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Note 23 - Fair Value of Financial Instruments
 12 Months Ended
Dec. 31, 2023
Notes to Financial Statements  
Fair Value Disclosures [Text Block]

NOTE 23 FAIR VALUE OF FINANCIAL INSTRUMENTS

 

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

 

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

 

 

•

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

 

•

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

 

•

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

 

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

 

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

 

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

 

 

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

 

 

•

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

 

•

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

 

•

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

 

•

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

 

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

 

Limited liability investments, at fair value - Limited liability investments, at fair value include the underlying investments of Net Lease and Argo Holdings. Prior to the second quarter of 2023, Net Lease owned investments in limited liability companies that held investment properties. Net Lease sold its final investment property during its first quarter of 2023, and as a result, the Net Lease's investment in its underlying investments is zero at December 31, 2023.  Argo Holdings makes investments in limited liability companies and limited partnerships that hold investments in search funds and private operating companies.

 

 

•

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

 

•

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

 

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

 

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

 

Derivative contracts - trust preferred debt repurchase options - As described in Note 11, "Derivatives," the Company entered into three TruPs Options contracts during the third quarter of 2022. During the first quarter of 2023, the Company executed the TruPs Options contracts.  The TruPs Options contracts were measured and reported at fair value and are included in other assets in the consolidated balance sheet at  December 31, 2022. The fair value of the TruPs Options contracts was estimated using the binomial lattice model.  Key inputs in the valuation included credit spread assumptions, interest rate volatility, debt coupon interest rate and time to maturity.  The TruPs Options contracts are categorized in Level 3 of the fair value hierarchy. 

 

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

 

 

•

The fair value of Ravix's contingent consideration liability is estimated by applying the Monte Carlo simulation method to forecast achievement of gross profit which  may result in up to $4.5 million in total payments to the former owners of Ravix through October 2024.  Key inputs in the valuation include forecasted gross profit, gross profit volatility, discount rate and discount term.  The estimated fair value of the Ravix contingent consideration liability at December 31, 2023 and December 31, 2022 was $3.1 million and $3.2 million, respectively.

 

 

 •The fair value of CSuite's contingent consideration liability is estimated by applying the Monte Carlo simulation method to forecast achievement of gross revenue which  may result in up to $3.6 million in total payments to the former owners of CSuite through November 2025.  Key inputs in the valuation include forecasted gross revenue, gross revenue volatility, discount rate and discount term.  The estimated fair value of the CSuite contingent consideration liability at December 31, 2023 and December 31, 2022 was zero.

 

Assets and Liabilities Measured at Fair Value on a Recurring Basis

 

The balances of the Company's financial assets and liabilities measured at fair value on a recurring basis by level within the fair value hierarchy as of December 31, 2023 and December 31, 2022 are as follows. Certain investments in limited liability companies that are measured at fair value using the net asset value practical expedient are not required to be classified using the fair value hierarchy, but are presented in the following tables to permit reconciliation of the fair value hierarchy to the amounts presented in the consolidated balance sheets:

 

(in thousands)

         

December 31, 2023

 
  

Fair Value Measurements at the End of the Reporting Period Using

 
                     
      

Quoted

             
      

Prices in

             
      

Active

  

Significant

         
      

Markets for

  

Other

  

Significant

     
      

Identical

  

Observable

  

Unobservable

  

Measured at

 
      

Assets

  

Inputs

  

Inputs

  

Net Asset

 
  

Total

  

(Level 1)

  

(Level 2)

  

(Level 3)

  

Value

 

Recurring fair value measurements

                    
                     

Assets:

                    

Fixed maturities:

                    

U.S. government, government agencies and authorities

 $12,997  $—  $12,997  $—  $— 

States, municipalities and political subdivisions

  2,783   —   2,783   —   — 

Mortgage-backed

  9,253   —   9,253   —   — 

Asset-backed

  1,210   —   1,210   —   — 

Corporate

  10,230   —   10,230   —   — 

Total fixed maturities

  36,473   —   36,473   —   — 

Equity investments

  79   79   —   —   — 

Limited liability investments, at fair value

  3,496   —   —   3,496   — 

Derivative contract - interest rate swap

  49   —   49   —   — 

Total assets

 $40,018  $—  $36,522  $3,496  $— 
                     

Liabilities:

                    

Subordinated debt

 $13,594  $—  $13,594  $—  $— 

Contingent consideration

  3,105   —   —   3,105   — 

Total liabilities

 $16,699  $—  $13,594  $3,105  $— 

 

 

(in thousands)

         

December 31, 2022

 
  Fair Value Measurements at the End of the Reporting Period Using 
                     
      

Quoted

             
      

Prices in

             
      

Active

  

Significant

         
      

Markets for

  

Other

  

Significant

     
      

Identical

  

Observable

  

Unobservable

  

Measured

 
      

Assets

  

Inputs

  

Inputs

  

at Net

 
  

Total

  

(Level 1)

  

(Level 2)

  

(Level 3)

  

Asset Value

 

Recurring fair value measurements

                    
                     

Assets:

                    

Fixed maturities:

                    

U.S. government, government agencies and authorities

 $15,080  $—  $15,080  $—  $— 

States, municipalities and political subdivisions

  2,232   —   2,232   —   — 

Mortgage-backed

  8,412   —   8,412   —   — 

Asset-backed

  1,610   —   1,610   —   — 

Corporate

  10,257   —   10,257   —   — 

Total fixed maturities

  37,591   —   37,591   —   — 

Equity investments

  153   153   —   —   — 

Limited liability investments, at fair value

  17,059   —   —   3,196   13,863 

Derivative contract - interest rate swap

  326   —   326   —   — 

Derivative contract - trust preferred debt repurchase options

  19,034   —   —   19,034   — 

Total assets

 $74,010  $—  $37,917  $22,230  $13,863 
                     

Liabilities:

                    

Subordinated debt

 $67,811  $—  $67,811  $—  $— 

Contingent consideration

  3,218   —   —   3,218   — 

Total liabilities

  71,029   —   67,811   3,218   — 

 

 

The following table provides a reconciliation of the fair value of recurring Level 3 fair value measurements for the years ended December 31, 2023 and December 31, 2022:

 

(in thousands)

 

Years ended December 31,

 
  

2023

  

2022

 

Assets:

        

Limited liability investments, at fair value:

        

Beginning balance

 $3,196  $4,022 

Contributions

  47   — 

Distributions received

  (876)  (621)

Realized gains included in net income

  481   607 

Change in fair value of limited liability investments, at fair value included in net income

  648   (812)

Ending balance

 $3,496  $3,196 

Unrealized gains (losses) on limited liability investments, at fair value held at end of period:

        

Included in net income

 $648  $(812)

Included in other comprehensive loss

 $—  $— 

Derivative - trust preferred debt repurchase options:

        

Beginning balance

 $19,034  $— 

Purchase of options

  —   2,304 

Initial valuation of options included in net income

  —   11,412 

Exercise of options included in net (loss) income

  (17,668)  — 

Change in fair value of derivative assets included in net income

  (1,366)  5,318 

Ending balance

 $—  $19,034 

Unrealized gains recognized on derivative assets held at end of period:

        

Included in net income

 $—  $16,730 

Included in other comprehensive loss

  —   — 

Ending balance - assets

 $3,496  $22,230 

Liabilities:

        

Contingent consideration:

        

Beginning balance

 $3,218  $2,458 

Settlements of contingent consideration liabilities

  (375)  (750)

Change in fair value of contingent consideration included in net income

  262   1,510 

Ending balance

 $3,105  $3,218 

Unrealized losses recognized on contingent consideration liabilities held at end of period:

        

Included in net income

 $262  $1,510 

Included in other comprehensive loss

 $—  $— 

Ending balance - liabilities

 $3,105  $3,218 

 

The following table summarizes the valuation techniques and significant unobservable inputs utilized in determining fair values for the Company's investments that are categorized as Level 3 at December 31, 2023:

 

Categories

 

Fair Value

 

Valuation Techniques

Unobservable Inputs

 

Input Value(s)

 

Limited liability investments, at fair value

 $3,496 

Market approach

Valuation multiples

 

1.0x - 9.0x

 

Contingent consideration

 $3,105 

Option-based income approach

Discount rate

  8.25%
      

Risk-free rate

 4.96%
      

Expected volatility

 9.0%

 

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

 

Categories

 

Fair Value

 

Valuation Techniques

Unobservable Inputs

 

Input Value(s)

 

Limited liability investments, at fair value

 $3,196 

Market approach

Valuation multiples

 

1.0x - 9.0x

 

Derivative - trust preferred debt repurchase options

 $19,034 

Binomial lattice option approach

Credit spread

  8.95%
      

Interest rate volatility

 2.3%
      

Debt coupon interest rate

 8.72%-8.87% 
      

Time to maturity (in years)

 10.4 - 10.59 

Contingent consideration

 $3,218 

Option-based income approach

Discount rate

  8.25%
      

Risk-free rate

 4.44%
      

Expected volatility

 13.0%

 

 

Investments Measured Using the Net Asset Value per Share Practical Expedient

 

The following table summarizes investments for which fair value is measured using the net asset value per share practical expedient at December 31, 2023:

 

  

Fair Value

          

Redemption

 

Category

 

(in thousands)

  

Unfunded Commitments

  

Redemption Frequency

  

Notice Period

 

Limited liability investments, at fair value

 $—   n/a   n/a   n/a 

 

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

 

  

Fair Value

          

Redemption

 

Category

 

(in thousands)

  

Unfunded Commitments

  

Redemption Frequency

  

Notice Period

 

Limited liability investments, at fair value

 $13,863   n/a   n/a   n/a 

 

Assets and Liabilities Measured at Fair Value on a Nonrecurring Basis

 

Certain assets and liabilities are measured at fair value on a nonrecurring basis, including assets that are adjusted for observable price changes or written down to fair value as a result of an impairment. For the years ended December 31, 2023 and December 31, 2022, the Company recorded adjustments to increase the fair value of certain investments in private companies for observable price changes of $0.1 million and zero, respectively, which are included in net change in unrealized gain on private company investments in the consolidated statements of operations. The Company did not record any impairments related to investments in private companies for the years ended December 31, 2023 and December 31, 2022. To determine the fair value of investments in these private companies, the Company considered rounds of financing and third-party transactions, discounted cash flow analyses and market-based information, including comparable transactions, trading multiples and changes in market outlook, among other factors. The Company has classified the fair value measurements of these investments in private companies as Level 3 because they involve significant unobservable inputs.

 

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

 

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

 

Categories

 

Fair Value

 

Valuation Techniques

Unobservable Inputs

 

Input Value(s)

 

Customer relationships

 $2,500 

Multi-period excess earnings

Growth rate

  3.0%
      

Attrition rate

  25.0%
      

Discount rate

  16.5%

Trade name

 $1,500 

Relief from royalty

Royalty rate

  2.5%
      

Discount rate

  15.5%

 

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

 

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

 

Categories

 

Fair Value

 

Valuation Techniques

Unobservable Inputs

 

Input Value(s)

 

Customer relationships

 $3,600 

Multi-period excess earnings

Growth rate

  3.0%
      

Attrition rate

  10.0%
      

Discount rate

  21.0%

Trade name

 $3,100 

Relief from royalty

Royalty rate

  3.0%
      

Discount rate

  21.0%

 

As further discussed in Note 4, "Acquisitions," the Company acquired SPI on September 7, 2023 and provisionally allocated the purchase price to the assets acquired and liabilities assumed. The fair values of intangible assets associated with the acquisition of SPI were determined to be Level 3 under the fair value hierarchy.

 

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

 

Categories  

Fair Value

 Valuation TechniquesUnobservable Inputs  Input Value(s) 

Customer relationships

  

$ 1,000

 

Multi-period excess earnings

Growth rate

  

3.0%

 
      

Attrition rate

  

5.0%

 
      

Discount rate

  

21.5%

 

Developed technology

  

$ 600

 

Relief from royalty

Royalty rate

  

5.0%

 
      

Discount rate

  

19.5%

 

Trade name

  

$ 120

 

Relief from royalty

Royalty rate

  

0.8%

 
      

Discount rate

  

19.5%

 

 

 

As further discussed in Note 4, "Acquisitions," the Company acquired DDI on October 26, 2023 and provisionally allocated the purchase price to the assets acquired and liabilities assumed. The fair values of intangible assets associated with the acquisition of DDI were determined to be Level 3 under the fair value hierarchy.

 

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

 

Categories

 

Fair Value

 

Valuation Techniques

Unobservable Inputs

 

Input Value(s)

 

Customer relationships

 $6,500 

Multi-period excess earnings

Growth rate

  3.0%
      

Attrition rate

  5.0%
      

Discount rate

  27.0%

Trade name

 $260 

Relief from royalty

Royalty rate

  1.0%
      

Discount rate

  25.0%