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Note 21 - Fair Value of Financial Instruments
 9 Months Ended
Sep. 30, 2024
Notes to Financial Statements  
Fair Value Disclosures [Text Block]

NOTE 21 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 investment, 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 and asset-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 investment, at fair value - Limited liability investment, at fair value, include the underlying investments of Argo Holdings. 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 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 10, "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. On February 29, 2024, the interest rate swap matured and the Company did not enter into any additional interest rate swap agreement upon its expiration. The interest rate swap contract was measured and reported at fair value and is included in other receivables in the consolidated balance sheet at  December 31, 2023. The fair value of the interest rate swap contract was estimated using inputs which the Company obtained from the counterparty and was determined using a discounted cash flow analysis on the expected cash flows of the derivative.  The discounted cash flow valuation technique reflected the contractual term of the derivative contract, including the period to maturity, and used 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 10, "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. 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.

 

 

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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 September 30, 2024 and December 31, 2023 was $3.4 million and $3.1 million, respectively.

 

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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 September 30, 2024 and December 31, 2023 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 September 30, 2024 and December 31, 2023 are as follows. 

 

(in thousands)

 

September 30, 2024

 
  

Fair Value Measurements at the End of the Reporting Period Using

 
                 
      

Quoted Prices in

  

Significant

  

Significant

 
      

Active Markets for

  

Other Observable

  

Unobservable

 
      

Identical Assets

  

Inputs

  

Inputs

 
  

Total

  

(Level 1)

  

(Level 2)

  

(Level 3)

 

Recurring fair value measurements:

                
                 

Assets:

                

Fixed maturities:

                

U.S. government, government agencies and authorities

 $12,767  $—  $12,767  $— 

States, municipalities and political subdivisions

  2,790   —   2,790   — 

Mortgage-backed

  9,747   —   9,747   — 

Asset-backed

  1,314   —   1,314   — 

Corporate

  10,238   —   10,238   — 

Total fixed maturities

  36,856   —   36,856   — 

Limited liability investment, at fair value

  2,691   —   —   2,691 

Total assets

 $39,547  $—  $36,856  $2,691 
                 

Liabilities:

                

Subordinated debt

 $13,681  $—  $13,681  $— 

Contingent consideration

  3,375   —   —   3,375 

Total liabilities

 $17,056  $—  $13,681  $3,375 

 

(in thousands)

 

December 31, 2023

 
  

Fair Value Measurements at the End of the Reporting Period Using

 
                 
      

Quoted Prices in

  

Significant

  

Significant

 
      

Active Markets for

  

Other Observable

  

Unobservable

 
      

Identical Assets

  

Inputs

  

Inputs

 
  

Total

  

(Level 1)

  

(Level 2)

  

(Level 3)

 

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 investment, at fair value

  3,496   —   —   3,496 

Derivative contract - interest rate swap

  49   —   49   — 

Total assets

 $40,097  $79  $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 

 

The following table provides a reconciliation of the fair value of recurring Level 3 fair value measurements for the three and nine months ended September 30, 2024 and September 30, 2023:

 

(in thousands)

 

Three months ended September 30,

  

Nine months ended September 30,

 
  

2024

  

2023

  

2024

  

2023

 

Assets:

                

Limited liability investments, at fair value:

                

Beginning balance

 $2,908  $3,688  $3,496  $3,196 

Contributions

  —   —   —   35 

Distributions received

  (1,186)  (600)  (2,238)  (802)

Realized gains included in net (loss) income

  874   191   1,260   407 

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

  95   320   173   763 

Ending balance

 $2,691  $3,599  $2,691  $3,599 

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

                

Included in net (loss) income

 $95  $320  $173  $763 

Included in other comprehensive income (loss)

 $—  $—  $—  $— 

Derivative - trust preferred debt repurchase options:

                

Beginning balance

 $—  $—  $—  $19,034 

Exercise of options included in net (loss) income

  —   —   —   (17,668)

Change in fair value of derivative assets included in net (loss) income

  —   —   —   (1,366)

Ending balance

 $—  $—  $—  $— 

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

                

Included in net (loss) income

 $—  $—  $—  $(1,366)

Included in other comprehensive income (loss)

  —   —   —   — 

Ending balance - assets

 $2,691  $3,599  $2,691  $3,599 

Liabilities:

                

Contingent consideration:

                

Beginning balance

 $3,375  $3,283  $3,105  $3,218 

Change in fair value of contingent consideration included in net (loss) income

  —   —   270   65 

Ending balance

 $3,375  $3,283  $3,375  $3,283 

Unrealized gains recognized on contingent consideration liability held at end of period:

                

Included in net (loss) income

 $—  $—  $270  $65 

Included in other comprehensive income (loss)

 $—  $—  $—  $— 

Ending balance - liabilities

 $3,375  $3,283  $3,375  $3,283 

 

The following table summarizes the valuation techniques and significant unobservable inputs utilized in determining fair values for the Company's financial assets and liabilities that are categorized as Level 3 at September 30, 2024:

 

  

Fair Value

      

Categories

  (in thousands) 

Valuation Techniques

Unobservable Inputs

  Input Value(s) 

Limited liability investment, at fair value

 $2,691 

Market approach

Valuation multiples

 

1.0x - 9.0x

 

Contingent consideration

 $3,375 

Option-based income approach

Discount rate

  8.25%
      

Risk-free rate

 4.96%
      

Expected volatility

 9.00%

 

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

 

  

Fair Value

       

Categories

  (in thousands) 

Valuation Techniques

Unobservable Inputs

  Input Value(s) 

Limited liability investment, 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%

 

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 three and nine months ended September 30, 2024, the Company did not record any adjustments to the fair value of its investments in private companies for observable price changes.  For the three and nine months ended September 30, 2023, the Company recorded  adjustments to increase the fair value of certain investments in private companies for observable price changes of $0.1 million, which are included in net change in unrealized gain on private company investments in the unaudited consolidated statements of operations.  The Company did not record any impairments related to investments in private companies for the three and nine months ended September 30, 2024 and September 30, 2023. 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.

 

Indefinite-lived intangible assets are recorded at carrying value, and, if impaired, are adjusted to fair value using Level 3 inputs.  Refer to Note 8, "Intangible Assets" for further information regarding the process of determining the fair value of indefinite-lived intangible assets and the impairment charges recorded for the three and nine months ended September 30, 2024.

 

As further discussed in Note 5, "Acquisitions and Discontinued Operations," the Company acquired Image Solutions on September 26, 2024 and provisionally allocated the purchase price to the assets acquired and liabilities assumed. The fair values of intangible assets associated with the acquisition of Image Solutions 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:

 

  

Fair Value

       

Categories

 

(in thousands)

 

Valuation Techniques

Unobservable Inputs

 

Input Value(s)

 

Customer relationships

 $11,100 

Multi-period excess earnings

Growth rate

  3.0%
      

Attrition rate

  2.0%
      

Discount rate

  25.0%

Trade name

 $1,500 

Relief from royalty

Royalty rate

  2.0%
      

Discount rate

  25.0%