at least the next twelve months.

We may continue to pursue the acquisition of complementary businesses and make strategic investments. We may increase capital expenditures consistent with our investment plans and anticipated growth strategy. Cash and cash equivalents may not be sufficient to fund such expenditures. As such, in addition to the use of our existing Credit Facilities, we may need to utilize additional debt to secure funds for such purposes.

As part of the Seventh Amendment to the Credit Agreement, discussed below, going forward, dividends and stock repurchases may be limited or restricted entirely and our ability to contribute capital to our insurance subsidiaries that are not parties to the Credit Agreement may be limited.

Cash Flows


	For the Nine Months Ended September 30,
	2022			2021			Change
	(in thousands)
Net cash (used in) provided by:
Operating activities	$	(15,480	)	$	72,772		$	(88,252	)
Investing activities		(33,507	)		(112,927	)		79,420
Financing activities		(11,952	)		(7,402	)		(4,550	)
Net (decrease) increase in cash and cash equivalents	$	(60,939	)	$	(47,557	)	$	(13,382	)

Operating Activities

Net cash used in operating activities was $15.5 million for the nine months ended September 30, 2022 compared to net cash provided by operating activities of $72.8 million for the comparable period in 2021. The decrease in cash from operating activities

relates primarily to timing of cash flows associated with claim and reinsurance payments as well as reinsurance reimbursements during the first nine months of 2022 compared to the first nine months of 2021.

Investing Activities

Net cash used in investing activities for the nine months ended September 30, 2022 was $33.5 million as compared to net cash used in investing activities of $112.9 million for the comparable period in 2021. The change in cash used in investing activities relates primarily to allocations of funds for investment in each period. Strategic sales of investments to yield realized gains in 2020 produced proceeds which were re-invested in 2021, driving up the cash used for investing activities for that period.

Financing Activities

Net cash used in financing activities for the nine months ended September 30, 2022 was $12.0 million, as compared to cash used in financing activities of $7.4 million for the comparable period in 2021. The increase in cash used for financing activities was driven by draws from our Revolving Credit Facility (defined below) totaling $25 million to purchase and retire $22.5 million of Convertible Notes and a larger amount of treasury stock purchases during the nine months ended September 30, 2022.

Credit Facilities

The Company is party to a Credit Agreement by and among the Company, as borrower, certain subsidiaries of the Company from time to time party thereto as guarantors, the lenders from time to time party thereto (the “Lenders”), Regions Bank, as Administrative Agent and Collateral Agent, BMO Harris Bank N.A., as Syndication Agent, Hancock Whitney Bank and Canadian Imperial Bank of Commerce, as Co-Documentation Agents, and Regions Capital Markets and BMO Capital Markets Corp., as Joint Lead Arrangers and Joint Bookrunners (as amended from time to time, the “Credit Agreement”).

Based on the Company’s results for the third quarter of 2022, management considered it likely at that time that the Company would be out of compliance with certain financial covenants in the Credit Agreement. In order to avoid a covenant violation, on November 7, 2022, the Company and its subsidiary guarantors entered into an amendment to the Credit Agreement to, among other things, (i) decrease the revolving credit facility from $75 million to $50 million, (ii) establish a new $25 million term loan facility to refinance loans outstanding under the existing revolving credit facility and to pay fees, costs and expenses related thereto, (iii) reduce, from $50 million to $25 million, the aggregate amount of potential future increases to the revolving credit facility commitments and/or term loan commitments, (iii) modify the amortization of the existing term loan facility and new term loan facility to 10% per annum, paid quarterly, and (iii) increase the applicable margin for loans under the Credit Agreement to a range from 2.75% to 3.25% per annum for SOFR loans (plus a 0.10% credit adjustment spread) and based on a leverage ratio (an increase from the prior range of 2.50% to 3.00%). The Seventh Amendment also modified certain financial covenants in the Credit Agreement which may limit the Company’s flexibility in connection with future financing transactions and in the allocation of capital in the future, including the Company’s ability to pay dividends and make stock repurchases, and contribute capital to its insurance subsidiaries that are not parties to the Credit Agreement. For additional information regarding the changes to the financial covenants in the Credit Agreement, refer to Part II, Item 5, “Other Information” in this Quarterly Report on Form 10-Q.

At our option, borrowings under the Credit Facilities bear interest at rates equal to either (1) a rate determined by reference to SOFR, plus an applicable margin (described below) and a credit adjustment spread equal to 0.10% or (2) a base rate determined by reference to the highest of (a) the “prime rate” of Regions Bank, (b) the federal funds rate plus 0.50%, and (c) the adjusted term SOFR in effect on such day for an interest period of one month plus 1.00%, plus an applicable margin (described below).

The applicable margin for loans under the Credit Facilities varies from 2.75% per annum to 3.25% per annum (for SOFR loans) and 1.75% to 2.25% per annum (for base rate loans) based on our consolidated leverage ratio ranging from 1.25-to-1 to greater than 2.25-to-1. Interest payments with respect to the Credit Facilities are required either on a quarterly basis (for base rate loans) or at the end of each interest period (for SOFR loans) or, if the duration of the applicable interest period exceeds three months, then every three months. As of September 30, 2022, the borrowing under our Credit Facilities were accruing interest at a rate of 5.88% per annum.

We may prepay the loans under the Credit Facilities, in whole or in part, at any time without premium or penalty, subject to certain conditions including minimum amounts and reimbursement of certain costs in the case of prepayments of SOFR loans. In addition, we are required to prepay the loan under the Term Loan Facility with the proceeds from certain financing transactions, involuntary dispositions or asset sales (subject, in the case of asset sales, to reinvestment rights).

All obligations under the Credit Facilities are or will be guaranteed by each existing and future direct and indirect wholly owned domestic subsidiary of the Company, other than all of the Company’s current and future regulated insurance subsidiaries (collectively, the “Guarantors”).

The Company and the Guarantors are party to a Pledge and Security Agreement, (as amended from time to time the “Security Agreement”), in favor of Regions Bank, as collateral agent. Pursuant to the Security Agreement, amounts borrowed under the Credit Facilities are secured on a first priority basis by a perfected security interest in substantially all of the present and future assets of the Company and each Guarantor (subject to certain exceptions), including all of the capital stock of the Company’s domestic subsidiaries, other than its regulated insurance subsidiaries.

Convertible Notes

On August 10, 2017, the Company and Heritage MGA, LLC (the “Notes Guarantor”) entered into a purchase agreement (the “Purchase Agreement”) with Citigroup Global Markets Inc., as the initial purchaser (the “Initial Purchaser”), pursuant to which the Company agreed to issue and sell, and the Initial Purchaser agreed to purchase, $125.0 million aggregate principal amount of the Company’s 5.875% Convertible Senior Notes due 2037 (the “Convertible Notes”) in a private placement transaction pursuant to Rule 144A under the Securities Act, as amended (the “Securities Act”). The Purchase Agreement contained customary representations, warranties and agreements of the Company and the Notes Guarantor and customary conditions to closing, indemnification rights and obligations of the parties and termination provisions. The net proceeds from the offering of the Convertible Notes, after deducting discounts and commissions and estimated offering expenses payable by the Company, were approximately $120.5 million. The offering of the Convertible Notes was completed on August 16, 2017.

The Company issued the Convertible Notes under an Indenture (the “Convertible Note Indenture”), dated August 16, 2017, by and among the Company, as issuer, the Notes Guarantor, as guarantor, and Wilmington Trust, National Association, as trustee (the “Trustee”).

The Convertible Notes bear interest at a rate of 5.875% per year. Interest is payable semi-annually in arrears, on February 1 and August 1 of each year. The Convertible Notes are senior unsecured obligations of the Company that rank senior in right of payment to the Company’s future indebtedness that is expressly subordinated in right of payment to the Convertible Notes; equal in right of payment to the Company’s unsecured indebtedness that is not so subordinated; effectively junior to any of the Company’s secured indebtedness to the extent of the value of the assets securing such indebtedness; and structurally junior to all indebtedness or other

liabilities incurred by the Company’s subsidiaries other than the Notes Guarantor, which fully and unconditionally guarantee the Convertible Notes on a senior unsecured basis.

The Convertible Notes mature on August 1, 2037, unless earlier repurchased, redeemed or converted.

Holders may convert their Convertible Notes at any time prior to the close of business on the business day immediately preceding February 1, 2037, other than during the period from, and including, February 1, 2022 to the close of business on the second business day immediately preceding August 5, 2022, only under the following circumstances: (1) during any calendar quarter commencing after the calendar quarter ending on September 30, 2017, if the closing sale price of the Company’s common stock, for at least 20 trading days (whether or not consecutive) in the period of 30 consecutive trading days ending on the last trading day of the calendar quarter immediately preceding the calendar quarter in which the conversion occurs, is more than 130% of the conversion price of the Convertible Notes in effect on each applicable trading day; (2) during the ten consecutive business-day period following any five consecutive trading-day period in which the trading price for the Convertible Notes for each such trading day was less than 98% of the closing sale price of the Company’s common stock on such date multiplied by the then-current conversion rate; (3) if the Company calls any or all of the Convertible Notes for redemption, at any time prior to the close of business on the second business day immediately preceding the redemption date; or (4) upon the occurrence of specified corporate events.

During the period from and including February 1, 2022 to the close of business on the second business day immediately preceding August 5, 2022, and on or after February 1, 2037 until the close of business on the second business day immediately preceding August 1, 2037, holders may surrender their Convertible Notes for conversion at any time, regardless of the foregoing circumstances.

The conversion rate for the Convertible Notes was initially 67.0264 shares of common stock per $1,000 principal amount of Convertible Notes (equivalent to an initial conversion price of approximately $14.92 per share of common stock). The conversion rate is subject to adjustment in certain circumstances and is subject to increase for holders that elect to convert their Convertible Notes in connection with certain corporate transactions (but not, at the Company’s election, a public acquirer change of control (as defined in the Convertible Note Indenture)) that occur prior to August 5, 2022.

Upon the occurrence of a fundamental change (as defined in the Convertible Note Indenture) (but not, at the Company’s election, a public acquirer change of control (as defined in the Convertible Note Indenture), holders of the Convertible Notes may require the Company to repurchase for cash all or a portion of their Convertible Notes at a fundamental change repurchase price equal to 100% of the principal amount of the Convertible Notes to be repurchased, plus accrued and unpaid interest to, but excluding, the fundamental change repurchase date.

Except as described below, the Company may not redeem the Convertible Notes prior to August 5, 2022. On or after August 5, 2022 but prior to February 1, 2037, the Company may redeem for cash all or any portion of the Convertible Notes, at the Company’s option, at a redemption price equal to 100% of the principal amount of the Convertible Notes to be redeemed, plus accrued and unpaid interest to, but excluding, the redemption date. No sinking fund is provided for the Convertible Notes, which means that the Company is not required to redeem or retire the Convertible Notes periodically. Holders of the Convertible Notes are able to cause the Company to repurchase their Convertible Notes for cash on any of August 1, 2022, August 1, 2027 and August 1, 2032, in each case at 100% of their principal amount, plus accrued and unpaid interest to, but excluding, the relevant repurchase date.

The Convertible Note Indenture contains customary terms and covenants and events of default. If an Event of Default (as defined in the Convertible Note Indenture) occurs and is continuing, the Trustee by notice to the Company, or the holders of at least 25% in aggregate principal amount of the Convertible Notes then outstanding by notice to the Company and the Trustee, may declare 100% of the principal of, and accrued and unpaid interest, if any, on, all the Convertible Notes to be immediately due and payable. In the case of certain events of bankruptcy, insolvency or reorganization (as set forth in the Convertible Note Indenture) with respect to the Company, 100% of the principal of, and accrued and unpaid interest, if any, on, the Notes automatically become immediately due and payable.

In January 2022, the Company repurchased $11.7 million principal amount of outstanding Convertible Notes. As of September 30, 2022, there was $885,000 principal amount of outstanding Convertible Notes, net of $21.1 million of Convertible Notes held by an insurance company subsidiary.

As discussed above, holders of the Convertible Notes issued by the Company had an optional put right, pursuant to the indenture governing the Convertible Notes, to require the Company to repurchase the aggregate principal amount of Convertible Notes that are validly tendered. The Company has received notice from the Depositary for the Convertible Notes that, on July 29, 2022, $10,895,000 aggregate principal amount of the Convertible Notes has been validly tendered in accordance with the terms of the indenture and the Company’s notice with respect to the optional put right of the Convertible Notes, and the Company has requested that the trustee cancel the Convertible Notes tendered. The outstanding balance as of September 30, 2022 of non-affiliated Notes was $11.8 million. On August 1, 2022, the Company made payments for the principal amount of the Convertible Notes tendered and unpaid interest in the aggregate amounts of $10.9 million and $320,041, respectively. The Company has drawn $10.0 million from its revolver to replenish the cash used to pay the $10.9 million for the purchase of the tendered Convertible Notes.

FHLB Loan Agreements

In December 2018, a subsidiary of the Company pledged U.S. government and agency fixed maturity securities with an estimated fair value of $26.4 million as collateral and received $19.2 million in a cash loan under an advance agreement with the FHLB Atlanta. The loan originated on December 12, 2018 and bears a fixed interest rate of 3.094% with interest payments due quarterly commencing in March 2019. The principal balance on the loan has a maturity date of December 13, 2023. In connection with the agreement, the subsidiary became a member of FHLB. Membership in the FHLB required an investment in FHLB’s common stock which was purchased on December 31, 2018 and valued at $1.4 million. As of September 30, 2022, the common stock is value at $1.2 million. The subsidiary is permitted to withdraw any portion of the pledged collateral over the minimum collateral requirement at any time, other than in the event of a default by the subsidiary. The proceeds from the loan was used to prepay the Company’s Senior Secured Notes due 2023 in 2018.

Critical Accounting Policies and Estimates

When we prepare our condensed consolidated financial statements and accompanying notes in conformity with U.S. generally accepted accounting principles (GAAP), we must make estimates and assumptions about future events that affect the amounts we report. Certain of these estimates result from judgments that can be subjective and complex. As a result of that subjectivity and complexity, and because we continuously evaluate these estimates and assumptions based on a variety of factors, actual results could materially differ from our estimates and assumptions if changes in one or more factors require us to make accounting adjustments. In September 2022, we assessed our deferred tax position and recorded a $10.7 million valuation against our net deferred tax asset at September 30, 2022. We intend to continue maintaining the valuation allowance on our net deferred tax asset until there is sufficient evidence to support the reversal of all or some portion of the allowance. We have made no other material changes or additions with regard to those policies and estimates as disclosed in our Annual Report on Form 10-K for the year ended December 31, 2021.

Seasonality of our Business

Our insurance business is seasonal; hurricanes typically occur during the period from June 1 through November 30 and winter storms generally impact the first and fourth quarters each year. With our catastrophe reinsurance program effective on June 1 each year, any variation in the cost of our reinsurance, whether due to changes to reinsurance rates or changes in the total insured value of our policy base will occur and be reflected in our financial results beginning June 1 of each year, subject to certain adjustments.

Recent Accounting Pronouncements

The information set forth under Note 1 to the condensed consolidated financial statements under the caption “Basis of Presentation and Significant Accounting Policies” is incorporated herein by reference. We do not expect any recently issued accounting pronouncements to have a material effect on our condensed consolidated financial statements.

Item 3. Quantitative and Qualitative Disclosures About Market Risk.

The duration of the financial instruments held in our portfolio that are subject to interest rate risk was 3.358 years and 3.891 years at September 30, 2022 and 2021, and 3.903 years at December 31, 2021. As interest rates continue to rise, the fair value of our fixed rate debt securities are subject to decline. Credit risk results from uncertainty in a counterparty’s ability to meet its obligations. Credit risk is managed by maintaining a high credit quality fixed maturity securities portfolio. As of September 30, 2022, the estimated weighted-average credit quality rating of the fixed maturity securities portfolio was A+, at fair value, consistent with the average rating at December 31, 2021.

Under the amended term loan agreement dated November 7, 2022, borrowings under the Credit Facilities bear interest at rates equal to either (1) a rate determined by reference to SOFR, plus an applicable margin and a credit adjustment spread equal to 0.10% or (2) a base rate determined by reference to the highest of (a) the “prime rate” of Regions Bank, (b) the federal funds rate plus 0.50%, and (c) the adjusted term SOFR in effect on such day for an interest period of one month plus 1.00%, plus an applicable margin, eliminating any reference to LIBOR.

The Federal Reserve has tightened monetary policy, including multiple interest rate increases in the first half of 2022; however, the outlook is less certain for longer-term rates during the second half of 2022 and beyond. At September 30, 2022, we have not experienced a material impact when compared to the tabular presentations of our interest rate and market risk sensitive instruments in our 2021 Annual Report on Form 10-K for the year ended December 31, 2021.

Item 4. Controls and Procedures.

Evaluation of Disclosure Controls and Procedures

We maintain disclosure controls and procedures (as defined in Exchange Act Rule 13a-15(e)) that are designed to assure that information required to be disclosed in our Exchange Act reports is recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and forms, and that such information is accumulated and communicated to management, including our Chief Executive Officer and Chief Financial Officer, as appropriate, to allow timely decisions regarding required disclosures.

As required by Exchange Act Rule 13a-15(b), as of the end of the period covered by this Quarterly Report, under the supervision and with the participation of our Chief Executive Officer and Chief Financial Officer, we evaluated the effectiveness of our disclosure controls and procedures. Based on this evaluation, our Chief Executive Officer and Chief Financial Officer concluded that our disclosure controls and procedures were effective as of September 30, 2022.

Changes in Internal Control over Financial Reporting

There has been no change in our internal controls over financial reporting during our most recent quarter that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting. There were no significant changes to our internal control over financial reporting for the period ending September 30, 2022.

PART II. OTHER INFORMATION

Item 1. Legal Proceedings

The Company is a party to claims and legal actions arising routinely in the ordinary course of our business. Although we cannot predict with certainty the ultimate resolution of the claims and lawsuits asserted against us, we do not believe that any currently pending legal proceedings to which we are a party will have a material adverse effect on our condensed consolidated financial position results of operations or cash flow.

Item 1A. Risk Factors

The Company documented its risk factors in Item 1A of Part I of its annual report on Form 10-K for the year ended December 31, 2021, filed on March 14, 2022. There have been no material changes to the Company’s risk factors since the filing of that report.

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

The Company's Board of Directors authorized during the second quarter of 2022 the $0.06 per share typically used to pay a quarterly dividend to shareholders to be allocated to repurchase common stock. The authorization was for $2.0 million to repurchase common stock commencing in August 2022.

During the third quarter ended September 30, 2022, the Company purchased 632,744 shares of common stock in aggregate of $1.7 million with an average share price of $2.73 per share.

A summary of our common stock repurchases during the quarter ended September 30, 2022, is set forth in the table below (in thousands, except shares and price per share):


	Total Number of Shares Purchased		Average Price (1) Paid Per Share		Total Number of Shares Purchased as Part of Publicly Announced Plans or Programs		Dollar Value of Shares that May Yet be Purchased Under the Plans or Programs (2)
July 1 - July 31, 2022		—	$	—		—	$	20,000
August 1 - August 31, 2022		237,911	$	2.78		237,911	$	19,328
September 1 - September 30, 2022		394,833	$	2.70		394,833	$	18,252
Total		632,744				632,744

(1)

Represents the balance before commission and fees at the end of each period.

(2)

Effective December 31, 2021, the Board of Directors established a new share repurchase program with an initial value of $25.0 million and with an expiration date of December 31, 2022.

Item 5. Other Information

Item 1.01 Entry into a Material Definitive Agreement

Seventh Amendment to Credit Agreement

Restricted Payments (as defined in the Credit Agreement) and (B) fee forgiveness & other capital contributions to the Company’s regulated insurance companies that are not a party to the Credit Agreement (“Non-credit Parties”) that exceed $38 million, when calculating (i) Consolidated Tangible Net Worth (as defined in the Credit Agreement) which is required to be not less than $100 million plus 50% of positive quarterly net income (including its subsidiaries and regulated subsidiaries) plus the net cash proceeds of any equity transactions and (ii) Consolidated Fixed Charge Ratio (as defined in the Credit Agreement) which is required to be 1.20x . The Seventh Amendment also (A) eliminates the current $10 million basket available to the Company to pay dividends to its shareholders or to repurchase its securities, (B) provides for a dividend of up to $2 million in the fourth quarter of 2024 under certain conditions and (C) restricts future dividends based on maintenance of certain financial ratios, including Consolidated Tangible Net Worth. As a result, going forward, dividends and stock repurchases may be limited or restricted entirely and the Company’s ability to contribute capital to its insurance subsidiaries that are not parties to the Credit Agreement may be limited.

All other material terms of the Credit Agreement remain unchanged.

Certain Relationships

The lenders under the Credit Agreement and their affiliates may in the future engage in transactions with and perform services, including commercial banking, financial advisory and investment banking services, for the Company and its affiliates in the ordinary course of business for which they may receive customary fees and expenses.

The above summary description of the Seventh Amendment does not purport to be complete and is subject to, and qualified in its entirety by reference to, the Seventh Amendment, a copy of which is filed herewith as Exhibit 10.1 and incorporated herein by reference.

Item 2.03 Creation of a Direct Financial Obligation or an Obligation under an Off-Balance Sheet Arrangement of a Registrant

The information contained in Item 1.01 is hereby incorporated into this Item 2.03 by reference thereto.

Item 6. Exhibits

The information required by this Item 6 is set forth in the Index to Exhibits accompanying this Quarterly Report on Form 10-Q.

Index to Exhibits


3.1	Certificate of Incorporation of Heritage Insurance Holdings, Inc. (incorporated by reference to Exhibit 3.1 to the Company’s Quarterly Report on Form 10-Q filed on August 6, 2014
3.2	By-laws of Heritage Insurance Holdings, Inc. (incorporated by reference to Exhibit 3.2 to the Company’s Quarterly Report on Form 10-Q filed on August 6, 2014
4	Form of Stock Certificate (incorporated by reference to Exhibit 4.1 to the Company’s Registration Statement on Form S-1/A (File No. 333-195409) filed on May 13, 2014)
4.1	Form of 5.875% Convertible Senior Notes due 2037 (included in Exhibit 4.1), (incorporated by reference to 1.1 to our Form 8-K filed on August 16, 2017)
4.2	Indenture, dated as of August 16, 2017, by and among the Company. Heritage MGA, LLC as guarantor, and Wilmington Trust, National Association, as trustee, (incorporated by reference to Exhibit 4.1 to the Company's Form 8-K filed on August 16, 2017)
10.1*	Seventh Amendment to Credit Agreement, dated November 7, 2022, among Heritage Insurance Holdings, Inc., certain subsidiaries of Heritage Insurance Holdings, Inc. from time to time party as guarantors, the lenders from time to time party and Regions Bank, as Administrative Agent and Collateral Agent
31.1*	Rule 13a-14(a)/15d-14(a) Certification of Principal Executive Officer as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
31.2*	Rule 13a-14(a)/15d-14(a) Certification of Principal Financial Officer as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
32.1**	Certification of Chief Executive Officer pursuant to 18 U.SC. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
32.2**	Certification of Chief Financial Officer pursuant to 18 U.SC. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002


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101.SCH*		Inline XBRL Taxonomy Extension Schema Document
101.CAL*		Inline XBRL Taxonomy Extension Calculation Linkbase Document
101.DEF*		Inline XBRL Taxonomy Extension Definition Linkbase Document
101.LAB*		Inline XBRL Taxonomy Extension Label Linkbase Data Document
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* Filed herewith

** Furnished herewith

SIGNATURES

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


	HERITAGE INSURANCE HOLDINGS, INC.

Date: November 9, 2022	By:	/s/ ERNESTO GARATEIX
		Ernesto Garateix
		Chief Executive Officer (Principal Executive Officer and Duly Authorized Officer)

Date: November 9, 2022	By:	/s/ KIRK LUSK
		Kirk Lusk
		Chief Financial Officer (Principal Financial Officer)

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Heritage Insurance (HRTG) 10-Q2022 Q3 Quarterly report

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