Table of Contents

 

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

 

WASHINGTON, D.C. 20549

 

FORM 10-Q

 

Quarterly report pursuant to Section 13 or 15(d) of the

Securities Exchange Act of 1934

 

For the quarterly period ended SeptemberJune 30, 20182019

 

Commission file number 001-11252001‑11252

 

Hallmark Financial Services, Inc.

(Exact name of registrant as specified in its charter)

 

Nevada

87-0447375

Nevada

87-0447375

(State or other jurisdiction of

(I.R.S. Employer

Incorporation or organization)

Identification No.)

777 Main Street,

5420 Lyndon B. Johnson Freeway, Suite 1000, Fort Worth,1100, Dallas, Texas

76102

75240

(Address of principal executive offices)

(Zip Code)

 

Registrant'sRegistrant’s telephone number, including area code: (817) 348-1600348‑1600

 

777 Main Street, Suite 1000, Fort Worth, Texas 76102

(former name, former address and former fiscal year, if changed since last report)

Securities registered pursuant to Section 12(b) of the Act:

Title of each class

Trading Symbol(s)

Name of each exchange on which registered

Common Stock, $0.18 par value

HALL

Nasdaq Global Market

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.   Yes    x      No ¨

 

Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit such files).  Yes x  No ¨

 

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer,  a smaller reporting company or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer,”  “smaller reporting company” and “emerging growth company” in Rule 12b-212b‑2 of the Exchange Act.

 

Large accelerated filer¨

Accelerated filerx

Non-accelerated filer¨

Smaller reporting company x

Emerging growth company¨  ☐

 

If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 15(a) of the Exchange Act.¨

 

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-212b‑2 of the Exchange Act).  Yes ¨☐ No x

 

Indicate the number of shares outstanding of each of the issuer'sissuer’s classes of common stock, as of the latest practicable date: Common Stock, par value $.18 per share – 18,058,676–18,123,093 shares outstanding as of November 7, 2018.August 9, 2019.

 

 

 

Table of Contents

 

PART I

FINANCIAL INFORMATION

Item 1.Financial Statements

Item 1.   Financial Statements

 

INDEX TO FINANCIAL STATEMENTS

2

Hallmark Financial Services, Inc. and Subsidiaries

Consolidated Balance Sheets

($ in thousands, except par value)

 

 

 

 

 

 

 

 

June 30,

 

 

December 31,

 September 30, 2018  December 31, 2017 

 

2019

 

2018

  (unaudited)     

 

 

(unaudited)

 

 

 

ASSETS        

 

 

  

 

 

  

Investments:        

 

 

  

 

 

  

Debt securities, available-for-sale, at fair value (cost: $571,657 in 2018 and $604,999 in 2017) $574,470  $605,746 
Equity securities (cost: $45,426 in 2018 and $30,253 in 2017)  70,152   51,763 
Other investments (cost: $3,763 in 2018 and 2017)  3,085   3,824 

Debt securities, available-for-sale, at fair value (amortized cost; $530,516 in 2019 and $550,268 in 2018)

 

$

533,148

 

$

545,870

Equity securities (cost; $68,709 in 2019 and $68,709 in 2018)

 

 

94,012

 

 

80,896

Other investments (cost; $3,763 in 2019 and $3,763 in 2018)

 

 

2,585

 

 

1,148

Total investments  647,707   661,333 

 

 

629,745

 

 

627,914

Cash and cash equivalents  59,925   64,982 

 

 

67,670

 

 

35,594

Restricted cash  3,519   2,651 

 

 

3,486

 

 

4,877

Ceded unearned premiums  135,567   112,323 

 

 

150,883

 

 

133,031

Premiums receivable  111,366   104,373 

 

 

144,674

 

 

119,778

Accounts receivable  1,464   1,513 

 

 

1,332

 

 

1,619

Receivable for securities  3,253   5,235 

 

 

2,581

 

 

3,369

Reinsurance recoverable  225,932   182,928 

 

 

300,155

 

 

252,029

Deferred policy acquisition costs  13,150   16,002 

 

 

20,308

 

 

14,291

Goodwill  44,695   44,695 

 

 

44,695

 

 

44,695

Intangible assets, net  8,174   10,023 

 

 

6,323

 

 

7,555

Deferred federal income taxes, net  1,042   1,937 

 

 

 —

 

 

4,983

Federal income tax recoverable  -   7,532 
Prepaid expenses  2,526   1,743 

 

 

3,282

 

 

2,588

Other assets  12,471   13,856 

 

 

30,634

 

 

12,571

Total assets $1,270,791  $1,231,126 

 

$

1,405,768

 

$

1,264,894

LIABILITIES AND STOCKHOLDERS' EQUITY        

LIABILITIES AND STOCKHOLDERS’ EQUITY

 

 

  

 

 

  

Liabilities:        

 

 

  

 

 

  

Revolving credit facility payable $30,000  $30,000 

 

$

30,000

 

$

30,000

Subordinated debt securities (less unamortized debt issuance cost of $911 in 2018 and $949 in 2017)  55,791   55,753 

Subordinated debt securities (less unamortized debt issuance cost of $872 in 2019 and $898 in 2018)

 

 

55,830

 

 

55,804

Reserves for unpaid losses and loss adjustment expenses  530,816   527,100 

 

 

551,543

 

 

527,247

Unearned premiums  297,389   276,642 

 

 

351,630

 

 

298,061

Reinsurance balances payable  55,830   52,487 

 

 

73,977

 

 

67,328

Current federal income tax payable  144   - 
Pension liability  1,403   1,605 

 

 

1,946

 

 

2,018

Payable for securities  7,699   7,488 

 

 

3,167

 

 

698

Federal income tax payable

 

 

870

 

 

 4

Deferred federal income taxes, net

 

 

143

 

 

 —

Accounts payable and other accrued expenses  24,667   28,933 

 

 

47,126

 

 

28,202

Total liabilities $1,003,739  $980,008 

 

 

1,116,232

 

 

1,009,362

Commitments and Contingencies (Note 17)        
Stockholders' equity:        
Common stock, $.18 par value, authorized 33,333,333; issued 20,872,831 shares in 2018 and 2017  3,757   3,757 

Commitments and contingencies (Note 17)

 

 

  

 

 

  

Stockholders’ equity:

 

 

  

 

 

  

Common stock, $.18 par value, authorized 33,333,333 shares; issued 20,872,831 shares in 2019 and 2018

 

 

3,757

 

 

3,757

Additional paid-in capital  123,053   123,180 

 

 

122,778

 

 

123,168

Retained earnings  166,270   136,474 

 

 

189,249

 

 

161,195

Accumulated other comprehensive income  (443)  12,234 
Treasury stock (2,814,155 shares in 2018 and 2,703,803 in 2017), at cost  (25,585)  (24,527)
Total stockholders' equity $267,052  $251,118 
Total liabilities and stockholders' equity $1,270,791  $1,231,126 

Accumulated other comprehensive loss

 

 

(1,047)

 

 

(6,660)

Treasury stock (2,749,738 shares in 2019 and 2,846,131 in 2018), at cost

 

 

(25,201)

 

 

(25,928)

Total stockholders’ equity

 

 

289,536

 

 

255,532

Total liabilities and stockholders’ equity

 

$

1,405,768

 

$

1,264,894

 

The accompanying notes are an integral part of the consolidated financial statements

3

3

Hallmark Financial Services, Inc. and Subsidiaries

Consolidated Statements of Operations

(Unaudited)

($ in thousands, except per share amounts)

 

 

 

 

 

 

 

 

 

 

 

 

 

 Three Months Ended September 30,  Nine Months Ended September 30, 

 

 

 

 

 

 

 

 

 

 

 

 

 

 2018  2017  2018  2017 

    

Three Months Ended June 30, 

 

Six Months Ended June 30, 

 

         

    

2019

    

2018

    

2019

    

2018

 

Gross premiums written $169,112  $161,151  $495,836  $458,319 

 

$

218,236

 

$

173,219

 

$

405,552

 

$

326,724

 

Ceded premiums written  (81,100)  (66,102)  (226,545)  (173,857)

 

 

(94,393)

 

 

(83,373)

 

 

(164,306)

 

 

(145,445)

 

Net premiums written  88,012   95,049   269,291   284,462 

 

 

123,843

 

 

89,846

 

 

241,246

 

 

181,279

 

Change in unearned premiums  850   (6,261)  2,496   (15,744)

 

 

(17,344)

 

 

1,132

 

 

(35,717)

 

 

1,646

 

Net premiums earned  88,862   88,788   271,787   268,718 

 

 

106,499

 

 

90,978

 

 

205,529

 

 

182,925

 

                

 

 

 

 

 

 

 

 

 

 

 

 

 

Investment income, net of expenses  4,860   5,295   13,706   14,361 

 

 

5,412

 

 

4,406

 

 

10,523

 

 

8,846

 

Investment gains, net  6,980   2,110   2,678   691 

Investment gains (losses), net

 

 

6,817

 

 

533

 

 

18,754

 

 

(4,302)

 

Finance charges  1,347   892   3,548   2,881 

 

 

1,797

 

 

1,161

 

 

3,531

 

 

2,201

 

Commission and fees  869   570   2,604   1,295 

 

 

364

 

 

1,032

 

 

657

 

 

1,735

 

Other income  28   68   89   200 

 

 

14

 

 

15

 

 

30

 

 

61

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Total revenues  102,946   97,723   294,412   288,146 

 

 

120,903

 

 

98,125

 

 

239,024

 

 

191,466

 

                

 

 

 

 

 

 

 

 

 

 

 

 

 

Losses and loss adjustment expenses  64,245   72,379   191,568   204,925 

 

 

73,226

 

 

63,648

 

 

143,313

 

 

127,323

 

Other operating expenses  24,829   25,071   78,402   78,445 

Operating expenses

 

 

29,336

 

 

26,360

 

 

56,582

 

 

53,573

 

Interest expense  1,180   1,181   3,335   3,530 

 

 

1,240

 

 

1,128

 

 

2,493

 

 

2,155

 

Amortization of intangible assets  617   617   1,851   1,851 

 

 

617

 

 

617

 

 

1,234

 

 

1,234

 

                

 

 

 

 

 

 

 

 

 

 

 

 

 

Total expenses  90,871   99,248   275,156   288,751 

 

 

104,419

 

 

91,753

 

 

203,622

 

 

184,285

 

                

 

 

 

 

 

 

 

 

 

 

 

 

 

Income (loss) before tax  12,075   (1,525)  19,256   (605)

Income before tax

 

 

16,484

 

 

6,372

 

 

35,402

 

 

7,181

 

Income tax expense  2,390   35   3,834   319 

 

 

3,455

 

 

1,282

 

 

7,348

 

 

1,444

 

Net income (loss)  9,685   (1,560)  15,422   (924)

Net income

 

 

13,029

 

 

5,090

 

 

28,054

 

 

5,737

 

                

 

 

 

 

 

 

 

 

 

 

 

 

 

Net income (loss) per share:                
                

Net income per share:

 

 

  

 

 

  

 

 

  

 

 

  

 

Basic $0.54  $(0.09) $0.85  $(0.05)

 

$

0.72

 

$

0.28

 

$

1.55

 

$

0.32

 

Diluted $0.53  $(0.09) $0.85  $(0.05)

 

$

0.71

 

$

0.28

 

$

1.54

 

$

0.31

 

 

The accompanying notes are an integral part of the consolidated financial statements

4

4

Hallmark Financial Services, Inc. and Subsidiaries

Consolidated Statements of Comprehensive Income

(Unaudited)

($ in thousands)

  Three Months Ended  Nine Months Ended 
  September 30,  September 30, 
  2018  2017  2018  2017 
             
Net income (loss) $9,685  $(1,560) $15,422  $(924)
                 
Other comprehensive income :                
                 
Change in net actuarial gain  27   37   80   107 
                 
Tax effect on change in net actuarial gain  (6)  (13)  (17)  (37)
                 
Unrealized holding gains arising during the period  342   308   1,909   8,208 
                 
Tax effect on unrealized holding gains arising during the period  (72)  (108)  (401)  (2,873)
                 
Reclassification adjustment for (gains) losses included in net income  166   (3,188)  159   (5,679)
                 
Tax effect on reclassification adjustment for (gains) losses included in net income  (35)  1,116   (33)  1,988 
                 
Other comprehensive income (loss), net of tax  422   (1,848)  1,697   1,714 
Comprehensive income (loss) $10,107  $(3,408) $17,119  $790 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

    

Three Months Ended

 

Six Months Ended

 

 

 

June 30,

 

June 30,

 

 

    

2019

    

2018

    

2019

    

2018

 

Net income

 

$

13,029

 

$

5,090

 

$

28,054

 

$

5,737

 

Other comprehensive income:

 

 

  

 

 

  

 

 

  

 

 

  

 

Change in net actuarial gain

 

 

37

 

 

26

 

 

72

 

 

53

 

Tax effect on change in net actuarial gain

 

 

(8)

 

 

(5)

 

 

(15)

 

 

(11)

 

Unrealized holding gains arising during the period

 

 

3,460

 

 

2,321

 

 

11,233

 

 

1,926

 

Tax effect on unrealized holding gains arising during the period

 

 

(727)

 

 

(487)

 

 

(2,359)

 

 

(404)

 

Reclassification adjustment for gains included in net income

 

 

(60)

 

 

(381)

 

 

(4,201)

 

 

(366)

 

Tax effect on reclassification adjustment for gains included in net income

 

 

13

 

 

80

 

 

883

 

 

77

 

Other comprehensive income, net of tax

 

 

2,715

 

 

1,554

 

 

5,613

 

 

1,275

 

Comprehensive income

 

$

15,744

 

$

6,644

 

$

33,667

 

$

7,012

 

 

The accompanying notes are an integral part of the consolidated financial statements

5

5

Hallmark Financial Services, Inc. and Subsidiaries

Consolidated Statements of Stockholders’ Equity

(Unaudited)

($ in thousands)

 

 

 

 

 

 

 

 

 

 

 

 

 Three Months Ended Nine Months Ended 

 

Three Months Ended

 

Six Months Ended

 September 30,  September 30, 

 

June 30, 

 

June 30, 

 2018  2017  2018  2017 

    

2019

    

2018

    

2019

    

2018

Common Stock                

    

 

  

    

 

  

    

 

  

    

 

  

Balance, beginning of period $3,757  $3,757  $3,757  $3,757 

 

$

3,757

 

$

3,757

 

$

3,757

 

$

3,757

 

 

 

 

 

 

 

 

 

 

 

 

Balance, end of period  3,757   3,757   3,757   3,757 

 

 

3,757

 

 

3,757

 

 

3,757

 

 

3,757

                

 

 

 

 

 

 

 

 

 

 

 

 

Additional Paid-In Capital                

 

 

  

 

 

  

 

 

  

 

 

  

Balance, beginning of period  123,017   123,110   123,180   123,166 

 

 

122,638

 

 

123,224

 

 

123,168

 

 

123,180

Equity based compensation  36   51   37   97 

 

 

140

 

 

(43)

 

 

197

 

 

 1

Shares issued under employee benefit plans  -   (5)  (164)  (107)

 

 

 —

 

 

(164)

 

 

(587)

 

 

(164)

Balance, end of period  123,053   123,156   123,053   123,156 

 

 

122,778

 

 

123,017

 

 

122,778

 

 

123,017

                

 

 

 

 

 

 

 

 

 

 

 

 

Retained Earnings                

 

 

  

 

 

  

 

 

  

 

 

  

Balance, beginning of period  156,585   148,663   136,474   148,027 

 

 

176,220

 

 

151,495

 

 

161,195

 

 

136,474

Cumulative effect of adoption of updated accounting guidance for equity financial instruments at January 1, 2018  -   -   16,993   - 
Reclassification of certain tax effects from accumulated other comprehensive income at January 1, 2018  -   -   (2,619)  - 
Net income (loss)  9,685   (1,560)  15,422   (924)

Cumulative effect of adoption of updated accounting guidance for equity financial instruments at January 1,2018

 

 

 —

 

 

 —

 

 

 —

 

 

16,993

Reclassification of certain tax effects from accumulated other comprehensive income at January 1,2018

 

 

 —

 

 

 —

 

 

 —

 

 

(2,619)

Net income

 

 

13,029

 

 

5,090

 

 

28,054

 

 

5,737

Balance, end of period  166,270   147,103   166,270   147,103 

 

 

189,249

 

 

156,585

 

 

189,249

 

 

156,585

                

 

 

 

 

 

 

 

 

 

 

 

 

Accumulated Other Comprehensive Income                

 

 

  

 

 

  

 

 

  

 

 

  

Balance, beginning of period  (865)  13,933   12,234   10,371 

 

 

(3,762)

 

 

(2,419)

 

 

(6,660)

 

 

12,234

Cumulative effect of adoption of updated accounting guidance for equity financial instruments at January 1, 2018  -   -   (16,993)  - 
Reclassification of certain tax effects from accumulated other comprehensive income at January 1, 2018  -   -   2,619   - 

Cumulative effect of adoption of updated accounting guidance for equity financial instruments at January 1,2018

 

 

 —

 

 

 —

 

 

 —

 

 

(16,993)

Reclassification of certain tax effects from accumulated other comprehensive income at January 1,2018

 

 

 —

 

 

 —

 

 

 —

 

 

2,619

Additional minimum pension liability, net of tax  21   24   63   70 

 

 

29

 

 

21

 

 

57

 

 

42

Unrealized holding gains arising during period, net of tax  270   200   1,508   5,335 

 

 

2,733

 

 

1,834

 

 

8,874

 

 

1,522

Reclassification adjustment for losses (gains) included in net income, net of tax  131   (2,072)  126   (3,691)

Reclassification adjustment for gains included in net income, net of tax

 

 

(47)

 

 

(301)

 

 

(3,318)

 

 

(289)

Balance, end of period  (443)  12,085   (443)  12,085 

 

 

(1,047)

 

 

(865)

 

 

(1,047)

 

 

(865)

                

 

 

 

 

 

 

 

 

 

 

 

 

Treasury Stock                

 

 

  

 

 

 

 

 

  

 

 

 

Balance, beginning of period  (25,585)  (23,763)  (24,527)  (19,585)

 

 

(25,201)

 

 

(24,904)

 

 

(25,928)

 

 

(24,527)

Acquisition of treasury stock  -   (883)  (1,464)  (5,308)

 

 

 —

 

 

(1,087)

 

 

(1,380)

 

 

(1,464)

Shares issued under employee benefit plans  -   18   406   265 

 

 

 —

 

 

406

 

 

2,107

 

 

406

Balance, end of period  (25,585)  (24,628)  (25,585)  (24,628)

 

 

(25,201)

 

 

(25,585)

 

 

(25,201)

 

 

(25,585)

                

 

 

 

 

 

 

 

 

 

 

 

 

Total Stockholders' Equity $267,052  $261,473   267,052   261,473 

 

$

289,536

 

$

256,909

 

$

289,536

 

$

256,909

 

The accompanying notes are an integral part of the consolidated financial statements

6

6

Hallmark Financial Services, Inc. and Subsidiaries

Consolidated Statements of Cash Flows

(Unaudited)

($ in thousands)

 

 

 

 

 

 

 

 Nine Months Ended September 30, 

 

Six Months Ended June 30,

 

 2018  2017 

 

2019

 

2018

 

Cash flows from operating activities:        

 

 

  

 

 

  

 

Net income $15,422  $(924)

 

$

28,054

 

$

5,737

 

        

 

 

 

 

 

 

 

Adjustments to reconcile net income to net cash (used in) provided by operating activities:        

Adjustments to reconcile net income to cash provided by (used in) operating activities:

 

 

  

 

 

  

 

Depreciation and amortization expense  3,801   3,467 

 

 

2,626

 

 

2,479

 

Deferred federal income taxes  445   (1,903)

 

 

3,634

 

 

(988)

 

Investment gains, net  (2,678)  (691)

Investment (gains) losses, net

 

 

(18,754)

 

 

4,302

 

Share-based payments expense  37   97 

 

 

197

 

 

 1

 

Change in ceded unearned premiums  (23,244)  (22,488)

 

 

(17,852)

 

 

(15,181)

 

Change in premiums receivable  (6,993)  (11,943)

 

 

(24,896)

 

 

(7,815)

 

Change in accounts receivable  49   335 

 

 

287

 

 

(538)

 

Change in deferred policy acquisition costs  2,852   (52)

 

 

(6,017)

 

 

1,944

 

Change in unpaid losses and loss adjustment expenses  3,716   49,932 

 

 

24,296

 

 

(6,548)

 

Change in unearned premiums  20,747   38,233 

 

 

53,569

 

 

13,535

 

Change in reinsurance recoverable  (43,004)  (34,140)

 

 

(48,126)

 

 

(32,117)

 

Change in reinsurance balances payable  3,343   10,535 

 

 

6,649

 

 

13,072

 

Change in current federal income tax recoverable/payable  7,676   1,918 

Change in current federal income tax payable

 

 

866

 

 

7,719

 

Change in all other liabilities  (4,429)  (1,495)

 

 

(2,708)

 

 

2,899

 

Change in all other assets  3,277   3,448 

 

 

4,860

 

 

1,604

 

        
Net cash (used in) provided by operating activities  (18,983)  34,329 
        

Net cash provided by (used in) operating activities

 

 

6,685

 

 

(9,895)

 

Cash flows from investing activities:        

 

 

  

 

 

  

 

Purchases of property and equipment  (1,530)  (1,576)

 

 

(2,447)

 

 

(1,118)

 

Purchases of investment securities  (160,147)  (196,976)

 

 

(97,292)

 

 

(97,610)

 

Maturities, sales and redemptions of investment securities  177,693   175,527 

 

 

123,599

 

 

124,873

 

        
Net cash provided by (used in) investing activities  16,016   (23,025)
        

Net cash provided by investing activities

 

 

23,860

 

 

26,145

 

Cash flows from financing activities:        

 

 

  

 

 

  

 

Proceeds from exercise of employee stock options  242   158 

 

 

1,520

 

 

242

 

Purchase of treasury shares  (1,464)  (5,308)

 

 

(1,380)

 

 

(1,464)

 

        
Net cash used in financing activities  (1,222)  (5,150)
        
(Decrease) increase in cash and cash equivalents and restricted cash  (4,189)  6,154 
Cash, cash equivalents and restricted cash at beginning of period  67,633   86,959 
Cash, cash equivalents and restricted cash at end of period $63,444  $93,113 

Net cash provided by (used in) financing activities

 

 

140

 

 

(1,222)

 

Increase in cash and cash equivalents and restricted cash

 

 

30,685

 

 

15,028

 

Cash and cash equivalents and restricted cash at beginning of period

 

 

40,471

 

 

67,633

 

Cash and cash equivalents and restricted cash at end of period

 

$

71,156

 

$

82,661

 

 

The accompanying notes are an integral part of the consolidated financial statements

7

7

Hallmark Financial Services, Inc. and Subsidiaries

Notes to Consolidated Financial Statements (Unaudited)

1. General

Hallmark Financial Services, Inc. (“Hallmark” and, together with subsidiaries, “we,” “us” or “our”) is an insurance holding company engaged in the sale of property/casualtythat offers commercial and personal insurance products tothat serves businesses and individuals. Our business involvesindividuals in specialty and niche markets.  We focus on marketing, distributing, underwriting and servicing ourproperty and casualty insurance products that require specialized underwriting expertise or market knowledge. We believe this approach provides us the best opportunity to achieve favorable policy terms and pricing. The insurance policies we produce are written by our six insurance company subsidiaries as well as providing other insurance related services.

unaffiliated insurers. We pursue our business activities primarily through subsidiaries whose operations are organized into product-specific operatingbusiness units that are supported by our insurance company subsidiaries. Our Contract Binding operatingCommercial Auto business unit offers primary and excess commercial vehicle insurance products and services; our E&S Casualty business unit offers primary and excess liability, excess public entity liability and E&S package insurance products and services; our E&S Property business unit offers primary and excess commercial property insurance for both catastrophe and non-catastrophe exposures; our Professional Liability business unit offers healthcare and financial lines professional liability insurance products and services in the excessprimarily for businesses, medical professionals, medical facilities and surplus lines market. Our Specialty Commercial operatingsenior care facilities; and our Aerospace & Programs business unit offers general aviation and satellite launch property/casualty insurance products and services, low and middle market commercial umbrella and primary/excess liability insurance, medical and financial professional liability insuranceas well as certain specialty programs. These products and services were previously reported as the Contract Binding and primary/excess commercial property coverages for both catastrophe and non-catastrophe exposures. Specialty Commercial operating units. Our Commercial Accounts business unit (f/k/a Standard Commercial P&C operating unitunit) offers industry-specific commercialpackage and monoline property/casualty and occupational accident insurance products and services in the standard market.products. Effective June 1, 2016 we ceased marketing new or renewal occupational accident policies.  Our former Workers Compensation operating unit specializesspecialized in small and middle market workers compensation business. Effective July 1, 2015, this operating unitwe no longer marketsmarket or retainsretain any risk on new or renewal workers compensation policies. Our Specialty Personal Lines operatingbusiness unit offers non-standard personal automobile and renters insurance products and services. Our insurance company subsidiaries supporting these operatingbusiness units are American Hallmark Insurance Company of Texas (“AHIC”), Hallmark Insurance Company (“HIC”), Hallmark Specialty Insurance Company (“HSIC”), Hallmark County Mutual Insurance Company, Hallmark National Insurance Company and Texas Builders Insurance Company.

 

These operatingbusiness units are segregated into three reportable industry segments for financial accounting purposes. The Specialty Commercial Segment includes our Contract Binding operatingCommercial Auto business unit, our E&S Casualty business unit, our E&S Property business unit, our Professional Liability business unit and our Specialty Commercial operatingAerospace & Programs business unit. The Standard Commercial Segment includes our Standard Commercial P&C operatingAccounts business unit and the run-off from our former Workers Compensation operating unit. The Personal Segment consists solely of our Specialty Personal Lines operatingbusiness unit. The realignment of our business units did not affect the comparability of our reportable industry segments.

 

2. Basis of Presentation

Our unaudited consolidated financial statements included herein have been prepared in accordance with U.S. generally accepted accounting principles (“GAAP”) and include our accounts and the accounts of our subsidiaries. All significant intercompany accounts and transactions have been eliminated in consolidation. Certain information and footnote disclosures normally included in financial statements prepared in accordance with GAAP have been condensed or omitted pursuant to rules and regulations of the Securities and Exchange Commission (“SEC”) for interim financial reporting. These unaudited consolidated financial statements should be read in conjunction with our audited consolidated financial statements for the year ended December 31, 20172018 included in our Annual Report on Form 10-K10‑K filed with the SEC.

The interim financial data as of SeptemberJune 30, 20182019 and 20172018 is unaudited. However, in the opinion of management, the interim data includes all adjustments, consisting of normal recurring adjustments, necessary for a fair statement of the results for the interim periods. The results of operations for the periodperiods ended SeptemberJune 30, 20182019 are not necessarily indicative of the operating results to be expected for the full year.

8

8

Reclassifications

Certain prior year amounts have been reclassified to conform with current year presentation.

Income Taxes

We file a consolidated federal income tax return. Deferred federal income taxes reflect the future tax consequences of differences between the tax basis of assets and liabilities and their financial reporting amounts at each year end. Deferred taxes are recognized using the liability method, whereby tax rates are applied to cumulative temporary differences based on when and how they are expected to affect the tax return. Deferred tax assets and liabilities are adjusted for tax rate changes in effect for the year in which these temporary differences are expected to be recovered or settled.

Reclassifications

Certain prior year amounts have been reclassified to conform with current year presentation.

Use of Estimates in the Preparation of the Financial Statements

Our preparation of financial statements in conformity with GAAP requires us to make estimates and assumptions that affect our reported amounts of assets and liabilities and our disclosure of contingent assets and liabilities at the date of our consolidated financial statements, as well as our reported amounts of revenues and expenses during the reporting period. Refer to “Critical Accounting Estimates and Judgments” under Item 7 of our Annual Report on Form 10-K10‑K for the year ended December 31, 20172018 for information on accounting policies that we consider critical in preparing our consolidated financial statements. Actual results could differ materially from those estimates.

Fair Value of Financial Instruments

Fair value estimates are made at a point in time based on relevant market data as well as the best information available about the financial instruments. Fair value estimates for financial instruments for which no or limited observable market data is available are based on judgments regarding current economic conditions, credit and interest rate risk. These estimates involve significant uncertainties and judgments and cannot be determined with precision. As a result, such calculated fair value estimates may not be realizable in a current sale or immediate settlement of the instrument. In addition, changes in the underlying assumptions used in the fair value measurement technique, including discount rate and estimates of future cash flows, could significantly affect these fair value estimates.

Cash and Cash Equivalents:  The carrying amounts reported in the balance sheet for these instruments approximate their fair values.

Restricted Cash:  The carrying amount for restricted cash reported in the balance sheet approximates the fair value.

Revolving Credit Facility Payable: A revolving credit facility with Frost Bank had a carried value of $30.0 million and a fair value of $30.2 million as of SeptemberJune 30, 2018.  The fair value is based on the lower of the discounted cash flows using a discount rate derived from LIBOR spot rates plus a market spread resulting in discount rates ranging between 4.5% to 5.3% for each future payment date and 100.5% of par.2019. This revolving credit facility would be included in Level 3 of the fair value hierarchy if it was reported at fair value.

9

Subordinated Debt Securities:  Our trust preferred securities have a carried value of $55.8 million and a fair value of $47.4$42.6 million as of SeptemberJune 30, 2018.2019. The fair value of our trust preferred securities is based on discounted cash flows using a current yield to maturity of 8.0%, which is based on similar issues to discount future cash flows. Our trust preferred securities would be included in Level 3 of the fair value hierarchy if they were reported at fair value.

For reinsurance balances, premiums receivable, federal income tax recoverable/payable, other assets and other liabilities, the carrying amounts approximate fair value because of the short maturity of such financial instruments.

Variable Interest Entities

On June 21, 2005, we formed Hallmark Statutory Trust I (“Trust I”), an unconsolidated trust subsidiary, for the sole purpose of issuing $30.0 million in trust preferred securities. Trust I used the proceeds from the sale of these securities

9

and our initial capital contribution to purchase $30.9 million of subordinated debt securities from Hallmark. The debt securities are the sole assets of Trust I, and the payments under the debt securities are the sole revenues of Trust I.

On August 23, 2007, we formed Hallmark Statutory Trust II (“Trust II”), an unconsolidated trust subsidiary, for the sole purpose of issuing $25.0 million in trust preferred securities. Trust II used the proceeds from the sale of these securities and our initial capital contribution to purchase $25.8 million of subordinated debt securities from Hallmark. The debt securities are the sole assets of Trust II, and the payments under the debt securities are the sole revenues of Trust II.

We evaluate on an ongoing basis our investments in Trust I and Trust II (collectively the “Trusts”) and have determined that we do not have a variable interest in the Trusts. Therefore, the Trusts are not included in our consolidated financial statements.

We are also involved in the normal course of business with variable interest entities (“VIE’s”) primarily as a passive investor in mortgage-backed securities and certain collateralized corporate bank loans issued by third party VIE’s. The maximum exposure to loss with respect to these investments is the investment carrying values included in the consolidated balance sheets.

Adoption of New Accounting Pronouncements

In  January 2017, the FASB issued ASU 2017-01, “Clarifying the Definition of a Business” (Topic 715). ASU 2017-01 is intended to assist entities with evaluating whether transactions should be accounted for as acquisitions (or disposals) of assets or businesses. ASU 2017-01 was effective for annual periods beginning after December 15, 2017, including interim periods within those annual periods. Effective January 1, 2018, we adopted this new guidance, which did not have a material impact on our financial results or disclosures.

On February 14, 2018, the FASB issued updated guidance that allows a reclassification of the stranded tax effects in accumulated other comprehensive income (AOCI) resulting from the Tax Cuts and Jobs Act of 2017 (TCJA). Current guidance requires the effect of a change in tax laws or rates on deferred tax balances to be reported in income from continuing operations in the accounting period that includes the period of enactment, even if the related income tax effects were originally charged or credited directly to AOCI. The amount of the reclassification would include the effect of the change in the U.S. federal corporate income tax rate on the gross deferred tax amounts and related valuation allowances, if any, at the date of the enactment of TCJA related to items in AOCI. The updated guidance was effective for reporting periods beginning after December 15, 2018 and is to be applied retrospectively to each period in which the effect of the TCJA related to items remaining in AOCI are recognized or at the beginning of the period of adoption. Early adoption is permitted. The Company adopted the updated guidance effective January 1, 2018 and elected to reclassify the income tax effects of the TCJA from AOCI to retained earnings as of January 1, 2018. This reclassification resulted in a decrease in retained earnings of $2.6 million as of January 1, 2018 and an increase in AOCI by the same amount.

In March 2017, the FASB issued ASU 2017‑08, “Premium Amortization on Purchased Callable Securities” (Subtopic 310‑20). ASU 2017‑08 is intended to enhance the accounting for amortization of premiums for purchased callable debt securities. The guidance amends the amortization period for certain purchased callable debt securities held at a premium. Securities that contain explicit, noncontingent call features that are callable at fixed prices and on preset dates should shorten the amortization period for the premium to the earliest call date (and if the call option is not exercised, the effective yield is reset using the payment terms of the debt security). The standard is effective for fiscal years, and interim periods within those years, beginning after December 15, 2018, and is to be applied on a modified retrospective basis through a cumulative-effect adjustment directly to retained earnings. The adoption of ASU 2017‑08 had no impact on our financial results and disclosures.

10

In January 2017, the FASB issued ASU 2017‑01, “Clarifying the Definition of a Business (Topic 715)”. ASU 2017‑01 is intended to assist entities in evaluating whether transactions should be accounted for as acquisitions (or disposals) of assets or businesses. ASU 2017‑01 is effective for annual periods beginning after December 15, 2017, including interim periods within those annual periods. The adoption of this standard did not have a material impact on our financial condition or results of operations.

In January 2016, the FASB issued ASU 2016-01,2016‑01, “Recognition and Measurement of Financial Assets and Financial Liabilities” (Subtopic 825-10)825‑10). ASU 2016-012016‑01 requires equity investments that are not consolidated or accounted for under the equity method of accounting to be measured at fair value with changes in fair value recognized in net income. ASU 2016-012016‑01 also requires us to assess the ability to realize our deferred tax assets (“DTAs”) related to an available-for-sale debt security in combination with our other DTAs. ASU 2016-012016‑01 was effective for fiscal years beginning after December 15, 2017, including interim periods within those fiscal years. The adoption of this guidance resulted in the

10

recognition of $17.0 million of net after-tax unrealized gains on equity investments as a cumulative effect adjustment that increased retained earnings as of January 1, 2018 and decreased AOCI by the same amount. The Company elected to report changes in the fair value of equity investments in investment gains and (losses) in the Consolidated Statement of Operations. At December 31, 2017, equity investments were classified as available-for-sale on the Company'sCompany’s balance sheet. However, upon adoption, the updated guidance eliminated the available-for-sale balance sheet classification for equity investments.

In February 2016, the FASB issued ASU 2016-02, “Leases (Topic 842)”. ASU 2016-02 requires organizations that lease assets to recognize on the balance sheet the assets and liabilities for the rights and obligations created by those leases. Additionally, ASU 2016-02 modifies current guidance for lessors' accounting. ASU 2016-02 is effective for interim and annual reporting periods beginning on or after January 1, 2019, with early adoption permitted. During 2018, the FASB issued several amendments and targeted improvements to ease the application of the standard, including the addition of a transition approach that gives the Company the option of applying the standard at either the beginning of the earliest comparative period presented or the beginning of the period of adoption. We adopted the standard on its effective date of January 1, 2019. We also elected certain practical expedients that allow us not to reassess existing leases under the new guidance. As of June 30, 2019, $17.1 million of right-of-use assets and $17.6 million of lease liabilities for operating leases were added to the other assets and other liabilities line items of the balance sheet, respectively, as a result of the adoption of this update.

In August 2016, the FASB issued ASU 2016-15,2016‑15, “Classification of Certain Cash Receipts and Cash Payments” (Topic 230). ASU 2016-152016‑15 will reduce diversity in practice on how eight specific cash receipts and payments are classified on the statement of cash flows. The ASU is effective for fiscal years beginning after December 15, 2017, including interim periods within those years. Effective January 1, 2018, we adoptedThe adoption of this new guidance which did not have a material impact on our financial results or disclosures.

In November 2016, the FASB issued ASU 2016-18,2016‑18, “Statement of Cash Flows (Topic 230): Restricted Cash.” The purpose of ASU 2016-182016‑18 is to eliminate the diversity in classifying and presenting changes in restricted cash in the statement of cash flows. The new guidance requires restricted cash to be combined with cash and cash equivalents when reconciling the beginning and ending balances of cash on the statement of cash flows, thereby no longer requiring transactions such as transfers between restricted and unrestricted cash to be treated as a cash flow activity. Further, the new guidance requires the nature of the restrictions to be disclosed, as well as a reconciliation between the balance sheet and the statement of cash flows on how restricted and unrestricted cash are segregated. The new guidance is effective for fiscal years beginning after December 15, 2017, and interim periods within that fiscal year, with early adoption permitted. Effective January 1, 2018, we retrospectively adopted this new guidance.

guidance which did not have a material impact on our financial results or disclosures.

In May 2014, the FASB issued ASU 2014-09,2014‑09, guidance which revises the criteria for revenue recognition. Under the guidance, the transaction price is attributed to underlying performance obligations in the contract and revenue is recognized as the entity satisfies the performance obligations and transfers control of a good or service to the customer. Incremental costs of obtaining a contract may be capitalized to the extent the entity expects to recover those costs. The guidance is effective for reporting periods beginning after December 15, 2017 and is to be applied retrospectively. Revenue from insurance contracts is excluded from the scope of this new guidance. While insurance contracts are excluded from this guidance, policy fee income, billing and other fees and fee income related to property business written as a cover-holder through a Lloyds Syndicate is subject to this updated guidance. Effective January 1, 2018, we adoptedThe adoption of this new guidance which did not have a material impact on our financial results or disclosures.

11

Recently Issued Accounting Pronouncements

In March 2017,On August 28, 2018, the FASB issued ASU 2017-08, “Premium Amortization on Purchased Callable Securities” (Subtopic 310-20). ASU 2017-08 is intended2018-13, “Fair Value Measurement: Disclosure Framework- Changes to enhance the accountingDisclosure Requirements for amortizationFair Value Measurement” (Topic 820), which amends ASC 820 to add, remove, and modify fair value measurement disclosure requirements.  The requirements to disclose the amount of premiumsand reasons for purchased callable debt securities. The guidance amendstransfers between Level 1 and Level 2 of the amortization periodfair value hierarchy, the policy for certain purchased callable debt securitiestiming of transfers between levels and the valuation processes for Level 3 fair value measurements have all been removed. However, the changes in unrealized gains and losses included in other comprehensive income for recurring Level 3 fair value measurements held at a premium. Securitiesthe end of the

11

reporting period must be disclosed along with the range and weighted average of significant unobservable inputs used to develop Level 3 fair value measurements (or other quantitative information if it is more reasonable). Finally, for investments measured at net asset value, the requirements have been modified so that contain explicit, noncontingent call features thatthe timing of liquidation and the date when restrictions from redemption might lapse are callable at fixed prices and on preset dates should shortenonly disclosed if the amortization period forinvestee has communicated the premiumtiming to the earliest call date (and ifentity or announced the call option is not exercised, the effective yield is reset using the payment terms of the debt security). The standardtiming publicly. This ASU is effective for fiscal years,annual and interim reporting periods within those years, beginning after December 15, 2018, and is to be applied on a modified retrospective basis through a cumulative-effect adjustment directly to retained earnings. We2019. As the amendments are currently evaluating the impact that the adoption of ASU 2017-08 will have ononly disclosure related, our financial results and disclosures.

statements will not be materially impacted by this update.

In January 2017, the FASB issued ASU 2017-04,2017‑04, “Simplifying the Test for Goodwill Impairment” (Topic 350). ASU 2017-042017‑04 requires only a one-step quantitative impairment test, whereby a goodwill impairment loss will be measured as the excess of a reporting unit’s carrying amount over its fair value (not to exceed the total goodwill allocated to that reporting unit). It eliminates Step 2 of the current two-step goodwill impairment test, under which a goodwill impairment loss is measured by comparing the implied fair value of a reporting unit’s goodwill. The ASU is effective for annual or any interim goodwill impairment tests in fiscal years beginning after December 15, 2019. We are currently evaluating the impact that the adoption of ASU 2017-042017‑04 will have on our financial results and disclosures.

In June 2016, the FASB issued ASU 2016-13,2016‑13, “Measurement of Credit Losses on Financial Instruments” (Topic 326). ASU 2016-132016‑13 requires organizations to estimate credit losses on certain types of financial instruments, including receivables and available-for-sale debt securities, by introducing an approach based on expected losses. The expected loss approach will require entities to incorporate considerations of historical information, current information and reasonable and supportable forecasts. ASU 2016-132016‑13 is effective for fiscal years beginning after December 15, 2019, including interim periods within those fiscal years. ASU 2016-132016‑13 requires a modified retrospective transition method and early adoption is permitted. We are currently evaluating the impact that the adoption of this standard will have on our financial results and disclosures, but do not anticipate that any potential impact would be material.

In February 2016, the FASB issued ASU 2016-02, “Leases” (Topic 842). ASU 2016-02 requires organizations that lease assets to recognize on the balance sheet the assets and liabilities for the rights and obligations created by those leases. Additionally, ASU 2016-02 modifies current guidance for lessors' accounting. ASU 2016-02 is effective for interim and annual reporting periods beginning on or after January 1, 2019, with early adoption permitted. We do not anticipate that this standard will have a material impact on our results of operations, but we anticipate an increase to the value of our assets and liabilities related to leases, with no material impact to equity.

   

3. Fair Value

ASC 820 defines fair value, establishes a consistent framework for measuring fair value and expands disclosure requirements about fair value measurements. ASC 820, among other things, requires us to maximize the use of observable inputs and minimize the use of unobservable inputs when measuring fair value. In addition, ASC 820 precludes the use of block discounts when measuring the fair value of instruments traded in an active market, which were previously applied to large holdings of publicly traded equity securities.

12

We determine the fair value of our financial instruments based on the fair value hierarchy established in ASC 820. In accordance with ASC 820, we utilize the following fair value hierarchy:

·

Level 1: quoted prices in active markets for identical assets;

·

Level 2: inputs to the valuation methodology include quoted prices for similar assets and liabilities in active markets, inputs of identical assets for less active markets, and inputs that are observable for the asset or liability, either directly or indirectly, for substantially the full term of the instrument; and

·

Level 3: inputs to the valuation methodology that are unobservable for the asset or liability.

This hierarchy requires the use of observable market data when available.

Under ASC 820, we determine fair value based on the price that would be received for an asset or paid to transfer a liability in an orderly transaction between market participants on the measurement date. It is our policy to maximize the use of observable inputs and minimize the use of unobservable inputs when developing fair value measurements, in accordance with the fair value hierarchy described above. Fair value measurements for assets and liabilities where there exists limited or no observable market data are calculated based upon our pricing policy, the economic and competitive environment, the characteristics of the asset or liability and other factors as appropriate. These estimated fair values may not be realized upon actual sale or immediate settlement of the asset or liability.

12

Where quoted prices are available on active exchanges for identical instruments, investment securities are classified within Level 1 of the valuation hierarchy. Level 1 investment securities include common and preferred stock and an equity warrant classified as Other Investments.

Level 2 investment securities include corporate bonds, collateralized corporate bank loans, municipal bonds, U.S. Treasury securities, other obligations of the U.S. Government and mortgage-backed securities for which quoted prices are not available on active exchanges for identical instruments. We use third party pricing services to determine fair values for each Level 2 investment security in all asset classes. Since quoted prices in active markets for identical assets are not available, these prices are determined using observable market information such as quotes from less active markets and/or quoted prices of securities with similar characteristics, among other things. We have reviewed the processes used by the pricing services and have determined that they result in fair values consistent with the requirements of ASC 820 for Level 2 investment securities. We have not adjusted any prices received from third party pricing sources. There were no transfers between Level 1 and Level 2 securities.

In cases where there is limited activity or less transparency around inputs to the valuation, investment securities are classified within Level 3 of the valuation hierarchy. Level 3 investments are valued based on the best available data in order to approximate fair value. This data may be internally developed and consider risk premiums that a market participant would require. Investment securities classified within Level 3 include other less liquid investment securities.

13

The following table presents for each of the fair value hierarchy levels, our assets that are measured at fair value on a recurring basis at SeptemberJune 30, 20182019 and December 31, 20172018 (in thousands):

  As of September 30, 2018 
  Quoted Prices in  Other       
  Active Markets for  Observable  Unobservable    
  Identical Assets  Inputs  Inputs    
  (Level 1)  (Level 2)  (Level 3)  Total 
             
U.S. Treasury securities and obligations of U.S. Government $-  $47,866  $-  $47,866 
Corporate bonds  -   249,177   325   249,502 
Collateralized corporate bank loans  -   135,309   -   135,309 
Municipal bonds  -   127,044   -   127,044 
Mortgage-backed  -   14,749   -   14,749 
Total debt securities  -   574,145   325   574,470 
                 
Total equity securities  70,152   -   -   70,152 
                 
Total other investments  3,085   -   -   3,085 
                 
Total investments $73,237  $574,145  $325  $647,707 

 As of December 31, 2017 

 

 

 

 

 

 

 

 

 

 

 

 

 Quoted Prices in Other      

 

As of June 30, 2019

 Active Markets for Observable Unobservable    

    

Quoted Prices in

    

 

 

    

 

 

    

 

 

 Identical Assets Inputs Inputs    

 

Active Markets for

 

 

 

 

 

 

 

 

 

 (Level 1)  (Level 2)  (Level 3)  Total 

 

Identical Assets

 

Other Observable

 

Unobservable

 

 

 

         

    

(Level 1)

    

Inputs (Level 2)

    

Inputs (Level 3)

    

Total

U.S. Treasury securities and obligations of U.S. Government $-  $49,947  $-  $49,947 

 

$

 —

 

$

48,422

 

$

 -

 

$

48,422

Corporate bonds  -   278,760   313   279,073 

 

 

 —

 

 

225,810

 

 

533

 

 

226,343

Collateralized corporate bank loans  -   125,937   -   125,937 

 

 

 —

 

 

132,678

 

 

 -

 

 

132,678

Municipal bonds  -   131,433   2,823   134,256 

 

 

 —

 

 

115,849

 

 

 -

 

 

115,849

Mortgage-backed  -   16,533   -   16,533 

 

 

 —

 

 

9,856

 

 

 -

 

 

9,856

Total debt securities  -   602,610   3,136   605,746 

 

 

 —

 

 

532,615

 

 

533

 

 

533,148

                
Total equity securities  51,142   -   621   51,763 

 

 

94,012

 

 

 —

 

 

 —

 

 

94,012

                
Total other investments  3,824   -   -   3,824 

 

 

2,585

 

 

 —

 

 

 —

 

 

2,585

                
Total investments $54,966  $602,610  $3,757  $661,333 

 

$

96,597

 

$

532,615

 

$

533

 

$

629,745

 

14

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

As of December 31, 2018

 

    

Quoted Prices in

    

 

 

    

 

 

    

 

 

 

 

Active Markets for

 

 

 

 

 

 

 

 

 

 

 

Identical Assets

 

Other Observable

 

Unobservable

 

 

 

 

    

(Level 1)

    

Inputs (Level 2)

    

Inputs (Level 3)

    

Total

U.S. Treasury securities and obligations of U.S. Government

 

$

 —

 

$

48,106

 

$

 —

 

$

48,106

Corporate bonds

 

 

 —

 

 

241,861

 

 

291

 

 

242,152

Collateralized corporate bank loans

 

 

 —

 

 

126,528

 

 

 —

 

 

126,528

Municipal bonds

 

 

 —

 

 

115,527

 

 

 —

 

 

115,527

Mortgage-backed

 

 

 —

 

 

13,557

 

 

 —

 

 

13,557

Total debt securities

 

 

 —

 

 

545,579

 

 

291

 

 

545,870

Total equity securities

 

 

80,896

 

 

 —

 

 

 —

 

 

80,896

Total other investments

 

 

1,148

 

 

 —

 

 

 —

 

 

1,148

Total investments

 

$

82,044

 

$

545,579

 

$

291

 

$

627,914

13

Due to significant unobservable inputs into the valuation model for one corporate bond as of SeptemberJune 30, 2019 and December 31, 2018, we classified this investment as Level 3 in the fair value hierarchy. Due to significant unobservable inputs into the valuation model for certain municipal bonds, one corporate bond and one equity security as of December 31, 2017, we classified these investments as Level 3 in the fair value hierarchy. We used an income approach in order to derive an estimated fair value of the municipal bonds classified as Level 3, which included inputs such as expected holding period, benchmark swap rate, benchmark discount rate and a discount rate premium for illiquidity. The corporate bond is a convertible senior note and its fair value was estimated by the sum of the bond value using an income approach discounting the scheduled interest and principal payments and the conversion feature utilizing a binomial lattice model. We also estimated the fair value of the corporate bond utilizing an as-if converted basis into the underlying securities. Significant changes in the unobservable inputs in the fair value measurement of this corporate bond could result in a significant change in the fair value measurement. The equity security previously classified as Level 3 in the fair value hierarchy was transferred to Level 1 during the second quarter of 2018.

The following table summarizes the changes in fair value for all financial assets measured at fair value on a recurring basis using significant unobservable inputs (Level 3) during the ninesix months ended SeptemberJune 30, 20182019 and 20172018 (in thousands):

Beginning balance as of January 1, 2018 $3,757 

 

 

 

Beginning balance as of January 1, 2019

    

$

291

Sales  (2,925)

 

 

 —

Settlements  - 

 

 

 —

Purchases  - 

 

 

 —

Issuances  - 

 

 

 —

Total realized/unrealized gains included in net income  114 

 

 

242

Net gains included in other comprehensive income  - 

Net gain included in other comprehensive income

 

 

 —

Transfers into Level 3  - 

 

 

 —

Transfers out of Level 3  (621)

 

 

 —

Ending balance as of September 30, 2018 $325 
    
Beginning balance as of January 1, 2017 $5,945 
Sales  - 
Settlements  (150)
Purchases  775 
Issuances  - 
Total realized/unrealized gains included in net income  - 
Net gains included in other comprehensive income  607 
Transfers into Level 3  - 
Transfers out of Level 3  - 
Ending balance as of September 30, 2017 $7,177 

Ending balance as of June 30, 2019

 

$

533

 

15

 

 

 

 

Beginning balance as of January 1, 2018

    

$

3,757

Sales

 

 

(2,925)

Settlements

 

 

 —

Purchases

 

 

 —

Issuances

 

 

 —

Total realized/unrealized gains included in net income

 

 

104

Net gains included in other comprehensive income

 

 

 —

Transfers into Level 3

 

 

 —

Transfers out of Level 3

 

 

(621)

Ending balance as of June 30, 2018

 

$

315

 

14

4. Investments

The amortized cost and estimated fair value of investments in debt and equity securities by category is as follows (in thousands):

     Gross  Gross    
  Amortized  Unrealized  Unrealized  Fair 
As of September 30, 2018 Cost  Gains  Losses  Value 
             
U.S. Treasury securities and obligations of U.S. Government $48,730  $-  $(864) $47,866 
Corporate bonds  250,739   403   (1,640)  249,502 
Collateralized corporate bank loans  134,807   642   (140)  135,309 
Municipal bonds  122,053   6,126   (1,135)  127,044 
Mortgage-backed  15,328   13   (592)  14,749 
                 
Total debt securities  571,657   7,184   (4,371)  574,470 
                 
Total equity securities  45,426   28,116   (3,390)  70,152 
                 
Total other investments  3,763   -   (678)  3,085 
                 
Total investments $620,846  $35,300  $(8,439) $647,707 
                 
As of December 31, 2017                
                 
U.S. Treasury securities and obligations of U.S. Government $50,088  $7  $(148) $49,947 
Corporate bonds  278,611   1,204   (742)  279,073 
Collateralized corporate bank loans  125,536   702   (301)  125,937 
Municipal bonds  134,052   709   (505)  134,256 
Mortgage-backed  16,712   37   (216)  16,533 
                 
Total debt securities  604,999   2,659   (1,912)  605,746 
                 
Total equity securities  30,253   23,014   (1,504)  51,763 
                 
Total other investments  3,763   61   -   3,824 
                 
Total investments $639,015  $25,734  $(3,416) $661,333 

16

 

 

 

 

 

 

 

 

 

 

 

 

 

 

    

 

 

    

Gross

    

Gross

    

 

 

 

 

 

 

 

Unrealized

 

Unrealized

 

 

 

 

    

Amortized Cost

    

Gains

    

Losses

    

Fair Value

As of June 30, 2019

 

 

 

 

 

 

 

 

 

 

 

 

U.S. Treasury securities and obligations of U.S. Government

 

$

48,369

 

$

112

 

$

(59)

 

$

48,422

Corporate bonds

 

 

223,770

 

 

2,813

 

 

(240)

 

 

226,343

Collateralized corporate bank loans

 

 

133,840

 

 

59

 

 

(1,221)

 

 

132,678

Municipal bonds

 

 

114,638

 

 

1,304

 

 

(93)

 

 

115,849

Mortgage-backed

 

 

9,899

 

 

51

 

 

(94)

 

 

9,856

Total debt securities

 

 

530,516

 

 

4,339

 

 

(1,707)

 

 

533,148

Total equity securities

 

 

68,709

 

 

30,657

 

 

(5,354)

 

 

94,012

Total other investments

 

 

3,763

 

 

 —

 

 

(1,178)

 

 

2,585

Total investments

 

$

602,988

 

$

34,996

 

$

(8,239)

 

$

629,745

 

 

 

 

 

 

 

 

 

 

 

 

 

As of December 31, 2018

 

 

  

 

 

  

 

 

 

 

 

  

U.S. Treasury securities and obligations of U.S. Government

 

$

48,609

 

$

 5

 

$

(508)

 

$

48,106

Corporate bonds

 

 

243,314

 

 

440

 

 

(1,602)

 

 

242,152

Collateralized corporate bank loans

 

 

131,779

 

 

19

 

 

(5,270)

 

 

126,528

Municipal bonds

 

 

112,574

 

 

3,791

 

 

(838)

 

 

115,527

Mortgage-backed

 

 

13,992

 

 

11

 

 

(446)

 

 

13,557

Total debt securities

 

 

550,268

 

 

4,266

 

 

(8,664)

 

 

545,870

Total equity securities

 

 

68,709

 

 

20,693

 

 

(8,506)

 

 

80,896

Total other investments

 

 

3,763

 

 

 —

 

 

(2,615)

 

 

1,148

Total investments

 

$

622,740

 

$

24,959

 

$

(19,785)

 

$

627,914

 

Major categories of net investment gains (losses) on investments are summarized as follows (in thousands):

 Three Months Ended September 30,  Nine Months Ended September 30, 

 

 

 

 

 

 

 

 

 

 

 

 

 

 2018  2017  2018  2017 

 

Three Months Ended June 30, 

 

Six Months Ended June 30, 

 

         

    

2019

    

2018

    

2019

    

2018

    

U.S. Treasury securities and obligations of U.S. Government $-  $-  $-  $- 

 

$

 —

 

$

 —

 

$

 —

 

$

 —

 

Corporate bonds  (44)  (107)  (66)  (125)

 

 

(6)

 

 

(14)

 

 

17

 

 

(22)

 

Collateralized corporate bank loans  23   8   70   56 

 

 

21

 

 

35

 

 

38

 

 

47

 

Municipal bonds  (145)  120   (164)  204 

 

 

46

 

 

 2

 

 

4,147

 

 

(19)

 

Mortgage-backed  -   (1)  1   (1)

 

 

(1)

 

 

(1)

 

 

(1)

 

 

 1

 

Realized (losses) gains on fixed maturities  (166)  20   (159)  134 
Realized gains on equity securities  -   3,168   359   5,545 
Realized (losses) gains on other investments  -   -   -   - 
Total realized (losses) gains on investments  (166)  3,188   200   5,679 
Other-than-temporary impairments  -   (850)  -   (4,257)

Equity securities

 

 

 —

 

 

359

 

 

 —

 

 

359

 

Gain on investments

 

 

60

 

 

381

 

 

4,201

 

 

366

 

Unrealized gains (losses) on equity securities

 

 

5,356

 

 

553

 

 

13,116

 

 

(3,904)

 

Unrealized gains (losses) on other investments  25   (228)  (739)  (731)

 

 

1,401

 

 

(401)

 

 

1,437

 

 

(764)

 

Unrealized gains (losses) on equity investments  7,121   -   3,217   - 
Investment gains (losses), net $6,980  $2,110  $2,678  $691 

 

$

6,817

 

$

533

 

$

18,754

 

$

(4,302)

 

 

We realized gross gains on investments of $0.3$0.2 million and $3.4$0.5 million during the three months ended SeptemberJune 30, 20182019 and 2017,2018, respectively and $0.9$4.4 million and $6.4$0.6 million for the ninesix months ended SeptemberJune 30, 20182019 and 2017,2018, respectively. We realized gross losses on investments of $0.5$0.1 million and $0.1 million for the three months ended June 30, 2019 and 2018, respectively, and $0.2 million and $0.2 million for the threesix months ended SeptemberJune 30, 20182019 and 2017, respectively, and $0.7 million and $0.7 million for the nine months ended September 30, 2018, and 2017, respectively. We recorded proceeds from the sale of investment securities of $0.4$0.1 million and $11.4$14.2 million during the three months ended SeptemberJune 30, 20182019 and 2017,2018, respectively, and $14.6$7.0 million and $19.4$14.2 million for the ninesix months ended SeptemberJune 30, 2019 or 2018, and 2017, respectively. Realized investment gains and losses are recognized in operations on the first in-first out method.

17

15

The following schedules summarize the gross unrealized losses showing the length of time that investments have been continuously in an unrealized loss position as of SeptemberJune 30, 20182019 and December 31, 20172018 (in thousands):

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

As of June 30, 2019

 

 

12 months or less

 

Longer than 12 months

 

Total

 

    

 

 

    

Unrealized

    

 

 

    

Unrealized

    

 

 

    

Unrealized

 

    

Fair Value

    

Losses

    

Fair Value

    

Losses

    

Fair Value

    

Losses

U.S. Treasury securities and obligations of U.S. Government

 

$

 —

 

$

 —

 

$

23,216

 

$

(59)

 

$

23,216

 

$

(59)

Corporate bonds

 

 

18,143

 

 

(144)

 

 

36,011

 

 

(96)

 

 

54,154

 

 

(240)

Collateralized corporate bank loans

 

 

85,804

 

 

(871)

 

 

17,564

 

 

(350)

 

 

103,368

 

 

(1,221)

Municipal bonds

 

 

10,898

 

 

(55)

 

 

5,735

 

 

(38)

 

 

16,633

 

 

(93)

Mortgage-backed

 

 

3,518

 

 

(6)

 

 

3,911

 

 

(88)

 

 

7,429

 

 

(94)

Total debt securities

 

 

118,363

 

 

(1,076)

 

 

86,437

 

 

(631)

 

 

204,800

 

 

(1,707)

Total equity securities

 

 

7,952

 

 

(1,588)

 

 

4,524

 

 

(3,766)

 

 

12,476

 

 

(5,354)

Total other investments

 

 

28

 

 

(10)

 

 

2,557

 

 

(1,168)

 

 

2,585

 

 

(1,178)

Total investments

 

$

126,343

 

$

(2,674)

 

$

93,518

 

$

(5,565)

 

$

219,861

 

$

(8,239)

 

  As of September 30, 2018 
  12 months or less  Longer than 12 months  Total 
     Unrealized     Unrealized     Unrealized 
  Fair Value  Losses  Fair Value  Losses  Fair Value  Losses 
                   
U.S. Treasury securities and obligations of U.S. Government $46,868  $(864) $-  $-  $46,868  $(864)
Corporate bonds  181,467   (1,313)  47,968   (327)  229,435   (1,640)
Collateralized corporate bank loans  18,794   (117)  6,064   (23)  24,858   (140)
Municipal bonds  38,292   (638)  11,924   (497)  50,216   (1,135)
Mortgage-backed  5,862   (63)  5,454   (529)  11,316   (592)
Total debt securities  291,283   (2,995)  71,410   (1,376)  362,693   (4,371)
                         
Total equity securities  3,017   (2,654)  3,359   (736)  6,376   (3,390)
                         
Total other investments  3,085   (678)  -   -   3,085   (678)
                         
Total investments $297,385  $(6,327) $74,769  $(2,112) $372,154  $(8,439)

 As of December 31, 2017 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 12 months or less  Longer than 12 months  Total 

 

As of December 31, 2018

    Unrealized     Unrealized     Unrealized 

 

12 months or less

 

Longer than 12 months

 

Total

 Fair Value  Losses  Fair Value  Losses  Fair Value  Losses 

    

 

 

    

Unrealized

    

 

 

    

Unrealized

    

 

 

    

Unrealized

             

    

Fair Value

    

Losses

    

Fair Value

    

Losses

    

Fair Value

    

Losses

U.S. Treasury securities and obligations of U.S. Government $28,825  $(145) $1,997  $(3) $30,822  $(148)

 

$

18,902

 

$

(181)

 

$

28,201

 

$

(327)

 

$

47,103

 

$

(508)

Corporate bonds  176,061   (736)  2,378   (6)  178,439   (742)

 

 

117,450

 

 

(907)

 

 

100,060

 

 

(695)

 

 

217,510

 

 

(1,602)

Collateralized corporate bank loans  30,008   (280)  2,517   (21)  32,525   (301)

 

 

120,410

 

 

(4,938)

 

 

4,931

 

 

(332)

 

 

125,341

 

 

(5,270)

Municipal bonds  35,200   (370)  8,917   (135)  44,117   (505)

 

 

14,281

 

 

(96)

 

 

25,891

 

 

(742)

 

 

40,172

 

 

(838)

Mortgage-backed  6,419   (127)  1,415   (89)  7,834   (216)

 

 

6,592

 

 

(60)

 

 

5,986

 

 

(386)

 

 

12,578

 

 

(446)

Total debt securities  276,513   (1,658)  17,224   (254)  293,737   (1,912)

 

 

277,635

 

 

(6,182)

 

 

165,069

 

 

(2,482)

 

 

442,704

 

 

(8,664)

                        
Total equity securities  8,375   (1,504)  -   -   8,375   (1,504)

 

 

30,981

 

 

(3,699)

 

 

4,475

 

 

(4,807)

 

 

35,456

 

 

(8,506)

                        
Total other investments  -   -   -   -   -   - 

 

 

1,148

 

 

(2,615)

 

 

 —

 

 

 —

 

 

1,148

 

 

(2,615)

                        
Total investments $284,888  $(3,162) $17,224  $(254) $302,112  $(3,416)

 

$

309,764

 

$

(12,496)

 

$

169,544

 

$

(7,289)

 

$

479,308

 

$

(19,785)

 

At SeptemberWe had a total of 173 debt securities with an unrealized loss, of which 117 were in an unrealized loss position for less than one year and 56 were in an unrealized loss position for a period of one year or greater, as of June 30, 2018, the gross2019.  We had a total of 328 debt securities with an unrealized losses moreloss, of which 221 were in an unrealized loss position for less than twelve months oldone year and 107 were attributable to 64 debt security positions and two equity securities. Atin an unrealized loss position for a period of one year or greater, as of December 31, 2017, the gross unrealized losses more than twelve months old were attributable to 25 debt security positions.2018.  We consider these losses as a temporary decline in value as they are predominately on securities that we do not intend to sell and do not believe we will be required to sell prior to recovery of our amortized cost basis. We see no other indications that the decline in values of these securities is other-than-temporary.

18

We complete a detailed analysis each quarter to assess whether any decline in the fair value of any fixed maturity investment below cost is deemed other-than-temporary. All fixed maturity investments with an unrealized loss are reviewed. We recognize an impairment loss when an investment'sinvestment’s value declines below cost, adjusted for accretion, amortization and previous other-than-temporary impairments, and it is determined that the decline is other-than-temporary.

We assess whether we intend to sell, or it is more likely than not that we will be required to sell, a fixed maturity investment before recovery of its amortized cost basis less any current period credit losses. For fixed maturity investments that are considered other-than-temporarily impaired and that we do not intend to sell and will not be required to sell, we separate the amount of the impairment into the amount that is credit related (credit loss component) and the amount due to all other factors. The credit loss component is recognized in earnings and is the difference between the investment’s amortized cost basis and the present value of its expected future cash flows. The remaining difference between the investment’s fair value and the present value of future expected cash flows is recognized in other comprehensive income.

16

Details regarding the carrying value of the other investments portfolio as of SeptemberJune 30, 20182019 and December 31, 20172018 are as follows (in thousands):

 

 

 

 

 

 

 September 30, December 31, 

    

June 30, 

    

December 31, 

 2018  2017 

    

2019

    

2018

Investment Type        

 

 

  

 

 

  

Equity warrant $3,085  $3,824 

 

$

2,585

 

$

1,148

Total other investments $3,085  $3,824 

 

$

2,585

 

$

1,148

 

We acquired this warrant in an active market. The warrant entitles us to buy the underlying common stock of a publicly traded company at a fixed price until the expiration date of January 19, 2021.

The amortized cost and estimated fair value of debt securities at SeptemberJune 30, 20182019 by contractual maturity are as follows. Expected maturities may differ from contractual maturities because certain borrowers may have the right to call or prepay obligations with or without penalties.

 

 

 

 

 

 

 

 

    

Amortized Cost

    

Fair Value

 

 

(in thousands)

Due in one year or less

 

$

117,306

 

$

117,293

Due after one year through five years

 

 

276,397

 

 

278,718

Due after five years through ten years

 

 

96,047

 

 

95,636

Due after ten years

 

 

30,867

 

 

31,645

Mortgage-backed

 

 

9,899

 

 

9,856

 

 

$

530,516

 

$

533,148

 

  Amortized  Fair 
  Cost  Value 
  (in thousands) 
Due in one year or less $120,070  $120,698 
Due after one year through five years  287,661   291,063 
Due after five years through ten years  121,834   122,121 
Due after ten years  26,764   25,839 
Mortgage-backed  15,328   14,749 
  $571,657  $574,470 

 

5. Pledged Investments

We have pledged certain of our securities for the benefit of various state insurance departments and reinsurers. These securities are included with our available-for-sale debt securities because we have the ability to trade these securities. We retain the interest earned on these securities. These securities had a carrying value of $29.4$29.7 million and $26.2$29.5 million at SeptemberJune 30, 20182019 and December 31, 2017,2018, respectively.

19

17

6. Reserves for Unpaid Losses and Loss Adjustment Expenses

Activity in the consolidated reserves for unpaid losses and LAE is summarized as follows (in thousands):

  September 30,  September 30, 
  2018  2017 
       
Balance at January 1 $527,100  $481,567 
Less reinsurance recoverable  154,612   123,237 
Net balance at January 1  372,488   358,330 
         
Incurred related to:        
Current year  185,506   184,685 
Prior years  6,062   20,240 
Total incurred  191,568   204,925 
         
Paid related to:        
Current year  56,687   61,288 
Prior years  184,337   128,329 
Total paid  241,024   189,617 
         
Net balance at September 30  323,032   373,638 
Plus reinsurance recoverable  207,784   157,861 
Balance at September 30 $530,816  $531,499 

20

 

 

 

 

 

 

 

 

 

 

June 30,

 

June 30,

 

 

 

2019

 

2018

 

Balance at January 1

 

$

527,247

 

 

527,100

 

Less reinsurance recoverable

 

 

221,716

 

 

154,612

 

Net balance at January 1

 

 

305,531

 

 

372,488

 

 

 

 

 

 

 

 

 

Incurred related to:

 

 

  

 

 

  

 

Current year

 

 

141,909

 

 

122,870

 

Prior years

 

 

1,404

 

 

4,453

 

Total incurred

 

 

143,313

 

 

127,323

 

 

 

 

 

 

 

 

 

Paid related to:

 

 

  

 

 

  

 

Current year

 

 

38,563

 

 

28,321

 

Prior years

 

 

107,899

 

 

140,339

 

Total paid

 

 

146,462

 

 

168,660

 

 

 

 

 

 

 

 

 

Net balance at June 30

 

 

302,382

 

 

331,151

 

Plus reinsurance recoverable

 

 

249,161

 

 

189,401

 

Balance at June 30

 

$

551,543

 

$

520,552

 

 

The impact from the unfavorable (favorable) net prior years’ loss development on each reporting segment is presented below:

 Nine Months Ended September 30, 

 

 

 

 

 

 

 2018  2017 

 

June 30, 

     

 

2019

    

2018

Specialty Commercial Segment $15,730  $17,824 

 

$

5,203

 

$

6,861

Standard Commercial Segment  (8,829)  1,594 

 

 

(3,583)

 

 

(1,560)

Personal Segment  (839)  822 

 

 

(216)

 

 

(848)

Corporate  -   - 

 

 

 —

 

 

 —

        
Total unfavorable (favorable) net prior years' development $6,062  $20,240 

Total (favorable) net prior year development

 

$

1,404

 

$

4,453

 

The following describes the primary factors behind each segment’s prior accident year reserve development for the ninesix months ended SeptemberJune 30, 20182019 and 2017:2018:

NineSix months ended SeptemberJune 30, 2019:

·

Specialty Commercial Segment. Our Commercial Auto business unit experienced net unfavorable development in the 2017 and prior accident years primarily in the primary commercial auto liability line of business, partially offset by net favorable development in the primary commercial auto line of business in the 2018 accident year. Our E&S Casualty business unit experienced net unfavorable development primarily in our E&S package insurance products in the 2017 and prior accident years, partially offset by net favorable development in the 2018 accident year. We experienced net favorable development in our E&S Property and Professional Liability business units, partially offset by net unfavorable development in our Aerospace & Programs business unit.

·

Standard Commercial Segment. Our Commercial Accounts business unit experienced net favorable development in the 2018, 2017, 2014 and 2012 and prior accident years primarily in the general liability line of business, partially offset by net unfavorable development primarily in the general liability line of business in the 2016 and 2015 accident years. Our Commercial Accounts business unit experienced net

18

favorable development in the 2017 and 2015 accident years in the occupational accident line of business, partially offset by net unfavorable development in the 2016 accident year. The run-off from our former Workers Compensation operating unit experienced net favorable development in the 2015 and 2012 and prior accident years.

·

Personal Segment. Net favorable development in our Specialty Personal Lines business unit was mostly attributable to the 2018, 2017, 2015,  2013 and prior accident years, partially offset by unfavorable development in the 2016 and 2014 accident years.

Six months ended June 30, 2018:

·

Specialty Commercial Segment.Our Contract Binding operatingCommercial Auto business unit experienced net unfavorable development in the 2016 and prior accident years primarily in the commercial auto liability line of business, partially offset by favorable development primarily in the commercial auto and general liability linesline of business in the 2017 accident year. Our Specialty Commercial operating unitWe experienced net unfavorable development in general aviation, commercial excess liability, satellite launch insurance products, primary/excess commercial property, professional liabilityour E&S Property, Professional Liability, E&S Casualty and Aerospace& Programs business units.specialty risk programs lines of business.

·

Standard Commercial Segment. Our  Standard Commercial P&C operatingAccounts business unit experienced net favorable development in the 2016 and prior accident years primarily in the general liability line of business, partially offset by net unfavorable development primarily in the commercial property line of business in the 2017 accident year and net unfavorable development in the 2017 and prior accident years in the occupational accident line of business. Our Workers Compensation operating unit experienced net favorable development in the 2016 and prior accident years.

·

Personal Segment. Net favorable development in our Specialty Personal Lines operating unit wasmostly attributable to the 2013 through 2017 accident years, partially offset by unfavorable development in the 2012 and prior accident years.

Nine months ended September 30, 2017:

·Specialty Commercial Segment.Our Contract Binding operating unit experienced net unfavorable development primarily in the commercial auto liability line of business in the 2015 and prior accident years, partially offset by favorable development in the 2016 accident year. Our Specialty Commercial operating unit experienced net unfavorable development in general aviation primarily in the 2010 accident year, commercial excess liability primarily in the 2013 accident year andspecialty risk programs primarily in the 2015 and prior accident years, partially offset by net favorable development in themedical professional liability and primary/excess commercial property lines of business primarily in the 2016 accident years.

21

·Standard Commercial Segment. Our Standard Commercial P&C operating unit experienced net unfavorable development in the 2016 and prior accident years in the occupational accident line of business, partially offset by net favorable development primarily in the general liability line of business in the 2016 and prior accident years.

·Personal Segment. Net unfavorable development in our Specialty Personal Lines operating unit wasmostly attributable to the 2016, 2014 and 2013 accident years, partially offset by favorable development in the 2015 accident year.

7. Share-Based Payment Arrangements

Our 2005 Long Term Incentive Plan (“2005 LTIP”) is a stock compensation plan for key employees and non-employee directors that was initially approved by the shareholders on May 26, 2005 and expired by its terms on May 27, 2015.  As of SeptemberJune 30, 2018,2019, there were no outstanding incentive stock options to purchase 1,074 shares of our common stock and outstanding non-qualified stock options to purchase 244,15714,157 shares of our common stock. The exercise price of all such outstanding stock options is equal to the fair market value of our common stock on the date of grant.

 

Our 2015 Long Term Incentive Plan (“2015 LTIP”) was approved by shareholders on May 29, 2015.  There are 2,000,000 shares authorized for issuance under the 2015 LTIP.  As of SeptemberJune 30, 2018,2019, restricted stock units representing the right to receive up to 508,345383,530 shares of our common stock were outstanding under the 2015 LTIP.  There were no stock option awards granted under the 2015 LTIP as of SeptemberJune 30, 2018.2019.

 

Stock Options:

Incentive stock options granted under the 2005 LTIP prior to 2009 vested 10%,  20%,  30% and 40% on the first, second, third and fourth anniversary dates of the grant, respectively, and terminated five to ten years from the date of grant. Incentive stock options granted in 2009 vest in equal annual increments on each of the first seven anniversary dates and terminate ten years from the date of grant. Non-qualified stock options granted under the 2005 LTIP generally vest 100% six months after the date of grant and terminate ten years from the date of grant. One grant of 200,000 non-qualified stock options in 2009 vestsvested in equal annual increments on each of the first seven anniversary dates and terminatesterminated ten years from the date of grant.

22

19

A summary of the status of our stock options as of SeptemberJune 30, 20182019 and changes during the ninesix months then ended is presented below:

      Average    

 

 

 

 

 

 

 

 

 

 

    Weighted Remaining Aggregate 

    

 

    

 

 

    

Average

    

 

 

    Average Contractual Intrinsic 

 

 

 

 

 

 

Remaining

 

Aggregate

 Number of Exercise Term Value 

 

Number of

 

Weighted Average

 

Contractual

 

Intrinsic Value

 Shares  Price  (Years)  ($000) 

    

Shares

    

Exercise Price

    

Term (Years)

    

($000)

         
Outstanding at January 1, 2018  406,731  $7.85         

Outstanding at January 1, 2019

 

244,157

 

$

6.63

 

  

 

 

  

Granted  -   -         

 

 —

 

 

 —

 

  

 

 

  

Exercised  (36,500) $6.61         

 

(230,000)

 

$

6.61

 

  

 

 

  

Forfeited or expired  (125,000) $10.60         

 

 —

 

$

 —

 

  

 

 

  

Outstanding at September 30, 2018  245,231  $6.63   0.7  $1,071 
Exercisable at September 30, 2018  245,231  $6.63   0.7  $1,071 

Outstanding at June 30, 2019

 

14,157

 

$

6.99

 

2.5

 

$

102

Exercisable at June 30, 2019

 

14,157

 

$

6.99

 

2.5

 

$

102

 

The following table details the intrinsic value of options exercised, total cost of share-based payments charged against income before income tax benefit and the amount of related income tax benefit recognized in income for the periods indicated (in thousands):

 Three Months Ended Nine Months Ended 

 

 

 

 

 

 

 

 

 

 

 

 

 September 30,  September 30, 

    

Three Months Ended

 

 

Six Months Ended

 2018  2017  2018  2017 

 

June 30, 

 

 

June 30, 

         

    

2019

    

2018

 

2019

 

2018

Intrinsic value of options exercised $-  $9  $122  $110 

 

$

 —

 

$

122

 

$

845

 

$

122

                
Cost of share-based payments (non-cash) $-  $-  $-  $- 

 

$

 —

 

$

 —

 

$

 —

 

$

 —

                
Income tax benefit of share-based payments recognized in income $-  $-  $-  $- 

 

$

 —

 

$

 —

 

$

 —

 

$

 —

 

As of SeptemberJune 30, 2018,2019, there was no unrecognized compensation cost related to non-vested stock options granted under our plans which is expected to be recognized in the future.

The fair value of each stock option granted is estimated on the date of grant using the Black-Scholes option pricing model. Expected volatilities are based on the historical volatility of Hallmark’s and similar companies’ common stock for a period equal to the expected term. The risk-free interest rates for periods within the contractual term of the options are based on rates for U.S. Treasury Notes with maturity dates corresponding to the options expected lives on the dates of grant. Expected term is determined based on the simplified method as we do not have sufficient historical exercise data to provide a basis for estimating the expected term. There were no stock options granted during the first ninesix months of 20182019 or 2017.2018.

23

Restricted Stock Units:

Restricted stock units awarded under the 2015 LTIP represent the right to receive shares of common stock upon the satisfaction of vesting requirements, performance criteria and other terms and conditions. Restricted stock units vest and, if performance criteria have been satisfied, shares of common stock become issuable on March 31 of the third calendar year following the year of grant.

The performance criteria for all restricted stock units require that we achieve certain compound average annual growth rates in book value per share as well as certain average combined ratio percentages over the vesting period in order to receive shares of common stock in amounts ranging from 50% to 150% of the number of restricted stock units granted. Grantees of restricted stock units do not have any rights of a stockholder, and do not participate in any distributions to our common stockholders, until the award fully vests upon satisfaction of the vesting schedule, performance criteria and other conditions set forth in their award agreement. Therefore, unvested restricted stock units are not considered participating securities under ASC 260, “Earnings Per Share,” and are not included in the calculation of basic or diluted earnings per share.

Compensation cost is measured as an amount equal to the fair value of the restricted stock units on the date of grant and is expensed over the vesting period if achievement of the performance criteria is deemed probable, with the amount of the expense recognized based on our best estimate of the ultimate achievement level.  The grant date fair value

20

of restricted stock units granted in 2015, 2016, 2017 and 2018 was $11.10,  $11.41,  $10.20 and $10.87 per unit, respectively.  We incurred compensation expense of $36$140 thousand and $37$197 thousand related to restricted stock units during the three months and ninesix months ended SeptemberJune 30, 2019, respectively.  We incurred compensation (benefit) expense of ($43) thousand and $1 thousand related to restricted stock units during the three and six months ended June 30, 2018, respectively.  We incurred compensation expenserecorded income tax benefit of $51$29 thousand and $97$41 thousand related to restricted stock units during the three months and ninesix months ended SeptemberJune 30, 2017,2019, respectively. We recorded income tax benefitexpense of $8 thousand related to restricted stock units during both the three months and nine months ended September 30, 2018. We recorded income tax benefit of $18 thousand and $34$9 thousand related to restricted stock units during the three months and nineended June 30, 2018.  We recorded de-minimus income tax expense related to restricted stock units during the six months ended SeptemberJune 30, 2017, respectively.

2018.

The following table details the status of our restricted stock units as of and for the ninesix months ended SeptemberJune 30, 20182019 and 2017:2018:

 Number of 

 

 

 

 

 

 Restricted 

 

 

 

 

 

 Stock Units 

 

Number of Restricted Stock Units

 

 2018  2017 

    

2019

    

2018

 

     
Non-vested at January 1  385,779   296,574 

Nonvested at January 1

 

338,897

 

385,779

 

Granted  144,059   138,712 

 

 —

 

 —

 

Vested  (8,198)  (5,998)

 

 —

 

(8,198)

 

Forfeited  (182,743)  (43,509)

 

(83,210)

 

(182,743)

 

Non-vested at September 30  338,897   385,779 

Nonvested at June 30

 

255,687

 

194,838

 

 

As of SeptemberJune 30, 2018,2019, there was $2.4$1.4 million of unrecognized grant date compensation cost related to unvested restricted stock units. Based on the current performance estimate, we expect to recognize $1.9$0.9 million of compensation cost related to unvested restricted stock units, of which $0.2$0.3 million is expected to be recognized during the remainder of 2018, $0.8 million is expected to be recognized in 2019, $0.7$0.5 million is expected to be recognized in 2020 and $0.2$0.1 million is expected to be recognized in 2021.

24

 

8. Segment Information

The following is business segment information for the three and ninesix months ended SeptemberJune 30, 20182019 and 20172018 (in thousands):

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Three Months Ended

 

Six Months Ended

 

 

    

2019

    

2018

 

2019

 

2018

 

Revenues

 

 

  

 

 

  

 

 

  

 

 

  

 

Specialty Commercial Segment

 

$

73,592

 

$

72,081

 

$

141,559

 

$

145,205

 

Standard Commercial Segment

 

 

17,310

 

 

19,247

 

 

35,683

 

 

38,122

 

Personal Segment

 

 

23,116

 

 

7,916

 

 

42,599

 

 

15,536

 

Corporate

 

 

6,885

 

 

(1,119)

 

 

19,183

 

 

(7,397)

 

Consolidated

 

$

120,903

 

$

98,125

 

$

239,024

 

$

191,466

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Pre-tax income (loss)

 

 

  

 

 

  

 

 

  

 

 

  

 

Specialty Commercial Segment

 

$

10,427

 

$

8,770

 

$

18,395

 

$

18,528

 

Standard Commercial Segment

 

 

2,057

 

 

2,656

 

 

3,564

 

 

3,975

 

Personal Segment

 

 

2,441

 

 

(1)

 

 

4,014

 

 

(23)

 

Corporate

 

 

1,559

 

 

(5,053)

 

 

9,429

 

 

(15,299)

 

Consolidated

 

$

16,484

 

$

6,372

 

$

35,402

 

$

7,181

 

 

  Three Months Ended  Nine Months Ended 
  September 30,  September 30, 
  2018  2017  2018  2017 
Revenues:            
Specialty Commercial Segment $68,302  $69,721  $213,507  $205,057 
Standard Commercial Segment  19,857   17,401   57,979   52,449 
Personal Segment  9,355   9,404   24,891   31,951 
Corporate  5,432   1,197   (1,965)  (1,311)
Consolidated $102,946  $97,723  $294,412  $288,146 
                 
Pre-tax income (loss):                
Specialty Commercial Segment $2,452  $1,288  $20,980  $13,018 
Standard Commercial Segment  7,264   229   11,239   881 
Personal Segment  684   (661)  661   (2,311)
Corporate  1,675   (2,381)  (13,624)  (12,193)
Consolidated $12,075  $(1,525) $19,256  $(605)

21

The following is additional business segment information as of the dates indicated (in thousands):

 

 

 

 

 

 

 

 

 

June 30,

 

December 31,

Assets:

 

2019

 

2018

Specialty Commercial Segment

 

$

1,005,810

 

$

858,262

Standard Commercial Segment

 

 

184,101

 

 

158,881

Personal Segment

 

 

170,348

 

 

226,431

Corporate

 

 

45,509

 

 

21,320

 Consolidated

 

$

1,405,768

 

$

1,264,894

 

  September 30,  December 31, 
  2018  2017 
Assets:        
Specialty Commercial Segment $854,360  $810,133 
Standard Commercial Segment  163,478   162,152 
Personal Segment  230,397   232,441 
Corporate  22,556   26,400 
  $1,270,791  $1,231,126 

25

 

9. Reinsurance

We reinsure a portion of the risk we underwrite in order to control the exposure to losses and to protect capital resources. We cede to reinsurers a portion of these risks and pay premiums based upon the risk and exposure of the policies subject to such reinsurance. Ceded reinsurance involves credit risk and is generally subject to aggregate loss limits. Although the reinsurer is liable to us to the extent of the reinsurance ceded, we are ultimately liable as the direct insurer on all risks reinsured. Reinsurance recoverables are reported after allowances for uncollectible amounts. We monitor the financial condition of reinsurers on an ongoing basis and review our reinsurance arrangements periodically. Reinsurers are selected based on their financial condition, business practices and the price of their product offerings. In order to mitigate credit risk to reinsurance companies, most of our reinsurance recoverable balance as of SeptemberJune 30, 20182019 was with reinsurers that had an A.M. Best rating of “A–” or better.

The following table shows earned premiums ceded and reinsurance loss recoveries by period (in thousands):

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Three Months Ended

 

Six Months Ended

 

 

June 30, 

 

June 30, 

 

    

2019

    

2018

    

2019

    

2018

 

 

 

 

 

 

 

 

 

 

 

 

 

Ceded earned premiums

 

$

76,309

 

$

68,635

 

$

146,455

 

$

130,264

Reinsurance recoveries

 

$

58,975

 

$

43,989

 

$

107,564

 

$

93,427

 

  Three Months Ended  Nine Months Ended 
  September 30,  September 30, 
  2018  2017  2018  2017 
             
Ceded earned premiums $73,038  $54,769  $203,302  $151,370 
Reinsurance recoveries $48,962  $45,122  $142,389  $103,552 

 

10. Revolving Credit Facility

Our Second Restated Credit Agreement with Frost Bank (“Frost”) dated June 30, 2015, as amended to date, provides a $15.0 million revolving credit facility (“Facility A”), with a $5.0 million letter of credit sub-facility. The outstanding balance of the Facility A bears interest at a rate equal to the prime rate or LIBOR plus 2.5%, at our election. We pay an annual fee of 0.25% of the average daily unused balance of Facility A and letter of credit fees at the rate of 1.00% per annum. All principal and accrued interest on Facility A becomes due and payable on June 30, 2020. As of SeptemberJune 30, 2018,2019, we had no outstanding borrowings under Facility A.

The Second Restated Credit Agreement with Frost also provides a $30.0 million revolving credit facility (“Facility B”), in addition to Facility A. We may use Facility B loan proceeds solely for the purpose of making capital contributions to AHIC and HIC. We may borrow, repay and reborrow under Facility B until December 17, 2019, at which time all amounts outstanding under Facility B are converted to a term loan. Through December 17, 2019, we pay Frost a quarterly fee of 0.25% per annum of the average daily unused balance of Facility B. Facility B bears interest at a rate equal to the prime rate or LIBOR plus 3.00%, at our election. Until December 17, 2019, interest only on amounts from time to time outstanding under Facility B are payable quarterly. Any amounts outstanding on Facility B as of December 17, 2019 are converted to a term loan payable in quarterly installments over five years based on a seven year amortization of principal plus accrued interest. All remaining principal and accrued interest on Facility B become due and payable on December 17, 2024. As of SeptemberJune 30, 2018,2019, we had $30.0 million outstanding under Facility B.

The obligations under both Facility A and Facility B are secured by a security interest in the capital stock of AHIC and HIC. Both Facility A and Facility B contain covenants that, among other things, require us to maintain certain

22

financial and operating ratios and restrict certain distributions, transactions and organizational changes. We are in compliance with all of these covenants.

26

11. Subordinated Debt Securities

On June 21, 2005, we entered into a trust preferred securities transaction pursuant to which we issued $30.9 million aggregate principal amount of subordinated debt securities due in 2035. To effect the transaction, we formed Trust I as a Delaware statutory trust. Trust I issued $30.0 million of preferred securities to investors and $0.9 million of common securities to us. Trust I used the proceeds from these issuances to purchase the subordinated debt securities. The interest rate on our Trust I subordinated debt securities was 7.725% until June 15, 2015,  after which interest adjusts quarterly to the three-month LIBOR rate plus 3.25 percentage points. Trust I pays dividends on its preferred securities at the same rate. Under the terms of our Trust I subordinated debt securities, we pay interest only each quarter and the principal of the note at maturity. The subordinated debt securities are uncollaterized and do not require maintenance of minimum financial covenants. As of SeptemberJune 30, 2018,2019, the principal balance of our Trust I subordinated debt was $30.9 million and the interest rate was 5.58%5.66% per annum.

On August 23, 2007, we entered into a trust preferred securities transaction pursuant to which we issued $25.8 million aggregate principal amount of subordinated debt securities due in 2037. To effect the transaction, we formed Trust II as a Delaware statutory trust. Trust II issued $25.0 million of preferred securities to investors and $0.8 million of common securities to us. Trust II used the proceeds from these issuances to purchase the subordinated debt securities. The interest rate on our Trust II subordinated debt securities was 8.28% until September 15, 2017,  after which interest adjusts quarterly to the three-month LIBOR rate plus 2.90 percentage points. Trust II pays dividends on its preferred securities at the same rate. Under the terms of our Trust II subordinated debt securities, we pay interest only each quarter and the principal of the note at maturity. The subordinated debt securities are uncollaterized and do not require maintenance of minimum financial covenants. As of SeptemberJune 30, 2018,2019, the principal balance of our Trust II subordinated debt was $25.8 million and the interest rate was 5.23%5.31% per annum.

12. Deferred Policy Acquisition Costs

The following table shows total deferred and amortized policy acquisition cost activity by period (in thousands):

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Three Months Ended

 

Six Months Ended

 

 

June 30, 

 

June 30, 

 

 

2019

 

2018

 

2019

 

2018

 

 

 

 

 

 

 

 

 

 

 

 

 

Deferred

 

$

(35,871)

 

$

6,306

 

$

(47,547)

 

$

16,671

Amortized

 

 

34,788

 

 

(8,242)

 

 

41,530

 

 

(18,615)

Net

 

$

(1,083)

 

$

(1,936)

 

$

(6,017)

 

$

(1,944)

 

   Three Months Ended  Nine Months Ended 
   September 30,  September 30, 
   2018  2017  2018  2017 
              
 Deferred  $11,001  $9,759  $27,672  $31,472 
 Amortized   (11,909)  (9,849)  (30,524)  (31,420)
                   
 Net  $(908) $(90) $(2,852) $52 

27

 

13. Earnings per Share

The following table sets forth basic and diluted weighted average shares outstanding for the periods indicated (in thousands):

 

 

 

 

 

 

 

 

 Three Months Ended Nine Months Ended 

 

Three Months Ended

 

Six Months Ended

 September 30,  September 30, 

 

June 30, 

 

June 30, 

 2018  2017  2018  2017 

    

2019

  

2018

    

2019

  

2018

         

 

 

 

 

 

 

 

 

Weighted average shares - basic  18,059   18,180   18,097   18,404 

 

18,123

 

18,067

 

18,090

 

18,116

Effect of dilutive securities  108   -   106   - 

 

128

 

107

 

160

 

114

Weighted average shares - assuming dilution  18,167   18,180   18,203   18,404 

 

18,251

 

18,174

 

18,250

 

18,230

 

For each of the three and ninesix months ended SeptemberJune 30, 2019, no shares of common stock potentially issuable upon the exercise of employee stock options were excluded from the weighted average number of shares outstanding on a diluted

23

basis.  For each of the three and six months ended June 30, 2018, no62,500 shares and 43,004 shares, respectively, of common stock potentially issuable upon the exercise of employee stock options were excluded from the weighted average number of shares outstanding on a diluted basis because the effect of such options would be anti-dilutive. For each of the three and nine months ended September 30, 2017, 417,830 shares of common stock potentially issuable upon the exercise of employee stock options were excluded from the weighted average number of shares outstanding on a diluted basis because the effect of such options would be anti-dilutive.

 

14. Net Periodic Pension Cost

The following table details the net periodic pension cost incurred by period (in thousands):

 

 

 

 

 

 

 

 

 

 

 

 

 Three Months Ended Nine Months Ended 

 

Three Months Ended

 

Six Months Ended

 September 30,  September 30, 

 

June 30, 

 

 

June 30, 

 2018  2017  2018  2017 

    

2019

    

2018

    

2019

    

2018

Interest cost $106  $111  $318  $333 

 

$

114

 

$

106

 

$

227

 

$

212

Amortization of net loss  26   37   79   107 

 

 

36

 

 

26

 

 

72

 

 

53

Expected return on plan assets  (173)  (164)  (520)  (487)

 

 

(150)

 

 

(174)

 

 

(299)

 

 

(347)

Net periodic pension cost $(41) $(16) $(123) $(47)

 

$

 —

 

$

(42)

 

$

 —

 

$

(82)

Contributed amount $-  $-  $-  $- 

 

$

 —

 

$

 —

 

$

 —

 

$

 —

 

Refer to Note 14 to the consolidated financial statements in our Annual Report on Form 10-K10‑K for the year ended December 31, 20172018 for more discussion of our retirement plans.

15.  Income Taxes

Our effective income tax rate for the ninesix months ended SeptemberJune 30, 2019 and 2018 was 20.8% and 2017 was 19.9% and (52.7) %,20.1%, respectively. The effective tax raterates for 2019 and 2018 waswere both favorably impacted by the lower statutory rate from the enactment of the Tax Cuts and Jobs Act onin December 22, 2017. The rate for 2017 varied from the statutory tax rate primarily due to a correction of an immaterial error in prior years’ deferred tax on bond premium amortization, partially offset by the amount of tax exempt income in relation to total pre-tax income.

28

16.  Supplemental Cash Flow Information

The following table provides a reconciliation of cash, cash equivalents and restricted cash reported in the consolidated balance sheet to the total of the same such amounts shown in the statement of cash flows:flows (in thousands):

 

 

 

 

 

 

 As of September 30, 

 

As of June 30,

 2018  2017 

    

2019

    

2018

     

 

 

 

 

 

 

Cash and cash equivalents $59,925  $89,770 

 

$

67,670

 

$

79,583

Restricted cash  3,519   3,343 

 

 

3,486

 

 

3,078

Total cash, cash equivalents and restricted cash shown in the statement of cash flows $63,444  $93,113 

 

$

71,156

 

$

82,661

 

Restricted cash represents amounts required to be set aside by a contractual agreement with a third-party insurer and amounts pledged for the benefit of various state insurance departments.

24

The following table provides supplemental cash flow information for the ninesix months ended SeptemberJune 30, 20182019 and 2017:2018:

 

 

 

 

 

 

 

 

 

Six Months Ended June 30, 

 

    

2019

    

2018

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Interest paid

 

$

2,527

 

$

2,145

 

 

 

 

 

 

 

Income taxes paid (recovered)

 

$

2,848

 

$

(5,287)

 

 

 

 

 

 

 

Supplemental schedule of non-cash investing activities:

 

 

 

 

 

 

 

 

 

 

 

 

 

Receivable for securities related to investment disposals

 

$

2,581

 

$

3,780

 

 

 

 

 

 

 

Payable for securities related to investment purchases

 

$

3,167

 

$

6,706

 

  Nine Months Ended September 30, 
  2018  2017 
       
Interest paid $3,325  $3,505 
         
Income taxes (recovered) paid $(4,287) $304 
         
Supplemental schedule of non-cash investing activities:        
         
Change in receivable for securities related to investment disposals that settled  after the balance sheet date $1,982  $1,338 
         
Change in payable for securities related to investment purchases that settled after the balance sheet date $211  $(6,580)

 

17. Commitments and Contingencies

We are engaged in various legal proceedings in the ordinary course of business, none of which, either individually or in the aggregate, are believed likely to have a material adverse effect on our consolidated financial position or results of operations, in the opinion of management. The various legal proceedings to which we are a party are routine in nature and incidental to our business.

29

25

18. Changes in Accumulated Other Comprehensive Income Balances

The changes in accumulated other comprehensive income balances as of SeptemberJune 30, 20182019 and 20172018 were as follows (in thousands):

 

 

 

 

 

 

 

 

 

 

 

    

 

    

 

 

    

Accumulated Other

 

 

Pension

 

Unrealized

 

Comprehensive

 

    

Liability

    

Gains (Loss)

    

Income (Loss)

Balance at December 31, 2017

 

$

(2,310)

 

$

14,544

 

$

12,234

Other comprehensive income:

 

 

  

 

 

  

 

 

  

Change in net actuarial gain

 

 

53

 

 

 —

 

 

53

Tax effect on change in net actuarial gain

 

 

(11)

 

 

 —

 

 

(11)

Unrealized holding gains arising during the period

 

 

 —

 

 

1,926

 

 

1,926

Tax effect on unrealized gains arising during the period

 

 

 —

 

 

(404)

 

 

(404)

Reclassification adjustment for realized gains included in investment gains and losses

 

 

 —

 

 

(366)

 

 

(366)

Tax effect on reclassification adjustment for gains included in income tax expense

 

 

 —

 

 

77

 

 

77

Other comprehensive income, net of tax

 

 

42

 

 

1,233

 

 

1,275

Reclassification of certain tax effects from accumulated other comprehensive income at January 1, 2018

 

 

(569)

 

 

3,188

 

 

2,619

Cumulative effect of adoption of updated accounting guidance for equity financial instruments at January 1, 2018

 

 

 —

 

 

(16,993)

 

 

(16,993)

 

 

 

 

 

 

 

 

 

 

Balance at June 30, 2018

 

$

(2,837)

 

$

1,972

 

$

(865)

 

 

 

 

 

 

 

 

 

 

Balance at December 31, 2018

 

$

(3,334)

 

$

(3,326)

 

$

(6,660)

Other comprehensive income:

 

 

  

 

 

  

 

 

  

Change in net actuarial gain

 

 

72

 

 

 —

 

 

72

Tax effect on change in net actuarial gain

 

 

(15)

 

 

 —

 

 

(15)

Unrealized holding gains arising during the period

 

 

 —

 

 

11,233

 

 

11,233

Tax effect on unrealized gains arising during the period

 

 

 —

 

 

(2,359)

 

 

(2,359)

Reclassification adjustment for gains included in net realized gains

 

 

 —

 

 

(4,201)

 

 

(4,201)

Tax effect on reclassification adjustment for gains included in income tax expense

 

 

 —

 

 

883

 

 

883

Other comprehensive income, net of tax

 

 

57

 

 

5,556

 

 

5,613

Balance at June 30, 2019

 

$

(3,277)

 

$

2,230

 

$

(1,047)

 

  Minimum     Accumulated Other 
  Pension  Unrealized  Comprehensive 
  Liability  Gains (Losses)  Income 
          
Balance at December 31, 2016 $(2,666) $13,037  $10,371 
Other comprehensive income:            
Change in net actuarial gain  107   -   107 
Tax effect on change in net actuarial gain  (37)  -   (37)
Net unrealized holding gains arising during the period  -   8,208   8,208 
Tax effect on unrealized gains arising during the period  -   (2,873)  (2,873)
Reclassification adjustment for gains included in investment gains  -   (5,679)  (5,679)
Tax effect on reclassification adjustment for gains included in income tax expense  -   1,988   1,988 
Other comprehensive income, net of tax  70   1,644   1,714 
Balance at September 30, 2017 $(2,596) $14,681  $12,085 
             
Balance at December 31, 2017 $(2,310) $14,544  $12,234 
Other comprehensive income:            
Change in net actuarial gain  80   -   80 
Tax effect on change in net actuarial gain  (17)  -   (17)
Net unrealized holding gains arising during the period  -   1,909   1,909 
Tax effect on unrealized gains arising during the period  -   (401)  (401)
Reclassification adjustment for realized gains included in investment gains  -   159   159 
Tax effect on reclassification adjustment for realized gains included in income tax expense  -   (33)  (33)
Other comprehensive income, net of tax  63   1,634   1,697 
Reclassification of certain tax effects from accumulated other comprehensive income at January 1, 2018  (569)  3,188   2,619 
Cumulative effect of adoption of updated accounting guidance for equity financial instruments at January 1, 2018  -   (16,993)  (16,993)
Balance at September 30, 2018 $(2,816) $2,373  $(443)

19. Leases

We adopted ASU 2016-02, “Leases, (Topic 842)” on January 1, 2019, which resulted in the recognition of operating leases on the balance sheet in 2019 and going forward. See Note 2 for more information on the adoption of ASU 2016-02. Right-of-use assets are included in the other assets line item and lease liabilities are included in the other liabilities line item of the consolidated balance sheet. We also elected certain practical expedients that allow us not to reassess existing leases under the new guidance. We determine if a contract contains a lease at inception and recognize operating lease right-of-use assets and operating lease liabilities based on the present value of the future minimum lease payments at the commencement date. Since our leases do not provide an implicit rate, we use our incremental borrowing rate based on the information available at the commencement date in determining the present value of future payments. Lease agreements have lease and non-lease components, which are accounted for as a single lease component. Lease expense is recognized on a straight-line basis over the lease term.

26

The Company’s operating lease obligations pertain to office leases utilized in the operation of our business. Our leases have remaining terms of 1 to 13 years, some of which include options to extend the leases. The components of lease expense and other lease information as of and during the three and six-month periods ended June 30, 2019 are as follows (in thousands):

 

30

 

 

 

 

 

 

 

 

 

Three Months Ended

 

Six Months Ended

 

June 30, 

 

June 30, 

 

2019

 

 

2019

    

 

 

 

 

 

 

 

 

Operating lease cost

$

816

 

 

$

1,356

 

 

 

 

 

 

 

 

 

Cash paid for amounts included in the measurement of lease liabilities

 

 

 

 

 

 

 

   Operating cash flows from operating leases

$

552

 

 

$

1,103

 

 

 

 

 

 

 

 

 

Right-of-use assets obtained in exchange for new operating lease liabilities

$

 —

 

 

$

 —

 

We incurred $16 thousand in short-term lease payments not included in our lease liability during the six months ended June 30, 2019. 

The components of lease expense and other lease information as of and during the six-month period ended June 30, 2019 are as follows (in thousands):

 

 

 

 

 

 

June 30, 

 

    

2019

 

 

 

 

Operating lease right-of-use assets

 

$

17,109

 

 

 

 

Operating lease liabilities

 

$

17,619

 

 

 

 

Weighted-average remaining lease term - operating leases

 

 

10.7

 

 

 

 

Weighted-average discount rate - operating leases

 

 

5.88%

Future minimum lease payments under non-cancellable leases as of June 30, 2019 and December 31, 2018 are as follows (in thousands):

 

 

��

 

 

 

 

 

 

June 30, 

 

 

December 31,

 

    

2019

 

 

2018

 

 

 

 

 

 

 

2019

 

$

786

 

$

1,889

2020

 

 

2,473

 

 

2,473

2021

 

 

2,172

 

 

2,172

2022

 

 

2,171

 

 

2,171

2023

 

 

1,885

 

 

1,885

Thereafter

 

 

15,266

 

 

15,266

Total future minimum lease payments

 

$

24,753

 

$

25,856

 

 

 

 

 

 

 

Less imputed interest

 

$

(7,134)

 

$

N/A

Total operating lease liability

 

$

17,619

 

$

N/A

27

 

Item 2.  Management'sManagement’s Discussion and Analysis of Financial Condition and Results of Operations.

The following discussion should be read together with our consolidated financial statements and the notes thereto.  This discussion contains forward-looking statements.  Please see “Risks Associated with Forward-Looking Statements in this Form 10-Q”10‑Q” for a discussion of some of the uncertainties, risks and assumptions associated with these statements.

Introduction

Hallmark Financial Services, Inc. (“Hallmark” and, together with subsidiaries, “we,” “us” or “our”) is an insurance holding company that, through its subsidiaries, engages in the sale of property/casualty insurance products to businesses and individuals. Our business involves marketing, distributing, underwriting and servicing our insurance products, as well as providing other insurance related services.  Our business is geographically concentrated in the south central and northwest regions of the United States, except for our Specialty Commercial business which is written on a national basis.  We pursue our business activities through subsidiaries whose operations are organized into product-specific operatingbusiness units, which are supported by our insurance company subsidiaries.

Our non-carrier insurance activities are segregated by operatingbusiness units into the following reportable segments:

·

Specialty Commercial Segment.Our Specialty Commercial Segment includes theour Commercial Auto business unit which offers primary and excess commercial vehicle insurance products and surplusservices; our E&S Casualty business unit which offers primary and excess liability, excess public entity liability and E&S package insurance products and services; our E&S Property business unit which offers primary and excess commercial property insurance for both catastrophe and non-catastrophe exposures; our Professional Liability business unit which offers healthcare and financial lines commercialprofessional liability insurance products and services primarily for businesses, medical professionals, medical facilities and senior care facilities; and our Aerospace & Programs business unit which offers general aviation and satellite launch property/casualty insurance products and services, handled by our Contract Binding operating unit and the general aviation, satellite launch, commercial umbrella and primary/excess liability, medical and financial professional liability and primary/excess commercial property insurance products and services handled by our Specialty Commercial operating unit, as well as certain specialty risk programs. These products were previously reported as the Contract Binding and Specialty Commercial operating units.  This realignment did not impact our reportable segments.

   

·

Standard Commercial Segment.Our Standard Commercial Segment includes the standard lines commercialpackage and monoline property/casualty and occupational accident insurance products and services handled by our Commercial Accounts business unit (f/k/a Standard Commercial P&C operating unitunit) and the runoff of workers compensation insurance products handled by our former Workers Compensation operating unit.  Effective June 1, 2016, we ceased marketing new or renewal occupational accident policies. Effective July 1, 2015, the former Workers Compensation operating unit ceased retaining any risk on new or renewal policies.

·

Personal Segment.Our Personal Segment includes the non-standard personal automobile and renters insurance products and services handled by our Specialty Personal Lines operatingbusiness unit.

The retained premium produced by these reportable segments is supported by our American Hallmark Insurance Company of Texas (“AHIC”), Hallmark Specialty Insurance Company (“HSIC”), Hallmark Insurance Company (“HIC”), Hallmark National Insurance Company (“HNIC”) and Texas Builders Insurance Company (“TBIC”) insurance subsidiaries. In addition, control and management of Hallmark County Mutual (“HCM”) is maintained through our wholly owned subsidiary, CYR Insurance Management Company (“CYR”). CYR has as its primary asset a management

28

agreement with HCM which provides for CYR to have management and control of HCM. HCM is used to front certain lines of business in our Specialty Commercial and Personal Segments in Texas. HCM does not retain any business.

31

AHIC, HIC, HSIC and HNIC have entered into a pooling arrangement pursuant to which AHIC retains 34% of the total net premiums written by any of them, HIC retains 32% of our total net premiums written by any of them, HSIC retains 24% of our total net premiums written by any of them and HNIC retains 10% of our total net premiums written by any of them.  Neither HCM nor TBIC is a party to the intercompany pooling arrangement.

Results of Operations

Management overview.During the three and ninesix months ended SeptemberJune 30, 2018,2019, our total revenues were $102.9$120.9 million and $294.4$239.0 million,  representing an increase of 5%23% and 2%25%, respectively, from the $97.7$98.1 million and $288.1$191.5 million in total revenues for the same periods of 2017.2018. During the three and ninesix months ended SeptemberJune 30, 2018,2019, our income before tax was $12.1$16.5 million and $19.3$35.4 million, respectively, representing an increase of $13.6$10.1 million and $19.9$28.2 million,  respectively, from the lossincome before tax of $1.5$6.4 million and $0.6$7.2 million reported during the same periods the prior year.

The increase in revenue for the three and ninesix months ended SeptemberJune 30, 20182019 compared to the same periods of the prior year was largely due to increased net premiums earned of $15.5 million and $22.6 million, respectively.  In addition, investment gains were $6.8 million and $18.8 million for the three and six months ended June 30, 2019 compared to investment gains of $7.0 million and $2.7 million, respectively, as compared to $2.1 million and $0.7$0.5 million during the same periodsthree months ended June 30, 2018 and investment losses of 2017, as well as higher$4.3 million during the six months ended June 30, 2018.   Higher finance charges and net earned premiums, higher commissions and fees and higher finance charges,investment income also contributed to the increase in revenue, partially offset by lower net investmentcommission and fees and other income and lower other income. The investment gains for the nine months ended September 30, 2018 included $3.2 million in loss attributable to the adoption effective January 1, 2018 of Accounting Standards Update No. 2016-01, “Recognition and Measurement of Financial Assets and Financial Liabilities” (“ASU 2016-01”) which requires equity investments that are not consolidated or accounted for under the equity method of accounting to be measured at fair value with changes in fair value recognized in net income. We adopted ASU 2016-01 using the modified-retrospective approach pursuant to which we recorded a cumulative effect adjustment to retained earnings of $17.0 million as of January 1, 2018 and decreased accumulated other comprehensive income by the same amount and did not restate prior periods. The decrease in net investment income forduring the three and ninesix months ended SeptemberJune 30, 2018 was primarily2019 as compared to the result of the final distribution on a fixed income securitysame periods during the third quarter of the prior year.

2018.

The increase in income before tax for the three and ninesix months ended SeptemberJune 30, 20182019 was due primarily to the increase in revenue, discussed above as well as decreasedpartially offset by increased losses and loss adjustment expenses (“LAE”) of $8.1$9.6 million and $13.4$16.0 million, respectively,  as compared to the same periods in 2017.2018. The decreaseincrease in losses and LAE was due primarily the resultto increased net premiums earned.  We reported $1.5 million and $1.4 million of improvement in unfavorable net prior year loss reserve development to $1.6 million and $6.1 million forduring the three and ninesix months ended SeptemberJune 30, 20182019 as compared to $10.6$5.0 million and $20.2$4.5 million during the same periods of 2017.2018.

We reported net income of $9.7$13.0 million for the three months ended SeptemberJune 30, 20182019 as compared to a net loss of $1.6$5.1 million for the same period of 2017. Wein 2018.  We reported net income of $15.4$28.1 million during the ninesix months ended SeptemberJune 30, 20182019 as compared to a net lossincome of $0.9$5.7 million for the same period during 2017. 2018. On a diluted basis per share, we reported net income of $0.53$0.71 per share for the three months ended SeptemberJune 30, 2018,2019, as compared to a net loss of $0.09$0.28 per share for the same period in 2017.2018. On a diluted basis per share, we reported net income of $0.85$1.54 per share for the ninesix months ended SeptemberJune 30, 2018,2019, as compared to a net loss of $0.05$0.31 per share for the same period in 2017.2018. Our effective tax rate was 19.9%20.8% for the first ninesix months of 20182019 as compared to -52.7%20.1% for the same period in 2017. The effective tax rate for 2018 was favorably impacted by the lower statutory rate from the enactment of the Tax Cuts and Jobs Act on December 22, 2017. The rate for 2017 varied from the statutory tax rate primarily due to a correction of an immaterial error in prior years’ deferred tax on bond premium amortization, partially offset by the amount of tax exempt income in relation to total pre-tax income.2018.

 

32

 

Third

29

Second Quarter 20182019 as Compared to ThirdSecond Quarter 2017

2018

The following is additional business segment information for the three months ended SeptemberJune 30, 20182019 and 20172018 (in thousands):

  Three Months Ended September 30 
  Specialty  Standard          
  Commercial
Segment
  Commercial
Segment
  Personal Segment  Corporate  Consolidated 
  2018  2017  2018  2017  2018  2017  2018  2017  2018  2017 
Gross premiums written $125,599  $127,062  $21,560  $19,240  $21,953  $14,849  $-  $-  $169,112  $161,151 
Ceded premiums written  (66,404)  (56,200)  (2,398)  (2,889)  (12,298)  (7,013)  -   -   (81,100)  (66,102)
Net premiums written  59,195   70,862   19,162   16,351   9,655   7,836   -   -   88,012   95,049 
Change in unearned premiums  3,203   (6,274)  (449)  (420)  (1,904)  433   -   -   850   (6,261)
Net premiums earned  62,398   64,588   18,713   15,931   7,751   8,269   -   -   88,862   88,788 
                            ��            
Total revenues  68,302   69,721   19,857   17,401   9,355   9,404   5,432   1,197   102,946   97,723 
                                         
Losses and loss adjustment expenses  52,106   53,899   6,261   11,760   5,878   6,720   -   -   64,245   72,379 
                                         
Pre-tax income (loss)  2,452   1,288   7,264   229   684   (661)  1,675   (2,381)  12,075   (1,525)
                                         
Net loss ratio (1)  83.5%  83.5%  33.5%  73.8%  75.8%  81.3%          72.3%  81.5%
Net expense ratio (1)  22.4%  21.9%  34.1%  34.2%  20.2%  31.2%          25.8%  27.1%
Net combined ratio (1)  105.9%  105.4%  67.6%  108.0%  96.0%  112.5%          98.1%  108.6%
                                         
Favorable (Unfavorable) Prior Year Development  (8,869)  (9,492)  7,269   (1,330)  (9)  266           (1,609)  (10,556)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Three Months Ended June 30, 

 

 

 

Specialty Commercial

 

Standard Commercial

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Segment

 

Segment

 

Personal Segment

 

Corporate

 

Consolidated

 

 

    

2019

    

2018

    

2019

    

2018

    

2019

    

2018

    

2019

    

2018

    

2019

    

2018

 

Gross premiums written

 

$

172,940

 

$

136,079

 

$

21,835

 

$

21,574

 

$

23,461

 

$

15,566

 

$

 —

 

$

 —

 

$

218,236

 

$

173,219

 

Ceded premiums written

 

 

(83,370)

 

 

(72,083)

 

 

(7,170)

 

 

(2,645)

 

 

(3,853)

 

 

(8,645)

 

 

 —

 

 

 —

 

 

(94,393)

 

 

(83,373)

 

Net premiums written

 

 

89,570

 

 

63,996

 

 

14,665

 

 

18,929

 

 

19,608

 

 

6,921

 

 

 —

 

 

 —

 

 

123,843

 

 

89,846

 

Change in unearned premiums

 

 

(20,216)

 

 

2,333

 

 

1,611

 

 

(824)

 

 

1,261

 

 

(377)

 

 

 —

 

 

 —

 

 

(17,344)

 

 

1,132

 

Net premiums earned

 

 

69,354

 

 

66,329

 

 

16,276

 

 

18,105

 

 

20,869

 

 

6,544

 

 

 —

 

 

 —

 

 

106,499

 

 

90,978

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Total revenues

 

 

73,592

 

 

72,081

 

 

17,310

 

 

19,247

 

 

23,116

 

 

7,916

 

 

6,885

 

 

(1,119)

 

 

120,903

 

 

98,125

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Losses and loss adjustment expenses

 

 

48,374

 

 

48,352

 

 

10,613

 

 

10,621

 

 

14,239

 

 

4,675

 

 

 —

 

 

 —

 

 

73,226

 

 

63,648

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

  

 

 

 

 

 

 

 

Pre-tax income (loss)

 

 

10,427

 

 

8,770

 

 

2,057

 

 

2,656

 

 

2,441

 

 

(1)

 

 

1,559

 

 

(5,053)

 

 

16,484

 

 

6,372

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Net loss ratio (1)

 

 

69.7

%  

 

72.9

%  

 

65.2

%  

 

58.7

%  

 

68.2

%  

 

71.4

%  

 

  

 

 

  

 

 

68.8

%  

 

70.0

%

Net expense ratio (1)

 

 

22.1

%  

 

22.3

%  

 

29.0

%  

 

33.2

%  

 

23.3

%  

 

33.7

%  

 

  

 

 

  

 

 

25.7

%  

 

27.0

%

Net combined ratio (1)

 

 

91.8

%  

 

95.2

%  

 

94.2

%  

 

91.9

%  

 

91.5

%  

 

105.1

%  

 

 

 

 

  

 

 

94.5

%  

 

97.0

%

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Net Favorable (Unfavorable) Prior Year Development

 

 

(3,277)

 

 

(5,849)

 

 

1,778

 

 

507

 

 

29

 

 

359

 

 

  

 

 

  

 

 

(1,470)

 

 

(4,983)

 


(1)

The net loss ratio is calculated as incurred losses and LAE divided by net premiums earned, each determined in accordance with GAAP. The net expense ratio is calculated as total underwriting expenses offset by agency fee income divided by net premiums earned, each determined in accordance with GAAP. Net combined ratio is calculated as the sum of the net loss ratio and the net expense ratio.

33

Specialty Commercial Segment

Gross premiums written for the Specialty Commercial Segment were $125.6$172.9  million for the three months ended SeptemberJune 30, 2018,2019, which was $1.5$36.8 million, or 1%27%, lessmore than the $127.1$136.1 million reported for the same period of 2017.2018.  Net premiums written were $89.6 million for the three months ended June 30, 2019 as compared to $64.0 million for the same period of 2018. The decreaseincrease in gross and net premiums written was primarily the result of decreasedincreased premium production reflected in  our Professional Liability, E&S Property and E&S Casualty business units,  partially offset by a decline in gross premium production in our Contract Binding operating unit, partially offset by higher premium production in our Specialty Commercial operatingAuto business unit. Net premiums written were $59.2 million for the three months ended September 30, 2018 as compared to $70.9 million for the same period of 2017. The decrease in net premiums written was due to a change in mix towards business with higher ceded premium as a percentage of the gross premium.

The $68.3$73.6 million of total revenue for the three months ended SeptemberJune 30, 20182019 was $1.4$1.5 million lessmore than the $69.7$72.1 million reported by the Specialty Commercial Segment for the same period in 2017.2018. This decreaseincrease in revenue was primarily due to lowerhigher net premiums earned of $2.2$3.0 million due to lower premium production in our Contract Binding operating unit partially offset by increased premium production in our SpecialtyProfessional Liability, E&S Property and E&S Casualty business units, partially offset by lower premium production during 2018 in our Commercial operatingAuto business unit,   as well as higherlower net investment income of $0.3$0.9 million and higherlower commission and fees of $0.5$0.6 million for the three months ended SeptemberJune 30, 20182019 as compared to the same period of 2017.

2018.

Pre-tax income for the Specialty Commercial Segment of $2.5$10.4 million for the thirdsecond quarter of 20182019 was $1.2$1.6 million higher than the $1.3$8.8 million reported for the same period in 2017.2018. The increase in pre-tax income was primarily the result of lower losses and LAE of $1.8 millionthe increased revenue discussed above and lower operating expenses of $0.8$0.1 million partially offset by the decreased revenue discussed above during the three months ended SeptemberJune 30, 20182019 as compared to the same period during  2017.

2018.

Our Contract Binding operating unitSpecialty Commercial Segment reported an $8.2stable losses and LAE as the combined result of (a) a $8.0 million decrease in losses and LAE in our Commercial Auto business unit due largely to decreasedlower net earned premiums, as well as $7.8$2.8 million of unfavorable prior year net loss reserve development recognized during the three months ended SeptemberJune 30, 20182019 as compared to $8.9$5.9 million of unfavorable prior year net loss reserve development during the same period of 2017. Our Specialty Commercial operating unit reported a $6.4 million increase in losses and LAE which consisted of (a) a $1.8 million increase in losses and LAE attributable to our professional liability insurance products due primarily to increased net premiums earned and favorable prior year loss development in the same period of 2017, partially offset by lower current accident year loss trends,2018, (b) a $0.6$4.1 million increase in losses and LAE in our satellite launch insurance line ofE&S Casualty  business unit due primarily to higher current accident$2.6 million of

30

unfavorable prior year net loss trends,reserve development during the second quarter of 2019 as compared to $1.1 million of favorable prior year net loss reserve development during the second quarter of 2018,  (c) a $1.3$0.5 million increase in losses and LAE in our commercial umbrella and primary/excess liability line ofE&S Property business unit due primarily to increased net premiums earned  as well as unfavorablehigher current accident year loss trends, partially offset by $2.1 million of net favorable prior year loss reserve development (d) a $0.1during the second quarter of 2019 as compared to $0.3 million decrease in our general aviation line of business due primarily to lower unfavorable prior year net loss reserve development during the thirdsecond quarter of 2018, as compared to the third quarter of 2017, partially offset by higher current accident year loss trends, (e)(d) a $1.8$2.3 million increase in losses and LAE attributable to our primary/excess property insurance productsProfessional Liability business unit due primarily to increased net premiums earned, as well as net unfavorable priorpartially offset by lower current accident year loss reserve development during the third quarter of 2018,trends, and (f)(e)  a $1.0$1.1 million increase in losses and LAE in our specialty programsAerospace & Programs business unit due primarily to increasedhigher current accident year loss trends and higher net premiums earned.

Operating expenses decreased $0.8$0.1 million primarily as the result of lower production related expenses of $2.4$0.6 million due primarily to increased ceding commissions in our Specialty Commercial operating unit,and decreased professional services of $0.3 million, partially offset by increased salary and related expenses of $1.1 million, increased professional services of $0.3$0.4 million and increased occupancy and other operating expenses of $0.2$0.4 million.

34

The Specialty Commercial Segment reported a net loss ratio of 83.5%69.7% for both the three months ended SeptemberJune 30, 2018 and 2017.2019 as compared to 72.9% for the same period in 2018. The gross loss ratio before reinsurance was 73.8%71.8%  for the three months ended SeptemberJune 30, 20182019 as compared to 83.0%68.5% for the same period in 2017. 2018. The decrease in the net loss ratio was favorably impacted by the run-off of prior quota share reinsurance agreements as higher ceded losses are measured against lower ceded earned premium due to increased premium retention under our current quota share reinsurance agreement entered into during the fourth quarter of 2018 on certain casualty lines of business produced by the Specialty Commercial Segment.   The lowerhigher gross loss ratio was largely the result of $8.9higher gross current accident year loss trends predominately in our E&S Property and E&S Casualty business units. The Specialty Commercial Segment reported $3.3 million of unfavorable prior year net loss reserve development for the three months ended SeptemberJune 30, 20182019 as compared to unfavorable prior year net loss reserve development of $9.5$5.8 million for the same period of 2017, as well as lower gross catastrophe losses during2018. During the third quarter of 2018 as compared tothree months ended June 30, 2019 the same period during 2017. The Specialty Commercial Segment reported $1.1$1.0 million of net catastrophe losses during the third quarter of 2018 as compared to $2.2$0.6 million of net catastrophe losses during the same period of 2017. 2018. The Specialty Commercial Segment reported a net expense ratio of 22.4%22.1% for the thirdsecond quarter of 20182019 as compared to 21.9%22.3% for the same period of 2017.2018. The increasedecrease in the expense ratio was due predominately to the impact of lower net premiums earned in our Contract Binding operating unit, partially offset by increased ceding commissions in our Specialty Commercial operating unit.commissions.

Standard Commercial Segment

Gross premiums written for the Standard Commercial Segment were $21.6$21.8 million for the three months ended SeptemberJune 30, 2018,2019, which was $2.4$0.2 million, or 12%1%, more than the $21.6 million reported for the same period in 2018. The increase in gross premiums written was due to higher premium production in our Commercial Accounts business unit.   Net premiums written were $14.7 million for the three months ended June 30, 2019 as compared to $18.9 million for the same period in 2018. The decrease in net premiums written was due to increased ceded premium under a quota share reinsurance agreement entered into during the fourth quarter of 2018 on the casualty lines of business produced by the Commercial Accounts business unit.

Total revenue for the Standard Commercial Segment of $17.3 million for the three months ended June 30, 2019, was $1.9 million, or 10%, less than the $19.2 million reported for the same period in 2017. Net2018. This decrease in total revenue was due to lower net premiums written were $19.2earned of $1.8 million due primarily to the quota share reinsurance agreement entered into during the fourth quarter of 2018 and lower commission and fees of $0.1 million for the three months ended SeptemberJune 30, 2018 as compared to $16.4 million for the same period in 2017. The increase in gross and net premiums written was due to higher premium production in our Standard Commercial P&C operating unit.

Total revenue for the Standard Commercial Segment of $19.9 million for the three months ended September 30, 2018, was $2.5 million, or 14%, more than the $17.4 million reported for the same period in 2017. This increase in total revenue was due to higher net premiums earned of $2.8 million due primarily to growth in our Standard Commercial P&C operating unit, partially offset by lower net investment income of $0.1 million and lower commission and fees of $0.2 million during the third quarter of 20182019 as compared to the same period during 2017.

of 2018.

Our Standard Commercial Segment reported pre-tax income of $7.3$2.1 million for the three months ended SeptemberJune 30, 20182019 as compared to $0.2$2.7 million reported for the same period of 2017. The increase2018. This decrease in pre-tax income was the result of the increaseddecreased revenue discussed above, partially offset by lower operating expenses of $1.3 million as the result of lower production related expenses of $1.3 million due to increased ceding commission from the reinsurance contract entered into during the fourth quarter of 2018 and lower lossessalary and LAErelated expenses of $5.5$0.1 million, partially offset by higher operating expensesprofessional services of $0.9 million largely the result$0.1 million.

31

The Standard Commercial Segment reported a net loss ratio of 33.5%65.2% for the three months ended SeptemberJune 30, 20182019 as compared to 73.8%58.7% for the same period of 2017.2018. The gross loss ratio before reinsurance for the three months ended SeptemberJune 30, 20182019 was 51.9%72.6% as compared to the 78.5%60.0% reported for the same period of 2017. The decreases2018. The increase in the gross and net loss ratios  were due primarily due to higher current net accident year loss trends, partially offset by higher favorable prior year reserve development.  The net loss ratio was also partially offset by higher ceded losses during the three months ended June 30, 2019 as compared to the same period during 2018. During the three months ended June 30, 2019, the Standard Commercial Segment reported favorable net loss reserve development of $7.3$1.8 million for the three months ended September 30, 2018 as compared to favorable net unfavorable prior year loss reserve development of $1.3$0.5 million forduring the three months ended September 30, 2017.same period of 2018. The Standard Commercial Segment also reported $0.9$0.7 million of net catastrophe losses during the thirdsecond quarter of 20182019 as compared to $2.1$1.3 million of net catastrophe losses during the same period of 2017. These improvements were partially offset by higher non-catastrophe current accident year loss trends. 2018. The Standard Commercial Segment reported a net expense ratio of 34.1%29.0% for the thirdsecond quarter of 20182019 as compared to 34.2%33.2% for the same period of 2017.2018. The decrease in the expense ratio was primarily due to the impact of increased net earned premium.ceding commissions in our Commercial Accounts business unit.

Personal Segment

Gross premiums written for the Personal Segment were $22.0$23.5 million for the three months ended SeptemberJune 30, 20182019 as compared to $14.8$15.6 million for the same period in the prior year. Net premiums written for our Personal Segment were $9.7$19.6 million in the thirdsecond quarter of 2018,2019, which was an increase of $1.9$12.7 million or 23%, from the $7.8$6.9 million reported for the thirdsecond quarter of 2017.2018. The increase in gross and net written premiums was primarily due to higher premium production in our current geographical footprint.

35

 The increase in net written premiums was due to increased production as well as increased retention of business effective October 1, 2018.

Total revenue for the Personal Segment was $9.4$23.1 million for both the thirdsecond quarter of 2018 and 2017. Net2019 as compared to $7.9 million for the same period in 2018. The increase in revenue was due to an increase in net premiums earned decreased $0.5of  $14.3 million,  offset by higherincreased finance charges of $0.5$0.7 million reportedand increased investment income of $0.2 million during the thirdsecond quarter of 20182019 as compared to the same period during 2017.

2018.

Pre-tax income for the Personal Segment was $0.7$2.4 million for the three months ended SeptemberJune 30, 20182019 as compared to pre-tax loss of $0.7 million$1 thousand for the same period of 2017.2018. The pre-tax income was primarily the result of decreasedthe increased revenue discussed above, partially offset by increased losses and LAE of $0.8$9.6 million and decreasedincreased operating expenses of $0.6$3.2 million for the three months ended SeptemberJune 30, 20182019 as compared to the same period during 2017.

2018.

The Personal Segment reported a net loss ratio of 75.8%68.2% for the three months ended SeptemberJune 30, 20182019 as compared to 81.3%71.4% for the same period of 2017.2018. The gross loss ratio before reinsurance was 66.2%75.9% for the three months ended SeptemberJune 30, 20182019 as compared to 79.7%69.2% for the same period in 2017.2018. The lower gross and net loss ratios wereratio for the three months ended June 30, 2019 was favorably impacted by the run-off of prior quota share reinsurance agreements as higher ceded losses are measured against lower ceded earned premium due to increased premium retention under our current quota share reinsurance agreement entered into during the fourth quarter of 2018 on the casualty lines of business produced by the Personal Segment. The higher gross loss ratio was primarily the result of lowerhigher current accident year loss trends, partially offset by unfavorabletrends. The Personal Segment reported favorable prior year net loss reserve development of $9$29 thousand during the three months ended SeptemberJune 30, 20182019 as compared to favorable net loss reserve development of $0.3$0.4 million reported during the same period of 2017.2018. The Personal Segment reported a net expense ratio of 20.2%23.3% for the thirdsecond quarter of 20182019 as compared to 31.2%33.7% for the same period of 2017.2018. The decrease in the expense ratio was due predominately to higher net premiums earned and higher finance charges, and lowerpartially offset by higher production related expenses partially offset by lower net premiums earned.due to increased retention of business effective October 1, 2018.

Corporate

Total revenue for Corporate increased by $4.2$8.0 million for the three months ended SeptemberJune 30, 20182019 as compared to the same period the prior year. This increase in total revenue was due predominately to investment gains of $7.0$6.8 million during the thirdsecond quarter of 20182019 as compared to investment gains of $2.1$0.5 million reported for the same period of 2017, partially offset by lower2018, as well as higher net investment income of $0.7$1.7 million for the three months ended SeptemberJune 30, 20182019 as compared to the same period during 2017.2018.

32

Corporate pre-tax income was $1.7$1.6 million for the three months ended SeptemberJune 30, 20182019 as compared to a pre-tax loss of $2.4$5.1 million for the same period of 2017.2018. The pre-tax income was primarily due to the higher revenue discussed above, partially offset by higher operating expenses of $0.1 million.

Operating expenses increased $0.1$1.2 million due primarily as a result of increased salary and related expense and higher professional service fees of $0.2 million, partially offset by lower other expensesinterest expense of $0.1 million.

36

NineSix Months Ended SeptemberJune 30, 20182019 as Compared to NineSix Months Ended SeptemberJune 30, 2017

2018

The following is additional business segment information for the ninesix months ended SeptemberJune 30, 20182019 and 20172018 (in thousands):

  Nine Months Ended September 30 
  Specialty  Standard          
  Commercial
Segment
  Commercial
Segment
  Personal Segment  Corporate  Consolidated 
  2018  2017  2018  2017  2018  2017  2018  2017  2018  2017 
Gross premiums written $376,491  $350,374  $65,931  $59,702  $53,414  $48,243  $-  $-  $495,836  $458,319 
Ceded premiums written  (189,145)  (144,510)  (7,598)  (6,816)  (29,802)  (22,531)  -   -   (226,545)  (173,857)
Net premiums written  187,346   205,864   58,333   52,886   23,612   25,712   -   -   269,291   284,462 
Change in unearned premiums  9,071   (14,563)  (3,648)  (3,859)  (2,927)  2,678   -   -   2,496   (15,744)
Net premiums earned  196,417   191,301   54,685   49,027   20,685   28,390   -   -   271,787   268,718 
                                         
Total revenues  213,507   205,057   57,979   52,449   24,891   31,951   (1,965)  (1,311)  294,412   288,146 
                                         
Losses and loss adjustment expenses  148,001   146,018   28,562   34,669   15,005   24,238   -   -   191,568   204,925 
                                         
Pre-tax income (loss)  20,980   13,018   11,239   881   661   (2,311)  (13,624)  (12,193)  19,256   (605)
                                         
Net loss ratio (1)  75.4%  76.3%  52.2%  70.7%  72.5%  85.4%          70.5%  76.3%
Net expense ratio (1)  22.8%  23.6%  33.5%  34.9%  29.2%  27.7%          27.0%  27.9%
Net combined ratio (1)  98.2%  99.9%  85.7%  105.6%  101.7%  113.1%          97.5%  104.2%
                                         
Favorable (Unfavorable) Prior Year Development  (15,730)  (17,824)  8,829   (1,594)  839   (822)          (6,062)  (20,240)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Six Months Ended June 30, 

 

 

 

Specialty Commercial

 

Standard Commercial

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Segment

 

Segment

 

Personal Segment

 

Corporate

 

Consolidated

 

 

    

2019

    

2018

    

2019

    

2018

    

2019

    

2018

    

2019

    

2018

    

2019

    

2018

 

Gross premiums written

 

$

307,339

 

$

250,892

 

$

47,363

 

$

44,371

 

$

50,850

 

$

31,461

 

$

 —

 

$

 —

 

$

405,552

 

$

326,724

 

Ceded premiums written

 

 

(140,731)

 

 

(122,741)

 

 

(15,273)

 

 

(5,200)

 

 

(8,302)

 

 

(17,504)

 

 

 —

 

 

 —

 

 

(164,306)

 

 

(145,445)

 

Net premiums written

 

 

166,608

 

 

128,151

 

 

32,090

 

 

39,171

 

 

42,548

 

 

13,957

 

 

 —

 

 

 —

 

 

241,246

 

 

181,279

 

Change in unearned premiums

 

 

(33,066)

 

 

5,868

 

 

1,560

 

 

(3,199)

 

 

(4,211)

 

 

(1,023)

 

 

 —

 

 

 —

 

 

(35,717)

 

 

1,646

 

Net premiums earned

 

 

133,542

 

 

134,019

 

 

33,650

 

 

35,972

 

 

38,337

 

 

12,934

 

 

 —

 

 

 —

 

 

205,529

 

 

182,925

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Total revenues

 

 

141,559

 

 

145,205

 

 

35,683

 

 

38,122

 

 

42,599

 

 

15,536

 

 

19,183

 

 

(7,397)

 

 

239,024

 

 

191,466

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Losses and loss adjustment expenses

 

 

94,323

 

 

95,895

 

 

22,264

 

 

22,301

 

 

26,726

 

 

9,127

 

 

 —

 

 

 —

 

 

143,313

 

 

127,323

 

 

 

 

  

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

  

 

 

  

 

 

 

 

 

  

 

Pre-tax income (loss)

 

 

18,395

 

 

18,528

 

 

3,564

 

 

3,975

 

 

4,014

 

 

(23)

 

 

9,429

 

 

(15,299)

 

 

35,402

 

 

7,181

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Net loss ratio (1)

 

 

70.6

%  

 

71.6

%  

 

66.2

%  

 

62.0

%  

 

69.7

%  

 

70.6

%  

 

  

 

 

  

 

 

69.7

%  

 

69.6

%

Net expense ratio (1)

 

 

22.2

%  

 

23.0

%  

 

29.7

%  

 

33.2

%  

 

22.8

%  

 

34.6

%  

 

  

 

 

  

 

 

25.7

%  

 

27.5

%

Net combined ratio (1)

 

 

92.8

%  

 

94.6

%  

 

95.9

%  

 

95.2

%  

 

92.5

%  

 

105.2

%  

 

  

 

 

  

 

 

95.4

%  

 

97.1

%

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Net Favorable (Unfavorable) Prior Year Development

 

 

(5,203)

 

 

(6,861)

 

 

3,583

 

 

1,560

 

 

216

 

 

848

 

 

  

 

 

  

 

 

(1,404)

 

 

(4,453)

 

(1)

The net loss ratio is calculated as incurred losses and LAE divided by net premiums earned, each determined in accordance with GAAP. The net expense ratio is calculated as total underwriting expenses offset by agency fee income divided by net premiums earned, each determined in accordance with GAAP. Net combined ratio is calculated as the sum of the net loss ratio and the net expense ratio.

37

Specialty Commercial Segment

Gross premiums written for the Specialty Commercial Segment were $376.5$307.3  million for the ninesix months ended SeptemberJune 30, 2018,2019, which was $26.1$56.4 million, or 7%22%, more than the $350.4$250.9 million reported for the same period in 2017.of 2018. Net premiums written were $166.6 million for the six months ended June 30, 2019 as compared to $128.2 million for the same period of 2018. The increase in gross and net premiums written werewas primarily the result of increased premium production reflected in our Specialty Commercial operating unit,Professional Liability, E&S Property and E&S Casualty business units,  partially offset by lowera decline in gross premium production in our Contract Binding operatingCommercial Auto business unit. Net premiums written were $187.3 million for the nine months ended September 30, 2018 as compared to $205.9 million for the same period of 2017. The decrease in net premiums written was due to a change in mix towards business with higher ceded premium as a percentage of the gross premium.

The $213.5$141.6 million of total revenue for the ninesix months ended SeptemberJune 30, 20182019 was $8.4$3.6 million moreless than the $205.1$145.2 million reported by the Specialty Commercial Segment for the same period in 2017.2018. This increasedecrease in revenue was primarily due to higherlower net premiums earned of $5.1$0.5 million due to increasedlower premium production during 2018 and the related impact in 2019 to net earned premium in our Specialty Commercial operatingAuto business unit, partially offset by decreased premium productionincreased net premiums earned in our Contract Binding operating unit.Professional Liability, E&S Property and E&S Casualty business units.  Further contributing to the increaseddecrease in revenue was higherlower net investment income of $2.1 million and higherlower commission and fees of $1.3 million, partially offset by lower other income of $0.1$1.0 million for the ninesix months ended SeptemberJune 30, 20182019 as compared to the same period of 2017.

2018.

Pre-tax income for the Specialty Commercial Segment of $21.0$18.4 million for the ninesix months ended SeptemberJune 30, 20182019 was $8.0$0.1 million higherlower than the $13.0$18.5 million reported for the same period in 2017.2018. The increasedecrease in pre-tax income was primarily the result of increasedthe decreased revenue discussed above, partially offset by lower losses and LAE of $1.6 million and lower operating expenses of $1.5 million, partially offset by higher losses and LAE of $1.9 million during the ninesix months ended SeptemberJune 30, 20182019 as compared to the same period during  2017.2018.

33

Our Contract Binding operating unitSpecialty Commercial Segment reported a $15.3$1.6 million decrease in losses and LAE which consisted of (a) a $18.0 million decrease in losses and LAE in our Commercial Auto Business unit due largely to decreasedlower net earned premiums, as well as $11.3$2.5 million of unfavorable prior year net loss reserve development recognized during the ninesix months ended SeptemberJune 30, 20182019 as compared to $16.4$9.5 million of unfavorable prior year net loss reserve development during the same period of 2017. Our Specialty Commercial operating unit reported2018, (b) a $17.2$8.3 million increase in losses and LAE which consistedin our E&S Casualty business unit due primarily to $3.6 million of (a)unfavorable prior year net loss reserve development during the six months ended June 30, 2019 as compared to $4.7 million of favorable prior year net loss reserve development during the same period of 2018,  (c) a $6.7$4.1 million increase in losses and LAE in our E&S Property business unit due to increased net premiums earned as well as higher current accident year loss trends, partially offset by $1.1 million of net favorable prior year loss reserve development during the six months ended June 30, 2019 as compared to $0.6 million of unfavorable prior year net loss reserve development during the same period of 2018, (d) a $3.9 million increase in losses and LAE attributable to our professional liability insurance productsProfessional Liability business unit due primarily to increased net earned premiums as well as higher current accident year loss trends and net unfavorable prior year loss reserve development as compared to favorable prior year loss development during the same period of 2017, (b) a $1.0 million increase in losses and LAE in our satellite launch insurance line of business due to higher current accident year loss trends as well as net unfavorable prior year loss reserve development during the nine months ended September 30, 2018, (c) a $4.0 million increase in losses and LAE in our commercial umbrella and primary/excess liability line of business due primarily to increased net earned, premiums as well as increased net unfavorable prior year loss reserve development during the nine months ended September 30, 2018 as compared to the nine months ended September 30, 2017, (d) a $0.5 million increase in our general aviation line of business due primarily to higher current accident year loss trends, partially offset by lower unfavorable prior year loss development for the nine months ended September 30, 2018 as compared to the prior year to date, (e) a $2.7 million increase in losses and LAE attributable to our primary/excess property insurance products due primarily to increased net earned premiums as well as unfavorable prior year reserve development for the nine months ended September 30, 2018 as compared to favorable prior year reserve development for the same period during 2017, partially offset by lower current accident year loss trends, driven by lower catastrophe losses, and (f)(e)  a $2.3$0.1 million increase in losses and LAE in our specialty programsAerospace & Programs business unit due primarily to increasedhigher net earned premiums.

premiums earned.

Operating expenses decreased $1.5$1.9 million primarily as athe result of lower production related expenses of $5.3$3.4 million due primarily to increased ceding commissions in our Specialty Commercial operating unit,commission from the reinsurance contract entered into during the fourth quarter of 2018, partially offset by increased salary and related expenses of $2.5 million, increased professional services of $0.8$1.0 million and increased occupancy and other operating expenses of $0.5 million.

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The Specialty Commercial Segment reported a net loss ratio of 75.4%70.6% for the ninesix months ended SeptemberJune 30, 20182019 as compared to 76.3%71.6% for the same period during 2017.in 2018. The gross loss ratio before reinsurance was 72.5%71.3% for the ninesix months ended SeptemberJune 30, 20182019 as compared to 73.5%71.8% for the same period in 2017. 2018.The lower gross and net loss ratios  were largely the result of $15.7lower gross current accident year loss trends, as well as lower unfavorable prior year loss reserve development.   During the six months ended June 30, 2019 the Specialty Commercial Segment reported $2.5 million of net catastrophe losses as compared to $0.6 million during the same period of 2018. The Specialty Commercial Segment reported $5.2 million of unfavorable prior year net loss reserve development for the ninesix months ended SeptemberJune 30, 20182019 as compared to unfavorable prior year net loss reserve development of $17.8$6.9 million for the same period of 2017 , partially offset by higher current accident year loss trends during the nine months ended September 30, 2018 as compared to the same period during 2017. The Specialty Commercial Segment reported $1.6 million of net catastrophe losses during the nine months ended September 30, 2018 as compared to $2.6 million of net catastrophe losses during the same period of 2017. 2018. The Specialty Commercial Segment reported a net expense ratio of 22.8%22.2% for the ninesix months ended SeptemberJune 30, 20182019 as compared to 23.6%23.0% for the same period of 2017.2018. The decrease in the expense ratio was due predominately to the impact of increased ceding commissions in our Specialty Commercial operating unit.commissions.

Standard Commercial Segment

Gross premiums written for the Standard Commercial Segment were $65.9$47.4 million for the ninesix months ended SeptemberJune 30, 2018,2019, which was $6.2$3.0 million, or 10%7%, more than the $59.7$44.4 million reported for the same period in 2017.2018. The increase in gross premiums written was due to higher premium production of $6.5 million in our Standard Commercial P&C Operating unit, partially offset by a $0.3 million decrease in gross premiums written related to the discontinued marketing of new and renewal occupational accident policies effective June 1, 2016.Accounts business unit.   Net premiums written were $58.3$32.1 million for the ninesix months ended SeptemberJune 30, 20182019 as compared to $52.9$39.2 million for the same period in 2017.2018. The increasedecrease in net premiums written was due to higher net premiums writtenincreased ceded premium under a quota share reinsurance agreement entered into during the fourth quarter of $5.7 million in our Standard2018 on the casualty lines of business produced by the Commercial P&C Operating unit, partially offset by a $0.3 million decrease in net premiums written related to the discontinued marketing of new and renewal occupational accident policies.

Accounts business unit.

Total revenue for the Standard Commercial Segment of $58.0$35.7 million for the ninesix months ended SeptemberJune 30, 2018,2019, was $5.6$2.4 million, or 11%6%, moreless than the $52.4$38.1 million reported for the same period in 2017.2018. This increasedecrease in total revenue was primarily due to higherlower net premiums earned of $5.7$2.3 million as a result of increased net premiums earned of $6.2 million in our Standard Commercial P&C operating unit, partially offset by a $0.5 million decrease in net premiums earneddue primarily related to the discontinued marketingquota share reinsurance agreement entered into during the fourth quarter of new and renewal occupational accident policies2018 and lower net investment incomecommission and fees of $0.1 million forduring the ninesix months ended SeptemberJune 30, 20182019 as compared to the same period in 2017.

during 2018.

Our Standard Commercial Segment reported pre-tax income of $11.2$3.6 million for the ninesix months ended SeptemberJune 30, 20182019 as compared to pre-tax income of $0.9$4.0 million reported for the same period of 2017.2018. The increasedecrease in pre-tax income was the result of the increaseddecreased revenue discussed above, partially offset by lower operating expenses of $2.0 million largely as the result of lower production related expenses of $2.4 million due to increased ceding commission from the reinsurance contract entered into during the fourth quarter of 2018 and lower losses and LAEother general expenses of $6.1$0.1 million, partially offset by higher operatingsalary and related expenses of $1.4$0.3 million primarily as the resultand higher professional service fees of higher production related expenses.$0.2 million.

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The Standard Commercial Segment reported a net loss ratio of 52.2%66.2% for the ninesix months ended SeptemberJune 30, 20182019 as compared to 70.7%62.0% for the same period of 2017.2018. The gross loss ratio before reinsurance for the ninesix months ended SeptemberJune 30, 20182019 was 60.5%70.3% as compared to the 66.8%65.1% reported for the same period of 2017. The decreases2018. The increase in the gross and net loss ratios werewas due predominantly to higher current net accident year loss trends, partially offset by higher net favorable prior year reserve development. During the six months ended June 30, 2019, the Standard Commercial Segment reported favorable net loss reserve development of $8.8$3.6 million during the nine months ended September 30, 2018 as compared to $1.6 million of unfavorable prior yearfavorable net loss reserve development forof $1.6 million during the same period of 2017. Further contributing to the lower gross and net loss ratios were lower catastrophe losses during the nine months ended September 30, 2018 as compared to the same period of 2017.2018. The Standard Commercial Segment reported $3.2$1.1 million of net catastrophe losses during the nine months ended September 30, 2018second quarter of 2019 as compared to $3.4$2.3 million of net catastrophe losses during the same period of 2017. 2018. The Standard Commercial Segment reported a net expense ratio of 33.5% during29.7% for the ninesix months ended SeptemberJune 30, 20182019 as compared to 34.9%33.2% for the same period of 2017.2018. The decrease in the expense ratio was primarily due to the impact of increased earned premium.ceding commissions in our Commercial Accounts business unit.

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Personal Segment

Gross premiums written for the Personal Segment were $53.4$50.9 million for the ninesix months ended SeptemberJune 30, 20182019 as compared to $48.2$31.5 million for the same period in the prior year. Net premiums written for our Personal Segment were $23.6$42.5 million infor the ninesix months ended SeptemberJune 30, 2018,2019, which was a decreasean increase of $2.1$28.5 million or 8%, from the $25.7$14.0 million reported for the same period of 2017.in 2018. The increase in gross written premiums was primarily due primarily to increasedhigher premium production in our current geographical footprint. The declineincrease in net written premiums was due to the impactincreased production as well as increased retention of a new quota share reinsurance contract entered into during the fourth quarter of 2017.

business effective October 1, 2018.

Total revenue for the Personal Segment was $24.9$42.6 million for the ninesix months ended SeptemberJune 30, 20182019 as compared to $32.0$15.5 million for the same period in 2017.2018. The $7.1 million decreaseincrease in revenue was primarily the result of lowerdue to an increase in net premiums earned of  $7.7$25.4 million, due to lower net written premium volumeincreased finance charges of  $1.4 million and lower netincreased investment income of $0.1$0.3 million partially offset by higher finance charges of $0.7 million reported during the ninesix months ended SeptemberJune 30, 20182019 as compared to the same period during 2017.

2018.

Pre-tax income for the Personal Segment was $0.7$4.0 million for the ninesix months ended SeptemberJune 30, 20182019 as compared to pre-tax loss of $2.3 million$23 thousand for the same period of 2017.2018. The pre-tax income was primarily the result of decreasedthe increased revenue discussed above, partially offset by increased losses and LAE of $9.2$17.6 million and lowerincreased operating expenses of $0.9$5.5 million for the ninesix months ended SeptemberJune 30, 20182019 as compared to the same period during 2017, partially offset by the decreased revenue discussed above.2018.

The Personal Segment reported a net loss ratio of 72.5%69.7%  for the ninesix months ended SeptemberJune 30, 20182019 as compared to 85.4%70.6% for the same period of 2017.2018. The gross loss ratio before reinsurance was 67.9%73.4% for the ninesix months ended SeptemberJune 30, 20182019 as compared to 82.1%69.0% for the same period in 2017.2018. The lower gross and net loss ratios wereratio for the six months ended June 30, 2019 was favorably impacted by the run-off of prior quota share reinsurance agreements as higher ceded losses are measured against lower ceded earned premium due to increased premium retention under our current quota share reinsurance agreement entered into during the fourth quarter of 2018 on the casualty lines of business produced by the Personal Segment. The higher gross loss ratio was primarily the result of lower favorable prior year loss reserve development   during the six months ended June 30, 2019 as compared to the same period of 2018. The Personal Segment reported favorable net loss reserve development of $0.2 million for the six months ended June 30, 2019 as compared to favorable net loss reserve development of $0.8 million during the nine months ended September 30, 2018 as compared to unfavorable net loss reserve development of $0.8 million reported during the same period of 2017, as well as lower current accident year loss trends. 2018. The Personal Segment reported a net expense ratio of 29.2%22.8% for the ninesix months ended SeptemberJune 30, 20182019 as compared to 27.7%34.6% for the same period of 2017.2018. The increasedecrease in the expense ratio was due predominately to lowerhigher net premiums earned.earned and higher finance charges, partially offset by higher production related expenses due to increased retention of business effective October 1, 2018.

Corporate

Total revenue for Corporate decreasedincreased by $0.7$26.6 million for the ninesix months ended SeptemberJune 30, 20182019 as compared to the same period the prior year. This decreaseincrease in total revenue was due predominately to lowerinvestment gains of $18.8 million during the six months ended June 30, 2019 as compared to investment losses of $4.3 million reported for the same period of 2018, as well as higher net investment income of $2.7$3.5 million for the ninesix months ended SeptemberJune 30, 20182019 as compared to the same period during 2017, partially offset by investment gains2018.

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Corporate pre-tax lossincome was $13.6$9.4 million for the ninesix months ended SeptemberJune 30, 20182019 as compared to a pre-tax loss of $12.2$15.3 million for the same period of 2017.2018. The increase in pre-tax lossincome was primarily due to higher operating expenses of $0.9 million and the lowerhigher revenue discussed above, partially offset by lower interest expensehigher operating expenses of $0.2 million.

Operating expenses increased $0.9$1.6 million due primarily as a result of higherincreased salary and related expenses of $0.8 million due primarily toand higher incentive compensation accruals during the first nine months of 2018.  Further contributing to the higher operating expenses were increased occupancy and related expenses of $0.4 million primarily related to the early termination of our Ft. Worth office lease.   These increases to operating expenses were partially offset by lower professional service fees and other expensesinterest expense of $0.3 million.

Financial Condition and Liquidity

Sources and Uses of Funds

Our sources of funds are from insurance-related operations, financing activities and investing activities. Major sources of funds from operations include premiums collected (net of policy cancellations and premiums ceded), commissions, and processing and service fees. As a holding company, Hallmark is dependent on dividend payments and management fees from its subsidiaries to meet operating expenses and debt obligations. As of SeptemberJune 30, 2018,2019, we had $16.2$21.6 million in unrestricted cash and cash equivalents, as well as $0.9 million in debt securities, at the holding company and our non-insurance subsidiaries. As of that date, our insurance subsidiaries held $43.7$46.1 million of unrestricted cash and cash equivalents, as well as $573.6$532.2 million in debt securities with an average modified duration of 1.51.6 years. Accordingly, we do not anticipate selling long-term debt instruments to meet any liquidity needs.

AHIC and TBIC, domiciled in Texas, are limited in the payment of dividends to their stockholders in any 12-month12‑month period, without the prior written consent of the Texas Department of Insurance, to the greater of statutory net income for the prior calendar year or 10% of statutory policyholders’ surplus as of the prior year end.  Dividends may only be paid from unassigned surplus funds. HIC and HNIC, both domiciled in Arizona, are limited in the payment of dividends to the lesser of 10% of prior year policyholders’ surplus or prior year'syear’s  statutory net income, without prior written approval from the Arizona Department of Insurance. HSIC, domiciled in Oklahoma, is limited in the payment of dividends to the greater of 10% of prior year policyholders’ surplus or prior year’s statutory net income, not including realized capital gains, without prior written approval from the Oklahoma Insurance Department. During 2018,2019, the aggregate ordinary dividend capacity of these subsidiaries is $20.0$33.9 million, of which $13.2$22.9 million is available to Hallmark. As a county mutual, dividends from HCM are payable to policyholders. During the first ninesix months of 20182019 and 2017,2018, our insurance company subsidiaries paid $4.6$10.0 million and $9.8$3.6 million in dividends to Hallmark, respectively.

Comparison of SeptemberJune 30, 20182019 to December 31, 2017

2018

On a consolidated basis, our cash (excluding restricted cash) and investments at SeptemberJune 30, 20182019 were $707.6$697.4 million compared to $726.3$663.5 million at December 31, 2017.2018. The primary reasons for this decreaseincrease in unrestricted cash and investments were cash usedprovided by operations, increases in investment fair values and proceeds from the exercise of employee stock options, partially offset by purchases of fixed assets and repurchases of our common stock.

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Comparison of NineSix Months Ended SeptemberJune 30, 20182019 and SeptemberJune 30, 2017

2018

During the ninesix months ended SeptemberJune 30, 2018,2019, our cash flow provided by operations was $6.7 million compared to cash flow used by operations was $19.0 million compared to cash flow provided by operations of $34.3$9.9 million during the same period the prior year. The  decreasecash flow provided by operations during the first half of 2019 was driven by an increase in collected net premiums,  higher collected investment income and higher collected finance charges. These increases in operating cash flow was driven by a decrease in collected net premiums due predominately to an intentional shift in the mix of business away from a commercial auto concentration in our portfolio towards targeted growth in the Specialty Commercial operating unit, a larger portion of which is ceded to third party reinsurers, as well as a temporary acceleration of paid claims as we improved our claims practices to address the increase in frequency and severity in our commercial auto portfolio. This decrease in operating cash flow waswere partially offset by increased paid operating expense, increased federal income taxes paid and higher collected ceding commissions and collected income tax recoverablepaid claims during the ninesix months ended SeptemberJune 30, 20182019 as compared to the same period the prior year.

Net cash provided by investing activities during the first ninesix months of 20182019 was $16.0$23.9 million as compared to net cash used inprovided by investing activities of $23.0$26.1 million during the first ninesix months of 2017.2018. The $2.2 million decline in net cash provided by investing activities during the first ninesix months of 20182019 as compared to the prior year was primarily comprised of an increase of $2.2a $1.2 million decrease in maturities, sales and redemptions of investment securities and a $1.3 million increase in purchases of fixed assets, partially offset by a $0.3 million decrease in purchases of debt and equity securities of $36.8 million.securities.

 

Cash provided by financing activities during the first six months of 2019 was $0.1 million primarily as a result of proceeds from the exercise of employee stock options of $1.5  million, partially offset by $1.4 million in repurchases of

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our common stock. Cash used in financing activities during the first ninesix months of 2018 was $1.2 million primarily as a result of repurchases of our common stock. Cash used in financing activities during the first nine months of 2017 was $5.2 million primarily as a result of repurchases of our common stock.

Credit Facilities

Our Second Restated Credit Agreement with Frost Bank (“Frost”) dated June 30, 2015, as amended to date, provides a $15.0 million revolving credit facility (“Facility A”), with a $5.0 million letter of credit sub-facility. The outstanding balance of the Facility A bears interest at a rate equal to the prime rate or LIBOR plus 2.5%, at our election. We pay an annual fee of 0.25% of the average daily unused balance of Facility A and letter of credit fees at the rate of 1.00% per annum.  All principal and accrued interest on Facility A becomes due and payable on June 30, 2020. As of SeptemberJune  30, 2018,2019, we had no outstanding borrowings under Facility A.

The Second Restated Credit Agreement with Frost also provides a $30.0 million revolving credit facility (“Facility B”), in addition to Facility A.  We may use Facility B loan proceeds solely for the purpose of making capital contributions to AHIC and HIC. We may borrow, repay and reborrow under Facility B until December 17, 2019, at which time all amounts outstanding under Facility B are converted to a term loan. Through December 17, 2019, we pay Frost a quarterly fee of 0.25% per annum of the average daily unused balance of Facility B. Facility B bears interest at a rate equal to the prime rate or LIBOR plus 3.00%, at our election. Until December 17, 2019, interest only on amounts from time to time outstanding under Facility B are payable quarterly. Any amounts outstanding on Facility B as of December 17, 2019 are converted to a term loan payable in quarterly installments over five years based on a seven year amortization of principal plus accrued interest. All remaining principal and accrued interest on Facility B become due and payable on December 17, 2024. As of SeptemberJune 30, 2018,2019, we had $30.0 million outstanding under Facility B.

The obligations under both Facility A and Facility B are secured by a security interest in the capital stock of AHIC and HIC.  Both Facility A and Facility B contain covenants that, among other things, require us to maintain certain financial and operating ratios and restrict certain distributions, transactions and organizational changes. We are in compliance with all of these covenants.

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Subordinated Debt Securities

On June 21, 2005, we entered into a trust preferred securities transaction pursuant to which we issued $30.9 million aggregate principal amount of subordinated debt securities due in 2035.  To effect the transaction, we formed a Delaware statutory trust, Hallmark Statutory Trust I (“Trust I”).  Trust I issued $30.0 million of preferred securities to investors and $0.9 million of common securities to us.  Trust I used the proceeds from these issuances to purchase the subordinated debt securities.  The initial interest rate on our Trust I subordinated debt securities was 7.725% until June 15, 2015, after which interest adjusts quarterly to the three-month LIBOR rate plus 3.25 percentage points.  Trust I pays dividends on its preferred securities at the same rate.  Under the terms of our Trust I subordinated debt securities, we pay interest only each quarter and the principal of the note at maturity.  The subordinated debt securities are uncollaterized and do not require maintenance of minimum financial covenants. As of SeptemberJune 30, 2018,2019, the principal balance of our Trust I subordinated debt was $30.9 million and the interest rate was 5.58%5.66% per annum.

On August 23, 2007, we entered into a trust preferred securities transaction pursuant to which we issued $25.8 million aggregate principal amount of subordinated debt securities due in 2037.  To effect the transaction, we formed a Delaware statutory trust, Hallmark Statutory Trust II (“Trust II”).  Trust II issued $25.0 million of preferred securities to investors and $0.8 million of common securities to us.  Trust II used the proceeds from these issuances to purchase the subordinated debt securities. The initial interest rate on our Trust II subordinated debt securities was 8.28% until September 15, 2017, after which interest adjusts quarterly to the three-month LIBOR rate plus 2.90 percentage points.  Trust II pays dividends on its preferred securities at the same rate.  Under the terms of our Trust II subordinated debt securities, we pay interest only each quarter and the principal of the note at maturity.  The subordinated debt securities are uncollaterized and do not require maintenance of minimum financial covenants. As of SeptemberJune 30, 2018,2019, the principal balance of our Trust II subordinated debt was $25.8 million and the interest rate was 5.23%5.31% per annum.

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Item 3.  Quantitative and Qualitative Disclosures About Market Risk.

There have been no material changes to the market risks discussed in Item 7A to Part II of our Form 10-KNot required for the fiscal year ended December 31, 2017.smaller reporting company.

Item 4.  Controls and Procedures.

The principal executive officer and principal financial officer of Hallmark have evaluated our disclosure controls and procedures and have concluded that, as of the end of the period covered by this report, such disclosure controls and procedures were effective in ensuring that information required to be disclosed by us in the reports that we file or submit under the Securities Exchange Act of 1934 is timely recorded, processed, summarized and reported. The principal executive officer and principal financial officer also concluded that such disclosure controls and procedures were effective in ensuring that information required to be disclosed by us in the reports that we file or submit under such Act is accumulated and communicated to our management, including our principal executive officer and principal financial officer, as appropriate, to allow timely decisions regarding required disclosure. During the most recent fiscal quarter, there have been no changes in our internal controls over financial reporting that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

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Risks Associated with Forward-Looking Statements Included in this Form 10-Q

10‑Q

This Form 10-Q10‑Q contains certain forward-looking statements within the meaning of Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934, which are intended to be covered by the safe harbors created thereby.  These statements include the plans and objectives of management for future operations, including plans and objectives relating to future growth of our business activities and availability of funds.  The forward-looking statements included herein are based on current expectations that involve numerous risks and uncertainties.  Assumptions relating to the foregoing involve judgments with respect to, among other things, future economic, competitive and market conditions, regulatory framework, weather-related events and future business decisions, all of which are difficult or impossible to predict accurately and many of which are beyond our control.  Although we believe that the assumptions underlying the forward-looking statements are reasonable, any of the assumptions could be inaccurate and, therefore, there can be no assurance that the forward-looking statements included in this Form 10-Q10‑Q will prove to be accurate.  In light of the significant uncertainties inherent in the forward-looking statements included herein, the inclusion of such information should not be regarded as a representation by us or any other person that our objectives and plans will be achieved.

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PART II

OTHER INFORMATION

Item 1.

Item 1.   Legal Proceedings.

We are engaged in various legal proceedings that are routine in nature and incidental to our business. None of these proceedings, either individually or in the aggregate, are believed, in our opinion, to have a material adverse effect on our consolidated financial position or our results of operations.

Item 1A.

Item 1A.  Risk Factors.

Not requiredThere have been no material changes to the risk factors discussed in Item 1A to Part I of our Form 10-K for a smaller reporting company.the fiscal year ended December 31, 2018.

Item 2.

Item 2.  Unregistered Sales of Equity Securities and Use of Proceeds.

Our stock buyback program initially announced on April 18, 2008, authorized the repurchase of up to 1,000,000 shares of our common stock in the open market or in privately negotiated transactions (the “Stock Repurchase Plan”). On January 24, 2011, we announced an increased authorization to repurchase up to an additional 3,000,000 shares.  The Stock Repurchase Plan does not have an expiration date.  We did not repurchase any shares of our common stock during the three months ended SeptemberJune 30, 2018.2019.

Item 3.Defaults Upon Senior Securities.

 

Item 3.  Defaults Upon Senior Securities.

None.

Item 4.

Item 4.  Mine Safety Disclosures.

None.

Item 5.

Item 5.  Other Information.

None.

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39

Item 6.

Item 6.  Exhibits.

The following exhibits are filed herewith or incorporated herein by reference:

Exhibit

Number

Description

3(a)

Restated Articles of Incorporation of the registrant, as amended (incorporated by reference to Exhibit 3.1 to the registrant’s Registration Statement on Form S-1S‑1 [Registration No. 333-136414]333‑136414] filed September 8, 2006).

3(b)

Amended and Restated By-Laws of the registrant (incorporated by reference to Exhibit 3.1 to the registrant’s Current Report on Form 8-K8‑K filed March 28, 2017).

10(a)

Office Lease between Hallmark Financial Services, Inc. and Teachers Insurance and Annuity Association of America dated August 6, 2018 (incorporated by reference to Exhibit 10.1 to the registrant’s Current Report on Form 8-K filed August 8, 2018).

31(a)

31(a)

Certification of principal executive officer required by Rule 13a-14(a)13a‑14(a) orRule 15d-14(a)15d‑14(a).

31(b)

Certification of principal financial officer required by Rule 13a-14(a)13a‑14(a) orRule 15d-14(a)15d‑14(a).

32(a)

Certification of principal executive officer Pursuant to 18 U.S.C. § 1350.

32(b)

Certification of principal financial officer Pursuant to 18 U.S.C. § 1350.

101 INS+

XBRL Instance Document.

101 SCH+

XBRL Taxonomy Extension Schema Document.

101 CAL+

XBRL Taxonomy Extension Calculation Linkbase Document.

101 LAB+

XBRL Taxonomy Extension Label Linkbase Document.

101 PRE+

XBRL Taxonomy Extension Presentation Linkbase Document.

101 DEF+

XBRL Taxonomy Extension Definition Linkbase Document.

+

Filed with this Quarterly Report on Form 10-Q and included in Exhibit 101 to this report are the following documents formatted in XBRL (Extensible Business Reporting Language): (i) Consolidated Balance Sheets as of SeptemberJune 30, 20182019 and December 31, 2017,2018, (ii) Consolidated Statements of Operations for the three and ninesix months ended SeptemberJune 30, 20182019 and 2017,2018, (iii) Consolidated Statements of Comprehensive Income for the three and ninesix months ended SeptemberJune 30, 20182019 and 2017,2018, (iv) Consolidated Statements of Stockholder’s Equity for the three and ninesix months ended SeptemberJune 30, 20182019 and 2017,2018, (v) Consolidated Statementsof Cash Flows for the ninesix months ended SeptemberJune 30, 20182019 and 20172018 and (vi) related notes.

 

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SIGNATURES

In accordance with the requirements of the Exchange Act, the registrant has caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.

HALLMARK FINANCIAL SERVICES, INC.

(Registrant)

 

Date: November 7, 2018August 9, 2019

/s/ Naveen Anand

Naveen Anand, Chief Executive Officer and President

Date: November 7, 2018August 9, 2019

/s/ Jeffrey R. Passmore

Jeffrey R. Passmore, Chief AccountingFinancial Officer and Senior Vice President

 

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