(7)	Reinsurance Agreements

Financing risk generally involves a combination of risk retention and risk transfer techniques. “Retention”, similar to a deductible, involves financing losses by funds internally generated. “Transfer” involves the existence of a contractual arrangement designed to shift financial responsibility to another party in exchange for premium. Secondary to the primary risk-transfer agreements, we use reinsurance agreements to transfer a portion of the risks insured under our policies to other companies through the purchase of reinsurance. We utilize reinsurance to reduce exposure to catastrophic and non-catastrophic risks and to help manage the cost of capital. Reinsurance techniques are designed to lessen earnings volatility, improve shareholder return, and to support the required statutory surplus requirements. We also use reinsurance to realize an arbitrage of premium rates, benefit from the availability of our reinsurers’ expertise, and benefit from the management of a profitable portfolio of insureds by way of enhanced analytical capacities. Our primary property line that is subject to catastrophic reinsurance is Homeowners’ Multiple Peril. FNIC cedes these risks to domestic and foreign reinsurance participants from Bermuda and Europe as well as to the FHCF.

Quota share reinsurance is a pro rata agreement among the primary insurer and one or more reinsurers where each party shares a fixed and predetermined percentage of the program’s premiums and losses. Excess of loss risk transfer agreements involve the transfer of premium in exchange for reimbursement for claims, if they occur, as a result of specific events such as severe catastrophic weather. For quota share and excess of loss reinsurance, coverage is generally afforded based on meeting predetermined risk characteristics. In contrast, facultative reinsurance is negotiated between the primary insurer and the reinsurer(s) on a case-by-case basis with no obligation on either part to cede or assume share of the risk.

Generally, there are three separate kinds of reinsurance structures – quota share, excess of loss, and facultative, each considered either proportional or non-proportional. Our reinsurance structures are maintained to protect our insurance subsidiary against the severity of losses on individual claims or unusually serious occurrences in which the frequency and or the severity of claims produce an aggregate extraordinary loss from catastrophic events. In addition to reinsurance agreements, we also from time to time enter into retro-cessionary reinsurance agreements; each designed to shift financial responsibility based on predefined conditions.

Although reinsurance does not discharge us from our primary obligation to pay for losses insured under the policies we issue, reinsurance does make the assuming reinsurer liable to the insurance subsidiary for the reinsured portion of the risk. A credit risk exposure exists with respect to ceded losses to the extent that any reinsurer is unable or unwilling to meet the obligations assumed under the reinsurance contracts. The collectability of reinsurance is subject to the solvency of the reinsurers, interpretation of contract language and other factors. A reinsurer's insolvency or inability to make payments under the terms of a reinsurance contract could have a material adverse effect on our results of operations and financial condition. Our reinsurance structure has significant risks, including the fact that the FHCF may not be able to raise sufficient money to pay its claims or impair its ability to pay its claims in a timely manner. This could result in significant financial, legal and operational challenges to all property and casualty companies associated with FHCF, including our company.

The availability and costs associated with the acquisition of reinsurance will vary year to year. These fluctuations, which can be significant, are not subject to our control and may limit our ability to purchase adequate coverage. For example, FHCF continues to restrict its reinsurance capacity and is expected to continue constricting capacity for future seasons. This gradual restriction is requiring us to replace that capacity with private market reinsurance. Our reinsurance program is subject to approval by the Florida OIR and review by Demotech, Inc. (“Demotech”). The recovery of increased reinsurance costs through rate action is not immediate and cannot be presumed and is subject to Florida OIR approval.

For the 2014–2015 hurricane season, the excess of loss and FHCF treaties insured the property lines for approximately $1.49 billion of aggregate catastrophic losses and LAE with a maximum single event coverage totaling approximately $1.01 billion, with the Company retaining the first $11.20 million in Florida and $3.0 million in Louisiana for losses and LAE from each event. Florida risks represent 98.5%, or $1.46 billion of the $1.49 billion of total aggregate catastrophic losses and LAE. The reinsurance program includes coverage purchased from the private market, which affords optional reinstatement premium protection that provides coverage beyond the first event, along with any remaining coverage from the FHCF. The FHCF only affords coverage for losses sustained in Florida. Coverage afforded by the FHCF totals approximately $546.3 million, or 37.4% of Florida’s $1.46 billion of aggregate catastrophic losses and LAE. The FHCF affords coverage for the entire season, subject to maximum payouts, without regard to any particular insurable event.

The estimated cost to the Company for the excess of loss reinsurance products for the 2014–2015 hurricane season, inclusive of approximately $40.20 million payable to the FHCF and the prepaid automatic premium reinstatement protection, is approximately $117.0 million.

Included in this year’s program is a 30% quota share reinsurance treaty for the Company’s in-force new and renewal homeowners’ insurance program in the State of Florida. This two-year quota share reinsurance treaty provides 30% of $200 million of aggregate catastrophe coverage per year with maximum single event coverage of 30% of $100 million per year. The approximate cost of this quota share is projected to be $6.7 million per year, net of ceding commissions, and it is included in the $117.0 million amount referenced above. The quota share treaty contains commutation provisions for the Company to share profits based on loss experience during the term of the treaty.

The 30% quota share reinsurance treaty described above contains profit sharing provisions that will adjust over its two-year term depending on the Company’s loss experience from catastrophic and non-catastrophic events during the term. The frequency and severity of catastrophic events, coupled with non-catastrophic loss experience, will determine the ultimate profit share, if any. In accordance with GAAP, the Company will initially recognize an asset and liability and the resultant net income or loss. For example, deferred quota-share profit sharing totaled $8.8 million and $10.5 million as of March 31, 2015 and December 31, 2014, respectively. The deferred quota-share profit sharing was originally recorded at $14.0 million at the program’s July 1, 2014 inception and will continue to amortize over the life of the program. Subsequently, the Company will adjust the value of the asset and liability based on information available at the time of valuation. Upward and downward adjustments to the asset’s value will affect the Company’s results of operations by increasing or decreasing net income in the period of the adjustment.

The 2014-2015 private reinsurance companies and their respective A.M. Best Company (“A.M. Best”) and S&P ratings are listed in the table as follows.

	Reinsurer	A.M. Best Rating			S&P Rating

UNITED STATES
	American Agricultural Insurance Company		A-			NR
	American Standard Insurance Company of Wisconsin		A			NR
	AIG (National Union Fire Insurance Company of Pittsburgh, PA)		A			A+
	Everest Reinsurance Company		A+			A+
	Odyssey Reinsurance Company		A			A-
	QBE Reinsurance Corporation		A			A+
	RLI Insurance Company		A+			A+
	Transatlantic Reinsurance Company		A			A+

BERMUDA
	ACE Tempest Reinsurance Limited		A++			AA-
	Allied World Assurance Company, Limited		A			A
	Arch Reinsurance Limited		A+			A+
	Argo Reinsurance Limited		A			NR
	Ariel Reinsurance Bermuda Ltd for and on Behalf of Ariel Syndicate 1910 (ARE)		A-			A+
	Aspen Bermuda Limited		A			A
	AXIS Specialty Limited		A+			A+
	BGS Services (Bermuda) Limited/Lloyds Syndicate 2987		A			A+
	DaVinci Reinsurance Ltd		A			AA-
	Endurance Specialty Insurance Limited		A			A
	Hamilton Re, Limited		A-			NR
	Hiscox Insurance Company (Bermuda) Limited		A			NR
	Partner Reinsurance Company Limited		A+			A+
	Platinum Underwriters Bermuda Limited		A			A-
	Renaissance Reinsurance, Limited		A+			AA-
	Securis Re III Limited Bermuda		NR	*	**	NR
	Securis Re IV Limited Bermuda		NR	*	**	NR
	Tokio Millennium Re AG, Bermuda Branch		A++			AA-
	XL RE Limited		A			A+

UNITED KINGDOM
	A.F. Beazley Syndicate No. 623 (AFB)		A			A+
	A.F. Beazley Syndicate No. 2623 (AFB)		A			A+
	Amlin Syndicate No. 2001 (AML)		A			A+
	Antares Syndicate No. 1274 (AUL)		A			A+
	Ariel Syndicate No. 1910 (ARE)		A			A+
	ARK Syndicate No. 4020 (ARK)		A			A+
	Ascot Syndicate No. 1414 (ASC)		A			A+
	Barbican Syndication No. 1955 (BAR)		A			A+
	Canopius Syndicate No. 958 (CNP)		A			A+
	Canopius Syndicate No. 4444 (CNP)		A			A+
	Cathederal Syndicate No. 2010 (MMX)		A			A+
	Chaucer Syndicate No. 1084 (CSL)		A			A+
	Dale Underwriting Syndicate No. 1729 (DUW)		A			A+
	Faraday Syndicate No. 435 (FDY)		A			A+
	Hiscox Syndicate No. 0033 (HIS)		A			A+
	Kiln Syndicate No. 510 (KLN)		A			A+
	Liberty Syndicates Services Limited, Paris for and on behalf of Lloyd's Syndicate No. 4472 (LIB)		A			A+
	MAP Underwriting Syndicate No. 2791 (MAP)		A			A+
	MAP Underwriting Syndicate No. 2791 (Parallel) (MAP)		A			A+
	Novae Syndicate No. 2007 (NVA)		A			A+
	S.J.O, Catlin & Others No. 2003 (SJC)		A			A+

EUROPE
	Amlin AG, Switzerland, Bermuda Branch		A			A
	Hannover Rueck SE (obo Pillar Capital Management)		NR	*	**	NR
	Lansforsakringar Sak Forsakringsaktiebolag (publ)		NR			A
	SCOR Global P&C SE, Paris, Zurich Branch		A			A

ASIA
	China Reinsurance (Group) Corporation		A			NR
	Qatar Reinsurance Company LLC		A			A

* Reinstatement Premium Protection Program Participants

** Participant will fund a trust agreement for their exposure with cash and U.S. Government obligations of American institutions at fair market value.

For the 2013–2014 hurricane season, the excess of loss and FHCF treaties insured the property lines for approximately $562.7 million of aggregate catastrophic losses and LAE with a maximum single event coverage totaling approximately $420.4 million, with the Company retaining the first $7.0 million of losses and LAE for each event. The reinsurance program includes coverage purchased from the private market, which affords optional reinstatement premium protection that provides coverage beyond the first event, along with any remaining coverage from the FHCF. Coverage afforded by the FHCF totals approximately $278.1 million, or 49.4% of the $562.7 million of aggregate catastrophic losses and LAE. The FHCF affords coverage for the entire season, subject to maximum payouts, without regard to any particular insurable event.

The estimated cost to the Company for the excess of loss reinsurance products for the 2013-2014 hurricane season, inclusive of approximately $21.7 million payable to the FHCF and the prepaid automatic premium reinstatement protection, is approximately $67.9 million.

The 2013-2014 private reinsurance companies and their respective A.M. Best and S&P ratings are listed in the table as follows.

	Reinsurer	A.M. Best Rating			S&P Rating

UNITED STATES
	American Agricultural Insurance Company		A-			NR
	Everest Reinsurance Company		A+			A+
	Houston Casualty Company, UK Branch		A			A+
	Odyssey Reinsurance Company		A			A-

BERMUDA
	ACE Tempest Reinsurance Limited		A+			AA-
	Allied World Assurance Company Limited, Bermuda		A			A
	Arch Reinsurance Limited		A+			A+
	Argo Reinsurance Limited		A			NR
	Ariel Reinsurance Bermuda Ltd for and on Behalf of Ariel Syndicate 1910 (ARE)		A-			NR
	DaVinci Reinsurance Ltd		A			A+
	Endurance Specialty Insurance Limited		A			A
	JC Re Ltd. (aka Pillar Capital and fka Juniperus & Actua Re Ltd.)		NR	*	**	NR
	Partner Reinsurance Company Limited		A+			A+
	Platinum Underwriters Bermuda Limited		A			A-
	Renaissance Reinsurance Ltd		A+			AA-
	S.A.C. Re, Ltd.		A-			NR
	XL Re Limited		A			A

UNITED KINGDOM
	A.F. Beazley Syndicate No. 623 (AFB)		A			A+
	A.F. Beazley Syndicate No. 2623 (AFB)		A			A+
	Amlin Syndicate No. 2001 (AML)		A			A+
	Ariel Syndicate No. 1910 (ARE)		A			A+
	ARK Syndicate No. 3902 (NOA)		A			A+
	Ascot Syndicate No. 1414 (ASC)		A			A+
	Barbican Syndication No. 1955 (BAR)		A			A+
	Canopius Syndicate No. 958 (CNP)		A			A+
	Canopius Syndicate No. 4444 (CNP)		A			A+
	Cathederal Syndicate No. 2010 (MMX)		A			A+
	Kiln Syndicate No. 510 (KLN)		A			A+
	Liberty Syndicates Services Limited, Paris for and on behalf of Lloyd's Syndicate No. 4472 (LIB)		NR			A+
	MAP Underwriting Syndicate No. 2791 (MAP)		A			A+
	MAP Underwriting Syndicate No. 2791 (Parallel) (MAP)		A			A+
	Novae Syndicate No. 2007 (NVA)		A			A+
	Pembroke Syndicate No. 4000 (PEM)		A			A+
	Tokio Marine Kiln Syndicate No. 1880 (TMK)		A			A+

EUROPE
	Amlin Bermuda (Branch of Amlin AG)		A			A
	SCOR Global P&C SE		A			A

* Reinstatement Premium Protection Program Participants

** Participant will fund a trust agreement for their exposure with cash and U.S. Government obligations of American institutions at fair market value.

Annually, the cost and amounts of reinsurance are based on management's analysis of FNIC's exposure to catastrophic risk as of June 30 and estimated to September 30. Our data is then subjected to actual exposure level analysis as of September 30. This analysis of our exposure level in relation to the total exposures to the FHCF and excess of loss treaties may produce changes in limits and reinsurance premiums as a result of the reconciliation of estimated to actual exposure level. The September 30, 2014 change to total insured value was an increase of $5.4 billion or 8.2% and the change to reinsurance premiums was an increase of $0.4 million. The September 30, 2013 change to total insured value was an increase of $8.7 billion or 25.3% and the change to reinsurance premiums was an increase of $8.3 million or 13.3%.These adjustments are amortized over the remaining underlying policy term.

To date, we have made no claims asserted against our reinsurers in connection with the 2014–2015 and 2013–2014 excess of loss and FHCF treaties.

The quota share retrocessionaire reinsurance agreements require FNIC to securitize credit, regulatory and business risk. Fully funded trust agreements totaled $4.9 million as of March 31, 2015 and December 31, 2014.

We are selective in choosing reinsurers and consider numerous factors, the most important of which are the financial stability of the reinsurer, its history of responding to claims and its overall reputation. In an effort to minimize our exposure to the insolvency of a reinsurer, we evaluate the acceptability and review the financial condition of the reinsurer at least annually.