kins_10q.htm


UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
 
FORM 10-Q
 
(Mark one)
     
þ
 
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
 
For the quarterly period ended March 31, 2013
 
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)
 
15 Joys Lane
Kington, NY 12401
(Address of principal executive offices)

(516) 374-7600
(Registrant’s telephone number, including area code)
 
1154 Broadway
Hewlett, NY 11557
(Former Address if changed since last report)
 
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 filero
 
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 May 15, 2013, there were 3,840,899 shares of the registrant’s common stock outstanding.
 


 
 

 

KINGSTONE COMPANIES, INC.
INDEX
 
     
PAGE
           
   
2
 
           
   
2
 
     
2
 
     
3
 
     
4
 
     
5-6
 
     
7
 
   
27
 
   
41
 
   
41
 
           
   
43
 
           
   
43
 
   
43
 
   
43
 
   
43
 
   
43
 
   
43
 
   
44
 
           
    45  
         
EXHIBIT 3(a)
       
EXHIBIT 3(b)
       
EXHIBIT 31(a)
       
EXHIBIT 31(b)
EXHIBIT 32
1 EXHIBIT 101.INS XBRL Instance Document
1 EXHIBIT 101.SCH XBRL Taxonomy Extension Schema
1 EXHIBIT 101.CAL XBRL Taxonomy Extension Calculation Linkbase
1 EXHIBIT 101.DEF XBRL Taxonomy Extension Definition Linkbase
1 EXHIBIT 101.LAB XBRL Taxonomy Extension Label Linkbase
1 EXHIBIT 101.PRE XBRL Taxonomy Extension Presentation Linkbase
 
 
 


Forward-Looking Statements
 
This Quarterly Report on Form 10-Q 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, 2012 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.
 
 
1

 
PART I.  FINANCIAL INFORMATION
 
ITEM 1.  FINANCIAL STATEMENTS.
 
KINGSTONE COMPANIES, INC. AND SUBSIDIARIES
 
           
   
March 31,
   
December 31,
 
   
2013
   
2012
 
   
(unaudited)
       
Assets
           
Fixed-maturity securities, held to maturity, at amortized cost (fair value of $750,137
           
at March 31, 2013 and $779,026 at December 31, 2012)
  $ 606,289     $ 606,281  
Fixed-maturity securities, available for sale, at fair value (amortized cost of
               
$24,502,275 at March 31, 2013 and $24,847,097 at December 31, 2012)
    25,842,570       26,181,938  
Equity securities, available-for-sale, at fair value (cost of $6,455,800
               
at March 31, 2013 and $5,073,977 at December 31, 2012)
    7,112,355       5,290,242  
Total investments
    33,561,214       32,078,461  
Cash and cash equivalents
    2,828,554       2,240,012  
Premiums receivable, net of provision for uncollectible amounts
    7,396,157       7,766,825  
Reinsurance receivables, net of provision for uncollectible amounts
    33,621,371       38,902,782  
Notes receivable-sale of business
    314,899       323,141  
Deferred acquisition costs
    5,552,777       5,569,878  
Intangible assets, net
    3,066,029       3,184,958  
Property and equipment, net of accumulated depreciation
    1,918,505       1,868,422  
Other assets
    552,858       1,563,919  
Total assets
  $ 88,812,364     $ 93,498,398  
                 
Liabilities
               
Loss and loss adjustment expenses
  $ 28,309,886     $ 30,485,532  
Unearned premiums
    26,563,888       26,012,363  
Advance premiums
    767,482       610,872  
Reinsurance balances payable
    6,242,200       1,820,527  
Advance payments from catastrophe reinsurers
    -       7,358,391  
Deferred ceding commission revenue
    4,922,256       4,877,030  
Notes payable (includes payable to related parties of $378,000
               
at March 31, 2013 and December 31, 2012)
    747,000       1,197,000  
Accounts payable, accrued expenses and other liabilities
    2,823,224       3,067,586  
Deferred income taxes
    1,814,302       1,787,281  
Total liabilities
    72,190,238       77,216,582  
                 
Commitments and Contingencies
               
                 
Stockholders' Equity
               
Preferred stock, $.01 par value; authorized 1,000,000 shares;
               
-0- shares issued and outstanding
  $ -     $ -  
Common stock, $.01 par value; authorized 10,000,000 shares; issued 4,730,357
               
shares at March 31, 2013 and December 31, 2012;
               
outstanding 3,840,899 shares at March 31, 2013 and December 31, 2012
    47,304       47,304  
Capital in excess of par
    13,859,784       13,851,036  
Accumulated other comprehensive income
    1,317,920       1,023,729  
Retained earnings
    2,824,663       2,787,292  
      18,049,671       17,709,361  
Treasury stock, at cost, 889,458 shares at March 31, 2013 and December 31, 2012
    (1,427,545 )     (1,427,545 )
Total stockholders' equity
    16,622,126       16,281,816  
                 
Total liabilities and stockholders' equity
  $ 88,812,364     $ 93,498,398  
 

See accompanying notes to condensed consolidated financial statements.
 
 
2

 
KINGSTONE COMPANIES, INC. AND SUBSIDIARIES
 
             
           
Three months ended March 31,
 
2013
   
2012
 
             
Revenues
           
Net premiums earned
  $ 4,623,215     $ 3,972,535  
Ceding commission revenue
    2,293,711       2,903,656  
Net investment income
    283,287       267,517  
Net realized gain on sale of investments
    105,125       39,400  
Other income
    213,990       239,055  
Total revenues
    7,519,328       7,422,163  
                 
Expenses
               
Loss and loss adjustment expenses
    2,469,641       2,278,514  
Commission expense
    2,115,820       1,671,607  
Other underwriting expenses
    2,213,345       1,857,746  
Other operating expenses
    243,310       286,887  
Depreciation and amortization
    152,986       146,549  
Interest expense
    21,215       20,785  
Total expenses
    7,216,317       6,262,088  
                 
Income from operations before taxes
    303,011       1,160,075  
Income tax expense
    112,003       394,657  
Net income
    191,008       765,418  
                 
Other comprehensive income, net of tax
               
Gross unrealized investment holding gains
               
arising during period
    445,743       447,165  
                 
Income tax expense related to items of other
               
comprehensive income
    (151,553 )     (152,036 )
Comprehensive income
  $ 485,198     $ 1,060,547  
                 
Earnings per common share:
               
Basic
  $ 0.05     $ 0.20  
Diluted
  $ 0.05     $ 0.20  
                 
Weighted average common shares outstanding
               
Basic
    3,840,899       3,771,109  
Diluted
    3,914,406       3,771,109  
                 
Dividends declared and paid per common share
  $ 0.04     $ 0.03  
 

See accompanying notes to condensed consolidated financial statements.
 
 
3

 
KINGSTONE COMPANIES, INC. AND SUBSIDIARIES
 
                                                             
 
Three months ended March 31, 2013 (unaudited)
 
                                                             
                                 
Accumulated
                         
                           
Capital
   
Other
                         
   
Preferred Stock
   
Common Stock
   
in Excess
   
Comprehensive
   
Retained
   
Treasury Stock
       
   
Shares
   
Amount
   
Shares
   
Amount
   
of Par
   
Income
   
Earnings
   
Shares
   
Amount
   
Total
 
                                                                                 
Balance, January 1, 2013
    -     $ -       4,730,357     $ 47,304     $ 13,851,036     $ 1,023,729     $ 2,787,292       889,458     $ (1,427,545 )   $ 16,281,816  
Stock-based compensation
    -       -       -       -       8,748       -       -       -       -       8,748  
Dividends
    -       -       -       -       -       -       (153,637 )     -       -       (153,637 )
Net income
    -       -       -       -       -       -       191,008       -       -       191,008  
Change in unrealized gains on available for
                                                                               
sale securities, net of tax
    -       -       -       -       -       294,191       -       -       -       294,191  
Balance, March 31, 2013
    -     $ -       4,730,357     $ 47,304     $ 13,859,784     $ 1,317,920     $ 2,824,663       889,458     $ (1,427,545 )   $ 16,622,126  
 

See accompanying notes to condensed consolidated financial statements.
 
 
KINGSTONE COMPANIES, INC. AND SUBSIDIARIES
 
             
           
Three months ended March 31,
 
2013
   
2012
 
             
Cash flows provided by (used in) operating activities:
           
Net income
  $ 191,008     $ 765,418  
Adjustments to reconcile net income to net cash provided by operating activities:
               
Net realized gain on sale of investments
    (105,125 )     (39,400 )
Depreciation and amortization
    152,986       146,549  
Amortization of bond premium, net
    45,074       32,938  
Stock-based compensation
    8,748       19,501  
Excess tax benefit from exercise of stock options
    -       (7,819 )
Deferred income tax expense
    (124,532 )     (60,780 )
(Increase) decrease in assets:
               
Premiums receivable, net
    370,668       (543,567 )
Receivables - reinsurance contracts
    -       (857,323 )
Reinsurance receivables, net
    5,281,411       (1,303,004 )
Deferred acquisition costs
    17,101       (180,579 )
Other assets
    1,011,071       (75,757 )
Increase (decrease) in liabilities:
               
Loss and loss adjustment expenses
    (2,175,646 )     1,452,292  
Unearned premiums
    551,525       970,562  
Advance premiums
    156,610       32,645  
Reinsurance balances payable
    4,421,673       341,414  
Advance payments from catastrophe reinsurers
    (7,358,391 )     -  
Deferred ceding commission revenue
    45,226       166,818  
Accounts payable, accrued expenses and other liabilities
    (244,362 )     (1,054,435 )
Net cash flows provided by (used in) operating activities
    2,245,045       (194,527 )
                 
Cash flows (used in) provided by investing activities:
               
Purchase - fixed-maturity securities available for sale
    (1,146,075 )     (105,544 )
Purchase - equity securities
    (2,298,727 )     (658,388 )
Sale or maturity - fixed-maturity securities available for sale
    1,522,781       1,032,800  
Sale - equity securities
    945,053       191,516  
Collections of notes receivable and accrued interest - sale of businesses
    8,242       7,066  
Other investing activities
    (84,140 )     (11,420 )
Net cash flows (used in) provided by investing activities
    (1,052,866 )     456,030  
                 
Cash flows used in financing activities:
               
Proceeds from line of credit
    100,000       50,000  
Principal payments on line of credit
    (550,000 )     (100,000 )
Proceeds from exercise of stock options
    -       41,200  
Excess tax benefit from exercise of stock options
    -       7,819  
Purchase of treasury stock
    -       (8,200 )
Dividends paid
    (153,637 )     (113,397 )
Net cash flows used in financing activities
    (603,637 )     (122,578 )


See accompanying notes to condensed consolidated financial statements.
 
 
KINGSTONE COMPANIES, INC. AND SUBSIDIARIES
 
             
Condensed Consolidated Statements of Cash Flows (Unaudited)
           
Three months ended March 31,
 
2013
   
2012
 
             
Increase in cash and cash equivalents
  $ 588,542     $ 138,925  
Cash and cash equivalents, beginning of period
    2,240,012       173,126  
Cash and cash equivalents, end of period
  $ 2,828,554     $ 312,051  
                 
Supplemental disclosures of cash flow information:
               
Cash paid for income taxes
  $ -     $ 500,000  
Cash paid for interest
  $ 39,087     $ 120,037  


See accompanying notes to condensed consolidated financial statements.
 
 
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, 2012 and notes thereto included in the Company’s Annual Report on Form 10-K filed on April 1, 2013. 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 three months ended March 31, 2013 may not be indicative of the results that may be expected for the year ending December 31, 2013.
 
Note 2 – 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. and 15 Joys Lane, LLC, which together own the land and building from which KICO operates. All significant inter-company transactions have been eliminated in consolidation.
 
 
7

 
Accounting Pronouncements
 
In February 2013, Financial Accounting Standards Board issued Accounting Standards Update ("ASU") No. 2013-02, Reporting of Amounts Reclassified out of Accumulated Other Comprehensive Income ("ASU 2013-02"). ASU 2013-02 supersedes and replaces the presentation requirements for the reclassifications out of accumulated other comprehensive income. None of the other requirements of previously issued ASUs related to comprehensive income are affected by ASU 2013-02. The Company adopted ASU 2013-02 on January 1, 2013 and the implementation of the standard did not have a material impact on the Company's results of operations, financial position or liquidity.

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 3 - Investments 

Available for Sale Securities

The amortized cost and fair value of investments in available for sale fixed-maturity securities and equities as of March 31, 2013 and December 31, 2012 are summarized as follows:
 
   
March 31, 2013
 
                                 
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
  $ 5,489,845     $ 268,889     $ (20,396 )   $ -     $ 5,738,338     $ 248,493  
                                                 
Corporate and other bonds
                                               
Industrial and miscellaneous
    19,012,430       1,132,479       (40,677 )     -       20,104,232       1,091,802  
Total fixed-maturity securities
    24,502,275       1,401,368       (61,073 )     -       25,842,570       1,340,295  
                                                 
Equity Securities:
                                               
Preferred stocks
    2,265,510       37,289       (6,174 )     -       2,296,625       31,115  
Common stocks
    4,190,290       636,664       (11,224 )     -       4,815,730       625,440  
Total equity securities
    6,455,800       673,953       (17,398 )     -       7,112,355       656,555  
                                                 
Total
  $ 30,958,075     $ 2,075,321     $ (78,471 )   $ -     $ 32,954,925     $ 1,996,850  
 

   
December 31, 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)
 
                                     
Fixed-Maturity Securities:
                                   
Political subdivisions of States,
                                   
Territories and Possessions
  $ 5,219,092     $ 257,298     $ (1,574 )   $ -     $ 5,474,816     $ 255,724  
                                                 
Corporate and other bonds
                                               
Industrial and miscellaneous
    19,628,005       1,123,392       (43,553 )     (722 )     20,707,122       1,079,117  
Total fixed-maturity securities
    24,847,097       1,380,690       (45,127 )     (722 )     26,181,938       1,334,841  
                                                 
Equity Securities:
                                               
Preferred stocks
    1,475,965       19,512       (11,130 )     -       1,484,347       8,382  
Common stocks
    3,598,012       353,782       (145,899 )     -       3,805,895       207,883  
Total equity securities
    5,073,977       373,294       (157,029 )     -       5,290,242       216,265  
                                                 
Total
  $ 29,921,074     $ 1,753,984     $ (202,156 )   $ (722 )   $ 31,472,180     $ 1,551,106  
 
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 March 31, 2013 and December 31, 2012 is shown below:
 
   
March 31, 2013
   
December 31, 2012
 
   
Amortized
         
Amortized
       
Remaining Time to Maturity
 
Cost
   
Fair Value
   
Cost
   
Fair Value
 
   
(unaudited)
       
Less than one year
  $ 551,998     $ 558,103     $ 546,952     $ 560,162  
One to five years
    8,657,117       9,197,497       9,031,248       9,569,943  
Five to ten years
    11,751,646       12,480,298       12,605,798       13,306,033  
More than 10 years
    3,541,514       3,606,672       2,663,099       2,745,800  
Total
  $ 24,502,275     $ 25,842,570     $ 24,847,097     $ 26,181,938  
 
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 March 31, 2013 and December 31, 2012 are summarized as follows:

   
March 31, 2013
 
                                 
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
  $ 606,289     $ 143,848     $ -     $ -     $ 750,137     $ 143,848  
 
 
 
 
December 31, 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)
 
                                                 
U.S. Treasury securities
  $ 606,281     $ 172,745     $ -     $ -     $ 779,026     $ 172,745  
  
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.

Investment Income

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

   
Three months ended
 
   
March 31,
 
   
2013
   
2012
 
   
(unaudited)
 
Income:
 
 
   
 
 
Fixed-maturity securities
  $ 260,035     $ 234,493  
Equity securities
    86,455       85,929  
Cash and cash equivalents
    29       1,406  
Other
    -       2  
Total
    346,519       321,830  
Expenses:
               
Investment expenses
    63,232       54,313  
Net investment income
  $ 283,287     $ 267,517  
 
Proceeds from the sale and maturity of fixed-maturity securities were $1,522,781 and $1,032,800 for the three months ended March 31, 2013 and 2012, respectively.

Proceeds from the sale of equity securities were $945,053 and $191,516 for the three months ended March 31, 2013 and 2012, respectively.

The Company’s net realized gains and losses on investments are summarized as follows:
 

   
Three months ended
 
   
March 31,
 
   
2013
   
2012
 
   
(unaudited)
 
Fixed-maturity securities:
           
Gross realized gains
  $ 76,976     $ 40,146  
Gross realized losses
    -       -  
      76,976       40,146  
                 
Equity securities:
               
Gross realized gains
    71,785       7,069  
Gross realized losses
    (43,636 )     (7,815 )
      28,149       (746 )
                 
Net realized gains
  $ 105,125     $ 39,400  
 
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 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 income 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 19 securities at March 31, 2013 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 three months ended March 31, 2013 and 2012. 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 March 31, 2013 and December 31, 2012 as follows:
 
 
   
March 31, 2013
 
   
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
  $ 795,799     $ (20,396 )     3     $ -     $ -       -     $ 795,799     $ (20,396 )
                                                                 
Corporate and other
                                                               
bonds industrial and
                                                               
miscellaneous
    1,998,132       (40,677 )     9       -       -       -       1,998,132       (40,677 )
                                                                 
Total fixed-maturity
                                                               
securities
  $ 2,793,931     $ (61,073 )     12     $ -     $ -       -     $ 2,793,931     $ (61,073 )
                                                                 
Equity Securities:
                                                               
Preferred stocks
  $ 898,900     $ (6,174 )     4     $ -     $ -       -     $ 898,900     $ (6,174 )
Common stocks
    632,850       (11,224 )     3       -       -       -       632,850       (11,224 )
                                                                 
Total equity securities
  $ 1,531,750     $ (17,398 )     7     $ -     $ -       -     $ 1,531,750     $ (17,398 )
                                                                 
Total
  $ 4,325,681     $ (78,471 )     19     $ -     $ -       -     $ 4,325,681     $ (78,471 )
 
   
December 31, 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
 
                                                 
Fixed-Maturity Securities:
                                           
Political subdivisions of
                                           
States, Territories and
                                               
Possessions
  $ 202,798     $ (1,574 )     1     $ -     $ -       -     $ 202,798     $ (1,574 )
                                                                 
Corporate and other
                                                               
bonds industrial and
                                                               
miscellaneous
    4,025,551       (43,553 )     19       128,125       (722 )     1       4,153,676       (44,275 )
                                                                 
Total fixed-maturity
                                                               
securities
  $ 4,228,349     $ (45,127 )     20     $ 128,125     $ (722 )     1     $ 4,356,474     $ (45,849 )
                                                                 
Equity Securities:
                                                               
Preferred stocks
  $ 387,925     $ (11,130 )     3     $ -     $ -       -     $ 387,925     $ (11,130 )
Common stocks
    1,536,860       (145,899 )     9       -       -       -       1,536,860       (145,899 )
                                                                 
Total equity securities
  $ 1,924,785     $ (157,029 )     12     $ -     $ -       -     $ 1,924,785     $ (157,029 )
                                                                 
Total
  $ 6,153,134     $ (202,156 )     32     $ 128,125     $ (722 )     1     $ 6,281,259     $ (202,878 )

 
Note 4 - 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. Municipal and corporate bonds that are traded in less active markets are classified as Level 2. These securities are valued using market price quotations for recently executed transactions.

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 March 31, 2013 and December 31, 2012 as follows:
 
   
March 31, 2013
 
($ in thousands)
 
Level 1
   
Level 2
   
Level 3
   
Total
 
   
(unaudited)
 
Fixed-maturity investments available for sale
                       
U.S. Treasury securities
                       
and obligations of U.S.
                       
government corporations
                       
and agencies
  $ -     $ -     $ -     $ -  
                                 
Political subdivisions of
                               
States, Territories and
                               
Possessions
    -       5,738       -       5,738  
                                 
Corporate and other
                               
bonds industrial and
                               
miscellaneous
    10,574       9,531       -       20,105  
Total fixed maturities
    10,574       15,269       -       25,843  
Equity investments
    7,112       -       -       7,112  
Total investments
  $ 17,686     $ 15,269     $ -     $ 32,955  
 
   
December 31, 2012
 
($ in thousands)
 
Level 1
   
Level 2
   
Level 3
   
Total
 
       
Fixed-maturity investments
                       
U.S. Treasury securities
                       
and obligations of U.S.
                       
government corporations
                       
and agencies
  $ -     $ -     $ -     $ -  
                                 
Political subdivisions of
                               
States, Territories and
                               
Possessions
    -       5,475       -       5,475  
                                 
Corporate and other
                               
bonds industrial and
                               
miscellaneous
    11,600       9,107       -       20,707  
Total fixed maturities
    11,600       14,582       -       26,182  
Equity investments
    5,290       -       -       5,290  
Total investments
  $ 16,890     $ 14,582     $ -     $ 31,472  
 
 
Note 5 - 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 3 - 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, and accordingly the real estate is a Level 3 asset under the fair value hierarchy.

Reinsurance balances payable: The carrying value reported in the condensed 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:

   
March 31, 2013
   
December 31, 2012
 
   
Carrying Value
   
Fair Value
   
Carrying Value
   
Fair Value
 
   
(unaudited)
             
Fixed-maturity investments held to maturity
  $ 606,289     $ 750,137     $ 606,281     $ 779,026  
Cash and cash equivalents
    2,828,554       2,828,554       2,240,012       2,240,012  
Premiums receivable
    7,396,157       7,396,157       7,766,825       7,766,825  
Receivables - reinsurance contracts
    -       -       -       -  
Reinsurance receivables
    38,574,184       38,574,184       38,902,782       38,902,782  
Notes receivable-sale of business
    314,899       314,899       323,141       323,141  
Real estate, net of accumulated depreciation
    1,729,527       1,763,500       1,696,924       1,720,000  
Reinsurance balances payable
    6,242,200       6,242,200       1,820,527       1,820,527  
Advance payments from catastrophe reinsurers
    -       -       7,358,391       7,358,391  
Notes payable (including related parties)
    747,000       747,000       1,197,000       1,197,000  
 
Note 6 - Notes Receivable-Sale of Businesses
 
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.
 
Notes receivable arising from the sale of businesses as of March 31, 2013 and December 31, 2012 consists of:
 
   
March 31,
 
December 31,
 
   
2013
 
2012
 
   
(unaudited)
     
Current maturities
  $ 36,797   $ 36,122  
Long-term
    278,102     287,019  
Total
  $ 314,899   $ 323,141  

Note 7 – Property and Casualty Insurance Activity
 
Earned Premiums

Premiums written, ceded and earned are as follows:
 
   
Direct
   
Assumed
   
Ceded
   
Net
 
                         
Three months ended March 31, 2013 (unaudited)
   
 
   
 
   
 
 
Premiums written
  $ 12,844,836     $ 9,815     $ (7,883,665 )   $ 4,970,986  
Change in unearned premiums
    (578,967 )     27,441       203,755       (347,771 )
Premiums earned
  $ 12,265,869     $ 37,256     $ (7,679,910 )   $ 4,623,215  
                                 
Three months ended March 31, 2012 (unaudited)
                         
Premiums written
  $ 11,235,725     $ 1,400     $ (6,856,962 )   $ 4,380,163  
Change in unearned premiums
    (972,141 )     1,579       562,934       (407,628 )
Premiums earned
  $ 10,263,584     $ 2,979     $ (6,294,028 )   $ 3,972,535  
 
Premium receipts in advance of the policy effective date are recorded as advance premiums. The balance of advance premiums as of March 31, 2013 (unaudited) and December 31, 2012 was approximately $767,000 and $611,000, respectively.
 
 
17


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”):

   
Three months ended
 
   
March 31,
 
   
2013
   
2012
 
   
(unaudited)
 
Balance at beginning of period
  $ 30,485,532     $ 18,480,717  
Less reinsurance recoverables
    (18,419,694 )     (10,001,060 )
Net balance, beginning of period
    12,065,838       8,479,657  
                 
Incurred related to:
               
Current year
    2,469,783       2,286,000  
Prior years
    (142 )     (7,486 )
Total incurred
    2,469,641       2,278,514  
                 
Paid related to:
               
Current year
    588,655       455,147  
Prior years
    1,365,361       1,194,688  
Total paid
    1,954,016       1,649,835  
 
               
Net balance at end of period
    12,581,463       9,108,336  
Add reinsurance recoverables
    15,728,423       10,824,673  
Balance at end of period
  $ 28,309,886     $ 19,933,009  
 
Incurred losses and LAE are net of reinsurance recoveries under reinsurance contracts of $5,055,495 and $2,688,652 for the three months ended March 31, 2013 and 2012, 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.

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.
 

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 annual, 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 reinsurance coverage of $2,650,000 with respect to losses of up to $2,900,000 per occurrence. See “Catastrophe Reinsurance” below for a discussion of the Company’s reinsurance coverage with respect to its Personal Lines business in the event of a catastrophe.

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 reinsurance coverage of $2,600,000 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.
 
 
19


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.

The Company received advance payments from catastrophe reinsurers related to Superstorm Sandy. As of March 31, 2013 and December 31, 2012, the balance of advance payments from catastrophe reinsurers which will be applied against unpaid losses when paid was $-0- and $7,358,391, respectively, and are included in “Advance payments from catastrophe reinsurers” in the Condensed Consolidated Balance Sheets.

Ceding Commission Revenue
 
The Company earns ceding commission revenue under its quota share reinsurance agreements based on: (i) a fixed provisional commission rate at which provisional ceding commissions are earned, and (ii) a sliding scale of commission rates and ultimate treaty year loss ratios on the policies reinsured under each of these agreements based upon which contingent ceding commissions are earned. The sliding scale includes minimum and maximum commission rates in relation to specified ultimate loss ratios. The commission rate and contingent ceding commissions earned increases when the estimated ultimate loss ratio decreases and, conversely, the commission rate and contingent ceding commissions earned decreases when the estimated ultimate loss ratio increases.
 
As of March 31, 2013, the Company’s estimated ultimate loss ratios are attributable to contracts for the July 1, 2012/June 30, 2013 treaty year (“2012/2013 Treaty”). As of March 31, 2013, the Company’s estimated ultimate loss ratios attributable to the 2012/2013 Treaty are greater than the contractual ultimate loss ratios at which the provisional ceding commissions are earned. Accordingly, for the three months ended March 31, 2013, the Company has recorded negative contingent ceding commissions earned with respect to the 2012/2013 Treaty.

As of March 31, 2012, the Company’s estimated ultimate loss ratios are attributable to contracts for the July 1, 2011/June 30, 2012 treaty year (“2011/2012 Treaty”). As of March 31, 2012, the Company’s estimated ultimate loss ratios attributable to contracts for the 2011/2012 Treaty are lower than the contractual ultimate loss ratios at which the provisional ceding commissions are earned. Accordingly, for the three months ended March 31, 2012, the Company has recorded contingent ceding commissions earned with respect to the 2011/2012 Treaty.

Ceding commissions earned consists of the following:
 
   
Three months ended
 
   
March 31,
 
   
2013
   
2012
 
   
(unaudited)
 
 Provisional ceding commissions earned
  $ 2,392,864     $ 1,984,983  
 Contingent ceding commissions earned
    (99,153 )     918,673  
    $ 2,293,711     $ 2,903,656  
 
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. As discussed above, as of March 31, 2013, the Company has recorded negative contingent ceding commissions earned with respect to the 2012/2013 Treaty, which results in ceding commissions payable to reinsurers. Contingent ceding commissions payable to reinsurers as of March 31, 2013 and December 31, 2012 was $897,344 and $807,415, respectively, and is included in “Reinsurance balances payable” in the Condensed Consolidated Balance Sheets.
 
 
Note 8 – Long-Term Debt
 
Long-term debt consists of:
 
   
March 31, 2013
   
December 31, 2012
 
         
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  
Bank line of credit
    -       -       -       450,000       450,000       -  
    $ 747,000     $ -     $ 747,000     $ 1,197,000     $ 450,000     $ 747,000  
 
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 each of the three months ended March 31, 2013 and 2012 was approximately $17,800.
 
Related party balances as of March 31, 2013 and December 31, 2012, 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  
Mr. Yedid and members of his family
    156,000  
A member of the family of Floyd Tupper, a director of KICO
    42,000  
Total related party transactions
  $ 378,000  
 
Interest expense on related party borrowings for each of the three months ended March 31, 2013 and 2012 was approximately $9,000.
 
 
Bank 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 (the “Credit Limit”). On January 25, 2013, the Credit Limit was increased to $600,000. 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. 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.
 
The line of credit is being used for general corporate purposes.
 
The weighted average interest rate on the amount outstanding as of March 31, 2013 was 3.75%. There are no other fees in connection with this credit line.
 
Note 9 – Stockholders’ Equity
 
Dividend Declared

Dividends declared and paid on Common Stock were $153,637 and $113,397 for the three months ended March 31, 2013 and 2012, respectively. The Company’s Board of Directors approved a quarterly dividend on May 14, 2013 of $.04 per share payable in cash on June 14, 2013 to stockholders of record as of May 31, 2013.

Stock Options

Pursuant to the Company’s 2005 Equity Participation Plan (the “2005 Plan”), which provides for the issuance of incentive stock options, non-statutory stock options and restricted stock, a maximum of 550,000 shares of Common Stock are permitted to be issued pursuant to options granted and restricted stock issued. 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 determines 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 three months ended March 31, 2013 and 2012 include share-based stock option compensation expense totaling approximately $9,000 and $20,000, respectively. Stock-based compensation expense related to stock options is net of estimated forfeitures of 21% for the three months ended March 31, 2013 and 2012. Such amounts have been included in the Condensed Consolidated Statements of Comprehensive Income within other operating expenses.

Stock option compensation expense in 2013 and 2012 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 three months ended March 31, 2013 and 2012.
 
 
22


A summary of option activity under the Company’s 2005 Plan for the three months ended March 31, 2013 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, 2013
    235,115     $ 2.58       2.24     $ 539,485  
                                 
Granted
    -     $ -       -     $ -  
Exercised
    -     $ -       -     $ -  
Forfeited
    -     $ -       -     $ -  
                                 
Outstanding at March 31, 2013
    235,115     $ 2.58       2.00     $ 734,631  
                                 
Vested and Exercisable at March 31, 2013
    212,615     $ 2.48       1.91     $ 683,931  
 
The aggregate intrinsic value of options outstanding and options exercisable at March 31, 2013 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 $5.70 closing price of the Company’s Common Stock on March 31, 2013.
 
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 (“Net Exercise”). No options were exercised during the three months ended March 31, 2013.

As of March 31, 2013, the fair value of unamortized compensation cost related to unvested stock option awards was approximately $18,000. Unamortized compensation cost as of March 31, 2013 is expected to be recognized over a remaining weighted-average vesting period of 1.94 years.

Note 10 – Income Taxes

Income taxes for the three months ended March 31, 2013 and 2012 were computed using the effective tax rate estimated to be applicable for the full fiscal year, which is subject to ongoing review and evaluation by management. 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 three months ended March 31, 2013 and 2012 was 37.0% and 34.0%, respectively.
 

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:
 
   
March 31,
   
December 31,
 
   
2013
   
2012
 
   
(unaudited)
       
Deferred tax asset:
           
Net operating loss carryovers (1)
  $ 266,800     $ 264,648  
Claims reserve discount
    326,944       313,544  
Unearned premium
    845,712       811,413  
Deferred ceding commission revenue
    1,673,567       1,658,190  
Other
    5,818       10,921  
Total deferred tax assets
    3,118,841       3,058,716  
                 
Deferred tax liability:
               
Investment in KICO (2)
    1,169,000       1,169,000  
Deferred acquisition costs
    1,887,944       1,893,759  
Intangibles
    1,042,450       1,082,886  
Depreciation and amortization
    154,821       152,576  
Reinsurance recoverable
    -       20,400  
Net unrealized appreciation of securities - available for sale
    678,928       527,376  
Total deferred tax liabilities
    4,933,143       4,845,997  
                 
Net deferred income tax liability
  $ (1,814,302 )   $ (1,787,281 )
 
(1)  
The deferred tax assets from net operating loss carryovers are as follows:
 
   
March 31,
   
December 31,
   
Type of NOL
 
2013
   
2012
 
Expiration
State only (A)
  $ 394,795     $ 380,810  
December 31, 2033
Valuation allowance
    (155,195 )     (146,762 )  
State only, net of valuation allowance
    239,600       234,048    
Amount subject to Annual Limitation, federal only (B)
    27,200       30,600  
December 31, 2019
Total deferred tax asset from net operating loss carryovers
  $ 266,800     $ 264,648    
 
(A) Kingstone generates operating losses for state purposes and has prior year net operating loss carryovers available. The state net operating loss carryover as of March 31, 2013 and December 31, 2012 was approximately and $4,757,000 and $4,588,000, respectively. 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 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 2027 and 2033.
 
(B) The Company has an NOL of $80,000 that 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.
 
(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 the stock of KICO is sold, or the assets of KICO are sold or KICO and the parent are merged.
 
In assessing the valuation of deferred tax assets, the Company considers whether it is more likely than not that some portion or all of the deferred tax assets will not be realized. The ultimate realization of deferred tax assets is dependent upon the generation of future taxable income during the periods in which those temporary differences become deductible. No valuation allowance against deferred tax assets has been established, except for NOL limitations, as the Company believes it is more likely than not the deferred tax assets will be realized based on the historical taxable income of KICO, or by offset to deferred tax liabilities.
 
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 the three months ended March 31, 2013 and 2012. If any had been recognized these would be reported in income tax expense.

Note 11 - 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 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.
 
The computation of diluted earnings per share excludes outstanding options in periods where the exercise of such options would be anti-dilutive. For the three months ended March 31, 2013 and 2012 there were 235,115 and 291,648 options, respectively, with an exercise price below the average market price of the Company’s Common Stock during the period.
 
The reconciliation of the weighted average number of shares of Common Stock used in the calculation of basic and diluted earnings per common share for the three months ended March 31, 2013 and 2012 follows:
 
 
25

 
   
Three months ended
 
   
March 31,
 
   
2013
   
2012
 
             
Weighted average number of shares outstanding
    3,840,899       3,771,109  
Effect of dilutive securities, common share equivalents
    73,507       -  
                 
Weighted average number of shares outstanding,
               
used for computing diluted earnings per share
    3,914,406       3,771,109  
 
Note 12 - Commitments and Contingencies

Litigation

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.

State Insurance Regulation

In the aftermath of Superstorm Sandy, the New York State Department of Financial Services has adopted various regulations that affect insurance companies that operate in the state of New York. Included among the regulations are accelerated claims investigation and settlement requirements and mandatory participation in non-binding mediation proceedings funded by the insurer. Further, in February 2013, the state of New York announced that the Department of Financial Services has commenced an investigation into the claims practices of three insurance companies, including KICO, in connection with Superstorm Sandy claims. The Department of Financial Services stated that the three insurers had a much larger than average consumer complaint rate with regard to Superstorm Sandy claims and indicated that the three insurers were being investigated for (i) failure to send adjusters in a timely manner; (ii) failure to process claims in a timely manner; and (iii) inability of homeowners to contact insurance company representatives. KICO has received a letter from the Department of Financial Services seeking information and data with regard to the foregoing. KICO is cooperating with the Department of Financial Services in connection with its investigation and believes that such matter will not have a material adverse effect on the Company’s financial position or results of operations.
 
Note 13 – Subsequent Event
 
Dividends Declared and Paid

On May 14, 2013, the Company’s board of directors approved a dividend of $.04 per share, or $153,637, payable in cash on June 14, 2013 to stockholders of record as of May 31, 2013.
 
 
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.
 
Key Measures
 
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.
 
Critical Accounting Policies and Estimates