KINGSTONE COMPANIES, INC. – 10-K – MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS.

Edgar Online, Inc.

Overview

We offer property and casualty insurance products to small businesses and individuals in New York State through our subsidiary, Kingstone Insurance Company ("KICO"). KICO's insureds are located primarily in downstate New York, consisting of New York City, Long Island and Westchester County.

  We derive 99% of our revenue from KICO, which includes revenues from earned premiums, ceding commissions from quota share reinsurance, net investment income generated from our portfolio, and net realized gains and losses on investment securities. All of our policies are for a one year period. Earned premiums represent premiums received from insureds, which are recognized as revenue over the period of time that insurance coverage is provided (i.e., ratably over the one year life of the policy). A significant period of time normally elapses between the receipt of insurance premiums and the payment of insurance claims. During this time, KICO invests the premiums, earns investment income and generates net realized and unrealized investment gains and losses on investments.                                          20

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Our expenses include the insurance underwriting expenses of KICO and other operating expenses. Insurance companies incur a significant amount of their total expenses from policyholder losses, which are commonly referred to as claims. In settling policyholder losses, various loss adjustment expenses ("LAE") are incurred such as insurance adjusters' fees and litigation expenses. In addition, insurance companies incur policy acquisition expenses. Policy acquisition costs include commissions paid to producers, premium taxes, and other expenses related to the underwriting process, including employees' compensation and benefits.

  Other operating expenses include the corporate expenses of our holding company, Kingstone Companies, Inc. These expenses include legal and auditing fees, occupancy costs related to our corporate office, executive employment costs, and other costs directly associated with being a public company.  

Principal Revenue and Expense Items

  Net premiums earned. Net premiums earned is the earned portion of our written premiums, less that portion of premium that is ceded to third party reinsurers under reinsurance agreements. The amount ceded under these reinsurance agreements is based on a contractual formula contained in the individual reinsurance agreement. Insurance premiums are earned on a pro rata basis over the term of the policy. At the end of each reporting period, premiums written that are not earned are classified as unearned premiums and are earned in subsequent periods over the remaining term of the policy. Our insurance policies have a term of one year. Accordingly, for a one-year policy written on July 1, 2011, we would earn half of the premiums in 2011 and the other half in 2012.  Ceding commission revenue. Commissions on reinsurance premiums ceded are earned in a manner consistent with the recognition of the direct acquisition costs of the underlying insurance policies, generally on a pro-rata basis over the terms of the policies reinsured.  Net investment income and net realized gains (losses) on investments. We invest our statutory surplus funds and the funds supporting our insurance liabilities primarily in cash and cash equivalents, short-term investments, fixed maturity and equity securities. Our net investment income includes interest and dividends earned on our invested assets, less investment expenses. Net realized gains and losses on our investments are reported separately from our net investment income. Net realized gains occur when our investment securities are sold for more than their costs or amortized costs, as applicable. Net realized losses occur when our investment securities are sold for less than their costs or amortized costs, as applicable, or are written down as a result of other-than-temporary impairment. We classify equity securities and our fixed maturity securities as available-for-sale. Net unrealized gains (losses) on those securities classified as available-for-sale are reported separately within accumulated other comprehensive income on our balance sheet.  Other income. We recognize installment fee income and fees charged to reinstate a policy after it has been cancelled for non-payment. We also recognize premium finance fee income on loans financed by a third party finance company.  Loss and loss adjustment expenses incurred. Loss and loss adjustment expenses ("LAE") incurred represent our largest expense item and, for any given reporting period, include estimates of future claim payments, changes in those estimates from prior reporting periods and costs associated with investigating, defending and servicing claims. These expenses fluctuate based on the amount and types of risks we insure. We record loss and LAE related to estimates of future claim payments based on case-by-case valuations and statistical analyses. We seek to establish all reserves at the most likely ultimate exposure based on our historical claims experience. It is typical for certain claims to take several years to settle and we revise our estimates as we receive additional information from the claimants. Our ability to estimate loss and LAE accurately at the time of pricing our insurance policies is a critical factor in our profitability.                                          21

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  Commission expenses and other underwriting expenses. Other underwriting expenses include acquisition costs and other underwriting expenses. Acquisition costs represent the costs of writing business that vary with, and are primarily related to, the production of insurance business (principally commissions, premium taxes and certain underwriting salaries). Policy acquisition costs are deferred and recognized as expense as the related premiums are earned. Other underwriting expenses represent general and administrative expenses. General and administrative expenses are comprised of other costs associated with our insurance activities such as regulatory fees, telecommunication and technology costs, occupancy costs, employment costs, and legal and auditing fees.  Other operating expenses. Other operating expenses include the corporate expenses of our holding company, Kingstone Companies, Inc. These expenses include executive employment costs, legal and auditing fees, occupancy costs related to our corporate office and other costs directly associated with being a public company.  Non-cash equity compensation. Non-cash equity compensation includes the fair value of stock grants issued to our directors and Chief Executive Officer and amortization of stock options issued to our employees.  Depreciation and amortization. Depreciation and amortization includes the amortization of intangibles related to the acquisition of KICO, depreciation of the office building used in KICO's operations, as well as depreciation of office equipment and furniture.  

Interest expense. Interest expense represents amounts we incur on our outstanding indebtedness at the then-applicable interest rates.

Income tax expense. We incur federal income tax expense on our consolidated operations as well as state income tax expense for our non-insurance underwriting subsidiaries.

Key Measures

We utilize the following key measures in analyzing the results of our insurance underwriting business:

  Net loss ratio. The net loss ratio is a measure of the underwriting profitability of an insurance company's business. Expressed as a percentage, this is the ratio of net losses and loss adjustment expenses ("LAE") incurred to net premiums earned.  Net underwriting expense ratio. The net underwriting expense ratio is a measure of an insurance company's operational efficiency in administering its business. Expressed as a percentage, this is the ratio of the sum of acquisition costs (the most significant being commissions paid to our producers) and other underwriting expenses less ceding commission revenue less other income to net premiums earned.  Net combined ratio. The net combined ratio is a measure of an insurance company's overall underwriting profit. This is the sum of the net loss and net underwriting expense ratios. If the net combined ratio is at or above 100 percent, an insurance company cannot be profitable without investment income, and may not be profitable if investment income is insufficient.                                          22

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  Underwriting income. Underwriting income is net pre-tax income attributable to our insurance underwriting business except for net investment income, net realized gains from investments, and depreciation and amortization (net premiums earned less expenses included in combined ratio). Underwriting income is a measure of an insurance company's overall operating profitability before items such as investment income, depreciation and amortization, interest expense and income taxes.  

Critical Accounting Policies and Estimates

  Our consolidated financial statements include the accounts of Kingstone Companies, Inc. and all majority-owned and controlled subsidiaries. The preparation of financial statements in conformity with accounting principles generally accepted in the United States requires our management to make estimates and assumptions in certain circumstances that affect amounts reported in our consolidated financial statements and related notes. In preparing these financial statements, our management has utilized information available including our past history, industry standards and the current economic environment, among other factors, in forming its estimates and judgments of certain amounts included in the consolidated financial statements, giving due consideration to materiality. It is possible that the ultimate outcome as anticipated by our management in formulating its estimates inherent in these financial statements might not materialize. However, application of the critical accounting policies involves the exercise of judgment and use of assumptions as to future uncertainties and, as a result, actual results could differ from these estimates. In addition, other companies may utilize different estimates, which may impact comparability of our results of operations to those of companies in similar businesses.  We believe that the most critical accounting policies relate to the reporting of reserves for loss and LAE, including losses that have occurred but have not been reported prior to the reporting date, amounts recoverable from third party reinsurers, deferred ceding commission revenue, deferred policy acquisition costs, deferred income taxes, the impairment of investment securities, intangible assets and the valuation of stock-based compensation. See Note 2 (Accounting Policies and Basis of Presentation) of the Notes to Consolidated Financial Statements following Item 15 of this Annual Report.                                          23

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Consolidated Results of Operations

The following table summarizes the changes in the results of our operations (in thousands) for the periods indicated:

                                                          Years ended December 31, ($ in thousands)                             2012          2011         Change        Percent  Revenues  Direct written premiums                   $  49,252     $  40,735     $   8,517           20.9 %  Net written premiums                         19,560        16,296         3,264           20.0 %  Change in net unearned premiums              (2,343 )      (1,427 )        

(916 ) 64.2 %

  Net premiums earned                          17,217        14,869         2,348           15.8 %  Ceding commission revenue (1)                 9,690        10,625          

(935 ) (8.8 ) %

  Net investment income                         1,015           754           261           34.6 %  Net realized gain on investments                288           524          (236 )        (45.0 )  %  Other income                                    868           921           (53 )         (5.8 )  %  Total revenues                               29,078        27,693         1,385            5.0 %   Expenses

Loss and loss adjustment expenses (1)

  Direct and assumed loss and loss adjustment expenses                           32,631        15,644        

16,987 108.6 %

  Less: ceded loss and loss adjustment expenses                                     (21,396 )      (7,073 )     

(14,323 ) 202.5 %

Net loss and loss adjustment expenses 11,235 8,571 2,664

           31.1 %  Commission expense                            7,246         6,230         1,016           16.3 %  Other underwriting expenses                   7,849         7,373           476            6.5 %  Other operating expenses                      1,000         1,203          

(203 ) (16.9 ) %

  Depreciation and amortization                   596           603            (7 )         (1.2 )  %  Interest expense                                 82           121           (39 )        (32.2 )  %  Total expenses                               28,008        24,101         3,907           16.2 %   Income from operations before taxes           1,070         3,592        (2,522 )        (70.2 )  %  Provision for income tax                        303         1,089          (786 )        (72.2 )  %  Net income                                $     767     $   2,503     $  (1,736 )        (69.4 )  %   Percent of total revenues:  Net premiums earned                            59.2 %        53.7 %  Ceding commission revenue                      33.3 %        38.4 %  Net investment income                           3.5 %         2.7 %  Net realized gains on investments               1.0 %         1.9 %  Other income                                    3.0 %         3.3 %                                                100.0 %       100.0 %    (1) For the year ended December 31, 2012, includes direct catastrophe losses and loss adjustment expenses of $13,261,000, and net catastrophe losses and loss adjustment expenses of $1,143,000, incurred on October 29, 2012 from Superstorm Sandy. The computation to arrive at contingent ceding commission revenue includes direct catastrophe losses and loss adjustment expenses incurred from Superstorm Sandy. Such losses increased our ceded loss ratio which reduced our contingent ceding commission revenue by $1,919,000. For the year ended December 31, 2011, includes direct catastrophe losses and loss adjustment expenses of $1,796,000, and net catastrophe losses and loss adjustment expenses of $449,000, incurred from August 27, 2011 to August 29, 2011 from Tropical Storm Irene. The computation to arrive at contingent ceding commission revenue includes direct catastrophe losses and loss adjustment expenses incurred from Tropical Storm Irene. Such losses increased our ceded loss ratio which reduced our contingent ceding commission revenue by $200,000. We define a "catastrophe" as an event that involves multiple first party policyholders, or an event that produces a number of claims in excess of a preset, per-event threshold of average claims in a specific area, occurring within a certain amount of time constituting the event. Catastrophes are caused by various natural events including high winds, excessive rain, winter storms, tornadoes, hailstorms, wildfires, tropical storms, and hurricanes.                                          24

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  Direct written premiums during the year ended December 31, 2012 ("2012") were $49,252,000 compared to $40,735,000 during the year ended December 31, 2011 ("2011"). The increase of $8,517,000, or 20.9%, was primarily due to an increase in policies in-force during 2012 as compared to 2011. We wrote more policies as a result of an increase in demand for the products in the markets that we serve. Policies in-force increased by 20.9% as of December 31, 2012 compared to December 31, 2011. In addition to the increase of policies in-force, we are also writing more policies which have higher premiums.  Net written premiums increased $3,264,000, or 20.0%, to $19,560,000 in 2012 from $16,296,000 in 2011. The increase in net written premiums resulted from: (1) an increase in direct written premiums in 2012 compared to direct written premiums in 2011, and (2) effective July 1, 2012, a decrease in the quota share percentage in our commercial lines quota share treaty from 60% to 40%. A decrease in the quota share percentage results in us retaining a greater amount of direct written premiums. Net written premiums grew at a lower rate than direct written premiums (20.0% compared to 20.9%) due to increases in policies written in lines of business that are subject to quota share reinsurance treaties, primarily personal lines and commercial lines, in excess of the decrease in policies written in lines of business without quota share reinsurance treaties, primarily commercial auto lines.  Net premiums earned increased $2,348,000, or 15.8%, to $17,217,000 in 2012 from $14,869,000 in 2011. As premiums written earn ratably over a twelve month period, the increase was a result of higher net written premiums for the twelve months ended December 31, 2012 compared to the twelve months ended December 31, 2011.  

The following table summarizes the changes in the components of ceding commission revenue (in thousands) for the periods indicated:

                                                      Years ended December 31,   ($ in thousands)                         2012         2011        Change      Percent 

Provisional ceding commissions earned $ 8,516$ 6,916$ 1,600

23.1 %

Contingent ceding commissions earned 1,174 3,709 (2,535 ) (68.3 ) %

Total ceding commission revenue $ 9,690$ 10,625 $ (935 ) (8.8 ) %

    Ceding commission revenue was $9,690,000 in 2012 compared to $10,625,000 in 2011. The decrease of $935,000, or 8.8%, was due to the increase provisional ceding commissions earned offset by a decrease in contingent ceding commissions earned. The $1,600,000 increase in provisional ceding commissions earned is due to a net increase in the amount of premiums ceded. The $2,535,000 decrease in contingent ceding commissions earned is due to the effects of Superstorm Sandy on our ceded net loss ratio which reduced our contingent ceding commission revenue by $1,918,000 and an increase in losses incurred under our personal lines quota share reinsurance treaty from prior year claims.  Net investment income was $1,015,000 in 2012 compared to $754,000 in 2011. The increase of $261,000, or 34.6%, was due to an increase in average invested assets in 2012 as compared to 2011. The increase in cash and invested assets resulted primarily from increased operating cash flows and by an adjustment to amortization of bond premium in 2011. The tax equivalent investment yield, excluding cash, was 5.14% and 5.43% at December 31, 2012 and 2011, respectively.  Net realized gains on investments were $288,000 in 2012 compared to $524,000 in 2011. The decrease of $236,000, or 45.0%, was due in part to an FDIC recovery of $133,000 in 2011 from a failed bank which was included in other than temporary impaired losses in 2009.  Net loss and loss adjustment expenses were $11,235,000 in 2012 compared to $8,571,000 in 2011. The net loss ratio was 65.3% in 2012 compared to 57.6% in 2011, an increase of 7.7 percentage points. Net losses in 2012 included the effects of Superstorm Sandy in October 2012 and Tropical Storm Irene in August 2011, which we define both as a catastrophe. As a result of Superstorm Sandy, we incurred $1,143,000 of losses and loss adjustment expenses (net of reinsurance recoverable of $12,118,000), and added 6.7 percentage points to our net loss ratio. As a result of Tropical Storm Irene, we incurred $449,000 of losses and loss adjustment expenses (net of reinsurance recoverable of $1,347,000), and added 3.0 percentage points to our net loss ratio. Our net loss ratio excluding the effect of catastrophes in 2012 was 58.6% in in 2012, compared to 54.6% in 2011, an increase of 4.0 percentage points.                                          25

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  Commission expense was $7,246,000 in 2012 or 14.7% of direct written premiums. Commission expense was $6,230,000 in 2011 or 15.3% of direct written premiums. The increase of $1,016,000 is due to the increase in direct written premiums in 2012 as compared to 2011, offset by a decrease in contingent commissions due to brokers as a result of the effects from Superstorm Sandy.  Other underwriting expenses were $7,849,000 in 2012 compared to $7,373,000 in 2011. The $476,000, or 6.5%, increase in other underwriting expenses was primarily due to expenses directly related to the increase in direct written premiums, increase in occupancy costs and additional employment costs due to both the hiring of additional staff needed to service our growth in written premiums and increases in annual salaries. Other underwriting expenses as a percentage of direct written premiums was 15.9% in 2012 and 18.1% in 2011. Our other underwriting expenses increased at a lower rate than the growth in our direct written premiums.  Other operating expenses, related to the corporate expenses of our holding company, were $1,000,000 in 2012 compared to $1,203,000 in 2011. The $203,000 decrease in 2012, or 16.9%, was primarily due to decreases in executive bonuses, occupancy costs, professional fees, and amortization of stock options as a result of more stock options being fully vested prior to 2012.  Interest expense was $82,000 in 2012 compared to $121,000 in 2011. The $39,000 decrease in interest expense, or 32.2%, was due to the partial redemption of $703,000 of our 2009/2010 Notes during the quarter ended September 30, 2011, and effective July 11, 2011, a reduction in the interest rate to 9.5% per annum from the previous 12.625% per annum. The decrease in interest expense from our 2009/2010 Notes was offset by $11,000 of interest paid on our bank line of credit which was opened in December 2011.  Income tax expense in 2012 was $303,000, which resulted in an effective tax rate of 28.3%. Income tax expense in 2011 was $1,089,000, which resulted in an effective tax rate of 30.3%. Income before taxes was $1,070,000 in 2012 compared to $3,592,000 in 2011. The decrease in the effective tax rate by 2.0% in 2012 is a result of permanent differences from nontaxable investment income and the dividends received deduction having a greater impact on the effective tax rate in 2012 due to a lesser amount of book income in 2012 compared to 2011. The decrease in the effective tax rate from the impact of permanent differences was offset by recording a valuation allowance in 2012 against our state net operating loss carryovers compared to no such allowance in 2011. Kingstone Companies, Inc. generates operating losses for state income tax purposes and has prior year net operating loss carryovers available. KICO, our insurance underwriting subsidiary is subject to a state tax based on premiums and is not included in our consolidated state income tax return. A valuation allowance of $42,000 was recorded by us in December 2011 and an additional valuation allowance of $105,000 was recorded in 2012. The valuation allowance was established due to the uncertainty of generating enough state taxable income to utilize 100% of our available state net operating loss carryovers over their remaining lives which expire between 2022 and 2027.  Net income was $767,000 in 2012 compared to $2,503,000 in 2011. The decrease in net income of $1,736,000 was due to the circumstances described above that caused the increase in our net loss ratio, decrease in contingent ceding commission revenues, and increases in other commission expense and underwriting expenses related to premium growth, offset by increases in our net premiums earned.                                          26

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Insurance Underwriting Business on a Standalone Basis

Our insurance underwriting business reported on a standalone basis for the years ended December 31, 2012 and 2011 follows:

                                                         Years ended                                                        December 31,                                                    2012             2011             Revenues            Net premiums earned                 $ 17,216,611     $

14,868,746

            Ceding commission revenue              9,690,155       

10,624,714

           Net investment income                  1,015,156          754,630            Net realized gain on investments         288,068          523,894            Other income                             476,661          430,034            Total revenues                        28,686,651       27,202,018             Expenses            Loss and loss adjustment expenses     11,234,713        

8,571,058

            Commission expense                     7,246,245        

6,230,564

            Other underwriting expenses            7,848,870        

7,372,878

           Depreciation and amortization            595,189         

597,943

            Total expenses                        26,925,017       

22,772,443

             Income from operations                 1,761,634        

4,429,575

            Income tax expense                       495,278        1,363,956            Net income                          $  1,266,356     $  3,065,619   

The effect of catastrophes by line of business on our net premiums earned and our direct, ceded and net loss and loss adjustment expenses included in our results of operations for the years ended December 31, 2012 and 2011 follows:

                                              Personal        Commercial       Commercial                                               Lines            Lines             Auto            Total  Year ended December 31, 2012: Reinstatement premiums for catastrophe coverage included in net premiums earned            $     77,344     $          -    

$ - $ 77,344

Direct loss and loss adjustment expenses $ 12,834,503$ 51,445

  $    375,016     $ 13,260,964 Less: ceded loss and loss adjustment expenses                                     12,084,503                -           33,439       12,117,942 Net loss and loss adjustment expenses      $    750,000     $     51,445    

$ 341,577$ 1,143,022

  Year ended December 31, 2011: Reinstatement premiums for catastrophe coverage included in net premiums earned            $          -     $          -    

$ - $ -

Direct loss and loss adjustment expenses $ 1,796,117 $ -

  $          -     $  1,796,117 Less: ceded loss and loss adjustment expenses                                      1,347,088                -                -        1,347,088 

Net loss and loss adjustment expenses $ 449,029 $ -

 $          -     $    449,029                                            27

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An analysis of our direct, assumed and ceded earned premiums, loss and loss adjustment expenses, and loss ratios is shown below:

                                                Direct         Assumed          Ceded             Net  

Year ended December 31, 2012

  Written premiums                          $ 49,251,630     $  23,967     $ 

(29,715,971 ) $ 19,559,626

  Unearned premiums                           (4,724,193 )      (5,010 )     

2,386,188 (2,343,015 )

  Earned premiums                           $ 44,527,437     $  18,957     $ 

(27,329,783 ) $ 17,216,611

   Loss and loss adjustment expenses exluding  the effect of catastrophes                $ 19,339,488     $  31,029     $  (9,278,826 )   $ 10,091,691  Catastrophe loss                            13,260,964             -       (12,117,942 )      1,143,022

Loss and loss adjustment expenses $ 32,600,452$ 31,029 $ (21,396,768 ) $ 11,234,713

   Loss ratio excluding the effect of catastrophes                                       43.4 %       163.7 %            34.0 %           58.6 %  Catastrophe loss                                  29.8 %         0.0 %            44.3 %            6.7 %  Loss ratio                                        73.2 %       163.7 %            78.3 %           65.3 % 

Year ended December 31, 2011

  Written premiums                          $ 40,734,767     $  10,990     $ 

(24,449,655 ) $ 16,296,102

  Unearned premiums                           (4,005,312 )        (516 )     

2,578,472 (1,427,356 )

  Earned premiums                           $ 36,729,455     $  10,474     $ 

(21,871,183 ) $ 14,868,746

   Loss and loss adjustment expenses exluding  the effect of catastrophes                $ 13,830,599     $  17,368     $  (5,725,938 )   $  8,122,029  Catastrophe loss                             1,796,117             -        (1,347,088 )        449,029

Loss and loss adjustment expenses $ 15,626,716$ 17,368 $

(7,073,026 ) $ 8,571,058

   Loss ratio excluding the effect of catastrophes                                       37.7 %       165.8 %            26.2 %           54.6 %  Catastrophe loss                                   4.9 %         0.0 %             6.2 %            3.0 %  Loss ratio                                        42.5 %       165.8 %            32.3 %           57.6 %                                            28

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The key measures for our insurance underwriting business for the years ended December 31, 2012 and 2011 are as follows:

                                                                 Years ended                                                                 December 31,                                                            2012             2011  Net premiums earned                                    $ 17,216,611     $  14,868,746 Ceding commission revenue (1)                             9,690,155        

10,624,714

 Other income                                                476,661         

430,034

  Loss and loss adjustment expenses (2)                    11,234,713         

8,571,058

Acquistion costs and other underwriting expenses:

  Commission expense                                       7,246,245         

6,230,564

  Other underwriting expenses                              7,848,870         

7,372,878

Total acquistion costs and other

 underwriting expenses                                   15,095,115        13,603,442   Underwriting income                                   $  1,053,599     $   3,748,994  Key Measures:  Net loss ratio excluding the effect of catastrophes           58.6 %       

54.6 %

  Effect of catastrophe loss on loss ratio (2)                   6.7 %       

3.0 %

  Net loss ratio                                                65.3 %       

57.6 %

Net underwriting expense ratio excluding the

  effect of catastrophes                                        17.5 %       

13.8 %

Effect of catastrophe loss on net underwriting

  expense ratio (1) (2)                                         11.1 %       

3.3 %

  Net underwriting expense ratio                                28.6 %       

17.1 %

Net combined ratio excluding the effect

  of catastrophes                                               76.1 %       

68.5 %

Effect of catastrophe loss on net combined

 ratio (1) (2)                                                 17.8 %             6.3 %  Net combined ratio                                            93.9 %            74.8 % 

Reconciliation of net underwriting expense ratio:

Acquisition costs and other

  underwriting expenses                                 $ 15,095,115     $  

13,603,442

  Less: Ceding commission revenue (1)                     (9,690,155 )     (10,624,714 )  Less: Other income                                        (476,661 )        (430,034 )                                                        $  4,928,299     $   2,548,694   Net earned premium                                    $ 17,216,611     $  14,868,746    (1) The effect of catastrophes reduced contingent ceding commission revenue by $1,918,871 and $200,516 for the years ended December 31, 2012 and 2011, respectively. A provision in our quota share reinsurance treaty, which expired June 30, 2011, limited the maximum contingent ceding commission that could be paid to us, with the unused benefit carried forward to the treaty year which began July 1, 2011. The carry forward of the unused benefit resulted in additional contingent ceding commission revenue of approximately $264,000 for the year ended December 31, 2011.  (2) Includes (a) the sum of direct catastrophe losses and loss adjustment expenses and (b) the sum of net catastrophe losses and loss adjustment expenses of $13,260,964 and $1,143,022, respectively, for the year ended December 31, 2012. Includes (x) the sum of direct catastrophe losses and loss adjustment expenses and (y) the sum of net catastrophe losses and loss adjustment expenses of $1,796,117 and $449,029, respectively, for the year ended December 31, 2011.                                          29

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  Table Of Contents  Investments  Portfolio Summary  The following table presents a breakdown of the amortized cost, aggregate fair value and unrealized gains and losses by investment type as of December 31, 2012 and 2011:  

Available for Sale Securities

                                                                  December 31, 2012                            Cost or           Gross              Gross Unrealized Losses             Aggregate         % of                          Amortized       Unrealized       Less than 12          More than 12          Fair           Fair Category                    Cost            Gains            Months                Months            Value           Value  Political subdivisions of States, Territories and Possessions             $  5,219,092     $   257,298     $        (1,574 )     $            -     $  5,474,816          17.4 %  Corporate and other bonds Industrial and miscellaneous             19,628,005       1,123,392             (43,553 )               (722 )     20,707,122          65.8 %  Total fixed-maturity securities                24,847,097       1,380,690             (45,127 )               (722 )     26,181,938          83.2 % Equity Securities          5,073,977         373,294            (157,029 )                  -        5,290,242          16.8 %  Total                  $ 29,921,074     $ 1,753,984     $      (202,156 )     $         (722 )   $ 31,472,180         100.0 %                                                                    December 31, 2011                             Cost or           Gross            Gross Unrealized Losses           Aggregate         % of                           Amortized       Unrealized      Less than 12       More than 12          Fair           Fair Category                     Cost            Gains           Months             Months            Value           Value  U.S. Treasury securities and obligations of U.S. government corporations and agencies                 $    499,832     $    50,356     $           -     $            -     $    550,188           2.1 %  Political subdivisions of States, Territories and Possessions                 5,868,743         301,559                 -                  -        6,170,302          23.2 %  Corporate and other bonds Industrial and miscellaneous              15,846,616         338,284          (228,792 )   

(107,666 ) 15,848,442 59.5 %

  Total fixed-maturity securities                 22,215,191         690,199          (228,792 )         (107,666 )     22,568,932          84.7 % Equity Securities           3,857,741         311,300           (98,938 )           (4,893 )      4,065,210          15.3 %  Total                   $ 26,072,932     $ 1,001,499     $    (327,730 )   $     (112,559 )   $ 26,634,142         100.0 %                                            30

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   Table Of Contents  Held to Maturity Securities                                                                       December 31, 2012                               Cost or          Gross                 Gross Unrealized Losses                             % of                             Amortized       Unrealized       Less than 12             More than 12        Fair          Fair Category                       Cost           Gains             Months                   Months           Value         Value   U.S. Treasury securities   $  606,281     $    172,745     $            -           $            -     $ 779,026         100.0 %                                                                        December 31, 2011                              Cost or          Gross                 Gross Unrealized Losses                             % of                            Amortized       Unrealized       Less than 12             More than 12        Fair          Fair Category                      Cost           Gains             Months                   Months           Value         Value  U.S. Treasury securities   $  606,234     $    171,719     $            -           $            -     $ 779,953         100.0 %   

All held to maturity securities are held in trust pursuant to the New York State Department of Financial Services' minimum funds requirement.

Contractual maturities of all held to maturity securities are greater than ten years.

Credit Rating of Fixed-Maturity Securities

  The table below summarizes the credit quality of our available for sale fixed-maturity securities as of December 31, 2012 and 2011 as rated by Standard and Poor's:                                                    December 31, 2012                    December 31, 2011                                                              Percentage of                        Percentage of                                            Fair Market        Fair Market       Fair Market        Fair Market                                               Value              Value             Value              Value  Rating U.S. Treasury securities                   $          -                 0.0 %   $    550,188                 2.4 % AAA                                           2,226,603                 8.5 %      3,041,576                13.5 % AA                                            4,088,304                15.6 %      4,502,733                20.0 % A                                             6,963,380                26.6 %      6,977,222                30.9 % BBB                                          12,903,651                49.3 %      7,497,213                33.2 % Total                                      $ 26,181,938              100.00 %   $ 22,568,932               100.0 %                                            31

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  The table below summarizes the average duration by type of fixed-maturity security as well as detailing the average yield as of December 31, 2012 and 2011:                                                   December 31, 2012                  December 31, 2011                                                               Weighted                           Weighted                                                                Average                            Average                                             Average          Duration in       Average          Duration in Category                                    Yield %             Years          Yield %             Years  U.S. Treasury securities and obligations of U.S. government corporations and agencies                        3.33 %              27.8           2.75 %              17.8  Political subdivisions of States, Territories and Possessions                      4.06 %               6.1           3.86 %               5.2  Corporate and other bonds Industrial and miscellaneous                     4.74 %               7.3           4.98 %               7.1    Fair Value Consideration  As disclosed in Note 4 to the Consolidated Financial Statements, with respect to "Fair Value Measurements," we define fair value under GAAP guidance as the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants (an "exit price"). This GAAP guidance establishes a fair value hierarchy that distinguishes between inputs based on market data from independent sources ("observable inputs") and a reporting entity's internal assumptions based upon the best information available when external market data is limited or unavailable ("unobservable inputs"). The fair value hierarchy in GAAP prioritizes fair value measurements into three levels based on the nature of the inputs. Quoted prices in active markets for identical assets have the highest priority ("Level 1"), followed by observable inputs other than quoted prices including prices for similar but not identical assets or liabilities ("Level 2"), and unobservable inputs, including the reporting entity's estimates of the assumption that market participants would use, having the lowest priority ("Level 3"). As of December 31, 2012 and 2011, 54% and 49%, respectively, of the investment portfolio recorded at fair value was priced based upon quoted market prices.  As more fully described in Note 3 to our Consolidated Financial Statements, "Investments-Impairment Review," we completed a detailed review of all our securities in a continuous loss position as of December 31, 2012 and 2011, and concluded that the unrealized losses in these asset classes are the result of a decrease in value due to technical spread widening and broader market sentiment, rather than fundamental collateral deterioration, and are temporary in nature.                                          32

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  The table below summarizes the gross unrealized losses of our fixed-maturity securities available for sale and equity securities by length of time the security has continuously been in an unrealized loss position as of December 31, 2012 and 2011:                                                                                 December 31, 2012                                       Less than 12 months                              12 months or more                              Total                                                             No. of                                          No. of          Aggregate                              Fair         Unrealized       Positions        Fair        Unrealized        Positions           Fair         Unrealized  Category                    Value          Losses           Held           Value         Losses             Held             Value          Losses  Fixed-Maturity Securities: U.S. Treasury securities and obligations of U.S. government corporations and agencies              $         -     $         -               -     $       -     $         -                  -     $         -     $         -  Political subdivisions of States, Territories and Possessions                   202,798          (1,574 )             1             -               -                  -         202,798          (1,574 )  Corporate and other bonds industrial and miscellaneous               4,025,551         (43,553 )            19       128,125            (722 )                1       4,153,676         (44,275 )  Total fixed-maturity securities                $ 4,228,349     $   (45,127 )            20     $ 128,125     $      (722 )                1     $ 4,356,474     $   (45,849 )  Equity Securities: Preferred stocks          $   387,925     $   (11,130 )             3     $       -     $         -                  -     $   387,925     $   (11,130 ) Common stocks               1,536,860        (145,899 )             9             -               -                  -       1,536,860        (145,899 )  Total equity securities   $ 1,924,785     $  (157,029 )            12     $       -     $         -                  -     $ 1,924,785     $  (157,029 )  Total                     $ 6,153,134     $  (202,156 )            32     $ 128,125     $      (722 )                1     $ 6,281,259     $  (202,878 )                                            33

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   Table Of Contents                                                                                 December 31, 2011                                       Less than 12 months                              12 months or more                             Total                                                             No. of                                          No. of         Aggregate                              Fair         Unrealized       Positions         Fair         Unrealized       Positions         Fair         Unrealized Category                     Value          Losses           Held            Value          Losses           Held            Value          Losses  Fixed-Maturity Securities: U.S. Treasury securities and obligations of U.S. government corporations and agencies              $         -     $         -               -     $         -     $         -               -     $         -     $         -  Political subdivisions of States, Territories and Possessions                         -               -               -               -               -               -               -               -  Corporate and other bonds industrial and miscellaneous               4,849,378        (228,792 )            26       1,483,425        (107,666 )             7       6,332,803        (336,458 )  Total fixed-maturity securities                $ 4,849,378     $  (228,792 )            26     $ 1,483,425     $  (107,666 )             7     $ 6,332,803     $  (336,458 )  Equity Securities: Preferred stocks          $   368,350     $   (76,969 )            12     $   189,364     $    (4,893 )             5     $   557,714     $   (81,862 ) Common stocks                 397,268         (21,969 )            14               -               -               -         397,268         (21,969 )  Total equity securities   $   765,618     $   (98,938 )            26     $   189,364     $    (4,893 )             5     $   954,982     $  (103,831 )  Total                     $ 5,614,996     $  (327,730 )            52     $ 1,672,789     $  (112,559 )            12     $ 7,287,785     $  (440,289 )                                            34

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  There were 33 securities at December 31, 2012 that accounted for the gross unrealized loss, none of which were deemed by us to be other than temporarily impaired. There were 64 securities at December 31, 2011 that accounted for the gross unrealized loss, none of which were deemed by us to be other than temporarily impaired. Significant factors influencing our determination that unrealized losses were temporary included the magnitude of the unrealized losses in relation to each security's cost, the nature of the investment and management's intent not to sell these securities and it being not more likely than not that we will be required to sell these investments before anticipated recovery of fair value to our cost basis.  

Liquidity and Capital Resources

Cash Flows

  The primary sources of cash flow are from our insurance underwriting subsidiary, KICO, which includes direct premiums written, ceding commissions from our quota share reinsurers, loss recovery payments from our reinsurers, investment income and proceeds from the sale or maturity of investments. Funds are used by KICO for ceded premium payments to reinsurers, which are paid on a net basis after subtracting losses paid on reinsured claims and reinsurance commissions. KICO also uses funds for loss payments and loss adjustment expenses on our net business, commissions to producers, salaries and other underwriting expenses as well as to purchase investments and fixed assets.  On July 1, 2009, we completed the acquisition of 100% of the issued and outstanding common stock of KICO (formerly known as Commercial Mutual Insurance Company ("CMIC")) pursuant to the conversion of CMIC from an advance premium cooperative to a stock property and casualty insurance company. Pursuant to the plan of conversion, we acquired a 100% equity interest in KICO. In connection with the plan of conversion of CMIC, we agreed with the Department of Financial Services (formerly known as the Insurance Department) (the "Department") that, for a period of two years following the effective date of conversion of July 1, 2009, no dividend could be paid by KICO to us without the approval of the Department ("Dividend Restriction Period"). No such request was made by us to the Department within the Dividend Restriction Period. For year ended December 31, 2012, KICO paid dividends of $700,000 to us. We also agreed with the Department that certain intercompany transactions between KICO and us must be filed with the Department 30 days prior to implementation and not disapproved by the Department.  The primary sources of cash flow for our holding company operations are in connection with the fee income we receive from the premium finance loans and collection of principal and interest income from the notes received by us upon the sale of businesses that were included in our former discontinued operations. Effective July 1, 2011, as discussed above, we may also receive cash dividends from KICO, subject to statutory restrictions.  In December 2011, we entered into an agreement with a bank for a $500,000 line of credit to be used for general corporate needs. In January 2013, the line of credit was increased to $600,000. The principal balance is payable on demand, and must be reduced to zero for a minimum of 30 consecutive days during each year of the term of the credit line. The principal balance was reduced to zero in accordance with the terms of the credit line in 2012. The outstanding balance was $450,000 as of December 31, 2012. On March 6, 2013, the line of credit, which had an outstanding balance of $550,000, was paid in full. If the aforementioned is insufficient to cover our holding company cash requirements, we will seek to obtain additional financing.                                          35

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  We prepaid $703,000 of our notes payable during the year ended December 31, 2011. As of December 31, 2012, the outstanding principal balance of our notes payable was $747,000; such notes bear interest at the rate of 9.5% per annum and mature on July 10, 2014. We believe that our present cash flows as described above will be sufficient on a short-term basis and over the next 12 months to fund our company-wide working capital requirements.  Our reconciliation of net income to cash provided by operations is generally influenced by the collection of premiums in advance of paid losses, the timing of reinsurance, issuing company settlements and loss payments.  

Cash flow and liquidity are categorized into three sources: (1) operating activities; (2) investing activities; and (3) financing activities, which are shown in the following table:

   Years Ended December 31,                                   2012

2011

Cash flows provided by (used in):

 Operating activities                                   $  6,375,322     $  7,253,489  Investing activities                                     (3,961,384 )     (6,525,524 )  Financing activities                                       (347,052 )       (881,459 )

Net increase (decrease) in cash and cash equivalents 2,066,886

(153,494 )

  Cash and cash equivalents, beginning of period              173,126        

326,620

  Cash and cash equivalents, end of period               $  2,240,012     $  

173,126

    Net cash provided by operating activities was $6,375,000 in 2012 as compared to $7,253,000 provided in 2011. The $878,000 decrease in cash flows provided by operating activities in 2012 was primarily a result of the fluctuations in assets and liabilities relating to operating activities of KICO as affected by the growth in its operations which are described above, offset by a decrease in net income (adjusted for non-cash items) of $1,600,000.  

Net cash used by investing activities was $3,961,000 in 2012 compared to $6,526,000 used in 2011. The $2,565,000 decrease in cash flows provided by investing activities is a result of the decrease in acquisitions of invested assets, offset by a decrease in sales of invested assets.

  Net cash used in financing activities was $347,000 in 2012 compared to $881,000 used in 2011. The $534,000 decrease in cash flows used in financing activities is a result of principal payments on long term debt of $714,000 in 2011 compared to no such payments in 2012, and dividend payments of $534,000 in 2012 compared to $230,000 in 2011.  Superstorm Sandy  The primary location of KICO's insureds is in the New York City area, which was struck by Superstorm Sandy on October 29, 2012. KICO purchases quota share and catastrophe reinsurance in order to reduce its net liability on insurance risks and to protect against catastrophes. KICO's personal lines business, which includes homeowners insurance, is reinsured under a 75% quota share treaty and catastrophe insurance pursuant to which KICO's net liability is limited to 25% of the initial $3,000,000 of direct losses incurred from a catastrophe occurrence, or $750,000. For catastrophe losses in excess of $3,000,000, KICO is 100% covered by catastrophe reinsurance with regard to the next $70,000,000 in losses. As of December 31, 2012, KICO's net loss incurred as a result of the storm was $750,000 with respect to KICO's personal lines business, which is the limit of loss pursuant to its quota share and catastrophe reinsurance treaties. Additional net losses of $393,000 were incurred with respect to KICO's business owners, commercial auto and livery physical damage policies. We were also required to pay $77,000 of reinstatement premiums to catastrophe reinsurers to obtain coverage for future catastrophe events during the current reinsurance treaty period.                                          36

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  KICO receives ceding commissions from the reinsurers. The amount of the commissions includes contingent ceding commissions which are based upon the loss ratio experienced by the reinsurers during the treaty term (July 1 to June 30) from the ceded business over that period of time. Such contingent ceding commission revenue was reduced by $1.9 million based upon the reinsurance losses incurred as a result of Superstorm Sandy. In addition, it is expected that there will be a decline of approximately $2 million in the ceding commission revenue to be earned during the first six months of 2013 (i.e., the final six months of the 2012-2013 treaty). Further, KICO was required to pay reinstatement premiums to catastrophe reinsurers to obtain coverage for future catastrophe events during the current reinsurance treaty period. A portion of the cost of such reinstatement premiums will be expensed during the first two quarters of 2013. Accordingly, the effects of the storm will be material to our post 2012 results of operations; however, we expect that such effects will not have a material adverse impact on our financial condition. See "Factors Relating to Superstorm Sandy That May Affect Future Results and Financial Condition" below.  

Reinsurance

  The following table summarizes each reinsurer that accounted for more than 10% of our reinsurance recoverables on paid and unpaid losses and loss adjustment expenses as of December 31, 2012:                                                            Amount                                                         Recoverable                                       A.M.                 as of       ($ in thousands)             Best Rating       December 31, 2012         %        Maiden Reinsurace Company              A-     $            11,162        46.10 %       SCOR Reinsurance Company                A                   5,932        24.50 %                                                                  17,094        70.60 %       Others                                                      7,118        29.40 %       Total                                         $            24,212       100.00 %    Reinsurance recoverable from Maiden Reinsurance Company and Motors Insurance Corporation (included in Others) are secured pursuant to collateralized trust agreements. Assets held in the two trusts are not included in our invested assets and investment income earned on these assets is credited to the two reinsurers respectively.                                          37

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Our reinsurance treaties for both our Personal Lines business, which primarily consists of homeowners' policies, and Commercial Lines business, other than commercial auto, were renewed as of July 1, 2012. The treaties, which are annual, provide for the following material terms as of July 1, 2012:

Personal Lines

  Personal Lines business, which includes homeowners, dwelling fire and canine legal liability insurance, is reinsured under a 75% quota share treaty which provides coverage with respect to losses of up to $1,000,000 per occurrence. An excess of loss contract provides 100% of coverage for the next $1,900,000 of losses for a total reinsurance coverage of $2,650,000 with respect to losses of up to $2,900,000 per occurrence. See "Catastrophe Reinsurance" below for a discussion of our reinsurance coverage with respect to our Personal Lines business in the event of a catastrophe.  Personal umbrella policies are reinsured under a 90% quota share treaty which provides coverage with respect to losses of up to $1,000,000 per occurrence. The second $1,000,000 of coverage is 100% reinsured.  

Commercial Lines

  General liability commercial policies written by us, except for commercial auto policies, are reinsured under a 40% quota share treaty, which provides coverage with respect to losses of up to $500,000 per occurrence. Excess of loss contracts provide 100% of coverage for the next $2,400,000 of losses for a total reinsurance coverage of $2,600,000 with respect to losses of up to $2,900,000 per occurrence.  Commercial Auto 

Commercial auto policies are covered by an excess of loss reinsurance contract which provides $1,750,000 of coverage in excess of $250,000.

Catastrophe Reinsurance

  We have catastrophe reinsurance coverage with regard to losses of up to $73,000,000. The initial $3,000,000 of losses in a catastrophe are subject to a 75% quota share treaty, such that we retain $750,000 per catastrophe occurrence With respect to any additional catastrophe losses of up to $70,000,000, we are 100% reinsured under our catastrophe reinsurance program.  Our reinsurance program is structured to enable us to write a greater amount of direct premiums than our statutory surplus could support and also provides income as a result of ceding commissions earned pursuant to the quota share reinsurance contracts. This structure has enabled us to significantly grow our direct premium volume while maintaining regulatory capital and other financial ratios generally within or below the expected ranges used for regulatory oversight purposes. Our participation in reinsurance arrangements does not relieve us from our obligations to policyholders.                                          38

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  Our reinsurance program is structured to reflect our obligations and goals. Reinsurance via quota share allows for a carrier to write business without increasing its leverage above a management determined ratio. The additional business written allows a reinsurer to assume the risks involved, but gives the reinsurer much of the profit (or loss) associated with such. We have determined it to be in the best interests of our shareholders to prudently reduce our reliance on quota share reinsurance. Any such reduction would result in higher earned premiums and a reduction in ceding commission revenue in future years. Our participation in reinsurance arrangements do not relieve us of our obligations to policyholders.  Inflation  Premiums are established before we know the amount of losses and loss adjustment expenses or the extent to which inflation may affect such amounts. We attempt to anticipate the potential impact of inflation in establishing our reserves, especially as it relates to medical and hospital rates where historical inflation rates have exceeded the general level of inflation. Inflation in excess of the levels we have assumed could cause loss and loss adjustment expenses to be higher than we anticipated, which would require us to increase reserves and reduce earnings.   Fluctuations in rates of inflation also influence interest rates, which in turn impact the market value of our investment portfolio and yields on new investments. Operating expenses, including salaries and benefits, generally are impacted by inflation.  

Off-Balance Sheet Arrangements

  We have no off-balance sheet arrangements that have or are reasonably likely to have a current or future effect on our financial condition, changes in financial condition, revenues or expenses, results of operations, liquidity, capital expenditures or capital resources that is material to investors.  

Factors That May Affect Future Results and Financial Condition

  Based upon the following factors, as well as other factors affecting our operating results and financial condition, past financial performance should not be considered to be a reliable indicator of future performance, and investors should not use historical trends to anticipate results or trends in future periods. In addition, such factors, among others, may affect the accuracy of certain forward-looking statements contained in this Annual Report.  

As a holding company, we are dependent on the results of operations of our subsidiaries, Kingstone Insurance Company ("KICO") and Payments, Inc.; there are restrictions on the payment of dividends by KICO.

  We are a holding company and a legal entity separate and distinct from our operating subsidiaries, KICO and Payments, Inc. As a holding company with limited operations of our own, the principal sources of our funds are dividends and other payments from KICO and Payments, Inc. Consequently, we must rely on KICO and Payments, Inc. for our ability to repay debts, pay expenses and pay cash dividends to our shareholders.                                          39

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  Our ability to receive dividends from KICO is restricted by the state laws and insurance regulations of New York. These restrictions are related to surplus and net investment income. Dividends are restricted to the lesser of 10% of surplus or 100% of investment income (on a statutory accounting basis) for the trailing four quarters. As of December 31, 2012, the maximum distribution that KICO could pay without prior regulatory approval was approximately $1,017,000, which is based on investment income for the last four quarters.  

As a property and casualty insurer, we may face significant losses from catastrophes and severe weather events.

  Because of the exposure of our property and casualty business to catastrophic events (such as Superstorm Sandy as discussed below), our operating results and financial condition may vary significantly from one period to the next. Catastrophes can be caused by various natural and man-made disasters, including earthquakes, wildfires, tornadoes, hurricanes, storms and certain types of terrorism. We may incur catastrophe losses in excess of: (1) those that we project would be incurred, (2) those that external modeling firms estimate would be incurred, (3) the average expected level used in pricing or (4) our current reinsurance coverage limits. Despite our catastrophe management programs, we are exposed to catastrophes that could have a material adverse effect on our operating results and financial condition. Our liquidity could be constrained by a catastrophe, or multiple catastrophes, which may result in extraordinary losses or a downgrade of our financial strength ratings.  

In addition, we are subject to claims arising from weather events such as hurricanes, tropical storms, winter storms, rain, hail and high winds. The incidence and severity of weather conditions are largely unpredictable. There is generally an increase in the frequency and severity of claims when severe weather conditions occur.

Unanticipated increases in the severity or frequency of claims may adversely affect our operating results and financial condition.

  Changes in the severity or frequency of claims may affect our profitability. Changes in homeowners claim severity are driven by inflation in the construction industry, in building materials and in home furnishings, and by other economic and environmental factors, including increased demand for services and supplies in areas affected by catastrophes. Changes in bodily injury claim severity are driven primarily by inflation in the medical sector of the economy and litigation. Changes in auto physical damage claim severity are driven primarily by inflation in auto repair costs, auto parts prices and used car prices. However, changes in the level of the severity of claims are not limited to the effects of inflation and demand surge in these various sectors of the economy. Increases in claim severity can arise from unexpected events that are inherently difficult to predict, such as a change in the law. Although we pursue various loss management initiatives to mitigate future increases in claim severity, there can be no assurances that these initiatives will successfully identify or reduce the effect of future increases in claim severity, and a significant increase in claim frequency could have an adverse effect on our operating results and financial condition.                                          40

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  The inability to obtain an upgrade to our financial strength rating from A.M. Best, or a downgrade in our rating, may have a material adverse effect on our competitive position, the marketability of our product offerings, and our liquidity, operating results and financial condition.  Financial strength ratings are important factors in establishing the competitive position of insurance companies and generally have an effect on an insurance company's business. Many insurance buyers, agents, brokers and secured lenders use the ratings assigned by A.M. Best and other agencies to assist them in assessing the financial strength and overall quality of the companies from which they are considering purchasing insurance or in determining the financial strength of the company that provides insurance with respect to the collateral they hold. In 2009, KICO applied for its initial A.M. Best rating, and was assigned a letter rating of "B" (Fair) by A.M. Best in 2010. Our rating was upgraded to B+ (Good) in 2011. KICO is preparing for the process of undergoing its annual review by A.M. Best, which may result in a change to its rating. A. M. Best ratings are derived from an in-depth evaluation of an insurance company's balance sheet strengths, operating performances and business profiles. A.M. Best evaluates, among other factors, the company's capitalization, underwriting leverage, financial leverage, asset leverage, capital structure, quality and appropriateness of reinsurance, adequacy of reserves, quality and diversification of assets, liquidity, profitability, spread of risk, revenue composition, market position, management, market risk and event risk. On an ongoing basis, rating agencies such as A.M. Best review the financial performance and condition of insurers and can downgrade or change the outlook on an insurer's ratings due to, for example, a change in an insurer's statutory capital, a reduced confidence in management or a host of other considerations that may or may not be under the insurer's control. We currently have a Demotech rating of A (Excellent), which generally permits lenders to accept our policies. All ratings are subject to continuous review; therefore, the retention of these ratings cannot be assured. A downgrade in any of these ratings could have a material adverse effect on our competitiveness, the marketability of our product offerings and our ability to grow in the marketplace.  

Adverse capital and credit market conditions may significantly affect our ability to meet liquidity needs or our ability to obtain credit on acceptable terms.

  The capital and credit markets have been experiencing extreme volatility and disruption. In some cases, the markets have exerted downward pressure on the availability of liquidity and credit capacity. In the event that we need access to additional capital to pay our operating expenses, make payments on our indebtedness, pay for capital expenditures or increase the amount of insurance that we seek to underwrite, our ability to obtain such capital may be limited and the cost of any such capital may be significant. Our access to additional financing will depend on a variety of factors, such as market conditions, the general availability of credit, the overall availability of credit to our industry, our credit ratings and credit capacity as well as lenders' perception of our long or short-term financial prospects. Similarly, our access to funds may be impaired if regulatory authorities or rating agencies take negative actions against us. If a combination of these factors occurs, our internal sources of liquidity may prove to be insufficient and, in such case, we may not be able to successfully obtain additional financing on favorable terms.                                          41

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We are exposed to significant financial and capital markets risk which may adversely affect our results of operations, financial condition and liquidity, and our net investment income can vary from period to period.

  We are exposed to significant financial and capital markets risk, including changes in interest rates, equity prices, market volatility, the performance of the economy in general, the performance of the specific obligors included in our portfolio and other factors outside our control. Our exposure to interest rate risk relates primarily to the market price and cash flow variability associated with changes in interest rates. Our investment portfolio contains interest rate sensitive instruments, such as fixed income securities, which may be adversely affected by changes in interest rates from governmental monetary policies, domestic and international economic and political conditions and other factors beyond our control. A rise in interest rates would increase the net unrealized loss position of our investment portfolio, which would be offset by our ability to earn higher rates of return on funds reinvested. Conversely, a decline in interest rates would decrease the net unrealized loss position of our investment portfolio, which would be offset by lower rates of return on funds reinvested.  In addition, market volatility can make it difficult to value certain of our securities if trading becomes less frequent. As such, valuations may include assumptions or estimates that may have significant period to period changes which could have a material adverse effect on our consolidated results of operations or financial condition. If significant, continued volatility, changes in interest rates, changes in defaults, a lack of pricing transparency, market liquidity and declines in equity prices, individually or in tandem, could have a material adverse effect on our results of operations, financial condition or cash flows through realized losses, impairments, and changes in unrealized positions.  

Reinsurance may be unavailable at current levels and prices, which may limit our ability to write new business.

  Our personal lines catastrophe reinsurance program was designed, utilizing our risk management methodology, to address our exposure to catastrophes. Market conditions beyond our control impact the availability and cost of the reinsurance we purchase. No assurances can be given that reinsurance will remain continuously available to us to the same extent and on the same terms and rates as is currently available. For example, our ability to afford reinsurance to reduce our catastrophe risk may be dependent upon our ability to adjust premium rates for its cost, and there are no assurances that the terms and rates for our current reinsurance program will continue to be available in the future. If we are unable to maintain our current level of reinsurance or purchase new reinsurance protection in amounts that we consider sufficient and at prices that we consider acceptable, we will have to either accept an increase in our exposure risk, reduce our insurance writings or develop or seek other alternatives.  

We intend to prudently reduce our reliance on quota share reinsurance; this would lead to greater exposure to net insurance losses.

  We have determined it to be in the best interests of our shareholders to prudently reduce our reliance on quota share reinsurance. Any such reduction would result in higher earned premiums and a reduction in ceding commission revenue in future years. Such approach would also lead to increased exposure to net insurance losses.                                          42

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The effects of Superstorm Sandy will be material to our post-2012 results of operations.

  On October 29, 2012, the New York City area, which is the primary location of KICO's insureds, was struck by Superstorm Sandy. Certain material effects of the storm on our post-2012 results of operations are described under "Liquidity and Capital Resources - Superstorm Sandy" above. Given the reinsurance losses that were incurred as a result of the storm, it is possible that the terms and conditions for any reinsurance that we may require following the end of our current reinsurance treaties on June 30, 2013 will be materially impacted.  

Reinsurance subjects us to the credit risk of our reinsurers, which may have a material adverse effect on our operating results and financial condition.

  The collectability of reinsurance recoverables is subject to uncertainty arising from a number of factors, including changes in market conditions, whether insured losses meet the qualifying conditions of the reinsurance contract and whether reinsurers, or their affiliates, have the financial capacity and willingness to make payments under the terms of a reinsurance treaty or contract. Since we are primarily liable to an insured for the full amount of insurance coverage, our inability to collect a material recovery from a reinsurer could have a material adverse effect on our operating results and financial condition.  

Applicable insurance laws regarding the change of control of our company may impede potential acquisitions that our stockholders might consider to be desirable.

  We are subject to statutes and regulations of the state of New York which generally require that any person or entity desiring to acquire direct or indirect control of KICO, our insurance company subsidiary, obtain prior regulatory approval. In addition, a change of control of Kingstone Companies, Inc. would require such approval. These laws may discourage potential acquisition proposals and may delay, deter or prevent a change of control of our company, including through transactions, and in particular unsolicited transactions, that some of our stockholders might consider to be desirable. Similar regulations may apply in other states in which we may operate.  The insurance industry is subject to extensive restrictive regulation that may affect our operating costs and limit the growth of our business, and changes within this regulatory environment may, too, adversely affect our operating costs and limit the growth of our business.  We are subject to extensive laws and regulations. State insurance regulators are charged with protecting policyholders and have broad regulatory, supervisory and administrative powers over our business practices, including, among other things, the power to grant and revoke licenses to transact business and the power to regulate and approve underwriting practices and rate changes, which may delay the implementation of premium rate changes or prevent us from making changes we believe are necessary to match rate to risk. In addition, many states have laws and regulations that limit an insurer's ability to cancel or not renew policies and that prohibit an insurer from withdrawing from one or more lines of business written in the state, except pursuant to a plan that is approved by the state insurance department. Laws and regulations that limit cancellation and non-renewal and that subject program withdrawals to prior approval requirements may restrict our ability to exit unprofitable markets.                                          43

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  Because the laws and regulations under which we operate are administered and enforced by a number of different governmental authorities, including state insurance regulators, state securities administrators and the SEC, each of which exercises a degree of interpretive latitude, we are subject to the risk that compliance with any particular regulator's or enforcement authority's interpretation of a legal issue may not result in compliance with another's interpretation of the same issue, particularly when compliance is judged in hindsight. In addition, there is risk that any particular regulator's or enforcement authority's interpretation of a legal issue may change over time to our detriment, or that changes in the overall legal and regulatory environment may, even absent any particular regulator's or enforcement authority's interpretation of a legal issue changing, cause us to change our views regarding the actions we need to take from a legal risk management perspective, thereby necessitating changes to our practices that may, in some cases, limit our ability to grow and improve the profitability of our business.  While the United States federal government does not directly regulate the insurance industry, federal legislation and administrative policies can affect us. Congress and various federal agencies periodically discuss proposals that would provide for a federal charter for insurance companies. We cannot predict whether any such laws will be enacted or the effect that such laws would have on our business. Moreover, there can be no assurance that changes will not be made to current laws, rules and regulations, or that any other laws, rules or regulations will not be adopted in the future, that could adversely affect our business and financial condition.  

We may not be able to maintain the requisite amount of risk-based capital, which may adversely affect our profitability and our ability to compete in the property and casualty insurance markets.

  The New York State Department of Financial Services imposes risk-based capital requirements on insurance companies to ensure that insurance companies maintain appropriate levels of surplus to support their overall business operations and to protect customers against adverse developments, after taking into account default, credit, underwriting and off-balance sheet risks. If the amount of our capital falls below this minimum, we may face restrictions with respect to soliciting new business and/or keeping existing business. Similar regulations will apply in other states in which we may operate.  

Changing climate conditions may adversely affect our financial condition, profitability or cash flows.

  We recognize the scientific view that the world is getting warmer. Climate change, to the extent it produces rising temperatures and changes in weather patterns, could impact the frequency or severity of weather events and wildfires and the affordability and availability of homeowners insurance.  

Our operating results and financial condition may be adversely affected by the cyclical nature of the property and casualty business.

  The property and casualty market is cyclical and has experienced periods characterized by relatively high levels of price competition, less restrictive underwriting standards and relatively low premium rates, followed by periods of relatively lower levels of competition, more selective underwriting standards and relatively high premium rates. A downturn in the profitability cycle of the property and casualty business could have a material adverse effect on our operating results and financial condition.                                          44

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Because substantially all of our revenue is currently derived from sources located in New York, our business may be adversely affected by conditions in such state.

  Substantially all of our revenue is currently derived from sources located in the state of New York and, accordingly, is affected by the prevailing regulatory, economic, demographic, competitive and other conditions in such state. Changes in any of these conditions could make it more costly or difficult for us to conduct our business. Adverse regulatory developments in New York, which could include fundamental changes to the design or implementation of the insurance regulatory framework, could have a material adverse effect on our results of operations and financial condition.  Recent regulatory action taken by the New York State Department of Financial Services following Superstorm Sandy may have a material adverse effect upon our operations and business.  In the aftermath of Superstorm Sandy, the New York State Department of Financial Services has adopted various regulations that could have a material adverse effect on insurance companies that operate in the state of New York. Included among the regulations are accelerated claims investigation and settlement requirements and mandatory participation in non-binding mediation proceedings funded by the insurer. In addition, the Department of Financial Services imposed a four month moratorium on property and casualty policy terminations and non-renewals notwithstanding failure to pay premiums when due. Further, in February 2013, the state of New York announced that the Department of Financial Services has commenced an investigation into the claims practices of three insurance companies, including KICO, in connection with Superstorm Sandy claims. The Department of Financial Services stated that the three insurers had a much larger than average consumer complaint rate with regard to Superstorm Sandy claims and indicated that the three insurers were being investigated for (i) failure to send adjusters in a timely manner; (ii) failure to process claims in a timely manner; and (iii) inability of homeowners to contact insurance company representatives. KICO has received a letter from the Department of Financial Services seeking information and data with regard to the foregoing. KICO is cooperating with the Department of Financial Services in connection with its investigation and we believe that such matter will not have a material adverse effect on our financial position. In settling insurance claims, including those related to Superstorm Sandy, if KICO were to pay for losses not covered by the insurance policy, such as those based on water and sewer back up claims, it could face disclaimers of coverage from its reinsurers with regard to the amounts paid.  

Actual claims incurred may exceed current reserves established for claims, which may adversely affect our operating results and financial condition.

  Recorded claim reserves in our business are based on our best estimates of losses after considering known facts and interpretations of circumstances. Internal and external factors are considered. Internal factors include, but are not limited to, actual claims paid, pending levels of unpaid claims, product mix and contractual terms. External factors include, but are not limited to, changes in the law, court decisions, changes in regulatory requirements and economic conditions. Because reserves are estimates of the unpaid portion of losses that have occurred, the establishment of appropriate reserves, including reserves for catastrophes, is an inherently uncertain and complex process. The ultimate cost of losses may vary materially from recorded reserves, and such variance may adversely affect our operating results and financial condition.                                          45

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Our future results may be adversely affected by claims made against an underwriting pool in which KICO was a participant but over which it has no control.

  KICO was a member of the New York Mutual Underwriters Pool (the "NYMU") and is responsible for its proportionate share of losses with respect to accident dates through October 31, 1997. During 2006 and 2007, the NYMU received a disproportionately large number of lead paint claims (approximately 50) for accident dates prior to October 31, 1997. KICO's liability for each claim is $50,000 (assuming full reinsurance recovery). Since 2007, far fewer lead paint claims have been filed against the NYMU. We believe that, as of December 31, 2012, KICO is fully reserved for all reported claims and that its provision for IBNR for future claims is adequate (in each case giving effect to the collectability of reinsurance); however, we do not have any control over the claims made against the NYMU. Accordingly, future results may be adversely affected from losses over which we have no control.  

Regulations requiring us to underwrite business and participate in loss sharing arrangements may adversely affect our operating results and financial condition.

  The state of New York has enacted laws that require a property liability insurer conducting business in such state to participate in assigned risk plans, reinsurance facilities and joint underwriting associations or require the insurer to offer coverage to all consumers, often restricting an insurer's ability to charge the price it might otherwise charge. In these markets, we may be compelled to underwrite significant amounts of business at lower than desired rates, possibly leading to an unacceptable return on equity, which may adversely affect our operating results and financial condition.  

Our future results are dependent in part on our ability to successfully operate in an insurance industry that is highly competitive.

  The insurance industry is highly competitive. Many of our competitors have well-established national reputations, substantially more capital and significantly greater marketing and management resources. Because of the competitive nature of the insurance industry, including competition for customers, agents and brokers, there can be no assurance that we will continue to effectively compete with our industry rivals, or that competitive pressures will not have a material adverse effect on our business, operating results or financial condition.  

If we lose key personnel or are unable to recruit qualified personnel, our ability to implement our business strategies could be delayed or hindered; KICO's Chief Executive Officer transitioned his duties and responsibilities effective January 1, 2012.

  Our future success will depend, in part, upon the efforts of Barry Goldstein, our President and Chief Executive Officer, and John Reiersen, who currently serves as Executive Vice President of KICO and, until January 1, 2012, served as President and Chief Executive Officer of KICO. The loss of Messrs. Goldstein and/or Reiersen or other key personnel could prevent us from fully implementing our business strategies and could materially and adversely affect our business, financial condition and results of operations. As we continue to grow, we will need to recruit and retain additional qualified management personnel, but we may not be able to do so. Our ability to recruit and retain such personnel will depend upon a number of factors, such as our results of operations and prospects and the level of competition then prevailing in the market for qualified personnel. Effective January 1, 2012, Mr. Reiersen became Executive Vice President of KICO and provides, in a part-time capacity, advice and assistance to the President and Chief Executive Officer of KICO, and other management personnel, with regard to the management and operation of KICO. Mr. Goldstein assumed the duties and responsibilities of President and Chief Executive Officer of KICO effective January 1, 2012. Although Mr. Goldstein has served as our President and Chief Executive Officer since 2001, as KICO's Chairman of the Board and Chairman of the Executive Committee since 2006 and as KICO's Chief Investment Officer since 2008, prior to January 1, 2012, he had never served as President and Chief Executive Officer of an insurance company.                                          46

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Difficult conditions in the economy generally could adversely affect our business and operating results.

  Some economists continue to project significant negative macroeconomic trends, including relatively high and sustained unemployment, reduced consumer spending, and substantial increases in delinquencies on consumer debt, including defaults on home mortgages. Moreover, recent disruptions in the financial markets, particularly the reduced availability of credit and tightened lending requirements, have impacted the ability of borrowers to refinance loans at more affordable rates. As with most businesses, we believe that difficult conditions in the economy could have an adverse effect on our business and operating results. General economic conditions also could adversely affect us in the form of consumer behavior, which may include decreased demand for our products. As consumers become more cost conscious, they may choose lower levels of insurance.  

Changes in accounting standards issued by the Financial Accounting Standards Board or other standard-setting bodies may adversely affect our results of operations and financial condition.

  Our financial statements are subject to the application of generally accepted accounting principles, which are periodically revised, interpreted and/or expanded. Accordingly, we are required to adopt new guidance or interpretations, which may have a material adverse effect on our results of operations and financial condition that is either unexpected or has a greater impact than expected.  

We rely on our information technology and telecommunication systems, and the failure of these systems could materially and adversely affect our business.

  Our business is highly dependent upon the successful and uninterrupted functioning of our information technology and telecommunications systems. We rely on these systems to support our operations. The failure of these systems could interrupt our operations and result in a material adverse effect on our business.  

We have incurred, and will continue to incur, increased costs as a result of being an SEC reporting company.

  The Sarbanes-Oxley Act of 2002, as well as a variety of related rules implemented by the SEC, have required changes in corporate governance practices and generally increased the disclosure requirements of public companies. As a reporting company, we incur significant legal, accounting and other expenses in connection with our public disclosure and other obligations. Based upon SEC regulations currently in effect, we are required to establish, evaluate and report on our internal control over financial reporting. We believe that compliance with the myriad of rules and regulations applicable to reporting companies and related compliance issues will require a significant amount of time and attention from our management.  

The enactment of tort reform could adversely affect our business.

  Legislation concerning tort reform is from time to time considered in the United States Congress. Among the provisions considered for inclusion in such legislation are limitations on damage awards, including punitive damages. Enactment of these or similar provisions by Congress or by the states in which we operate could result in a reduction in the demand for liability insurance policies or a decrease in the limits of such policies, thereby reducing our revenues. We cannot predict whether any such legislation will be enacted or, if enacted, the form such legislation will take, nor can we predict the effect, if any, such legislation would have on our business or results of operations.                                          47

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