Hagerty, Inc.: Form 10-Q for the period ended Sep 30, 2024

The following discussion and analysis of our financial condition and results of operations should be read in conjunction with our Annual Report and our Condensed Consolidated Financial Statements and related Notes included in Item 1 of Part I of this Quarterly Report. This discussion contains forward-looking statements based upon current expectations that involve risks and uncertainties. Please refer to the section in this Quarterly Report entitled "Cautionary Statement Regarding Forward-Looking Statements".

Overview

We are a market leader in providing insurance for classic cars and enthusiast vehicles. Through our insurance model, we act as a Managing General Agent ("MGA") by underwriting, selling, and servicing classic car and enthusiast vehicle insurance policies. Then, due to our consistent track record of delivering strong underwriting results, we reinsure a large portion of the risks written by our MGA subsidiaries through our wholly owned subsidiary, Hagerty Reinsurance Limited ("Hagerty Re"). In addition, we offer Hagerty Drivers Club ("HDC") memberships, which can be bundled with our insurance policies and give subscribers access to an array of products and services, including Hagerty Drivers Club Magazine, automotive enthusiast events, our proprietary vehicle valuation tool, emergency roadside assistance, and special vehicle-related discounts. Lastly, to complement our insurance and membership offerings, we also offer Hagerty Marketplace ("Marketplace"), where car enthusiasts can buy, sell, and finance collector cars. Through these offerings, our goal is to be the world's most trusted and preferred brand for enthusiasts to protect, buy and sell, and enjoy the special cars that are their passion.

Business Review

In 2023, we began a review of certain components of our operations which resulted in the sale or reorganization of certain businesses, including Hagerty Garage + Social, DriveShare, and Motorsport Reg ("MSR"). This initiative supports our strategy to prioritize investments and resources in the areas of our business that offer the strongest growth and profit potential. As a result of this review, we recognized approximately $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, and a $0.1 million gain in the second quarter of 2024 related to the sale of MSR. We may incur additional losses and/or impairment charges in future periods as a result of actions which we may take related to this review. Refer to Note 9 — Divestitures in Item 1 of Part I of this Quarterly Report for additional information.

Recent Developments

Warrant Exchange

In July 2024, we completed an exchange offer under which holders of our warrants were issued 3,876,201 shares of Class A Common Stock in exchange for 19,483,539 warrants, with a nominal cash settlement paid in lieu of fractional shares (the "Warrant Exchange"). No warrants remained outstanding following the completion of the Warrant Exchange. As a result of the Warrant Exchange, we recognized a loss of $2.0 million during the three and nine months ended September 30, 2024, representing the difference between the fair value of the warrants immediately prior to the Warrant Exchange and the fair value of Class A Common Stock issued. Refer to Note 17 — Warrant Exchange in Item 1 of Part I of this Quarterly Report for additional information with respect to the Warrant Exchange.

Acquisition

On September 1, 2024, our subsidiary, Hagerty Insurance Holdings, Inc., acquired Consolidated National Insurance Company, which was subsequently renamed to Drivers Edge Insurance Company ("Drivers Edge"), for a purchase price of $19.3 million, including $0.9 million in direct and incremental transaction costs. We believe that this acquisition will allow us to continue driving high rates of written premium growth, optimize our underwriting profits, and offer new products and coverages to fill an underserved segment of the enthusiast vehicle market. Refer to Note 8 — Acquisition in Item 1 of Part I of this Quarterly Report for additional information with respect to the Drivers Edge acquisition.

Hurricane Helene

On September 26, 2024, Hurricane Helene made landfall, causing significant damage in Florida as well as several other states including Georgia, South Carolina, North Carolina, Virginia, and Tennessee. As a result of Hurricane Helene, we recorded estimated pre-tax losses of $24.7 million during the three and nine months ended September 30, 2024. Our estimated pre-tax losses related to Hurricane Helene are currently below the 2024 catastrophe reinsurance program per event retention of $28.0 million. There is inherent variability in estimates of early loss projections and claims severity, particularly in high-damage regions. Accordingly, our estimate may change as additional information becomes available.

Hurricane Milton

On October 9, 2024, Hurricane Milton made landfall along Florida's Central Gulf Coast. We currently estimate that pre-tax losses resulting from Hurricane Milton will be approximately $5.0 million, which is below the 2024 catastrophe reinsurance program per event retention of $28.0 million. There is inherent variability in estimates of early loss projections and claims severity, particularly in high-damage regions. Accordingly, our estimate may change as additional information becomes available. Losses from Hurricane Milton will be reflected in our results for the three months ended December 31, 2024.

Key Performance Indicators

The tables below present a summary of our Key Performance Indicators, which include important operational metrics, as well as certain financial measures prepared in accordance with accounting principles generally accepted in the United States of America ("GAAP") and non-GAAP financial measures. 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 subsidiaries 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 benchmark for profitability. This benchmark allows us to evaluate our historical loss patterns, including incurred losses, and make necessary and appropriate adjustments. Refer to "Losses and Loss Adjustment Expenses" below for additional information regarding the changes in our loss ratio period over period.

(3) New Business Count represents the number of new insurance policies issued by our MGA subsidiaries 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 we benefit from strong renewal retention, new business policies more than offset those cancelled or non-renewed at expiration. New policies often 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") represents 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 represents the percentage of expiring insurance 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.

(7) Vehicles in Force represents 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.

(8) HDC Paid Member Count represents 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) We use Net Promoter Score ("NPS") as an important measure of the overall strength of our relationship with insurance policyholders and paid HDC subscribers (collectively referred to as "Members"). NPS is measured twice annually through a web-based survey sent by email invitation to a random sample of existing Members, which currently excludes customers in our new Marketplace business, and is reported annually using an average of the two surveys. Often referred to as a barometer of brand loyalty and engagement, NPS is well-known in our industry as a strong indicator of growth and retention.

Components of Our Results of Operations

Revenue

Commission and fee revenue

We generate commission and fee revenue through our MGA subsidiaries, primarily from the underwriting, sale, and servicing of classic car and enthusiast vehicle insurance policies on behalf of our insurance carrier partners. Commissions are earned for both new and renewed policies. In addition, under the terms of certain of our contracts with insurance carriers, we have the opportunity to earn a contingent underwriting commission ("CUC") based on written or earned premium and the loss ratio results of the insurance book of business.

Historically, our MGA subsidiaries have earned, on average, a base commission of approximately 32% of written premium, as well as a CUC of up to 10%. In December 2023, our alliance agreement and associated agency agreement with Markel Group, Inc. ("Markel"), which generates approximately 93% of our total commission revenue, was amended to increase the base commission rate to 37% and to adjust the contingent commission to range from -5% to a maximum of +5% of annual written premium, with 80% of the expected CUC being paid monthly, beginning in the first quarter of 2024.

Commission and fee revenue is earned when the policy becomes effective, net of allowances for policy changes and cancellations, as our performance obligation is substantially complete when the policy is issued.

Earned premium

We earn reinsurance premium revenue for the risks assumed by Hagerty Re from the classic car and enthusiast vehicle insurance policies underwritten by our MGA subsidiaries. Hagerty Re is registered as a Class 3A reinsurer under the Bermuda Insurance Act of 1978.

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 various reinsurers and the cost of catastrophe reinsurance coverage. Premiums assumed and ceded are recognized on a pro-rata basis over the term of the related reinsured 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 HDC memberships, which can be bundled with our insurance policies and give subscribers access to an array of products and services, including 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 primarily from the sale of collector cars through live auctions, time-based online auctions, and brokered private sales. In addition, Marketplace earns revenue from the sale of collector cars in inventory that have been acquired opportunistically for resale and from financing provided to qualified collectors and businesses secured by collector cars. Fee-based revenue earned by Marketplace is recognized when the underlying sale is completed. Revenue from the sale of collector cars from inventory is recognized at the point in time when title and control of the car is transferred to the buyer, which is generally upon payment of the full purchase price. 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.

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

Operating Expenses

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, as well as various incentive compensation plans, including share-based compensation. Employee benefits include the costs of various employee benefit plans, including retirement, medical, dental, wellness, and severance plans. Costs related to employee education, training, and recruiting are included in employee development costs. Salaries and benefits are expensed as incurred except for those costs which are required to be capitalized, which are then amortized over the useful life of the asset created, primarily software. Salaries and benefits are expected to increase in dollar amount over time as the business continues to grow but will likely decrease as a percent of revenue.

Ceding commissions, net

Ceding commissions, net represents the commissions paid by Hagerty Re to insurance carrier partners for the risk assumed under the quota share agreements with those carriers. These commissions represent Hagerty Re's pro-rata share of the carrier's costs including (i) policy acquisition costs, which consists of the commissions earned by our MGA subsidiaries, (ii) general and administrative costs, and (iii) other costs. Ceding commissions paid is recorded net of commissions received by Hagerty Re related to ceded reinsurance premiums. Ceding commissions, net is recognized ratably over the term of the related reinsured policies, which is generally 12 months.

Losses and loss adjustment expenses

Losses and loss adjustment expenses represent our best estimate of the losses related to the risk assumed by Hagerty Re. Losses consist of claims paid, case reserves, and incurred but not reported costs, which are recorded net of estimated recoveries from reinsurance, salvage and subrogation. Loss adjustment expenses consist of the cost associated with the investigation and settlement 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 our 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 payment processing fees, emergency roadside service costs, postage and other variable costs associated with the sale and servicing of a policy. Cost of sales also includes the cost of vehicles held in inventory and sold through Marketplace, as well as interest expense and borrowing costs associated with the Broad Arrow Capital LLC ("BAC") credit facility ("BAC Credit Facility"). 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

General and administrative primarily consist of expenses related to non-capitalized hardware and software, professional services, and occupancy costs. These costs are expensed as incurred. We expect this expense category to increase in dollar amount over time as the business continues to grow 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 hardware, furniture and equipment, and leasehold improvements. Amortization relates to internally developed software, software as a service ("SaaS") implementation, and investments associated with acquisitions. 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

Gain (loss) related to warrant liabilities, net

Prior to the Warrant Exchange, which was completed in the third quarter of 2024, our warrants were accounted for as liabilities and were 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 increased, the warrant liability increased, and we recognized additional expense. In periods when our stock price decreased, the warrant liability decreased, and we recognized additional income. In addition, "Gain (loss) related to warrant liabilities, net" includes the loss on the Warrant Exchange recorded in the third quarter of 2024. Refer to Note 17 — Warrant Exchange in Item 1 of Part I of this Quarterly Report for additional information about the Company's Warrant Exchange.

Interest and other income (expense), net

Interest and other income (expense), net primarily includes interest income related to our cash balances and fixed maturity securities, dividend income on equity securities, realized gains or losses from the sale of fixed maturity securities, and realized and unrealized gains and losses related to equity securities. Additionally, Interest and other income (expense), net includes interest expense related to outstanding borrowings, primarily related to the JPM Credit Facility, and changes in the value of the liability related to our Tax Receivable Agreement ("TRA") with Hagerty Holding Corp. ("HHC") and Markel. Refer to Note 20 — Taxation in Item 1 of Part I of this Quarterly Report for additional information related to the TRA.

Income tax benefit (expense)

The Hagerty Group, LLC ("THG") is taxed as a pass-through ownership structure under provisions of the Internal Revenue Code ("IRC") and a similar section of state income tax law, except certain United States ("U.S.") corporate subsidiaries and foreign subsidiaries. Any taxable income or loss generated by THG is passed through to and included in the taxable income or loss of all holders of THG 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 THG. Hagerty, Inc., Hagerty Insurance Holdings, Inc., Broad Arrow Group, Inc. ("Broad Arrow"), Hagerty Radwood, Inc., and various foreign subsidiaries are treated as taxable entities and income taxes are provided where applicable. Hagerty Insurance Holdings, Inc. files a consolidated tax return with its wholly owned corporate subsidiaries Hagerty Re and Drivers Edge.

Results of Operations

Three Months Ended September 30, 2024 compared to the Three Months Ended September 30, 2023

The following table summarizes our results of operations for the three months ended September 30, 2024 and 2023, and the dollar and percentage changes between the two periods:

Revenue

Commission and fee revenue

Commission and fee revenue was $116.2 million for the three months ended September 30, 2024, an increase of $13.0 million, or 12.6%, compared to 2023, consisting of increases of $11.3 million related to policy renewals and $1.7 million related to new policies.

The increase in revenue from policy renewals was primarily driven by a 13.4% increase in underlying policy premiums, as well as continued strong policy retention.

The increase in revenue from new policies was primarily driven by a 11.7% increase in underlying policy premiums, as well as sustained year-over-year growth in New Business Count, which increased 11.1% during the current year period.

The increase in underlying policy premiums for both policy renewals and new policies is a result of 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. In addition, average premiums on newly issued policies increased as a result of writing policies with higher insured values at higher premium rates.

Commission and fee revenue from agent sources increased $7.6 million, or 13.6%, and Commission and fee revenue from direct sources increased $5.3 million, or 11.4%, during the three months ended September 30, 2024. 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 at Hagerty Re was $165.7 million for the three months ended September 30, 2024, an increase of $25.9 million, or 18.5%, compared to 2023. This increase was primarily due to continued growth of subject premiums written through our MGA subsidiaries, partially offset by an increase in ceded reinsurance premiums related to high-net-worth accounts in the U.S. In addition, effective January 1, 2024, Hagerty Re is no longer reinsuring classic auto risks produced by its United Kingdom ("U.K.") MGA affiliate, and the book is in run-off.

The following tables present the amount of premiums assumed by Hagerty Re and the related quota share percentages for the three months ended September 30, 2024 and 2023:

Membership, marketplace and other revenue

Membership, marketplace and other revenue was $41.5 million for the three months ended September 30, 2024, an increase of $8.9 million, or 27.3%, compared to 2023.

Membership fee revenue was $14.8 million for the three months ended September 30, 2024, an increase of $1.0 million, or 7.0%, compared to 2023. This increase was primarily attributable to a $2.1 million, or 17.8%, increase in revenue attributable to new policies issued with a bundled HDC membership, partially offset by a $0.9 million, or 50.7%, decrease in storage revenue as a result of fewer Hagerty Garage + Social locations in operation. For the three months ended September 30, 2024 and 2023, membership fees were 35.6% and 42.4%, respectively, of the Membership, marketplace and other revenue total.

Marketplace revenue was $21.6 million for the three months ended September 30, 2024, an increase of $8.6 million, or 66.2%, compared to 2023, which was primarily due to stronger results from Broad Arrow's Monterey Jet Center auction in August, an increase of $7.8 million in Marketplace inventory sales, and an increase in finance revenue associated with the growth of the BAC loan portfolio. For the three months ended September 30, 2024 and 2023, Marketplace revenue was 51.9% and 39.8%, respectively, of the Membership, marketplace and other revenue total.

Other revenue, which includes sponsorship, admission, advertising, valuation, and sublease revenue, totaled $5.2 million for the three months ended September 30, 2024, a decrease of $0.6 million, or 11.1%, compared to 2023. This decrease was primarily attributable to the loss of registration fee revenue associated with MSR, which was sold in the second quarter of 2024, partially offset by an increase in sublease and advertising revenue. For the three months ended September 30, 2024 and 2023, other revenue was 12.4% and 17.8%, respectively, of the Membership, marketplace and other revenue total. Refer to Note 9 — Divestitures in Item 1 of Part I of this Quarterly Report for additional information related to the sale of MSR.

Operating Expenses

Salaries and benefits

Salaries and benefits were $47.2 million for the three months ended September 30, 2024, a decrease of $4.1 million, or 8.0%, compared to 2023. This decrease was primarily due to a reduction in accrued incentive compensation which reflects the losses associated with Hurricane Helene in the period. The decrease in accrued incentive compensation was partially offset by increases in base salaries as a result of annual merit increases, which occur in the second quarter of each year, as well as an increase in employee benefit costs.

Ceding commissions, net

Ceding commissions, net was $77.5 million for the three months ended September 30, 2024, an increase of $12.1 million, or 18.5%, compared to 2023. This increase is primarily attributable to the 18.5% increase in Earned premium discussed above.

The following table summarizes the components of Ceding commissions, net for the three months ended September 30, 2024 and 2023:

Losses and loss adjustment expenses

Losses and loss adjustment expenses were $99.4 million for the three months ended September 30, 2024, an increase of $41.9 million, or 73.0%, compared to 2023. This increase was primarily driven by $24.7 million of estimated losses related to Hurricane Helene, as well as the higher volume of assumed premium at Hagerty Re.

For the three months ended September 30, 2024, our loss ratio was 60.0%, including the impact of catastrophe losses, which added 16.2% to our loss ratio. For the three months ended September 30, 2023, our loss ratio was 41.1% including the impact of catastrophe losses, which added 2.1% to our loss ratio. Excluding the impact of catastrophe losses, our loss ratio was 43.8% and 39.0% for the three months ended September 30, 2024 and 2023, respectively.

Sales expense

Sales expense was $59.1 million for the three months ended September 30, 2024, an increase of $11.4 million, or 23.9%, compared to 2023. This increase was due, in part, to a $9.3 million increase in cost of sales, primarily as a result of a higher level of Marketplace inventory sales, as well as borrowing costs associated with the BAC Credit Facility which was entered into in December 2023. In addition, broker expense increased $2.2 million, which is consistent with written premium growth within the agent channel.

General and administrative

General and administrative expense was $20.8 million for the three months ended September 30, 2024, a decrease of $1.3 million, or 6.0%, compared to 2023. This decrease was primarily driven by a $1.7 million reduction in occupancy costs as a result of fewer Hagerty Garage + Social locations in operation, as well as lower insurance costs. The overall decrease was partially offset by an increase in professional fees primarily associated with various corporate initiatives.

Depreciation and amortization

Depreciation and amortization expense was $9.2 million for the three months ended September 30, 2024, a decrease of $1.6 million, or 14.6%, compared to 2023. This decrease was primarily attributable to a smaller base of fixed assets and finite-lived intangible assets as of September 30, 2024 when compared to the same period in 2023.

Restructuring, impairment and related charges, net

In the third quarter of 2023, we recognized $0.5 million of costs associated with our vacated office space within "Restructuring, impairment and related charges, net". Refer to Note 13 — Restructuring, Impairment and Related Charges in Item 1 of Part I of this Quarterly Report for additional information with respect to our restructuring initiatives.

Gains, losses, and impairments related to divestitures

In the third quarter of 2023, we recognized $4.1 million of losses and impairments related to Hagerty Garage + Social and DriveShare. Refer to Note 9 — Divestitures in Item 1 of Part I of this Quarterly Report for additional information.

Other Items

Gain (loss) related to warrant liabilities, net

During the three months ended September 30, 2024, Gain (loss) related to warrant liabilities, net was a $0.5 million loss, compared to a $0.9 million gain in 2023. The $0.5 million loss in the current year period consists of a $2.0 million loss related the Warrant Exchange that was completed in July 2024, partially offset by a $1.5 million gain resulting from the change in the fair value of our warrant liabilities prior to the completion of the Warrant Exchange. The $0.9 million gain during the three months ended September 30, 2023 was a result of the change in fair value of our warrant liabilities. Refer to Note 4 — Fair Value Measurements and Note 17 — Warrant Exchange in Item 1 of Part I of this Quarterly Report for additional information with respect to our warrants.

Interest and other income (expense), net

The following table presents the components of Interest and other income (expense), net for the three months ended September 30, 2024 and 2023:

N/M = Not meaningful

Interest and other income (expense), net increased $2.1 million during the three months ended September 30, 2024, compared to 2023. This increase was primarily due to the diversification of Hagerty Re's investment portfolio in the second quarter of 2024, which resulted in the opening of positions in higher yielding fixed maturity securities and, to a much lesser extent, equity securities. These increases were partially offset by an increase in interest expense as a result of a higher level of borrowings under the JPM Credit Facility.

Income tax benefit (expense)

Income tax benefit was $1.0 million for the three months ended September 30, 2024, which compares to income tax expense of $4.6 million in 2023. The income tax benefit recorded in the current period is primarily due to a $4.8 million pre-tax loss within Hagerty Re as a result of losses associated with Hurricane Helene, 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 for additional information with respect to items affecting our effective tax rate.

Nine Months Ended September 30, 2024 compared to the Nine Months Ended September 30, 2023

The following table summarizes our results of operations for the nine months ended September 30, 2024 and 2023, and the dollar and percentage change between the two periods:

N/M = Not meaningful

Revenue

Commission and fee revenue

Commission and fee revenue was $333.8 million for the nine months ended September 30, 2024, an increase of $45.8 million, or 15.9%, compared to 2023, consisting of increases of $36.9 million related to renewal policies and $9.0 million related to new policies.

The increase in revenue from renewal policies was primarily driven by a 16.2% increase in underlying policy premiums, as well as continued strong policy retention.

The increase in revenue from new policies was primarily driven by a 16.7% increase in underlying policy premiums. as well as sustained year-over-year growth in New Business Count, which increased 12.0% during the current year period.

The increase in underlying policy premiums for both policy renewals and new policies is a result of 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. In addition, average premiums on newly issued policies increased as a result of writing policies with higher insured values at higher premium rates.

Commission and fee revenue from agent sources increased $26.1 million, or 16.6%, and Commission and fee revenue from direct sources increased $19.8 million, or 15.1%, during the nine months ended September 30, 2024. 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 at Hagerty Re was $474.9 million for the nine months ended September 30, 2024, an increase of $90.4 million, or 23.5%, compared to 2023. This increase was primarily due to continued growth of subject premiums written through our MGA subsidiaries, partially offset by an increase in ceded reinsurance premiums related to high-net-worth accounts in the U.S. In addition, effective January 1, 2024, Hagerty Re is no longer reinsuring classic auto risks produced by its U.K. MGA affiliates, and the book is in run-off.

The following tables present premiums assumed by Hagerty Re and the related quota share percentages for the nine months ended September 30, 2024 and 2023:

Membership, marketplace and other revenue

Membership, marketplace and other revenue was $99.6 million for the nine months ended September 30, 2024, an increase of $16.9 million, or 20.4%, compared to 2023.

Membership fee revenue was $42.4 million for the nine months ended September 30, 2024, an increase of $2.9 million, or 7.2%, compared to 2023. This increase was primarily due to a $5.4 million, or 15.8%, increase in revenue attributable to new insurance policies issued with a bundled HDC membership, partially offset by a $1.8 million decrease in storage revenue as a result of fewer Hagerty Garage + Social locations in operation. For the nine months ended September 30, 2024 and 2023, membership fees were 42.6% and 47.8%, respectively, of total Membership, marketplace and other revenue.

Marketplace revenue was $38.3 million for the nine months ended September 30, 2024, an increase of $13.5 million, or 54.2%, compared to 2023. This improvement was primarily due to stronger Broad Arrow auction results, an increase of $8.7 million in Marketplace inventory sales, and an increase in finance revenue associated with the growth of the BAC loan portfolio. For the nine months ended September 30, 2024 and 2023, Marketplace revenue was 38.5% and 30.1%, respectively, of total Membership, marketplace and other revenue.

Other revenue, which primarily includes sponsorship, admission, advertising, valuation, and sublease revenue, was $18.8 million for the nine months ended September 30, 2024, an increase of $0.5 million, or 2.9%, compared to 2023. This increase was primarily attributable to an increase in advertising and sublease revenue, partially offset by the loss of registration fee revenue attributable to MSR, which was sold in the second quarter of 2024. For the nine months ended September 30, 2024 and September 30, 2023, other revenue was 18.9% and 22.1%, respectively, of total Membership, marketplace and other revenue. Refer to Note 9 — Divestitures in Item 1 of Part I of this Quarterly Report for additional information related to the sale of MSR.

Costs and Expenses

Salaries and benefits

Salaries and benefits were $161.0 million for the nine months ended September 30, 2024, an increase of $0.9 million, or 0.5%, compared to 2023. This increase was primarily due to an increase in base salaries as a result of annual merit increases, which occur in the second quarter of each year, as well as a higher level of share-based compensation expense and employee benefits. These increases were almost entirely offset by a decrease in accrued incentive compensation which reflects the losses associated with Hurricane Helene in the period.

Ceding commissions, net

Ceding commissions, net was $221.9 million for the nine months ended September 30, 2024, an increase of $40.7 million, or 22.5%, compared to 2023. This increase is primarily attributable to the 23.5% increase in Earned premium discussed above.

The following table summarizes the components of Ceding commissions, net for the nine months ended September 30, 2024 and 2023:

Losses and loss adjustment expenses

Losses and loss adjustment expenses were $226.5 million for the nine months ended September 30, 2024, an increase of $67.1 million, or 42.1%, compared to 2023. This increase was primarily driven by $24.7 million of estimated losses related to Hurricane Helene, as well as the higher volume of assumed premium at Hagerty Re.

For the nine months ended September 30, 2024, our loss ratio was 47.7%, including the impact of catastrophe losses, which added 7.1% to our loss ratio. For the nine months ended September 30, 2023, our loss ratio was 41.5%, including the impact of catastrophe losses, which added 1.5% to our loss ratio. Excluding the impact of catastrophe losses, our loss ratio was 40.6% and 40.0% for the nine months ended September 30, 2024 and 2023, respectively.

Sales expense

Sales expense was $146.8 million for the nine months ended September 30, 2024, an increase of $22.0 million, or 17.6%, compared to 2023. This increase was due, in part, to a $13.5 million increase in cost of sales, primarily as a result of a higher level of Marketplace inventory sales, as well as borrowing costs associated with the BAC Credit Facility, which was entered into in December 2023. In addition, broker expense increased $7.4 million which is consistent with written premium growth within the agent channel. Lastly, credit card processing fees increased, primarily due to a shift in customer preference towards credit cards as a payment method within our MGA subsidiaries.

General and administrative

General and administrative expense was $62.1 million for the nine months ended September 30, 2024, a decrease of $2.8 million, or 4.3%, compared to 2023. This decrease was primarily driven by a $4.2 million reduction in occupancy costs as a result of fewer Hagerty Garage + Social locations in operation, as well as lower insurance costs. The overall decrease was partially offset by a $2.9 million increase in professional fees associated with various corporate initiatives, including $0.8 million of professional fees associated with the exchange offer related to our warrants. Refer to Note 17 — Warrant Exchange in Item 1 of Part I of this Quarterly Report for additional information with respect to the Warrant Exchange offer.

Depreciation and amortization

Depreciation and amortization expense was $29.8 million for the nine months ended September 30, 2024, a decrease of $5.1 million, or 14.7%, compared to 2023. This decrease was driven primarily by a $4.3 million impairment of digital media content assets recorded in the prior year period, which was the result of lower than anticipated advertising and sponsorship revenue associated with these assets. The remainder of the decrease was primarily driven by a smaller base of fixed assets and finite-lived intangible assets as of September 30, 2024 when compared to the same period in 2023.

Restructuring, impairment and related charges, net

In the first quarter of 2023, our Board approved a reduction in force (the "2023 RIF") following a strategic review of business processes as we focus on driving efficiencies in order to achieve growth and profitability goals. As a result of these actions, in the first quarter of 2023, we recognized restructuring, impairment and related charges of $5.5 million, which consisted 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, we recognized $2.8 million of restructuring, impairment and other changes. These charges consisted of $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 our continuing transition to a "remote first" work model. The amount recognized in the second quarter of 2023 also included $0.2 million of additional severance related costs associated with the 2023 RIF.

In the third quarter of 2023, we recognized $0.5 million of costs associated with our vacated office space within "Restructuring, impairment and related charges, net".

Refer to Note 13 — Restructuring, Impairment and Related Charges in Item 1 of Part I of this Quarterly Report for additional information with respect to our restructuring initiatives.

Gains, losses, and impairments related to divestitures

During the nine months ended September 30, 2024, we recognized a $0.1 million gain related to the sale of MSR. During the nine months ended September 30, 2023, we recognized $4.1 million of losses and impairments related to Hagerty Garage + Social and DriveShare. Refer to Note 9 — Divestitures in Item 1 of Part I of this Quarterly Report for additional information.

Gain (loss) related to warrant liabilities, net

During the nine months ended September 30, 2024, Gain (loss) related to warrant liabilities, net was an $8.5 million loss, compared to a $1.4 million loss in 2023. The $8.5 million loss in the current year period consists of a $2.0 million loss related the Warrant Exchange that was completed in July 2024 and a $6.5 million loss resulting from the change in fair value of our warrant liabilities prior to the completion of the Warrant Exchange. The $1.4 million loss during the nine months ended September 30, 2023 was a result of the change in fair value of our warrant liabilities. Refer to Note 4 — Fair Value Measurements and Note 17 — Warrant Exchange in Item 1 of Part I of this Quarterly Report for additional information with respect to our warrants.

Interest and other income (expense), net

The following table presents a breakout of Interest and other income (expense), net for the nine months ended September 30, 2024 and 2023:

N/M = Not meaningful

Interest and other income (expense), net increased $12.3 million during the nine months ended September 30, 2024, compared to 2023. This increase was primarily due to the diversification of Hagerty Re's investment portfolio in the second quarter of 2024, which resulted in the opening of positions in higher yielding fixed maturity securities and, to a much lesser extent, equity securities. These increases were partially offset by a decrease in interest expense as a result of a lower level of borrowings under the JPM Credit Facility.

Income tax benefit (expense)

Income tax expense was $9.9 million for the nine months ended September 30, 2024, a decrease of $2.1 million compared to 2023. This decrease is primarily due to a decrease in pre-tax income of $9.6 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 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. As a holding company without direct operations, we manage liquidity globally and across all operating subsidiaries.

Sources and Uses of Liquidity

Our sources of liquidity include our: (i) balances of cash and cash equivalents; (ii) net working capital; (iii) cash flows from operations; (iv) borrowings from the JPM Credit Facility (as defined below) to fund the general corporate needs of THG and its subsidiaries; and (v) borrowings from the BAC Credit Facility (as defined below) to fund a portion of the lending activities of BAC.

Our primary liquidity needs and capital requirements include cash required for: (i) funding the business operations of THG and its subsidiaries; (ii) funding strategic investments and acquisitions; (iii) servicing and repayment of borrowings under the JPM Credit Facility, the BAC Credit Facility, and the unsecured term loan credit facility with State Farm Mutual Automobile Insurance Company (the "State Farm Term Loan"); (iv) funding potential cash dividend payments on the Series A Convertible Preferred Stock; (v) payment of income taxes; and (vi) funding potential payments under the TRA.

As of September 30, 2024, we believe that our 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.

Financing Arrangements

JPM Credit Facility

THG has a credit agreement with JPMorgan Chase Bank, N.A. ("JPM"), as administrative agent, and the other financial institutions party thereto from time to time as lenders, as amended (the "JPM Credit Agreement").

The JPM Credit Agreement provides for a revolving credit facility (the "JPM Credit Facility") with an aggregate borrowing capacity of $305.0 million, including the new $75.0 million commitment provided by Wells Fargo Bank, National Association in May 2024. The JPM Credit Agreement matures in October 2026, but may be extended if agreed to by us and the lenders party thereto.

As of September 30, 2024, total outstanding borrowings under the JPM Credit Facility were $51.8 million. JPM Credit Facility borrowings are collateralized by the assets of and equity interests in THG and its consolidated subsidiaries, except for (i) the assets held by the special purpose entities related to the BAC Credit Facility and (ii) all or a portion of certain foreign and certain excluded or immaterial subsidiaries.

Under the JPM 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, 2024.

BAC Credit Facility

In December 2023, BAC and its wholly owned subsidiary BAC Funding 2023-1, LLC, as borrower, entered into the BAC Credit Agreement. The BAC Credit Agreement provides for the BAC Credit Facility, which has an aggregate borrowing capacity of $75.0 million and is subject to a borrowing base that is determined based on the carrying value of certain BAC notes receivable. As of September 30, 2024, the applicable borrowing base for the BAC Credit Agreement was $46.1 million.

The revolving borrowing period provided by the BAC Credit Agreement expires on December 21, 2025 and the BAC Credit Agreement matures on December 21, 2026. The revolving borrowing period and the maturity date of the BAC Credit Agreement may be extended by one year if requested by BAC and agreed to by the administrative agent. BAC is not a borrower or guarantor of the BAC Credit Facility.

In connection with the BAC Credit Agreement, BAC and certain of its subsidiaries may transfer originated notes receivable to wholly owned, bankruptcy remote special purpose entities (each, an "SPE") to secure the borrowings. The assets transferred to SPEs are legally isolated from us and our other (non-SPE) subsidiaries. Accordingly, those assets are not available to satisfy our debts or other obligations and our recourse under the BAC Credit Agreement is limited.

Recourse to the Company and its subsidiaries that originated and transferred notes receivable that represent collateral under the BAC Credit Facility is limited to (i) an obligation of the applicable seller to repurchase a note receivable if it is determined that there was a breach of any representation or warranty relating to such note receivable as of the relevant date specified in the related transfer agreement and (ii) a limited guarantee covering certain liabilities that may result under certain foreign exchange hedging activity of one of the SPEs.

BAC and BAC Funding 2023-1, LLC are required, among other things, to meet certain financial covenants under the BAC Credit Agreement, including that BAC, as the servicer, maintain a minimum tangible net worth, minimum liquidity balances, and an indebtedness to tangible net worth ratio. As of September 30, 2024, we were in compliance with the financial covenants under the BAC Credit Agreement.

Refer to Note 14 — Long-Term Debt in Item 1 of Part I of this Quarterly Report for additional information related to the JPM Credit Agreement and BAC Credit Agreement.

Capital and Dividend Restrictions

We are a holding company with no material assets other than our ownership of THG and its operating subsidiaries. Accordingly, our ability to meet our cash requirements depends on THG's financial performance and the distributions we receive from THG. Our subsidiaries' ability to make distributions, pay dividends and make other payments may be regulated by the states and territories where they are domiciled.

For a discussion of the risks associated with our holding company structure, please see Item 1A — Risk Factors — Risks Related to Tax — "We are a holding company, and our only material asset is our interest in The Hagerty Group, and we will therefore be dependent upon distributions made by The Hagerty Group to pay taxes, make payments under the TRA and pay other expenses" in our Annual Report.

Capital Restrictions

Our reinsurance company, Hagerty Re, is subject to the Bermuda Solvency Capital Requirement ("BSCR"), which establishes a target capital level and enhanced capital requirements for each insurer. As of September 30, 2024, Hagerty Re maintained sufficient statutory capital and surplus to comply with the BSCR. Similarly, our U.S. insurance company subsidiary, Drivers Edge, which holds certificates of authority in 38 states, is subject to state-specific minimum capital and surplus requirements, as well as risk-based capital ("RBC") requirements. RBC levels are reported on an annual basis. As of September 30, 2024, Drivers Edge maintained sufficient capital and surplus levels to comply with state insurance regulators.

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 Bermuda Monetary Authority ("BMA") is also required if Hagerty Re's proposed dividend payments would exceed 25% of its prior year-end total statutory capital and surplus. In 2024, Hagerty Re could pay approximately $55 million in dividends without prior BMA approval. As of September 30, 2024, there were no plans to issue dividends from Hagerty Re.

Similarly, state statutes restrict the amount of dividends that Drivers Edge may pay without prior approval of state insurance regulators. As of September 30, 2024, there were no plans to issue dividends from Drivers Edge and a change in such plans may require regulatory approval.

Comparative Cash Flows

The following table summarizes our cash flow data for the nine months ended September 30, 2024 and 2023:

N/M = Not meaningful

Operating Activities

Cash provided by operating activities primarily consists of net income, adjusted for non-cash items, and changes in working capital balances. Net cash provided by operating activities for the nine months ended September 30, 2024 and 2023 is presented below:

Net cash provided by operating activities for the nine months ended September 30, 2024 was $189.6 million, an increase of $57.4 million, compared to 2023. This increase was due to a $40.1 million increase in Net income, after excluding non-cash adjustments, and a $17.3 million increase in cash from operating assets and liabilities.

The increase in Net income, after excluding non-cash adjustments, was primarily driven by revenue growth across all areas of our business, as well as management's cost containment measures. The increase in cash provided by operating assets and liabilities was primarily driven by this growth, as well as increased CUC payments collected in the current year as a result of an amendment to our alliance agreement and associated agency agreement with Markel, which accelerated the timing of these payments. The overall increase in cash provided by operating assets and liabilities was partially offset by a $13.9 million increase in cash paid for prepaid SaaS implementation costs. Refer to Note 2 — Revenue in Item 1 of Part I of this Quarterly Report for additional information with respect to our amendment to our alliance agreement and associated agency agreement with Markel.

Investing Activities

Cash used in investing activities for the nine months ended September 30, 2024 increased $528.0 million when compared to 2023. This increase was primarily a driven by the diversification of Hagerty Re's investment portfolio in the second quarter of 2024, which resulted in the purchase of investment-grade fixed maturity securities and, to a much lesser extent, equity securities.

Financing Activities

During the nine months ended September 30, 2024, we utilized available liquidity to reduce outstanding borrowings by $10.5 million and pay a $5.6 million cash dividend on the Series A Convertible Preferred Stock. In addition, we funded $5.7 million in employee tax obligations relating to share-based compensation vestings and $5.3 million in required distributions to THG non-controlling interest unit holders. During the nine months ended September 30, 2023, we took a number of actions to raise capital, including $79.2 million in net proceeds raised through the issuance of the Series A Convertible Preferred Stock.

Tax Receivable Agreement

We expect to have adequate capital resources to meet the requirements and obligations under the TRA entered into with the Legacy Unit Holders on December 2, 2021. The TRA requires us to pay holders of our Class V Common Stock, HHC and Markel (together the "Legacy Unit Holders"), 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 THG 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 THG 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 as described in the Legacy Unit Holders Exchange Agreement executed in connection with the Business Combination, redeem or exchange their Class V Common Stock and THG units for shares of Class A Common Stock of Hagerty, Inc. on a one-for-one basis. THG made an election under Section 754 of the IRC with the filing of its 2019 income tax return, which cannot be revoked without the permission of the Internal Revenue Service ("IRS") Commissioner and will be in place for any future exchange of THG units. The redemptions and exchanges are expected to result in increases in the tax basis of the tangible and intangible assets of THG. These increases in tax basis may reduce the amount of tax that we 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 THG. 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 THG 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.

Off-Balance Sheet Arrangements

We do not have any material off-balance sheet arrangements as of September 30, 2024.

Critical Accounting Policies and Estimates

The preparation of the unaudited Condensed Consolidated Financial Statements in accordance with GAAP requires management to make significant judgments, assumptions, and estimates that materially affect the amounts reported in the Company's Condensed Consolidated Financial Statements. Management's judgments, assumptions, and estimates are based on historical experience, future expectations, and other factors that are believed to be reasonable as of the date of the Condensed Consolidated Financial Statements. Actual results may ultimately differ from management's original estimates, as future events and circumstances sometimes do not develop as expected.

Our accounting policies are set forth in Note 1 — Basis of Presentation and Accounting Policies to Consolidated Financial Statements contained in our Annual Report. 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, which are incorporated herein by reference.

Non-GAAP Financial Measures

Adjusted EBITDA

We define Adjusted EBITDA as consolidated Net income, excluding interest and other income (expense), net, income tax (expense) benefit, and depreciation and amortization, further adjusted to exclude (i) gains and losses related to our warrant liabilities; (ii) share-based compensation expense; and when applicable, (iii) restructuring, impairment and related charges, net; (iv) gains, losses and impairments related to divestitures; and (v) certain other unusual items.

We present Adjusted EBITDA because we consider it to be an important supplemental measure of our 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, 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 or other financial statement data presented in our Condensed Consolidated Financial Statements as indicators of financial performance. Our definition of Adjusted EBITDA may be different than similarly titled measures used by 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:

in thousands

(1) Excludes interest expense related to the BAC Credit Facility, which is recorded within "Sales expense" on the Condensed Consolidated Statements of Operations.

(2) Other unusual items includes professional fees associated with the Warrant Exchange, as well as certain material severance expenses for the three and nine months ended September 30, 2024 and a net legal settlement accrual for the three and nine months ended September 30, 2023. Refer to Note 17 — Warrant Exchange in Item 1 of Part I of this Quarterly Report for additional information with respect to our warrants.

Adjusted EPS

We define Adjusted Earnings Per Share ("Adjusted EPS") as consolidated Net income, less gains and losses related to our warrant liabilities, 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 units of THG; (iii) all issued and outstanding shares of our Series A Convertible Preferred Stock on an as-converted basis; (iv) all unissued share-based compensation awards; and (v) all unexercised warrants outstanding prior to the Warrant Exchange. Refer to Note 17 — Warrant Exchange in Item 1 of Part I of this Quarterly Report for additional information with respect to the Warrant Exchange.

The most directly comparable GAAP measure to Adjusted EPS is basic earnings per share ("Basic EPS"), which is calculated as Net income 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 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, respectively, of the GAAP measure Basic EPS

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

During the second quarter of 2024, we diversified our investment portfolio and, as a result, we are exposed to interest rate risk and credit risk related to our investments. For a discussion of our exposure to market risk, refer to the market risk disclosures set forth in Part II, Item 1A of this Quarterly Report and Part II, Item 7A, "Quantitative and Qualitative Disclosures About Market Risk" in our Annual Report.

Interest rate risk - Available-for-sale securities

Interest rate risk is the risk that we will incur economic losses due to adverse changes in interest rates. The primary market risk to the investment portfolio is interest rate risk associated with investments in fixed maturity securities. Fluctuations in interest rates have a direct effect on the market valuation of these securities. When market interest rates increase, the fair value of our fixed maturity securities decreases. Conversely, as interest rates decrease, the fair value of our fixed maturity securities increases. We manage this interest rate risk by investing in securities with varied maturity dates and by managing the duration of our investment portfolio. The target duration of our investment portfolio is two to four years.

As of September 30, 2024, we held fixed maturity securities with a fair value of $522.2 million. The table below illustrates the sensitivity of the value of our fixed maturity securities with hypothetical changes in interest rates as of September 30, 2024:

Credit risk - Available-for-sale securities

Credit risk is the potential loss resulting from adverse changes in an issuer's ability to repay its debt obligations. We have exposure to credit risk as a holder of fixed maturity securities. Our risk management strategy and investment policy are designed to invest in investment grade debt and to limit the amount of credit exposure with respect to a single issuer to no greater than 5%, except for the U.S. Federal Government. As of September 30, 2024, all fixed income securities in our investment portfolio were rated investment grade by at least one nationally recognized rating organization.

Disclosure Controls and Procedures

Our management, with the participation of our 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 Securities Exchange Act of 1934, as amended (the "Exchange Act")) as of the end of the period covered by this Quarterly Report.

Based on that evaluation, our Chief Executive Officer and Chief Financial Officer concluded that our disclosure controls and procedures were effective as of September 30, 2024 to provide reasonable assurance that the information required to be disclosed by us in reports that we file or submit under the Exchange Act is (i) recorded, processed, summarized and reported within the time periods specified in the rules and forms specified by the SEC and (ii) accumulated and communicated to our management, including our Chief Executive Officer and Chief Financial Officer, as appropriate to allow timely decisions regarding required disclosure.

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, 2024, which were identified in connection with management's evaluation required by paragraph (d) of Rules 13a-15 and 15d-15 under the Exchange Act, that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

Other than the risk factor below, as of the date of this Quarterly Report, there have been no material changes to our risk factors as previously disclosed in our Annual Report. We may disclose changes to such factors or disclose additional factors from time to time in our future filings with the 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.

Performance of our investment portfolio is subject to a variety of investment risks that may adversely affect our financial results.

Our results of operations depend, in part, on the performance of our investment portfolio. We seek to hold a portfolio of investments in accordance with our investment policy, which is routinely reviewed by our Investment Committee.

Historically, our investment portfolio was primarily invested in cash and cash equivalents and fixed maturity securities. However, during the second quarter of 2024, we diversified our investment portfolio by opening positions in higher-yield fixed maturity securities and, to a lesser extent, equity securities. Our investments in marketable equity securities are carried on our balance sheet at fair market value and are subject to potential losses and declines in market value.

The Federal Reserve began lowering interest rates in September 2024. If interest rates continue to decline, this would place pressure on our net investment income, particularly as it relates to our short-term investments, which, in turn, may adversely affect our operating results. Conversely, if interest rates were to increase, it could cause the values of our fixed income securities portfolios to decline, with the magnitude of the decline depending on the duration of securities included in our portfolio and the amount by which interest rates increase.

The value of our investment portfolio is subject to the risk that certain investments may default or become impaired due to deterioration in the financial condition of one or more issuers of the securities we hold, or due to deterioration in the financial condition of an insurer that guarantees an issuer's payments on such investments. Downgrades in the credit ratings of fixed maturity securities also have a significant negative effect on the market value of such securities.

Each of the foregoing factors could reduce our net investment income and result in realized investment losses. Risks for all types of securities are managed through the application of our investment policy, which establishes investment parameters that include, but are not limited to, maximum percentages of investment in certain types of securities and minimum levels of credit quality. We cannot be certain that our investment objectives will be achieved, and results may vary substantially over time. In addition, although we seek to employ investment strategies that are not correlated with our insurance and reinsurance exposures, losses in our investment portfolio may occur at the same time as underwriting losses and, therefore, exacerbate the adverse effect of the losses on us.