Note 23 - Fair Value of Financial Instruments

12 Months Ended

Dec. 31, 2022

Notes to Financial Statements

Fair Value Disclosures [Text Block]

Fair value is the price that would be received upon sale of an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. Fair value is best evidenced by quoted bid or ask price, as appropriate, in an active market. Where bid or ask prices are not available, such as in an illiquid or inactive market, the closing price of the most recent transaction of that instrument subject to appropriate adjustments as required is used. Where quoted market prices are not available, the quoted prices of similar financial instruments or valuation models with observable market-based inputs are used to estimate the fair value. These valuation models may use multiple observable market inputs, including observable interest rates, foreign exchange rates, index levels, credit spreads, equity prices, counterparty credit quality, corresponding market volatility levels and option volatilities. Minimal management judgment is required for fair values calculated using quoted market prices or observable market inputs for models. Greater subjectivity is required when making valuation adjustments for financial instruments in inactive markets or when using models where observable parameters do not exist. Also, the calculation of estimated fair value is based on market conditions at a specific point in time and may not be reflective of future fair values. For the Company's financial instruments carried at cost or amortized cost, the book value is not adjusted to reflect increases or decreases in fair value due to market fluctuations, including those due to interest rate changes, as it is the Company's intention to hold them until there is a recovery of fair value, which may be to maturity.

The Company employs a fair value hierarchy to categorize the inputs it uses in valuation techniques to measure the fair value. The following fair value hierarchy is used in selecting inputs, with the highest priority given to Level 1:

• Level 1 – Quoted prices for identical instruments in active markets.

• Level 2 – Quoted prices for similar instruments in active markets; quoted prices for identical or similar instruments in markets that are not active; and model-derived valuations in which all significant inputs are observable in active markets.

• Level 3 – Valuations derived from valuation techniques in which one or more significant inputs are not observable.

The Company classifies its investments in fixed maturities as available-for-sale and reports these investments at fair value. The Company's equity investments, limited liability investments, at fair value, real estate investments, subordinated debt, stock-based compensation liabilities, derivative contracts (interest rate swap and trust preferred debt repurchase options) and contingent consideration are measured and reported at fair value.

Fixed maturities - Fair values of fixed maturities for which no active market exists are derived from quoted market prices of similar instruments or other third-party evidence. All classes of the Company’s fixed maturities, primarily consisting of investments in US. Treasury bills and government bonds; obligations of states, municipalities and political subdivisions; mortgage-backed securities; and corporate securities, are classified as Level 2. Level 2 is applied to valuations based upon quoted prices for similar assets in active markets; quoted prices for identical or similar assets in markets that are inactive; or valuations based on models where the significant inputs are observable or can be corroborated by observable market data.

The Company engages a third-party vendor who utilizes third-party pricing sources and primarily employs a market approach to determine the fair values of our fixed maturities. The market approach includes primarily obtaining prices from independent third-party pricing services as well as, to a lesser extent, quotes from broker-dealers. Our third-party vendor also monitors market indicators, as well as industry and economic events, to ensure pricing is appropriate. All classes of our fixed maturities are valued using this technique. The Company has obtained an understanding of our third-party vendor’s valuation methodologies and inputs. Fair values obtained from our third-party vendor are not adjusted by the Company.

The following is a description of the significant inputs, by asset class, used by the third-party pricing services to determine the fair values of our fixed maturities included in Level 2:

• U.S. government, government agencies and authorities are generally priced using the market approach. Inputs generally consist of trades of identical or similar securities, quoted prices in inactive markets and maturity.

• States, municipalities and political subdivisions are generally priced using the market approach. Inputs generally consist of trades of identical or similar securities, quoted prices in inactive markets, new issuances and credit spreads.

• Mortgage-backed securities are generally priced using the market approach. Inputs generally consist of trades of identical or similar securities, quoted prices in inactive markets, expected prepayments, expected credit default rates, delinquencies and issue specific information including, but not limited to, collateral type, seniority and vintage.

• Corporate securities are generally priced using the market approach using pricing vendors. Inputs generally consist of trades of identical or similar securities, quoted prices in inactive markets, issuer rating, benchmark yields, maturity and credit spreads.

Equity investments - Fair values of equity investments, including warrants, reflect quoted market values based on latest bid prices, where active markets exist, or models based on significant market observable inputs, where no active markets exist.

Limited liability investments, at fair value - Limited liability investments, at fair value include the underlying investments of Net Lease and Argo Holdings. Net Lease owns investments in limited liability companies that hold investment properties. Argo Holdings makes investments in limited liability companies and limited partnerships that hold investments in search funds and private operating companies.

• The fair value of Net Lease's investments in limited liability companies is based upon the net asset values of the underlying investments in companies as a practical expedient to estimate fair value. The Company applies the net asset value practical expedient to Net Lease's limited liability investments on an investment-by-investment basis unless it is probable that the Company will sell a portion of an investment at an amount different from the net asset value of the investment. Investments that are measured at fair value using the net asset value practical expedient are not required to be classified using the fair value hierarchy.

• The fair value of Argo Holdings' limited liability investments that hold investments in search funds is based on the initial investment in the search funds. The fair value of Argo Holdings' limited liability investments that hold investments in private operating companies is valued using a market approach including valuation multiples applied to corresponding performance metrics, such as earnings before interest, tax, depreciation and amortization; revenue; or net earnings. The selected valuation multiples were estimated using multiples provided by the investees and review of those multiples in light of investor updates, performance reports, financial statements and other relevant information. These investments are categorized in Level 3 of the fair value hierarchy.

Real estate investments - The fair value of real estate investments involves a combination of the market and income valuation techniques. Under this approach, a market-based capitalization rate is derived from comparable transactions, adjusted for any unique characteristics of each asset, and applied to the asset under consideration. The cap rates used during underwriting and subsequent valuation incorporate the consideration of risks of vacancy and collection loss, administrative costs of owning net leased assets and possible capital expenditures that could be determined a landlord expense. These investments are categorized in Level 3 of the fair value hierarchy.

Subordinated debt - The fair value of the subordinated debt is calculated using a model based on significant market observable inputs and inputs developed by a third-party. These inputs include credit spread assumptions developed by a third-party and market observable swap rates. The subordinated debt is categorized in Level 2 of the fair value hierarchy.

Stock-based compensation liabilities- Certain of the restricted stock awards granted by PWSC were classified as a liability prior to the sale of PWSC on July 29, 2022. Liability-classified awards are measured and reported at fair value and are included in accrued expenses and other liabilities in the consolidated balance sheets. The fair value of the liability-classified awards granted by PWSC were estimated using an internal valuation model without relevant observable market inputs. The significant inputs used in the model include a valuation multiple applied to trailing twelve month earnings before interest, tax, depreciation and amortization. Liability-classified PWSC restricted stock awards were categorized in Level 3 of the fair value hierarchy.

Derivative contract interest rate swap - As described in Note 11, "Derivatives," the Company entered into an interest rate swap agreement effective April 1, 2021 to convert the variable interest rate on a portion of the 2020 KWH Loan to a fixed interest rate.  The interest rate swap contract is measured and reported at fair value and is included in other receivables and accrued expenses and other liabilities in the consolidated balance sheets at  December 31, 2022 and December 31, 2021, respectively. The fair value of the interest rate swap contract is estimated using inputs which the Company obtains from the counterparty and is determined using a discounted cash flow analysis on the expected cash flows of the derivative.  The discounted cash flow valuation technique reflects the contractual term of the derivative contract, including the period to maturity, and uses observable market based inputs, including quoted mid-market prices or third-party consensus pricing, interest rate curves and implied volatilities.  The interest rate swap contract is categorized in Level 2 of the fair value hierarchy.

Derivative contracts - trust preferred debt repurchase options - As described in Note 11, "Derivatives," the Company entered into three TruPs Options contracts during the third quarter of 2022.  The TruPs Options contracts are measured and reported at fair value and are included in other assets in the consolidated balance sheet at December 31, 2022. The fair value of the TruPs Options contracts are estimated using the binomial lattice model.  Key inputs in the valuation include credit spread assumptions, interest rate volatility, debt coupon interest rate and time to maturity.  The TruPs Options contracts are categorized in Level 3 of the fair value hierarchy. 

Contingent consideration - The consideration for the Company's acquisitions of Ravix and CSuite includes future payments to the former owners that are contingent upon the achievement of certain targets over future reporting periods. Liabilities for contingent consideration are measured and reported at fair value and are included in accrued expenses and other liabilities in the consolidated balance sheets.  Contingent consideration liabilities are revalued each reporting period. Changes in the fair value of contingent consideration liabilities can result from changes to one or multiple inputs, including adjustments to the discount rates or changes in the assumed achievement or timing of any targets. Any changes in fair value are reported in the consolidated statements of operations as non-operating other (expense) revenue. The contingent consideration liabilities are categorized in Level 3 of the fair value hierarchy.

• The fair value of Ravix's contingent consideration liability is estimated by applying the Monte Carlo simulation method to forecast achievement of gross profit which  may result in up to $4.5 million in total payments to the former owners of Ravix through October 2024.  Key inputs in the valuation include forecasted gross profit, gross profit volatility, discount rate and discount term.

• The fair value of CSuite's contingent consideration liability is estimated by applying the Monte Carlo simulation method to forecast achievement of gross revenue which  may result in up to $3.6 million in total payments to the former owners of CSuite through November 2025.  Key inputs in the valuation include forecasted gross revenue, gross revenue volatility, discount rate and discount term.

Assets and Liabilities Measured at Fair Value on a Recurring Basis

The balances of the Company's financial assets and liabilities measured at fair value on a recurring basis by level within the fair value hierarchy as of December 31, 2022 and December 31, 2021 are as follows. Certain investments in limited liability companies that are measured at fair value using the net asset value practical expedient are not required to be classified using the fair value hierarchy, but are presented in the following tables to permit reconciliation of the fair value hierarchy to the amounts presented in the consolidated balance sheets:

(in thousands)					December 31, 2022
	Fair Value Measurements at the End of the Reporting Period Using
			Quoted
			Prices in
			Active		Significant
			Markets for		Other		Significant
			Identical		Observable		Unobservable		Measured at
			Assets		Inputs		Inputs		Net Asset
	Total		(Level 1)		(Level 2)		(Level 3)		Value
Recurring fair value measurements
Assets:
Fixed maturities:
U.S. government, government agencies and authorities	$	15,080	$	—	$	15,080	$	—	$	—
States, municipalities and political subdivisions		2,232		—		2,232		—		—
Mortgage-backed		8,412		—		8,412		—		—
Asset-backed		1,610		—		1,610		—		—
Corporate		10,257		—		10,257		—		—
Total fixed maturities		37,591		—		37,591		—		—
Equity investments:
Common stock		153		153		—		—		—
Total equity investments		153		153		—		—		—
Limited liability investments, at fair value		17,059		—		—		3,196		13,863
Derivative contract - interest rate swap		326		—		326		—		—
Derivative contract - trust preferred debt repurchase options		19,034		—		—		19,034		—
Total assets	$	74,163	$	153	$	37,917	$	22,230	$	13,863
Liabilities:
Subordinated debt	$	67,811	$	—	$	67,811	$	—	$	—
Contingent consideration		3,218		—		—		3,218		—
Total liabilities	$	71,029	$	—	$	67,811	$	3,218	$	—

(in thousands)					December 31, 2021
	Fair Value Measurements at the End of the Reporting Period Using
			Quoted
			Prices in
			Active		Significant
			Markets for		Other		Significant
			Identical		Observable		Unobservable		Measured
			Assets		Inputs		Inputs		at Net
	Total		(Level 1)		(Level 2)		(Level 3)		Asset Value
Recurring fair value measurements
Assets:
Fixed maturities:
U.S. government, government agencies and authorities	$	16,223	$	—	$	16,223	$	—	$	—
States, municipalities and political subdivisions		1,878		—		1,878		—		—
Mortgage-backed		7,629		—		7,629		—		—
Asset-backed		445		—		445		—		—
Corporate		9,491		—		9,491		—		—
Total fixed maturities		35,666		—		35,666		—		—
Equity investments:
Common stock		171		171		—		—		—
Warrants		8		—		8		—		—
Total equity investments		179		171		8		—		—
Limited liability investments, at fair value		18,826		—		—		4,022		14,804
Real estate investments		10,662		—		—		10,662		—
Total assets	$	65,333	$	171	$	35,674	$	14,684	$	14,804
Liabilities:
Subordinated debt	$	60,973	$	—	$	60,973	$	—	$	—
Contingent consideration		2,458		—		—		2,458		—
Stock-based compensation liabilities		1,402		—		—		1,402		—
Derivative contract - interest rate swap		14		—		14		—		—
Total liabilities	$	64,847	$	—	$	60,987	$	3,860	$	—

The following table provides a reconciliation of the fair value of recurring Level 3 fair value measurements for the years ended December 31, 2022 and December 31, 2021:

(in thousands)	Years ended December 31,
	2022			2021
Assets:
Limited liability investments, at fair value:
Beginning balance	$	4,022		$	3,263
Distributions received		(621	)		(658	)
Realized gains included in net income		607			631
Change in fair value of limited liability investments, at fair value included in net income		(812	)		786
Ending balance	$	3,196		$	4,022
Unrealized (gains) losses on limited liability investments, at fair value held at end of period:
Included in net income	$	(812	)	$	786
Included in other comprehensive loss	$	—		$	—
Real estate investments:
Beginning balance	$	10,662		$	10,662
Realized gains on sale of real estate investments included in net income		1,488			—
Sale of real estate investments		(12,150	)		—
Ending balance	$	—		$	10,662
Unrealized gains recognized on real estate investments held at end of period:
Included in net income	$	—		$	—
Included in other comprehensive loss		—			—
Derivative - trust preferred debt repurchase options:
Beginning balance	$	—		$	—
Purchase of options		2,304			—
Initial valuation of options included in net income		11,412			—
Change in fair value of derivative assets included in net income		5,318			—
Ending balance	$	19,034		$	—
Unrealized gains recognized on derivative assets held at end of period:
Included in net income	$	16,730		$	—
Included in other comprehensive loss		—			—
Ending balance - assets	$	22,230		$	14,684
Liabilities:
Contingent consideration:
Beginning balance	$	2,458		$	—
Issuance of contingent consideration in connection with acquisition		—			2,195
Settlements of contingent consideration liabilities		(750	)		—
Change in fair value of contingent consideration included in net income		1,510			263
Ending balance	$	3,218		$	2,458
Unrealized gains recognized on contingent consideration liabilities held at end of period:
Included in net income	$	1,510		$	263
Included in other comprehensive loss	$	—		$	—
Stock-based compensation liabilities:
Beginning balance	$	1,402		$	443
Issuance of stock-based compensation awards		—			—
Change in fair value of stock-based compensation liabilities included in net income		2,780			959
Stock-based compensation liabilities disposed of related to PWSC		(4,182	)		—
Ending balance	$	—		$	1,402
Unrealized gains recognized on stock-based compensation liabilities held at end of period:
Included in net income	$	2,780		$	959
Included in other comprehensive loss	$	—		$	—
Ending balance - liabilities	$	3,218		$	3,860

Notes to Consolidated Financial Statements

The following table summarizes the valuation techniques and significant unobservable inputs utilized in determining fair values for the Company's investments that are categorized as Level 3 at December 31, 2022:

Categories	Fair Value		Valuation Techniques	Unobservable Inputs	Input Value(s)
Limited liability investments, at fair value	$	3,196	Market approach	Valuation multiples	1.0x - 9.0x
Derivative - trust preferred debt repurchase options	$	19,034	Binomial lattice option approach	Credit spread		8.95	%
				Interest rate volatility	2.3		%
				Debt coupon interest rate	8.72%-8.87%
				Time to maturity (in years)	10.4 - 10.59
Contingent consideration	$	3,218	Option-based income approach	Discount rate		8.25	%
				Risk-free rate	4.44		%
				Expected volatility	13.0		%

The following table summarizes the valuation techniques and significant unobservable inputs utilized in determining fair values for the Company's investments that are categorized as Level 3 at December 31, 2021:

Categories	Fair Value		Valuation Techniques	Unobservable Inputs	Input Value(s)
Limited liability investments, at fair value	$	4,022	Market approach	Valuation multiples	1.0x - 8.0x
Real estate investments	$	10,662	Market and income approach	Cap rates		7.5	%
Contingent consideration	$	2,458	Option-based income approach	Discount rate		4.0	%
				Risk-free rate	0.49		%
				Expected volatility	15.0		%
Stock-based compensation liabilities	$	1,402	Market approach	Valuation multiple	6.0x

Investments Measured Using the Net Asset Value per Share Practical Expedient

The following table summarizes investments for which fair value is measured using the net asset value per share practical expedient at December 31, 2022:

	Fair Value						Redemption
Category	(in thousands)		Unfunded Commitments		Redemption Frequency		Notice Period
Limited liability investments, at fair value	$	13,863		n/a		n/a		n/a

The following table summarizes investments for which fair value is measured using the net asset value per share practical expedient at December 31, 2021:

	Fair Value						Redemption
Category	(in thousands)		Unfunded Commitments		Redemption Frequency		Notice Period
Limited liability investments, at fair value	$	14,804		n/a		n/a		n/a

Assets and Liabilities Measured at Fair Value on a Nonrecurring Basis

Certain assets and liabilities are measured at fair value on a nonrecurring basis, including assets that are adjusted for observable price changes or written down to fair value as a result of an impairment. For the years ended December 31, 2022 and December 31, 2021, the Company did not record any adjustments to the fair value of its investments in private companies for observable price changes. The Company did not record any impairments related to investments in private companies for the years ended December 31, 2022 and December 31, 2021. To determine the fair value of investments in these private companies, the Company considered rounds of financing and third-party transactions, discounted cash flow analyses and market-based information, including comparable transactions, trading multiples and changes in market outlook, among other factors. The Company has classified the fair value measurements of these investments in private companies as Level 3 because they involve significant unobservable inputs.

As further discussed in Note 4, "Acquisitions," the Company acquired Ravix on October 1, 2021 and allocated the purchase price to the assets acquired and liabilities assumed. The fair values of intangible assets associated with the acquisition of Ravix were determined to be Level 3 under the fair value hierarchy.

The following table summarizes the valuation techniques and significant unobservable inputs utilized in determining fair values for these Level 3 measurements:

Categories	Fair Value		Valuation Techniques	Unobservable Inputs	Input Value(s)
Customer relationships	$	4,000	Multi-period excess earnings	Growth rate		3.0	%
				Attrition rate		15.0	%
				Discount rate		21.0	%
Trade name	$	2,500	Relief from royalty	Royalty rate		3.0	%
				Discount rate		21.0	%

As further discussed in Note 4, "Acquisitions," the Company acquired CSuite on November 1, 2022 and provisionally allocated the purchase price to the assets acquired and liabilities assumed. The fair values of intangible assets associated with the acquisition of CSuite were determined to be Level 3 under the fair value hierarchy.

The following table summarizes the valuation techniques and significant unobservable inputs utilized in determining fair values for these Level 3 measurements:

Categories	Fair Value		Valuation Techniques	Unobservable Inputs	Input Value(s)
Customer relationships	$	2,500	Multi-period excess earnings	Growth rate		3.0	%
				Attrition rate		25.0	%
				Discount rate		16.5	%
Trade name	$	1,500	Relief from royalty	Royalty rate		2.5	%
				Discount rate		15.5	%

As further discussed in Note 4, "Acquisitions," the Company acquired SNS on November 18, 2022 and provisionally allocated the purchase price to the assets acquired and liabilities assumed. The fair values of intangible assets associated with the acquisition of SNS were determined to be Level 3 under the fair value hierarchy.

The following table summarizes the valuation techniques and significant unobservable inputs utilized in determining fair values for these Level 3 measurements:

Categories	Fair Value		Valuation Techniques	Unobservable Inputs	Input Value(s)
Customer relationships	$	3,600	Multi-period excess earnings	Growth rate		3.0	%
				Attrition rate		10.0	%
				Discount rate		21.0	%
Trade name	$	3,100	Relief from royalty	Royalty rate		3.0	%
				Discount rate		21.0	%