STOCK-BASED COMPENSATION

At December 31, 2014, the Company had one stock-based payment arrangement outstanding, the PICO Holdings, Inc. 2014 Equity Incentive Plan (the “2014 Plan”). UCP also issues stock-based compensation under its own long term incentive plan that provides for equity-based awards, which upon vesting results in newly issued shares of UCP Class A common stock.

In May 2014, the PICO Holdings, Inc. 2005 Long Term Incentive Plan (the “2005 Plan”) was terminated and replaced by the 2014 Plan, which became effective upon shareholder approval at the Company’s 2014 Annual Meeting of Shareholders. At the time of its termination, the 2005 Plan provided for the issuance of up to 2.7 million shares of common stock through the issuance of ISO, non-statutory stock options, SAR, restricted stock awards (“RSA”), performance shares, performance units, RSU, deferred compensation awards, and other stock-based awards to PICO employees, non-employee directors, and consultants. No further awards will be granted under the 2005 Plan.

The 2014 Plan provides for the issuance of up to 3.3 million shares of common stock, which includes one million shares of common stock initially authorized for issuance under the 2014 Plan, 218,000 shares of common stock previously available for issuance under the 2005 Plan that became part of the share reserve under the 2014 Plan upon termination of the 2005 Plan, and up to 2.1 million shares of common stock currently reserved for issuance upon the exercise of outstanding awards granted under the 2005 Plan that will become available for issuance under the 2014 Plan upon the termination or expiration of such awards. Similar to the 2005 Plan, the 2014 Plan provides for the issuance of ISO, non-statutory stock options, SAR, RSA, performance shares, performance units, RSU, deferred compensation awards, and other stock-based awards to employees, directors and consultants of the Company (or any present or future parent or subsidiary corporation or other affiliated entity of the Company). The 2014 Plan allows for broker assisted cashless exercises and net-settlement of income taxes and employee withholding taxes. Upon exercise of a SAR and RSU, the employee will receive newly issued shares of PICO common stock with a fair value equal to the in-the-money value of the award, less applicable federal, state and local withholding and income taxes (however, the holder of an RSU can elect to pay withholding taxes in cash).

The Company recorded total stock based compensation expense of $7.1 million, $6 million and $3.9 million during 2014, 2013 and 2012, respectively. Of the $7.1 million in stock based compensation expense recorded during 2014, $3.7 million related to RSU and stock options for UCP common stock granted to the officers of UCP, of which $1.9 million was allocated to noncontrolling interest. Of the $6 million in stock based compensation expense recorded in 2013, $2.2 million related to RSU for UCP common stock granted to the officers of UCP, of which $1.2 million was allocated to noncontrolling interest. There was no stock based compensation expense related to UCP in 2012.

Incentive Stock Options (ISO)

The Company issued a total of 453,333 performance-based ISO in November 2014 to various officers. Of the options granted, 285,714 are exercisable for up to 4 years, 7 months from the grant date and 167,619 are exercisable for up to 10 years from the grant date. All of the ISO issued contain a market condition based on the achievement of a stock price target during the contractual term and vest monthly over a three year period. The vested portion of the options may be exercised only if the 30-trading-day average closing sales price of the Company’s common stock equals or exceeds 125% of the grant date stock price. The stock price contingency may be met any time before the options expire and it only needs to be met once for the ISO to remain exercisable for the remainder of the term. Compensation expense is amortized on a straight-line basis over the requisite service period for the entire award, which is the vesting period of the award.

The estimated fair value of the Company’s ISO was determined using a Monte Carlo model, which was estimated using the following assumptions:



	10-Year Option			4.58-Year Option
Grant date	11/14/2014			11/14/2014
Expiration date	11/14/2024			6/14/2019
Grant date stock price	$	19.51		$	19.51
Historical volatility	35.00		%	28.85		%
Risk-free rate (annualized)	2.38		%	1.5		%
Dividend yield (annualized)	—		%	—		%

The determination of the fair value of ISO using an option valuation model is affected by the Company’s stock price, as well as assumptions regarding a number of complex and subjective variables. The volatility is calculated through an analysis based on historical daily returns of PICO’s stock over a look-back period equal to the ISO contractual term. The risk-free interest rate assumption is based upon a risk-neutral framework using the 10-year and 4.58-year zero-coupon risk-free interest rates derived from the treasury constant maturities yield curve on the grant date, for the 10-year ISO award and the 4.58-year ISO award, respectively. The dividend yield assumption is based on the expectation of no future dividend payouts by the Company.

The total fair value of the 285,714 shares, 4.58-year options was $1.5 million and the total fair value of the 167,619 shares, 10-year options was $1.5 million.

A summary of ISO activity is as follows:



	ISO Awards		Weighted-Average Exercise Price Per Share		Weighted-Average Remaining Contractual Term (In Years)
Awards granted	453,333		$	19.51	6.6
Awards vested	(12,593	)	$	19.51	6.5
Outstanding and unvested at December 31, 2014	440,740		$	19.51	6.5

As of December 31, 2014, there were no ISO exercisable as the market condition had not been met. The unrecognized compensation cost related to unvested ISO at December 31, 2014 was $2.9 million.

Restricted Stock Units (RSU)

RSU entitle the recipient, who must be continuously employed by the Company until the vesting date, unless the employment contracts stipulate otherwise, the right to receive one share of the Company’s common stock. RSU do not vote and are not entitled to receive dividends. Compensation expense for RSU is recognized ratably over the vesting period for each grant.

A summary of RSU activity is as follows:



	RSU Shares		Weighted-Average Grant Date Fair Value Per Share
Outstanding and unvested at December 31, 2012	467,716		$	30.43
Granted	15,435		$	22.67
Vested	(13,716	)	$	21.87
Outstanding and unvested at December 31, 2013	469,435		$	30.43
Granted	142,131		$	19.81
Vested	(469,435	)	$	30.43
Outstanding and unvested at December 31, 2014	142,131		$	19.81

There were no RSU forfeited during 2014 or 2013.

The unrecognized compensation cost related to unvested RSU for the years ended December 31, 2014 and 2013 was $2.5 million and $3 million, respectively.

In November of 2014, the Company issued a total of 128,919 RSU to various company officers and members of management. Of the awards granted, 113,334 vest over a four year period and 15,585 vest over a three year period. The total fair value of the four year vesting awards was $2.2 million and the total fair value of the three year vesting awards was $304,000. The RSU were valued at the Company’s closing stock price on the date of grant and the compensation expense is recognized over the vesting period of the award.

In June of 2014, the Company issued 2,202 RSU to each of the six non-employee directors of the Company for a total of 13,212 awards. The total fair value of the awards was $300,000 based on the Company’s closing stock price on the grant date. Each award vests one year from the date of grant. The RSU were valued at the Company’s closing stock price on the date of grant and the compensation expense is recognized over the vesting period of the award.

When an award vests, the recipient receives a new share of PICO common stock for each RSU, less that number of shares of common stock equal in value to applicable withholding taxes. During 2014, 15,435 RSU granted to directors in 2013 and 454,000 RSU granted to various officers in 2010 vested, which resulted in the delivery of 247,253 newly issued shares of PICO common stock. The 469,435 vested shares were reduced by 222,182 shares that were equal to the value of the applicable withholding taxes.

Stock-Settled Stock Appreciation Right (SAR)

Upon exercise, a SAR entitles the recipient to receive a newly issued share of the Company’s common stock equal to the in-the-money value of the award, less applicable federal, state and local withholding and income taxes. SAR do not vote and are not entitled to receive dividends. Compensation expense for SAR was recognized ratably over the vesting period for each grant.

There were no unvested SAR, and therefore no compensation expense recognized, during the three years ended December 31, 2014. In addition, there were no SAR granted or exercised during the three years ended December 31, 2014.

A summary of SAR activity is as follows:



	SAR Shares		Weighted Average Exercise Price		Weighted Average Contractual Term Remaining (Years)
Outstanding and exercisable at December 31, 2012	1,812,079		$	36.16	3.5
Expired	(195,454	)	$	33.76
Outstanding and exercisable at December 31, 2013	1,616,625		$	36.45	2.5
Expired	(20,000	)	$	33.76
Outstanding and exercisable at December 31, 2014	1,596,625		$	36.49	1.5

At December 31, 2014, none of the outstanding SAR were in-the-money.

The fair value of each SAR awarded was estimated on the grant date using a Black-Scholes option pricing model that uses various assumptions and estimates to calculate a fair value as described below.

Expected volatility was based on the actual trading volatility of the Company’s common stock. The Company uses historical experience to estimate expected forfeitures and estimated terms. The expected term of a SAR grant represents the period of time that the SAR is expected to be outstanding. The risk-free rate is the U.S. Treasury Bond yield that corresponds to the expected term of each SAR grant. Expected dividend yield is zero as the Company has not and does not foresee paying a dividend in the future. Forfeitures are estimated to be zero based on the strike price and expected holding period of the SAR.



Expected volatility	29% — 31%
Expected term	7 years
Risk-free rate	4.3% — 4.7%
Expected dividend yield	—	%
Expected forfeiture rate	—	%