ITEM 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
Management's Discussion and Analysis of Financial Condition and Results of Operations is intended to provide the reader of the financial statements with a narrative from the perspective of management on the financial condition, results of operations, liquidity and certain other factors that may affect our operating results. The following discussion and analysis of our financial condition and results of operations should be read in conjunction with the Consolidated Financial Statements and related Notes included in Item 8 of Part II of this Annual Report on Form 10-K. In addition to historical financial information, the following discussion and analysis contains forward-looking statements that involve risks, uncertainties, and assumptions. Our actual results and timing of selected events may differ materially from those anticipated in these forward-looking statements as a result of many factors, including those discussed within "Risk Factors" in Item 1A of this report.
Unless otherwise indicated or the context otherwise requires, references in this "Management’s Discussion and Analysis of Financial Condition and Results of Operations" to "we", "our", "Hagerty" and "the Company" refer to the business and operations of The Hagerty Group, LLC and its consolidated subsidiaries prior to the Business Combination and to Hagerty, Inc. and its consolidated subsidiaries, following the consummation of the Business Combination.
Overview
Hagerty is a global market leader in providing insurance for classic cars and enthusiast vehicles. We consistently earn strong net promoter scores by providing auto enthusiasts superior insurance coverage with excellent customer service and at lower prices than traditional carriers. We have also leveraged our trusted insurance brand to build a leading automotive lifestyle brand. We offer an automotive enthusiast platform that protects, engages, entertains and connects with our Members and other car enthusiasts. Our goal is to save driving and car culture for future generations.
Recent Developments Affecting Comparability
Broad Arrow Acquisition
In January 2022, we entered into a joint venture with Broad Arrow, pursuant to which we invested $15.3 million in exchange for equity ownership of approximately 40% of Broad Arrow. In August 2022, we acquired the remaining 60% outstanding equity interest of Broad Arrow, in exchange for $73.3 million of equity consideration of both Hagerty, Inc. and The Hagerty Group.
Prior to the acquisition, we accounted for our approximately 40% ownership interest in Broad Arrow using the equity method of accounting under which we recognized our share of Broad Arrow's income (loss) within Income (loss) from equity method investment, net of tax in the Consolidated Statements of Operations. Subsequent to the acquisition, Broad Arrow became a wholly-owned subsidiary of the Company and as a result, the financial statements of Broad Arrow are now consolidated as a part of Hagerty. Revenue from Broad Arrow is included with our existing revenue from Marketplace and recorded within "Membership, marketplace and other revenue" in our Consolidated Statements of Operations.
Also, as a result of the acquisition, we remeasured our pre-existing 40% equity ownership interest to its estimated fair value of approximately $48.3 million, which resulted in a $34.7 million gain within our Consolidated Statements of Operations for the year ended December 31, 2022. Refer to Note 9 — Acquisitions and Investments – in Item 8 of Part II of this Annual Report on Form 10-K for additional information on the consideration paid for the Broad Arrow Acquisition.
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Business Combination
On December 2, 2021, The Hagerty Group completed a business combination pursuant to the Business Combination Agreement with Aldel and Merger Sub. In connection with the Closing, Aldel changed its name from Aldel Financial Inc. to Hagerty, Inc.
Following the Closing, Hagerty, Inc. owns an equity interest in The Hagerty Group in what is commonly known as an "Up-C" structure. Under this structure, substantially all of Hagerty, Inc.'s assets and liabilities are held by The Hagerty Group. Hagerty, Inc. owned 24.5% and 24.7% of The Hagerty Group as of December 31, 2022 and 2021, respectively.
Refer to Note 1 — Summary of Significant Accounting Policies and New Accounting Standards and Note 8 — Business Combination in Item 8 of Part II of this Annual Report on Form 10-K for additional information on the Business Combination.
Key Performance Indicators and Certain Non-GAAP Financial Measures
Key Performance Indicators
The table below presents a summary of our Key Performance Indicators, including important operational metrics, as well as certain GAAP and non-GAAP financial measures as of and for the years ended December 31, 2022 and 2021. We use these Key Performance Indicators to evaluate our business, measure our performance, identify trends against planned initiatives, prepare financial projections and make strategic decisions. We believe these Key Performance Indicators are useful in evaluating the Company's performance when read together with our Consolidated Financial Statements prepared in accordance with GAAP.
Year Ended December 31,
Operational Metrics (period of time)
Operational Metrics (point in time)
Policies in Force Retention (5) 88.0% 89.1%
GAAP Measures
Operating Income (Loss) (in thousands) $(67,566) $(10,070)
Net Income (Loss) (in thousands) $2,403 $(61,354)
Basic Earnings (Loss) Per Share $0.39 $(0.56)
Non-GAAP Measures
Adjusted EBITDA (in thousands) (9) $(1,940) $25,350
Adjusted Earnings (Loss) Per Share (9) $(0.20) $(0.05)
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(1) Total Written Premium is the total amount of insurance premium written on policies that were bound by our insurance carrier partners during the period. We view Total Written Premium as an important metric as it most closely correlates with our growth in insurance commission revenue and Hagerty Re earned premium. Total Written Premium reflects the actual business volume and direct economic benefit generated from our policy acquisition efforts.
(2) Loss Ratio, expressed as a percentage, is the ratio of (1) losses and loss adjustment expenses incurred to (2) earned premium in Hagerty Re. We view Loss Ratio as an important metric because it is a powerful benchmark for profitability. The benchmark allows us to evaluate our historical loss patterns including incurred losses and make necessary and appropriate adjustments. Hurricane Ian, which made landfall in the third quarter of 2022, generated $10.0 million of net losses and added 2.5% to the loss ratio for the year ended December 31, 2022. Additionally, we strengthened reserves for U.S. auto liability by $6.5 million for the 2022 accident year, which added 1.6% to the loss ratio for the year ended December 31, 2022. These two items account for the significant increase in the 2022 loss ratio compared to 2021.
(3) New Business Count represents the number of new insurance policies issued during the applicable period. We view New Business Count as an important metric to assess our financial performance because it is critical to achieving our growth objectives. While Hagerty benefits from strong renewal retention, new business policies more than offset those cancelled or non-renewed at expiration. Often new policies mean new relationships and an opportunity to sell additional products and services.
(4) Policies in Force ("PIF") are the number of current and active insurance policies as of the applicable period end date. We view PIF as an important metric to assess our financial performance because policy growth drives our revenue growth, increases brand awareness and market penetration, generates additional insight to improve the performance of our platform, and provides key data to assist strategic decision making for the Company.
(5) PIF Retention is the percentage of expiring policies that are renewed on the renewal effective date, calculated on a rolling twelve months basis. We view PIF Retention as an important measurement of the number of policies retained each year, which contributes to recurring revenue streams from MGA commissions, membership fees and earned premiums. It also contributes to maintaining our NPS as discussed below.
(6) Vehicles in Force are the number of current insured vehicles as of the applicable period end date. We view Vehicles in Force as an important metric to assess our financial performance because insured vehicle growth drives our revenue growth and increases market penetration. Vehicles in Force generates additional insight to support Marketplace and Hagerty Media, and provides key data to assist strategic decision making for the Company.
(7) HDC Paid Member Count is the number of current Members who pay an annual membership subscription as of an applicable period end date. We view HDC Paid Member Count as important because it helps us measure membership revenue growth and provides an opportunity to customize our value proposition and benefits to specific types of enthusiasts, both by demographic and vehicle interest.
(8) Hagerty uses Net Promoter Score ("NPS") as an important measure of the overall strength of our relationship with Members. NPS is measured twice annually through a web-based survey sent by email invitation to a random sample of existing Members, and is reported annually using an average of the two surveys. Often referred to as a barometer of brand loyalty and Member engagement, NPS is well-known in our industry as a strong indicator of growth and retention.
(9) Refer to "Non-GAAP Financial Measures" below for a description of this non-GAAP financial measure and a reconciliation to the most comparable GAAP amount.
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Components of Our Results of Operations
Revenue
We generate commission and fee-based revenue primarily from the sale of automotive insurance policies on behalf of our insurance carrier partners and reinsurance premiums from participating in the underwriting of these policies. To a lesser extent, we also generate fee-based revenue from HDC membership subscriptions, media and entertainment and Marketplace services. Our revenue model incorporates multiple touchpoints in the insurance and lifestyle value chains, built on data collection and Member experience.
Commission and fee revenue
Certain of our insurance affiliated subsidiaries act as MGAs who, among other things, write collector vehicle and marine policies on behalf of our insurance carrier partners, in exchange for commissions. Commissions are earned for new and renewed policies. Additionally, policyholders pay fees directly to us related to their insurance coverage. Commission and fee revenue is earned when the policy becomes effective, net of policy changes and cancellations, as our performance obligation is complete when the policy is issued.
Under the terms of many of our contracts with insurance carriers, we have the opportunity to earn an annual contingent underwriting commission ("CUC"), or profit-share, based on the calendar-year performance of the insurance book of business. Our CUC agreements are based on written or earned premium and loss ratio results. Each insurance carrier partner contract and related CUC is calculated independently. Revenue from CUC is accrued throughout the year and settled annually.
Earned premium
Reinsurance premiums are earned by Hagerty Re, which reinsures the collector vehicle and marine risks written through our affiliated MGAs in the U.S., Canada and the U.K. Hagerty Re is a Bermuda-domiciled, Class 3A reinsurer.
Earned premium represents the earned portion of written premiums that Hagerty Re has assumed under quota share reinsurance agreements with our insurance carrier partners. Earned premium is recognized over the term of the policy, which is generally 12 months.
Membership, marketplace and other revenue
We earn subscription revenue through bundled HDC membership offerings, which include access to products and services such as, Hagerty Drivers Club Magazine, automotive enthusiast events, our proprietary vehicle valuation tool, emergency roadside assistance and special vehicle-related discounts. We also earn fee-based revenue from Hagerty Garage + Social memberships, which include storage in addition to the HDC Member benefits. Revenue from the sale of HDC and storage memberships is recognized ratably over the period of the membership. The membership is treated as a single performance obligation to provide access to stated Member benefits over the life of the membership, which is currently one year.
Marketplace earns fee-based revenue from the sale of collector cars through classified listings, live and time-based online auctions and brokered private sales, as well as finance revenue from term loans to high-net-worth individuals and businesses secured by collector cars. Fee-based revenue earned by Marketplace is recognized when the underlying sale is completed. Finance revenue is recognized when earned based on the amount of the outstanding loan, the applicable interest rate on the loan and the length of time the loan was outstanding during the period.
Other revenue includes sponsorship, admission, advertising, valuation and registration income. Other revenue is recognized when the performance obligation for the related product or service is satisfied.
Operating Expenses
Our operating expenses typically consist of salaries and benefits, ceding commission, losses and loss adjustment expenses, sales expenses, general and administrative services and depreciation and amortization.
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Salaries and benefits
Salaries and benefits consist primarily of costs related to employee compensation, payroll taxes, employee benefits and employee development costs. Employee compensation includes wages paid to employees, as well as various incentive compensation plans. Employee benefits include the costs of various employee benefits plans, including medical, dental insurance and wellness plans. Costs related to employee education, training and recruiting are included in employee development costs. Salaries and benefits costs are expensed as incurred except for those costs which are required to be capitalized, which are then amortized over the useful life of the asset created (generally software or media content). Salaries and benefits are expected to increase over time as the business continues to grow but will likely decrease as a percent of revenue.
Ceding commission
Ceding commission consists of the commission paid by Hagerty Re to insurance carriers for our pro-rata share of policy acquisition costs (primarily the commission earned by our MGA affiliates), general and administrative services and other costs. Hagerty Re pays a fixed rate ceding commission which varies by insurance carrier partner, averaging approximately 47% and 48% of net earned premium for the years ended December 31, 2022 and 2021, respectively. Ceding commission is recognized into expense over the annual policy term. In future periods, ceding commission will change in proportion to earned premium assumed through our various quota share reinsurance agreements.
Losses and loss adjustment expenses
Losses and loss adjustment expenses represent management's best estimate of the share of losses assumed by Hagerty Re, including its share of the net cost to settle claims submitted by insureds. Losses consist of claims paid, case reserves and IBNR, net of estimated recoveries for reinsurance, salvage and subrogation. Loss adjustment expenses consist of the cost associated with the investigation and settling of claims. The estimates utilized in determining the amount of losses and loss adjustment expenses recorded in a period are based on statistical analysis performed by our internal and external actuarial team. Reserves are reviewed regularly and adjusted as necessary to reflect management’s estimate of the ultimate cost of settlement.
Sales expense
Sales expense includes costs related to the sales and servicing of insurance policies, as well as costs related to our Membership and Marketplace offerings, such as broker expense, cost of sales, promotion expense and travel and entertainment expenses. Broker expense is the compensation paid to our agent partners and national broker partners when an insurance policy is written through a broker relationship. Broker expense generally tracks with written premium growth. Cost of sales includes postage, document costs, payment processing fees, emergency roadside service costs and other variable costs associated with the sale and servicing of a policy. Cost of sales also includes costs associated with the vehicle sales through Marketplace. Promotion expense includes various expenses related to branding, events, advertising, marketing, and acquisition. Promotion expense and travel and entertainment expense will likely decrease as a percent of revenue over the long-term. Sales expenses, in general, are expensed as incurred and will trend with revenue growth.
General and administrative services
General and administrative services primarily consist of professional services, occupancy costs and hardware and software. These costs are expensed as incurred. We expect this expense category to increase commensurate with our expected business volume and growth expectations and be managed lower as a percent of revenue over the next few years after we reach scale to handle incoming business from new partnerships.
Depreciation and amortization
Depreciation and amortization reflects the recognition of the cost of our investments in various assets over their useful lives. Depreciation expense relates to leasehold improvements, furniture and equipment, vehicles, hardware and purchased software. Amortization relates to investments related to recent acquisitions, SaaS implementation, internal software development and investments made in digital media and content assets. Depreciation and amortization are expected to increase in dollar amount over time but will likely decrease as a percent of revenue as investments in platform technology reach scale.
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Other Items
Change in fair value of warrant liabilities
Our warrants are accounted for as liabilities in accordance with ASC Topic 815, Derivatives and Hedging ("ASC 815"), and are measured at fair value each reporting period, with changes in fair value recognized as non-operating income (expense). In general, under the fair value accounting model, in periods when our stock price increases, the warrant liability increases, and we recognize additional expense in our Consolidated Statements of Operations. In periods when our stock price decreases, the warrant liability decreases, and we recognize additional income in our Consolidated Statements of Operations.
Income tax expense
The Hagerty Group is taxed as a pass-through ownership structure under provisions of the IRC and a similar section of state income tax law, except certain U.S. corporate subsidiaries and foreign subsidiaries. Any taxable income or loss generated by The Hagerty Group is passed through to and included in the taxable income or loss of all holders of Hagerty Group Units, including Hagerty, Inc. Hagerty, Inc. is taxed as a corporation and pays corporate federal, state, and local taxes with respect to income allocated from The Hagerty Group.
Results of Operations
Year Ended December 31, 2022 compared to the Year Ended December 31, 2021
The following table summarizes our results of operations for the years ended December 31, 2022 and 2021, and the dollar and percentage change between the two years:
Year Ended December 31,
REVENUE: in thousands (except percentages)
OPERATING EXPENSES:
Restructuring, impairment and related charges, net 18,324 — 18,324 100.0 %
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Revenue
Commission and fee revenue
Commission and fee revenue was $307.2 million for the year ended December 31, 2022, an increase of $35.7 million, or 13.1%, compared to 2021, consisting of an increase of $31.6 million in revenue from renewal policies, as well as an increase of $4.3 million in revenue from new policies.
The increase in revenue from renewal policies was primarily related to a 6.5% increase in renewal policy premiums as well as continued strong retention. The increase in renewal policy premiums for the year ended December 31, 2022 compared to 2021 reflects sustained year-over-year growth in our business and rate increases in several states due to inflation and appreciation of vehicle values, all of which contribute to higher premiums and, in turn, higher commission revenue.
The increase in revenue from new policies was related to sustained year-over-year growth in our business, as well as rate actions and higher vehicle values. The average premium on a newly issued policy has increased 14.5% year-over-year as a result of writing accounts with higher insured values at higher rates. As a result, premiums from newly insured policies increased $13.2 million, or 9.9% during the year ended December 31, 2022. In turn, commission revenue from newly issued policies grew by $4.1 million over the same period.
The overall increase in commission and fee revenue during the year ended December 31, 2022 was partially offset by a downward adjustment of $4.1 million associated with a reduction in the expected CUC payout percentage for 2022 due to higher loss ratios during the year. Our loss ratio for the year ended December 31, 2022 was adversely impacted by the increased severity in U.S. auto liability claims in the 2022 accident year and net losses related to Hurricane Ian.
Earned premium
Earned premium revenue was $403.1 million for the year ended December 31, 2022, an increase of $107.2 million, or 36.3%, compared to 2021. Earned premium is a function of written premium and is recognized over the term of the policy, which is generally 12 months. The increase in earned premium generally correlates with an increase in written premiums assumed by us, which increased $120.4 million, or 34.0%, compared to 2021. In the U.S., the increase in premiums assumed by Hagerty Re during the year ended December 31, 2022 compared to 2021 was primarily due to Hagerty Re’s U.S. quota share increasing from 60% in 2021 to 70% in 2022, which accounted for $64.4 million of the overall $120.4 million increase. The remaining increase was primarily a result of consistent underlying growth in the premiums assumed across all geographic areas in which we operate.
Membership, marketplace and other revenue
Membership, marketplace and other revenue was $77.3 million for the year ended December 31, 2022, an increase of $25.6 million, or 49.5%, compared to 2021.
Membership fee revenue was $45.2 million for the year ended December 31, 2022, an increase of $4.6 million, or 11.4%, compared 2021, which was primarily attributable to the increase in the issuance of new policies bundled with an HDC membership as well as an increase in storage revenue related to our Hagerty Garage + Social locations. For the year ended December 31, 2022, membership fees were 58.5% of the Membership, marketplace and other revenue total.
Marketplace revenue was $13.7 million for the year ended December 31, 2022, which was primarily generated by Broad Arrow auctions. For the year ended December 31, 2022, Marketplace revenue was 17.7% of the Membership, marketplace and other revenue total.
Other revenue was $18.4 million for the year ended December 31, 2022, an increase of $7.3 million, or 66.0%, compared to 2021, primarily due to newly acquired events, resulting in increases of $3.3 million and $2.6 million in sponsorship revenue and admission revenue, respectively. Other revenue includes sponsorship, admission, advertising, valuation and registration revenue and accounts for 23.8% of the Membership, marketplace and other revenue total.
Operating Expenses
Salaries and benefits
Salaries and benefits expenses were $199.5 million for the year ended December 31, 2022, an increase of $27.6 million, or 16.1%, compared to 2021. The increase was primarily attributable to a net increase of approximately 200 employees, or 12%, year over year. In 2022, headcount increased to support current and anticipated growth, such as the additions of several new large national insurance partnerships and our continued development of new systems and digital transformation technology investments, as well as several acquisitions, including the Broad Arrow Acquisition.
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Ceding commission
Ceding commission expense was $191.2 million for the year ended December 31, 2022, an increase of $50.2 million, or 35.6%, compared to 2021. The higher level of ceding commission expense was primarily attributable to an increase in our U.S. quota share percentage from 60% in 2021 to 70% in 2022, which accounted for $30.7 million of the increase, as well as higher U.S. premium volume ceded to Hagerty Re from our insurance carrier partner, which added approximately $16.4 million.
The following table presents the amount of premiums assumed and related ceding commission, as well as the quota share percentages for the year ended December 31, 2022 and 2021:
U.S. Canada U.K. Total
in thousands (except percentages)
Losses and loss adjustment expenses
Losses and loss adjustment expenses were $182.4 million for the year ended December 31, 2022, an increase of $60.3 million, or 49.4%, compared to 2021. This increase was primarily driven by Hagerty Re’s U.S. quota share increasing from 60% in 2021 to 70% in 2022, $10.0 million in net losses related to Hurricane Ian and a $6.5 million loss related to the strengthening of reserves recorded for U.S. auto liability for the 2022 accident year. The Company's loss ratio, including catastrophe losses, was 45.3% and 41.3% for the year ended December 31, 2022 and 2021, respectively. Hurricane Ian and the increase in IBNR reserves added 2.5% and 1.6%, respectively, to the loss ratio for the year ended December 31, 2022. The Company's loss ratio excluding Hurricane Ian was 42.8% for the year ended December 31, 2022.
Sales expense
Sales expense was $140.8 million for the year ended December 31, 2022, an increase of $33.3 million, or 31.0%, compared to 2021. This increase was primarily driven by a $19.0 million increase in travel and promotion costs, primarily related to newly acquired events and increased advertising and a $7.6 million increase in broker expense which was driven by additional premium volume across our independent agent and broker distribution channel.
General and administrative services
General and administrative services expenses were $89.1 million for the year ended December 31, 2022, an increase of $24.5 million, or 38.0%, compared to 2021, which was primarily driven by an $11.2 million increase in expenses related to operating as a public company, a $3.7 million increase in software subscription licenses and a $2.5 million increase in occupancy costs, primarily attributable to additional Hagerty Garage + Social locations.
Depreciation and amortization
Depreciation and amortization expense was $33.9 million for the year ended December 31, 2022, an increase of $11.7 million, or 53.0%, compared to 2021. The increase was primarily attributable to a higher base of capital assets from our software development investment. Amortization on these capital assets increased by $8.9 million. Amorization expense also increased as a result of intangible asset additions due to acquisitions, such as Broad Arrow and Speed Digital. Total amortization expense related to these acquisitions was $1.8 million.
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Restructuring, impairment and related charges, net
During the year ended December 31, 2022, we recognized restructuring, impairment and related charges of $18.3 million, which primarily consisted of $12.2 million in expenses related to our voluntary retirement program and reduction in force and $6.2 million related to operating lease ROU asset impairments and related leasehold disposals. Refer to Note 14 — Restructuring, Impairment and Related Charges in Item 8 of Part II of this Annual Report on Form 10-K for additional information with respect to the restructuring initiatives implemented in 2022.
Other Items
Change in fair value of warrant liabilities
During the years ended December 31, 2022 and 2021, the change in fair value of warrant liabilities resulted in a gain of $41.9 million and a loss of $42.5 million, respectively, which represents the net change in our valuation of warrant liabilities. Refer to Note 20 — Warrant Liabilities in Item 8 of Part II of this Annual Report on Form 10-K for additional information with respect to our warrants.
Revaluation gain on previously held equity method investment
During the year ended December 31, 2022, we recognized a revaluation gain on a previously held equity method investment of $34.7 million, which represents the remeasurement of our 40% equity interest in Broad Arrow immediately prior to the Broad Arrow Acquisition in August 2022. Refer to Note 9 — Acquisitions and Investments in Item 8 of Part II of this Annual Report on Form 10-K for additional information with respect to our acquisition of Broad Arrow.
Income tax benefit (expense)
Income tax expense was $7.0 million for the year ended December 31, 2022, an increase of $0.3 million, or 3.9%, compared to 2021. The increase was primarily due to an increase in income before income tax expense of $1.4 million within Broad Arrow, which is taxed as a corporation. Refer to Note 22 — Taxation in Item 8 of Part II of this Annual Report on Form 10-K for additional information with respect to items affecting our effective tax rate.
In August 2022, the Inflation Reduction Act ("IRA") was enacted into law. Among the provisions in the IRA was a 15% corporate minimum tax effect rate for years beginning after December 31, 2022, and a 1% tax on share repurchases after December 31, 2022. We do not expect the tax provisions of the IRA to have a material impact on our results.
Liquidity and Capital Resources
Maintaining a strong balance sheet and capital position is a top priority for us. We manage liquidity globally and across all operating subsidiaries.
Future Sources and Uses of Liquidity
Our sources of liquidity include our: (1) cash on hand; (2) short-term investments; (3) net working capital; (4) cash flows from operations; and (5) our Credit Facility (as defined below). Based on our current expectations, we believe that these sources of liquidity will be sufficient to meet our needs for at least the next 12 months.
We expect that our primary liquidity needs will include cash used to: (1) fund business operations including continued investments in technology; (2) service borrowings under the Credit Agreement (as defined below); (3) pay income taxes; and (4) make payments under the TRA.
Capital and Dividend Restrictions
Through our reinsurance subsidiary, Hagerty Re, we reinsure the same personal lines risks that are underwritten by our affiliated MGA subsidiaries on behalf of our insurance carrier partners. Our reinsurance operations are self-funded primarily through existing capital and net cash flows from operations. As of December 31, 2022, Hagerty Re had approximately $398.8 million in Cash and cash equivalents and Restricted cash and cash equivalents.
We, and particularly Hagerty Re, pay close attention to the underlying underwriting and reserving risks by monitoring the pricing and loss development of the underlying business written through our affiliated MGAs. Additionally, Hagerty Re seeks to minimize its investment risk by investing in low yield cash, money market accounts and investment grade municipal securities.
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Capital Restrictions
In Bermuda, Hagerty Re is subject to the BSCR administered by the BMA. No regulatory action is taken by the BMA if an insurer’s capital and surplus is equal to or in excess of their enhanced capital requirement as determined by the BSCR model. In addition, the BMA has established a target capital level for each insurer which is 120% of the enhanced capital requirement. Hagerty Re maintained sufficient statutory capital and surplus to comply with regulatory requirements as of December 31, 2022.
Dividend Restrictions
Under Bermuda law, Hagerty Re is prohibited from declaring or issuing a dividend if it fails to meet its minimum solvency margin or minimum liquidity ratio. Prior approval from the BMA is also required if Hagerty Re's proposed dividend payments would exceed 25% of its prior year-end total statutory capital and surplus. The amount of dividends which could be paid by Hagerty Re in 2023 without prior approval is $32.9 million.
Regulation relating to insurer solvency is generally for the protection of the policyholders rather than for the benefit of the stockholders of an insurance company. We believe that our existing cash and cash equivalents and municipal securities and cash flow from operations will be sufficient to support working capital and capital expenditure requirements for at least the next 12 months. Our future capital requirements will depend on many factors, including our reinsurance premium growth rate, renewal rates, the introduction of new and enhanced products, entry into, and successful entry in new geographic markets, and the continuing market adoption of our product offerings.
Comparative Cash Flows
The following table summarizes our cash flow data for the years ended December 31, 2022 and 2021:
Year Ended December 31,
in thousands (except percentages)
Operating Activities
Cash provided by operating activities primarily consists of net income (loss) adjusted for non-cash items and changes in working capital balances.
Net cash provided by operating activities is presented below:
Year Ended December 31,
in thousands (except percentages)
Net cash provided by operating activities for the year ended December 31, 2022 was $55.3 million, an increase of $13.0 million, or 30.9%, compared to 2021, which was due to a $25.1 million increase in cash from operating assets and liabilities, partially offset by a $12.1 million decrease in Net income (loss) after excluding non-cash adjustments. The increase in cash from operating assets and liabilities was primarily due to the increase in our U.S. quota share percentage from 60% in 2021 to 70% in 2022, severity of claims and timing of Hurricane Ian, all of which resulted in an increase in Provision for unpaid losses and loss adjustment expenses and Losses payable of approximately $25.5 million during the year ended December 31, 2022, with associated cash outflow expected in 2023.
Additionally, we collected approximately $7.8 million of cash from buyers in Broad Arrow transactions during the year ended December 31, 2022 that was not paid to sellers until 2023. The decrease in Net income (loss) after excluding non-cash adjustments was primarily driven by the impact of Hurricane Ian, increased loss reserves and restructuring charges.
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Investing Activities
Cash used in investing activities for the year ended December 31, 2022 was $91.5 million, an increase of $22.5 million, or 32.7%, compared to 2021. We invested approximately $44.4 million in property, equipment and software (excluding acquisitions) which was primarily driven by internally developed software, as compared to $43.4 million in the prior year, and had payments related to acquisitions, net of cash acquired, totaling $15.4 million for the year ended December 31, 2022, as compared to $14.6 million in the prior year. Additionally, in January 2022 we invested approximately $15.3 million for an interest in an equity method investment and joint venture with Broad Arrow. We subsequently acquired the remaining 60% outstanding equity interest of Broad Arrow in an all equity transaction. Subsequent to the acquisition, we issued $6.1 million in notes receivable related to Broad Arrow's asset-backed financing activity. For additional information regarding our 2022 acquisitions and equity method investments, refer to Note 9 — Acquisitions and Investments in Item 8 of Part II of this Annual Report on Form 10-K.
Financing Activities
Cash used in financing activities for the year ended December 31, 2022 was $28.1 million, compared to $332.1 million provided by financing activities in 2021. During the year ended December 31, 2022, there were net repayments of $28.1 million related to our long-term debt, primarily our Credit Facility, compared to $66.5 million in net borrowings in 2021. In 2021, net cash inflows from the Business Combination were $269.0 million, including proceeds of $789.7 million, offset by $489.7 million of distributions to the Legacy Unit Holders and $31.0 million of capitalized transaction costs. Refer to Note 8 — Business Combination in Item 8 of Part II of this Annual Report on Form 10-K for additional information on the Business Combination.
Financing Arrangements
Multi-bank Credit Facility
In September 2022 and December 2022, The Hagerty Group entered into a Fourth and Fifth Amendment to the Amended and Restated Credit Agreement ("Credit Agreement"), which amended the terms of our revolving credit facility ("Credit Facility") with JPMorgan Chase Bank, N.A., as administrative agent, and the other financial institutions party thereto from time to time as lenders.
The aggregate amount of commitments available to the Company under the Credit Facility is $230.0 million. The current term of the Credit Agreement expires in October 2026 and may be extended by one year on an annual basis if agreed to by us and the lenders party thereto. Any unpaid balance on the Credit Facility is due at maturity. As of December 31, 2022, total outstanding borrowings under the Credit Facility were $105.0 million.
The Credit Facility borrowings are collateralized by our assets, except for the assets of our U.K., Bermuda and German subsidiaries as well as MHH and its subsidiaries. In January 2023, Broad Arrow Europe Limited and Broad Arrow Capital UK Limited were joined to the Credit Facility as co-borrowers.
Under the Credit Agreement, we are required, among other things, to meet certain financial covenants, including a fixed charge coverage ratio and a leverage ratio. We were in compliance with these financial covenants as of December 31, 2022.
Refer to Note 16 — Debt in Item 8 of Part II of this Annual Report on Form 10-K for additional information on the Credit Facility.
Interest Rate Swap
Interest rate swap agreements are contracts to exchange floating rate for fixed rate interest payments over the life of the agreement without the exchange of the underlying notional amounts. The notional amounts of the interest rate swap agreements are used to measure interest to be paid or received and do not represent the amount of exposure to credit loss. The differential paid or received on the interest rate swap agreements is recognized as an adjustment to interest expense.
The purpose of the interest rate swap agreement is to fix the interest rate on a portion of our existing variable rate debt in order to reduce exposure to interest rate fluctuations. Under such agreements, we pay the counterparty interest at a fixed rate. In exchange, the counterparty pays us interest at a variable rate, adjusted quarterly and based on the Secured Overnight Financing Rate ("SOFR"). The amount exchanged is calculated based on the notional amount. The significant inputs, primarily the SOFR forward curve, used to determine the fair value are considered Level 2 observable market inputs. We monitor the credit and nonperformance risk associated with our counterparty and believe the risk to be insignificant and does not warrant a credit adjustment at December 31, 2022.
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In December 2020, we entered into a 5-year interest rate swap agreement with an original notional amount of $35.0 million. In September 2022, the interest rate swap was amended to replace LIBOR with SOFR and the fixed swap rate is now 0.81%. This interest rate swap matures in December 2025.
In March 2017, we entered into an interest rate swap agreement with an original notional amount of $15.0 million at a fixed swap rate of 2.20%. This interest rate swap matured in March 2022.
Tax Receivable Agreement
Hagerty, Inc. expects to have adequate capital resources to meet the requirements and obligations under the TRA entered into with the Legacy Unit Holders on December 2, 2021 that provides for the payment by Hagerty, Inc. to the Legacy Unit Holders of 85% of the amount of cash savings, if any, under U.S. federal, state and local income tax or franchise tax realized as a result of (1) any increase in tax basis of Hagerty, Inc.'s assets resulting from (a) purchase of Hagerty Group Unitsfrom any of the Legacy Unit Holders using the net proceeds from any future offering, (b) redemptions or exchanges by the Legacy Unit Holders of Class V Common Stock and Hagerty Group Units for shares of Class A Common Stock or (c) payments under the TRA and (2) tax benefits related to imputed interest deemed arising as a result of payments made under the TRA.
Legacy Unit Holders may, subject to certain conditions and transfer restrictions described above, redeem or exchange their Class V Common Stock and Hagerty Group Units for shares of Class A Common Stock of Hagerty, Inc. on a one-for-one basis. The Hagerty Group intends to have in effect an election under Section 754 of the IRC of 1986, as amended, and the regulations thereunder for each taxable year in which a redemption or exchange of Class V Common Stock and Hagerty Group Units for shares of Class A Common Stock occurs, which is expected to result in increases to the tax basis of the assets of The Hagerty Group at the time of a redemption or exchange of Hagerty Group Units. The redemptions and exchanges are expected to result in increases in the tax basis of the tangible and intangible assets of The Hagerty Group. These increases in tax basis may reduce the amount of tax that Hagerty, Inc. would otherwise be required to pay in the future. This payment obligation as a part of the TRA is an obligation of Hagerty, Inc. and not of The Hagerty Group. For purposes of the TRA, the cash tax savings in income tax will be computed by comparing the actual income tax liability of Hagerty, Inc. (calculated with certain assumptions) to the amount of such taxes that Hagerty, Inc. would have been required to pay had there been no increase to the tax basis of the assets of The Hagerty Group as a result of the redemptions or exchanges and had Hagerty, Inc. not entered into the TRA. Estimating the amount of payments that may be made under the TRA is by nature imprecise, insofar as the calculation of amounts payable depends on a variety of factors.
Contractual Obligations
The following table summarizes significant contractual obligations and other commitments as of December 31, 2022:
in thousands
Interest payments excludes variable rate debt interest payments and commitment fees related to our Credit Facility.
Off-Balance Sheet Arrangements
We do not have any material off-balance sheet financing arrangements as of December 31, 2022.
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Critical Accounting Estimates
Our significant accounting policies are described in Note 1 — Summary of Significant Accounting Policies and New Accounting Standards, in Item 8 of Part II of this Annual Report on Form 10-K. Our Consolidated Financial Statements are prepared in accordance with GAAP. The preparation of our Consolidated Financial Statements requires management to make assumptions and estimates that affect the reported results of operations and financial position, disclosure of contingent assets and liabilities, and the reported amounts of revenues and expenses during the reporting period. The following is a discussion of the accounting estimates and judgments that management believes are most significant in the application of GAAP used in the preparation of our Consolidated Financial Statements. These accounting estimates, among others, may involve a high degree of complexity and judgment on the part of management. Further, these estimates and other factors could have a significant impact to our financial condition, results of operations and cash flows. Management evaluates its significant accounting estimates on an ongoing basis using historical experience and various other assumptions that it believes to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying value of assets and liabilities that are not readily apparent from other sources. Actual results could differ materially from management's estimates.
Unpaid Losses and Loss Adjustment Expenses
Unpaid losses and loss adjustment expenses are the difference between the estimated ultimate cost of losses incurred and the amount of paid losses as of the reporting date. These reserves reflect management’s best estimate of unpaid losses related to both reported claims and IBNR claims. The reserves also include estimates of all expenses associated with processing and settling reported and unreported claims. We regularly review our reserve estimates and update those estimates as new information becomes available or as events emerge that may affect the resolution of unsettled claims. Updates made to reserve estimates based on new information may cause changes in prior reserve estimates. These changes are recorded as losses and loss adjustment expenses in the period such changes are determined. Estimating the ultimate cost of claims and claims expenses is an inherently complex and subjective process that involves a high degree of judgment. The judgments made by management in estimating the provision for unpaid losses and loss adjustment expenses are impacted by:
•uncertainty around inflationary costs, both economic and social inflation;
•estimates of expected losses through the use of historical loss data;
•the changing mix of business due to the large growth in modern collectible cars which carry a different risk profile than the risks associated with classic cars;
•legislative and judicial changes in the jurisdictions in which we write insurance; and
•management's industry experience.
Claims are analyzed and reported based on the accident year or the year in which the claims occurred. Accident year data is classified and utilized within actuarial models to prepare estimates of required reserves for payments to be made in the future. The timing of claim settlement varies and depends on the type of claim being reported (i.e. property damage as compared to personal injury claims). Claims involving property damage are generally settled faster than personal injury claims. Historical loss patterns are then applied to actual paid losses and reported losses by accident year to develop expectations of future payments. Implicit within the actuarial models are estimates of the impacts of inflation, especially for claims with longer expected cycle times. Refer to Note 11 — Provision for Unpaid Losses and Loss Adjustment Expenses in Item 8 of Part II of this Annual Report on Form 10-K for additional information regarding the methodologies used to estimate loss and loss adjustment expense reserves.
Given the inherent complexity and uncertainty regarding the estimate of our ultimate cost of settling claims, reserves are reviewed quarterly and periodically throughout the year by combining historical results and current actual results to calculate new development factors. In estimating loss and loss adjustment expense reserves, our actuarial reserving group considers claim cycle time, claims settlement practices, adequacy of case reserves over time, and current economic conditions. Because actual experience can differ from key assumptions used in estimating reserves, there may be significant variation in the development of these reserves and the actual losses and loss adjustment expenses ultimately paid in the future. These adjustments to the loss and loss adjustment expense reserves are recognized in our Consolidated Statements of Operations in the period in which the change occurs.
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The following table presents our gross and net provision for losses and loss adjustment expenses as of December 31, 2022 and 2021:
Gross % of Total Net % of Total
in thousands (except percentages)
The following table summarizes our gross losses and loss adjustment expenses, and net losses and loss adjustment expenses by accident years as of December 31, 2022 and 2021:
in thousands
Warrant Liabilities
Our warrants are accounted for in accordance with ASC 815. The warrants do not meet the criteria for equity treatment and as such, are recorded at fair value as a liability. The fair value of this liability is subject to remeasurement each reporting period.
Our Public Warrants are Level 1 within the fair value hierarchy as they are measured utilizing quoted market prices. We determined that our Private Placement Warrants, OTM Warrants, Underwriter Warrants and PIPE Warrants are Level 3 within the fair value hierarchy. We utilize a Monte Carlo simulation model to measure the fair value of these warrants. Our Monte Carlo simulation model includes assumptions related to the expected stock-price volatility, expected term, dividend yield and risk-free interest rate.
The impact of remeasuring the fair value of the warrants is recognized within Change in fair value of warrant liabilities in the Consolidated Statements of Operations each reporting period.
Refer to Note 15 — Fair Value Measurements, in Item 8 of Part II of this Annual Report on Form 10-K, for additional information related to the significant inputs to the Monte Carlo simulation model.
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Liabilities under the Tax Receivable Agreement
In connection with the Business Combination, Hagerty, Inc. entered into a TRA with the Legacy Unit Holders. The amount and timing of any payments under the TRA will vary depending on a number of factors, including, but not limited to, the increase in tax basis of The Hagerty Group's assets, the timing of any future redemptions, exchanges or purchases of Hagerty Group Units held by Legacy Unit Holders, the price of Class A Common Stock at the time of the purchase, redemption or exchange, the extent to which redemptions or exchanges are taxable, the amount and timing of the taxable income that Hagerty, Inc. generates in the future, the tax rates then applicable and the portion of the payments under the TRA constituting imputed interest. Hagerty, Inc. recognized a liability of $3.2 million and $3.5 million relating to obligations under the TRA for the years ended December 31, 2022 and 2021, respectively. Refer to Note 1 — Summary of Significant Accounting Policies and New Accounting Standards, in Item 8 of Part II of this Annual Report on Form 10-K, for additional information related to the TRA.
Acquisitions and Investments
A component of our growth strategy has been to acquire and integrate businesses that complement our existing operations. We account for business combinations in accordance with the guidance for business combinations and related literature. Accordingly, we allocate the purchase price of acquired businesses to the identifiable tangible and intangible assets acquired and liabilities assumed based upon their estimated fair values at the date of acquisition. Any purchase consideration in excess of the estimated fair values of the net assets acquired is recorded as goodwill. In determining the estimated fair values of assets acquired and liabilities assumed in a business combination, we use various recognized valuation methods including the income, market and cost approaches. Valuations are performed by management or independent valuation specialists under management’s supervision, where appropriate.
Accounting for business combinations requires our management to make significant estimates and assumptions, especially at the acquisition date, including our estimates for intangible assets, contractual obligations assumed and contingent consideration, where applicable. Although we believe the assumptions and estimates we have made in the past have been reasonable and appropriate, they are based in part on historical experience and information obtained from the management of the acquired companies and are inherently uncertain. Examples of critical estimates in valuing certain of the intangible assets we have acquired include, but are not limited to: determination of weighted average cost of capital, market participant assumptions, royalty rates, terminal multiples and estimates of future cash flows to be generated by the acquired assets. In addition to the estimates and assumptions applied to valuing intangible assets acquired, the determination of the estimated fair value of contingent consideration, including estimating the likelihood and timing of achieving the relevant thresholds for contingent consideration payments, requires the use of subjective judgments.
We believe that the estimated fair values assigned to the assets acquired and liabilities assumed are based on reasonable assumptions that a marketplace participant would use. While we use our best estimates and assumptions to accurately value assets acquired and liabilities assumed at the acquisition date, our estimates are inherently uncertain and subject to refinement. As a result, during the measurement period, which may be up to one year from the acquisition date, we may record adjustments to the assets acquired and liabilities assumed with the corresponding offset to goodwill. Upon the conclusion of the measurement period or final determination of the estimated fair values of assets acquired or liabilities assumed, whichever comes first, any subsequent adjustments would be recorded in our Consolidated Statements of Operations.
We recognize the fair value of contingent consideration at the date of acquisition as part of the consideration transferred to acquire a business. The liability associated with contingent consideration is remeasured to fair value at each reporting period subsequent to the date of acquisition taking into consideration changes in financial projections and long-term growth rates, among other factors, that may impact the timing and amount of contingent consideration payments until the term of the agreement has expired or the contingency is resolved. Increases in the fair value of contingent consideration are recorded as losses in our Consolidated Statements of Operations, while decreases in fair value are recorded as gains.
Goodwill and Intangible Assets
Goodwill is tested for impairment at least annually as of October 1 or between annual events if an event occurs or circumstances change that would more likely than not reduce the estimated fair value of a reporting unit below its carrying value. As of October 1, 2022, we performed a qualitative analysis in which we determined that it was not more likely than not that the fair values of our reporting units with goodwill were less than their carrying values. Our intangible assets are evaluated for impairment only when there is evidence that events or changes in circumstances indicate that the carrying amount of these assets may not be recoverable.
Application of the goodwill impairment test requires judgment, including the identification of reporting units and the determination of the estimated fair value of reporting units. For reporting units with goodwill, we perform a qualitative analysis to determine whether it is more likely than not the fair value of the reporting unit is less than its carrying amount. When assessing goodwill for impairment, our decision to perform a qualitative assessment for an individual reporting unit is based on a number of factors, including the carrying value of the reporting unit's goodwill, the amount of time in
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between quantitative fair value assessments, macro-economic conditions, industry and market conditions and the operating performance of the reporting unit. If it is determined, based on qualitative factors, that it is more likely than not that the fair value of the reporting unit is less than its carrying amount, a quantitative impairment test is performed, in which we determine the estimated fair value of the reporting unit using a discounted cash flow analysis. This analysis requires significant judgments, including estimation of future cash flows, which is dependent on internal forecasts, available industry/market data (to the extent available), estimation of the long-term rate of growth for the reporting unit including expectations and assumptions regarding the impact of general economic conditions on the reporting unit, estimation of the useful life over which cash flows will occur (including terminal multiples), determination of the respective weighted average cost of capital and market participant assumptions. Changes in these estimates and assumptions could materially affect the determination of estimated fair value and potential impairment for each reporting unit.
Fair value determinations require considerable judgment and are sensitive to changes in underlying assumptions and factors. As a result, there can be no assurance that the estimates and assumptions made for purposes of the annual goodwill impairment test will prove to be an accurate prediction of the future. Examples of events or circumstances that could reasonably be expected to negatively affect the underlying key assumptions and ultimately impact the estimated fair value of our reporting units may include such items as: (1) failure to meet business plans; (2) deterioration of the U.S. economy; (3) an increase in interest rates; or (4) other unanticipated events and circumstances that may decrease the projected cash flows or increase the discounts rates and could potentially result in an impairment charge.
While historical performance and current expectations have generally resulted in the conclusion that our goodwill is not impaired, if our assumptions are not realized, it is possible that an impairment charge may need to be recorded in the future. There can be no assurance that the estimates and assumptions made for purposes of the annual goodwill impairment tests will prove to be an accurate prediction of the future.
New Accounting Standards
New accounting standards are described in Note 1 — Summary of Significant Accounting Policies and New Accounting Standards, in Item 8 of Part II of this Annual Report on Form 10-K.
Non-GAAP Financial Measures
Adjusted EBITDA
We define Adjusted EBITDA as consolidated net income (loss) (the most directly comparable GAAP measure) before interest and other income (expense), income tax (expense) benefit, and depreciation and amortization, adjusted to exclude (i) restructuring, impairment and related charges, net, (ii) changes in the fair value of warrant liabilities, (iii) stock-based compensation expense, (iv) the revaluation gain on a previously held equity method investment, (v) expense associated with the accelerated vesting of incentive plans, (vi) net gains and losses from asset disposals and (vii) certain other unusual items. We present Adjusted EBITDA because we consider it to be an important supplemental measure of our performance and believe it is frequently used by securities analysts, investors, and other interested parties in the evaluation of companies in our industry.
Our management uses Adjusted EBITDA:
•as a measurement of operating performance of our business on a consistent basis, as it removes the impact of items not directly resulting from our core operations;
•for planning purposes, including the preparation of our internal annual operating budget and financial projections;
•to evaluate the performance and effectiveness of our operational strategies;
•to evaluate our capacity to expand our business;
•as a performance factor in measuring performance under our executive compensation plan; and
•as a predictor of core operating performance, comparisons to prior periods and competitive positioning.
By providing this non-GAAP financial measure, together with a reconciliation to net income (loss), which is the most directly comparable GAAP measure, we believe we are enhancing investors’ understanding of our business and our results of operations, as well as assisting investors in evaluating how well we are executing our strategic initiatives. However, Adjusted EBITDA has limitations as an analytical tool, and should not be considered in isolation, or as an alternative to, or a substitute for net income (loss) or other financial statement data presented in our Consolidated Financial Statements as indicators of financial performance. Hagerty's Adjusted EBITDA may be determined or calculated differently than similarly titled measures of other companies in our industry, which could reduce the usefulness of this non-GAAP financial measure when comparing our performance to that of other companies.
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The following table reconciles Adjusted EBITDA to the most directly comparable GAAP measure, which is Net income (loss):
Year Ended December 31,
in thousands
Interest and other (income) expense (2,028) 1,993
Restructuring, impairment and related charges, net 18,324 —
Change in fair value of warrant liabilities (41,899) 42,540
Stock-based compensation expense 12,129 —
Revaluation gain on previously held equity method investment (34,735) —
Accelerated vesting of incentive plans — 9,321
Net (gain) loss from asset disposals 1,970 1,764
(1) Other unusual items in 2021 relates to expenses incurred related to the Business Combination. Other unusual items in 2022 relates to certain severance and legal settlement expenses.
Net income (loss) and Adjusted EBITDA for the year ended December 31, 2022 include $10.0 million of estimated net losses related to Hurricane Ian. Additionally, we strengthened reserves for U.S. auto liability by $6.5 million for the 2022 accident year. Both of these events adversely impacted the 2022 results compared to the year ended December 31, 2021.
We incurred $29.8 million and $31.0 million during the years ended December 31, 2022 and 2021, respectively, for certain pre-revenue costs related to scaling our infrastructure, newly-developed digital platforms and legacy systems, human resources and occupancy to accommodate our alliance with State Farm and other potential distribution partnerships as well as to further develop our Marketplace initiatives. These costs were not included in the Adjusted EBITDA reconciliation above.
Pursuant to a defined set of activities and objectives, these expenses are adding entirely new capabilities for us, integrating our new and legacy policyholder, membership and Marketplace systems with State Farm’s legacy policy and agent management systems and other third-party platforms.
Adjusted EPS
We define Adjusted Earnings (Loss) Per Share ("Adjusted EPS") as consolidated Net income (loss) attributable to both our controlling and non-controlling interest, less the change in fair value of our warrants and the revaluation gain on previously held equity method investment, divided by our outstanding and total potentially dilutive securities. The total potentially dilutive securities includes (1) the weighted-average issued and outstanding shares of Class A Common Stock, (2) all issued and outstanding non-controlling interest Hagerty Group Units, (3) all unexercised warrants and (4) all unissued stock-based compensation awards.
In the third quarter of 2022, we began removing (1) the change in fair value of our warrants and (2) the revaluation gain on previously held equity method investment from consolidated Net income (loss) attributable to both our controlling and non-controlling interest for purposes of calculating Adjusted EPS. For comparability, references to prior period non-GAAP measures have been updated to show the effect of removing the change in the fair value of our warrants from Adjusted EPS. We believe this updated presentation of Adjusted EPS enhances investors' understanding of our financial performance from activities occurring in the ordinary course of our business.
The most directly comparable GAAP measure is basic earnings per share ("Basic EPS"), which is calculated as Net income (loss) attributable to controlling interest divided by the weighted average of Class A Common Stock outstanding during the period.
We present Adjusted EPS because we consider it to be an important supplemental measure of our operating performance and believe it is used by investors and securities analysts in evaluating the consolidated performance of other companies in our industry. We also believe that Adjusted EPS, which compares our consolidated Net income (loss) (which includes our controlling and non-controlling interest) with our outstanding and potentially dilutive shares, provides useful information to investors regarding our performance on a fully consolidated basis.
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Our management uses Adjusted EPS:
•as a measurement of operating performance of our business on a fully consolidated basis;
•to evaluate the performance and effectiveness of our operational strategies;
•to evaluate our capacity to expand our business; and
•as a preferred predictor of core operating performance, comparisons to prior periods and competitive positioning.
We caution investors that Adjusted EPS is not a recognized measure under GAAP and should not be considered in isolation or as a substitute for, or superior to, the financial information prepared and presented in accordance with GAAP, including Basic EPS, and that Adjusted EPS, as we define it, may be defined or calculated differently by other companies. In addition, Adjusted EPS has limitations as an analytical tool and should not be considered as a measure of profit or loss per share.
The following table reconciles Adjusted EPS to the most directly comparable GAAP measure, which is Basic EPS:
Year Ended December 31,
in thousands (except per share amounts)
Numerator:
Net income (loss) attributable to controlling interest(1) $ 32,078 $ (46,358)
Net income (loss) attributable to non-controlling interest (29,675) (398)
Net income (loss) attributable to redeemable non-controlling interest — (14,598)
Consolidated net income (loss) $ 2,403 $ (61,354)
Change in fair value of warrant liabilities (41,899) 42,540
Revaluation gain on previously held equity method investment (34,735) —
Adjusted consolidated net income (loss)(2) $ (74,231) $ (18,814)
Denominator:
Total potentially dilutive securities outstanding:
Total unissued stock-based compensation 6,902 —
(1)Numerator and Denominator of the GAAP measure Basic EPS
(2)Numerator and Denominator of the non-GAAP measure Adjusted EPS
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
We are a smaller reporting company as defined by Rule 12b-2 of the Exchange Act, and are not required to provide the information otherwise required under this item.
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ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
Financial Statements Page No.
Report of Independent Registered Public Accounting Firm (PCAOB ID No. 34) 59
Consolidated Balance Sheets as of December 31, 2022 and 2021 62
Consolidated Statements of Equity for the two years ended December 31, 2022 64
Notes Accompanying the Consolidated Financial Statements 67
All other schedules are omitted because they are not applicable or the required information is shown in the Consolidated Financial Statements or Notes thereto.
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REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
To the stockholders and the Board of Directors of Hagerty, Inc.
Opinion on the Financial Statements
We have audited the accompanying consolidated balance sheets of Hagerty, Inc. and subsidiaries (the "Company") as of December 31, 2022 and 2021, the related consolidated statements of operations, comprehensive income (loss), changes in members’ and stockholders’ equity, and cash flows, for each of the two years in the period ended December 31, 2022, and the related notes (collectively referred to as the "financial statements"). In our opinion, the financial statements present fairly, in all material respects, the financial position of the Company as of December 31, 2022 and 2021, and the results of its operations and its cash flows for each of the two years in the period ended December 31, 2022, in conformity with accounting principles generally accepted in the United States of America.
Basis for Opinion
These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on the Company's financial statements based on our audits. We are a public accounting firm registered with the Public Company Accounting Oversight Board (United States) (PCAOB) and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB.
We conducted our audits in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement, whether due to error or fraud. The Company is not required to have, nor were we engaged to perform, an audit of its internal control over financial reporting. As part of our audits, we are required to obtain an understanding of internal control over financial reporting but not for the purpose of expressing an opinion on the effectiveness of the Company’s internal control over financial reporting. Accordingly, we express no such opinion.
Our audits included performing procedures to assess the risks of material misstatement of the financial statements, whether due to error or fraud, and performing procedures that respond to those risks. Such procedures included examining, on a test basis, evidence regarding the amounts and disclosures in the financial statements. Our audits also included evaluating the accounting principles used and significant estimates made by management, as well as evaluating the overall presentation of the financial statements. We believe that our audits provide a reasonable basis for our opinion.
/s/ DELOITTE & TOUCHE LLP
Detroit, Michigan
March 14, 2023
We have served as the Company’s auditor since 2019.
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Hagerty, Inc.
Consolidated Statements of Operations
Year Ended December 31,
REVENUE: in thousands (except per share amounts)
Membership, marketplace and other revenue 77,289 51,684
OPERATING EXPENSES:
Restructuring, impairment and related charges, net 18,324 —
Change in fair value of warrant liabilities 41,899 (42,540)
Revaluation gain on previously held equity method investment 34,735 —
Interest and other income (expense) 2,028 (1,993)
INCOME (LOSS) BEFORE INCOME TAX EXPENSE 11,096 (54,603)
Income tax benefit (expense) (7,017) (6,751)
Income (loss) from equity method investment, net of tax (1,676) —
Net loss (income) attributable to non-controlling interest 29,675 398
Net loss (income) attributable to redeemable non-controlling interest — 14,598
NET INCOME (LOSS) ATTRIBUTABLE TO CONTROLLING INTEREST $ 32,078 $ (46,358)
Earnings (loss) per share of Class A Common Stock:
Weighted-average shares of Class A Common Stock outstanding:
The accompanying Notes are an integral part of these Consolidated Financial Statements.
See Note 23 for information regarding Related-Party Transactions.
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Hagerty, Inc.
Consolidated Statements of Comprehensive Income (Loss)
Year Ended December 31,
in thousands
Other comprehensive income (loss), net of tax:
Foreign currency translation adjustments (1,834) (792)
Other comprehensive income (loss) 865 227
Comprehensive loss (income) attributable to non-controlling interest 29,675 398
The accompanying Notes are an integral part of these Consolidated Financial Statements.
See Note 23 for information regarding Related-Party Transactions.
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Hagerty, Inc.
Consolidated Balance Sheets
ASSETS in thousands (except share amounts)
Current Assets:
Prepaid expenses and other current assets 45,651 30,155
Long-Term Assets:
Prepaid expenses and other non-current assets 37,082 30,565
Lease right-of-use assets 82,398 —
LIABILITIES AND EQUITY
Current Liabilities:
Provision for unpaid losses and loss adjustment expenses 111,741 74,869
Current lease liabilities 7,556 —
Accrued expenses and other current liabilities 53,211 47,960
Long-Term Liabilities:
Long-term lease liabilities 80,772 —
(continued)
The accompanying Notes are an integral part of these Consolidated Financial Statements.
See Note 23 for information regarding Related-Party Transactions.
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Hagerty, Inc.
Consolidated Balance Sheets
in thousands (except share amounts)
Commitments and Contingencies (Note 24)
Redeemable non-controlling interest (Note 18) $ — $ 593,277
STOCKHOLDERS' EQUITY
Accumulated other comprehensive income (loss) (213) (1,727)
(concluded)
The accompanying Notes are an integral part of these Consolidated Financial Statements.
See Note 23 for information regarding Related-Party Transactions.
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Hagerty, Inc.
Consolidated Statements of Changes in Members' and Stockholders' Equity
in thousands Shares Amount Shares Amount
Distributions before transaction (4,056) — — — — — — — (4,056) — (4,056) —
Restricted stock issued — 37 — — — — — — — — — —
Non-controlling interest issued capital — — — — — — — — — 1,700 1,700 —
The accompanying Notes are an integral part of these Consolidated Financial Statements.
See Note 23 for information regarding Related-Party Transactions.
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Hagerty, Inc.
Consolidated Statements of Cash Flows
Year Ended December 31,
OPERATING ACTIVITIES: in thousands
Change in fair value of warrant liabilities (41,899) 42,540
Loss on equity method investment 1,676 —
Revaluation gain on previously held equity method investment (34,735) —
Impairment of operating lease right-of-use assets 4,698 —
Depreciation and amortization expense 33,887 22,144
Loss on disposals of equipment, software and other assets 4,316 2,425
Stock-based compensation expense 12,129 —
Non-cash lease expense 10,875 —
Changes in assets and liabilities:
Prepaid expenses and other assets (12,021) (18,523)
Provision for unpaid losses and loss adjustment expenses 36,872 19,882
Operating lease liabilities (9,779) —
Accrued expenses and other current liabilities 1,239 6,096
Net Cash Provided by Operating Activities 55,328 42,281
INVESTING ACTIVITIES:
Purchases of property, equipment and software (44,375) (43,370)
Acquisitions, net of cash acquired (15,404) (14,609)
Purchase of previously held equity method investment (15,250) —
Issuance of note receivable to previously held equity investment (7,000) —
Issuance of notes receivable (6,123) —
Proceeds from notes receivable 370 —
Purchase of fixed income securities (4,234) (12,246)
Maturities of fixed income securities 1,216 1,183
Other investing activities (721) 48
Net Cash Used in Investing Activities $ (91,521) $ (68,994)
(continued)
The accompanying Notes are an integral part of these Consolidated Financial Statements.
See Note 23 for information regarding Related-Party Transactions.
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Hagerty, Inc.
Consolidated Statements of Cash Flows
Year Ended December 31,
FINANCING ACTIVITIES: in thousands
Contribution from non-controlling interest 1,700 1,580
Distributions — (4,056)
Deferred financing costs — (962)
Cash received in Business Combination — 789,661
Cash consideration to HHC at Closing of Business Combination — (489,661)
Payment of capitalized transaction costs (1,651) (30,991)
Net Cash Provided by (Used in) Financing Activities (28,084) 332,071
NON-CASH INVESTING AND FINANCING ACTIVITIES:
Purchase of property, equipment and software $ 1,592 $ 4,668
Broad Arrow acquisition $ 73,253 $ —
Warrant liabilities recognized in Business Combination $ — $ 46,826
CASH PAID FOR:
(concluded)
The following table provides a reconciliation of cash and cash equivalents and restricted cash and cash equivalents as presented for the years ended December 31, 2022 and 2021:
in thousands
The accompanying Notes are an integral part of these Consolidated Financial Statements.
See Note 23 for information regarding Related-Party Transactions.
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Hagerty, Inc.
Notes To Consolidated Financial Statements
1 — Summary of Significant Accounting Policies and New Accounting Standards
Description of Business — In these notes to the Consolidated Financial Statements,"we," "our," "us," "Hagerty," "HGTY," and the "Company" refer to Hagerty, Inc., formerly known as Aldel Financial Inc. ("Aldel"), and its consolidated subsidiaries including The Hagerty Group, LLC ("The Hagerty Group"), unless the context requires otherwise. Hagerty is a global market leader in providing insurance for classic cars and enthusiast vehicles. In addition, Hagerty provides an automotive enthusiast platform that engages, entertains and connects with its insurance policyholders andHagerty Drivers Club ("HDC") paid subscribers ("Members") and other car enthusiasts.
The Company operates several entities which collectively support Hagerty's revenue streams. Hagerty earns commission and fee revenue for the distribution and servicing of classic and collector motor vehicle and boat insurance policies written through personal and commercial lines agency agreements with multiple insurance carriers in the United States ("U.S."), Canada and the United Kingdom ("U.K.").
Reinsurance premiums are earned through Hagerty Reinsurance Limited ("Hagerty Re"), which is registered as a Class 3A reinsurer under the Bermuda Insurance Act 1978. Hagerty Re solely reinsures the classic and collector auto and marine risks written through Hagerty's Managing General Agency ("MGA") entities in the U.S., Canada and the U.K.
•The business produced by Hagerty's U.S. MGAs is written by Essentia Insurance Company ("Essentia") and reinsured with its affiliate, Evanston Insurance Company ("Evanston"). In turn, Hagerty Re assumes premiums through a quota share agreement with Evanston. Essentia and Evanston are wholly owned subsidiaries of Markel Corporation ("Markel"), which is a related party. Refer to Note 23 — Related-Party Transactions for additional information.
•The business produced by Hagerty's Canadian MGA is written by Aviva Canada Inc. ("Aviva"), through Aviva's Canadian subsidiary, Elite Insurance Company, ("Elite"). In turn, Hagerty Re assumes premiums through a quota share agreement with Elite.
•In 2021, Hagerty Re entered into a reinsurance agreement with Markel International Insurance Company Limited to reinsure classic and collector auto risks produced by Hagerty's U.K. MGA. In connection with this agreement, Hagerty Re purchased reinsurance to limit its liability to £1,000,000 per claim as U.K. law requires unlimited liability coverage. Markel International Insurance Company Limited is a subsidiary of Markel, which is a related party. Refer to Note 23 — Related-Party Transactions for additional information.
The Company earns subscription revenue through HDC membership offerings. HDC memberships are sold as a bundled product which give Members access to our products and services, including Hagerty Drivers Club Magazine, automotive enthusiast events, our proprietary vehicle valuation tool, emergency roadside services and special vehicle-related discounts. Marketplace offers services for buying and selling collector vehicles through classified listings, auctions and private sales, and also provides asset-based financing. The Company also owns and operates collector vehicle events, including The Amelia and Greenwich Concours d'Elegance, earning revenue through ticket sales and sponsorships. Lastly, the Company operates Hagerty Garage + Social, a network of world-class vehicle storage and exclusive social club facilities for classic, collector and exotic car owners.
In January 2022, the Company entered into a joint venture with Broad Arrow Group, Inc. and its consolidated subsidiaries ("Broad Arrow"), pursuant to which Hagerty invested $15.3 million in exchange for equity ownership of approximately 40% of Broad Arrow. Then, in August 2022, the Company acquired the remaining 60% equity interest in Broad Arrow in exchange for approximately $73.3 million of equity consideration consisting of Class A Common Stock and limited liability units in The Hagerty Group ("Hagerty Group Units"). As a result of this acquisition, the Company and Broad Arrow expect to further leverage their respective product offerings and continue to build Marketplace. Refer to Note 9 — Acquisitions and Investments for additional information.
The Company’s headquarters are located in Traverse City, Michigan.
Basis of Presentation — The Company's Consolidated Financial Statements are prepared in accordance with accounting principles generally accepted in the United States of America ("GAAP") and pursuant to the rules and regulations of the Securities and Exchange Commission and include the accounts of Hagerty, Inc. and The Hagerty Group with its consolidated subsidiaries.
The financial statements reflect all normal recurring adjustments and accruals that are, in the opinion of management, necessary for a fair statement of financial position and results of operations for the periods presented.
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Principles of Consolidation — The Company's Consolidated Financial Statements contain the accounts of Hagerty and its majority-owned or controlled subsidiaries. The Company had economic ownership of 24.5% and 24.7% of The Hagerty Group as of December 31, 2022 and 2021, respectively. In addition, Member Hubs Holding, LLC ("MHH"), which operates as Hagerty Garage + Social, is an 80% owned subsidiary of The Hagerty Group. The Company consolidates these entities under the voting interest method guidance in accordance with Accounting Standards Codification ("ASC") Topic 810, Consolidations ("ASC 810"). Non-controlling interest is presented separately on the Consolidated Statements of Operations, Consolidated Statements of Comprehensive Income (Loss), Consolidated Balance Sheets and the Consolidated Statements of Changes in Members' and Stockholders' Equity.
From January 2022 to August 2022, the Company owned approximately 40% of the outstanding equity interest of Broad Arrow and accounted for it as an equity method investment. Subsequent to the acquisition of the remaining 60% outstanding equity interest of Broad Arrow in August 2022, Broad Arrow became a wholly-owned subsidiary of the Company and as a result, is consolidated in accordance with ASC 810. Refer to Note 9 — Acquisitions and Investments for additional information.
All intercompany accounts and transactions have been eliminated in consolidation.
Business Combination —On December 2, 2021 (the "Closing"), The Hagerty Group completed a business combination with Aldel, and Aldel Merger Sub LLC ("Merger Sub"), a Delaware limited liability company and wholly owned subsidiary of Aldel (the "Business Combination"). In connection with the Closing, Aldel changed its name from Aldel Financial Inc. to Hagerty, Inc.
The Business Combination was accounted for as a common control reverse acquisition, for which The Hagerty Group was determined to be the accounting acquirer and Aldel was treated as the "acquired" company. The Hagerty Group issued equity for the net assets of Aldel, accompanied by a recapitalization. Business combinations in which the legal acquirer is not the accounting acquirer are commonly referred to as "reverse acquisitions". A reverse acquisition occurs when the entity that issues securities (legal acquirer) is identified as the acquiree for accounting purposes and the entity whose equity interests are acquired (the legal acquiree) is identified as the acquirer for accounting purposes. Reverse acquisitions are accounted for in accordance with Subtopic 805-40 of ASC Topic 805, Business Combinations ("ASC 805"). While other factors were evaluated but not considered to have a material impact on the determination, The Hagerty Group was determined to be the accounting acquirer based on the following factors:
•Hagerty Holding Corp. ("HHC") controlled the operating company prior to the Business Combination and controls the Company subsequent to the Business Combination through control of the board of directors (the "Board"), as well as by having majority voting ownership.
•The Hagerty Group’s management is also the management of the Company.
•The Hagerty Group is larger as compared to Aldel based on assets, revenue and earnings.
Unless otherwise indicated or the context otherwise requires, "Hagerty" and "the Company" refer to the business and operations of The Hagerty Group and its consolidated subsidiaries prior to the Business Combination and to Hagerty, Inc. and its consolidated subsidiaries, including The Hagerty Group, following the consummation of the Business Combination.
Refer to Note 8 — Business Combination for additional information.
Emerging Growth Company — The Company currently qualifies as an "emerging growth company" under the Jumpstart Our Business Startups Act of 2012 and can delay the adoption of new or revised accounting standards until those standards would apply to private companies.
The Company intends to avail itself of such extended transition period and, therefore, the Company may not be subject to the same new or revised accounting standards as other public companies that are not emerging growth companies or have opted out of using such extended transition period.
Use of Estimates — The preparation of the Company's Consolidated Financial Statements in conformity with GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities, disclosure of contingent assets and liabilities at the date of the Consolidated Financial Statements and the reported amounts of revenue and expenses during the reporting period. Although the estimates are considered reasonable, actual results could materially differ from those estimates.
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Significant estimates made by management include, but are not limited to: (1) the provision for unpaid losses and loss adjustment expenses, including incurred but not reported ("IBNR") claims; (2) the change in fair value of warrant liabilities; (3) the liability associated with the payments due under the Tax Receivable Agreement ("TRA"); (4) the purchase price allocation and related estimates and assumptions in business combinations; (5) the fair values of the reporting units used in assessing the recoverability of goodwill; and (6) the useful lives of intangible assets. Although some variability is inherent in these estimates, the Company believes that the current estimates are reasonable in all material respects. These estimates are reviewed regularly and adjusted as necessary. Adjustments related to changes in estimates are reflected in the Company’s results of operations in the period for which those estimates changed.
Segment Information — The Company has one operating segment and one reportable segment. The Company’s Chief Operating Decision Maker ("CODM") is the Chief Executive Officer ("CEO"), who makes resource allocation decisions and assesses performance based on financial information presented on a consolidated basis. The Company’s management approach is to utilize an internally developed strategic decision making framework with its Members at the center of all decisions, which requires the CODM to have a consolidated view of the operations so that decisions can be made in the best interest of Hagerty and its Members.
Foreign Currency Translation — The Company translates its foreign operations’ assets and liabilities denominated in foreign currencies into U.S. dollars at current rates of exchange as of the balance sheet date, and income and expense items at the average exchange rate for the reporting period. Translation adjustments resulting from exchange rate fluctuations are recorded in "Foreign currency translation adjustments", a component of Accumulated other comprehensive income (loss). Foreign currency transaction gains and losses are recognized within "Interest and other income (expense)" in the Consolidated Statements of Operations.
Cash and Cash Equivalents and Restricted Cash and Cash Equivalents — Cash includes amounts held in banks in operating accounts and money market funds. The Company considers money market funds with maturities within 90 days of the purchase date to be equivalent to cash. At December 31, 2022 and 2021, the Company’s cash accounts exceeded federally insured limits.
The Company maintains cash collected by its MGAs for premiums from insured parties that have not yet been remitted to insurance companies. These funds are required to be held in trust and segregated from operating cash. These funds and a corresponding liability are included within "Restricted cash and cash equivalents" and "Due to insurers", respectively, on the Consolidated Balance Sheets.
The Company has also established a trust account for the benefit of the ceding insurer as security for Hagerty Re's obligations for losses, loss expenses, unearned premium and profit-sharing commissions. The use of this fund is restricted to the payment of these amounts and is included within "Restricted cash and cash equivalents" on the Consolidated Balance Sheets.
Accounts Receivable — Accounts receivable are recorded, and revenue is recognized, at the latter of the billed or policy effective date, net of estimated cancellations.
Ceded Reinsurance Premiums — Cededreinsurance premiums are recognized pro-rata over the term of the reinsurance treaties and are recorded as a reduction of "Earned premium" in the Consolidated Statements of Operations. The portion of the reinsurance premium related to the unexpired portions of the treaties at the end of the reporting period is reflected within "Prepaid expenses and other current assets" on the Consolidated Balance Sheets.
Prepaid Expenses and Other Assets — Prepaid expenses and other assets consist primarily of prepaid sales and general and administrative services expenses, prepaid Software-as-a-Service ("SaaS") implementation costs and fixed income investments.
•Prepaid expenses are recorded at cost and amortized over the service term.
•SaaS implementation costs are recorded as incurred in prepaid expenses. The Company expenses the costs incurred during the preliminary project stage and, upon management approval, capitalizes the direct implementation costs once the development phase begins. The Company monitors implementation on an ongoing basis and capitalizes the costs of any major improvements or new functionality. Once the software is fully implemented, the ongoing maintenance costs are expensed.
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•Fixed income investments consist of Canadian provincial and municipal bonds which qualify as debt securities under ASC Topic 320 Investments – Debt Securities. Fixed income investments are classified as held-to-maturity, as the Company has the intent and ability to hold these investments to maturity, and as a result are carried at amortized cost on the Consolidated Balance Sheets. Amortized cost is the amount at which an investment is acquired, adjusted for applicable accrued interest and accretion of discount or amortization of premium. Premium or discount is amortized on a straight-line basis to maturity. Pricing information for each fixed income security is obtained from our outside investment manager. The Company ultimately determines whether the inputs and the resulting market values are reasonable. Market pricing is based on fair value level 2 guidance using observable inputs such as quoted prices for similar assets at the measurement date. Refer to Note 15 — Fair Value Measurements for additional information.
Notes Receivable — Notes receivable, net of an allowance for loan losses, includes amounts due on term loans secured by collateral consisting of collector cars. Any potential allowance for loan losses is estimated based upon the impact of current economic conditions on the collateral value, knowledge about the client's financial standing and other factors and is evaluated periodically. Term loans are recorded on the date the loan is made based on the loan amount in the agreement. Term loans typically have an initial maturity of up to two years with an option to renew for one year increments, and accrue interest based on the stated rate in the loan agreement. The valuation of collector vehicles is inherently subjective, and the realizable value of collector cars often fluctuates over time. Refer to Note 5 — Notes Receivable for additional information.
Deferred Acquisition Costs — Deferred acquisition costs are comprised of ceding commission and premium taxes that relate directly to the successful acquisition of new or renewal policy premiums by Hagerty Re. Acquisition costs are deferred and recognized in income over the period of the exposure in the underlying insurance treaties.
The Company evaluates the recoverability of deferred acquisition costs by determining if the sum of future-earned premiums is greater than the expected future claims and expenses. Anticipated investment income is also a factor in this determination. If a loss is probable on the unexpired portion of policies in force, a premium deficiency reserve is recognized. At December 31, 2022 and 2021, the deferred acquisition costs were considered fully recoverable and no premium deficiency reserve was recorded.
Property and Equipment — Property and equipment are recorded at cost and depreciated over the estimated useful life of each asset. Leasehold improvements are amortized over the shorter of either the lease term or the estimated useful lives of the improvements. Useful lives for financial reporting range from three to seven years for computers, automobiles and office furniture. Building and building improvements have useful lives of 39 years. Upon sale or retirement, the cost and related accumulated depreciation of assets disposed of are removed from the accounts, and any resulting gain or loss is reflected in the Consolidated Statements of Operations. Annual depreciation is calculated based on the straight-line method. Maintenance, repair costs and minor renovations are expensed as incurred, while expenditures that increase the asset lives are capitalized.
Leases — The Company evaluates its contracts to determine whether such contracts contain a lease at inception. A contract contains a lease if the contract conveys the right to control the use of identified property, plant or equipment for a period of time in exchange for consideration. At commencement, contracts containing a lease are further evaluated for classification as an operating lease or finance lease. Operating lease right-of-use ("ROU") assets and liabilities are recognized at the commencement date of the lease based on the present value of lease payments over the lease term, discounted using the Company's incremental borrowing rate. The Company estimates the incremental borrowing rate based on qualitative factors including company specific credit rating, lease term, impact of collateral, general economics and the interest rate environment. Operating lease liabilities represent the present value of lease payments not yet paid. Operating lease ROU assets are based upon the operating lease liabilities adjusted for prepayments or accrued lease payments, initial direct costs, lease incentives, and impairment of operating lease assets. The Company made a policy election not to recognize ROU assets and lease liabilities for short-term leases for all asset classes. The Company has real estate lease agreements that contain lease and non-lease components, which are accounted for as a single lease component.
The Company’s leases often contain fixed rent escalations over the lease term. The Company recognizes expense for these leases on a straight-line basis over the lease term. The Company also has lease agreements that are subject to annual changes in the Consumer Price Index ("CPI"). While lease liabilities are not remeasured as a result of changes to the CPI, changes to the CPI are treated as variable lease payments and recognized in the period in which the obligation for those payments has incurred.
The Company’s lease agreements may contain variable costs such as common area maintenance, operating expenses, real estate taxes or other costs. Variable lease costs are expensed as incurred within "General and administrative services" in the Consolidated Statements of Operations. The Company’s lease agreements generally do not contain any residual value guarantees or restrictive covenants.
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The Company has the option to extend most of its lease agreements, with renewals ranging from one to 20 years. The Company includes renewal options in lease terms that are deemed reasonably certain of being exercised in the lease term. As it was not reasonably certain that the Company would exercise these renewal options, they were not included in the lease terms for purposes of calculating the Company's lease liability. The Company adopted ASC Topic 842 ("ASC 842") effective January 1, 2022 under the modified retrospective approach. Refer to "Recently Adopted Accounting Guidance" below for additional information.
The Company’s primary operating leases consist of office space and Hagerty Garage + Social locations. The Company’s leases have remaining terms of one to 14 years. As of December 31, 2022, the Company had not entered into any finance leases. Refer to Note 7 — Leases for additional information.
Intangible Assets — Intangible assets are recorded at cost and amortized over the estimated useful life of each intangible asset. Acquired intangible assets are initially valued at fair value using generally accepted valuation methods appropriate for the type of intangible assets. Intangible assets primarily consist of insurance policy renewal rights, internally developed software, trade names, non-compete agreements and customer relationships. Amortization is recorded using the straight-line method over their estimated useful lives as it approximates the pattern over which economic benefits are realized. Insurance policy renewal rights, internally developed software, trade names, non-complete agreements and customer relationships are amortized over 3 to 25 years. For internally developed software, the Company expenses the costs incurred during the preliminary project stage and capitalizes the direct development costs (including the associated payroll and related costs for employees working on development and outside contractor costs) once management approval is obtained. Refer to Note 10 — Goodwill and Intangible Assets for additional information.
Impairment of Long-Lived Assets — The Company reviews all long-lived assets that have finite lives for impairment whenever events or changes in circumstances indicate that the carrying amount may not be recoverable in accordance with ASC Topic 360, Impairment and Disposal of Long-Lived Assets ("ASC 360"). If it is determined the carrying amount of the asset is not recoverable, the Company recognizes an impairment loss as an operating expense in the current period in the Consolidated Statements of Operations.
Determination of the recoverability of long-lived assets is based on an estimate of the undiscounted cash flows resulting from the use of the assets and its eventual disposition. If the carrying value of the long-lived asset is not recoverable on an undiscounted cash flow basis, an impairment is recognized to the extent that the carrying value exceeds its fair value. Fair value is determined through various valuation techniques including discounted cash flow models, quoted market values and third-party independent appraisals, as necessary.
For the Company's operating leases, the circumstances that might lead to an impairment of the associated ROU assets and leasehold improvements may include situations when the space is sublet or available for sublease and we do not expect to fully recover the costs of the lease. During the year ended December 31, 2022, the Company recognized an impairment charge of $4.7 million related to operating lease ROU assets, which was recorded within "Restructuring, impairment and related charges, net" in the Consolidated Statements of Operations. Refer to Note 14 — Restructuring, Impairment and Related Charges for additional information. During the year ended December 31, 2021, the Company did not identify any impairment indicators.
Goodwill — Goodwill represents the excess of the cost of a business combination, as defined in ASC 805, over the fair value of net assets acquired, including identifiable intangible assets. Goodwill is tested for impairment at the reporting unit level annually as of October 1, and whenever indicators of impairment exist. The Company evaluates for the potential impairment of goodwill by assessing qualitative factors to determine whether it is more likely than not that the fair value of a reporting unit is less than its carrying amount. Qualitative factors include industry and market considerations, overall financial performance, and other relevant events and circumstances affecting the reporting unit. If after performing the qualitative assessment, the Company determines it is more likely than not that the fair value of the reporting unit is less than its carrying amount, the Company performs a quantitative fair value test. The primary valuation method used in the quantitative impairment assessment to determine the fair value of the reporting unit has been a discounted cash flow model. The Company primarily uses a discounted cash flow model to determine the fair value of its reporting units, but other valuation methods or comparable transactions may be used when appropriate and applicable to determine the fair value of a reporting unit.
The Company did not recognize any goodwill impairments during the years ended December 31, 2022 and 2021.
Losses Payable — Losses payable represents the amount of losses paid and billed by the primary carrier that have not been paid by Hagerty Re as of the balance sheet date.
Provision for Unpaid Losses and Loss Adjustment Expenses — The provision for unpaid losses and loss adjustment expenses is the difference between the estimated cost of losses incurred and the amount of paid losses as of the reporting date. This reserve reflects management’s best estimate of losses related to both reported claims and IBNR claims. The reserve also includes estimates of all expenses associated with processing and settling reported and unreported claims.
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Given the inherent complexity and uncertainty regarding the estimate of our ultimate cost of settling claims, reserves are reviewed quarterly and periodically throughout the year by comparing historical results and current results to calculate new development factors. In estimating loss and loss adjustment expense reserves, our actuarial reserving group considers claim cycle time, claims settlement practices, adequacy of case reserves over time and current economic conditions. Because actual experience can differ from key assumptions used in estimating reserves, there may be significant variation in the development of these reserves and the actual losses and loss adjustment expenses ultimately paid in the future. These adjustments to the loss and loss adjustment expense reserves and related reinsurance recoverables are recognized in the Consolidated Statements of Operations in the period in which the change occurs.
The amount of any reinsurance recoverable is determined by applying contract language specific to the Company’s third-party reinsurance program to losses and loss expenses arising from claims occurring as a result of a qualifying event. Reinsurance recoverables are recorded within "Prepaid expenses and other current assets" on the Consolidated Balance Sheets.
Due to Insurers — Due to insurers represents the net amount of premium due to carriers based on the respective contract with each carrier. The net amount due is equal to the gross written premium less the Company’s commission for policies that have reached their effective date.
Advanced Premiums — Advanced premiums represent the gross written premium received from insurance Members prior to the effective date of the policy. At the effective date of the policy, advanced premiums are reclassified to "Due to insurers" and commission revenue is recognized in the Consolidated Statements of Operations.
Accrued Expenses — Accrued expenses consist primarily of amounts owed for wages, payroll taxes, incentive compensation, benefits, professional services and future installments for purchase consideration resulting from asset acquisitions and business combinations.
Warrant Liabilities — The Company accounts for its outstanding warrants in accordance with ASC Topic 815, Derivatives and Hedging ("ASC 815"). The warrants do not meet the criteria for equity treatment and as such, are recorded at fair value as a liability. The fair value of this liability is subject to remeasurement each reporting period and the Company utilizes a Monte Carlo simulation model to value the warrants. The change in the fair value of the warrants is recognized within "Change in fair value of warrant liabilities" in the Consolidated Statements of Operations each reporting period. Refer to Note 20 — Warrant Liabilities for additional information.
Derivative Instruments — The Company enters into certain derivative financial instruments, when available on a cost-effective basis, to mitigate its risk associated with changes in interest rates. The Company accounts for derivatives in accordance with ASC 815, which establishes accounting and reporting standards requiring that all derivative instruments (including certain derivative instruments embedded in other contracts), whether designated as hedging relationships or not, be recorded on the Consolidated Balance Sheets as either an asset or liability measured at fair value. If a derivative is designated as a cash flow hedge for accounting purposes, the effective portion of the change in the fair value of the derivative is recorded in "Other comprehensive income (loss)". If a derivative is not designated as an accounting hedge for accounting purposes, the change in fair value is recognized within "Interest and other income (expense)" in the Consolidated Statements of Operations each reporting period. All derivative instruments are managed on a consolidated basis to efficiently minimize exposures.
Gains and losses related to the derivative instruments are expected to be largely offset by gains and losses on the underlying asset or liability. The Company does not use derivative financial instruments for speculative purposes.
The Company is exposed to credit loss in the event of nonperformance by the counterparties on derivative contracts. It is the Company’s policy to manage its credit risk on these transactions by dealing only with financial institutions having a long-term credit rating of "A" or better.
Equity Method Investments — The Company applies the equity method of accounting to 20% to 50% owned investments where Hagerty exercises significant influence, in accordance with ASC Topic 323, Investments—Equity Method and Joint Ventures.
Acquisitions — The Company accounts for acquisitions of entities or asset groups that qualify as businesses using the acquisition method of accounting in accordance with ASC 805. Purchase consideration is allocated to the tangible and intangible assets acquired and liabilities assumed based on the estimated fair values as of the acquisition date, which are measured in accordance with the principles outlined in ASC Topic 820, Fair Value Measurement ("ASC 820"). The determination of fair value requires management to make estimates about discount rates, future expected cash flows, market conditions and other future events that are highly subjective in nature. The excess of the total purchase consideration over the fair value of the identified net assets acquired is recognized as goodwill. The results of the acquired businesses are included in the results of operations beginning from the date of acquisition. Acquisition-related costs are expensed as incurred.
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During the measurement period, which may be up to one year from the acquisition date, the Company may record adjustments to the allocation of purchase consideration and to the fair values of assets acquired and liabilities assumed to the extent that additional information becomes available. After this period, any subsequent adjustments are recorded in the Consolidated Statements of Operations.
Revenue Recognition — The Company recognizes revenue under both ASC Topic 606, Revenue from Contracts with Customers ("ASC 606") and ASC Topic 944, Financial Services — Insurance ("ASC 944").
Commission and fee revenue
Hagerty earns commissions from its insurance carrier partners for new and renewal policies, as well as fees paid by the carriers’ insureds for the binding of insurance coverage. The Company has identified the insurance carrier as its customer and determined that the transaction price is the estimated commissions to be received over the term of the policy. The transaction is determined based on an estimate of premiums placed, net of a constraint for policy changes and cancellations. These commissions and fees, including those paid via installment plan, are earned when the policy becomes effective, as all rights are passed to the insured and the obligation to pay a claim resides with the carrier.
Under the terms of many of its contracts with insurance carrier partners, the Company has the opportunity to earn an annual contingent underwriting commission ("CUC"), or profit share, based on the calendar-year performance of the insurance book of business with each of those insurance carrier partners. The Company’s CUC agreements are based on written or earned premium and loss ratio results. Each insurance carrier partner contract and related CUC is calculated independently. The CUCs represent a form of variable consideration associated with the placement of coverage, for which the Company earns commissions and fees. Under ASC 606, the Company must estimate the amount of consideration that it will become entitled to receive during the calendar year such that a significant reversal of revenue is not probable. As such, CUCs are recognized as a contract asset within "Commission receivable" on the Consolidated Balance Sheets in the period that the policy is issued using the applicable premium and payout factors based on the estimated loss ratio from the contract. Revenue from CUCs is recognized throughout the year and settled annually.
Earned premium
Reinsurance premium revenue is earned by Hagerty Re under ASC 944, and represents the earned portion of gross written premiums that Hagerty Re has assumed under quota share reinsurance agreements with our insurance carrier partners. Earned premium is recognized over the term of the policy, which is generally 12 months, with the unearned portion recorded as "Unearned premiums" on the Consolidated Balance Sheets.
Membership, marketplace and other revenue
The Company earns subscription revenue through membership offerings. HDC memberships are sold as a bundled product which give Members access to its products and services, including Hagerty Drivers Club Magazine, automotive enthusiast events, the Company's proprietary vehicle valuation tool, emergency roadside services and special vehicle-related discounts. Hagerty Garage + Social storage memberships include storage in addition to the HDC Member benefits. Revenue from the sale of HDC and storage membership subscriptions is recognized ratably over the period of the membership, resulting in contract liabilities at December 31, 2022 and 2021. The Company treats the membership as a single performance obligation to provide access to stated Member benefits over the life of the membership, which is currently one year.
Marketplace earns fee-based revenue from the sale of collector vehicles through classified listings, live and time-based online auctions and brokered private sales, as well as finance revenue from term loans to high-net-worth individuals and businesses secured by collector cars. Fee-based revenue earned by Marketplace is recognized when the underlying sale is completed. Finance revenue is recognized when earned based on the amount of the outstanding loan, the applicable interest rate on the loan and the length of time the loan was outstanding during the period.
Lastly, other revenue includes sponsorship, admission, advertising, valuation and registration income. Other revenue is recognized when the performance obligation for the related product or service is satisfied.
Contract Assets and Liabilities — The Company recognizes contract assets for amounts due to the Company for CUCs earned but not yet billed under terms of the contract. Contract assets are recorded within "Commission receivable" on the Consolidated Balance Sheets.
Contract liabilities are recorded primarily as deferred revenue when payments are received in advance of performance under a contract before the transfer of goods or services to a customer or fulfillment of the contract obligations. Contract liabilities consist primarily of an advanced commission payment, along with the obligation to fulfill HDC membership benefits over the one-year life of a membership.
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Contract Costs — The Company accounts for contract costs under ASC Topic 340, Other Assets and Deferred Costs, which requires companies to defer certain incremental costs to obtain customer contracts and certain costs to fulfill customer contracts.
The Company capitalizes the incremental costs to obtain contracts, which are primarily related to commission payments on new policy sales. These deferred costs are amortized within "Sales expense" in the Consolidated Statements of Operations based on the average expected life of the insurance policy and are included within "Prepaid expenses and other assets" on the Company’s Consolidated Balance Sheets as of December 31, 2022 and 2021.
Advertising — Advertising and sales promotion costs are expensed the first time the advertising or sales promotion takes place. Advertising costs were $27.8 million and $24.1 million for the years ended December 31, 2022 and 2021, respectively, and are reflected as a component of "Sales expense" in the Consolidated Statements of Operations.
Income Taxes — The Hagerty Group is taxed as a pass-through ownership structure under provisions of the Internal Revenue Code ("IRC") and a similar section of state income tax law, except for certain U.S. corporate subsidiaries and foreign subsidiaries. Any taxable income or loss generated by The Hagerty Group is passed through to and included in the taxable income or loss of all holders of Hagerty Group Units, which includes Hagerty, Inc. Hagerty, Inc. is taxed as a corporation and pays corporate federal, state and local taxes with respect to income allocated from The Hagerty Group. Hagerty, Inc., Hagerty Re, Broad Arrow and various foreign subsidiaries are treated as taxable entities and income taxes are provided where applicable. Refer to Note 22 — Taxation for additional information.
Where applicable, income taxes are accounted for under the asset and liability method. Deferred tax assets and liabilities are recognized for the future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax basis and operating loss and tax-credit carryforwards. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. The effect on deferred tax assets and liabilities of a change in tax rates is recognized in the Consolidated Statements of Operations in the period that includes the enactment date.
Deferred tax assets are recognized to the extent that there is sufficient positive evidence as allowed under the ASC Topic 740, Income Taxes ("ASC 740"), to support the recoverability of those deferred tax assets. The Company establishes a valuation allowance when it is more likely than not that all or a portion of a deferred tax asset will not be realized. In making such a determination, management considers all available positive and negative evidence, including future reversals of existing taxable temporary differences, projected future taxable income, tax planning strategies, and results of recent operations. If it is determined that the deferred tax assets would be realizable in the future in excess of their net recorded amount, an adjustment would be made to the deferred tax asset valuation allowance, which would reduce the provision for income taxes.
As of December 31, 2022 and 2021, the Company did not have any unrecognized tax benefits and had no material accrued interest or penalties related to uncertain tax positions. If recorded, interest and penalties would be recorded as "Income tax benefit (expense)" within the Consolidated Statements of Operations.
Tax Receivable Agreement Liability — In connection with the Business Combination, Hagerty, Inc. entered into a TRA with HHC and Markel (together, the "Legacy Unit Holders"). The TRA provides for payment to the Legacy Unit Holders of 85% of the U.S. federal, state and local income tax savings realized by Hagerty, Inc. as a result of the increases in tax basis and certain other tax benefits as outlined in the Business Combination Agreement upon the exchange of Hagerty Group Units and Class V Common Stock of the Company for Class A Common Stock of the Company or cash. The Hagerty Group will have in effect an election under Section 754 of the IRC effective for each taxable year in which an exchange of Hagerty Group Units occurs. The remaining 15% cash tax savings resulting from the basis adjustments will be retained by Hagerty, Inc.
In general, cash tax savings result in a year when the tax liability of Hagerty, Inc. for the year, computed without regard to the deductions attributable to the amortization of the basis increase and other deductions that arise in connection with the payment of the cash consideration under the TRA or the exchange of Hagerty Group Units and Class V Common Stock for Class A Common Stock, would be more than the tax liability for the year taking into account such deductions. Payments under the TRA will not be due until the Company produces taxable income and the resulting cash tax liability is reduced by deducting the amortization of the basis increase on a filed tax return. The payments under the TRA are expected to be substantial. The estimated value of the TRA is recorded in "Other long-term liabilities" on the Consolidated Balance Sheets.
Hagerty, Inc. accounts for the effects of the basis increases as follows:
•Hagerty, Inc. records an increase in deferred tax assets for the income tax effects of the increases in tax basis based on enacted federal and state income tax rates at the date of the exchange.
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•Hagerty, Inc. evaluates the ability to realize the full benefit represented by the deferred tax asset based on an analysis that will consider expectations of future earnings among other things. If Hagerty, Inc. determines that the full benefit is not likely to be realized, a valuation allowance is established to reduce the amount of the deferred tax assets to an amount that is more likely than not to be realized.
•Hagerty, Inc. recorded 85% of the estimated realizable tax benefit as an increase to the liability due under the TRA, which is recorded within "Other long-term liabilities", with a decrease to "Additional paid-in capital" on the Consolidated Balance Sheets. The remaining 15% of the estimated realizable tax benefit will be retained by Hagerty, Inc.
All of the effects of changes in any of the estimates after the date of the redemption or exchange will be recorded within "Interest and other income (expense)" in the Consolidated Statements of Operations.
Non-controlling Interest — Hagerty, Inc. is the sole managing member of The Hagerty Group and, as a result, consolidates the financial results of The Hagerty Group. Hagerty, Inc. reports a non-controlling interest representing the economic interest in The Hagerty Group held by other unit holders of The Hagerty Group. Additionally, non-controlling interest represents the portion of economic ownership of MHH that is not owned or controlled by The Hagerty Group. Hagerty, Inc. consolidates its ownership of The Hagerty Group and MHH under the voting interest method.
Redeemable Non-controlling Interest — In connection with the Business Combination, Hagerty, Inc. entered into an exchange agreement with the Legacy Unit Holders ("Legacy Unit Holders Exchange Agreement"). The Legacy Unit Holders Exchange Agreement permitted the Legacy Unit Holders to exchange Class V Common Stock and associated Hagerty Group Units for an equivalent amount of Class A Common Stock or, at the option of the Company, for cash. Because the Company had the option to redeem the non-controlling interest for cash and the Company is controlled by the Legacy Unit Holders through their voting control, the non-controlling interest was considered redeemable as the redemption was considered outside the Company's control. Redeemable non-controlling interest represented the economic interests of the Legacy Unit Holders. Income or loss was attributed to the redeemable non-controlling interest based on the weighted average ownership of the Hagerty Group Units outstanding during the period held by the Legacy Unit Holders. The redeemable non-controlling interest was measured at the greater of the initial fair value or the redemption value and was required to be presented as temporary equity on the Consolidated Balance Sheets as of December 31, 2021.
On March 23, 2022, the Legacy Unit Holders Exchange Agreement was amended to revise the option for the Company to settle the exchange of Class V Common Stock and associated Hagerty Group Units in cash. Under the terms of the amendment, a cash exchange is only allowable in the event that net cash proceeds are received from a new permanent equity offering. As a result of the amendment, the redeemable non-controlling interest was accreted to its redemption value as of March 23, 2022 and subsequently removed from temporary equity and recorded to equity as non-controlling interest.
Earnings Per Share — The Company calculates basic and dilutive earnings per share ("EPS") in accordance with ASC Topic 260, Earnings Per Share ("ASC 260"). Basic earnings per share is computed by dividing Net income (loss) attributable to controlling interest by the weighted-average number of shares of Class A Common Stock outstanding during the period. Diluted EPS reflects the potential dilution that could occur if securities were exercised, resulting in the issuance of shares of Class A Common Stock that would then share in the earnings of Hagerty, Inc. In periods in which the Company reports a net loss available to stockholders, diluted net loss per share available to stockholders would be equal to basic net loss per share available to stockholders, since dilutive common shares are not assumed to have been issued if their effect is anti-dilutive.
Stock-Based Compensation — The Company issues restricted stock units and performance restricted stock units under the 2021 Equity Incentive Plan. The grant date fair value for restricted stock units is determined based on the closing price of the Company's common stock on the business day prior to grant. The Company uses a Monte Carlo simulation model to estimate the fair value of performance restricted stock units. Stock-based compensation expense is recognized over the applicable requisite service period of the award, generally using the straight-line method. Forfeitures are recorded as they occur. Refer to Note 21 — Stock-Based Compensation for additional information.
Self-Insurance — The Company has elected to self-insure certain costs related to U.S. employee health benefit and short-term disability programs. Costs resulting from self-insured losses are charged to expense when incurred. The Company has purchased insurance that limits its aggregate annual exposure for healthcare costs to approximately $11.4 million and $10.8 million for the years ended December 31, 2022 and 2021, respectively. Total expenses for healthcare claims incurred for the years ended December 31, 2022 and 2021 were approximately $13.2 million and $10.9 million, respectively. Healthcare claims are recorded within "Salaries and benefits" on the Consolidated Statements of Operations. As of December 31, 2022 and 2021, the Company has recorded approximately $1.2 million and $0.9 million as an estimate of IBNR claims, respectively. The amount of actual losses incurred could differ materially from the estimate reflected in these financial statements.
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Postretirement Benefits — The Company offers postretirement benefits. In the U.S., the Company offers a 401(k) plan covering substantially all U.S. employees. The plan provides for 4.0% matching contributions. Contributions to the plan were $6.2 million and $4.9 million for the years ended December 31, 2022 and 2021, respectively.
Recently Adopted Accounting Guidance
Media Content — In March 2019, the Financial Accounting Standards Board ("FASB") issued Accounting Standards Update ("ASU") 2019-02, Improvements to Accounting for Costs of Films and License Agreements for Program Materials, to align the accounting for production costs of an episodic television series with the accounting for production costs of films by removing the content distinction for capitalization.
As a result of adopting this ASU on January 1, 2021, the Company applied the guidance of ASC Topic 926, Entertainment – Films for the original content the Company self-produces and where the intellectual property is owned by the Company. For content the Company produces, the costs associated with production, including development costs, direct costs and production overhead will be capitalized and amortized over the estimated useful life of the asset. The adoption of the ASU had a $3.3 million impact on the Company’s Consolidated Financial Statements during the year ended December 31, 2021.
Leases — In February 2016, the FASB issued ASC 842, which supersedes the lease requirements in ASC Topic 840, Leases ("ASC 840"). The new guidance requires companies to recognize the assets and liabilities for the rights and obligations created by leased assets, initially measured at the present value of lease payments. ASC 842 and subsequent amendments are designed to increase transparency and comparability among organizations with leasing activities. In June 2020, the FASB issued ASU No. 2020-05, Effective Dates for Certain Entities, which deferred the effective date for nonpublic entities, including emerging growth companies, that had not yet adopted the original ASU. Utilizing the amended guidance, management adopted this standard effective January 1, 2022 under the modified retrospective approach. The Company, upon adopting ASC 842, measured the operating lease liability as the present value of the remaining rental payments as defined in ASC 840. The ROU asset equaled the lease liability, adjusted by any unamortized lease incentives, deferred rent accrual and initial direct costs. Adoption of this standard resulted in the Company recognizing initial ROU assets and lease liabilities of $72.8 million. The guidance requires sellers in a sale-leaseback transaction to recognize the entire gain from the sale of an underlying asset at the time of sale rather than over the leaseback term. The carrying value of the deferred gain on the single sale-leaseback transaction executed prior to January 1, 2022 is approximately $4.3 million and was recorded as an increase to retained earnings at adoption. The adoption of this standard did not have a material impact on the Consolidated Statements of Operations or Consolidated Statements of Cash Flows.
The Company elected the transition method permitted by ASU 2018-11, which does not adjust prior comparative periods to align with the new standard. The Company elected the package of practical expedients not to reassess prior conclusions related to contracts containing leases, lease classification and initial direct costs and the lessee practical expedient to combine lease and non-lease components for all asset classes. In addition, the Company did not elect the hindsight practical expedient. The expense of operating leases under ASC 842 is generally recognized on a straight-line basis which is calculated as the total lease cost divided by the lease term and is recognized in the Consolidated Statements of Operations.
Reference Rate Reform — In March 2020, the FASB issued ASU No. 2020-04, Reference Rate Reform (ASC Topic 848): Facilitation of the Effects of Reference Rate Reform on Financial Reporting ("ASC 848"), which provides optional relief to all entities, subject to meeting certain criteria, that have contracts, hedging relationships, and other transactions that reference London Inter-Bank Offered Rate ("LIBOR") or another reference rate expected to be discontinued because of reference rate reform. In January 2021, the FASB issued ASU No. 2021-01, Reference Rate Reform (ASC Topic 848), which clarifies that certain optional expedients and exceptions in ASC 848 for contract modifications and hedge accounting apply to derivatives that are affected by the discounting transition. Both ASUs were effective immediately upon issuance. As of September 2022, all of Hagerty's outstanding debt bears interest at variable interest rates, primarily based on the Term Secured Overnight Financing Rate ("SOFR"). The adoption of these ASUs did not have a material impact on the Company's Consolidated Financial Statements and related disclosures.
Recent Accounting Guidance Not Yet Adopted
Credit Losses — In June 2016, the FASB issued ASU No. 2016-13, Financial Instruments - Credit Losses (ASC Topic 326): Measurement of Credit Losses on Financial Instruments, which requires a company to consider forward looking information to determine current estimated credit losses for all financial instruments that are not accounted for at fair value through net income (loss). ASU No. 2019-10 deferred the effective date of ASU No. 2016-13 to January 1, 2023. The Company does not expect the adoption of ASU No. 2016-13 to have a material impact on Consolidated Financial Statements and related disclosures.
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2 — Revenue
Disaggregation of Revenue — The following table presents Hagerty's revenue by distribution channel offering, as well as a reconciliation to total revenue for the years ended December 31, 2022 and 2021:
Agent Direct Total
in thousands
Earned premium recognized under ASC 944 403,061
Earned premium recognized under ASC 944 295,824
The following table presents Hagerty's revenue disaggregated by geographic area, as well as a reconciliation to total revenue for the years ended December 31, 2022 and 2021:
U.S. Canada Europe Total
in thousands
Earned premium recognized under ASC 944 403,061
Earned premium recognized under ASC 944 295,824
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Earned Premium —The following table presents Hagerty Re's total premiums assumed and the change in unearned premiums for the years ended December 31, 2022 and 2021:
Year Ended December 31,
in thousands
Underwriting income:
Change in deferred reinsurance premiums (220) 310
Contract Assets and Liabilities — The following table is a summary of the Company's contract assets and liabilities for the periods specified below. Contract assets are classified as "Commission receivable", and liabilities are classified as "Contract liabilities" within current and non-current liabilities on the Consolidated Balance Sheets.
in thousands
Contract assets consist of CUC receivables, which are earned throughout the year and received in the first quarter of the following year. As such, the Commission receivable balance is generally smallest in the first quarter, and grows throughout the year as additional CUC receivables are accrued. For the year ended December 31, 2022, the increase in contract assets was primarily due to $59.8 million of CUC that was recognized but not received, offset by $57.2 million of CUC that had been included in the year ended December 31, 2021 contract assets and subsequently received in the current year.
Contract liabilities consist of cash collected in advance of revenue recognition, which primarily includes HDC membership. In addition, the Company entered into an agreement with State Farm Mutual Automobile Insurance Company ("State Farm") in 2020 and received an advanced commission payment to offset costs of system development (refer to Note 17 — Related-Party Transactions for additional information). For the year ended December 31, 2022, the increase in contract liabilities was due to $60.2 million of advanced consideration received for which revenue was not recognized in the period, primarily related to HDC memberships, partially offset by $57.2 million of revenue recognized during the period that had been included in the year ended December 31, 2021 contract liabilities balance.
3 — Deferred Acquisition Costs
The following table presents a reconciliation of the changes in deferred acquisition costs for the periods specified below:
in thousands