Hagerty, Inc.: Form 10-Q for the period ended Sep 30, 2023

The following Management's Discussion and Analysis of Financial Condition and Results of Operations ("MD&A") is intended to help the reader understand our results of operations and financial condition. MD&A is provided as a supplement to, and should be read in conjunction with, our Annual Report on Form 10-K for the year ended December 31, 2022 and our Condensed Consolidated Financial Statements and related Notes included in Item 1 of Part I of this Quarterly Report on Form 10-Q.

MD&A contains forward-looking statements based on our current expectations that involve risks, uncertainties, and assumptions. Our actual results and timing of selected events may differ materially from those anticipated in these forward-looking statements as a result of many factors, including those discussed within Part I, Item 1A. "Risk Factors" of our Annual Report on Form 10-K for the year ended December 31, 2022. Please also refer to the section included in this Quarterly Report on Form 10-Q entitled "Cautionary Note Regarding Forward-Looking Statements".

Overview

Hagerty is a global market leader in providing insurance for classic cars and enthusiast vehicles. We consistently earn strong net promoter scores by providing auto enthusiasts superior insurance coverage with excellent customer service and lower prices than traditional carriers. We have also leveraged our trusted insurance brand to build a leading automotive lifestyle brand. We provide an automotive enthusiast platform that protects, engages, entertains and connects with our Members and other car enthusiasts. Hagerty also offers Marketplace, which earns fee-based revenue from the sale of collector cars through live auctions, time-based online auctions, and brokered private sales, as well as finance revenue from term loans secured by collector cars. Our goal is to save driving and car culture for future generations.

In August 2022, the Company acquired the Broad Arrow Group, Inc. and its consolidated subsidiaries ("Broad Arrow") (the "Broad Arrow Acquisition"). As a result of the Broad Arrow Acquisition, the Company and Broad Arrow are further leveraging their respective product offerings and continue to build Marketplace.

Business Review

Management is conducting a review of certain components of the Company's operations which has resulted and may result in the sale and/or reorganization of certain of its businesses, including Hagerty Garage + Social and DriveShare, as discussed below. This initiative supports the Company's strategy to prioritize investments and resources in the areas of its business that offer the strongest growth and profit potential. As a result of this review, the Company recognized $4.1 million of losses and impairments in the third quarter of 2023 related to actions taken with respect to Hagerty Garage + Social and DriveShare. The Company may incur additional losses and/or impairment charges in future periods as a result of actions taken related to this review.

Hagerty Garage + Social

On September 29, 2023, Hagerty Ventures LLC ("HV"), a wholly owned subsidiary of The Hagerty Group, entered into an agreement with HGS Hub Holdings LLC ("H3") to terminate the joint venture agreement governing Member Hubs Holding, LLC ("MHH"), which operates as Hagerty Garage + Social. In connection with this agreement, H3's 20% equity interest in MHH was redeemed and MHH's equity interests in the Palm Beach, Florida and Redmond, Washington locations of Hagerty Garage + Social were distributed to H3. Following the termination of the joint venture agreement, HV now owns 100% of MHH and its remaining Hagerty Garage + Social locations in Delray Beach, Florida; Miami, Florida; Van Nuys, California; and Burlington, Ontario.

As a result of the joint venture termination, the Company recognized a loss of $2.9 million in the third quarter of 2023, as well as a $0.6 million loss related to the termination of the real estate lease held by the Culver City, California location of Hagerty Garage + Social. Following this lease termination, MHH no longer operates a Hagerty Garage + Social location in Culver City, California. Refer to Note 7 — Losses and Impairments Related to Divestitures in Item 1 of Part I of this Quarterly Report on Form 10-Q for additional information.

Hagerty DriveShare

In the third quarter of 2023, The Hagerty Group entered into an agreement to sell Hagerty DriveShare, LLC ("DriveShare"), a peer-to-peer rental platform for collector vehicles, to a third party. The sale was completed on October, 9, 2023. As a result of the anticipated completion of this sale, the Company recognized a $0.4 million loss in the third quarter of 2023 to write-down the carrying value of its investment in DriveShare. Refer to Note 7 — Losses and Impairments Related to Divestitures in Item 1 of Part I of this Quarterly Report on Form 10-Q for additional information.

Key Performance Indicators

The tables below present a summary of our Key Performance Indicators, including important operational metrics, as well as certain GAAP and non-GAAP financial measures as of and for the periods presented. We use these Key Performance Indicators to evaluate our business, measure our performance, identify trends against planned initiatives, prepare financial projections, and make strategic decisions. We believe these Key Performance Indicators are useful in evaluating our performance when read together with our Condensed Consolidated Financial Statements prepared in accordance with GAAP.

(1) Total Written Premium is the total amount of insurance premium written by our MGA affiliates on policies that were bound by our insurance carrier partners during the period. We view Total Written Premium as an important metric as it most closely correlates with our growth in insurance commission revenue and Hagerty Re earned premium. Total Written Premium reflects the actual business volume and direct economic benefit generated from our policy acquisition efforts.

(2) Loss Ratio, expressed as a percentage, is the ratio of (i) losses and loss adjustment expenses incurred to (ii) earned premium in Hagerty Re. We view Loss Ratio as an important metric because it is a powerful benchmark for profitability. This benchmark allows us to evaluate our historical loss patterns including incurred losses and make necessary and appropriate adjustments. The improvement compared to 2022 was due, in part, to better underwriting results in the current year. In addition, prior year results include $10.0 million of catastrophe losses related to Hurricane Ian.

(3) New Business Count represents the number of new insurance policies issued by our MGA affiliates during the applicable period. We view New Business Count as an important metric to assess our financial performance because it is critical to achieving our growth objectives. While Hagerty benefits from strong renewal retention, new business policies more than offset those cancelled or non-renewed at expiration. Often new policies mean new relationships and an opportunity to sell additional products and services.

(4) Refer to "Non-GAAP Financial Measures" below for a description of this non-GAAP financial measure and a reconciliation to the most comparable GAAP amount.

(5) Policies in Force ("PIF") are the number of current and active insurance policies as of the applicable period end date. We view PIF as an important metric to assess our financial performance because policy growth drives our revenue growth, increases brand awareness and market penetration, generates additional insight to improve the performance of our platform, and provides key data to assist us in strategic decision making.

(6) PIF Retention is the percentage of expiring policies that are renewed on the renewal effective date, calculated on a rolling twelve months basis. We view PIF Retention as an important measurement of the number of policies retained each year, which contributes to recurring revenue streams from MGA commissions, membership fees, and earned premiums. It also contributes to maintaining our NPS, as discussed below.

(7) Vehicles in Force are the number of current insured vehicles as of the applicable period end date. We view Vehicles in Force as an important metric to assess our financial performance because insured vehicle growth drives our revenue growth and increases market penetration. Vehicles in Force generates additional insight to support Marketplace and Hagerty Media, and provides key data to assist us in strategic decision making.

(8) HDC Paid Member Count is the number of current Members who pay an annual membership subscription as of the applicable period end date. We believe that HDC Paid Member Count is important because it helps us measure membership revenue growth and provides an opportunity to customize our value proposition and benefits to specific types of enthusiasts, both by demographic and vehicle interest.

(9) Hagerty uses Net Promoter Score ("NPS") as an important measure of the overall strength of our relationship with Members. NPS is measured twice annually through a web-based survey sent by email invitation to a random sample of existing Members, and is reported annually using an average of the two surveys. Often referred to as a barometer of brand loyalty and Member engagement, NPS is well-known in our industry as a strong indicator of growth and retention.

Components of Our Results of Operations

Revenue

We generate commission and fee-based revenue primarily from the sale of automotive insurance policies on behalf of our insurance carrier partners and reinsurance premium revenue from participating in the underwriting of these policies. To a lesser extent, we also generate fee-based revenue from HDC membership subscriptions, our Marketplace services and our media and entertainment activities. Our revenue model incorporates multiple touchpoints in the insurance and lifestyle value chains, built on data collection and Member experience.

Commission and fee revenue

Certain of our insurance affiliated subsidiaries act as MGAs who, among other things, write collector car, enthusiast vehicle, and marine policies on behalf of our insurance carrier partners in exchange for commissions. Commissions are earned for new and renewed policies. Additionally, policyholders pay fees directly to us related to their insurance coverage. Commission and fee revenue is earned when the policy becomes effective, net of allowances for policy changes and cancellations, as our performance obligation is complete when the policy is issued.

Under the terms of many of our contracts with insurance carriers, we have the opportunity to earn an annual contingent underwriting commission ("CUC"), or profit-share, based on the calendar-year performance of the insurance book of business. Our CUC agreements are based on written or earned premium and loss ratio results. Each insurance carrier partner contract and related CUC is calculated independently. Revenue from CUC is accrued throughout the year and settled annually in the first quarter of the following year.

Earned premium

Reinsurance premiums are earned by Hagerty Re, which reinsures collector car, enthusiast vehicle, and marine risks written through our affiliated MGAs in the United States ("U.S."), Canada, and the United Kingdom ("U.K."). Hagerty Re is a Bermuda-domiciled, Class 3A reinsurer.

Earned premium represents the earned portion of written premiums that Hagerty Re has assumed under quota share reinsurance agreements with our insurance carrier partners, net of premiums ceded to third-party reinsurers and the cost of catastrophe reinsurance coverage. Premiums assumed and ceded are earned on a pro-rata basis over the term of the related policies, which is generally 12 months. The cost of catastrophe reinsurance coverage is recognized over the contract period in proportion to the related earned premium.

Membership, marketplace and other revenue

We earn subscription revenue through bundled HDC membership offerings, which include access to products and services such as Hagerty Drivers Club Magazine, automotive enthusiast events, our proprietary vehicle valuation tool, emergency roadside assistance, and special vehicle-related discounts. We also earn fee-based revenue from Hagerty Garage + Social memberships, which include storage services in addition to the HDC Member benefits. Revenue from the sale of HDC and storage memberships is recognized ratably over the period of the membership. The membership is treated as a single performance obligation to provide access to stated Member benefits over the life of the membership, which is currently one year.

Marketplace earns fee-based revenue from the sale of collector cars through live auctions, time-based online auctions, and brokered private sales, as well as finance revenue from term loans secured by collector cars. Fee-based revenue earned by Marketplace is recognized when the underlying sale is completed. Finance revenue is recognized when earned based on the amount of the outstanding loan, the applicable interest rate on the loan, and the length of time the loan was outstanding during the period.

Other revenue includes sponsorship, admission, advertising, valuation and registration income. Other revenue is recognized when the performance obligation for the related product or service is satisfied.

Operating Expenses

Our operating expenses typically consist of salaries and benefits, ceding commission, losses and loss adjustment expenses, sales expenses, general and administrative services, and depreciation and amortization.

Salaries and benefits

Salaries and benefits consist primarily of costs related to employee compensation, payroll taxes, employee benefits, and employee development costs. Employee compensation includes wages paid to employees, as well as various incentive compensation plans. Employee benefits include the costs of various employee benefit plans, including pension, medical, dental, and wellness plans. Costs related to employee education, training, and recruiting are included in employee development costs. Salaries and benefits costs are expensed as incurred except for those costs which are required to be capitalized, which are then amortized over the useful life of the software or digital media content asset created. Salaries and benefits are expected to increase over time as the business continues to grow but will likely decrease as a percent of revenue.

Ceding commission

Ceding commission consists of the commission paid by Hagerty Re for business assumed from insurance carrier partners for its pro-rata share of the carrier's costs including (i) policy acquisition costs, which primarily consists of the commissions earned by our MGA affiliates, (ii) general and administrative costs, and (iii) other costs. Commissions received by Hagerty Re related to ceded reinsurance premiums are recorded net within ceding commission. Ceding commission is recognized ratably over the term of the related policies, which is generally 12 months.

Losses and loss adjustment expenses

Losses and loss adjustment expenses represent management's best estimate of the share of losses assumed by Hagerty Re, including its share of the net cost to settle claims submitted by insureds. Losses consist of claims paid, case reserves and IBNR, net of estimated recoveries from reinsurance, salvage and subrogation. Loss adjustment expenses consist of the cost associated with the investigation and settling of claims. The estimates utilized in determining the amount of losses and loss adjustment expenses recorded in a period are based on statistical analysis performed by our internal and external actuarial team. Reserves are reviewed regularly and adjusted, as necessary, to reflect management’s estimate of the ultimate cost of settlement.

Sales expense

Sales expense includes costs related to the sale and servicing of insurance policies, as well as costs related to our Membership and Marketplace offerings, such as broker expense, cost of sales, promotion expense, and travel and entertainment expenses. Broker expense is the compensation paid to our agent partners and national broker partners when an insurance policy is written through a broker relationship. Broker expense generally tracks with written premium growth. Cost of sales includes postage, document costs, payment processing fees, emergency roadside service costs, and other variable costs associated with the sale and servicing of a policy. Cost of sales also includes costs associated with vehicles sold through Marketplace. Promotion expense includes various costs related to branding, events, advertising, marketing, and customer acquisition. Sales expenses, in general, are expensed as incurred and will trend with revenue growth.

General and administrative services

General and administrative services primarily consist expenses related to professional services, occupancy costs, and non-capitalized hardware and software. These costs are expensed as incurred. We expect this expense category to increase in dollar amount over time but will likely decrease as a percentage of revenue over the next few years after we reach scale to handle incoming business from new partnerships.

Depreciation and amortization

Depreciation and amortization reflects the recognition of the cost of our investments in various assets over their useful lives. Depreciation expense relates to leasehold improvements, furniture and equipment, vehicles, hardware, and purchased software. Amortization relates to investments associated with recent acquisitions, SaaS implementation, and internal software development, as well as investments made in and impairments of digital media content assets. Depreciation and amortization are expected to increase in dollar amount over time, but will likely decrease as a percent of revenue as investments in platform technology reach scale.

Other Items

Change in fair value of warrant liabilities

Our warrants are accounted for as liabilities in accordance with ASC Topic 815, Derivatives and Hedging, and are measured at fair value each reporting period, with changes in fair value recognized as non-operating income (expense) in our Condensed Consolidated Statements of Operations. In general, under the fair value accounting model, in periods when our stock price increases, the warrant liability increases, and we recognize additional expense. In periods when our stock price decreases, the warrant liability decreases, and we recognize additional income.

Interest and other income (expense)

Interest and other income (expense) primarily includes interest income related to our cash balances and interest expense related to outstanding borrowings, as well as changes in the value of the liability related to the Company's Tax Receivable Agreement ("TRA") with Hagerty Holding Corp. ("HHC") and Markel Group, Inc., f/k/a Markel Corporation ("Markel"). Refer to Note 20 — Taxation in Item 1 of Part I of this Quarterly Report on Form 10-Q for additional information related to the TRA.

Income tax expense

The Hagerty Group is taxed as a pass-through ownership structure under provisions of the IRC and a similar section of state income tax law, except certain U.S. corporate subsidiaries and foreign subsidiaries. Any taxable income or loss generated by The Hagerty Group is passed through to and included in the taxable income or loss of all holders of Hagerty Group Units, including Hagerty, Inc. Hagerty, Inc. is taxed as a corporation and pays corporate federal, state, and local taxes with respect to income allocated from The Hagerty Group.

Results of Operations

Three Months Ended September 30, 2023 compared to the Three Months Ended September 30, 2022

The following table summarizes our results of operations for the three months ended September 30, 2023 and 2022, and the dollar and percentage changes between the two periods:

Revenue

Commission and fee revenue

Commission and fee revenue was $103.2 million for the three months ended September 30, 2023, an increase of $17.7 million, or 20.7%, compared to 2022, consisting of increases of $15.3 million related to policy renewals and $2.4 million related to new policies.

The increase in revenue from policy renewals was primarily related to an increase of 16.3% in the underlying policy premiums, as well as continued strong policy retention. The increase in renewal policy premiums reflects sustained year-over-year growth in policies in force, as well as rate increases in several states due to inflation and higher vehicle repair costs, both of which contribute to higher premiums and, in turn, higher commission revenue.

The increase in revenue from new policies was driven by sustained year-over-year growth in New Business Count, as well as rate increases in several states. The average premium on newly issued policies increased 8.0% when compared to the prior year period as a result of writing policies with higher insured values at higher rates. Accordingly, premiums from new policies increased $4.0 million, or 9.6%, during the three months ended September 30, 2023. In turn, base commission revenue from newly issued policies grew by $1.3 million over the same period.

Commission and fee revenue from agent sources increased $10.3 million, or 22.4%, and Commission and fee revenue from direct sources increased $7.4 million, or 18.8%, during the three months ended September 30, 2023. Commission rates vary based on geography, but do not differ by distribution channel (i.e., whether they are direct-sourced or agent-sourced).

Earned premium

Earned premium was $139.8 million for the three months ended September 30, 2023, an increase of $32.3 million, or 30.0%, compared to 2022. The increase in earned premium generally correlates with the increase in assumed premium at Hagerty Re, which increased $42.1 million, or 30.9%, compared to 2022. This increase was due to Hagerty Re's U.S. quota share increasing from 70% in 2022 to approximately 80% in 2023, as well as consistent growth in the volume of subject premiums written through our affiliated MGAs in the U.S.

The following table presents the amount of premiums assumed by Hagerty Re and the related quota share percentages for the three months ended September 30, 2023 and 2022:

Membership, marketplace and other revenue

Membership, marketplace and other revenue was $32.6 million for the three months ended September 30, 2023, an increase of $8.8 million, or 37.0%, compared to 2022.

Membership fee revenue was $13.8 million for the three months ended September 30, 2023, an increase of $2.5 million, or 21.6%, compared to 2022, which was primarily attributable to an increase in new policies issued with a bundled HDC membership, as well as an increase in storage revenue related to Hagerty Garage + Social as a result of more locations generating revenue during the current period. For the three months ended September 30, 2023, membership fees were 42.4% of the Membership, marketplace and other revenue total. Refer to Note 7 — Losses and Impairments Related to Divestitures in Item 1 of Part I of this Quarterly Report on Form 10-Q for additional information related to Hagerty Garage + Social.

Marketplace revenue was $13.0 million for the three months ended September 30, 2023, an increase of $6.0 million, or 87.3%, compared to 2022, which was primarily attributable to the auction, private sale, and lending activities of Broad Arrow, which was acquired and consolidated into our results beginning in August 2022. For the three months ended September 30, 2023, Marketplace revenue was 39.8% of the Membership, marketplace and other revenue total.

Other revenue, which includes sponsorship, admission, advertising, valuation and registration income, totaled $5.8 million for the three months ended September 30, 2023, an increase of $0.3 million or 5.4% compared to 2022. For the three months ended September 30, 2023, Other revenue was 17.8% of the Membership, marketplace and other revenue total.

Operating Expenses

Salaries and benefits

Salaries and benefits were $51.3 million for the three months ended September 30, 2023, an increase of $1.2 million, or 2.4%, compared to 2022. When compared to the prior year period, additional employees were hired in member services and Marketplace to support our growth initiatives, including the addition of several new large national insurance partnerships and our continued development of new systems and digital transformation technology investments, as well as the acquisition of Broad Arrow in August 2022. These headcount additions were largely offset by headcount reductions associated with the voluntary retirement program and reductions in force implemented in the fourth quarter of 2022 and first quarter of 2023. Refer to Note 11 — Restructuring, Impairment and Related Charges in Item 1 of Part I of this Quarterly Report on Form 10-Q for information related to our restructuring plans.

Ceding commission

Ceding commission expense was $65.4 million for the three months ended September 30, 2023, an increase of $15.0 million, or 29.7%, compared to 2022. This increase is consistent with the 30.0% increase in Earned premium, as discussed above.

The following table summarizes the components of ceding commission expense for the three months ended September 30, 2023 and 2022:

Losses and loss adjustment expenses

Losses and loss adjustment expenses were $57.5 million for the three months ended September 30, 2023, a decrease of $3.1 million, or 5.1%, compared to 2022. This improvement was due, in part, to better underwriting results in the current year. In addition, prior year results include $10.0 million of catastrophe losses related to Hurricane Ian. The overall improvement in losses and loss adjustment expenses was partially offset by the effect of the 30.0% increase in Earned premium over the same period.

For the three months ended September 30, 2023, our loss ratio was 41.1%. For the three months ended September 30, 2022, our loss ratio was 56.4%, including the impact of the Hurricane Ian, and 47.1%, excluding the impact of Hurricane Ian.

Sales expense

Sales expense was $47.7 million for the three months ended September 30, 2023, an increase of $3.6 million, or 8.3%, compared to 2022. This increase was primarily due to a $4.9 million increase in cost of sales, driven by Broad Arrow vehicle sales. Broker expense also increased $2.4 million which is consistent with written premium growth within the agent channel. The overall increase in Sales expense was partially offset by a reduction in promotion and sales costs of $2.8 million.

General and administrative services

General and administrative services expense was $22.2 million for the three months ended September 30, 2023, a decrease of $1.7 million, or 7.1%, compared to 2022. This decrease was primarily driven by a $2.9 million decrease in professional services, as well as management's continued focus on expense management, partially offset by a $0.9 million increase in software subscription licenses.

Depreciation and amortization

Depreciation and amortization expense was $10.8 million for the three months ended September 30, 2023, an increase of $1.9 million, or 21.0%, compared to 2022. This increase was primarily attributable to a higher base of capital assets from our digital platform investments that resulted in increased depreciation and amortization of approximately $1.6 million.

Restructuring, impairment and related charges, net

During the three months ended September 30, 2023, the Company recognized $0.5 million of costs associated with its vacated office space within "Restructuring, impairment and related charges, net". Refer to Note 11 — Restructuring, Impairment and Related Charges in Item 1 of Part I of this Quarterly Report on Form 10-Q for additional information with respect to our restructuring initiatives.

Losses and impairments related to divestitures

During the three months ended September 30, 2023, the Company recognized $4.1 million of losses and impairments related to Hagerty Garage + Social and DriveShare, as discussed above under "Business Review". Refer to Note 7 — Losses and Impairments Related to Divestitures in Item 1 of Part I of this Quarterly Report on Form 10-Q for additional information.

Other Items

Change in fair value of warrant liabilities

During the three months ended September 30, 2023 and 2022, the change in the fair value of our warrant liabilities resulted in gains of $0.9 million and $11.6 million, respectively. Refer to Note 12 — Fair Value Measurements and Note 18 — Warrant Liabilities in Item 1 of Part I of this Quarterly Report on Form 10-Q for additional information with respect to our warrants.

Revaluation gain on previously held equity method investment

During the three months ended September 30, 2022, the Company recognized a revaluation gain on previously held equity method investments of $34.7 million, which represents the remeasurement of our 40% equity interest in Broad Arrow immediately prior to the Broad Arrow Acquisition in August 2022. The Company did not have a revaluation gain on previously held equity investments during the three months ended September 30, 2023. Refer to Note 6 — Acquisitions and Investments in Item 1 of Part I of this Quarterly Report on Form 10-Q for additional information with respect to our acquisition of Broad Arrow.

Interest and other income (expense)

Interest and other income (expense) was $6.3 million of income for the three months ended September 30, 2023, compared to $0.7 million of income for the three months ended September 30, 2022. This increase was primarily due to a $4.9 million increase in interest income on cash balances resulting from higher variable interest rates.

Income tax benefit (expense)

Income tax expense was $4.6 million for the three months ended September 30, 2023, an increase of $4.7 million compared to 2022. The increase in income tax expense for the three months ended September 30, 2023 compared to 2022 was primarily due to an increase in income before income tax expense of $24.4 million within Hagerty Re, which is taxed as a corporation in the U.S. Refer to Note 20 — Taxation in Item 1 of Part I of this Quarterly Report on Form 10-Q for additional information with respect to items affecting our effective tax rate.

Nine Months Ended September 30, 2023 compared to the Nine Months Ended September 30, 2022

The following table summarizes our results of operations for the nine months ended September 30, 2023 and 2022, and the dollar and percentage change between the two periods:

Revenue

Commission and fee revenue

Commission and fee revenue was $288.0 million for the nine months ended September 30, 2023, an increase of $44.5 million, or 18.3%, compared to 2022, consisting of increases of $37.9 million related to renewal policies and $6.6 million related to new policies.

The increase in revenue from renewal policies was primarily related to an increase of 17.2% in the underlying policy premiums, as well as continued strong policy retention. The increase in renewal policy premiums reflects sustained year-over-year growth in policies in force, as well as rate increases in several states due to inflation and higher vehicle repair costs, both of which contribute to higher premiums and, in turn, higher commission revenue.

The increase in revenue from new policies was driven by sustained year-over-year growth in New Business Count, as well as rate increases in several states. The average premium on a newly issued policy increased 6.3% when compared to the prior year period as a result of writing policies with higher insured values at higher rates. Accordingly, premiums from new policies increased $14.4 million, or 12.2%, during the nine months ended September 30, 2023. In turn, base commission revenue from newly issued policies grew by $4.5 million over the same period.

Commission and fee revenue from agent sources increased $26.0 million, or 19.9%, and Commission and fee revenue from direct sources increased $18.6 million, or 16.4%, during the nine months ended September 30, 2023. Commission rates vary based on geography, but do not differ by distribution channel (i.e., whether they are direct-sourced or agent-sourced).

Earned premium

Earned premium was $384.5 million for the nine months ended September 30, 2023, an increase of $93.8 million, or 32.3%, compared to 2022. The increase in earned premium generally correlates with the increase in assumed premium at Hagerty Re, which increased $125.5 million, or 33.6%, compared to 2022. This increase was due to Hagerty Re's U.S. quota share increasing from 70% in 2022 to approximately 80% in 2023, as well as consistent growth in the volume of subject premiums written through our affiliated MGAs in the U.S.

The following table presents the amount of premiums assumed by Hagerty Re and the related quota share percentages for the nine months ended September 30, 2023 and 2022:

Membership, marketplace and other revenue

Membership, marketplace and other revenue was $82.7 million for the nine months ended September 30, 2023, an increase of $26.3 million, or 46.5%, compared to 2022.

Membership fee revenue was $39.5 million for the nine months ended September 30, 2023, an increase of $6.7 million, or 20.4%, compared to 2022, which was primarily attributable to an increase in new policies issued with a bundled HDC membership, as well as an increase in storage revenue related to Hagerty Garage + Social during the current period. For the nine months ended September 30, 2023, membership fees were 47.8% of the Membership, marketplace and other revenue total. Refer to Note 7 — Losses and Impairments Related to Divestitures in Item 1 of Part I of this Quarterly Report on Form 10-Q for additional information related to Hagerty Garage + Social.

Marketplace revenue was $24.9 million for the nine months ended September 30, 2023, an increase of $16.8 million, or 210.1%, compared to 2022, which was primarily attributable to the auction, private sale, and lending activities of Broad Arrow, which was acquired and consolidated into our results beginning in August 2022. For the nine months ended September 30, 2023, Marketplace revenue was 30.1% of the Membership, marketplace and other revenue total.

Other revenue was $18.3 million for the nine months ended September 30, 2023, an increase of $2.7 million, or 17.4%, compared to 2022, primarily due to increased event sponsorship and admission revenue. Other revenue includes sponsorship, admission, advertising, valuation and registration income and was 22.1% of the Membership, marketplace and other revenue total for the nine months ended September 30, 2023.

Costs and Expenses

Salaries and benefits

Salaries and benefits were $160.1 million for the nine months ended September 30, 2023, an increase of $10.3 million, or 6.8%, compared to 2022. This increase was primarily attributable to a higher base of employees in the first quarter of 2023 as compared to the first quarter of 2022, due to headcount increases to support our growth initiatives, including the addition of several new large national insurance partnerships and our continued development of new systems and digital transformation technology investments, as well as the acquisition of Broad Arrow in August 2022. These headcount additions were partially offset by headcount reductions associated with the voluntary retirement program and reductions in force implemented in the fourth quarter of 2022 and first quarter of 2023. Refer to Note 11 — Restructuring, Impairment and Related Charges in Item 1 of Part I of this Quarterly Report on Form 10-Q for information related to our restructuring plans.

Ceding commission

Ceding commission expense was $181.2 million for the nine months ended September 30, 2023, an increase of $43.1 million, or 31.3%, compared to 2022. This increase is consistent with the 32.3% increase in Earned premium, as discussed above.

The following table summarizes the components of ceding commission expense for the nine months ended September 30, 2023 and 2022:

Losses and loss adjustment expenses

Losses and loss adjustment expenses were $159.5 million for the nine months ended September 30, 2023, an increase of $23.3 million, or 17.1%, compared to 2022. This improvement was due, in part, to better underwriting results in the current year. In addition, prior year results include $10.0 million of catastrophe losses related to Hurricane Ian. The overall improvement in losses and loss adjustment expenses was partially offset by the effect of the 32.3% increase in Earned premium over the same period.

For the nine months ended September 30, 2023, our loss ratio was 41.5%. For the nine months ended September 30, 2022, our loss ratio was 46.8%, including the impact of Hurricane Ian, and 43.4%, excluding the impact of Hurricane Ian.

Sales expense

Sales expense was $124.8 million for the nine months ended September 30, 2023, an increase of $14.8 million, or 13.5%, compared to 2022. This increase was driven by an $8.2 million increase in cost of sales, driven by Broad Arrow vehicles sales and higher roadside program costs. Broker expense and credit card processing fees also increased $7.2 million and $1.6 million, respectively, both of which is consistent with written premium growth across our agent distribution channel. The overall increase in Sales expense was partially offset by reductions in travel and entertainment and promotion and sales costs of $1.2 million and $1.0 million, respectively.

General and administrative services

General and administrative services expense was $64.9 million for the nine months ended September 30, 2023, an increase of $0.8 million, or 1.3%, compared to 2022. This increase was primarily driven by a $4.6 million increase in software subscription licenses and a $3.1 million increase in occupancy costs attributable Hagerty Garage + Social, partially offset by a $6.7 million decrease in professional services, as well as management's continued focus on expense management. Refer to Note 7 — Losses and Impairments Related to Divestitures in Item 1 of Part I of this Quarterly Report on Form 10-Q for additional information related to Hagerty Garage + Social.

Depreciation and amortization

Depreciation and amortization expense was $34.9 million for the nine months ended September 30, 2023, an increase of $10.6 million, or 43.4%, compared to 2022. This increase was due, in part, to $4.3 million of digital media content asset impairments as a result of lower than anticipated advertising and sponsorship revenue associated with these assets. Additionally, a higher base of capital assets related to our digital platform investments resulted in increased depreciation and amortization expense of approximately $4.8 million.

Restructuring, impairment and related charges, net

In the first quarter of 2023, the Board approved a reduction in force (the "2023 RIF") following a strategic review of business processes as the Company focuses on driving efficiencies in order to achieve growth and profitability goals. As a result of these actions (collectively, the "2023 Restructuring Actions"), in the first quarter of 2023, the Company recognized $5.5 million within "Restructuring, impairment and related charges, net" in the Condensed Consolidated Statements of Operations. These charges consist of $5.1 million of severance related costs associated with the 2023 RIF and a $0.4 million impairment charge to write-down the value of certain digital media content assets.

In the second quarter of 2023, the Company recognized $2.8 million of "Restructuring, impairment and related charges, net". These charges include $2.6 million of impairment and related charges associated with operating lease ROU assets and leasehold improvements for office space that was vacated and listed for sublease in the period as a result of the Company's continuing transition to a "remote first" work model. The amount recognized in the second quarter of 2023 also includes $0.2 million of additional severance related costs associated with the 2023 RIF. In the third quarter of 2023, the Company recognized $0.5 million of costs associated with its vacated office space within "Restructuring, impairment and related charges, net".

Refer to Note 11 — Restructuring, Impairment and Related Charges in Item 1 of Part I of this Quarterly Report on Form 10-Q for additional information with respect to our restructuring initiatives.

Losses and impairments related to divestitures

During the nine months ended September 30, 2023, the Company recognized $4.1 million of losses and impairments related to Hagerty Garage + Social and DriveShare, as discussed above under "Business Review". Refer to Note 7 — Losses and Impairments Related to Divestitures in Item 1 of Part I of this Quarterly Report on Form 10-Q for additional information.

Change in fair value of warrant liabilities

During the nine months ended September 30, 2023 and 2022, the change in the fair value of our warrant liabilities resulted in a loss of $1.4 million and a gain of $37.9 million, respectively. Refer to Note 12 — Fair Value Measurements and Note 18 — Warrant Liabilities in Item 1 of Part I of this Quarterly Report on Form 10-Q for additional information with respect to our warrants.

Revaluation gain on previously held equity method investment

During the nine months ended September 30, 2022, the Company recognized a revaluation gain on a previously held equity method investment of $34.7 million, which represents the remeasurement of our 40% equity interest in Broad Arrow immediately prior to the Broad Arrow Acquisition in August 2022. Refer to Note 6 — Acquisitions and Investments in Item 1 of Part I of this Quarterly Report on Form 10-Q for additional information with respect to our acquisition of Broad Arrow.

Interest and other income (expense)

Interest and other income (expense) was $15.7 million of income for the nine months ended September 30, 2023, compared to $0.4 million of expense for the nine months ended September 30, 2022. This increase was primarily due to a $15.1 million increase in interest income on cash balances, resulting from higher variable interest rates, and a decrease in the value of the TRA liability of $2.6 million. These factors were partially offset by an increase in interest expense of $1.5 million related to outstanding Credit Facility borrowings due to higher variable interest rates.

Income tax benefit (expense)

Income tax expense was $12.0 million for the nine months ended September 30, 2023, an increase of $7.9 million compared to 2022. The increase in income tax expense for the nine months ended September 30, 2023 compared to 2022 was primarily due to an increase in income before income tax expense of $39.6 million within Hagerty Re, which is taxed as a corporation in the U.S. Refer to Note 20 — Taxation in Item 1 of Part I of this Quarterly Report on Form 10-Q for additional information with respect to items affecting our effective tax rate.

Liquidity and Capital Resources

Maintaining a strong balance sheet and capital position is a top priority for us. We manage liquidity globally and across all operating subsidiaries.

Key Developments — Financing Activities

On June 23, 2023, we issued 8,483,561 shares of our newly-designated Series A Convertible Preferred Stock for an aggregate purchase price of $80.0 million. In addition, on September 19, 2023, Hagerty Re entered into an unsecured term loan credit facility with State Farm Mutual Automobile Insurance Company ("State Farm") in the aggregate principal amount of $25.0 million (the "State Farm Term Loan"). The State Farm Term Loan bears interest at a rate of 8.0% per annum with repayment of the principal amount due on September 19, 2033. Refer to Note 13 — Long-Term Debt and Note 15 — Convertible Preferred Stock in Item 1 of Part I of this Quarterly Report on Form 10-Q for additional information related to the State Farm Term Loan and the Series A Convertible Preferred Stock, respectively.

Sources and Uses of Liquidity

Our sources of liquidity include our: (i) cash on hand, including the proceeds from the Series A Convertible Preferred Stock and the State Farm Term Loan, as discussed above under "Key Developments — Financing Activities"; (ii) short-term investments; (iii) net working capital; (iv) cash flows from operations; and (v) borrowings from our Credit Facility (as defined below). Our primary liquidity needs and capital requirements include cash required for: (i) the funding of business operations, including continued investments in technology; (ii) the servicing and repayment of borrowings under the Credit Agreement (as defined below); (iii) the payment of income taxes; and (iv) the funding of potential payments under the TRA. Based on our current expectations, we believe that these sources of liquidity will be sufficient to provide an adequate level of capital to support our anticipated short and long-term commitments, operating needs, and capital requirements.

Capital and Dividend Restrictions

Through our reinsurance subsidiary, Hagerty Re, we reinsure the same personal lines risks that are underwritten by our affiliated MGA subsidiaries on behalf of our insurance carrier partners. Our reinsurance operations are funded primarily through existing capital and net cash flows from operations. In addition, as discussed above under "Key Developments — Financing Activities," on September 19, 2023, Hagerty Re bolstered its balance of Cash and cash equivalents with the $25.0 million in gross proceeds from the State Farm Term Loan. As of September 30, 2023, Hagerty Re had approximately $500.1 million in Cash and cash equivalents and Restricted cash and cash equivalents.

We, and particularly Hagerty Re, pay close attention to the underlying underwriting and reserving risks by monitoring the pricing and loss development of the underlying business written through our affiliated MGAs. Additionally, Hagerty Re seeks to minimize its investment risk by investing in low yield cash, money market accounts, and investment grade municipal securities.

Capital Restrictions

In Bermuda, Hagerty Re is subject to the Bermuda Solvency Capital Requirement ("BSCR") administered by the BMA. No regulatory action is taken by the BMA if an insurer’s capital and surplus is equal to or in excess of their enhanced capital requirement, as determined by the BSCR model. In addition, the BMA has established a target capital level for each insurer which is 120% of the enhanced capital requirement. Hagerty Re maintained sufficient statutory capital surplus to comply with regulatory requirements as of September 30, 2023.

Dividend Restrictions

Under Bermuda law, Hagerty Re is prohibited from declaring or issuing a dividend if it fails to meet its minimum solvency margin or minimum liquidity ratio. Prior approval from the BMA is also required if Hagerty Re's proposed dividend payments would exceed 25% of its prior year-end total statutory capital and surplus. The amount of dividends which could be paid by Hagerty Re in 2023 without prior approval is $32.9 million.

Regulation relating to insurer solvency is generally for the protection of the policyholders rather than for the benefit of the stockholders of an insurance company. We believe that Hagerty Re's existing cash and cash equivalents, municipal securities, and cash flow from operations will be sufficient to support its working capital and capital expenditure requirements for at least the next 12 months. Hagerty Re's future capital requirements will depend on many factors, including its reinsurance premium growth rate, renewal rates, the introduction of new and enhanced products, entry into, and successful entry in new geographic markets, and the continuing market adoption of its product offerings.

Comparative Cash Flows

The following table summarizes our cash flow data for the nine months ended September 30, 2023 and 2022:

Operating Activities

Cash provided by operating activities primarily consists of net income (loss), adjusted for non-cash items, and changes in working capital balances. Net cash provided by operating activities for the nine months ended September 30, 2023 and 2022 is presented below:

Net cash provided by operating activities for the nine months ended September 30, 2023 was $132.2 million, an increase of $38.7 million, or 41.3%, compared to 2022. This increase was due to an $79.8 million increase in Net income (loss), after excluding non-cash adjustments, partially offset by a $41.1 million decrease in cash from operating assets and liabilities.

The increase in Net income (loss), after excluding non-cash adjustments, was primarily driven by organic growth across all areas of our business, as well as management's cost containment measures. Also contributing to the favorable comparison to the prior year is an increase in interest income due to higher variable interest rates earned on cash balances.

The decrease in cash from operating assets and liabilities was primarily due to a decrease in Losses payable and provision for unpaid losses and loss adjustment expenses as a result of the settlement of claims related to Hurricane Ian and settlements of other claims for the 2022 accident year. Also contributing to the change in operating assets and liabilities was the increase in Hagerty Re's U.S. quota share percentage and organic revenue growth across our business.

Investing Activities

Cash used in investing activities for the nine months ended September 30, 2023 decreased $45.2 million when compared to 2022. The lower level of cash used in investing activities was principally due to a decrease in spending on internally developed software, as well as a lower level of acquisitions. Also contributing to the year-over-year decrease is the $15.3 million Broad Arrow equity method investment made in January 2022 for which there was no comparable investment made in the current year. Lastly, net cash outflows associated with the lending activities of Broad Arrow decreased $7.2 million compared to 2022. Refer to Note 3 — Notes Receivable and Note 6 — Acquisitions and Investments in Item 1 of Part I of this Quarterly Report on Form 10-Q for additional information related to the acquisition of Broad Arrow and its lending activities.

Financing Activities

Cash provided by financing activities for the nine months ended September 30, 2023 increased $47.8 million when compared to 2022, primarily due to the issuance of the Series A Convertible Preferred Stock, which resulted in net cash proceeds of $79.2 million, after deducting issuance costs. In addition, Hagerty Re entered into the State Farm Term Loan resulting in net cash inflows of $24.4 million, after deducting issuance costs. These inflows were partially offset by net repayments of $60.0 million related to our Credit Facility during the nine months ended September 30, 2023, compared to $0.5 million of net repayments during the nine months ended September 30, 2022.

Financing Arrangements

Credit Facility

The Hagerty Group has a credit agreement with JPMorgan Chase Bank, N.A., as administrative agent, and the other financial institutions party thereto from time to time as lenders, as amended (the "Credit Agreement"). The Credit Agreement provides for a revolving credit facility (the "Credit Facility") with an aggregate borrowing capacity of $230.0 million. The Credit Agreement matures in October 2026, but may be extended by one year on an annual basis if agreed to by us and the lenders party thereto. Any unpaid balance on the Credit Facility is due at maturity. As of September 30, 2023, total outstanding borrowings under the Credit Facility were $45.4 million.

The Credit Facility borrowings are collateralized by assets of The Hagerty Group and its consolidated subsidiaries, except for foreign and certain excluded or immaterial subsidiaries.

Under the Credit Agreement, we are required, among other things, to meet certain financial covenants, including a fixed charge coverage ratio and a leverage ratio. We were in compliance with these financial covenants as of September 30, 2023.

Refer to Note 13 — Long-Term Debt in Item 1 of Part I of this Quarterly Report on Form 10-Q for additional information on the Credit Facility.

Interest Rate Swap

Hagerty's interest rate swap agreements are used to fix the interest rate on a portion of the Company's existing variable rate debt to reduce the exposure to interest rate fluctuations. The notional amounts of the interest rate swap agreements are used to measure interest to be paid or received and do not represent the amount of exposure to credit loss. The differential paid or received on the interest rate swap agreements is recognized as an adjustment to interest expense within "Interest and other income (expense)" in the Condensed Consolidated Statements of Operations.

As of September 30, 2023, the Company had one outstanding interest rate swap, which was entered into in December 2020, with an original notional amount of $35.0 million and maturity in December 2025. In September 2022, the interest rate swap was amended to replace LIBOR with Term SOFR and, as a result, the fixed swap rate is now 0.81%. The estimated fair value of the interest rate swap is included within either "Other long-term assets" or "Other long-term liabilities" on the Condensed Consolidated Balance Sheets and the change in fair value is recorded within "Derivative instruments" in the Condensed Consolidated Statements of Comprehensive Income (Loss).

Tax Receivable Agreement

Hagerty, Inc. expects to have adequate capital resources to meet the requirements and obligations under the TRA entered into with HHC and Markel (together the "Legacy Unit Holders") on December 2, 2021 that provides for the payment by Hagerty, Inc. to the Legacy Unit Holders of 85% of the amount of cash savings, if any, under U.S. federal, state and local income tax or franchise tax realized as a result of (i) any increase in tax basis of Hagerty, Inc.'s assets resulting from (a) the purchase of Hagerty Group Units from any of the Legacy Unit Holders using the net proceeds from any future offering, (b) redemptions or exchanges by the Legacy Unit Holders of Class V Common Stock and Hagerty Group Units for shares of Class A Common Stock or (c) payments under the TRA and (ii) tax benefits related to imputed interest deemed arising as a result of payments made under the TRA.

Legacy Unit Holders may, subject to certain conditions and transfer restrictions described above, redeem or exchange their Class V Common Stock and Hagerty Group Units for shares of Class A Common Stock of Hagerty, Inc. on a one-for-one basis. The Hagerty Group intends to have in effect an election under Section 754 of the IRC of 1986, as amended, and the regulations thereunder for each taxable year in which a redemption or exchange of Class V Common Stock and Hagerty Group Units for shares of Class A Common Stock occurs, which is expected to result in increases to the tax basis of the assets of The Hagerty Group at the time of a redemption or exchange of Hagerty Group Units. The redemptions and exchanges are expected to result in increases in the tax basis of the tangible and intangible assets of The Hagerty Group. These increases in tax basis may reduce the amount of tax that Hagerty, Inc. would otherwise be required to pay in the future. This payment obligation as a part of the TRA is an obligation of Hagerty, Inc. and not of The Hagerty Group. For purposes of the TRA, the cash tax savings in income tax will be computed by comparing the actual income tax liability of Hagerty, Inc. (calculated with certain assumptions) to the amount of such taxes that Hagerty, Inc. would have been required to pay had there been no increase to the tax basis of the assets of The Hagerty Group as a result of the redemptions or exchanges and had Hagerty, Inc. not entered into the TRA. Estimating the amount of payments that may be made under the TRA is by nature imprecise, insofar as the calculation of amounts payable depends on a variety of factors.

Contractual Obligations

The following table summarizes significant contractual obligations and other commitments as of September 30, 2023:

in thousands

(1) Excludes variable rate debt interest payments and commitment fees related to our Credit Facility.

On June 23, 2023, we issued 8,483,561 shares of Series A Convertible Preferred Stock for an aggregate purchase price of $80.0 million. Dividends on the Series A Convertible Preferred Stock are cumulative and accrue from the date of issuance at the rate per annum of 7% of the Series A Purchase Price of each share, plus the amount of previously accrued dividends, compounded annually (the "Accruing Dividends"). The Company may elect to pay the Accruing Dividends either in cash or in additional shares of Series A Convertible Preferred Stock. In addition, shares of the Series A Convertible Preferred Stock are contingently redeemable for cash under certain circumstances. The table of contractual obligations above excludes any potential cash payments related to the Series A Convertible Preferred Stock. Refer to Note 15 — Convertible Preferred Stock in Item 1 of Part I of this Quarterly Report on Form 10-Q for additional information on the Series A Convertible Preferred Stock.

Off-Balance Sheet Arrangements

We do not have any material off-balance sheet arrangements as of September 30, 2023.

Critical Accounting Policies and Estimates

Our unaudited Condensed Consolidated Financial Statements are prepared in accordance with GAAP. The preparation of our Condensed Consolidated Financial Statements requires management to make assumptions and estimates that affect the reported results of operations and financial position, disclosure of contingent assets and liabilities, and the reported amounts of revenues and expenses during the reporting period. These accounting estimates, among others, may involve a high degree of complexity and judgment on the part of management. Further, these estimates and other factors could have a significant impact to our financial condition, results of operations and cash flows. Management evaluates its significant accounting estimates on an ongoing basis using historical experience and various other assumptions it believes to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying value of assets and liabilities that are not readily apparent from other sources. Actual results could differ materially from management's estimates.

Our accounting policies are set forth in Note 1 — Basis of Presentation and Accounting Policies to Consolidated Financial Statements contained in the Company’s 2022 Annual Report on Form 10-K. We include herein certain updates to those policies.

New Accounting Standards

New accounting standards are described in Note 1 — Basis of Presentation and Accounting Policies, in Item 1 of Part I of this Quarterly Report on Form 10-Q, which are incorporated herein by reference.

Non-GAAP Financial Measures

Adjusted EBITDA

We define Adjusted EBITDA as consolidated Net income (loss) excluding interest and other income (expense), income tax (expense) benefit, and depreciation and amortization, adjusted to exclude (i) changes in fair value of warrant liabilities; (ii) share-based compensation expense; and when applicable, (iii) restructuring, impairment and related charges, net; (iv) the net gain or loss from asset disposals; (v) losses and impairments related to divestitures; (vi) revaluation gain on previously held equity method investment; and (vii) certain other unusual items.

We present Adjusted EBITDA because we consider it to be an important supplemental measure of the Company's performance and believe it is frequently used by securities analysts, investors, and other interested parties in the evaluation of companies in our industry. Management uses Adjusted EBITDA as a measure of the operating performance of our business on a consistent basis, as it removes the impact of items not directly resulting from our core operations.

By providing this non-GAAP financial measure, together with a reconciliation to net income (loss), which is the most comparable GAAP measure, we believe we are enhancing investors’ understanding of our business and our results of operations, as well as assisting investors in evaluating how well we are executing our strategic initiatives. However, Adjusted EBITDA has limitations as an analytical tool, and should not be considered in isolation, or as an alternative to, or a substitute for net income (loss) or other financial statement data presented in our Condensed Consolidated Financial Statements as indicators of financial performance. Hagerty's Adjusted EBITDA may be determined or calculated differently than similarly titled measures of other companies in our industry, which could reduce the usefulness of this non-GAAP financial measure when comparing our performance to that of other companies.

The following table reconciles Adjusted EBITDA to the most directly comparable GAAP measure, which is Net income (loss):

in thousands

(1) Other unusual items primarily includes a net legal settlement accrual recognized in the three and nine months ended September 30, 2023 and non-restructuring severance expense recognized in the nine months ended September 30, 2022.

Adjusted EPS

We define Adjusted Earnings (Loss) Per Share ("Adjusted EPS") as consolidated Net income (loss), less the change in fair value of our warrants and, when applicable, the revaluation gain on previously held equity method investment divided by our outstanding and total potentially dilutive securities, which includes (i) the weighted-average issued and outstanding shares of Class A Common Stock; (ii) all issued and outstanding non-controlling interest Hagerty Group Units; (iii) all unexercised warrants; (iv) all unissued share-based compensation awards; and (v) all issued and outstanding shares of the Series A Convertible Preferred Stock.

The most directly comparable GAAP measure is basic earnings per share ("Basic EPS"), which is calculated as Net income (loss) available to Class A Common Stockholders divided by the weighted average number of Class A Common Stock shares outstanding during the period.

We present Adjusted EPS because we consider it to be an important supplemental measure of our operating performance and believe it is used by securities analysts, investors and other interested parties in evaluating the consolidated performance of other companies in our industry. We also believe that Adjusted EPS, which compares our consolidated Net income (loss) with our outstanding and potentially dilutive shares, provides useful information to investors regarding our performance on a fully consolidated basis.

Management uses Adjusted EPS:

• as a measurement of operating performance of our business on a fully consolidated basis;
• to evaluate the performance and effectiveness of our operational strategies; and
• as a preferred predictor of core operating performance, comparisons to prior periods and competitive positioning.

We caution investors that Adjusted EPS is not a recognized measure under GAAP and should not be considered in isolation or as a substitute for, or superior to, the financial information prepared and presented in accordance with GAAP, including Basic EPS, and that Adjusted EPS, as we define it, may be defined or calculated differently by other companies. In addition, Adjusted EPS has limitations as an analytical tool and should not be considered as a measure of profit or loss per share.

The following table reconciles Adjusted EPS to the most directly comparable GAAP measure, which is Basic EPS:

(1) Numerator and Denominator of the GAAP measure Basic EPS

(2) Numerator and Denominator of the non-GAAP measure Adjusted EPS

We are exposed to certain market risks as part of our ongoing business operations, which primarily include interest rate risk, liquidity risk, and concentration risk. The following sections address the significant market risks associated with our business.

Interest Rate Risk. Interest rate risk is the risk that the fair value of future cash flows of a financial instrument will fluctuate due to changes in prevailing market interest rates. As of September 30, 2023, we had approximately $10.4 million of variable rate indebtedness (after taking into consideration $35.0 million in interest rate swaps which effectively converts variable-rate debt to fixed-rate debt), representing approximately 14% of our total debt outstanding, at an average interest rate during the nine months ended September 30, 2023 of approximately 7.41%. Based on variable-rate borrowings outstanding as of September 30, 2023, a 100-basis point (or 1.0%) change in our borrowing rates would result in our annual interest payments changing by approximately $0.1 million. Our market risk exposure fluctuates based on changes in underlying interest rates.

We also have a portfolio of term loans secured by collector cars of approximately $40.2 million as of September 30, 2023, upon which interest is earned predominately at variable rates including Prime Rate and Term SOFR. Finally, the assets of Hagerty Re are substantially invested in cash and cash equivalents (including money market funds) which generally earn a higher rate of return as interest rates increase.

Liquidity Risk. Liquidity risk is the risk that we will not be able to meet our financial obligations associated with financial liabilities. We manage our liquidity risk through the management of our capital structure. Our approach to managing liquidity is to ensure that we have sufficient liquidity to settle obligations and liabilities when due. Refer to "Liquidity and Capital Resources" in Item 2 of Part I of this Quarterly Report on Form 10-Q for additional information.

Concentration Risk. We rely on Markel and its subsidiaries for a significant portion of our revenue, representing approximately 95% of our commission revenues and 97% of our assumed premium for the nine months ended September 30, 2023. Termination or disruption of this relationship could materially and adversely impact our revenue. Refer to Note 21 — Related-Party Transactions in Item 1 of Part I of this Quarterly Report on Form 10-Q for additional information with respect to our relationship with Markel.

Disclosure Controls and Procedures

Our management, including the Chief Executive Officer and Chief Financial Officer, evaluated the effectiveness of our disclosure controls and procedures (as such term is defined in Rules 13a-15(e) and 15d-15(e) under the Exchange Act) as of the end of the period covered by this Quarterly Report on Form 10-Q. Hagerty disclosure procedures and controls are designed to sufficiently reduce the risk of a material misstatement and can provide only reasonable assurance of achieving desired control objectives.

Based on this evaluation, our Chief Executive Officer and Chief Financial Officer concluded that our disclosure controls and procedures were effective as of September 30, 2023 to provide reasonable assurance that information required to be disclosed by us in reports that we file or submit under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in the rules and forms specified by the SEC. There were no material weaknesses in our disclosure controls and procedures identified in the evaluation and therefore, no corrective actions were taken.

Changes in Internal Controls Over Financial Reporting

There were no changes to our internal control over financial reporting that occurred during the three months ended September 30, 2023 that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

As of the date of this Quarterly Report on Form 10-Q, with the exception of the Risk Factor below related to the issuance of our Series A Convertible Preferred Stock on June 23, 2023, there have been no material changes to our Risk Factors as previously disclosed in our Annual Report on Form 10-K for the year ended December 31, 2022. We may disclose additional changes to such factors or disclose additional factors from time to time in our future filings with the Securities and Exchange Commission ("SEC"). Additional risks that we currently do not know about or currently view as immaterial may also materially adversely affect our business, financial condition, or operating results.

There is no public market for the Series A Convertible Preferred Stock.

There is no established public trading market for the Series A Convertible Preferred Stock, and we do not expect a market to develop. The Series A Convertible Preferred Stock is not currently listed on any securities exchange or nationally recognized trading system, including the New York Stock Exchange, and we may choose not to apply to list it in the future. Without an active market, the liquidity of the Series A Convertible Preferred Stock will be limited.