5. REINSURANCE

Reinsurance is used to mitigate the exposure to losses, manage capacity and protect capital resources. The Company reinsures (cedes) a portion of written premiums on an excess of loss or a quota share basis in order to limit our loss exposure. To the extent that reinsuring companies are unable to meet their obligations assumed under these reinsurance agreements, we remain primarily liable to our policyholders.

We are selective in choosing reinsurers and consider numerous factors, the most important of which are the financial stability of the reinsurer or capital specifically pledged to uphold the contract, 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 with the assistance of our reinsurance broker.

Significant Reinsurance Contracts

FNIC and MNIC operate primarily by underwriting and accepting risks for their direct account on a gross basis and reinsuring a portion of the exposure on either an individual risk or an aggregate basis to the extent those exceed the desired retention level. We continually evaluate the relative attractiveness of different forms of reinsurance contracts and different markets that may be used to achieve our risk and profitability objectives. All of our reinsurance contracts do not relieve FNIC or MNIC from their direct obligations to the insured.

FNIC’s 2016-2017 reinsurance programs, costing approximately $179.5 million, included approximately $125.7 million for the private reinsurance for Federated National’s Florida exposure, including prepaid automatic premium reinstatement protection on all layers, along with approximately $53.8 million payable to the FHCF. The combination of private and FHCF reinsurance treaties afforded Federated National with approximately $2.22 billion of aggregate coverage with a maximum single event coverage totaled approximately $1.58 billion, exclusive of retentions. FNIC maintained its FHCF participation at 75% for the 2016 hurricane season. FNIC’s single event pre-tax retention for a catastrophic event in Florida is $18.45 million. In addition, FNIC purchases separate underlying reinsurance layers in Louisiana, Texas, Alabama, and South Carolina to cover losses and LAE outside of Florida for each catastrophic event from $8.0 million to $18.45 million. Depending on the characteristics of the catastrophic event, and the states involved, FNIC’s single event pre-tax retention could have been as low as $8.0 million.

Additionally, the Company’s private market excess of loss treaties became effective July 1, 2016 and all private layers have prepaid automatic reinstatement protection, which afforded us additional coverage against multiple catastrophic events in the same hurricane season. The Company obtained multiple year protection for a portion of its program; as a result, some of the coverage expired on June 30, 2017, and a portion of the coverage will remain in-force one additional treaty year until June 30, 2018. These private market excess of loss treaties structure coverage into layers, with a cascading feature such that substantially all private layers attach after $18.45 million in losses for FNIC’s Florida exposure. If the aggregate limit of the preceding layer is exhausted, the next layer drops down (cascades) in its place. Additionally, any unused layer protection drops down for subsequent events until exhausted.

FNIC’s 2017-2018 reinsurance programs are estimated to cost $180 million which includes approximately $125 million for the private reinsurance for FNIC’s Florida exposure described above, including prepaid automatic premium reinstatement protection, along with approximately $53.1 million payable to the FHCF. The combination of private and FHCF reinsurance treaties will afford FNIC approximately $2.19 billion of aggregate coverage with a maximum single event coverage totaling approximately $1.56 billion, exclusive of retentions. FNIC maintained its FHCF participation at 75% for the 2017 hurricane season. FNIC’s single event pre-tax retention for a catastrophic event in Florida is $18 million, down slightly from the 2016-2017 reinsurance programs.

FNIC’s private market excess of loss treaties, covering both Florida and Non-Florida exposures, are effective July 1, 2017 and all private layers have prepaid automatic reinstatement protection, which affords FNIC additional coverage for subsequent events. The reinsurance program includes multiple year protection with $89 million of new multiple year protection this year and $156 million of renewing multiple year protection from last year. These private market excess of loss treaties structure coverage into layers, with a cascading feature such that substantially all layers attach after $25.1 million in losses for FNIC’s exposure. If the aggregate limit of the preceding layer is exhausted, the next layer drops down (cascades) in its place. Additionally, any unused layer protection drops down for subsequent events until exhausted. FNIC purchased an underlying limit of protection for $7.1 million excess of $18 million with prepaid automatic reinstatement protection. These treaties are with reinsurers that currently have an A.M. Best Company (“AM Best”) or Standard & Poor’s rating of “A-” or better, or have fully collateralized their maximum potential obligations in dedicated trusts.

FNIC’s Non-Florida excess of loss reinsurance treaties affords us an additional $21 million of aggregate coverage with first event coverage totaling $5 million and second event coverage totaling $16 million. The Non-Florida retention is lowered to $13 million for the first event and $2 million for the second event on a gross basis though it is reduced to $6.5 million and $1 million on a net basis after taking into account the profit share agreement that FNIC has with our non-affiliated managing general underwriter that writes our Non-Florida property business. FNIC’s Non-Florida reinsurance program cost includes $1.9 million for this private reinsurance, including prepaid automatic premium reinstatement protection.

MNIC’s 2016-2017 catastrophe reinsurance program, which ran from either June 1 to May 31 or June 1 to June 30 (13 month period), consisted of the FHCF and private market excess of loss treaties. All private layers have prepaid automatic reinstatement protection, which afforded MNIC additional coverage, and had a cascading feature such that substantially all layers attached at $3.4 million for MNIC's Florida exposure.

MNIC’s 2017-2018 reinsurance programs are estimated to cost $5.17 million which includes approximately $3.23 million for the private reinsurance as described below, along with approximately $1.94 million payable to FHCF. The combination of private and FHCF reinsurance treaties will afford Monarch National approximately $109.81 million of aggregate coverage with a maximum single event coverage totaling approximately $68.89 million, exclusive of retentions. Monarch National’s FHCF participation is at 75% for the 2017 hurricane season.

MNIC’s private market excess of loss treaties are effective July 1, 2017 and all private layers have prepaid automatic reinstatement protection, which affords MNIC additional coverage for subsequent events, and have a cascading feature such that substantially all layers attach at $3.4 million for Monarch National’s Florida exposure. These treaties are with reinsurers that currently have an AM Best or Standard & Poor’s rating of “A-” or better, or have fully collateralized their maximum potential obligations in dedicated trusts.

The Company’s property quota share treaties, which are included in the reinsurance program, ran for a two-year period from July 1 to July 1 of the following year. The property quota-share treaties consisted of two different treaties, one for 30% which became effective July 1, 2014, and the other for 10% which became effective July 1, 2015. The combined treaties provided a 40% quota-share reinsurance on the first $100 million of covered losses for the homeowners’ property insurance program in Florida. The treaties are accounted for as retrospectively rated contracts whereby the estimated ultimate premium or commission is recognized over the period of the contracts.

On July 1, 2016, the 30% property quota-share treaty expired on a cut-off basis, which means as of that date the Company retained an incremental 30% of its unearned premiums and losses. The reinsurers will remain liable for 30% of the paid losses occurring during the term of the treaty, until the treaty is commuted.

The Company’s private passenger automobile quota share treaties are typically one-year programs which become effective at different points in the year and cover auto policies across several states. These automobile quota share treaties cede approximately 75% of all written premiums entered into by the Company.

Certain reinsurance agreements require FNIC and MNIC to secure the credit, regulatory and business risk. Fully funded trust agreements securing these risks for FNIC totaled $2.6 million as of June 30, 2017 and as of December 31, 2016. Fully funded trust agreements securing these risks for MNIC totaled $0.3 million as of June 30, 2017 and as of December 31, 2016.

Subsequent Events

On July 1, 2017, the 10% property quota-share treaty expired on a cut-off basis, which means as of that date the Company retained an incremental 10% of its unearned premiums and losses. The reinsurers will remain liable for 10% of the paid losses occurring during the term of the treaty, until the treaty is commuted.

Additionally, FNIC has bound a new 10% quota-share on its Florida homeowners book of business, which became effective on July 1, 2017 and excludes named storms.

Reinsurance Recoverables

Amounts recoverable from reinsurers are recognized in a manner consistent with the claims liabilities associated with the reinsurance placement and presented on the consolidated balance sheet as reinsurance recoverables. The following table presents reinsurance recoverables as reflected in the consolidated balance sheets as of June 30, 2017 and December 31, 2016:



	June 30,		December 31,
	2017		2016
	(in thousands)
Reinsurance recoverable on paid losses	$	7,629	$	7,451
Reinsurance recoverable on unpaid losses		33,461		41,079
Reinsurance recoverable, net	$	41,090	$	48,530

Premiums Written and Earned

The following table presents premiums written and earned for the three and six months ended June 30, 2017 and 2016:



	Three Months Ended				Six Months Ended
	June 30,				June 30,
	2017		2016		2017		2016
	(in thousands)				(in thousands)
Net premiums written:
Direct	$	168,692	$	171,218	$	314,743	$	307,242
Ceded		(78,983)		(119,410)		(106,287)		(162,980)
	$	89,709	$	51,808	$	208,456	$	144,262
Net premiums earned:
Direct	$	150,563	$	137,334	$	298,541	$	265,433
Ceded		(67,404)		(77,289)		(136,889)		(150,391)
	$	83,159	$	60,045	$	161,652	$	115,042