kins_10qa.htm


UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
 
FORM 10- Q/A
(Amendment No. 1)
 
(Mark one)
     
þ
 
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
 
For the quarterly period ended September 30, 2012
 
OR
     
o
 
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
 
For the transition period from _________to _________

Commission File Number 0-1665

KINGSTONE COMPANIES, INC.
(Exact name of registrant as specified in its charter)
 
Delaware  
36-2476480
(State or other jurisdiction of
incorporation or organization)
 
(I.R.S. Employer
Identification Number)
 
1154 Broadway
Hewlett, NY 11557
(Address of principal executive offices)

(516) 374-7600
(Registrant’s telephone number, including area code)
 
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 þ No o

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted 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 and post such files).  Yes þ No o

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer or a smaller reporting company. See the definitions of  “large accelerated filer”, “accelerated filer”, and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):
             
Large accelerated filer o
 
Accelerated filer o
 
Non-accelerated filer o
(Do not check if a smaller reporting company)
 
Smaller reporting company þ

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

As of November 14, 2012, there were 3,842,869 shares of the registrant’s common stock outstanding.
 


 
 

 
 
EXPLANATORY NOTE
 
This Quarterly Report on Form 10-Q/A (“Form 10-Q/A”) is being filed as Amendment No. 1 (the “Amendment”) to our Quarterly Report on Form 10-Q for the quarter ended September 30, 2012, which was filed with the Securities and Exchange Commission (the “SEC”) on November 14, 2012 (the “Original Quarterly Report”). This Form 10-Q/A is being filed to restate the condensed consolidated balance sheet as of September 30, 2012, the condensed consolidated statements of comprehensive income for the three months and nine months ended September 30, 2012, consolidated statement of stockholders’ equity for the nine months ended September 30, 2012, condensed consolidated statement of cash flows for the nine months ended September 30, 2012, and certain footnote disclosures thereto.
 
The need to restate these consolidated financial statements resulted from an error in the calculation of net premiums earned relating to the change in commercial lines reinsurance quota share from 60% to 40% effective as of July 1, 2012. The error was caused by the inclusion of $865,195 of earned premiums in revenue during the quarter ended September 30, 2012 rather than over the term of the reinsurance quota share treaty from July 1, 2012 through June 30, 2013.  The $865,195 of earned premiums, net of expenses as discussed below, will be recorded over the term of the treaty.
 
The earned premium error also affects other calculations based on net income including other underwriting expenses, other operating expenses, and income tax expense. Management has concluded that the correction of the $865,195 earned premium error ($466,156, net of other underwriting expenses, other operating expenses, and income taxes) as more fully described in Note 2 to the consolidated financial statements is material to the September 30, 2012 consolidated quarterly financial statements.  Management is restating its September 30, 2012 Form 10-Q for the error discussed above.
 
As a result of the restatement, management has also re-assessed the effectiveness of its disclosure controls and procedures and internal control over financial reporting and concluded that they were not effective as of the end of the period covered by this report on Form 10-Q/A because of a material weakness in internal control over financial reporting as discussed further in Item 4 contained herein.
 
The effects of this restatement to our consolidated financial statements are described in Note 2 to the consolidated financial statements. We have not updated the financial statement disclosures for any significant events that have occurred subsequent to the filing of the Original Quarterly Report.
 
The following sections have been amended from the Original Quarterly Report as a result of the restatement described above:
 
 
Part I - Item 1. Financial Statements
 
 
Part I - Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations
 
 
Part I - Item 4. Controls and Procedures
 
This Form 10-Q/A also includes as exhibits certifications from our Chief Executive Officer and Chief Financial Officer dated as of the date of this filing. Except as described above, no other sections have been amended from the Original Quarterly Report.
 
 
 
 
 
 
 

 
 
KINGSTONE COMPANIES, INC.
INDEX
           
     
PAGE
           
PART I — FINANCIAL INFORMATION
   
 
 
Item 1 —
Financial Statements
   
3
 
 
Condensed Consolidated Balance Sheets at September 30, 2012 (Unaudited) and December 31, 2011
   
3
 
 
Condensed Consolidated Statements of Comprehensive Income for the three and nine months ended September 30, 2012 (Unaudited) and 2011 (Unaudited)
   
4
 
 
Condensed Consolidated Statement of Stockholders’ Equity for the nine months ended September 30, 2012 (Unaudited)
   
5
 
 
Condensed Consolidated Statements of Cash Flows for the nine months ended September 30, 2012 (Unaudited) and 2011 (Unaudited)
   
6
 
 
Notes to Condensed Consolidated Financial Statements  (Unaudited)
   
7
 
Item 2 —
Management’s Discussion and Analysis of Financial Condition and Results of Operations
   
29
 
Item 3 —
Quantitative and Qualitative Disclosures About Market Risk
   
47
 
Item 4—
Controls and Procedures
   
47
 
           
PART II — OTHER INFORMATION
   
 
 
Item 1 —
Legal Proceedings
   
48
 
Item 1A —
Risk Factors
   
48
 
Item 2 —
Unregistered Sales of Equity Securities and Use of Proceeds
   
48
 
Item 3 —
Defaults Upon Senior Securities
   
48
 
Item 4 —
Mine Safety Disclosures
   
48
 
Item 5 —
Other Information
   
49
 
Item 6 —
Exhibits
   
 
 
Signatures
       
EXHIBIT 3(a)
EXHIBIT 3(b)
EXHIBIT 31(a)
EXHIBIT 31(b)
EXHIBIT 32
EXHIBIT 101.INS XBRL Instance Document
EXHIBIT 101.SCH XBRL Taxonomy Extension Schema
EXHIBIT 101.CAL XBRL Taxonomy Extension Calculation Linkbase
EXHIBIT 101.DEF XBRL Taxonomy Extension Definition Linkbase
EXHIBIT 101.LAB XBRL Taxonomy Extension Label Linkbase
EXHIBIT 101.PRE XBRL Taxonomy Extension Presentation Linkbase
 
 
1

 

Forward-Looking Statements
 
This Quarterly Report contains forward-looking statements as that term is defined in the federal securities laws.  The events described in forward-looking statements contained in this Quarterly Report may not occur.  Generally these statements relate to business plans or strategies, projected or anticipated benefits or other consequences of our plans or strategies, projected or anticipated benefits from acquisitions to be made by us, or projections involving anticipated revenues, earnings or other aspects of our operating results.  The words "may," "will," "expect," "believe," "anticipate," "project," "plan," "intend," "estimate," and "continue," and their opposites and similar expressions are intended to identify forward-looking statements.  We caution you that these statements are not guarantees of future performance or events and are subject to a number of uncertainties, risks and other influences, many of which are beyond our control, that may influence the accuracy of the statements and the projections upon which the statements are based.  Factors which may affect our results include, but are not limited to, the risks and uncertainties discussed in Item 7 of our Annual Report on Form 10-K for the year ended December 31, 2011 under “Factors That May Affect Future Results and Financial Condition”.
 
Any one or more of these uncertainties, risks and other influences could materially affect our results of operations and whether forward-looking statements made by us ultimately prove to be accurate.  Our actual results, performance and achievements could differ materially from those expressed or implied in these forward-looking statements. We undertake no obligation to publicly update or revise any forward-looking statements, whether from new information, future events or otherwise.
 
 
2

 
 
PART I.  FINANCIAL INFORMATION
 
ITEM 1.   FINANCIAL STATEMENTS.
 

KINGSTONE COMPANIES, INC. AND SUBSIDIARIES
 
   
Condensed Consolidated Balance Sheets
           
   
September 30,
       
   
2012
(restated)
   
December 31,
2011
 
   
(unaudited)
       
 Assets
           
 Fixed-maturity securities, held to maturity, at amortized cost (fair value of $792,101 at
           
 September 30, 2012 and $777,953 at December 31, 2011)
  $ 606,273     $ 606,234  
 Fixed-maturity securities, available for sale, at fair value (amortized cost of $21,780,082
               
 at September 30, 2012 and $22,215,191 at December 31, 2011)
    23,102,130       22,568,932  
 Equity securities, available-for-sale, at fair value (cost of $4,716,098
               
 at September 30, 2012 and $3,857,741 at December 31, 2011)
    5,230,893       4,065,210  
 Total investments
    28,939,296       27,240,376  
 Cash and cash equivalents
    2,447,849       173,126  
 Premiums receivable, net of provision for uncollectible amounts
    6,854,026       5,779,085  
 Receivables - reinsurance contracts
    2,668,123       1,734,535  
 Reinsurance receivables, net of provision for uncollectible amounts
    27,182,289       23,880,814  
 Notes receivable-sale of business
    331,207       393,511  
 Deferred acquisition costs
    5,397,647       4,535,773  
 Intangible assets, net
    3,303,886       3,660,672  
 Property and equipment, net of accumulated depreciation
    1,640,464       1,646,341  
 Other assets
    1,076,577       660,672  
 Total assets
  $ 79,841,364     $ 69,704,905  
                 
 Liabilities
               
 Loss and loss adjustment expenses
  $ 22,283,145     $ 18,480,717  
 Unearned premiums
    25,309,496       21,283,160  
 Advance premiums
    497,273       544,791  
 Reinsurance balances payable
    3,164,848       2,761,828  
 Deferred ceding commission revenue
    4,662,272       3,982,399  
 Notes payable (includes payable to related parties of $378,000
               
 at September 30, 2012 and December 31, 2011)
    1,097,000       1,047,000  
 Accounts payable, accrued expenses and other liabilities
    3,246,084       4,505,016  
 Deferred income taxes
    1,952,289       1,789,439  
 Total liabilities
    62,212,407       54,394,350  
                 
 Commitments and Contingencies
               
                 
 Stockholders' Equity
               
 Common stock, $.01 par value; authorized 10,000,000 shares; issued 4,715,829
               
 shares at September 30, 2012 and 4,643,122 shares at December 31, 2011;
               
 outstanding 3,828,391 shares at September 30, 2012 and 3,759,900 shares
               
 at December 31, 2011
    47,159       46,432  
 Preferred stock, $.01 par value; authorized 1,000,000 shares;
               
 -0- shares issued and outstanding
    -       -  
 Capital in excess of par
    13,839,741       13,739,792  
 Accumulated other comprehensive income
    1,212,316       370,399  
 Retained earnings
    3,947,868       2,554,349  
      19,047,084       16,710,972  
 Treasury stock, at cost, 887,438 shares at September 30, 2012 and 883,222 shares
               
 at December 31, 2011
    (1,418,127 )     (1,400,417 )
 Total stockholders' equity
    17,628,957       15,310,555  
                 
 Total liabilities and stockholders' equity
  $ 79,841,364     $ 69,704,905  
 

See accompanying notes to condensed consolidated financial statements.
 
 
3

 
 
KINGSTONE COMPANIES, INC. AND SUBSIDIARIES
 
                         
Condensed Consolidated Statements of Comprehensive Income (Unaudited)
             
   
For the Three Months Ended
   
For the Nine Months Ended
 
   
September 30,
   
September 30,
 
   
2012
(restated)
   
2011
   
2012
(restated)
   
2011
 
                         
 Revenues
                       
 Net premiums earned
  $ 4,416,506     $ 3,937,189     $ 12,553,613     $ 10,822,137  
 Ceding commission revenue
    2,711,431       2,307,390       8,525,945       7,347,832  
 Net investment income
    242,159       172,039       739,555       510,173  
 Net realized gain on investments
    65,986       196,574       111,546       357,006  
 Other income
    218,723       228,615       680,469       693,188  
 Total revenues
    7,654,805       6,841,807       22,611,128       19,730,336  
                                 
 Expenses
                               
 Loss and loss adjustment expenses
    2,691,402       2,933,531       7,378,421       7,307,925  
 Commission expense
    1,952,583       1,596,281       5,430,000       4,472,924  
 Other underwriting expenses
    2,004,331       1,734,137       5,856,653       5,045,051  
 Other operating expenses
    226,505       260,149       800,834       863,114  
 Depreciation and amortization
    150,351       144,122       447,372       457,264  
 Interest expense
    19,781       23,577       60,677       108,249  
 Total expenses
    7,044,953       6,691,797       19,973,957       18,254,527  
                                 
 Income from operations before taxes
    609,852       150,010       2,637,171       1,475,809  
 Income tax expense (benefit)
    162,021       (69,559 )     863,606       355,685  
 Net income
    447,831       219,569       1,773,565       1,120,124  
                                 
 Gross unrealized investment holding gains
                               
 arising during period
    533,877       (166,793 )     1,275,632       166,513  
                                 
 Income tax (expense) benefit related to items of other
                               
 comprehensive income
    (181,518 )     56,710       (433,715 )     (56,614 )
 Comprehensive income
  $ 800,190     $ 109,486     $ 2,615,482     $ 1,230,023  
                                 
Earnings per common share:
                               
Basic
  $ 0.12     $ 0.06     $ 0.47     $ 0.29  
Diluted
  $ 0.11     $ 0.06     $ 0.47     $ 0.29  
                                 
Weighted average common shares outstanding
                               
Basic
    3,824,461       3,838,386       3,794,979       3,838,386  
Diluted
    3,936,167       3,913,036       3,884,172       3,838,386  
                                 
Dividends declared and paid per common share
  $ 0.04     $ 0.03     $ 0.10     $ 0.03  


See accompanying notes to condensed consolidated financial statements.
 
 
4

 
 

KINGSTONE COMPANIES, INC. AND SUBSIDIARIES
 
                                                             
Consolidated Statement of Stockholders' Equity
 
Nine months ended September 30, 2012 (unaudited)
 
                                                             
                                 
Accumulated
                         
                           
Capital
   
Other
                         
   
Common Stock
   
Preferred Stock
   
in Excess
   
Comprehensive
   
Retained
   
Treasury Stock
       
   
Shares
   
Amount
   
Shares
   
Amount
   
of Par
   
Income
   
Earnings
   
Shares
   
Amount
   
Total
 
Balance, December 31, 2011
    4,643,122       46,432       -       -       13,739,792       370,399       2,554,349       883,222       (1,400,417 )     15,310,555  
Stock-based compensation
    -       -       -       -       39,125       -       -       -       -       39,125  
Exercise of stock options
    90,985       910       -       -       46,164       -       -       -       -       47,074  
                                                                                 
Shares deducted from exercise of stock options for payment of withholding taxes
    (18,278 )     (183 )     -       -       (103,410 )     -       -       -       -       (103,593 )
Tax benefit from exercise of stock options
    -       -       -       -       118,070       -       -       -       -       118,070  
Acquisition of treasury stock
    -       -       -       -       -       -       -       4,216       (17,710 )     (17,710 )
Dividends
    -       -       -       -       -       -       (380,046 )     -       -       (380,046 )
Net income (restated)
    -       -       -       -       -       -       1,773,565       -       -       1,773,565  
Change in unrealized gains on available for sale securities, net of tax
    -       -       -       -       -       841,917       -       -       -       841,917  
Balance, September 30, 2012, as restated
    4,715,829     $ 47,159       -     $ -     $ 13,839,741     $ 1,212,316     $ 3,947,868       887,438     $ (1,418,127 )   $ 17,628,957  
 

See accompanying notes to condensed consolidated financial statements.
 
 
5

 
 
KINGSTONE COMPANIES, INC. AND SUBSIDIARIES
 
             
Condensed Consolidated Statements of Cash Flows (Unaudited)
           
Nine months ended September 30,
 
2012
   
2011
 
   
(restated)
       
 Cash flows provided by operating activities:
           
 Net income
  $ 1,773,565     $ 1,120,124  
 Adjustments to reconcile net income to net cash provided by operations:
               
 Gain on sale of investments
    (111,545 )     (357,006 )
 Depreciation and amortization
    447,372       457,264  
 Amortization of bond premium, net
    88,127       162,990  
 Stock-based compensation
    39,125       85,571  
 Deferred income tax expense
    (270,865 )     (402,447 )
 (Increase) decrease in assets:
               
 Premiums receivable, net
    (1,074,941 )     (1,036,447 )
 Receivables - reinsurance contracts
    (933,588 )     489,413  
 Reinsurance receivables, net
    (3,301,475 )     (4,923,362 )
 Deferred acquisition costs
    (861,874 )     (796,055 )
 Other assets
    (446,020 )     860,804  
 Increase (decrease) in liabilities:
               
 Loss and loss adjustment expenses
    3,802,428       3,661,655  
 Unearned premiums
    4,026,336       3,824,216  
 Advance premiums
    (47,518 )     226,783  
 Reinsurance balances payable
    403,020       1,815,918  
 Deferred ceding commission revenue
    679,873       638,307  
 Accounts payable, accrued expenses and other liabilities
    (1,258,932 )     (37,087 )
 Net cash flows provided by operating activities
    2,953,088       5,790,641  
                 
 Cash flows used in investing activities:
               
 Purchase - fixed-maturity securities available for sale
    (2,264,507 )     (4,372,917 )
 Purchase - equity securities
    (1,873,253 )     (2,570,333 )
 Sale or maturity - fixed-maturity securities available for sale
    2,766,758       3,034,295  
 Sale - equity securities
    1,001,247       1,362,700  
 Recovery of loss from failed bank
    -       133,211  
 Collections of notes receivable and accrued interest - sale of businesses
    62,304       304,602  
 Other investing activities
    (84,709 )     (148,601 )
 Net cash flows used in investing activities
    (392,160 )     (2,257,043 )
                 
 Cash flows used in financing activities:
               
 Proceeds from line of credit
    465,000       -  
 Principal payments on line of credit
    (415,000 )     -  
 Principal payments on long-term debt (includes $407,000 to related parties)
    -       (713,997 )
 Proceeds from exercise of stock options
    47,074       -  
 Withholding taxes paid on cashless exercise of stock options
    (103,593 )     -  
 Tax benefit from exercise of stock options
    118,070       -  
 Purchase of treasury stock
    (17,710 )     -  
 Dividends paid
    (380,046 )     (115,153 )
 Net cash flows used in financing activities
    (286,205 )     (829,150 )
                 
 Increase in cash and cash equivalents
  $ 2,274,723     $ 2,704,448  
 Cash and cash equivalents, beginning of period
    173,126       326,620  
 Cash and cash equivalents, end of period
  $ 2,447,849     $ 3,031,068  
                 
 Supplemental disclosures of cash flow information:
               
 Cash paid for income taxes
  $ 1,853,000     $ 458,871  
 Cash paid for interest
  $ 78,122     $ 172,964  
 

See accompanying notes to condensed consolidated financial statements.
 
 
6

 
 
KINGSTONE COMPANIES, INC. AND SUBSIDIARIES
 
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)

Note 1 - Basis of Presentation and Nature of Business
 
Kingstone Companies, Inc. (referred to herein as "Kingstone" or the “Company”), through its subsidiary, Kingstone Insurance Company (“KICO”), underwrites property and casualty insurance to small businesses and individuals exclusively through independent agents and brokers. KICO is a licensed insurance company in the State of New York. In February 2011, KICO’s application for an insurance license to write insurance in the Commonwealth of Pennsylvania was approved; however, KICO has only nominally commenced writing business in Pennsylvania. Kingstone, through its subsidiary, Payments, Inc., a licensed premium finance company in the State of New York, receives fees for placing contracts with a third party licensed premium finance company.
 
The accompanying unaudited condensed consolidated financial statements included in this report have been prepared in accordance with accounting principles generally accepted in the United States (“GAAP”) for interim financial information and the instructions to Securities and Exchange Commission (“SEC”) Form 10-Q and Article 8-03 of SEC Regulation S-X. The principles for condensed interim financial information do not require the inclusion of all the information and footnotes required by generally accepted accounting principles for complete financial statements. Therefore, these financial statements should be read in conjunction with the consolidated financial statements as of and for the year ended December 31, 2011 and notes thereto included in the Company’s Annual Report on Form 10-K filed on March 30, 2012. The accompanying condensed consolidated financial statements have not been audited by an independent registered public accounting firm in accordance with standards of the Public Company Accounting Oversight Board (United States) but, in the opinion of management, such financial statements include all adjustments, consisting only of normal recurring adjustments, necessary for a fair statement of the Company’s financial position and results of operations. The results of operations for the nine months ended September 30, 2012 may not be indicative of the results that may be expected for the year ending December 31, 2012.
 
Note 2—Restatement of Previously Issued Financial Statements
 
In the three month period ended September 30, 2012, the Company recorded an adjustment to ceded premiums written to record the change in commercial lines reinsurance quota share from 60% to 40% effective as of July 1, 2012, and other immaterial true-ups to ceded premiums written. The Company incorrectly recorded the corresponding change to ceded unearned premiums, which overstated net premiums earned by $865,195 in the quarter ended September 30, 2012. The error was caused by the inclusion of $865,195 of earned premiums in revenue during the quarter ended September 30, 2012 rather than over the term of the reinsurance quota share treaty from July 1, 2012 through June 30, 2013.  The overstatement to net premiums earned also affects other calculations which are based on net income, including entries to decrease other underwriting expenses by $129,775, decrease other operating expenses by $29,123, and decrease income tax expense by $240,141. The net effect of the error in the calculation of net premiums earned and the related expense offsets was $466,156. The amount of net premiums earned and related expenses incorrectly included in the results for the quarter ended September 30, 2012 will be recorded over the term of the reinsurance quota share treaty from July 1, 2012 through June 30, 2013.  Management has concluded this net adjustment is material to the September 30, 2012 Form 10-Q.
 
The effects of the restatement on the condensed consolidated balance sheet as of September 30, 2012 are presented in the table below:
 
   
As
         
Effect
 
   
Previously
         
of
 
   
Filed
   
Restated
   
Adjustments
 
 Assets
                 
 Total investments
  $ 28,939,296     $ 28,939,296     $ -  
 Cash and cash equivalents
    2,447,849       2,447,849       -  
 Premiums receivable
    6,854,026       6,854,026       -  
 Receivables - reinsurance contracts
    2,668,123       2,668,123       -  
 Reinsurance receivables
    28,047,484       27,182,289       (865,195
 Notes receivable-sale of business
    331,207       331,207       -  
 Deferred acquisition costs
    5,397,647       5,397,647       -  
 Intangible assets
    3,303,886       3,303,886       -  
 Property and equipment
    1,640,464       1,640,464       -  
 Other assets (includes prepaid income taxes)
    895,269       1,076,577       181,308  
 Total assets
  $ 80,525,251     $ 79,841,364     $ (683,887
                         
 Liabilities
                       
 Loss and loss adjustment expenses
  $ 22,283,145     $ 22,283,145     $ -  
 Unearned premiums
    25,309,496       25,309,496       -  
 Advance premiums
    497,273       497,273       -  
 Reinsurance balances payable
    3,164,848       3,164,848       -  
 Deferred ceding commission revenue
    4,662,272       4,662,272       -  
 Notes payable
    1,097,000       1,097,000       -  
 Accounts payable, accrued expenses and other liabilities
    3,404,982       3,246,084       (158,898 )
 Deferred income taxes
    2,011,122       1,952,289       (58,833 )
 Total liabilities
    62,430,138       62,212,407       (217,731 )
                         
 Stockholders' Equity
                       
 Common stock
    47,159       47,159       -  
 Preferred stock
    -       -       -  
 Capital in excess of par
    13,839,741       13,839,741       -  
 Accumulated other comprehensive income
    1,212,316       1,212,316       -  
 Retained earnings
    4,414,024       3,947,868       (466,156 )
 Treasury stock, at cost
    (1,418,127 )     (1,418,127 )     -  
 Total stockholders' equity
    18,095,113       17,628,957       (466,156 )
                         
 Total liabilities and stockholders' equity
  $ 80,525,251     $ 79,841,364     $ (683,887 )
 
 
 
7

 
 
The effects of the restatement on the consolidated statement of comprehensive income for the three months and nine months ended September 30, 2012 are presented in the table below.
 
   
Three Months Ended September 30, 2012
   
Nine Months Ended September 30, 2012
 
   
As
         
Effect
   
As
         
Effect
 
   
Previously
         
of
   
Previously
         
of
 
   
Filed
   
Restated
   
Adjustments
   
Filed
   
Restated
   
Adjustments
 
                                     
 Revenues
                                   
 Net premiums earned
  $ 5,281,701     $ 4,416,506     $ (865,195 )   $ 13,418,808     $ 12,553,613     $ (865,195 )
 Ceding commission revenue
    2,711,431       2,711,431       -       8,525,945       8,525,945       -  
 Net investment income
    242,159       242,159       -       739,555       739,555       -  
 Net realized gain on investments
    65,986       65,986       -       111,546       111,546       -  
 Other income
    218,723       218,723       -       680,469       680,469       -  
 Total revenues
    8,520,000       7,654,805       (865,195 )     23,476,323       22,611,128       (865,195 )
                                                 
 Expenses
                                               
 Loss and loss adjustment expenses
    2,691,402       2,691,402       -       7,378,421       7,378,421       -  
 Commission expense
    1,952,583       1,952,583       -       5,430,000       5,430,000       -  
 Other underwriting expenses
    2,134,106       2,004,331       (129,775 )     5,986,428       5,856,653       (129,775 )
 Other operating expenses
    255,628       226,505       (29,123 )     829,957       800,834       (29,123 )
 Depreciation and amortization
    150,351       150,351       -       447,372       447,372       -  
 Interest expense
    19,781       19,781       -       60,677       60,677       -  
 Total expenses
    7,203,851       7,044,953       (158,898 )     20,132,855       19,973,957       (158,898 )
                                                 
 Income from operations before taxes
    1,316,149       609,852       (706,297 )     3,343,468       2,637,171       (706,297 )
 Income tax expense
    402,162       162,021       (240,141 )     1,103,747       863,606       (240,141 )
 Net income
    913,987       447,831       (466,156 )     2,239,721       1,773,565       (466,156 )
                                                 
 Gross unrealized investment
                                               
 holding gains arising during
                                               
 during period
    533,877       533,877       -       1,275,632       1,275,632       -  
                                                 
 Income tax expense related to items
                                               
 of other comprehensive income
    (181,518 )     (181,518 )     -       (433,715 )     (433,715 )     -  
 Comprehensive income
  $ 1,266,346     $ 800,190     $ (466,156 )   $ 3,081,638     $ 2,615,482     $ (466,156 )
                                                 
Earnings per common share:
                                               
Basic
  $ 0.24     $ 0.12     $ (0.12 )   $ 0.59     $ 0.47     $ (0.12 )
Diluted
  $ 0.23     $ 0.11     $ (0.12 )   $ 0.59     $ 0.47     $ (0.12 )
                                                 
Weighted average common shares outstanding
                                         
Basic
    3,824,461       3,824,461       -       3,794,979       3,794,979       -  
Diluted
    3,936,167       3,936,167       -       3,884,172       3,884,172       -  
 
The restatements to the condensed consolidated financial statements had no impact on the captions cash flows provided by operating activities, cash flows provided used in investing activities, cash flows used in financing activities or net increase in cash and cash equivalents as reported in the condensed consolidated statements of cash flows for the nine months ended September 30, 2012 and 2011. However, there were corrections to certain captions within net cash flows provided by operations.
 
 
 
8

 
 
 
 
Note  3 – Accounting Policies and Basis of Presentation
 
Use of Estimates

The preparation of financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the consolidated financial statements and the reported amounts of revenues and expenses during the reporting period. Such estimates and assumptions, which include the reserves for losses and loss adjustment expenses, are subject to considerable estimation error due to the inherent uncertainty in projecting ultimate claim amounts that will be reported and settled over a period of several years. In addition, estimates and assumptions associated with receivables under reinsurance contracts related to contingent ceding commission revenue require considerable judgment by management. On an on-going basis, management reevaluates its assumptions and the methods of calculating its estimates. Actual results may differ significantly from the estimates and assumptions used in preparing the consolidated financial statements.

Principles of Consolidation

The consolidated financial statements consist of Kingstone and its wholly-owned subsidiaries. Subsidiaries include KICO and its subsidiaries, CMIC Properties, Inc. (“Properties”) and 15 Joys Lane, LLC (“15 Joys Lane”), which together own the land and building from which KICO operates. All significant inter-company transactions have been eliminated in consolidation.
 
 
9

 
 
Accounting Pronouncements
 
In July 2012, the Financial Accounting Standards Board (the “FASB”) issued ASU 2012-02, Intangibles—Goodwill and Other (Topic 350): Testing Indefinite-Lived Intangible Assets for Impairment, to simplify the guidance for testing the decline in the realizable value (impairment) of indefinite-lived intangible assets other than goodwill. Under this update, an entity has the option to first assess qualitative factors to determine whether the existence of events or circumstances leads to a determination that it is more likely than not that the fair value of an intangible asset is less than its carrying amount.  If such a determination is not reached, then performance of further impairment testing is not necessary. The new guidance is effective for annual and interim goodwill tests performed for fiscal years beginning after September 15, 2012.  However, early adoption is permitted. The adoption of ASU 2012-02 is not expected to have a material effect on the Company’s consolidated financial condition or results of operations.

In June 2011 (and as amended in December 2011), the FASB issued ASU No. 2011-05, “Presentation of Comprehensive Income” (“ASU 2011-05”). ASU 2011-05 provides amendments to ASC No. 220 “Comprehensive Income”, which require an entity to present the total of comprehensive income, the components of net income, and the components of other comprehensive income either in a single continuous statement of comprehensive income or in two separate but consecutive statements. The amendments in this update are effective retrospectively for fiscal years and interim periods within those years, beginning after December 15, 2011, with early adoption permitted. The Company adopted this guidance effective January 1, 2012.

The Company has determined that all other recently issued accounting pronouncements will not have a material impact on its consolidated financial position, results of operations and cash flows, or do not apply to its operations.

Note  4 - Investments 

Available for Sale Securities

The amortized cost and fair value of investments in available for sale fixed-maturity securities and equities as of September 30, 2012 and December 31, 2011 are summarized as follows:
 
 
10

 
 
   
September 30, 2012
 
                                 
Net
 
  
 
Cost or
   
Gross
   
Gross Unrealized Losses
         
Unrealized
 
   
Amortized
   
Unrealized
   
Less than 12
   
More than 12
   
Fair
   
Gains/
 
 Category
 
Cost
   
Gains
   
Months
   
Months
   
Value
   
(Losses)
 
   
(unaudited)
 
 Fixed-Maturity Securities:
                                   
 Political subdivisions of States,
                                   
 Territories and Possessions
  $ 5,568,774     $ 290,672     $ -     $ (40,055 )   $ 5,819,391     $ 250,617  
                                                 
 Corporate and other bonds
                                               
 Industrial and miscellaneous
    16,211,308       1,085,116       (5,348 )     (8,337 )     17,282,739       1,071,431  
 Total fixed-maturity securities
    21,780,082       1,375,788       (5,348 )     (48,392 )     23,102,130       1,322,048  
                                                 
 Equity Securities:
                                               
 Preferred stocks
    1,453,688       44,552       (8,977 )     -       1,489,263       35,575  
 Common stocks
    3,262,410       505,609       (26,389 )     -       3,741,630       479,220  
 Total equity securities
    4,716,098       550,161       (35,366 )     -       5,230,893       514,795  
                                                 
 Total
  $ 26,496,180     $ 1,925,949     $ (40,714 )   $ (48,392 )   $ 28,333,023     $ 1,836,843  

   
December 31, 2011
 
                                 
Net
 
  
 
Cost or
   
Gross
   
Gross Unrealized Losses
         
Unrealized
 
   
Amortized
   
Unrealized
   
Less than 12
   
More than 12
   
Fair
   
Gains/
 
 Category
 
Cost
   
Gains
   
Months
   
Months
   
Value
   
(Losses)
 
                                     
 Fixed-Maturity Securities:
                                   
 U.S. Treasury securities and
                                   
 obligations of U.S. government
                                   
 corporations and agencies
  $ 499,832     $ 50,356     $ -     $ -     $ 550,188     $ 50,356  
                                                 
 Political subdivisions of States,
                                               
 Territories and Possessions
    5,868,743       301,559       -       -       6,170,302       301,559  
                                                 
 Corporate and other bonds
                                               
 Industrial and miscellaneous
    15,846,616       338,284       (228,792 )     (107,666 )     15,848,442       1,826  
 Total fixed-maturity securities
    22,215,191       690,199       (228,792 )     (107,666 )     22,568,932       353,741  
                                                 
 Equity Securities:
                                               
 Preferred stocks
    1,428,435       36,762       (76,969 )     (4,893 )     1,383,335       (45,100 )
 Common stocks
    2,429,306       274,538       (21,969 )     -       2,681,875       252,569  
 Total equity securities
    3,857,741       311,300       (98,938 )     (4,893 )     4,065,210       207,469  
                                                 
 Total
  $ 26,072,932     $ 1,001,499     $ (327,730 )   $ (112,559 )   $ 26,634,142     $ 561,210  
 
 
11

 
 
A summary of the amortized cost and fair value of the Company’s investments in available for sale fixed-maturity securities by contractual maturity as of September 30, 2012 and December 31, 2011 is shown below:
 
   
September 30, 2012
   
December 31, 2011
 
   
Amortized
         
Amortized
       
 Remaining Time to Maturity
 
Cost
   
Fair Value
   
Cost
   
Fair Value
 
   
(unaudited)
       
 Less than one year
  $ 1,212,342     $ 1,179,180     $ 1,063,493     $ 1,079,924  
 One to five years
    7,523,680       7,967,410       6,899,892       7,045,774  
 Five to ten years
    11,909,521       12,760,814       12,547,046       12,680,441  
 More than 10 years
    1,134,539       1,194,726       1,704,760       1,762,793  
 Total
  $ 21,780,082     $ 23,102,130     $ 22,215,191     $ 22,568,932  
 
The actual maturities may differ from contractual maturities because certain borrowers have the right to call or prepay obligations with or without penalties.

Held to Maturity Securities

The amortized cost and fair value of investments in held to maturity fixed-maturity securities as of September 30, 2012 and December 31, 2011 are summarized as follows:

   
September 30, 2012
 
                                 
Net
 
  
 
Cost or
   
Gross
   
Gross Unrealized Losses
         
Unrealized
 
   
Amortized
   
Unrealized
   
Less than 12
   
More than 12
   
Fair
   
Gains/
 
 Category
 
Cost
   
Gains
   
Months
   
Months
   
Value
   
(Losses)
 
   
(unaudited)
 
                                                 
 U.S. Treasury securities
  $ 606,273     $ 185,828     $ -     $ -     $ 792,101     $ 185,828  
 
   
December 31, 2011
 
                                 
Net
 
  
 
Cost or
   
Gross
   
Gross Unrealized Losses
         
Unrealized
 
   
Amortized
   
Unrealized
   
Less than 12
   
More than 12
   
Fair
   
Gains/
 
 Category
 
Cost
   
Gains
   
Months
   
Months
   
Value
   
(Losses)
 
                                                 
 U.S. Treasury securities
  $ 606,234     $ 171,719     $ -     $ -     $ 777,953     $ 171,719  

All held to maturity securities are held in trust pursuant to the New York State Department of Financial Services’ minimum funds requirement.

Contractual maturities of all held to maturity securities are greater than ten years.
 
 
12

 

Investment Income

Major categories of the Company’s net investment income are summarized as follows:

   
Three months ended
   
Nine months ended
 
   
September 30,
   
September 30,
 
   
2012
   
2011
   
2012
   
2011
 
   
(unaudited)
   
(unaudited)
 
 Income:
             
 
   
 
 
 Fixed-maturity securities
  $ 249,315     $ 170,083     $ 710,585     $ 526,583  
 Equity securities
    49,279       44,089       197,518       114,387  
 Cash and cash equivalents
    25       2,552       84       4,775  
 Other
    2       8       6       (3,307 )
 Total
    298,621       216,732       908,193       642,438  
 Expenses:
                               
 Investment expenses
    56,462       44,693       168,638       132,265  
 Net investment income
  $ 242,159     $ 172,039     $ 739,555     $ 510,173  

Proceeds from the sale and maturity of fixed-maturity securities were $2,766,758 and $3,034,295 for the nine months ended September 30, 2012 and 2011, respectively.

Proceeds from the sale of equity securities were $1,001,247 and $1,362,700 for the nine months ended September 30, 2012 and 2011, respectively.

The Company’s net realized gains and losses on investments are summarized as follows:
 
   
Three months ended
   
Nine months ended
 
   
September 30,
   
September 30,
 
   
2012
   
2011
   
2012
   
2011
 
   
(unaudited)
   
(unaudited)
 
 Fixed-maturity securities:
                       
 Gross realized gains
  $ 60,349     $ 51,805     $ 153,695     $ 139,107  
 Gross realized losses
    -       -       (52,600 )     (1,983 )
      60,349       51,805       101,095       137,124  
                                 
 Equity securities:
                               
 Gross realized gains
    7,735       11,558       40,019       147,375  
 Gross realized losses
    (2,098 )     -       (29,568 )     (60,704 )
      5,637       11,558       10,451       86,671  
                                 
 Cash and short term investments (1)
    -       133,211       -       133,211  
                                 
 Net realized gains
  $ 65,986     $ 196,574     $ 111,546     $ 357,006  
 
(1) Realized gain on cash and short term investments is a partial recovery from the FDIC of an amount previously written off in 2009 due to the failure of Waterfield Bank.
 
 
13

 

Impairment Review
 
The Company regularly reviews its fixed-maturity securities and equity securities portfolios to evaluate the necessity of recording impairment losses for other-than-temporary investment (“OTTI”) declines in the fair value of investments. In evaluating potential impairment, management considers, among other criteria: (i) the current fair value compared to amortized cost or cost, as appropriate; (ii) the length of time the security’s fair value has been below amortized cost or cost; (iii) specific credit issues related to the issuer such as changes in credit rating, reduction or elimination of dividends or non-payment of scheduled interest payments; (iv) management’s intent and ability to retain the investment for a period of time sufficient to allow for any anticipated recovery in value to cost; and (v) current economic conditions.

OTTI losses are recorded in the condensed consolidated statement of operations and comprehensive income as net realized losses on investments and result in a permanent reduction of the cost basis of the underlying investment. The determination of OTTI is a subjective process and different judgments and assumptions could affect the timing of loss realization. There are 13 securities at September 30, 2012 that account for the gross unrealized loss. The Company determined that none of the unrealized losses were deemed to be OTTI for its portfolio of fixed maturity investments and equity securities for the nine months ended September 30, 2012 and 2011. Significant factors influencing the Company’s determination that unrealized losses were temporary included the magnitude of the unrealized losses in relation to each security’s cost, the nature of the investment and management’s intent and ability to retain the investment for a period of time sufficient to allow for anticipated recovery of fair value to the Company’s cost basis.

The Company held securities with unrealized losses representing declines that were considered temporary at September 30, 2012 and December 31, 2011 as follows:
 
   
September 30, 2012
 
   
Less than 12 months
   
12 months or more
   
Total
 
  
             
No. of
               
No. of
   
Aggregate
       
   
Fair
   
Unrealized
   
Positions
   
Fair
   
Unrealized
   
Positions
   
Fair
   
Unrealized
 
 Category
 
Value
   
Losses
   
Held
   
Value
   
Losses
   
Held
   
Value
   
Losses
 
   
(unaudited)
 
Fixed-Maturity Securities:
                                           
Political subdivisions of
                                           
States, Territories and
                                               
Possessions
  $ -     $ -       -     $ 764,668     $ (40,055 )     2     $ 764,668     $ (40,055 )
                                                                 
Corporate and other
                                                               
bonds industrial and
                                                               
miscellaneous
    877,005       (5,348 )     3       370,758       (8,337 )     2       1,247,763       (13,685 )
                                                                 
Total fixed-maturity
                                                               
securities
  $ 877,005     $ (5,348 )     3     $ 1,135,426     $ (48,392 )     4     $ 2,012,431     $ (53,740 )
                                                                 
Equity Securities:
                                                               
Preferred stocks
  $ 386,950     $ (8,977 )     3     $ -     $ -       -     $ 386,950     $ (8,977 )
Common stocks
    439,205       (26,389 )     3       -       -       -       439,205       (26,389 )
                                                                 
Total equity securities
  $ 826,155     $ (35,366 )     6     $ -     $ -       -     $ 826,155     $ (35,366 )
                                                                 
Total
  $ 1,703,160     $ (40,714 )     9     $ 1,135,426     $ (48,392 )     4     $ 2,838,586     $ (89,106 )
 
   
December 31, 2011
 
   
Less than 12 months
   
12 months or more
   
Total
 
  
             
No. of
               
No. of
   
Aggregate
       
   
Fair
   
Unrealized
   
Positions
   
Fair
   
Unrealized
   
Positions
   
Fair
   
Unrealized
 
 Category
 
Value
   
Losses
   
Held
   
Value
   
Losses
   
Held
   
Value
   
Losses
 
                                                 
Fixed-Maturity Securities:
                                           
Corporate and other
   
 
         
 
   
 
         
 
   
 
 
 bonds industrial and
                                               
 miscellaneous
  $ 4,849,378     $ (228,792 )     26     $ 1,483,425     $ (107,666 )     7     $ 6,332,803     $ (336,458 )
                                                                 
 Total fixed-maturity
                                                               
 securities
  $ 4,849,378     $ (228,792 )     26     $ 1,483,425     $ (107,666 )     7     $ 6,332,803     $ (336,458 )
                                                                 
 Equity Securities:
                                                               
 Preferred stocks
  $ 368,350     $ (76,969 )     12     $ 189,364     $ (4,893 )     5     $ 557,714     $ (81,862 )
 Common stocks
    397,268       (21,969 )     14       -       -       -       397,268       (21,969 )
 Total equity securities
  $ 765,618     $ (98,938 )     26     $ 189,364     $ (4,893 )     5     $ 954,982     $ (103,831 )
                                                                 
 Total
  $ 5,614,996     $ (327,730 )     52     $ 1,672,789     $ (112,559 )     12     $ 7,287,785     $ (440,289 )
 
 
 
14

 
  
Note  5 - Fair Value Measurements

The Company follows GAAP guidance regarding fair value measurements. The valuation technique used to fair value the financial instruments is the market approach which uses prices and other relevant information generated by market transactions involving identical or comparable assets.
 
This guidance establishes a three-level hierarchy that prioritizes the inputs to valuation techniques used to measure fair value. The fair value hierarchy gives the highest priority to quoted prices in active markets for identical assets or liabilities (Level 1) and the lowest priority to unobservable inputs (Level 3). If the inputs used to measure the assets or liabilities fall within different levels of the hierarchy, the classification is based on the lowest level input that is significant to the fair value measurement of the asset or liability. Classification of assets and liabilities within the hierarchy considers the markets in which the assets and liabilities are traded, including during period of market disruption, and the reliability and transparency of the assumptions used to determine fair value. The hierarchy requires the use of observable market data when available. The levels of the hierarchy and those investments included in each are as follows:
 
Level 1—Inputs to the valuation methodology are quoted prices (unadjusted) for identical assets or liabilities traded in active markets. Included are those investments traded on an active exchange, such as the NASDAQ Global Select Market, U.S. Treasury securities and obligations of U.S. government agencies, together with corporate debt securities that are generally investment grade.
 
Level 2—Inputs to the valuation methodology include quoted prices for similar assets or liabilities in active markets, quoted prices for identical or similar assets or liabilities in markets that are not active, inputs other than quoted prices that are observable for the asset or liability and market-corroborated inputs.
 
Level 3—Inputs to the valuation methodology are unobservable for the asset or liability and are significant to the fair value measurement. Material assumptions and factors considered in pricing investment securities and other assets may include appraisals, projected cash flows, market clearing activity or liquidity circumstances in the security or similar securities that may have occurred since the prior pricing period.

The availability of observable inputs varies and is affected by a wide variety of factors. When the valuation is based on models or inputs that are less observable or unobservable in the market, the determination of fair value requires significantly more judgment. The degree of judgment exercised by management in determining fair value is greatest for investments categorized as Level 3. For investments in this category, the Company considers prices and inputs that are current as of the measurement date. In periods of market dislocation, as characterized by current market conditions, the observability of prices and inputs may be reduced for many instruments. This condition could cause a security to be reclassified between levels.
  
The Company’s investments are allocated among pricing input levels at September 30, 2012 and December 31, 2011 as follows:

   
September 30, 2012
 
 ($ in thousands)
 
Level 1
   
Level 2
   
Level 3
   
Total
 
   
(unaudited)
 
 Fixed-maturity investments available for sale
                       
 Political subdivisions of
                       
 States, Territories and
                       
 Possessions
    -       5,819       -       5,819  
                                 
 Corporate and other
                               
 bonds industrial and
                               
 miscellaneous
    8,334       8,949       -       17,283  
 Total fixed maturities
    8,334       14,768       -       23,102  
 Equity investments
    5,231       -       -       5,231  
 Total investments
  $ 13,565     $ 14,768     $ -     $ 28,333  
 
 
15

 
 
   
December 31, 2011
 
 ($ in thousands)
 
Level 1
   
Level 2
   
Level 3
   
Total
 
       
 Fixed-maturity investments available for sale
                       
 U.S. Treasury securities
                       
 and obligations of U.S.
                       
 government corporations
                       
 and agencies
  $ 550     $ -     $ -     $ 550  
                                 
 Political subdivisions of
                               
 States, Territories and
                               
 Possessions
    -       6,171       -       6,171  
                                 
 Corporate and other
                               
 bonds industrial and
                               
 miscellaneous
    8,465       7,383       -       15,848  
 Total fixed maturities
    9,015       13,554       -       22,569  
 Equity investments
    4,065       -       -       4,065  
 Total investments
  $ 13,080     $ 13,554     $ -     $ 26,634  
 
Note  6 - Fair Value of Financial Instruments

GAAP requires all entities to disclose the fair value of financial instruments, both assets and liabilities recognized and not recognized in the balance sheet, for which it is practicable to estimate fair value. The Company uses the following methods and assumptions in estimating its fair value disclosures for financial instruments:
 
Equity and fixed income investments:  Fair value disclosures for investments are included in “Note  4 - Investments.”

Cash and cash equivalents: The carrying values of cash and cash equivalents approximate their fair values because of the short maturity of these instruments.

Premiums receivable, reinsurance receivables:  The carrying values reported in the accompanying consolidated balance sheets for these financial instruments approximate their fair values due to the short term nature of the assets.

Notes receivable: The carrying amount of notes receivable related to the sale of businesses approximates fair value because of the recently negotiated interest rates based on term of the loan, risk and guaranty.

Real Estate: The fair value of the land and building included in property and equipment, which is used in the Company’s operations, approximates the carrying value. The fair value was based on an appraisal prepared using the sales comparison approach.
 
 
16

 

Reinsurance balances payable:  The carrying value reported in the consolidated balance sheets for these financial instruments approximates fair value.

Notes payable (including related parties): The Company estimates that the carrying amount of notes payable approximates fair value because of the recently negotiated interest rates based on term of the loan, risk and guaranty.

The estimated fair values of the Company’s financial instruments are as follows:

   
September 30, 2012
(restated)
   
December 31, 2011
 
   
Carrying Value
   
Fair Value
   
Carrying Value
   
Fair Value
 
   
(unaudited)
             
 Fixed-maturity investments held to maturity
  $ 606,273     $ 792,101     $ 606,234     $ 777,953  
 Cash and cash equivalents
    2,447,849       2,447,849       173,126       173,126  
 Premiums receivable
    6,854,026       6,854,026       5,779,085       5,779,085  
 Receivables - reinsurance contracts
    2,668,123       2,668,123       1,734,535       1,734,535  
 Reinsurance receivables
    27,182,289       27,182,289       23,880,814       23,880,814  
 Notes receivable-sale of business
    331,207       331,207       393,511       393,511  
 Real estate, net of accumulated depreciation
    1,446,196       1,510,000       1,477,639       1,510,000  
 Reinsurance balances payable
    3,164,848       3,164,848       2,761,828       2,761,828  
 Notes payable (including related parties)
    1,097,000       1,097,000       1,047,000       1,047,000  
 
Note  7 - Notes Receivable-Sale of Businesses
 
Pennsylvania Stores
 
Effective June 30, 2009, the Company sold all of the outstanding stock of the subsidiary that operated the three remaining Pennsylvania stores included in the former network of retail brokerage outlets (the “Pennsylvania Stock”).  The purchase price for the Pennsylvania Stock was approximately $397,000 which is being paid for by the payment of a promissory note with interest at the rate of 8.63% per annum and is payable in equal monthly installments of $5,015.
 
Franchise Business
 
Effective May 1, 2009, the Company sold all of the outstanding stock of the subsidiaries that operated the Company’s former DCAP franchise business (collectively, the “Franchise Stock”).  The purchase price for the Franchise Stock was $200,000 which was paid by delivery of a promissory note in such principal amount (the “Franchise Note”). The Franchise Note was paid in full during the quarter ended June 30, 2012.
 
 
17

 
 
Notes receivable arising from the sale of businesses as of September 30, 2012 and December 31, 2011 consists of:
 
   
September 30, 2012
   
December 31, 2011
 
   
Total
   
Current
         
Total
   
Current
       
   
Note
   
Maturities
   
Long-Term
   
Note
   
Maturities
   
Long-Term
 
   
(unaudited)
                   
Sale of Pennsylvania stores
  $ 328,842     $ 33,094     $ 295,748     $ 351,861     $ 31,028     $ 320,833  
Sale of Franchise business
    -       -       -       37,797       37,797       -  
      328,842       33,094       295,748       389,658       68,825       320,833  
Accrued interest
    2,365       2,365       -       3,853       3,853       -  
Total
  $ 331,207     $ 35,459     $ 295,748     $ 393,511     $ 72,678     $ 320,833  

Note  8 – Property and Casualty Insurance Activity
 
Earned Premiums

Premiums written, ceded and earned are as follows (unaudited):
 
   
Direct
   
Assumed
   
Ceded
   
Net
 
                         
Nine months ended September 30, 2012 (restated)
   
 
   
 
   
 
 
 Premiums written
  $ 36,439,884     $ 21,553     $ (21,699,102 )   $ 14,762,335  
 Change in unearned premiums
    (4,017,217 )     (9,119 )     1,817,614       (2,208,722 )
 Premiums earned
  $ 32,422,667     $ 12,434     $ (19,881,488 )   $ 12,553,613  
                                 
Nine months ended September 30, 2011
                         
 Premiums written
  $ 30,502,800     $ 6,289     $ (18,099,446 )   $ 12,409,643  
 Change in unearned premiums
    (3,823,593 )     1,611       2,234,476       (1,587,506 )
 Premiums earned
  $ 26,679,207     $ 7,900     $ (15,864,970 )   $ 10,822,137  
                                 
Three months ended September 30, 2012 (restated)
                         
 Premiums written
  $ 12,765,358     $ 18,354     $ (7,218,500 )   $ 5,565,212  
 Change in unearned premiums
    (1,363,818 )     (13,031 )     228,143       (1,148,706 )
 Premiums earned
  $ 11,401,540     $ 5,323     $ (6,990,357 )   $ 4,416,506  
                                 
Three months ended September 30, 2011
                         
 Premiums written
  $ 10,382,641     $ 3,409     $ (6,119,576 )   $ 4,266,474  
 Change in unearned premiums
    (909,125 )     (41 )     579,881       (329,285 )
 Premiums earned
  $ 9,473,516     $ 3,368     $ (5,539,695 )   $ 3,937,189  
 
Premium receipts in advance of the policy effective date are recorded as advance premiums. The balance of advance premiums was approximately $497,000 and $545,000 as of September 30, 2012 (unaudited) and December 31, 2011, respectively.
 
 
18

 

Loss and Loss Adjustment Expenses

The following table provides a reconciliation of the beginning and ending balances for unpaid losses and loss adjustment expenses (“LAE”):

   
Nine months ended
 
   
September 30,
 
   
2012
   
2011
 
   
(unaudited)
 
 Balance at beginning of period
  $ 18,480,717     $ 17,711,907  
 Less reinsurance recoverables
    (10,001,060 )     (10,431,415 )
 Net balance, beginning of period
    8,479,657       7,280,492  
                 
 Incurred related to:
               
 Current year
    6,554,087       6,742,201  
 Prior years
    824,334       565,724  
 Total incurred
    7,378,421       7,307,925  
                 
 Paid related to:
               
 Current year
    2,572,948       2,414,171  
 Prior years
    2,681,698       2,608,709  
 Total paid
    5,254,646       5,022,880  
  
               
 Net balance at end of period
    10,603,432       9,565,537  
 Add reinsurance recoverables
    11,679,713       11,808,025  
 Balance at end of period
  $ 22,283,145     $ 21,373,562  
 
Incurred losses and LAE are net of reinsurance recoveries under reinsurance contracts of $6,917,332 and $7,035,191 for the nine months ended September 30, 2012 and 2011, respectively.

Prior year incurred loss and LAE development is based upon numerous estimates by line of business and accident year. The Company’s management continually monitors claims activity to assess the appropriateness of carried case and IBNR reserves, giving consideration to Company and industry trends (See Note 14 - Subsequent events).

Loss and loss adjustment expense reserves

The reserving process for loss adjustment expense reserves provides for the Company’s best estimate at a particular point in time of the ultimate unpaid cost of all losses and loss adjustment expenses incurred, including settlement and administration of losses, and is based on facts and circumstances then known and including losses that have been incurred but not yet been reported. The process includes using actuarial methodologies to assist in establishing these estimates, judgments relative to estimates of future claims severity and frequency, the length of time before losses will develop to their ultimate level and the possible changes in the law and other external factors that are often beyond the Company’s control. The loss ratio projection method is used to estimate loss reserves. The process produces carried reserves set by management based upon the actuaries’ best estimate and is the result of numerous best estimates made by line of business, accident year, and loss and loss adjustment expense. The amount of loss and loss adjustment expense reserves for reported claims is based primarily upon a case-by-case evaluation of coverage, liability, injury severity, and any other information considered pertinent to estimating the exposure presented by the claim. The amounts of loss and loss adjustment expense reserves for unreported claims are determined using historical information by line of insurance as adjusted to current conditions. Since this process produces loss reserves set by management based upon the actuaries’ best estimate, there is no explicit or implicit provision for uncertainty in the carried loss reserves.
 
 
19

 
 
Due to the inherent uncertainty associated with the reserving process, the ultimate liability may differ, perhaps substantially, from the original estimate. Such estimates are regularly reviewed and updated and any resulting adjustments are included in the current year’s results. Reserves are closely monitored and are recomputed periodically using the most recent information on reported claims and a variety of statistical techniques. Specifically, on at least a quarterly basis, the Company reviews, by line of business, existing reserves, new claims, changes to existing case reserves and paid losses with respect to the current and prior years.

Reinsurance
 
The Company’s reinsurance treaties for both its Personal Lines business, which primarily consists of homeowners’ policies, and Commercial Lines business, other than commercial auto, were renewed as of July 1, 2012. The treaties, which are renewed annually, provide for the following material terms as of July 1, 2012:

Personal Lines

Personal Lines business, which includes homeowners, dwelling fire and canine legal liability insurance, is reinsured under a 75% quota share treaty which provides coverage with respect to losses of up to $1,000,000 per occurrence. An excess of loss contract provides 100% of coverage for the next $1,900,000 of losses for a total coverage with respect to losses of up to $2,900,000 per occurrence. See “Catastrophe Reinsurance” below.

Personal umbrella policies are reinsured under a 90% quota share treaty limiting the Company to a maximum of $100,000 per occurrence for the first $1,000,000 of coverage. The second $1,000,000 of coverage is 100% reinsured. 

Commercial Lines

General liability commercial policies written by the Company, except for commercial auto policies, are reinsured under a 40% quota share treaty, which provides coverage with respect to losses of up to $500,000 per occurrence.   Excess of loss contracts provide 100% of coverage for the next $2,400,000 of losses for a total coverage with respect to losses of up to $2,900,000 per occurrence.

Commercial Auto

Commercial auto policies are covered by an excess of loss reinsurance contract which provides $1,750,000 of coverage in excess of $250,000.

Catastrophe Reinsurance

The Company has catastrophe reinsurance coverage with regard to losses of up to $73,000,000.  The initial $3,000,000 of losses in a catastrophe are subject to a 75% quota share treaty, such that the Company retains $750,000 per catastrophe occurrence With respect to any additional catastrophe losses of up to $70,000,000, the Company is 100% reinsured under its catastrophe reinsurance program.

The Company’s reinsurance program is structured to enable the Company to significantly grow its premium volume while maintaining regulatory capital and other financial ratios generally within or below the expected ranges used for regulatory oversight purposes. The reinsurance program also provides income as a result of ceding commissions earned pursuant to the quota share reinsurance contracts. The Company’s participation in reinsurance arrangements does not relieve the Company from its obligations to policyholders.
 
 
20

 

Ceding Commission Revenue
 
The Company earns ceding commissions under its quota share reinsurance agreements based on a sliding scale of commission rates and ultimate treaty year loss ratios on the policies reinsured under each of these agreements. The sliding scale includes minimum and maximum commission rates in relation to specified ultimate loss ratios.  The commission rate and ceding commissions earned increases when the estimated ultimate loss ratio decreases and, conversely, the commission rate and ceding commissions earned decreases when the estimated ultimate loss ratio increases.
 
As of September 30, 2012 and 2011, the Company’s estimated ultimate loss ratios attributable to these contracts are lower than the contractual ultimate loss ratios at which the minimum amount of ceding commissions can be earned. Accordingly, the Company has recorded ceding commissions earned that are greater than the minimum provisional commissions (see Note 14 - Subsequent Events).

Ceding commission revenue consists of the following:

   
Three months ended
   
Nine months ended
 
   
September 30,
   
September 30,
 
   
2012
   
2011
   
2012
   
2011
 
   
(unaudited)
   
(unaudited)
 
 Provisional ceding commissions earned
  $ 2,171,391     $ 1,763,930     $ 6,231,106     $ 5,048,609  
 Contingent ceding commissions earned
    540,040       543,460       2,294,839       2,299,223  
    $ 2,711,431     $ 2,307,390     $ 8,525,945     $ 7,347,832  
 
Provisional ceding commissions are settled monthly. Balances due from reinsurers for contingent ceding commissions on quota share treaties are settled annually based on the loss ratio of each treaty year that ends on June 30. Ceding commissions due from reinsurers, which include contingent ceding commissions receivable, as of September 30, 2012 (unaudited) and December 31, 2011 were $2,668,123 and $1,734,535, respectively, and are included in “Receivables – reinsurance contracts” in the Consolidated Balance Sheets.
 
Note  9 – Long-Term Debt
 
Long-term debt consists of:
 
   
September 30, 2012
   
December 31, 2011
 
         
Less
               
Less
       
   
Total
   
Current
   
Long-Term
   
Total
   
Current
   
Long-Term
 
   
Debt
   
Maturities
   
Debt
   
Debt
   
Maturities
   
Debt
 
   
(unaudited)
                   
                                     
Notes payable
  $ 747,000     $ -     $ 747,000     $ 747,000     $ -     $ 747,000  
Line of credit
    350,000       350,000       -       300,000       300,000       -  
    $ 1,097,000     $ 350,000     $ 747,000     $ 1,047,000     $ 300,000     $ 747,000  
 
 
21

 

Notes Payable
 
From June 2009 through March 2010, the Company borrowed $1,450,000 (including $785,000 from related parties as disclosed below) and issued promissory notes in such aggregate principal amount (the “2009/2010 Notes”).  The 2009/2010 Notes provided for interest at the rate of 12.625% per annum through the maturity date of July 10, 2011. During the quarter the ended June 30, 2011, the Company prepaid $703,000 (including $407,000 to related parties) of the principal amount of the 2009/2010 Notes. In June 2011, the remaining note holders agreed to extend the maturity date for a period of three years from July 10, 2011 to July 10, 2014, and, effective July 11, 2011, reduce the interest rate from 12.625% to 9.5% per annum. The remaining 2009/2010 Notes, as extended, can be prepaid without premium or penalty. The reduction in the interest rate and the extension of the maturity date did not significantly change the fair value of the 2009/2010 Notes.
 
Interest expense on the 2009/2010 Notes for the nine months ended September 30, 2012 and 2011 was approximately $53,000 and $108,000, respectively. Interest expense includes related party borrowings for the nine months ended September 30, 2012 and 2011 of approximately $27,000 and $57,000, respectively. Interest expense on the 2009/2010 Notes for the three months ended September 30, 2012 and 2011 was approximately $18,000 and $24,000, respectively. Interest expense includes related party borrowings for the three months ended September 30, 2012 and 2011 of approximately $9,000 and $12,000, respectively.
 
Related party balances as of September 30, 2012 and December 31, 2011 under the 2009/2010 Notes are as follows:

Barry Goldstein IRA (Mr. Goldstein is Chairman of the Board, President and
     
 Chief Executive Officer, and principal stockholder of the Company)
  $ 90,000  
 Jay Haft, a director of the Company
    30,000  
 A member of the family of Michael Feinsod, a director of the Company
    60,000  
 Sam Yedid, a director of KICO, and members of his family
    156,000  
 A member of the family of Floyd Tupper, a director of KICO
    42,000  
 Total related party balances
  $ 378,000  
 
Line of credit
 
On December 27, 2011, Kingstone executed a Promissory Note pursuant to a line of credit (together, the “Trustco Agreement”) with Trustco Bank (“Lender”). Under the Trustco Agreement, Kingstone may receive advances from Lender not to exceed an unpaid principal balance of $500,000. Advances extended under the Trustco Agreement will bear interest at a floating rate based on the Lender’s prime rate.
 
Interest only payments are due monthly. The principal balance is payable on demand, and must be reduced to zero for a minimum of thirty consecutive days during each year of the term of the Trustco Agreement. The principal balance was reduced to zero for thirty consecutive days in accordance with terms of the Trustco Agreement within the three month period ended September 30, 2012. Lender may set off any depository accounts maintained by Kingstone that are held by Lender. Payment of amounts due pursuant to the Trustco Agreement is secured by all of Kingstone’s cash and deposit accounts, receivables, inventory and  fixed assets, and is guaranteed by Kingstone’s subsidiary, Payments, Inc.
 
There were no closing costs or fees paid in connection with the Trustco Agreement. Kingstone received an initial advance of $300,000 on December 27, 2011. The line of credit is being used for general corporate purposes.
 
The interest rate on the amount outstanding as of September 30, 2012 was 3.75%. There are no other fees in connection with this credit line.
 
 
22

 
 
Note  10 – Stockholders’ Equity
 
Dividend Declared

Dividends declared and paid on Common Stock was $380,046 and $115,153 for the nine months ended September 30, 2012 and 2011, respectively. Dividends declared and paid on Common Stock was $153,218 and $115,153 for the three months ended September 30, 2012 and 2011, respectively. The Company’s Board of Directors approved a quarterly dividend on November 12, 2012 of $.04 per share payable in cash on December 14, 2012 to stockholders of record as of November 30, 2012.

Stock Options

In December 2005, the Company’s shareholders ratified the adoption of the 2005 Equity Participation Plan (the “2005 Plan”), which provides for the issuance of incentive stock options, non-statutory stock options and restricted stock. Under the 2005 Plan, a maximum of 300,000 shares of Common Stock were permitted to be issued pursuant to options granted and restricted stock issued.  In March 2010, the Board of Directors of the Company increased the number of shares of Common Stock authorized to be issued pursuant to the 2005 Plan to 550,000, subject to stockholder approval.  In June 2010, the stockholders approved the increase to 550,000 shares.  Incentive stock options granted under the 2005 Plan expire no later than ten years from date of grant (except no later than five years for a grant to a 10% stockholder). The Board of Directors or the Stock Option Committee will determine the expiration date with respect to non-statutory options, and the vesting provisions for restricted stock, granted under the 2005 Plan.
 
The results of operations for the nine months ended September 30, 2012 and 2011 include share-based stock option compensation expense totaling $39,000 and $86,000, respectively. The results of operations for the three months ended September 30, 2012 and 2011 include share-based stock option compensation expense totaling $9,000 and $21,000, respectively. Share-based compensation expense related to stock options is net of estimated forfeitures of 21% for the nine months and three months ended September 30, 2012 and 2011, respectively. Such amounts have been included in the Condensed Consolidated Statements of Comprehensive Income within other operating expenses.

Stock option compensation expense in 2012 and 2011 is the estimated fair value of options granted amortized on a straight-line basis over the requisite service period for the entire portion of the award. No stock options were granted during the nine months ended September 30, 2012 and 2011.

A summary of option activity under the Company’s 1998 Stock Option Plan (terminated in November, 2008) and the 2005 Plan as of September 30, 2012, and changes during the nine months then ended, is as follows:
 
 
Stock Options
 
Number of Shares
   
Weighted Average Exercise Price per Share
   
Weighted Average Remaining Contractual Term
   
Aggregate Intrinsic Value
 
                         
Outstanding at January 1, 2012
    393,865     $ 2.32       2.28     $ 498,913  
                                 
Granted
    -     $ -       -     $ -  
Exercised
    (135,000 )   $ 2.13       -     $ 319,925  
Forfeited
    -     $ -       -     $ -  
                                 
Outstanding at September 30, 2012
    258,865     $ 2.43       2.10     $ 689,510  
                                 
Vested and Exercisable at September 30, 2012
    199,148     $ 2.41       2.02     $ 533,043  
 
 
23

 
 
The aggregate intrinsic value of options outstanding and options exercisable at September 30, 2012 is calculated as the difference between the exercise price of the underlying options and the market price of the Company’s Common Stock for the options that had exercise prices that were lower than the $5.09 closing price of the Company’s Common Stock on September 30, 2012. The total intrinsic value of options exercised in the nine months ended September 30, 2012 was $319,925, determined as of the date of exercise.

Participants in the 2005 Plan may exercise their outstanding vested options, in whole or in part, by having the Company reduce the number of shares otherwise issuable by a number of shares having a fair market value equal to the exercise price of the option being exercised (“Cashless Exercise”). The Company received cash proceeds of $47,074 from 22,500 options exercised in the nine months ended September 30, 2012. The remaining 112,500 options exercised in 2012 were Cashless Exercises. No stock options were exercised in the nine months ended September 30, 2011.

As of September 30, 2012, the fair value of unamortized compensation cost related to unvested stock option awards was approximately $16,000. Unamortized compensation cost as of September 30, 2012 is expected to be recognized over a remaining weighted-average vesting period of .58 years.
 
Note 11 – Income Taxes

The Company files a consolidated U.S. Federal Income Tax return that includes all wholly-owned subsidiaries. State tax returns are filed on a consolidated or separate basis depending on applicable laws. The Company records adjustments related to prior years’ taxes during the period when they are identified, generally when the tax returns are filed.   The effect of these adjustments on the current and prior periods (during which the differences originated) is evaluated based upon quantitative and qualitative factors and are considered in relation to the financial statements taken as a whole for the respective periods. The Company has evaluated this year’s amounts in relation to the current and prior reporting periods and determined that a restatement of those prior reporting periods is not appropriate. The Company’s effective tax rate from continuing operations for the nine months and three months ended September 30, 2012 was 32.7% and 26.6%, respectively. The Company’s effective tax rate from continuing operations for the nine months and three months ended September 30, 2011 was 24.1% and (46.4)%, respectively. A reconciliation of the Federal statutory rate to our effective rate from continuing operations is as follows:
 
   
For the Three Months Ended
   
For the Nine Months Ended
 
   
September 30,
   
September 30,
 
   
2012
(restated)
   
2011
   
2012
(restated)
   
2011
 
                                                 
 Computed expected tax expense
  $ 207,350       34.0 %   $ 51,003       34.0 %   $ 896,638       34.0 %   $ 501,775       34.0 %
 State taxes, net of Federal benefit
    9,754       1.6       (10,225 )     (6.8 )     55,553       2.1       (24,976 )     (1.7 )
 Permanent differences
                                                               
 Dividends received deduction
    (10,386 )     (1.7 )     (18,782 )     (12.5 )     (46,963 )     (1.8 )     (25,911 )     (1.8 )
 Non-taxable investment income
    (15,781 )     (2.6 )     (16,449 )     (11.0 )     (49,590 )     (1.9 )     (62,992 )     (4.3 )
 Stock-based compensation expense
    3,065       0.5       7,284       4.9       13,302       0.5       29,094       2.0  
 Other permanent differences
    6,287       1.0       (42,889 )     (28.6 )     18,568       0.7       (28,344 )     (1.9 )
 Prior year tax matters
    (32,456 )     (5.3 )     (72,960 )     (48.6 )     (32,456 )     (1.2 )     (50,886 )     (3.5 )
 Other
    (5,812 )     (0.9 )     33,458       22.3       8,554       0.3       17,926       1.2  
 Total tax
  $ 162,021       26.6 %   $ (69,560 )     (46.4 )  %   $ 863,606       32.7  %   $ 355,686       24.1 %
 
 
24

 

Deferred tax assets and liabilities are determined using the enacted tax rates applicable to the period the temporary differences are expected to be recovered. Accordingly, the current period income tax provision can be affected by the enactment of new tax rates. The net deferred income taxes on the balance sheet reflect temporary differences between the carrying amounts of the assets and liabilities for financial reporting purposes and income tax purposes, tax effected at a various rates depending on whether the temporary differences are subject to Federal taxes, State taxes, or both. Significant components of the Company’s deferred tax assets and liabilities are as follows:
 
   
September 30,
   
December 31,
 
   
2012
(restated)
   
2011
 
   
(unaudited)
       
 Deferred tax asset:
       
 
 
 Net operating loss carryovers (1)
  $ 264,648     $ 276,312  
 Claims reserve discount
    275,543       220,354  
 Unearned premium
    794,556       647,596  
 Deferred ceding commission revenue
    1,585,172       1,354,016  
 Other
    13,721       4,583  
 Total deferred tax assets
    2,933,640       2,502,861  
                 
 Deferred tax liability:
               
 Investment in KICO (2)
    1,169,000       1,169,000  
 Deferred acquisition costs
    1,835,200       1,542,163  
 Intangibles
    1,123,321       1,244,628  
 Depreciation and amortization
    136,117       133,411  
 Reinsurance recoverable
    20,400       20,400  
 Net unrealized appreciation of securities - available for sale
    601,891       172,155  
 Investment income
    -       10,543  
 Total deferred tax liabilities
    4,885,929       4,292,300  
                 
 Net deferred income tax liability
  $ (1,952,289 )   $ (1,789,439 )
 
(1)  
The deferred tax assets from net operating loss carryovers are as follows:
 
   
September 30,
   
December 31,
     
 Type of NOL
 
2012
   
2011
 
Expiration
 
 State only (A)
  $ 364,633     $ 284,749  
December 31, 2027
 
 Valuation allowance
    130,585       42,437      
 State only, net of valuation allowance
    234,048       242,312      
 Amount subject to Annual Limitation, Federal only (B)
    30,600       34,000  
December 31, 2019
 
 Total deferred tax asset from net operating loss carryovers
  $ 264,648     $ 276,312      
 
(A) Kingstone generates operating losses for state purposes and has prior year net operating loss carryovers available. KICO, the Company’s insurance underwriting subsidiary, is not subject to state income taxes. KICO’s state tax obligations are paid through a gross premiums tax which is included in the Condensed Consolidated Statements of Comprehensive Income within other underwriting expenses. A valuation allowance has been recorded due to the uncertainty of generating enough state taxable income to utilize 100% of the available state net operating loss carryovers over their remaining lives which expire between 2022 and 2027.
 
(B) NOL is subject to Internal Revenue Code Section 382, which places a limitation on the utilization of the federal net operating loss to approximately $10,000 per year (“Annual Limitation”) as a result of a greater than 50% ownership change of the Company in 1999. The losses subject to the Annual Limitation will be available for future years, expiring through December 31, 2019.
 
25

 
 
(2)  
Deferred tax liability -  investment in KICO
 
On July 1, 2009, the Company completed the acquisition of 100% of the issued and outstanding common stock of KICO (formerly known as Commercial Mutual Insurance Company (“CMIC”)) pursuant to the conversion of CMIC from an advance premium cooperative to a stock property and casualty insurance company. Pursuant to the plan of conversion, the Company acquired a 100% equity interest in KICO, in consideration for the exchange of $3,750,000 principal amount of surplus notes of CMIC. In addition, the Company forgave all accrued and unpaid interest on the surplus notes as of the date of conversion. As of the date of acquisition, unpaid accrued interest on the surplus notes along with the accretion of the discount on the original purchase of the surplus notes totaled $2,921,319 (together “Untaxed Interest”). As of the date of acquisition the deferred tax liability on the Untaxed Interest was $1,169,000. Under GAAP guidance for business combinations, a temporary difference with an indefinite life exists when the parent has a lower carrying value of its subsidiary for income tax purposes. The Company is required to maintain its deferred tax liability of $1,169,000 related to this temporary difference until either the stock of KICO is sold, the assets of KICO are sold or KICO and the parent are merged.

The Company had no material unrecognized tax benefit and no adjustments to liabilities or operations were required. There were no interest or penalties related to income taxes that have been accrued or recognized as of and for nine months ended September 30, 2012 and 2011. If any had been recognized these would be reported in income tax expense.

IRS Tax Audit

The Company’s Federal income tax return for the year ended December 31, 2009 has been examined by the Internal Revenue Service and was accepted as filed. The tax returns for years ended December 31, 2010 and 2011 are subject to examination, generally for three years after filing.

Note 12 - Net Income Per Common Share
 
Basic net earnings per common share is computed by dividing income available to common shareholders by the weighted-average number of common shares outstanding. Diluted earnings per share reflect, in periods in which they have a dilutive effect, the impact of common shares issuable upon exercise of vested stock options.  The computation of diluted earnings per share excludes those options with an exercise price in excess of the average market price of the Company’s common shares during the periods presented.
 
For the nine months and three months ended September 30, 2012 there were 199,148 vested options with an exercise price below the average market price of the Company’s Common Stock during the period. For the nine months and three months ended September 30, 2011 there were 269,432 vested options with an exercise price below the average market price of the Company’s Common Stock during the period.
 
 
26

 
 
The reconciliation of the weighted average number of shares of Common Stock and net income used in the calculation of basic and diluted earnings per common share follows:
                         
   
Three months ended
   
Nine months ended
 
   
September 30,
   
September 30,
 
   
2012
(restated)
   
2011
   
2012
(restated)
   
2011
 
   
(unaudited)
   
(unaudited)
 
 Net income used in the calculation of basic earnings per share
  $ 447,831     $ 219,569     $ 1,773,565     $ 1,120,124  
 Effect of dilutive securities, common share equivalents
    455       1,117       39,434       -  
                                 
 Net income used for computing diluted earnings per share
  $ 448,286     $ 220,686     $ 1,812,999     $ 1,120,124  
                                 
 Weighted average number of shares outstanding
    3,824,461       3,838,386       3,794,979       3,838,386  
 Effect of dilutive securities, common share equivalents
    111,706       74,650       89,193       -  
                                 
 Weighted average number of shares outstanding,
                               
 used for computing diluted earnings per share
    3,936,167       3,913,036       3,884,172       3,838,386  

Note 13 - Commitments and Contingencies

Legal Proceedings

From time to time, the Company is involved in various legal proceedings in the ordinary course of business. For example, to the extent a claim asserted by a third party in a law suit against one of the Company’s insureds covered by a particular policy, the Company may have a duty to defend the insured party against the claim. These claims may relate to bodily injury, property damage or other compensable injuries as set forth in the policy. Such proceedings are considered in estimating the liability for loss and LAE expenses. The Company is not subject to any other pending legal proceedings that management believes are likely to have a material adverse effect on the financial statements.

Employment Agreement
 
Effective January 1, 2012, Barry Goldstein, the Company’s President, Chairman of the Board and Chief Executive Officer, assumed the positions of President and Chief Executive Officer of KICO. Effective April 16, 2012, the Company entered into an amendment to its employment agreement with Mr. Goldstein, pursuant to which, effective January 1, 2012 and continuing through the term of the agreement, Mr. Goldstein’s annual base salary was increased to $450,000 from $375,000 in consideration for his additional responsibilities to KICO.
 
 
27

 
 
Note 14 – Subsequent Event
 
Dividends Declared and Paid
 
On November 12, 2012, the Company’s board of directors approved a dividend of $.04 per share payable in cash on December 14, 2012 to stockholders of record as of November 30, 2012.
 
Superstorm Sandy

The New York City area, the primary location of KICO’s insureds, was struck by Superstorm Sandy on October 29, 2012. KICO purchases quota share and catastrophe reinsurance in order to reduce its net liability on insurance risks and to protect against catastrophes. KICO’s personal lines business, which includes homeowners insurance, is reinsured under a 75% quota share treaty and catastrophe insurance pursuant to which KICO’s net liability is limited to 25% of the initial $3,000,000 of direct losses incurred from an occurrence, or $750,000. For catastrophe losses in excess of $3,000,000, KICO is 100% covered by catastrophe reinsurance with regard to the next $70,000,000 in losses. The Company estimates that its net losses incurred as a result of the storm will be $750,000 with respect to KICO’s personal lines business, which is the limit of loss pursuant to its quota share and catastrophe reinsurance treaties. Additional losses will be incurred with respect to KICO’s commercial auto and livery physical damage policies.

KICO receives ceding commissions from the reinsurers. The amount of the commissions includes contingent ceding commissions which are based upon the loss ratio experienced by the reinsurers during the treaty term (July 1 to June 30) from the ceded business over that period of time.  During the three month period ended September 30, 2012 (which was the initial quarter of the 2012-2013 treaty year), the Company’s revenue includes contingent ceding commission revenue of $755,000.  Such contingent ceding commission revenue is subject to downward adjustment (to possibly less than zero) based upon the reinsurance losses expected to be incurred as a result of Superstorm Sandy.  In addition, it is expected that there will be a significant decline in the ceding commission revenue earned during the 4th quarter of 2012 and the first two quarters of 2013 (i.e., the final nine months of the 2012-2013 treaty); however, the amount cannot yet be reasonably estimated due to the high volume of claims that KICO has already received and the anticipation of many more to follow.  Further, KICO will be required to pay reinstatement premiums to catastrophe reinsurers to obtain coverage for future catastrophe events during the current reinsurance treaty period.  Accordingly, the effects of the storm will be material to the Company’s post-3rd quarter of 2012 results of operations; however, the Company expects that, based upon its results of operations for the three and nine months ended September 30, 2012, such effects will not have a material adverse impact on its financial condition.
 
 
28

 
 
ITEM 2.   MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS.
 
Overview
 
We offer property and casualty insurance products to small businesses and individuals in New York State through our subsidiary, Kingstone Insurance Company (“KICO”). KICO’s insureds are located primarily in downstate New York, consisting of New York City, Long Island and Westchester County.
 
We derive 99% of our revenue from KICO, which includes revenues from earned premiums, ceding commissions from quota share reinsurance, net investment income generated from our portfolio, and net realized gains and losses on investment securities.  All of our policies are for a one year period. Earned premiums represent premiums received from insureds, which are recognized as revenue over the period of time that insurance coverage is provided (i.e., ratably over the one year life of the policy). A significant period of time normally elapses between the receipt of insurance premiums and the payment of insurance claims. During this time, KICO invests the premiums, earns investment income and generates net realized and unrealized investment gains and losses on investments.
 
Our expenses include the insurance underwriting expenses of KICO and other operating expenses. Insurance companies incur a significant amount of their total expenses from policyholder losses, which are commonly referred to as claims. In settling policyholder losses, various loss adjustment expenses (“LAE”) are incurred such as insurance adjusters’ fees and litigation expenses. In addition, insurance companies incur policy acquisition expenses. Policy acquisition costs include commissions paid to producers, premium taxes, and other expenses related to the underwriting process, including employees’ compensation and benefits.
 
Other operating expenses include the corporate expenses of our holding company, Kingstone Companies, Inc. These expenses include legal and auditing fees, occupancy costs related to our corporate office, executive employment costs, and other costs directly associated with being a public company.
 
We utilize the following key measures in analyzing the results of our insurance underwriting business:
 
Net loss ratio.  The net loss ratio is a measure of the underwriting profitability of an insurance company’s business.  Expressed as a percentage, this is the ratio of net losses and loss adjustment expenses (“LAE”) incurred to net premiums earned.
 
Net underwriting expense ratio.  The net underwriting expense ratio is a measure of an insurance company’s operational efficiency in administering its business. Expressed as a percentage, this is the ratio of the sum of acquisition costs (the most significant being commissions paid to our producers) and other underwriting expenses less ceding commission revenue less other income to net premiums earned.
 
Net combined ratio.  The net combined ratio is a measure of an insurance company’s overall underwriting profit. This is the sum of the net loss and net underwriting expense ratios. If the net combined ratio is at or above 100 percent, an insurance company cannot be profitable without investment income, and may not be profitable if investment income is insufficient.
 
Underwriting income. Underwriting income is net pre-tax income attributable to our insurance underwriting business except for net investment income, net realized gains from investments, and depreciation and amortization (net premiums earned less expenses included in combined ratio). Underwriting income is a measure of an insurance company’s overall operating profitability before items such as investment income, depreciation and amortization, interest expense and income taxes.
 
 
29

 
 
Critical Accounting Policies
 
Our condensed consolidated financial statements include the accounts of Kingstone Companies, Inc. and all majority-owned and controlled subsidiaries. The preparation of financial statements in conformity with accounting principles generally accepted in the United States requires our management to make estimates and assumptions in certain circumstances that affect amounts reported in our consolidated financial statements and related notes. In preparing these financial statements, our management has utilized information available including our past history, industry standards and the current economic environment, among other factors, in forming its estimates and judgments of certain amounts included in the consolidated financial statements, giving due consideration to materiality. It is possible that the ultimate outcome as anticipated by our management in formulating its estimates inherent in these financial statements might not materialize. However, application of the critical accounting policies  involves the exercise of judgment and use of assumptions as to future uncertainties and, as a result, actual results could differ from these estimates. In addition, other companies may utilize different estimates, which may impact comparability of our results of operations to those of companies in similar businesses.
 
We believe that the most critical accounting policies relate to the reporting of reserves for loss and LAE, including losses that have occurred but have not been reported prior to the reporting date, amounts recoverable from third party reinsurers, deferred ceding commission revenue, deferred policy acquisition costs, deferred income taxes, the impairment of investment securities, intangible assets and the valuation of stock based compensation. See Note  3 to the Condensed Consolidated Financial Statements - “Accounting Policies and Basis of Presentation” for information related to updated accounting policies.
 
 
30

 
 
Consolidated Results of Operations
 
Nine Months Ended September 30, 2012 Compared to Nine Months Ended September 30, 2011
 
The following table summarizes the changes in the results of our operations (in thousands) for the periods indicated:
 
   
Nine months ended September 30,
 
($ in thousands)
 
2012
   
2011
   
Change
   
Percent
 
 Revenues
  (restated)                    
 Direct and assumed written premiums
  $ 36,461     $ 30,509     $ 5,952       19.5 %
 Net written premiums
    14,762       12,410       2,352       19.0 %
 Change in net unearned premiums
    (2,209 )     (1,588 )     (621 )     39.1 %
 Net premiums earned
    12,553       10,822       1,731       16.0 %
 Ceding commission revenue (1)
    8,526       7,348       1,178       16.0 %
 Net investment income
    740       510       230       45.1 %
 Net realized gain on investments
    112       357       (245 )     (68.6 )%
 Other income
    680       693       (13 )     (1.9 )%
 Total revenues
    22,611       19,730       2,881       14.6  %
                                 
 Expenses
                               
 Loss and loss adjustment expenses (1)
                               
 Direct loss and loss adjustment expenses
    14,295       14,343       (48 )     (0.3 %
 Less: ceded loss and loss adjustment expenses
    (6,917 )     (7,035 )     118       (1.7 )%
 Net loss and loss adjustment expenses
    7,378       7,308       70       1.0 %
 Commission expense
    5,430       4,473       957       21.4 %
 Other underwriting expenses
    5,857       5,045       812       16.1  %
 Other operating expenses
    801       863       (62 )     (7.2 )%
 Depreciation and amortization
    447       457       (10 )     (2.2 )%
 Interest expense
    61       108       (47 )     (43.5 )%
 Total expenses
    19,974       18,254       1,720       9.4  %
                                 
 Income from operations before taxes
    2,637       1,476       1,161       78.7  %
 Provision for income tax
    864       356       508       142.7  %
 Net income
  $ 1,773     $ 1,120     $ 653       58.3  %
                                 
 Percent of total revenues:
                               
 Net premiums earned
    55.5 %     54.9 %                
 Ceding commission revenue
    37.7 %     37.2 %                
 Net investment income
    3.3 %     2.6 %                
 Net realized gains on investments
    0.5 %     1.8 %                
 Other income
    3.0 %     3.5 %                
      100.0 %     100.0 %                
                                 
 Net loss ratio excluding the effect of catastrophes
    58.8 %     63.6 %                
 Net catastrophe loss
    0.0 %     3.9 %                
 Net loss ratio
    58.8 %     67.5 %                
 
(1) Includes net catastrophe losses and net loss adjustment expenses for the nine months ended September 30, 2011of $422,000 incurred from August 27, 2011 to August 29, 2011 from Tropical Storm Irene. During the quarter that a catastrophe occurs, it is not possible to estimate the full amount of losses and loss adjustment expenses incurred. Accordingly, additional net catastrophe losses and net loss adjustment expenses from Tropical Storm Irene were recorded subsequent to September 30, 2011. Catastrophe losses incurred from Tropical Storm Irene decreased our ceded loss ratio which reduced our contingent ceding commission revenue by $493,000. For the nine months ended September 30, 2012, we did not incur any catastrophe losses and loss adjustment expenses. We define a “catastrophe” as an event that involves multiple first party policyholders, or an event that produces a number of claims in excess of a preset, per-event threshold of average claims in a specific area, occurring within a certain amount of time constituting the event.  Catastrophes are caused by various natural events including high winds, excessive rain, winter storms, tornadoes, hailstorms, wildfires, tropical storms, and hurricanes. See Note 14 to the Consolidated Financial Statements – “Subsequent Events” for information relating to the effects of Superstorm Sandy that occurred in October 2012.
 
 
31

 
 
Direct and assumed written premiums during the nine months ended September 30, 2012 (“2012”) were $36,461,000 compared to $30,509,000 during the nine months ended September 30, 2011 (“2011”). The increase of $5,952,000, or 19.5%, was primarily due to an increase in policies in-force during 2012 as compared to 2011. We wrote more policies as a result of an increase in demand for the products in the markets that we serve. Policies in-force increased by 18.9% as of September 30, 2012 compared to September 30, 2011. In addition to the increase of policies in-force, we are also writing more policies which have higher premiums.
 
Net written premiums increased $2,352,000, or 19.0%, to $14,762,000 in 2012 from $12,410,000 in 2011. The increase in net written premiums resulted from: (1) an increase in direct written premiums in 2012 compared to direct written premiums in 2011, and (2) effective July 1, 2012, a decrease in quota share percentage in our commercial lines from 60% to 40%. A decrease in the quota share percentage results in us retaining a greater amount of direct written premiums. Net written premiums grew at a lower rate than direct written premiums (19.0% compared to 19.5%) due to increases in policies written in lines of business that are subject to quota share reinsurance treaties, primarily personal lines and commercial lines, in excess of the decrease in policies written in lines of business without quota share reinsurance treaties, primarily commercial auto lines.
 
Net premiums earned increased $1,731,000, or 16.0%, to $12,553,000 in 2012 from $10,822,000 in 2011. As premiums written earn ratably over a twelve month period, the increase was a result of higher net written premiums for the twelve months ended September 30, 2012 compared to the twelve months ended September 30, 2011.
 
The following table summarizes the changes in the components of ceding commission revenue (in thousands) for the periods indicated:
 
   
Nine months ended September 30,
($ in thousands)
 
2012
   
2011
   
Change
   
Percent
 Provisional ceding commissions earned
  $ 6,231     $ 5,049     $ 1,182       23.4 %
 Contingent ceding commissions earned
    2,295       2,299       (4 )     (0.2 )%
 Total ceding commission revenue
  $ 8,526     $ 7,348     $ 1,178       16.0 %
 
Ceding commission revenue was $8,526,000 in 2012 compared to $7,348,000 in 2011. The increase of $1,178,000, or 16.0%, was due a $1,182,000 increase in provisional ceding commissions earned offset by a $4,000 decrease in contingent ceding commissions earned. The $1,182,000 increase in provisional ceding commissions earned is due to a net increase in the amount of premiums ceded.
 
Net investment income was $740,000 in 2012 compared to $510,000 in 2011. The increase of $230,000, or 45.1%, was due to an increase in average invested assets in 2012 as compared to 2011. The increase in cash and invested assets resulted primarily from increased operating cash flows and by an adjustment to amortization of bond premium in 2011. The tax equivalent investment yield, excluding cash, was 4.99% and 5.07% at September 30, 2012 and 2011, respectively.
 
Net realized gains on investments were $112,000 in 2012 compared to $357,000 in 2011. The decrease of $245,000, or 68.6%, was due to an FDIC recovery of $133,000 in 2011 from a failed bank which was included in other than temporary impaired losses in 2009.
 
Net loss and loss adjustment expenses were $7,378,000 in 2012 compared to $7,308,000 in 2011. The net loss ratio was 58.8% in 2012 compared to 67.5% in 2011. The decrease of  8.7  percentage points in our net loss ratio for 2012 as compared to 2011 is primarily due to a decrease in the loss ratios in our personal lines and commercial lines of business. As a result of Tropical Storm Irene in 2011, which we define as a catastrophe, we incurred $422,000 of losses and loss adjustment expenses (net of reinsurance recoverable of $1,266,000), and added 3.9 percentage points to our 2011 net loss ratio.
 
 
32

 
 
Commission expense was $5,430,000 in 2012 or 14.9% of direct written premiums. Commission expense was $4,473,000 in 2011 or 14.7% of direct written premiums. The increase of $957,000 is due to the increase in direct written premiums in 2012 as compared to 2011.
 
Other underwriting expenses were $5,857,000 in 2012 compared to $5,045,000 in 2011. The $812,000, or 16.1%, increase in other underwriting expenses was primarily due to expenses directly related to the increase in direct written premiums, increase in occupancy costs and additional employment costs due to both the hiring of additional staff needed to service our growth in written premiums and increases in annual salaries. Underwriting expenses as a percentage of direct written premiums was 16.1% in 2012 and 16.5% in 2011. Our other underwriting expenses increased at a lower rate than the growth in our direct written premiums.
 
Other operating expenses, related to the corporate expenses of our holding company, were $801,000 in 2012 compared to $863,000 in 2011. The $62,000 decrease in 2012 was primarily due to a decrease in occupancy costs and amortization of stock options as a result of more stock options being fully vested prior to September 30, 2012, offset by increase in professional fees.
 
Interest expense was $61,000 in 2012 compared to $108,000 in 2011. The $47,000 decrease in interest expense was due to the partial redemption of $703,000 to our 2009/2010 Notes during the quarter ended September 30, 2011, and effective July 11, 2011, a reduction in the interest rate to 9.5% per annum from the previous 12.625% per annum.
 
Income tax expense in 2012 was $864,000, which resulted in an effective tax rate of 32.7%. Income tax expense in 2011 was $356,000, which resulted in an effective tax rate of 24.1%. Income before taxes was $2,637,000 in 2012 compared to $1,476,000 in 2011. The increase in the effective tax rate by 8.6% in 2012 is a result of: (A) permanent differences from non taxable investment income and the dividends received deduction having a lesser impact on the effective tax rate in 2012 due to a greater amount of book income in 2012 compared to 2011, and (B) recording a valuation allowance in 2012 against our state net operating loss carryovers compared to no such allowance in 2011. Kingstone Companies, Inc. generates operating losses for state purposes and has prior year net operating loss carryovers available. KICO, our insurance underwriting subsidiary, is not subject to state income taxes. A valuation allowance of $42,000 was recorded by us in December 2011 and an additional valuation allowance of $86,000 was recorded in 2012. The valuation allowance was established due to the uncertainty of generating enough state taxable income to utilize 100% of our available state net operating loss carryovers over their remaining lives which expire between 2022 and 2027.
 
Net income was $1,773,000 in 2012 compared to $1,120,000 in 2011. The increase in net income of $653,000 was due to the circumstances described above that caused the increases in our net premiums earned and ceding commission revenue, and a decrease in our net loss ratio, offset by increases in our other commission expense and underwriting expenses related to premium growth.
 
 
33

 
 
Three Months Ended September 30, 2012 Compared to Three Months Ended September 30, 2011
 
The following table summarizes the changes in the results of our operations (in thousands) for the periods indicated:
 
   
Three months ended September 30,
 
($ in thousands)
 
2012
   
2011
   
Change
   
Percent
 
 Revenues
  (restated)                    
 Direct and assumed written premiums
  $ 12,783     $ 10,386     $ 2,397       23.1 %
 Net written premiums
    5,565       4,267       1,298       30.4 %
 Change in net unearned premiums
    (1,148 )     (330 )     (818 )     247.9 %
 Net premiums earned
    4,417       3,937       480       12.2 %
 Ceding commission revenue (1)
    2,711       2,307       404       17.5 %
 Net investment income
    242       172       70       40.7 %
 Net realized gain on investments
    66       197       (131 )     (66.5 )%
 Other income
    219       229       (10 )     (3.9 )%
 Total revenues
    7,655       6,842       813       11.9 %
                                 
 Expenses
                               
 Loss and loss adjustment expenses (1)
                               
 Direct and assumed loss and loss adjustment expenses
    4,981       6,555       (1,574 )     (24.0 )%
 Less: ceded loss and loss adjustment expenses
    (2,290 )     (3,621 )     1,331       (36.8 )%
 Net loss and loss adjustment expenses
    2,691       2,934       (243 )     (8.3 )%
 Commission expense
    1,953       1,596       357       22.4 %
 Other underwriting expenses
    2,004       1,734       270       15.6 %
 Other operating expenses
    227       260       (33 )     (12.7 )%
 Depreciation and amortization
    150       144       6       4.2 %
 Interest expense
    20       24       (4 )     (16.7 )%
 Total expenses
    7,045       6,692       353       5.3 %
                                 
 Income from operations before taxes
    610       150       460       306.7 %
 Provision for (benefit from) income tax
    162       (70 )     232       (331.4 )%
 Net income
  $ 448     $ 220     $ 228       103.6  %
                                 
 Percent of total revenues:
                               
 Net premiums earned
    57.7 %     57.5 %                
 Ceding commission revenue
    35.4 %     33.7 %                
 Net investment income
    3.1 %     2.5 %                
 Net realized gains on investments
    0.9 %     2.9 %                
 Other income
    2.9 %     3.3 %                
      100.0 %     100.0 %                
                                 
 Net loss ratio excluding the effect of catastrophes
    61.0 %     63.8 %                
 Net catastrophe loss
    0.0 %     10.7 %                
 Net loss ratio
    61.0 %     74.5 %                
 
(1) Includes net catastrophe losses and net loss adjustment expenses for the three months ended September 30, 2011of $422,000 incurred from August 27, 2011 to August 29, 2011 from Tropical Storm Irene. During the quarter that a catastrophe occurs, it is not possible to estimate the full amount of losses and loss adjustment expenses incurred. Accordingly, additional net catastrophe losses and net loss adjustment expenses from Tropical Storm Irene were recorded subsequent to September 30, 2011. Catastrophe losses incurred from Tropical Storm Irene decreased our ceded loss ratio which reduced our contingent ceding commission revenue by $493,000. For the three months ended September 30, 2012, we did not incur any catastrophe losses and loss adjustment expenses. We define a “catastrophe” as an event that involves multiple first party policyholders, or an event that produces a number of claims in excess of a preset, per-event threshold of average claims in a specific area, occurring within a certain amount of time constituting the event.  Catastrophes are caused by various natural events including high winds, excessive rain, winter storms, tornadoes, hailstorms, wildfires, tropical storms, and hurricanes. See Note 14 to the Consolidated Financial Statements – “Subsequent Events” for information relating to the effects of Superstorm Sandy that occurred in October 2012.
 
 
34

 
 
Direct and assumed written premiums during the three months ended September 30, 2012 (“Q3 2012”) were $12,783,000 compared to $10,386,000 during the three months ended September 30, 2011 (“Q3 2011”). The increase of $2,397,000, or 23.1%, was primarily due to an increase in policies in-force during Q3 2012 as compared to Q3 2011. We wrote more policies as a result of an increase in demand for the products in the markets that we serve. Policies in-force increased by 18.9% as of September 30, 2012 compared to September 30, 2011. In addition to the increase of policies in-force, we are also writing more policies which have higher premiums.
 
Net written premiums increased $1,298,000, or 30.4%, to $5,565,000 in Q3 2012 from $4,267,000 in 2011. The increase in net written premiums resulted from: (1) an increase in direct written premiums in Q3 2012 compared to direct written premiums in Q3 2011, and (2) effective July 1, 2012, a decrease in quota share percentage in our commercial lines from 60% to 40%. A decrease in the quota share percentage results in us retaining a greater amount of direct written premiums. Net written premiums grew at a greater rate than direct written premiums (30.4% compared to 23.1%) due to an increase in retained premiums as result of the change in quota share percentage in our commercial lines from 60% to 40% on July 1, 2012.
 
Net premiums earned increased $480,000, or 12.2%, to $4,417,000 in Q3 2012 from $3,937,000 in Q3 2011. As premiums written earn ratably over a twelve month period, the increase was a result of higher net written premiums for the twelve months ended September 30, 2012 compared to the twelve months ended September 30, 2011.
 
The following table summarizes the changes in the components of ceding commission revenue (in thousands) for the periods indicated:
 
   
Three months ended September 30,
($ in thousands)
 
2012
   
2011
   
Change
   
Percent
 Provisional ceding commissions earned
  $ 2,171     $ 1,764     $ 407       23.1 %
 Contingent ceding commissions earned
    540       543       (3 )     (0.7 )%
 Total ceding commission revenue
  $ 2,711     $ 2,307     $ 404       17.5 %
 
Ceding commission revenue was $2,711,000 in Q3 2012 compared to $2,307,000 in Q3 2011. The increase of $403,000, or 17.5%, was due to a $407,000 increase in provisional ceding commissions earned offset by a $3,000 decrease in contingent ceding commissions earned. The $407,000 increase in provisional ceding commissions earned is due to a net increase in the amount of premiums ceded.
 
Net investment income was $242,000 in Q3 2012 compared to $172,000 in Q3 2011. The increase of $70,000, or 40.7%, was due to an increase in average invested assets in Q3 2012 as compared to Q3 2011. The increase in cash and invested assets resulted primarily from increased operating cash flows.. The tax equivalent investment yield, excluding cash, was 4.99% and 5.07% at September 30, 2012 and 2011, respectively.
 
Net realized gains on investments were $66,000 in Q3 2012 compared to $197,000 in Q3 2011. The decrease of $131,000, or 66.5%, was due to an FDIC recovery of $133,000 in Q3 2011 from a failed bank which was included in other than temporary impaired losses in 2009.
 
Net loss and loss adjustment expenses were $2,691,000 in Q3 2012 compared to $2,934,000 in 2011. The net loss ratio was 61.0% in Q3 2012 compared to 74.5% in Q3 2011. The decrease of 13.5  percentage points in our net loss ratio for Q3 2012 as compared to Q3 2011 is primarily due to a decrease in the loss ratios in our personal lines and commercial lines of business. As a result of Tropical Storm Irene in 2011, which we define as a catastrophe, we incurred $422,000 of losses and loss adjustment expenses (net of reinsurance recoverable of $1,266,000), and added 10.7 percentage points to our Q3 2011 net loss ratio.
 
Commission expense was $1,953,000 in Q3 2012 or 15.3% of direct written premiums. Commission expense was $1,596,000 in Q3 2011 or 15.4% of direct written premiums. The increase of $357,000 is due to the increase in direct written premiums in Q3 2012 as compared to Q3 2011.
 
 
35

 
 
Other underwriting expenses were $2,004,000 in Q3 2012 compared to $1,734,000 in Q3 2011. The $270,000, or 15.6%, increase in other underwriting expenses was primarily due to expenses directly related to the increase in direct written premiums and an increase in occupancy costs. Underwriting expenses as a percentage of direct written premiums was 15.7% in Q3 2012 and 16.7% in Q3 2011. Our other underwriting expenses increased at a lower rate than the growth in our direct written premiums.
 
Other operating expenses, related to the corporate expenses of our holding company, were $227,000 in Q3 2012 compared to $260,000 in Q3 2011. The $33,000 decrease in Q3 2012 was due nominal net decreases in various overhead expenses.
 
Interest expense was $20,000 in Q3 2012 compared to $24,000 in Q3 2011. The $4,000 decrease in interest expense was due to the partial redemption of $703,000 to our 2009/2010 Notes during the quarter ended June 30, 2011, and effective July 11, 2011, a reduction in the interest rate to 9.5% per annum from the previous 12.625% per annum.
 
Income tax expense in Q3 2012 was $162,000, which resulted in an effective tax rate of 26.6%. Income tax benefit in Q3 2011 was $70,000, which resulted in an effective tax rate of (46.4)%. Income before taxes was $610,000 in Q3 2012 compared to $150,000 in Q3 2011. The increase in the effective tax rate in Q3 2012 is a result of non-taxable permanent differences in Q3 2011 having a greater effect on income tax due the minimal amount of book taxable income in Q3 2011. In addition, we recorded a valuation allowance in Q3 2012 against our state net operating loss carryovers compared to no such allowance in Q3 2011. Kingstone Companies, Inc. generates operating losses for state purposes and has prior year net operating loss carryovers available. KICO, our insurance underwriting subsidiary, is not subject to state income taxes. Valuation allowances totaling of $98,000 were recorded by us in December 2011 and for the first six months of 2012. An additional valuation allowance of $24,000 was recorded in Q3 2012. The valuation allowance was established due to the uncertainty of generating enough state taxable income to utilize 100% of our available state net operating loss carryovers over their remaining lives which expire between 2022 and 2027.
 
Net income was $448,000 in Q3 2012 compared to $220,000 in Q3 2011. The increase in net income of $228,000 was due to the circumstances described above that caused the increases in our net premiums earned and ceding commission revenue, and a decrease in our net loss ratio, offset by increases in our other commission expense and underwriting expenses related to premium growth.
 
 
36

 
 
Insurance Underwriting Business on a Standalone Basis
 
Our insurance underwriting business reported on a standalone basis for the periods indicated is as follows:
 
   
Three months ended
   
Nine months ended
 
   
September 30,
   
September 30,
 
   
2012
   
2011
   
2012
   
2011
 
    (restated)            (restated)        
 Revenues
                       
 Net premiums earned
  $ 4,416,506     $ 3,937,189     $ 12,553,613     $ 10,822,137  
 Ceding commission revenue
    2,711,431       2,307,390       8,525,945       7,347,832  
 Net investment income
    242,159       172,039       739,555       510,173  
 Net realized gain on investments
    65,986       196,574       111,546       357,006  
 Other income
    129,788       109,452       369,085       307,511  
 Total revenues
    7,565,870       6,722,644       22,299,744       19,344,659  
                                 
 Expenses
                               
 Loss and loss adjustment expenses
    2,691,402       2,933,531       7,378,421       7,307,925  
 Commission expense
    1,952,583       1,596,281       5,430,000       4,472,924  
 Other underwriting expenses
    2,004,331       1,734,137       5,856,652       5,045,051  
 Depreciation and amortization
    150,061       144,122       446,503       452,503  
 Total expenses
    6,798,377       6,408,071       19,111,576       17,278,403  
                                 
 Income from operations
    767,493       314,573       3,188,168       2,066,256  
 Income tax expense
    242,037       30,295       1,012,634       601,939  
 Net income
  $ 525,456     $ 284,278     $ 2,175,534     $ 1,464,317  
 
 
37

 
 
An analysis of our direct, assumed and ceded earned premiums, loss and loss adjustment expenses, and loss ratios is shown below:
 
   
Direct
   
Assumed
   
Ceded
   
Net
 
                         
 Nine months ended September 30, 2012 (restated)
                       
 Written premiums
  $ 36,439,884     $ 21,553     $ (21,699,102 )   $ 14,762,335  
 Unearned premiums
    (4,017,217 )     (9,119 )     1,817,614       (2,208,722 )
 Earned premiums
  $ 32,422,667     $ 12,434     $ (19,881,488 )   $ 12,553,613  
                                 
 Loss and loss adjustment expenses exluding
                               
 the effect of catastrophes
  $ 14,268,577     $ 27,176     $ (6,917,332 )   $ 7,378,421  
 Catastrophe loss
    -       -       -       -  
 Loss and loss adjustment expenses
  $ 14,268,577     $ 27,176     $ (6,917,332 )   $ 7,378,421  
                                 
 Loss ratio excluding the effect of catastrophes
    44.0 %     218.6 %     34.8 %     58.8 %
 Catastrophe loss
    0.0 %     0.0 %     0.0 %     0.0 %
 Loss ratio
    44.0 %     218.6 %     34.8 %     58.8 %
                                 
 Nine months ended September 30, 2011
                               
 Written premiums
  $ 30,502,800     $ 6,289     $ (18,099,446 )   $ 12,409,643  
 Unearned premiums
    (3,823,593 )     1,611       2,234,476       (1,587,506 )
 Earned premiums
  $ 26,679,207     $ 7,900     $ (15,864,970 )   $ 10,822,137  
                                 
 Loss and loss adjustment expenses exluding
                               
 the effect of catastrophes
  $ 12,639,123     $ 15,704     $ (5,768,974 )   $ 6,885,853  
 Catastrophe loss
    1,688,289       -       (1,266,217 )     422,072  
 Loss and loss adjustment expenses
  $ 14,327,412     $ 15,704     $ (7,035,191 )   $ 7,307,925  
                                 
 Loss ratio excluding the effect of catastrophes
    47.4 %     198.8 %     36.4 %     63.6 %
 Catastrophe loss
    6.3 %     0.0 %     8.0 %     3.9 %
 Loss ratio
    53.7 %     198.8 %     44.3 %     67.5 %
                                 
 Three months ended September 30, 2012 (restated)
                               
 Written premiums
  $ 12,765,358     $ 18,354     $ (7,218,500 )   $ 5,565,212  
 Unearned premiums
    (1,363,818 )     (13,031 )     228,143       (1,148,706 )
 Earned premiums
  $ 11,401,540     $ 5,323     $ (6,990,357 )   $ 4,416,506  
                                 
 Loss and loss adjustment expenses exluding
                               
 the effect of catastrophes
  $ 4,969,890     $ 12,269     $ (2,290,757 )   $ 2,691,402  
 Catastrophe loss
    -       -       -       -  
 Loss and loss adjustment expenses
  $ 4,969,890     $ 12,269     $ (2,290,757 )   $ 2,691,402  
                                 
 Loss ratio excluding the effect of catastrophes
    43.6 %     230.5 %     32.8 %     60.9 %
 Catastrophe loss
    0.0 %     0.0 %     0.0 %     0.0 %
 Loss ratio
    43.6 %     230.5 %     32.8 %     60.9 %
                                 
 Three months ended September 30, 2011
                               
 Written premiums
  $ 10,382,641     $ 3,409     $ (6,119,576 )   $ 4,266,474  
 Unearned premiums
    (909,125 )     (41 )     579,881       (329,285 )
 Earned premiums
  $ 9,473,516     $ 3,368     $ (5,539,695 )   $ 3,937,189  
                                 
 Loss and loss adjustment expenses exluding
                               
 the effect of catastrophes
  $ 4,857,144     $ 9,649     $ (2,355,334 )   $ 2,511,459  
 Catastrophe loss
    1,688,289       -       (1,266,217 )     422,072  
 Loss and loss adjustment expenses
  $ 6,545,433     $ 9,649     $ (3,621,551 )   $ 2,933,531  
                                 
 Loss ratio excluding the effect of catastrophes
    51.3 %     286.5 %     42.5 %     63.8 %
 Catastrophe loss
    17.8 %     0.0 %     22.9 %     10.7 %
 Loss ratio
    69.1 %     286.5 %     65.4 %     74.5 %

 
38

 
 
Key Measures
 
The key measures for our insurance underwriting business for the periods indicated are as follows:
 
   
Three months ended
   
Nine months ended
 
   
September 30,
   
September 30,
 
   
2012
   
2011
   
2012
   
2011
 
    (restated)           (restated)        
 Net premiums earned
  $ 4,416,506     $ 3,937,189     $ 12,553,613     $ 10,822,137  
 Ceding commission revenue (1)
    2,711,431       2,307,390       8,525,945       7,347,832  
 Other income
    129,788       109,452       369,085       307,511  
                                 
 Loss and loss adjustment expenses (2)
    2,691,402       2,933,531       7,378,421       7,307,925  
                                 
 Acquistion costs and other underwriting expenses:
                               
 Commission expense
    1,952,583       1,596,281       5,430,000       4,472,924  
 Other underwriting expenses
    2,004,331       1,734,137       5,856,653       5,045,051  
 Total acquistion costs and other
                               
 underwriting expenses
    3,956,914       3,330,418       11,286,653       9,517,975  
                                 
 Underwriting income
  $ 609,409     $ 90,082     $ 2,783,569     $ 1,651,580  
                                 
 Key Measures:
                               
 Net loss ratio excluding the effect of catastrophes
    60.9 %     63.8 %     58.8 %     63.6 %
 Effect of catastrophe loss on loss ratio (2)
    0.0 %     10.7 %     0.0 %     3.9 %
 Net loss ratio
    60.9 %     74.5 %     58.8 %     67.5 %
                                 
 Net underwriting expense ratio excluding the
                               
 effect of catastrophes
    25.3 %     10.7 %     19.1 %     12.7 %
 Effect of catastrophe loss on net underwriting
                               
 expense ratio (1) (2)
    0.0 %     12.5 %     0.0 %     4.6 %
 Net underwriting expense ratio
    25.3 %     23.2 %     19.1 %     17.2 %
                                 
 Net combined ratio excluding the effect
                               
 of catastrophes
    86.2 %     74.5 %     77.8 %     76.3 %
 Effect of catastrophe loss on net combined
                               
 ratio (1) (2)
    0.0 %     23.2 %     0.0 %     8.5 %
 Net combined ratio
    86.2 %     97.7 %     77.8 %     84.7 %
                                 
 Reconciliation of net underwriting expense ratio:
                               
 Acquisition costs and other
                               
 underwriting expenses
  $ 3,956,914     $ 3,330,418     $ 11,286,653     $ 9,517,975  
 Less: Ceding commission revenue (1)
    (2,711,431 )     (2,307,390 )     (8,525,945 )     (7,347,832 )
 Less: Other income
    (129,788 )     (109,452 )     (369,085 )     (307,511 )
   
  $ 1,115,695     $ 913,576     $ 2,391,623     $ 1,862,632  
                                 
 Net earned premium
  $ 4,416,506     $ 3,937,189     $ 12,553,613     $ 10,822,137  
 
(1) The effect of catastrophes reduced contingent ceding commission revenue by $492,870 for the three months and nine months ended September 30, 2011. A provision in our quota share reinsurance treaty, which expired June 30, 2011, limited the maximum contingent ceding commission that could be paid to us, with the unused benefit carried forward to the following   treaty year which began July 1, 2011. The carry forward of the unused benefit resulted in additional contingent ceding commission revenue of approximately $136,000 for the three months and nine months ended September 30, 2011.
 
(2) Includes net catastrophe losses and net loss adjustment expenses for the three months and nine months ended September 30, 2011of $422,072.
 
 
39

 
 
Investments
 
Portfolio Summary
 
The following table presents a breakdown of the amortized cost, aggregate fair value and unrealized gains and losses by investment type as of September 30, 2012 and December 31, 2011:

Available for Sale Securities

   
September 30, 2012
 
  
 
Cost or
   
Gross
   
Gross Unrealized Losses
   
Aggregate
   
% of
 
   
Amortized
   
Unrealized
   
Less than 12
   
More than 12
   
Fair
   
Fair
 
 Category
 
Cost
   
Gains
   
Months
   
Months
   
Value
   
Value
 
   
(unaudited)
 
Political subdivisions of States,
                                   
 Territories and Possessions
  $ 5,568,774     $ 290,672     $ -     $ (40,055 )   $ 5,819,391       20.5 %
                                                 
Corporate and other bonds
                                               
Industrial and miscellaneous
    16,211,308       1,085,116       (5,348 )     (8,337 )     17,282,739       61.0 %
 Total fixed-maturity securities
    21,780,082       1,375,788       (5,348 )     (48,392 )     23,102,130       81.5 %
Equity Securities
    4,716,098       550,161       (35,366 )     -       5,230,893       18.5 %
 Total
  $ 26,496,180     $ 1,925,949     $ (40,714 )   $ (48,392 )   $ 28,333,023       100.0 %
 
   
December 31, 2011
 
  
 
Cost or
   
Gross
   
Gross Unrealized Losses
   
Aggregate
   
% of
 
   
Amortized
   
Unrealized
   
Less than 12
   
More than 12
   
Fair
   
Fair
 
 Category
 
Cost
   
Gains
   
Months
   
Months
   
Value
   
Value
 
                                     
 U.S. Treasury securities and
                                   
 obligations of U.S. government
                                   
 corporations and agencies
  $ 499,832     $ 50,356     $ -     $ -     $ 550,188       2.1 %
                                                 
 Political subdivisions of States,
                                               
 Territories and Possessions
    5,868,743       301,559       -       -       6,170,302       23.2 %
                                                 
 Corporate and other bonds
                                               
 Industrial and miscellaneous
    15,846,616       338,284       (228,792 )     (107,666 )     15,848,442       59.5 %
 Total fixed-maturity securities
    22,215,191       690,199       (228,792 )     (107,666 )     22,568,932       84.7 %
 Equity Securities
    3,857,741       311,300       (98,938 )     (4,893 )     4,065,210       15.3 %
 Total
  $ 26,072,932     $ 1,001,499     $ (327,730 )   $ (112,559 )   $ 26,634,142       100.0 %

 
40

 
 
Held to Maturity Securities
 
   
September 30, 2012
 
   
(unaudited)
 
  
 
Cost or
   
Gross
   
Gross Unrealized Losses
         
% of
 
   
Amortized
   
Unrealized
   
Less than 12
   
More than 12
   
Fair
   
Fair
 
Category
 
Cost
   
Gains
   
Months
   
Months
   
Value
   
Value
 
       
U.S. Treasury securities
  $ 606,273     $ 185,828     $ -     $ -     $ 792,101       100.0 %
                                                 
   
December 31, 2011
 
  
 
Cost or
   
Gross
   
Gross Unrealized Losses
           
% of
 
   
Amortized
   
Unrealized
   
Less than 12
   
More than 12
   
Fair
   
Fair
 
Category
 
Cost
   
Gains
   
Months
   
Months
   
Value
   
Value
 
                                                 
U.S. Treasury securities
  $ 606,234     $ 171,719     $ -     $ -     $ 779,953       100.0 %
 
Credit Rating of Fixed-Maturity Securities
 
The table below summarizes the credit quality of our fixed-maturity securities available for sale as of September 30, 2012 and December 31, 2011 as rated by Standard and Poor’s.
 
   
September 30, 2012
   
December 31, 2011
 
         
Percentage of
         
Percentage of
 
   
Fair Market
   
Fair Market
   
Fair Market
   
Fair Market
 
   
Value
   
Value
   
Value
   
Value
 
   
(unaudited)
             
 Rating
                       
 U.S. Treasury securities
  $ -       0.0 %   $ 550,188       2.4 %
 AAA
    3,002,082       13.0 %     3,041,576       13.5 %
 AA
    3,914,821       16.9 %     4,502,733       20.0 %
 A
    6,691,583       29.0 %     6,977,222       30.9 %
 BBB
    9,493,644       41.1 %     7,497,213       33.2 %
 Total
  $ 23,102,130       100.00 %   $ 22,568,932       100.0 %
 
 
41

 
 
The table below summarizes the average duration by type of fixed-maturity security available for sale as well as detailing the average yield as of September 30, 2012 and December 31, 2011:
 
   
September 30, 2012
   
December 31, 2011
 
         
Weighted
         
Weighted
 
         
Average
         
Average
 
   
Average
   
Duration in
   
Average
   
Duration in
 
 Category
 
Yield %
   
Years
   
Yield %
   
Years
 
 U.S. Treasury securities and
                       
 obligations of U.S. government
                       
 corporations and agencies
    3.28 %     28.0       2.75 %     17.8  
                                 
 Political subdivisions of States,
                               
 Territories and Possessions
    4.11 %     4.7       3.86 %     5.2  
                                 
 Corporate and other bonds
                               
 Industrial and miscellaneous
    4.76 %     6.6       4.98 %     7.1  
 
Fair Value Consideration
 
As disclosed in Note  5 to the Condensed Consolidated Financial Statements, with respect to “Fair Value Measurements,” we define fair value under GAAP guidance as the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants (an “exit price”). This GAAP guidance establishes a fair value hierarchy that distinguishes between inputs based on market data from independent sources (“observable inputs”) and a reporting entity’s internal assumptions based upon the best information available when external market data is limited or unavailable (“unobservable inputs”). The fair value hierarchy in GAAP prioritizes fair value measurements into three levels based on the nature of the inputs. Quoted prices in active markets for identical assets have the highest priority (“Level 1”), followed by observable inputs other than quoted prices including prices for similar but not identical assets or liabilities (“Level 2”), and unobservable inputs, including the reporting entity’s estimates of the assumption that market participants would use, having the lowest priority (“Level 3”). As of September 30, 2012 and December 31, 2011, 48% and 49%, respectively, of the investment portfolio recorded at fair value was priced based upon quoted market prices.
 
As more fully described in Note  4 to our Condensed Consolidated Financial Statements, “Investments—Impairment Review,” we completed a detailed review of all our securities in a continuous loss position as of September 30, 2012 and December 31, 2011, and concluded that the unrealized losses in these asset classes are the result of a decrease in value due to technical spread widening and broader market sentiment, rather than fundamental collateral deterioration, and are temporary in nature.
 
 
42

 
 
The table below summarizes the gross unrealized losses of our fixed-maturity securities available for sale and equity securities by length of time the security has continuously been in an unrealized loss position as of September 30, 2012 and December 31, 2011:
 
   
September 30, 2012
 
   
Less than 12 months
   
12 months or more
   
Total
 
  
             
No. of
               
No. of
   
Aggregate
       
   
Fair
   
Unrealized
   
Positions
   
Fair
   
Unrealized
   
Positions
   
Fair
   
Unrealized
 
 Category
 
Value
   
Losses
   
Held
   
Value
   
Losses
   
Held
   
Value
   
Losses
 
   
(unaudited)
 
Fixed-Maturity Securities:
                                           
Political subdivisions of
                                           
 States, Territories and
                                               
 Possessions
  $ -     $ -       -     $ 764,668     $ (40,055 )     2     $ 764,668     $ (40,055 )
                                                                 
 Corporate and other
                                                               
 bonds industrial and
                                                               
 miscellaneous
    877,005       (5,348 )     3       370,758       (8,337 )     2       1,247,763       (13,685 )
                                                                 
 Total fixed-maturity
                                                               
 securities
  $ 877,005     $ (5,348 )     3     $ 1,135,426     $ (48,392 )     4     $ 2,012,431     $ (53,740 )
                                                                 
 Equity Securities:
                                                               
 Preferred stocks
  $ 386,950     $ (8,977 )     3     $ -     $ -       -     $ 386,950     $ (8,977 )
 Common stocks
    439,205       (26,389 )     3       -       -       -       439,205       (26,389 )
                                                                 
 Total equity securities
  $ 826,155     $ (35,366 )     6     $ -     $ -       -     $ 826,155     $ (35,366 )
                                                                 
 Total
  $ 1,703,160     $ (40,714 )     9     $ 1,135,426     $ (48,392 )     4     $ 2,838,586     $ (89,106 )
 
 
43

 
 
   
December 31, 2011
 
   
Less than 12 months
   
12 months or more
   
Total
 
  
             
No. of
               
No. of
   
Aggregate
       
   
Fair
   
Unrealized
   
Positions
   
Fair
   
Unrealized
   
Positions
   
Fair
   
Unrealized
 
 Category
 
Value
   
Losses
   
Held
   
Value
   
Losses
   
Held
   
Value
   
Losses
 
                                                 
Fixed-Maturity Securities:
                                           
U.S. Treasury securities
                                           
 and obligations of U.S.
                                               
government corporations
                                           
 and agencies
  $ -     $ -       -     $ -     $ -       -     $ -     $ -  
                                                                 
Political subdivisions of
                                                         
 States, Territories and
                                                               
 Possessions
    -       -       -       -       -       -       -       -  
                                                                 
 Corporate and other
                                                               
 bonds industrial and
                                                               
 miscellaneous
    4,849,378       (228,792 )     26       1,483,425       (107,666 )     7       6,332,803       (336,458 )
                                                                 
 Total fixed-maturity
                                                               
 securities
  $ 4,849,378     $ (228,792 )     26     $ 1,483,425     $ (107,666 )     7     $ 6,332,803     $ (336,458 )
                                                                 
 Equity Securities:
                                                               
 Preferred stocks
  $ 368,350     $ (76,969 )     12     $ 189,364     $ (4,893 )     5     $ 557,714     $ (81,862 )
 Common stocks
    397,268       (21,969 )     14       -       -       -       397,268       (21,969 )
 Total equity securities
  $ 765,618     $ (98,938 )     26     $ 189,364     $ (4,893 )     5     $ 954,982     $ (103,831 )
                                                                 
 Total
  $ 5,614,996     $ (327,730 )     52     $ 1,672,789     $ (112,559 )     12     $ 7,287,785     $ (440,289 )

 
44

 
 
There were 13 securities at September 30, 2012 that accounted for the gross unrealized loss, none of which were deemed by us to be other than temporarily impaired. There were 64 securities at December 31, 2011 that accounted for the gross unrealized loss, none of which were deemed by us to be other than temporarily impaired. Significant factors influencing our determination that unrealized losses were temporary included the magnitude of the unrealized losses in relation to each security’s cost, the nature of the investment and management’s intent not to sell these securities and it being not more likely than not that we will be required to sell these investments before anticipated recovery of fair value to our cost basis.
 
Liquidity and Capital Resources
 
Cash Flows
 
The primary sources of cash flow are from our insurance underwriting subsidiary, KICO, which includes direct premiums written, ceding commissions from our quota share reinsurers, loss recovery payments from our reinsurers, investment income and proceeds from the sale or maturity of investments. Funds are used by KICO for ceded premium payments to reinsurers, which are paid on a net basis after subtracting losses paid on reinsured claims and reinsurance commissions. KICO also uses funds for loss payments and loss adjustment expenses on our net business, commissions to producers, salaries and other underwriting expenses as well as to purchase investments and fixed assets.
 
On July 1, 2009, we completed the acquisition of 100% of the issued and outstanding common stock of KICO (formerly known as Commercial Mutual Insurance Company (“CMIC”)) pursuant to the conversion of CMIC from an advance premium cooperative to a stock property and casualty insurance company. Pursuant to the plan of conversion, we acquired a 100% equity interest in KICO. In connection with the plan of conversion of CMIC, we agreed with the Department of Financial Services (formerly known as the Insurance Department) (the “Department”) that, for a period of two years following the effective date of conversion of July 1, 2009, no dividend could be paid by KICO to us without the approval of the Department (“Dividend Restriction Period”). No such request was made by us to the Department within the dividend restriction period. For the nine months ended September 30, 2012, KICO paid dividends of $700,000 to us. We also agreed with the Department that certain intercompany transactions between KICO and us must be filed with the Department 30 days prior to implementation and not disapproved by the Department.
 
During the nine months ended September 30, 2012 we declared and paid $380,046 of dividends on our Common Stock. Our Board of Directors approved a quarterly dividend on November 12, 2012 at the rate of $.04 per share payable in cash on December 14, 2012 to stockholders of record as of November 30, 2012.
 
The primary sources of cash flow for our holding company operations are in connection with the fee income we receive from the premium finance loans and collection of principal and interest income from the notes received by us upon the sale of businesses that were included in our former discontinued operations. Effective July 1, 2011, as discussed above, we may also receive cash dividends from KICO, subject to statutory restrictions.
 
In December 2011, we entered into an agreement with a bank for a $500,000 line of credit to be used for general corporate needs. The principal balance is payable on demand, and must be reduced to zero for a minimum of 30 consecutive days during each year of the term of the credit line. The principal balance was reduced to zero in accordance with the terms of the credit line during the three months ended September 30, 2012. The outstanding balance was $350,000 as of September 30, 2012.  If the aforementioned is insufficient to cover our holding company cash requirements, we will seek to obtain additional financing.

            We prepaid $703,000 of our notes payable during the year ended December 31, 2011. As of September 30, 2012, the outstanding principal balance of our notes payable was $747,000; such notes bear interest at the rate of 9.5% per annum and mature on July 10, 2014. We believe that our present cash flows as described above will be sufficient on a short-term basis and over the next 12 months to fund our company-wide working capital requirements.

 
45

 
 
Our reconciliation of net income to cash provided by operations is generally influenced by the collection of premiums in advance of paid losses, the timing of reinsurance, issuing company settlements and loss payments.
 
Cash flow and liquidity are categorized into three sources: (1) operating activities; (2) investing activities; and (3) financing activities, which are shown in the following table:
 
Nine Months Ended September 30,
 
2012
   
2011
 
             
 Cash flows provided by (used in):
           
 Operating activities
  $ 2,953,088     $ 5,790,641  
 Investing activities
    (392,160 )     (2,257,043 )
 Financing activities
    (286,205 )     (829,150 )
 Net increase in cash and cash equivalents
    2,274,723       2,704,448  
 Cash and cash equivalents, beginning of period
    173,126       326,620  
 Cash and cash equivalents, end of period
  $ 2,447,849     $ 3,031,068  
 
Net cash provided by operating activities was $2,953,000 in 2012 as compared to $5,791,000 provided in 2011. The $2,838,000 decrease in cash flows provided by operating activities in 2012 was primarily a result of the fluctuations in assets and liabilities relating to operating activities of KICO as affected by the growth in its operations which are described above, offset by an increase in net income (adjusted for non-cash items) of $899,000.
 
 Net cash used by investing activities was $392,000 in 2012 compared to $2,257,000 used in 2011. The $1,865,000 increase in cash flows provided by investing activities is a result of the decrease in acquisitions, offset by a decrease in sales of invested assets.
 
Net cash used in financing activities was $286,000 in 2012 compared to $829,000 used in 2011. The $543,000 decrease in cash flows used in financing activities is a result of principal payments on long term debt of $714,000 in 2011 compared to no such payments in 2012, and dividend payments of $380,000 in 2012 compared to $115,000 in 2011.
 
Superstorm Sandy

The primary location of KICO’s insureds is in the New York City area, which was struck by Superstorm Sandy on October 29, 2012. KICO purchases quota share and catastrophe reinsurance in order to reduce its net liability on insurance risks and to protect against catastrophes. KICO’s personal lines business, which includes homeowners insurance, is reinsured under a 75% quota share treaty and catastrophe insurance pursuant to which KICO’s net liability is limited to 25% of the initial $3,000,000 of direct losses incurred from an occurrence, or $750,000. For catastrophe losses in excess of $3,000,000, KICO is 100% covered by catastrophe reinsurance with regard to the next $70,000,000 in losses. We estimate that KICO’s net loss incurred as a result of the storm will be $750,000 with respect to KICO’s personal lines business, which is the limit of loss pursuant to its quota share and catastrophe reinsurance treaties.  Additional losses will be incurred with respect to KICO’s commercial auto and livery physical damage policies.

KICO receives ceding commissions from the reinsurers. The amount of the commissions includes contingent ceding commissions which are based upon the loss ratio experienced by the reinsurers during the treaty term (July 1 to June 30) from the ceded business over that period of time. During the three month period ended September 30, 2012 (which was the initial quarter of the 2012-2013 treaty year), our revenue includes contingent ceding commission revenue of $755,000.  Such contingent ceding commission revenue is subject to downward adjustment (to possibly less than zero) based upon the reinsurance losses expected to be incurred as a result of Superstorm Sandy.  In addition, it is expected that there will be a significant decline in the ceding commission revenue to be earned during the 4th quarter of 2012 and the first two quarters of 2013 (i.e., the final nine months of the 2012-2013 treaty); however, the amount cannot yet be reasonably estimated due to the high volume of claims that KICO has already received and the anticipation of many more to follow. Further, KICO will be required to pay reinstatement premiums to catastrophe reinsurers to obtain coverage for future catastrophe events during the current reinsurance treaty period.  Accordingly, the effects of the storm will be material to our post-3rd quarter of 2012 results of operations; however, we expect that, based upon our results of operations for the three and nine months ended September 30, 2012, such effects will not have a material adverse impact on our financial condition.  See “Factors Relating to Superstorm Sandy That May Affect Future Results and Financial Condition” below.
 
 
46

 
 
Off-Balance Sheet Arrangements
 
We have no off-balance sheet arrangements that have or are reasonably likely to have a current or future effect on our financial condition, changes in financial condition, revenues or expenses, results of operations, liquidity, capital expenditures or capital resources that is material to investors.
 
Factors Relating to Superstorm Sandy That May Affect Future Results and Financial Condition

 
Based upon the following factors relating to Superstorm Sandy, the factors set forth under “Factors That May Affect Future Results and Financial Condition” in Item 7 of our Annual Report on Form 10-K for the year ended December 31, 2011, as well as other factors affecting our operating results and financial condition, past financial performance should not be considered to be a reliable indicator of future performance, and investors should not use historical trends to anticipate results or trends in future periods.  In addition, such factors, among others, may affect the accuracy of certain forward-looking statements contained in this Quarterly Report.

The effects of Superstorm Sandy will be material to our post-3rd quarter of 2012 results of operations.

 
On October 29, 2012, the New York City area, which is the primary location of KICO’s insureds, was struck by Superstorm Sandy.  Certain material effects of the storm on our post-3rd quarter of 2012 results of operations are described under “Liquidity and Capital Resources - Superstorm Sandy” above.  Given its recent occurrence and the limited information currently available, we cannot provide a reasonable estimate of the ongoing effects of the storm; however, given the likely reinsurance losses that will be incurred as a result of the storm, it is possible that the terms and conditions for any reinsurance that we may require following the end of our current reinsurance treaties on June 30, 2013 will be impacted.
 
ITEM  3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK.

Not applicable

ITEM  4. CONTROLS AND PROCEDURES.

In the Original Form 10-Q, we indicated that, with the participation of our Chief Executive Officer and Chief Financial Officer, we evaluated the effectiveness of our disclosure controls and procedures (as described in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934, as amended (the “Exchange Act”)) as of the end of the period covered by this report. Based on the evaluation of these controls and procedures required by paragraph (b) of Rules 13a-15 and 15d-5 under the Exchange Act, we indicated that our Chief Executive Officer and Chief Financial Officer concluded that, as of the end of such period, our disclosure controls and procedures were effective in recording, processing, summarizing and reporting, on a timely basis, information required to be disclosed by us in the reports that we file or submit under the Exchange Act.
 
Our Chief Executive Officer and Chief Financial Officer, in consultation with the Audit Committee, have concluded that the $865,195 error ($466,156, net of other underwriting expenses, other operating expenses, and income tax expense), as more fully described in Note 2 to the consolidated financial statements, resulted from a material weakness in our internal control over financial reporting related to the recording of the change in ceded unearned premiums associated with the decrease in commercial lines reinsurance quota share from 60% to 40% effective as of July 1, 2012. A material weakness is a deficiency, or combination of deficiencies, in internal control over financial reporting, such that there is a reasonable possibility that a material misstatement of the company’s annual or interim financial statements will not be prevented or detected on a timely basis. Specifically, controls did not operate effectively to ensure that the entries associated with the decrease in commercial lines reinsurance quota share from 60% to 40% effective as of July 1, 2012 were accurately recorded to properly reflect the correct change in ceded unearned premiums.  As a result of the material weakness, our Chief Executive Officer and Chief Financial Officer have concluded that our disclosure controls and procedures were not effective as of September 30, 2012 in recording, processing, summarizing and reporting, on a timely basis, information required to be disclosed by us in the reports that we file or submit under the Exchange Act.
 
The financial statements included in this Form 10-Q/A were prepared with particular attention to the material weakness. We concluded that the financial statements included in the Form 10-Q/A fairly present, in all material respects, the financial condition, results of operations and cash flows as of and for the periods ended in accordance with U.S. generally accepted accounting principles.
 
We continually review our disclosure controls and procedures and makes changes, as necessary, to ensure the quality of our financial reporting.
 
Management’s Plan for Remediation
 
Management and the Board of Directors are committed to remediation of the material weakness to the consolidated financial statements as well as the continued improvement of our overall system of internal control over financial reporting. As management continues to evaluate and work to enhance the internal control over financial reporting, it may be determined that additional measures must be taken to address control deficiencies or it may be determined that we need to modify or otherwise adjust the remediation procedures described below.
 
Subsequent to the period covered by the report, management is implementing measures to remediate the material weakness in internal control over financial reporting. Specifically, management is implementing controls and communicating to the financial reporting personnel the importance of correctly recording the changes to unearned premiums arising from our annual changes to our reinsurance quota share treaties and ensuring that the ceded unearned premium balances are properly reconciled during the financial reporting process. We will add an item to our financial closing checklist to review that the changes to reinsurance contracts have been properly recorded to all accounts requiring adjustment.
 
Risks Related to the Restatement
 
As a result of the material weakness described above, our disclosure controls and procedures were not effective to timely prevent or detect errors in our consolidated financial statements which led to the restatement herein. As of the date of this Form 10-Q/A and as described above, management has implemented remedial measures related to the identified material weakness. If our efforts to remediate the weakness identified are not successful, or if other deficiencies occur, these weaknesses or deficiencies could result in misstatements of our results of operations, additional restatements of our consolidated financial statements, a decline in stock price and investor confidence or other material effects on our business, reputation, results of operations or financial condition.
 
 
47

 
 
PART II.  OTHER INFORMATION
 
ITEM 1.   LEGAL PROCEEDINGS.
 
    None
 
ITEM 1A. RISK FACTORS.
 
   Not applicable.  See, however, “Management’s Discussion and Analysis of Financial Condition and Results of Operations – Factors Relating to Superstorm Sandy That May Affect Future Results and Financial Condition” in Item 2 of Part I of this Quarterly Report.
 
ITEM 2.   UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS.
 
(a)  
None

(b)  
Not applicable

(c) The following table sets forth certain information with respect to purchases of common stock made by us or any “affiliated purchaser” during the quarter ended September 30, 2012:

Period
 
Total Number of Shares Purchased(1)
   
Average Price Paid per Share
   
Total Number of Shares Purchased as Part of Publicly Announced Plans or Programs
   
Maximum Number of Shares that May Be Purchased Under the Plans or Programs
 
                         
7/1/12 - 7/31/12
    -       -       -       -  
8/1/12 – 8/31/12
    4,602     $ 4.98       -       -  
9/1/12 - 9/30/12
    4,600     $ 4.78       -       -  
Total
    9,202     $ 4.88       -       -  
 
ITEM 3.   DEFAULTS UPON SENIOR SECURITIES.
 
None
 
ITEM 4.   MINE SAFETY DISCLOSURES.
 
Not applicable
 
ITEM 5.   OTHER INFORMATION.
 
None

 
48

 
 
ITEM 6.   EXHIBITS.

3(a)
 
Restated Certificate of Incorporation, as amended1
     
3(b)
 
By-laws, as amended2
     
31(a)
 
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(b)
 
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
 
Certification of Chief Executive Officer and Chief Financial Officer Certification of Chief Executive Officer and Chief Financial Officer Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
_____________
1 Denotes document filed as an exhibit to our Quarterly Report on Form 10-Q for the period ended March 31, 2012 and incorporated herein by reference.
2 Denotes document filed as an exhibit to our Current Report on Form 8-K for an event dated November 5, 2009 and incorporated herein by reference.
 
 
49

 
 
SIGNATURES
 
In accordance with the requirements of the Exchange Act, the registrant caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
 
  KINGSTONE COMPANIES, INC.  
       
Dated:   February 25, 2013
By:
/s/ Barry B. Goldstein  
    Barry B. Goldstein  
    President  
       
  By:  /s/ Victor Brodsky  
    Victor Brodsky  
    Chief Financial Officer  
 
 
50