entities. The maximum exposure to loss with respect to these investments is limited to the investment carrying values included in the consolidated balance sheets.

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.

Adoption of New Accounting Pronouncements

In February 2018, the Financial Accounting Standards Board (“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.

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.

10

~~Table of Contents~~

In January 2016, the FASB issued ASU 2016‑01, “Recognition and Measurement of Financial Assets and Financial Liabilities” (Subtopic 825‑10). ASU 2016‑01 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 2016‑01 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 2016‑01 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 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 (losses) in the Consolidated Statement of Operations.

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 September 30, 2019, $16.6 million of right-of-use assets and $17.5 million of lease liabilities for operating leases were included in 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, “Classification of Certain Cash Receipts and Cash Payments” (Topic 230). ASU 2016‑15 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. The adoption of this new guidance did not have a material impact on our financial results or disclosures.

In November 2016, the FASB issued ASU 2016‑18, “Statement of Cash Flows (Topic 230): Restricted Cash.” The purpose of ASU 2016‑18 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 which did not have a material impact on our financial results or disclosures.

In May 2014, the FASB issued ASU 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. The adoption of this new guidance did not have a material impact on our financial results or disclosures.

~~Recently Issued Accounting Pronouncements~~

On August 28, 2018, the FASB issued ASU 2018-13, “Fair Value Measurement: Disclosure Framework- Changes to the Disclosure Requirements for Fair Value Measurement” (Topic 820), which amends ASC 820 to add, remove, and

11

~~Table of Contents~~

modify fair value measurement disclosure requirements. The requirements to disclose the amount of and reasons for transfers between Level 1 and Level 2 of the fair value hierarchy, the policy for timing 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 the end of the 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 the timing of liquidation and the date when restrictions from redemption might lapse are only disclosed if the investee has communicated the timing to the entity or announced the timing publicly. This ASU is effective for annual and interim reporting periods beginning after December 15, 2019. As the amendments are only disclosure related, our financial statements ~~will~~were 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 ~~2017‑04~~2017-04 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. The adoption of this guidance did not have a material effect on the Company’s results of operations, financials position or liquidity.

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 ~~are currently evaluating~~adopted the ~~impact~~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 September 30, 2020, $14.5 million of right-of-use assets and $16.3 million of lease liabilities for operating leases were included in the other assets and other liabilities line items of the balance sheet, respectively, as a result of the adoption of ~~ASU 2017‑04 will~~this update.

Recently Issued Accounting Pronouncements

In December 2019, the FASB issued updated guidance for the accounting for income taxes. The updated guidance is intended to simplify the accounting for income taxes by removing several exceptions contained in the existing guidance and amending other existing guidance to simplify several other income tax accounting matters. The updated guidance is effective for the quarter ending March 31, 2021. Early adoption is permitted. The adoption of this guidance is not expected to have a material effect on ~~our financial~~the Company’s results ~~and disclosures.~~of operations, financials position or liquidity.

10

Table of Contents

In June 2016, the FASB issued ASU ~~2016‑13,~~2016-13, “Measurement of Credit Losses on Financial Instruments” (Topic 326). ASU ~~2016‑13~~2016-13 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. As a smaller reporting company, ASU ~~2016‑13~~2016-13 is effective for fiscal years of the Company beginning after December 15, 2022, including interim periods within those fiscal years. ASU ~~2016‑13~~2016-13 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.

3. Acquisitions, Goodwill and Intangible Assets

In connection with its normal process for evaluating impairment triggering events, the Company determined that a significant decline in its market capitalization below its stockholders’ equity during the first quarter of 2020 indicated the impairment of the goodwill and indefinite-lived intangible assets included in its balance sheet. As a result, the Company took a $44.7 million charge to goodwill and a $1.3 million charge to indefinite-lived intangible assets during the first quarter of 2020. As of September 30, 2020 there is 0 goodwill reported on our consolidated balance sheet.

4. 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.

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

12

~~Table of Contents~~

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.

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

11

Table of Contents

not available on active exchanges for identical instruments. We use ~~third party~~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~~third-party pricing sources. There were no0 transfers betweenLevel 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.

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 September 30, ~~2019~~2020 and December 31, ~~2018~~2019 (in thousands):


	As of September 30, 2019
	Quoted Prices in
	Active Markets for
	Identical Assets		Other Observable		Unobservable
	(Level 1)		Inputs (Level 2)		Inputs (Level 3)		Total

									As of September 30, 2020
									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	$	—	$	48,345	$	��-	$	48,345	$	—	$	61,001	$	-	$	61,001
Corporate bonds		—		283,678		444		284,122		—		239,154		325		239,479
Collateralized corporate bank loans		—		121,317		-		121,317		—		55,334		-		55,334
Municipal bonds		—		106,311		-		106,311		—		55,638		-		55,638
Mortgage-backed		—		8,736		-		8,736		—		6,117		-		6,117
Total debt securities		—		568,387		444		568,831		—		417,244		325		417,569
Total equity securities		92,099		—		—		92,099		23,372		—		—		23,372
Total other investments		3,009		—		—		3,009		34		—		—		34
Total investments	$	95,108	$	568,387	$	444	$	663,939	$	23,406	$	417,244	$	325	$	440,975


	As of December 31, 2019
	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	$	0	$	66,600	$	0	$	66,600
Corporate bonds		0		300,486		339		300,825
Collateralized corporate bank loans		0		115,757		0		115,757
Municipal bonds		0		83,270		0		83,270
Mortgage-backed		0		7,827		0		7,827
Total debt securities		0		573,940		339		574,279
Total equity securities		99,215		0		0		99,215
Total other investments		2,169		0		0		2,169
Total investments	$	101,384	$	573,940	$	339	$	675,663

13

~~Table of Contents~~

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

Due to significant unobservable inputs into the valuation model for ~~one~~1 corporate bond as of September 30, ~~2019~~2020 and December 31, ~~2018,~~2019, we classified this investment as Level 3 in the fair value hierarchy. 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.

12

Table of Contents

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 nine months ended September 30, ~~2019~~2020 and ~~2018~~2019 (in thousands):


Beginning balance as of January 1, 2019	$	291

Beginning balance as of January 1, 2020			$	339
Sales		—		0
Settlements		—		0
Purchases		—		0
Issuances		—		0
Total realized/unrealized gains included in net income		—
Total realized/unrealized losses included in net income				0
Net gain included in other comprehensive income		153		(14)
Transfers into Level 3		—		0
Transfers out of Level 3		—		0
Ending balance as of September 30, 2019	$	444
Ending balance as of September 30, 2020			$	325


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

Beginning balance as of January 1, 2019			$	291
Sales		(2,925)		0
Settlements		—		0
Purchases		—		0
Issuances		—		0
Total realized/unrealized gains included in net income		—		0
Net gains included in other comprehensive income		114		153
Transfers into Level 3		—		0
Transfers out of Level 3		(621)		0
Ending balance as of September 30, 2018	$	325
Ending balance as of September 30, 2019			$	444

1413

Table of Contents

4.5. Investments

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


			Gross		Gross
			Unrealized		Unrealized
	Amortized Cost		Gains		Losses		Fair Value
As of September 30, 2019

											Gross		Gross
										Cost /	Unrealized		Unrealized
									Amortized Cost		Gains		Losses		Fair Value
As of September 30, 2020
U.S. Treasury securities and obligations of U.S. Government	$	48,246	$	121	$	(22)	$	48,345	$	60,332	$	671	$	(2)	$	61,001
Corporate bonds		281,228		3,068		(174)		284,122		235,469		5,291		(1,281)		239,479
Collateralized corporate bank loans		121,741		363		(787)		121,317		57,559		-		(2,225)		55,334
Municipal bonds		104,540		1,826		(55)		106,311		54,837		852		(51)		55,638
Mortgage-backed		8,847		38		(149)		8,736		6,000		122		(5)		6,117
Total debt securities		564,602		5,416		(1,187)		568,831		414,197		6,936		(3,564)		417,569
Total equity securities		68,737		30,124		(6,762)		92,099		25,735		2,989		(5,352)		23,372
Total other investments		3,763		—		(754)		3,009		3,763		0		(3,729)		34
Total investments	$	637,102	$	35,540	$	(8,703)	$	663,939	$	443,695	$	9,925	$	(12,645)	$	440,975

As of December 31, 2018

As of December 31, 2019
U.S. Treasury securities and obligations of U.S. Government	$	48,609	$	5	$	(508)	$	48,106	$	66,441	$	162	$	(3)	$	66,600
Corporate bonds		243,314		440		(1,602)		242,152		297,601		3,387		(163)		300,825
Collateralized corporate bank loans		131,779		19		(5,270)		126,528		115,669		556		(468)		115,757
Municipal bonds		112,574		3,791		(838)		115,527		81,787		1,531		(48)		83,270
Mortgage-backed		13,992		11		(446)		13,557		8,000		46		(219)		7,827
Total debt securities		550,268		4,266		(8,664)		545,870		569,498		5,682		(901)		574,279
Total equity securities		68,709		20,693		(8,506)		80,896		71,895		35,028		(7,708)		99,215
Total other investments		3,763		—		(2,615)		1,148		3,763		0		(1,594)		2,169
Total investments	$	622,740	$	24,959	$	(19,785)	$	627,914	$	645,156	$	40,710	$	(10,203)	$	675,663

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,
	2019		2018		2019		2018

									Three Months Ended September 30,				Nine Months Ended September 30,
									2020		2019		2020		2019
U.S. Treasury securities and obligations of U.S. Government	$	—	$	—	$	—	$	—	$	(3)	$	—	$	(3)	$	—
Corporate bonds		154		(44)		171		(66)		352		154		766		171
Collateralized corporate bank loans		(103)		23		(65)		70		66		(103)		(19)		(65)
Municipal bonds		124		(145)		4,271		(164)		(25)		124		1,397		4,271
Mortgage-backed		—		—		(1)		1		—		—		—		(1)
Equity securities		—		—		—		359		—		—		3,471		—
Gain (loss) on investments		175		(166)		4,376		200
Unrealized (losses) gains on equity securities		(1,941)		7,121		11,175		3,217
Gain on investments										390		175		5,612		4,376
Unrealized gains (losses) on equity securities										937		(1,941)		(29,683)		11,175
Other-than-temporary impairments										(1,692)		—		(1,692)		—
Unrealized (losses) gains on other investments		424		25		1,861		(739)		(262)		424		(2,136)		1,861
Investment (losses) gains, net	$	(1,342)	$	6,980	$	17,412	$	2,678	$	(627)	$	(1,342)	$	(27,899)	$	17,412

We realized gross gains on investments of $0.5 million and ~~$0.3~~$0.5 million during the three months ended September 30, ~~2019~~2020 and ~~2018,~~2019, respectively and ~~$4.9~~$22.4 million and ~~$0.9~~$4.9 million for the nine months ended September 30, ~~2019~~2020 and ~~2018,~~2019, respectively. We realized gross losses on investments of ~~$0.3~~$0.1 million and ~~$0.5~~$0.3 million for the three months ended September 30, ~~2019~~2020 and ~~2018,~~2019, respectively and ~~$0.5~~$16.8 million and ~~$0.7~~$0.5 million for the nine months ended September 30, ~~2019~~2020 and ~~2018,~~2019, respectively. We recorded proceeds from the sale of investment securities of ~~$6.0~~$47.4 million and ~~$0.4~~$6.0 million during the three months ended September 30, 2020 and 2019 respectively, and ~~2018, respectively,~~$155.0 million and $13.0 million ~~and $14.6 million~~ for the

14

Table of Contents

nine months ended September 30, ~~2019~~2020 or ~~2018,~~2019, respectively. Realized investment gains and losses are recognized in operations on the first in-first out method.

15

~~Table of Contents~~

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 September 30, ~~2019~~2020 and December 31, ~~2018~~2019 (in thousands):


	As of September 30, 2019
	12 months or less				Longer than 12 months				Total
			Unrealized				Unrealized				Unrealized
	Fair Value		Losses		Fair Value		Losses		Fair Value		Losses

													As of September 30, 2020
													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	$	—	$	—	$	23,142	$	(22)	$	23,142	$	(22)	$	18,091	$	(2)	$	0	$	0	$	18,091	$	(2)
Corporate bonds		29,172		(142)		13,305		(32)		42,477		(174)		8,982		(1,035)		4,071		(246)		13,053		(1,281)
Collateralized corporate bank loans		33,961		(636)		4,782		(151)		38,743		(787)		49,558		(1,571)		5,638		(654)		55,196		(2,225)
Municipal bonds		6,537		(48)		1,036		(7)		7,573		(55)		2,550		(33)		1,379		(18)		3,929		(51)
Mortgage-backed		1,384		(65)		599		(84)		1,983		(149)		0		0		14		(5)		14		(5)
Total debt securities		71,054		(891)		42,864		(296)		113,918		(1,187)		79,181		(2,641)		11,102		(923)		90,283		(3,564)
Total equity securities		9,538		(4,275)		2,391		(2,487)		11,929		(6,762)		10,265		(4,187)		1,935		(1,165)		12,200		(5,352)
Total other investments		—		—		3,009		(754)		3,009		(754)		0		0		34		(3,729)		34		(3,729)
Total investments	$	80,592	$	(5,166)	$	48,264	$	(3,537)	$	128,856	$	(8,703)	$	89,446	$	(6,828)	$	13,071	$	(5,817)	$	102,517	$	(12,645)


	As of December 31, 2018
	12 months or less				Longer than 12 months				Total
			Unrealized				Unrealized				Unrealized
	Fair Value		Losses		Fair Value		Losses		Fair Value		Losses

													As of December 31, 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	$	18,902	$	(181)	$	28,201	$	(327)	$	47,103	$	(508)	$	0	$	0	$	5,513	$	(3)	$	5,513	$	(3)
Corporate bonds		117,450		(907)		100,060		(695)		217,510		(1,602)		27,268		(144)		1,150		(19)		28,418		(163)
Collateralized corporate bank loans		120,410		(4,938)		4,931		(332)		125,341		(5,270)		9,000		(41)		10,228		(427)		19,228		(468)
Municipal bonds		14,281		(96)		25,891		(742)		40,172		(838)		4,808		(29)		1,618		(19)		6,426		(48)
Mortgage-backed		6,592		(60)		5,986		(386)		12,578		(446)		1,712		(101)		562		(118)		2,274		(219)
Total debt securities		277,635		(6,182)		165,069		(2,482)		442,704		(8,664)		42,788		(315)		19,071		(586)		61,859		(901)
Total equity securities		30,981		(3,699)		4,475		(4,807)		35,456		(8,506)		10,905		(2,363)		6,093		(5,345)		16,998		(7,708)
Total other investments		1,148		(2,615)		—		—		1,148		(2,615)		0		0		2,169		(1,594)		2,169		(1,594)
Total investments	$	309,764	$	(12,496)	$	169,544	$	(7,289)	$	479,308	$	(19,785)	$	53,693	$	(2,678)	$	27,333	$	(7,525)	$	81,026	$	(10,203)

We had a total of 8184 debt securities with an unrealized loss, of which 5868 were in an unrealized loss position for less than one year and 2316 were in an unrealized loss position for a period of one year or greater, as of September 30, ~~2019.~~2020. We ~~had~~held a total of ~~328~~61 debt securities with an unrealized loss, of which ~~221~~41 were in an unrealized loss position for less than one year and ~~107~~20 were in an unrealized loss position for a period of one year or greater, as of December 31, ~~2018.~~2019. 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. WeThe gross unrealized losses on the debt security positions at September 30, 2020 were due predominately to market and interest rate fluctuations and we see no other indications that the decline in values of these securities is other-than-temporary.

Based on evidence gathered through our normal credit evaluation process, we presently expect that all debt securities held in our investment portfolio will be paid in accordance with their contractual terms. Nonetheless, it is at least reasonably possible that the performance of certain issuers of these debt securities will be worse than currently expected resulting in future write-downs within our portfolio of debt securities.

Also, as a result of the challenging market conditions, we expect the volatility in the valuation of our equity securities to continue in the foreseeable future. This volatility may lead to changes regarding retention strategies for certain equity securities.

15

Table of Contents

We complete a detailed analysis each quarter to assess whether any decline in the fair value of any ~~fixed maturity investment~~debt security below cost is deemed other-than-temporary. All ~~fixed maturity investments~~debt securities with an unrealized loss are reviewed. We recognize an impairment loss when ~~an investment’s~~a debt security’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 recognized $1.7 million of other-than-temporary impairment on debt securities during the nine months ended September 30, 2020. We did not recognize any impairment loss on debt securities during the nine months ended September 30, 2019.

Debt Investments: 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~~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. During the nine months ended September 30, 2020 we did not dispose of any previously impaired securities. During the nine months ended September 30, 2019 we disposed of 6 previously impaired securities and recognized a realized gain of $4.1 million.

16

~~Table~~Equity Investments: On January 1, 2018, we adopted ASU 2016-01, “Recognition and Measurement of ~~Contents~~

Financial Assets and Financial Liabilities (Topic 825).” ASU 2016-01 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 each reporting period. As a result of this standard, equity securities with readily determinable fair values are not required to be evaluated for other-than-temporary-impairment.

Details regarding the carrying value of the other investments portfolio as of September 30, ~~2019~~2020 and December 31, ~~2018~~2019 are as follows (in thousands):


	September 30,		December 31,
	2019		2018

					2020		2019
Investment Type
Equity warrant	$	3,009	$	1,148	$	34	$	2,169
Total other investments	$	3,009	$	1,148	$	34	$	2,169

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 September 30, ~~2019~~2020 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

	Amortized Cost		Fair Value
	(in thousands)
					(in thousands)
Due in one year or less	$	121,593	$	121,977	$	113,961	$	115,144
Due after one year through five years		309,542		312,076		248,003		250,693
Due after five years through ten years		94,338		94,489		32,766		31,560
Due after ten years		30,282		31,553		13,467		14,055
Mortgage-backed		8,847		8,736		6,000		6,117
	$	564,602	$	568,831
					$	414,197	$	417,569

5.6. 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 ~~$28.4~~$26.8 million and ~~$29.5~~$28.9 million at September 30, ~~2019~~2020 and December 31, ~~2018,~~2019, respectively.

1716

Table of Contents

6.7. Reserves for Unpaid Losses and Loss Adjustment Expenses

Year ~~to date~~to-date activity in the consolidated reserves for unpaid losses and LAE is summarized as follows (in thousands):


	September 30,		September 30,
	2019		2018

					September 30,		September 30,
					2020		2019
Balance at January 1	$	527,247		527,100	$	620,355	$	527,247
Less reinsurance recoverable		221,716		154,612		272,604		221,716
Net balance at January 1		305,531		372,488		347,751		305,531


Incurred related to:
Current year		214,080		185,506		257,572		214,080
Loss portfolio transfer						21,700		0
Prior years		7,781		6,062		33,259		7,781
Total incurred		221,861		191,568		312,531		221,861


Paid related to:
Current year		75,834		56,687		67,146		75,834
Loss portfolio transfer						21,700		0
Prior years		146,929		184,337		177,325		146,929
Total paid		222,763		241,024		266,171		222,763


Net balance at September 30		304,629		323,032		394,111		304,629
Plus reinsurance recoverable		260,667		207,784		361,780		260,667
Balance at September 30	$	565,296	$	530,816	$	755,891	$	565,296

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


	September 30,
	2019		2018

					September 30,
					2020		2019
Specialty Commercial Segment	$	11,232	$	15,730	$	23,961	$	11,232
Standard Commercial Segment		(3,508)		(8,829)		2,350		(3,508)
Personal Segment		57		(839)		6,948		57
Corporate		—		—		0		0
Total unfavorable net prior year development	$	7,781	$	6,062	$	33,259	$	7,781

The following describes the primary factors behind each segment’s prior accident year reserve development for the nine months ended September 30, ~~2019~~2020 and ~~2018:~~2019:

Nine months ended September 30, 2020:

●

Specialty Commercial Segment. Our Commercial Auto business unit experienced net unfavorable development in the 2018 and prior accidentyears both in the primary and excess commercial automobile liability lines of business, partially offset by net favorable development in the excess commercial automobile lines of business in the 2019 accidentyear. Our E&S Casualty business unit experienced net unfavorable development primarily in our primary liability line of business and our E&S package insurance products in the 2017, 2016, 2015 and 2013 and prior accident years, partially offset by net favorable development in the 2019, 2018 and 2014 accident years. We experienced net favorable development in our E&S Property business unit, partially offset by net unfavorable development in our Aerospace & Programs and Professional Liability business units.

17

Table of Contents

●

Standard Commercial Segment. Our Commercial Accounts business unit experienced net unfavorable development primarily in the general liability line of business in the 2018, 2017, 2016, 2015 and 2013 and prior accident years, partially offset by net favorable development in the 2019 and 2014 accidentyears primarily in the general liability line of business. Our Commercial Accounts business unit experienced net favorable development in the 2016 and 2015 accident years, partially offset by net unfavorable development in the 2017 and 2014 accidentyears, in the occupational accident line of business. The run-off from our former Workers Compensation operating unit experienced net favorable development in the 2014 and prior accidentyears, partially offset by net unfavorable development in the 2015 accident year.

●

Personal Segment. Net unfavorable development in our Specialty Personal Lines business unit was mostly attributable to the 2019, 2018, 2017 and 2016 accidentyears, partially offset by favorable development in the 2015 and prior accident years. The net development during the nine months ended September 30, 2020 was driven predominately by unfavorable development attributable to more recent treaty years where we retain a greater portion of the claims.

Nine months ended September 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~~automobile liability line of business, partially offset by net favorable development in the primary commercial ~~auto~~automobile 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

18

~~Table of Contents~~

business in the 2016 and 2015 accident years. Our Commercial Accounts business unit experienced net favorable development in the 2017 and 2015 accident years in the occupational accident line of business. The run-off from our former Workers Compensation operating unit experienced net favorable development in the 2015 and 2012 and prior accident years, partially offset by net unfavorable ~~net~~ development in the 2014 and 2013 ~~prior~~ accident years.

·

●

Personal Segment. Net unfavorable development in our Specialty Personal Lines business unit was mostly attributable to the 2018, 2016, 2014, 2012 and prior accident years, partially offset by favorable development in the 2017, 2015 and 2013 accident years.

~~Nine months ended September 30, 2018:~~

·

~~Specialty Commercial Segment.~~ Our Commercial 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 liability line of business in the 2017 accident year. We experienced net unfavorable development in our E&S Property, Professional Liability, E&S Casualty and Aerospace& Programs business units.

·

~~Standard Commercial Segment.~~ Our Commercial Accounts 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. The run-off from our former 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 business unit was~~ ~~mostly attributable to the 2013 through 2017 accident years, partially offset by unfavorable development in the 2012 and prior accident years~~.

7.8. 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 September 30, ~~2019,~~2020, there were no0 outstanding incentive stock options and outstanding non-qualified stock options to purchase 14,157 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 September 30, ~~2019,~~2020, restricted stock units representing the right to receive up to ~~530,236~~362,794 shares of our common stock were outstanding under the 2015 LTIP. There were no0 stock option awards granted under the 2015 LTIP as of September 30, ~~2019.~~2020.

18

Table of Contents

Stock Options:

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~~The grant of 200,000 non-qualified stock options in 2009 vested in equal annual increments on each of the first ~~seven~~7 anniversary dates and ~~terminated ten years from the date of grant.~~

19

~~Table of Contents~~

was fully exercised prior to termination in 2019.

A summary of the status of our stock options as of September 30, ~~2019~~2020 and changes during the nine months then ended is presented below:


				Average
				Remaining	Aggregate
	Number of	Weighted Average		Contractual	Intrinsic Value
	Shares	Exercise Price		Term (Years)	($000)
Outstanding at January 1, 2019	244,157	$	6.63

										Average
										Remaining	Aggregate
							Number of	Weighted Average		Contractual	Intrinsic Value
							Shares	Exercise Price		Term (Years)	($000)
Outstanding at January 1, 2020							14,157	$	6.99
Granted	—		—				0		0
Exercised	(230,000)	$	6.61				0	$	0
Forfeited or expired	—	$	—				0	$	0
Outstanding at September 30, 2019	14,157	$	6.99	2.3	$	172
Exercisable at September 30, 2019	14,157	$	6.99	2.3	$	172
Outstanding at September 30, 2020							14,157	$	6.99	1.3	$	—
Exercisable at September 30, 2020							14,157	$	6.99	1.3	$	—

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,
	2019		2018		2019		2018

										Three Months Ended September 30,				Nine Months Ended September 30,
									2020		2019		2020		2019
Intrinsic value of options exercised	$	—	$	—	$	845	$	122	$	0	$	0	$	0	$	845
Cost of share-based payments (non-cash)	$	—	$	—	$	—	$	—	$	0	$	0	$	0	$	0
Income tax benefit of share-based payments recognized in income	$	—	$	—	$	—	$	—	$	0	$	0	$	0	$	0

As of September 30, ~~2019,~~2020, there was no0 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 no0 stock options granted during the first nine months of ~~2019~~2020 or ~~2018.~~2019.

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.~~grant if performance criteria have been satisfied.

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

19

Table of Contents

conditions set forth in their award agreement. Therefore, unvested restricted stock units are not considered participating securities under ASC 260, “Earnings Per ~~Share,”~~Share” (Topic 260), 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

~~Table of Contents~~

of restricted stock units granted in ~~2015,~~ 2016, 2017, 2018 and 2019 was ~~$11.10,~~ $11.41, $10.20, $10.87 and $18.10 per unit, respectively. We incurred compensation expense (benefit) of $154 thousand and ($416) thousand related to restricted stock units during the three months and nine months ended September 30, 2020, respectively. We incurred compensation expense of $317 thousand and $514 thousand related to restricted stock units during the three months and nine months ended September 30, 2019, respectively. We ~~incurred compensation expense~~recorded income tax benefit (expense) of ~~$36~~$32 thousand and ~~$37~~($88) thousand related to restricted stock units during the three months and nine months ended September 30, ~~2018,~~2020, respectively. We recorded income tax benefit of $67 thousand and $108 thousand related to restricted stock units during the three months and nine months ended September 30, 2019, respectively. ~~We recorded income tax benefit of $8 thousand related to restricted stock units during both the three months and nine months ended September 30, 2018, respectively.~~

The following table details the status of our restricted stock units as of and for the nine months ended September 30, ~~2019~~2020 and ~~2018:~~2019:



	Number of Restricted Stock Units
	2019	2018


			Number of Restricted Stock Units
			2020	2019
Nonvested at January 1	338,897	385,779	353,491	338,897
Granted	97,804	144,059	0	97,804
Vested	—	(8,198)	(19,065)	0
Forfeited	(83,210)	(182,743)	(92,563)	(83,210)
Nonvested at September 30	353,491	338,897	241,863	353,491

As of September 30, ~~2019,~~2020, there was ~~$2.9~~$1.4 million of unrecognized grant date compensation cost related to unvested restricted stock units assuming compensation cost accrual at target achievement level. Based on the current performance estimate, we expect to recognize ~~$2.7~~$0.4 million of compensation cost related to unvested restricted stock units, of which ~~$0.3~~$0.1 million is expected to be recognized during the remainder of ~~2019, $1.4 million is expected to be recognized in~~ 2020, ~~$0.8~~$0.2 million is expected to be recognized in 2021 and ~~$0.2~~$0.1 million is expected to be recognized in 2022.

8.

20

Table of Contents

9. Segment Information

The following is business segment information for the three and nine months ended September 30, ~~2019~~2020 and ~~2018~~2019 (in thousands):


		Three Months Ended			Nine Months Ended
	2019		2018		2019		2018

										Three Months Ended				Nine Months Ended
									2020		2019		2020		2019
Revenues
Specialty Commercial Segment	$	81,341	$	68,302	$	222,900	$	213,507	$	86,589	$	81,341	$	269,833	$	222,900
Standard Commercial Segment		16,344		19,857		52,027		57,979		17,398		16,344		52,130		52,027
Personal Segment		22,943		9,355		65,542		24,891		20,513		22,943		65,300		65,542
Corporate		(2,343)		5,432		16,840		(1,965)		(1,367)		(2,343)		(30,430)		16,840
Consolidated	$	118,285	$	102,946	$	357,309	$	294,412	$	123,133	$	118,285	$	356,833	$	357,309

Pre-tax income (loss)

Pre-tax (loss) income
Specialty Commercial Segment	$	14,766	$	2,452	$	33,161	$	20,980	$	(26,751)	$	14,766	$	(4,577)	$	33,161
Standard Commercial Segment		62		7,264		3,626		11,239		(1,672)		62		(154)		3,626
Personal Segment		(740)		684		3,274		661		(2,065)		(740)		(5,836)		3,274
Corporate		(7,428)		1,675		2,001		(13,624)		(6,818)		(7,428)		(90,742)		2,001
Consolidated	$	6,660	$	12,075	$	42,062	$	19,256	$	(37,306)	$	6,660	$	(101,309)	$	42,062

21

~~Table of Contents~~

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


	September 30,		December 31,

					September 30,		December 31,
Assets:	2019		2018		2020		2019
Specialty Commercial Segment	$	1,055,106	$	858,262	$	1,117,057	$	1,082,804
Standard Commercial Segment		192,285		158,881		182,977		193,710
Personal Segment		170,715		226,431		137,108		164,685
Corporate		45,428		21,320		60,365		54,075
Consolidated	$	1,463,534	$	1,264,894	$	1,497,507	$	1,495,274

9.10. 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 September 30, ~~2019~~2020 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				Nine Months Ended
	September 30,				September 30,
	2020		2019		2020		2019

Ceded earned premiums	$	80,447	$	83,242	$	250,240	$	229,697
Reinsurance recoveries	$	64,697	$	50,564	$	217,814	$	158,128

Three Months Ended

Nine Months Ended

September 30,

September 30,


2019

2018

2019

2018

Ceded earned premiums

$
83,242

$
73,038

$
229,697

$
203,302
Reinsurance recoveries

$
50,564

$
48,962

$
158,128

$
142,389

21

Table of Contents

Loss Portfolio Transfer

~~10.~~On July 16, 2020, AHIC, HIC, HSIC, HCM and HNIC (collectively, the “Hallmark Insurers”), entered into a Loss Portfolio Transfer Reinsurance Contract to be effective as of January 1, 2020 (the “LPT Contract”) with DARAG Bermuda Ltd. (“DARAG Bermuda”) and DARAG Insurance (Guernsey) Limited (“DARAG Guernsey” and, collectively, the “Reinsurers”).

The Hallmark LPT Contract was consummated on July 31, 2020. The Company recorded a $21.7 million pre-tax loss during the third quarter of 2020 attributable to the closing of the LPT Contract.

Pursuant to the LPT Contract, (a) the Hallmark Insurers ceded to the Reinsurers all existing and future claims for losses occurring on or prior to December 31, 2019 on the binding primary commercial automobile liability insurance policies and the brokerage primary commercial automobile liability insurance policies issued by the Hallmark Insurers (the “Subject Business”) up to an aggregate limit of $240.0 million, with (i) the first layer of $151.2 million in reinsurance provided by DARAG Bermuda, (ii) the Hallmark Insurers retaining a loss corridor of the next $24.9 million in losses on the Subject Business, (iii) DARAG Bermuda reinsuring a second layer of $27.8 million above the first layer and the Hallmark Insurers’ loss corridor, and (iv) DARAG Guernsey reinsuring the top layer of $36.1 million in losses on the Subject Business, in each case net of third-party reinsurance and other recoveries; (b) the Hallmark Insurers will continue to manage and retain the benefit of other third-party reinsurance on the Subject Business; and (c) the Hallmark Insurers paid the Reinsurers a net reinsurance premium of $92.6 million. In connection with the closing, the parties also entered into a Services Agreement and a Trust Agreement. Pursuant to the Services Agreement, DARAG Bermuda assumed responsibility for certain administrative services, including claims handling, for the Subject Business. Pursuant to the Trust Agreement, the Reinsurers made initial cash deposits in the aggregate amount of $96.7 million into collateral trust accounts with The Bank of New York Mellon, as trustee, to be held as security for the Reinsurers’ obligations to the Hallmark Insurers under the LPT Contract.

As of September 30, 2020, the ultimate incurred losses are $157.9 million or $6.7 million in excess of the first layer and currently in the loss corridor in which Hallmark retains $24.9 million. Our reinsurance recoverables of $504.5 million include $72.8 million related to the LPT as of September 30, 2020.

11. Revolving Credit Facility

Our Second Restated Credit Agreement with Frost Bank (“Frost”) dated June 30, 2015, as amended, provided 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 bore interest at a rate equal to the prime rate or LIBOR plus 2.5%, at our election. We paid 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. On August 19, 2019, we terminated Facility A.

The Second Restated Credit Agreement with Frost also provided a $30.0 million revolving credit facility (“Facility B”), in addition to Facility A. We used Facility B loan proceeds solely for the purpose of making capital contributions to AHIC and HIC. We paid a quarterly fee of 0.25% per annum of the average daily unused balance of Facility B. Facility B bore interest at a rate equal to the prime rate or LIBOR plus 3.00%, at our election. On August 19, 2019, we repaid the ~~$30~~$30.0 million principal balance and accrued interest on Facility B. Upon such repayment, we terminated Facility B.

~~11.~~12. Subordinated Debt Securities

We issued trust preferred securities through ~~Hallmark~~ Trust I and ~~Hallmark~~ Trust II. These Delaware statutory trusts are sponsored and wholly-owned by Hallmark and each was created solely for the purpose of issuing the trust preferred securities. Each trust pays dividends on its preferred securities at the same rate each quarter as interest is paid on the junior subordinated debt securities. Under the terms of the ~~trust~~junior subordinated debt securities, we pay interest only each quarter and the

22

Table of Contents

~~each quarter and the~~ principal of each note at maturity. The subordinated debt securities of each trust are uncollateralized and do not require maintenance of minimum financial covenants.

The following table summarizes the nature and terms of the junior subordinated debt and trust preferred securities:


		Hallmark		Hallmark
		Statutory		Statutory
		Trust I		Trust II



						Trust I		Trust II

Issue date		June 21, 2005		August 23, 2007		June 21, 2005		August 23, 2007
Principal amount of trust preferred securities	$	30,000	$	25,000	$	30,000	$	25,000
Principal amount of junior subordinated debt securities	$	30,928	$	25,774	$	30,928	$	25,774
Maturity date of junior subordinated debt securities		June 15, 2035		September 15, 2037		June 15, 2035		September 15, 2037
Trust common stock	$	928	$	774	$	928	$	774
Interest rate, per annum		Three Month LIBOR + 3.25%		Three Month LIBOR + 2.90%		Three Month LIBOR + 3.25%		Three Month LIBOR + 2.90%
Current interest rate at September 30, 2019		5.37%		5.02%
Current interest rate at September 30, 2020						3.50%		3.15%

~~12.~~13. Senior Unsecured Notes

On August 19, 2019, Hallmark issued $50.0 million of senior unsecured notes (“Notes”) due August 15, 2029. Interest on the Notes accrues at the rate of 6.25% per annum and is payable semi-annually in arrears commencing February 15, 2020. The Notes are not obligations of or guaranteed by any of Hallmark’s subsidiaries and are not subject to any sinking fund requirements. At Hallmark’s option, the Notes are redeemable, in whole or in part, prior to the stated maturity subject to certain provisions intended to make the holders of the Notes whole on scheduled interest and principal payments. The indenture governing the Notes contains ~~certain~~ covenants which ~~among other things,~~ restrict Hallmark’s ability to incur additional indebtedness,pay dividends on or acquire its common stock, or make ~~certain~~ payments on its other securities or indebtedness if any such action would cause the Company’s debt to capital ratio (calculated in accordance with the indenture) to exceed 35%. Among other things, the indenture also limits Hallmark’s ability to create liens on the stock of, ~~certain subsidiaries,~~ dispose of ~~certain~~all or substantially all of the assets of, or ~~merge~~permit the merger or ~~consolidate~~consolidation with ~~other entities. As~~another entity of ~~September 30, 2019,~~any direct or indirect insurance company subsidiary with statutory surplus of at least $50.0 million. Hallmark ~~was~~is in compliance with all of these covenants.

~~13.~~14. Deferred Policy Acquisition Costs

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


	Three Months Ended				Nine Months Ended
	September 30,				September 30,
	2019		2018		2019		2018


									Three Months Ended				Nine Months Ended
									September 30,				September 30,
									2020		2019		2020		2019

Deferred	$	8,247	$	11,001	$	(39,300)	$	27,672	$	(20,939)	$	8,247	$	(45,342)	$	(39,300)
Amortized		(9,843)		(11,909)		31,687		(30,524)		21,684		(9,843)		45,971		31,687
Net	$	(1,596)	$	(908)	$	(7,613)	$	(2,852)	$	745	$	(1,596)	$	629	$	(7,613)

23

Table of Contents

~~14.~~15. 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
	September 30,		September 30,
	2019	2018	2019	2018


					Three Months Ended		Nine Months Ended
					September 30,		September 30,
					2020	2019	2020	2019

Weighted average shares - basic	18,123	18,059	18,101	18,097	18,142	18,123	18,136	18,101
Effect of dilutive securities	172	108	182	106	0	172	0	182
Weighted average shares - assuming dilution	18,295	18,167	18,283	18,203	18,142	18,295	18,136	18,283

For the three months and nine months ended September 30, ~~2018, 43,004~~2020, 14,157 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. For the three months and nine months ended September 30, 2019, all shares of common stock potentially issuable upon the exercise of employee stock options were included in the weighted average number of shares outstanding on a diluted basis.

~~15.~~16. Net Periodic Pension Cost

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


	Three Months Ended				Nine Months Ended
	September 30,					September 30,
	2019		2018		2019		2018

									Three Months Ended				Nine Months Ended
									September 30,					September 30,
									2020		2019		2020		2019
Interest cost	$	113	$	106	$	340	$	318	$	89	$	113	$	266	$	340
Amortization of net loss		36		26		108		79		34		36		104		108
Expected return on plan assets		(149)		(173)		(448)		(520)		(171)		(149)		(513)		(448)
Net periodic pension cost	$	—	$	(41)	$	—	$	(123)	$	(48)	$	0	$	(143)	$	0
Contributed amount	$	500	$	—	$	500	$	—	$	0	$	500	$	0	$	500

Refer to Note 1415 to the consolidated financial statements in our Annual Report on Form ~~10‑K~~10-K for the year ended December 31, ~~2018~~2019 for more discussion of our retirement plans.

~~16.~~17. Income Taxes

Our effective income tax rate for the nine months ended September 30, 2020 and 2019 was 15.5% and ~~2018 was~~ 20.7% ~~and 19.9%~~, respectively. The effective rate for the nine months ended September 30, 2020 varied from the statutory tax rates primarily due to the non-deductible impairment of goodwill. The effective tax rate for the nine months ended September 30, 2019 ~~and 2018~~ varied from the statutory tax rates primarily due to tax exempt interest income.

~~17.~~24

Table of Contents

18. 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 (in thousands):


	As of September 30,
	2019		2018


					As of September 30,
					2020		2019

Cash and cash equivalents	$	64,045	$	59,925	$	186,683	$	64,045
Restricted cash		1,697		3,519		17,671		1,697
Total cash, cash equivalents and restricted cash shown in the statement of cash flows	$	65,742	$	63,444	$	204,354	$	65,742

24

~~Table of Contents~~

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.

The following table provides supplemental cash flow information for the nine months ended September 30, ~~2019~~2020 and ~~2018:~~2019:


	Nine Months Ended September 30,
	2019		2018



					Nine Months Ended September 30,
					2020		2019


Interest paid	$	3,911	$	3,325	$	4,845	$	3,911

Income taxes paid (recovered)	$	5,449	$	(4,287)


Income taxes paid					$	654	$	5,449

Supplemental schedule of non-cash investing activities:


Receivable for securities related to investment disposals	$	6,351	$	3,253	$	1,568	$	6,351


Payable for securities related to investment purchases	$	1,952	$	7,699	$	507	$	1,952

~~18.~~19. Commitments and Contingencies

We

On May 5, 2020, a lawsuit styled Schulze v. Hallmark Financial Services, Inc., et. al (Case No. 3:20-cv-01130) was filed in the U.S. District Court for the Northern District of Texas, Dallas Division. The Company, its Chief Executive Officer and its former Chief Financial Officer are named defendants in the lawsuit brought on behalf of a putative class of shareholders who acquired Hallmark securities between March 5, 2019 and March 17, 2020. In general, the complaint alleges that the defendants violated the Securities Exchange Act of 1934 by failing to disclose that (a) the Company lacked effective internal controls over financial reporting related to its reserves for unpaid losses, (b) the Company improperly accounted for reserves for unpaid losses, (c) the Company would be forced to report $63.8 million of prior year net adverse loss development, (d) the Company would exit the contract binding line of its commercial automobile primary insurance business, and (e) the defendants’ positive statements about the Company’s business, operations and prospects were materially misleading and/or lacked a reasonable basis. An amended complaint was filed on September 30, 2020. Defendants’ responsive pleading is not yet due and has not been filed. The litigation is in its initial stages and we are unable to reasonably predict its potential outcome. The Company, however, believes that the lawsuit is without merit and intends to vigorously defend the claims. The Company’s current policy is to expense legal costs as incurred. Historically, the Company has not carried director and officer liability insurance and does not currently hold such a policy.

25

Table of Contents

As of September 30, 2020, we were engaged in various other 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 other legal proceedings to which we ~~are~~were a party are routine in nature and incidental to our business.

25

~~Table of Contents~~

~~19.~~20. Changes in Accumulated Other Comprehensive Income Balances

The changes in accumulated other comprehensive income balances as of September 30, ~~2019~~2020 and ~~2018~~2019 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		80		—		80
Tax effect on change in net actuarial gain		(17)		—		(17)
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) losses included in investment gains and losses		—		159		159
Tax effect on reclassification adjustment for gains (losses) 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)


											Accumulated Other
							Pension		Unrealized		Comprehensive
							Liability		Gains (Loss)		Income (Loss)
Balance at December 31, 2018	$	(3,334)	$	(3,326)	$	(6,660)	$	(3,334)	$	(3,326)	$	(6,660)
Other comprehensive income:
Change in net actuarial gain		108		—		108		108		—		108
Tax effect on change in net actuarial gain		(23)		—		(23)		(23)		—		(23)
Unrealized holding gains arising during the period		—		13,010		13,010		—		13,010		13,010
Tax effect on unrealized gains arising during the period		—		(2,732)		(2,732)		—		(2,732)		(2,732)
Reclassification adjustment for (gains) losses included in net realized gains		—		(4,376)		(4,376)
Tax effect on reclassification adjustment for gains (losses) included in income tax expense		—		919		919
Reclassification adjustment for gains included in net income								—		(4,376)		(4,376)
Tax effect on reclassification adjustment for gains included in net income								—		919		919
Other comprehensive income, net of tax		85		6,821		6,906		85		6,821		6,906
Balance at September 30, 2019	$	(3,249)	$	3,495	$	246	$	(3,249)	$	3,495	$	246

Balance at December 31, 2019							$	(3,239)	$	3,927	$	688
Other comprehensive income (loss):
Change in net actuarial gain								104		—		104
Tax effect on change in net actuarial gain								(22)		—		(22)
Unrealized holding gains arising during the period								—		4,149		4,149
Tax effect on unrealized holding gains arising during the period								—		(872)		(872)
Reclassification adjustment for gains included in net loss								—		(5,612)		(5,612)
Tax effect on reclassification adjustment for gains included in net loss								—		1,179		1,179
Other comprehensive income (loss), net of tax								82		(1,156)		(1,074)
Balance at September 30, 2020							$	(3,157)	$	2,771	$	(386)

~~20.~~21. 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

26

~~Table of Contents~~

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.

The Company’s operating lease obligations predominately 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 ~~nine month~~nine-month periods ended September 30, 2020 and 2019 were as follows (in thousands):

26

Table of Contents


	Three Months Ended				Nine Months Ended
	September 30,				September 30,
	2020		2019		2020		2019

Operating lease cost	$	750	$	790	$	2,291	$	2,146

Cash paid for amounts included in the measurement of lease liabilities
Operating cash flows from operating leases	$	758	$	392	$	1,749	$	1,495

Right-of-use assets obtained in exchange for new operating lease liabilities	$	0	$	0	$	0	$	0

Other lease information as of September 30, 2020 and December 31, 2019 are as follows (in thousands):

Three Months Ended

Nine Months Ended

September 30,

September 30,

2019

2019

Operating lease cost
$
790

$
2,146

Cash paid for amounts included in the measurement of lease liabilities

Operating cash flows from operating leases
$
392

$
1,495

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

$
—


	September 30,		December 31,
	2020		2019

Operating lease right-of-use assets	$	14,467	$	16,044

Operating lease liabilities	$	16,348	$	17,347

Weighted-average remaining lease term - operating leases		10.3		10.6

Weighted-average discount rate - operating leases		5.87%		5.88%

We incurred ~~$8 thousand and $24~~$12 thousand in short-term lease payments not included in our lease liability during the ~~three and~~ nine months ended September 30, ~~2019.~~ 2020.

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

September 30,

2019

Operating lease right-of-use assets

$
16,578

Operating lease liabilities

$
17,485

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 September 30, ~~2019~~2020 and December 31, ~~2018 are~~2019 were as follows (in thousands):


	September 30,			December 31,
	2019			2018

2019	$	394	$	1,889

					September 30,			December 31,
					2020			2019

2020		2,473		2,473	$	724	$	2,473
2021		2,172		2,172		2,172		2,172
2022		2,171		2,171		2,171		2,171
2023		1,885		1,885		1,885		1,885
2024						1,941		1,941
Thereafter		15,266		15,266		13,325		13,325
Total future minimum lease payments(a)	$	24,361	$	25,856	$	22,218	$	23,967


Less imputed interest	$	(6,876)	$	N/A	$	(5,870)	$	(6,620)
Total operating lease liability	$	17,485	$	N/A	$	16,348	$	17,347

(a)

Minimum lease payments have not been reduced by minimum sublease rentals of $433 thousand due in the future under non-cancelable subleases.

During the third quarter of 2020 we entered into a sublease on an office space located at 13727 Noel Road, Dallas, Texas. Certain employees of our Commercial Auto and E&S Casualty business units, were previously located at this office space. During the third quarter we recorded sublease income of $45 thousand as a reduction to rent expense.

27

Table of Contents

Item 2. Management’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,” “our,” or the Company) 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 business units, which are supported by our insurance company subsidiaries.

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

·

●

Specialty Commercial Segment. Our Specialty Commercial Segment includes our Commercial Auto business unit which offers primary and excess commercial vehicle insurance products and services; our E&S Casualty business unit which offers primary and excess liability, excess public entity liability and E&S package and garage liability 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 professional 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, as well as certain specialty 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 package 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 unit)~~ 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 business 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 Insurance Company (“HCM”) is maintained through our wholly owned subsidiary, CYR Insurance Management Company (“CYR”). CYR has as its primary asset a management 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.

28

Table of Contents

AHIC, HIC, HSIC and HNIC have entered into a pooling arrangement pursuant to which AHIC retains 32% 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 26% 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.

28

~~Table of Contents~~

Results of Operations

Management overview. During the three ~~and nine~~ months ended September 30, ~~2019,~~2020, our total ~~revenues were $118.3 million and $357.3~~revenue was $123.1 million, representing an increase of ~~15% and 21%, respectively,~~4% from the ~~$102.9 million and $294.4~~$118.3 million in total ~~revenues~~revenue for the same ~~periods~~period of ~~2018.~~2019. During the three and nine months ended September 30, 2019, our income before tax was $6.7 million and $42.1 million, respectively, as compared to $12.1 million and $19.3 million reported during the same periods the prior year.

The increase in revenue for the three and nine months ended September 30, 2019 compared to the same periods of the prior year was largely due to increased net premiums earned of $23.6 million and $46.2 million, respectively. In addition, the increase in revenue for the nine months ended September 30, ~~2019~~2020, our total revenue was ~~impacted by investment gains~~$356.8 million which was $0.5 million lower than the $357.3 million in total revenue for the same period of ~~$17.4~~2019. During the three months ended September 30, 2020, we reported a pre-tax loss of $37.3 million, as compared to ~~$2.7~~pre-tax income of $6.7 million reported during the same period the prior year. During the nine months ended September 30, 2018. Higher finance charges and net investment income also contributed to the increase in revenue, partially offset by lower commission and fees and other income during the three and nine months ended September 30, 20192020, we reported a pre-tax loss of $101.3 million, as compared to pre-tax income of $42.1 million reported during the same ~~periods during 2018.~~ period the prior year.

The increase in revenue for the three months ended September 30, ~~2019~~2020 was ~~also~~largely due to higher net premiums earned and lower net investment losses, partially offset by lower net investment income and finance charges as compared to the same period of the prior year. The decrease in revenue for the nine months ended September 30, 2020 was primarily due to net investment losses of ~~$1.3~~$27.9 million as compared to net investment gains of ~~$7.0~~$17.4 million during the same period of 2019, as well as a $5.3 million decrease in net investment income for the nine months ended September 30, 2020 as compared to the same period of the prior year. This decrease in revenue was partially offset by increased net premiums earned of $51.1 million for the nine months ended September 30, 2020 compared to the same period of the prior year.

The decrease in income before tax for the three months ended September 30, ~~2018.~~

~~The increases in revenue for the three and nine months ended September 30, 2019 were partially offset by~~2020 was due primarily to increased losses and loss adjustment expenses (“LAE”) of ~~$14.3~~$45.7 million, ~~and $30.3 million, respectively,~~ as compared to the same ~~periods~~period in ~~2018~~2019, partially offset by the increase in revenue. The increase in losses and LAE was due primarily to a $21.7 million charge for a loss portfolio transfer reinsurance contract that closed during the quarter, increased net premiums ~~earned. We reported $6.4~~earned, $13.9 million ~~and $7.8 million, respectively,~~ of unfavorable net prior year loss reserve development during the three months ended September 30, 2020 as compared to $6.4 million during the same period of 2019, and net catastrophe losses of $9.6 million during the three months ended September 30, 2020 as compared to $0.6 million for the same period the prior year.

The pre-tax loss during the nine months ended September 30, ~~2019~~2020 was largely due to a $44.7 million impairment charge to goodwill and a $1.3 million charge to indefinite-lived intangible assets. In connection with its normal process for evaluating impairment triggering events, the Company determined that a significant decline in its market capitalization below its stockholders’ equity during the first quarter of 2020 indicated the impairment of the goodwill and indefinite-lived intangible assets included in our balance sheet.

Further contributing to the increase in the pre-tax loss for the nine months ended September 30, 2020 were increased losses and LAE of $90.7 million, due primarily to a $21.7 million charge for a loss portfolio transfer reinsurance contract, increased net premiums earned as compared to ~~$1.6~~the same period in 2019, and unfavorable prior year loss reserve development and increased net catastrophe losses. We reported $33.3 million ~~and $6.1~~of unfavorable net prior year loss reserve development during the nine months ended September 30, 2020 as compared to $7.8 million of unfavorable net prior year loss reserve development during the same ~~periods~~period of ~~2018.~~2019. Loss and LAE for the first nine months of 2020 was also impacted by a $17.6 million increase in catastrophe losses as compared to the same period of the prior year, of which $5.0 million was attributable to reserves for COVID-19 claims.

We reported a net ~~income~~loss of ~~$5.3~~$28.0 million for the three months ended September 30, ~~2019~~2020 as compared to ~~$9.7~~net income of $5.3 million for the same period in ~~2018. W~~e2019. We reported a net ~~income~~loss of ~~$33.3~~$85.6 million ~~during~~for the nine months ended September 30, ~~2019~~2020 as compared to ~~$15.4~~net income of $33.3 million for the same period ~~during 2018.~~ in 2019. On a diluted basis per share, we reported a net ~~income~~loss of ~~$0.29~~$1.54 per share for the three months ended September 30, ~~2019,~~2020, as compared to ~~$0.53~~net income of $0.29 per share for the same period in ~~2018.~~2019. On a diluted basis per share, we reported a net ~~income~~loss of ~~$1.82~~$4.72 per share for the nine months ended September 30, ~~2019,~~2020, as compared to ~~$0.85~~net income of $1.82 per share for the same period in ~~2018.~~2019. Our effective tax rate was ~~20.7%~~15.5% for the first nine months of ~~2019~~2020 as compared to ~~19.9%~~20.7% for the same period in ~~2018.~~2019. The ~~increase~~decrease in the

29

Table of Contents

effective tax rate for the first nine months in ~~2019~~2020 was due in large part to ~~a decreased percentage~~the non-deductible impairment of ~~tax exempt interest income compared to prior year period.~~

29

~~Table of Contents~~

goodwill and indefinite-lived intangible assets.

Third Quarter ~~2019~~2020 as Compared to Third Quarter ~~2018~~2019

The following is additional business segment information for the three months ended September 30, ~~2019~~2020 and ~~2018~~2019 (in thousands):

Three Months Ended September 30,

Specialty Commercial

Standard Commercial

Segment

Segment

Personal Segment

Corporate

Consolidated


2019

2018

2019

2018

2019

2018

2019

2018

2019

2018

Gross premiums written

$
174,695

$
125,599

$
23,563

$
21,560

$
25,920

$
21,953

$
—

$
—

$
224,178

$
169,112

Ceded premiums written

(84,369)

(66,404)

(7,814)

(2,398)

(4,222)

(12,298)

—

—

(96,405)

(81,100)

Net premiums written

90,326

59,195

15,749

19,162

21,698

9,655

—

—

127,773

88,012

Change in unearned premiums

(14,043)

3,203

(590)

(449)

(641)

(1,904)

—

—

(15,274)

850

Net premiums earned

76,283

62,398

15,159

18,713

21,057

7,751

—

—

112,499

88,862

Total revenues

81,341

68,302

16,344

19,857

22,943

9,355

(2,343)

5,432

118,285

102,946

Losses and loss adjustment expenses

50,107

52,106

11,433

6,261

17,008

5,878

—

—

78,548

64,245



Pre-tax income (loss)

14,766

2,452

62

7,264

(740)

684

(7,428)

1,675

6,660

12,075

Net loss ratio (1)

65.7
%

83.5
%

75.4
%

33.5
%

80.8
%

75.8
%





69.8
%

72.3
%
Net expense ratio (1)

22.0
%

22.4
%

32.1
%

34.1
%

24.1
%

20.2
%





26.0
%

25.8
%
Net combined ratio (1)

87.7
%

105.9
%

107.5
%

67.6
%

104.9
%

96.0
%



95.8
%

98.1
%

Net Favorable (Unfavorable) Prior Year Development

(6,029)

(8,869)

(75)

7,269

(273)

(9)





(6,377)

(1,609)


	Three Months Ended September 30,
	Specialty Commercial						Standard Commercial
	Segment						Segment						Personal Segment						Corporate				Consolidated
	2020			2019			2020			2019			2020			2019			2020		2019		2020			2019
Gross premiums written	$	150,016		$	174,695		$	24,726		$	23,563		$	21,722		$	25,920		$	—	$	—	$	196,464		$	224,178
Ceded premiums written		(69,922)			(84,369)			(7,270)			(7,814)			(3,161)			(4,222)			—		—		(80,353)			(96,405)
Net premiums written		80,094			90,326			17,456			15,749			18,561			21,698			—		—		116,111			127,773
Change in unearned premiums		3,764			(14,043)			(744)			(590)			429			(641)			—		—		3,449			(15,274)
Net premiums earned		83,858			76,283			16,712			15,159			18,990			21,057			—		—		119,560			112,499

Total revenues		86,589			81,341			17,398			16,344			20,513			22,943			(1,367)		(2,343)		123,133			118,285

Losses and loss adjustment expenses		94,323			50,107			14,683			11,433			15,247			17,008			—		—		124,253			78,548

Pre-tax (loss) income	$	(26,751)		$	14,766		$	(1,672)		$	62		$	(2,065)		$	(740)		$	(6,818)	$	(7,428)	$	(37,306)		$	6,660

Net loss ratio (1)		112.5	%		65.7	%		87.9	%		75.4	%		80.3	%		80.8	%						103.9	%		69.8	%
Net expense ratio (1)		22.2	%		22.0	%		26.1	%		32.1	%		32.0	%		24.1	%						27.6	%		26.0	%
Net combined ratio (1)		134.7	%		87.7	%		114.0	%		107.5	%		112.3	%		104.9	%						131.5	%		95.8	%

Net (Unfavorable) Favorable Prior Year Development	$	(11,493)		$	(6,029)		$	(1,431)		$	(75)		$	(987)		$	(273)						$	(13,911)		$	(6,377)

(1)

~~(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.~~

ratio.

Specialty Commercial Segment

Gross premiums written for the Specialty Commercial Segment were ~~$174.7~~$150.0 million for the three months ended September 30, ~~2019,~~2020, which was ~~$49.1~~$24.7 million, or ~~39%~~14%, ~~more~~less than the ~~$125.6~~$174.7 million reported for the same period of ~~2018.~~2019. Net premiums written were ~~$90.3~~$80.1 million for the three months ended September 30, ~~2019~~2020 as compared to ~~$59.2~~$90.3 million for the same period of ~~2018.~~2019. The ~~increase~~decrease in gross and net premiums written was primarily the result of lower premium production in our Commercial Auto and E&S Property business units, partially offset by increased premium production ~~reflected~~ in ~~all~~our E&S Casualty, Professional Liability and Aerospace & Programs business units.In February 2020, we made the strategic decision to exit the contract binding line of the primary automobile business marketed by our Commercial Auto business unit as a result of increasing claim severity and limited opportunity for meaningful rate increases. At that time, we began the process of non-renewing policies and placing in-force policies in runoff in accordance with state regulatory guidelines. The exit of the contract binding line of the primary commercial automobile business contributed $25.1 million and $18.9 million to the decline in gross premiums written and net premiums written, respectively, for the three months ended September 30, 2020 as compared to the same period the prior year.

The ~~$81.3~~$86.6 million of total revenue for the three months ended September 30, ~~2019~~2020 was ~~$13.0~~$5.3 million more than the ~~$68.3~~$81.3 million reported by the Specialty Commercial Segment for the same period in ~~2018.~~2019. This increase in revenue was primarily due to higher net premiums earned of ~~$13.9~~$7.6 million ~~due to~~driven mostly by increased ~~premium production in our~~net premiums earned of $6.2 million from the Professional Liability business unit, $4.7 million from the E&S Casualty business unit, $1.1 million each from the E&S Property ~~E&S Casualty~~ and Aerospace & Programs business units partially offset by ~~lower~~a decrease of $5.5 million in net premiums earned ~~premium~~ in ~~our~~the Commercial Auto business ~~unit,~~unit. The increase in net premiums earned was partially offset by lower net investment income of ~~$0.4~~$2.2 million and lower commission and fees of ~~$0.5~~$0.1 million for the three months ended September 30, ~~2019~~2020 as compared to the same period of ~~2018.~~2019.

~~Pre-tax income for the~~30

Table of Contents

The Specialty Commercial Segment reported a pre-tax loss of ~~$14.8~~$26.7 million for the third quarter of ~~2019 was $12.3 million higher than the $2.5~~2020 as compared to pre-tax income of $14.8 million reported for the same period in ~~2018.~~2019. The ~~increase~~$41.5 million decline in pre-tax ~~income~~results was primarily the result of higher losses and LAE of $44.2 million and higher operating expenses of $2.6 million, partially offset by the increased revenue discussed above ~~and lower~~ ~~losses and loss adjustment expenses of $2.0 million, partially offset by higher operating~~ ~~expenses of $2.7 million~~ during the three months ended September 30, ~~2019~~2020 as compared to the same period during ~~2018.~~2019.The exit of the contract binding line of the primary commercial automobile business contributed $29.9 million to the pre-tax loss for the third quarter of 2020 as compared to $3.6 million of pre-tax income during the same period the prior year. The $29.9 million pre-tax loss from the exited contract binding line of the primary commercial automobile business includes the $21.7 million charge for the loss portfolio transfer reinsurance contract that closed during the quarter.

Our Specialty Commercial Segment reported ~~lower~~higher losses and LAE as the combined result of (a) a ~~$5.9~~$26.9 million ~~decrease~~increase in losses and LAE in our Commercial Auto business unit due largely to ~~$5.1~~$8.3 million of unfavorable prior year net loss reserve development recognized during the three months ended September 30, ~~2019~~2020 as compared to ~~$8.1~~$5.1 million of unfavorable prior year net loss reserve development during the same period of ~~2018,~~2019, as well as a $21.7 million charge for the loss portfolio transfer reinsurance contract that closed during the quarter and higher current accident year net loss trends, (b) a ~~$2.6~~$1.7 million increase in losses and LAE in our E&S Casualty business unit due primarily to increased net premiums earned as well as ~~$1.4~~$2.3 million of

30

~~Table of Contents~~

unfavorable prior year net loss reserve development recognized during the third quarter of ~~2019~~2020 as compared to ~~$0.2~~$1.4 million of unfavorable prior year net loss reserve development during the third quarter of ~~2018,~~2019, (c) a ~~$1.8~~$11.1 million ~~decrease~~increase in losses and LAE in our E&S Property business unit due primarily to ~~lower~~higher net catastrophe ~~and attritional~~losses of $8.1 million during the third quarter of 2020 as compared to negative net catastrophe losses of $0.9 million from favorable current accident year development of net catastrophe losses during the third quarter of 2019, ~~as compared to~~higher net premiums earned, higher current accident year net loss trends and unchanged unfavorable net prior year loss reserve development of $0.3 million during both the third quarter of ~~2018,~~2020 and 2019, (d) a ~~$2.2~~$6.4 million increase in losses and LAE attributable to our Professional Liability business unit due primarily to increased net premiums earned, higher current accident year net loss trends and unfavorable net prior year loss reserve development of $0.5 million during the third quarter of 2020 as compared to favorable net prior year loss reserve development of $0.7 million during the same period the prior year, and (e) a ~~$0.9~~$1.9 million ~~increase~~decrease in losses and LAE in our Aerospace & Programs business unit due primarily to ~~higher~~lower current accident year net loss ~~trends.~~trends driven by lower satellite losses partially offset by $0.1 million of unfavorable prior year net loss reserve development during the third quarter of 2020 compared to $0.1 million of favorable prior year net loss reserve development during the third quarter of 2019 and higher net premiums earned. The exit of the contract binding line of the primary automobile business contributed $2.9 million to the Commercial Auto business unit’s prior year loss reserve development during the third quarter of 2020 as compared to $4.2 million for the same period the prior year.

Operating expenses increased ~~$2.7~~$2.6 million primarily as the result of higher ~~production~~salary and related expenses of $1.6 million driven by increased incentive compensation expense, increased professional services of $0.8 million and higher ~~salary~~production related expenses of $0.5 million, partially offset by lower travel and related expenses of ~~$0.6 million, increased occupancy and other operating expenses of $0.4 million and higher travel related expenses of $0.1~~$0.3 million.

The Specialty Commercial Segment reported a net loss ratio of ~~65.7%~~112.5% for the three months ended September 30, ~~2019~~2020 as compared to ~~83.5%~~65.7% for the same period in ~~2018.~~2019. The gross loss ratio before reinsurance was ~~62.4%~~100.4% for the three months ended September 30, ~~2019~~2020 as compared to ~~73.8%~~62.4% for the same period in ~~2018. The decrease~~2019. The increase in the net loss ratio was due in large part from the $21.7 million charge for the loss portfolio transfer reinsurance contract that closed during the quarter that was reported as ceded incurred losses. The increase in the gross and ~~gross~~net loss ratios were the result of lower current accident year loss trends primarily in our Commercial Auto, E&S Casualty, Professional Liability and E&S Property business units, as well as a decrease in unfavorable prior year net loss reserve development. ~~The Specialty Commercial Segment reported $6.0~~also impacted by $11.5 million of unfavorable prior year net loss reserve development for the three months ended September 30, ~~2019~~2020 as compared to unfavorable prior year net loss reserve development of ~~$8.9~~$6.0 million for the same period of ~~2018.~~ 2019. Catastrophe losses of $8.1 million for the three months ended September 30, 2020 as compared to negative catastrophe losses of $0.5 million from favorable current accident year development of catastrophe losses during the third quarter of 2019 also contributed to the increase in the loss ratios.The Specialty Commercial Segment reported a net expense ratio of ~~22.0%~~22.2% for the third quarter of ~~2019~~2020 as compared to ~~22.4%~~22.0% for the same period of ~~2018. The decrease in the expense ratio was due predominately to the impact~~2019.

31

Table of ~~increased ceding commissions.~~Contents

Standard Commercial Segment

Gross premiums written for the Standard Commercial Segment were ~~$23.6~~$24.7 million for the three months ended September 30, ~~2019,~~2020, which was ~~$2.0~~$1.1 million, or 9%5%, more than the ~~$21.6~~$23.6 million reported for the same period in ~~2018.~~2019. Net premiums written were $17.5 million for the three months ended September 30, 2020 as compared to $15.7 million for the same period in 2019. The increase in the gross and net premiums written was due to higher premium production in our Commercial Accounts business unit. Net premiums written were $15.7 million for the three months ended September 30, 2019 as compared to $19.2 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 ~~$16.3~~$17.4 million for the three months ended September 30, ~~2019,~~2020, was ~~$3.6~~$1.1 million, or ~~18%~~7%, ~~less~~more than the ~~$19.9~~$16.3 million reported for the same period in ~~2018.~~2019. This ~~decrease~~increase in total revenue was due to ~~lower~~higher net premiums earned of ~~$3.6~~$1.6 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,~~higher premium production, partially offset by ~~higher~~lower net investment income of ~~$0.1~~$0.5 million for the three months ended September 30, ~~2019~~2020 as compared to the same period of ~~2018.~~2019.

Our Standard Commercial Segment reported a pre-tax ~~income~~loss of ~~$62 thousand~~$1.7 million for the three months ended September 30, ~~2019~~2020 as compared to ~~$7.3 million~~pre-tax income of $62 thousand reported for the same period of ~~2018.~~2019. This ~~decrease~~decline in pre-tax ~~income~~results was the result of ~~the decreased revenue discussed above and~~ higher loss and ~~loss adjustment expense~~LAE of ~~$5.2~~$3.3 million, partially offset by the higher revenue discussed above as well as lower operating expenses of ~~$1.5~~$0.5 million. ~~Reduced~~Decreased operating expenses were primarily the result of lower production related expenses of ~~$1.6~~$0.3 million ~~due to increased ceding commission from the reinsurance contract entered into during the fourth quarter~~and lower occupancy and other general expenses of ~~2018, partially offset by higher professional services of $0.1~~$0.2 million.

The Standard Commercial Segment reported a net loss ratio of ~~75.4%~~87.9% for the three months ended September 30, ~~2019~~2020 as compared to ~~33.5%~~75.4% for the same period of ~~2018.~~2019. The gross loss ratio before reinsurance for the three months ended September 30, ~~2019~~2020 was ~~67.6%~~72.0% as compared to ~~51.9%~~67.6% reported for the same period of ~~2018. T~~he2019. The increase in the gross and net loss ratios ~~were~~was due primarily to ~~higher current~~unfavorable net ~~accident year~~ loss ~~trends and~~reserve development of $1.4 million during the three months ended September 30, 2020 as compared to unfavorable net loss reserve development of $75 thousand ~~as compared to favorable net loss reserve development of $7.3 million~~ during the same period of ~~2018. The Standard Commercial Segment reported $0.4 million of~~ 2019,net catastrophe losses of $1.5 million during the third quarter of ~~2019 as~~2020 compared to ~~$0.9~~$0.4 million ~~of net catastrophe losses during~~for the same period of ~~2018.~~ the prior year and higher net premiums earned, partially offset by improved current accident year non-catastrophe net loss trends. The Standard Commercial Segment reported a net expense ratio of ~~32.1%~~26.1% for the third quarter of ~~2019~~2020 as compared to ~~34.1%~~32.1% for the same period of

31

~~Table of Contents~~

~~2018.~~ 2019. The decrease in the expense ratio was primarily due to ~~the impact of increased ceding commissions~~lower operating expenses in our Commercial Accounts business ~~unit.~~unit, as well as increased net premiums earned.

Personal Segment

Gross premiums written for the Personal Segment were ~~$25.9~~$21.7 million for the three months ended September 30, ~~2019~~2020 as compared to ~~$22.0~~$25.9 million for the same period in the prior year. Net premiums written for our Personal Segment were ~~$21.7~~$18.6 million in the third quarter of ~~2019,~~2020, which was ~~an increase~~a decrease of ~~$12.0~~$3.1 million from the ~~$9.7~~$21.7 million reported for the third quarter of ~~2018.~~2019. The ~~increase~~decrease in gross and net written premiums was primarily due to ~~higher~~lower premium production in our current geographical footprint. ~~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 ~~$22.9~~$20.5 million for the third quarter of ~~2019~~2020 as compared to ~~$9.4~~$22.9 million for the same period in ~~2018.~~2019. The ~~increase~~decrease in revenue was primarily due to ~~an increase in~~lower net premiums earned of ~~$13.3~~$2.1 million and ~~increased~~lower finance charges of $0.4 million, partially offset by ~~lower~~higher investment income of ~~$0.2~~$0.1 million during the third quarter of ~~2019~~2020 as compared to the same period during ~~2018.~~2019.

Pre-tax loss for the Personal Segment was ~~$0.7~~$2.1 million for the three months ended September 30, ~~2019~~2020 as compared to a pre-tax ~~income~~loss of $0.7 million for the same period of ~~2018.~~2019. The decline in pre-tax ~~loss~~results was primarily the result of decreased revenue as discussed above as well as increased operating expenses of $0.7 million, partially offset by lower losses and LAE of ~~$11.1~~$1.7 million ~~and increased operating expenses of $3.8 million, partially offset by increased revenue discussed above~~ for the three months ended September 30, ~~2019~~2020 as compared to the same period during ~~2018.~~2019. The increased operating expenses were primarily the result of higher production related expenses of $0.9

32

Table of Contents

million, partially offset by lower salary and related expenses of $0.1 million and lower other general expenses of $0.1 million.

The Personal Segment reported a net loss ratio of ~~80.8%~~80.3% for the three months ended September 30, ~~2019~~2020 as compared to ~~75.8%~~80.8% for the same period of ~~2018.~~2019. The gross loss ratio before reinsurance was ~~86.3%~~80.3% for the three months ended September 30, ~~2019~~2020 as compared to ~~66.2%~~86.3% for the same period in ~~2018.~~2019. The ~~higher~~lower gross and net loss ratios for the three months ended September 30, ~~2019~~2020 was ~~primarily the result of higher~~due to lower current accident year loss trends, including ~~net~~lower catastrophe losses of $0.7 million, partially offset by higher net unfavorable prior year loss reserve development. The Personal Segment reported $1.0 million of net unfavorable prior year loss reserve development during the third quarter of 2020 as compared to ~~$22 thousand reported~~$0.3 million net unfavorable prior year loss reserve development during the third quarter of 2019.The Personal Segment had negligible catastrophe losses during the third quarter of 2020 compared to $0.7 million for the same period ~~in 2018. The increases in~~of the ~~net loss ratio were partially offset by a higher ceded loss ratio. The Personal Segment reported unfavorable~~ prior year net loss reserve development of $0.3 million during the three months ended September 30, 2019 as compared to unfavorable net loss reserve development of $9 thousand reported during the same period of 2018.year. The Personal Segment reported a net expense ratio of ~~24.1%~~32.0% for the third quarter of ~~2019~~2020 as compared to ~~20.2%~~24.1% for the same period of ~~2018.~~2019. The increase in the expense ratio was due ~~predominately~~primarily to higher ~~production related~~operating expenses, ~~due to increased retention of business effective October 1, 2018~~as well as lower net premiums earned.

Corporate

Total revenue for Corporate ~~decreased~~increased by ~~$7.8~~$1.0 million for the three months ended September 30, ~~2019~~2020 as compared to the same period the prior year. This ~~decrease~~increase in total revenue was due predominately to investment losses of ~~$1.3~~$0.6 million during the third quarter of ~~2019~~2020 as compared to investment ~~gains~~losses of ~~$7.0~~$1.3 million reported for the same period of ~~2018, partially offset by~~2019, and higher net investment income of ~~$0.5~~$0.3 million for the three months ended September 30, ~~2019~~2020 as compared to the same period during ~~2018.~~2019.

Corporate pre-tax loss was ~~$7.4~~$6.8 million for the three months ended September 30, ~~2019~~2020 as compared to a pre-tax ~~income~~loss of ~~$1.7~~$7.4 million for the same period of ~~2018.~~2019. The improvement in pre-tax ~~loss~~results for the third quarter of 2020 as compared to the same period the prior year was primarily due to the ~~lower~~higher revenue discussed above as well as lower interest expense of $0.1 million, partially offset by higher operating expenses of ~~$1.1~~$0.5 million, ~~due~~ primarily as a result of ~~increased salary~~higher audit and ~~related expense, and higher interest expense of $0.2 million.~~

32

~~Table of Contents~~

legal fees.

Nine Months Ended September 30, ~~2019~~2020 as ~~Compared~~compared to Nine Months Ended September 30, ~~2018~~2019

The following is additional business segment information for the nine months ended September 30, ~~2019~~2020 and ~~2018~~2019 (in thousands):


	Nine Months Ended September 30,
	Specialty Commercial						Standard Commercial
	Segment						Segment						Personal Segment						Corporate				Consolidated
	2019			2018			2019			2018			2019			2018			2019		2018		2019			2018

																													Nine Months Ended September 30,
																													Specialty Commercial						Standard Commercial
																													Segment						Segment						Personal Segment						Corporate				Consolidated
																													2020			2019			2020			2019			2020			2019			2020		2019		2020			2019
Gross premiums written	$	482,034		$	376,491		$	70,926		$	65,931		$	76,770		$	53,414		$	—	$	—	$	629,730		$	495,836		$	438,113		$	482,034		$	74,944		$	70,926		$	68,640		$	76,770		$	—	$	—	$	581,697		$	629,730
Ceded premiums written		(225,100)			(189,145)			(23,087)			(7,598)			(12,524)			(29,802)			—		—		(260,711)			(226,545)			(198,526)			(225,100)			(21,770)			(23,087)			(9,798)			(12,524)			—		—		(230,094)			(260,711)
Net premiums written		256,934			187,346			47,839			58,333			64,246			23,612			—		—		369,019			269,291			239,587			256,934			53,174			47,839			58,842			64,246			—		—		351,603			369,019
Change in unearned premiums		(47,109)			9,071			970			(3,648)			(4,852)			(2,927)			—		—		(50,991)			2,496			19,580			(47,109)			(3,643)			970			1,549			(4,852)			—		—		17,486			(50,991)
Net premiums earned		209,825			196,417			48,809			54,685			59,394			20,685			—		—		318,028			271,787			259,167			209,825			49,531			48,809			60,391			59,394			—		—		369,089			318,028


Total revenues		222,900			213,507			52,027			57,979			65,542			24,891			16,840		(1,965)		357,309			294,412			269,833			222,900			52,130			52,027			65,300			65,542			(30,430)		16,840		356,833			357,309


Losses and loss adjustment expenses		144,430			148,001			33,697			28,562			43,734			15,005			—		—		221,861			191,568			224,468			144,430			37,313			33,697			50,750			43,734			—		—		312,531			221,861

Pre-tax income (loss)		33,161			20,980			3,626			11,239			3,274			661			2,001		(13,624)		42,062			19,256


Pre-tax (loss) income																														(4,577)			33,161			(154)			3,626			(5,836)			3,274			(90,742)		2,001		(101,309)		$	42,062

Net loss ratio (1)		68.8	%		75.4	%		69.0	%		52.2	%		73.6	%		72.5	%						69.8	%		70.5	%		86.6	%		68.8	%		75.3	%		69.0	%		84.0	%		73.6	%						84.7	%		69.8	%
Net expense ratio (1)		22.1	%		22.8	%		30.4	%		33.5	%		23.3	%		29.2	%						25.8	%		27.0	%		19.4	%		22.1	%		30.6	%		30.4	%		27.0	%		23.3	%						24.2	%		25.8	%
Net combined ratio (1)		90.9	%		98.2	%		99.4	%		85.7	%		96.9	%		101.7	%						95.6	%		97.5	%		106.0	%		90.9	%		105.9	%		99.4	%		111.0	%		96.9	%						108.9	%		95.6	%

Net Favorable (Unfavorable) Prior Year Development		(11,232)			(15,730)			3,508			8,829			(57)			839							(7,781)			(6,062)

Net (Unfavorable) Favorable Prior Year Development																														(23,961)			(11,232)			(2,350)			3,508			(6,948)			(57)							(33,259)			(7,781)

(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.~~

ratio.

33

Table of Contents

Specialty Commercial Segment

Gross premiums written for the Specialty Commercial Segment were ~~$482.0~~$438.1 million for the nine months ended September 30, ~~2019,~~2020, which was ~~$105.5~~$43.9 million, or ~~28%~~9%, ~~more~~less than the ~~$376.5~~$482.0 million reported for the same period of ~~2018.~~2019. Net premiums written were ~~$256.9~~$239.6 million for the nine months ended September 30, ~~2019~~2020 as compared to ~~$187.3~~$256.9 million for the same period of ~~2018.~~2019. The ~~increase~~decrease in gross premiums written was primarily the result of lower premium production in our Commercial Auto business unit, partially offset by increased premium production in our E&S Casualty, Professional Liability, E&S Property and Aerospace & Programs business units.The decrease in net premiums written was primarily the result of ~~increased premium production reflected~~lower net premiums written in our Commercial Auto ~~Professional Liability,~~and E&S Property business units, partially offset by increased net premiums written in our E&S Casualty, Professional Liability and Aerospace & Programs business units.In February 2020, we made the strategic decision to exit the contract binding line of the primary automobile business marketed by our Commercial Auto business unit as a result of increasing claim severity and limited opportunity for meaningful rate increases. At that time, we began the process of non-renewing policies and placing in-force policies in runoff in accordance with state regulatory guidelines. The exit of the contract binding line of the primary commercial automobile business contributed $66.4 million and $46.3 million to the decline in gross premiums written and net premiums written, respectively, for the nine months ended September 30, 2020 as compared to the same period the prior year.

The ~~$222.9~~$269.8 million of total revenue for the nine months ended September 30, ~~2019~~2020 was ~~$9.4~~$46.9 million more than the ~~$213.5~~$222.9 million reported by the Specialty Commercial Segment for the same period in ~~2018.~~2019. This increase in revenue was primarily due to higher net premiums earned of ~~$13.4~~$49.3 million ~~due~~attributable to ~~higher premium production in our~~increased net premiums earned of $19.5 million from the Professional Liability business unit, $16.1 million from the E&S Casualty business unit, $6.4 million from the E&S Property ~~E&S Casualty~~business unit, $5.0 million from the Commercial Auto business unit and $2.3 million from the Aerospace & Programs business ~~units, partially offset by lower net earned premium in our Commercial Auto business~~ unit. ~~This~~The increase in net premiums earned was partially offset by lower net investment income of ~~$2.5~~$2.3 million and lower commission and fees of ~~$1.5~~$0.1 million for the nine months ended September 30, ~~2019~~2020 as compared to the same period of ~~2018.~~2019.

~~Pre-tax income for the~~The Specialty Commercial Segment reported a pre-tax loss of $33.2 million for the nine months ended September 30, 2019 was $12.2 million higher than the $21.0 million reported for the same period in 2018. This increase in pre-tax income was primarily the result of the increased revenue discussed above and lower losses and LAE of $3.6 million, partially offset by higher operating expenses of $0.8$4.6 million during the nine months ended September 30, ~~2019~~2020 as compared to pre-tax income of $33.2 million reported for the same period in 2019. The decrease in pre-tax results was primarily the result of higher losses and LAE of $80.0 million and higher operating expenses of $4.7 million during the nine months ended September 30, 2020 as compared to the same period during ~~2018.~~2019, partially offset by higher revenue as discussed above. The exit of the contract binding line of the primary commercial automobile business contributed $37.6 million to the pre-tax loss for the nine months ended September 30, 2020 as compared to $3.6 million of pre-tax income during the same period the prior year. The $37.6 million pre-tax loss from the exited contract binding line of the primary commercial automobile business includes the $21.7 million charge for the loss portfolio transfer reinsurance contract that closed during the third quarter of 2020.

Our Specialty Commercial Segment reported ~~a $3.6 million decrease in~~higher losses and LAE ~~which consisted~~as the combined result of (a) a ~~$24.0~~$40.8 million ~~decrease~~increase in losses and LAE in our Commercial Auto ~~Business~~business unit due largely to ~~lower net earned premiums, as well as $7.6~~$22.8 million of unfavorable prior year net loss reserve development recognized during the nine months ended September 30, ~~2019~~2020 as compared to ~~$17.5~~$7.5 million of unfavorable prior year net loss reserve development during the same

33

~~Table of Contents~~

period of ~~2018,~~2019, as well as a $21.7 million charge for the loss portfolio transfer reinsurance contract that closed during the third quarter 2020 and higher current accident year net loss trends, (b) a ~~$10.9~~$7.2 million increase in losses and LAE in our E&S Casualty business unit due primarily to increased net premiums earned as well as higher current accident year net loss trends, partially offset by $2.6 million of unfavorable prior year net loss reserve development recognized during the nine months ended September 30, 2020 as compared to $5.0 million of unfavorable prior year net loss reserve development during the ~~nine months ended September 30,~~third quarter of 2019, ~~as compared to $4.6 million of favorable prior year net loss reserve development during the same period of 2018, as well as higher net earned premiums,~~ (c) a ~~$2.4~~$13.7 million increase in losses and LAE in our E&S Property business unit due primarily to ~~increased~~higher net ~~premiums earned, partially offset by $0.8~~catastrophe losses of $13.9 million ~~of net favorable prior year loss reserve development~~ during the nine months ended September 30, ~~2019~~2020 as compared to ~~$0.8~~net catastrophe losses of $1.5 million ~~of unfavorable prior year net loss reserve development~~ during the same period of ~~2018,~~2019 and higher net premiums earned, partially offset by favorable net prior year loss reserve development of $1.9 million during the nine months ended September 30, 2020 as compared to favorable net prior year loss reserve development of $0.8 million during the same period of 2019, (d) a ~~$6.1~~$15.2 million increase in losses and LAE attributable to our Professional Liability business unit due primarily to increased net premiums earned, ~~partially offset by lower~~higher current accident year net loss trends as well as unfavorable net prior year loss reserve development of $32 thousand during the nine months ended September 30, 2020 as compared to favorable net prior year loss reserve development of $0.8 million during the same period the prior year, and (e) a ~~$1.0~~$3.1 million increase in losses and LAE in our Aerospace & Programs

34

Table of Contents

business unit due primarily to higher net premiums earned, higher current accident year net loss trends and $0.5 million of unfavorable prior year net loss reserve development during the nine months ended September 30, 2020 compared to $0.3 million of unfavorable prior year net loss reserve development during the same period of 2019. The exit of the contract binding line of the primary automobile business contributed $11.7 million to the Commercial Auto business unit’s prior year loss reserve development during the nine months ended September 30, 2020 as ~~well as higher net premiums earned.~~compared to $6.9 million for the same period the prior year.

Operating expenses increased ~~$0.8~~$4.7 million primarily as the result of higher production related expenses of $3.7 million, increased professional services of $2.2 million and increased other operating expenses of $0.5 million, partially offset by lower salary and related expenses of ~~$1.6 million, increased occupancy and other operating expenses of $0.9 million and higher travel related expenses of $0.1 million, partially offset by lower production related expenses of $1.7~~$1.1 million, due primarily to ~~increased ceding commission from the reinsurance contract entered into~~incentive compensation accrual adjustments reported during the ~~fourth~~first quarter of ~~2018~~2020, and lower ~~professional services~~travel and related expenses of ~~$0.1~~$0.6 million.

The Specialty Commercial Segment reported a net loss ratio of ~~68.8%~~86.6% for the nine months ended September 30, ~~2019~~2020 as compared to ~~75.4%~~68.8% for the same period in ~~2018.~~2019. The gross loss ratio before reinsurance was ~~68.0%~~89.7% for the nine months ended September 30, ~~2019~~2020 as compared to ~~72.5%~~68.0% for the same period in ~~2018.~~2019. The ~~lower~~increase in the net loss ratio was due in large part to the $21.7 million charge for the loss portfolio transfer reinsurance contract that closed during the third quarter of 2020 that was reported as ceded incurred losses. The increase in the gross and net loss ratios ~~were largely the result of lower gross current accident year loss trends, as well as lower unfavorable prior year loss reserve development.~~ ~~The Specialty Commercial Segment reported $11.2~~was also impacted by $24.0 million of unfavorable prior year net loss reserve development for the nine months ended September 30, ~~2019~~2020 as compared to unfavorable prior year net loss reserve development of ~~$15.7~~$11.2 million for the same period of ~~2018.~~ ~~During~~2019. Catastrophe losses of $16.4 million for the nine months ended September 30, ~~2019, the Specialty Commercial Segment reported $2.1 million of net catastrophe losses~~2020 as compared to ~~$1.3~~catastrophe losses of $2.1 million during the same period of ~~2018.~~2019 also contributed to the increase in the loss ratios.The Specialty Commercial Segment reported a net expense ratio of ~~22.1%~~19.4% for the nine months ended September 30, ~~2019~~2020 as compared to ~~22.8%~~22.1% for the same period of ~~2018.~~2019. The decrease in the net expense ratio was due ~~predominately~~largely to the ~~impact of increased ceding commissions.~~increase in net premiums earned partially offset by the increase in operating expenses.

Standard Commercial Segment

Gross premiums written for the Standard Commercial Segment were ~~$70.9~~$74.9 million for the nine months ended September 30, ~~2019,~~2020, which was ~~$5.0~~$4.0 million, or ~~8.0%~~6%, more than the ~~$65.9~~$70.9 million reported for the same period in ~~2018.~~2019. Net premiums written were $53.2 million for the nine months ended September 30, 2020 as compared to $47.8 million for the same period in 2019. The increase in the gross and net premiums written was due to higher premium production in our Commercial Accounts business unit. Net premiums written were $47.8 million for the nine months ended September 30, 2019 as compared to $58.3 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 ~~$52.0~~$52.1 million for the nine months ended September 30, ~~2019,~~2020, was ~~$6.0~~$0.1 million ~~or 10%, less~~more than the ~~$58.0~~$52.0 million reported for the same period in ~~2018.~~2019. This ~~decrease~~increase in total revenue was due to ~~lower~~higher net premiums earned of ~~$5.9 million, due primarily to the quota share reinsurance agreement entered into during the fourth quarter of 2018, and lower commission and fees of $0.2~~$0.7 million, partially offset by ~~higher~~lower net investment income of ~~$0.1~~$0.5 million ~~during the nine months ended September 30, 2019 as compared to the same period during 2018.~~

~~Our Standard Commercial Segment reported pre-tax income~~and lower finance charges of ~~$3.6~~$0.1 million for the nine months ended September 30, ~~2019~~2020 as compared to ~~$11.2~~the same period of 2019.

Our Standard Commercial Segment reported a pre-tax loss of $0.2 million for the nine months ended September 30, 2020 as compared to pre-tax income of $3.6 million reported for the same period of ~~2018. The decrease~~2019. This decline in pre-tax ~~income~~results was the result of ~~decreased revenue discussed above and~~ higher ~~losses~~loss and LAE of ~~$5.1~~$3.6 million and higher operating expenses of $0.3 million, partially offset by ~~lower operating expenses of $3.5 million. Reduced~~increased revenue as discussed above. Increased operating expenses were ~~largely~~primarily the result of ~~lower production related expenses of $4.0 million due to increased ceding commission from the reinsurance contract entered into during the fourth quarter of 2018, partially offset by~~ higher salary and related expenses of ~~$0.3~~$0.2 million, higher professional services of $0.2 million and ~~higher professional service fees~~increased other operating expense of $0.1 million, partially offset by lower travel and ~~other general~~related expenses of ~~$0.2~~$0.1 million and lower occupancy and related expenses of $0.1 million.

34

~~Table of Contents~~

The Standard Commercial Segment reported a net loss ratio of ~~69.0%~~75.3% for the nine months ended September 30, ~~2019~~2020 as compared to ~~52.2%~~69.0% for the same period of ~~2018.~~2019. The gross loss ratio before reinsurance for the nine months ended September 30, ~~2019~~2020 was ~~69.4%~~68.9% as compared to ~~the 60.5%~~69.4% reported for the same period of ~~2018. T~~he2019. The decrease in the gross loss ratio was due primarily to lower gross current accident year loss trends. The increase in the ~~gross and~~ net loss ~~ratios~~ratio was due to higher current net accident year loss trends and a lower net favorable prior year reserve development. During the nine months ended September 30, 2019, the Standard Commercial Segment reported favorableincreased ceded earned premium, unfavorable net loss reserve development of ~~$3.5~~$2.4 million during the nine months ended

35

Table of Contents

September 30, 2020 as compared to favorable net loss reserve development of ~~$8.8~~$3.5 million during the same period of ~~2018. The Standard Commercial Segment reported $1.5 million of~~2019and net catastrophe losses of $5.4 million during the nine months ended September 30, ~~2019~~ as2020 compared to ~~$3.2~~$1.5 million ~~of net catastrophe losses during~~for the same period of ~~2018.~~ the prior year. Catastrophe losses during the nine months ended September 30, 2020 included $3.0 million of net losses for COVID-19 claims. The Standard Commercial Segment reported a net expense ratio of ~~30.4%~~30.6% for the nine months ended September 30, ~~2019~~2020 as compared to ~~33.5%~~30.4% for the same period of ~~2018.~~2019. The ~~decrease~~increase in the expense ratio was primarily due to ~~the impact of increased ceding commissions~~higher operating expenses, partially offset by higher net premiums earned in our Commercial Accounts business unit.

Personal Segment

Gross premiums written for the Personal Segment were ~~$76.8~~$68.6 million for the nine months ended September 30, ~~2019~~2020 as compared to ~~$53.4~~$76.8 million for the same period in the prior year. Net premiums written for our Personal Segment were ~~$64.2~~$58.8 million for the nine months ended September 30, ~~2019,~~2020, which was ~~an increase~~a decrease of ~~$40.6~~$5.4 million from the ~~$23.6~~$64.2 million reported for the same period ~~in 2018.~~of 2019. The ~~increase~~decrease in gross and net written premiums was primarily due to ~~higher~~lower premium production in our current geographical footprint. ~~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 ~~$65.5~~$65.3 million for the nine months ended September 30, ~~2019~~2020 as compared to ~~$24.9~~$65.5 million for the same period in ~~2018.~~2019. The ~~increase~~decrease in revenue was due to ~~an increase in~~lower finance charges of $0.7 million and lower investment income of $0.5 million, partially offset by higher net premiums earned of ~~$38.7 million, increased finance charges of $1.7 million and increased investment income of $0.2~~$1.0 million during the nine months ended September 30, ~~2019~~2020 as compared to the same period during ~~2018.~~2019.

Pre-tax ~~income~~loss for the Personal Segment was ~~$3.3~~$5.8 million for the nine months ended September 30, ~~2019~~2020 as compared to pre-tax income of ~~$0.7~~$3.3 million for the same period of ~~2018.~~2019. The pre-tax ~~income~~loss was primarily the result of ~~the increased revenue discussed above, partially offset by~~ increased losses and LAE of ~~$28.7~~$7.0 million, ~~and~~ increased operating expenses of ~~$9.3~~$1.9 million and the decreased revenue discussed above for the nine months ended September 30, ~~2019~~2020 as compared to the same period during ~~2018.~~2019. The increase in operating expenses was due primarily to increased production related expenses of $2.3 million and increased professional services expenses of $0.2 million, partially offset by lower salary and related expenses of $0.5 million and lower travel and related expenses of $0.1 million.

The Personal Segment reported a net loss ratio of ~~73.6%~~84.0% for the nine months ended September 30, ~~2019~~2020 as compared to ~~72.5%~~73.6% for the same period of ~~2018.~~2019. The gross loss ratio before reinsurance was ~~77.8%~~77.1% for the nine months ended September 30, ~~2019~~2020 as compared to ~~67.9%~~77.8% for the same period in ~~2018.~~2019. The ~~higher~~lower gross loss ratio was primarily the result of higher current accident year loss trends, as well as unfavorable gross loss reserve development as compared to favorable gross loss reserve development for the prior year to date period. The higher net loss ratio was primarily the result of higher gross current accident year loss trends, including net catastrophe losses of $1.1 million as compared to $0.1 million for the prior year, and unfavorable net reserve development as compared to favorable net reserve development for the prior year, partially offset by a higher ceded loss ratio. The Personal Segment reported un~~favorable net loss reserve development of $57 thousand~~ for the nine months ended September 30, ~~2019~~2020 as compared to ~~favorable~~the same period in 2019 was due primarily to lower current accident year gross loss trends. The higher net loss ratio for the nine months ended September 30, 2020 was primarily the result of $6.9 million net unfavorable prior year loss reserve development during the first nine months of 2020 as compared to net unfavorable prior year loss reserve development of ~~$0.8~~$57 thousand during the first nine months of 2019. The net unfavorable development for the first nine months of 2020 was driven in large part by unfavorable development attributable to more recent treaty years where we retain a greater portion of the claims.The Personal Segment had catastrophe losses of $0.4 million during the nine months ended September 30, 2020 as compared to $1.1 million during the same period of ~~2018.~~ 2019. The Personal Segment reported a net expense ratio of ~~23.3% for~~27.0% during the nine months ended September 30, ~~2019~~2020 as compared to ~~29.2%~~23.3% for the same period of ~~2018.~~2019. The ~~decrease~~increase in the expense ratio was due ~~predominately~~ to higher ~~net premiums earned and higher finance charges,~~operating expenses, partially offset by higher ~~production related expenses due to increased retention of business effective October 1, 2018.~~net premiums earned.

Corporate

Total revenue for Corporate ~~increased~~decreased by ~~$18.8~~$47.3 million for the nine months ended September 30, ~~2019~~2020 as compared to the same period the prior year. This ~~increase~~decrease in total revenue was due predominately to investment ~~gains~~losses of ~~$17.4~~$27.9 million during the nine months ended September 30, ~~2019~~2020 as compared to investment gains of ~~$2.7~~$17.4 million reported for the same period of ~~2018, as well as higher~~2019 and lower net investment income of ~~$4.1 million for the nine months ended September 30, 2019 as compared to the same period during 2018.~~

35

~~Table of Contents~~

~~Corporate pre-tax income was~~ $2.0 million for the nine months ended September 30, ~~2019~~2020 as compared to athe same period during 2019.

Corporate pre-tax loss was $90.7 million for the nine months ended September 30, 2020 as compared to pre-tax income of ~~$13.6~~$2.0 million for the same period of ~~2018.~~2019. The pre-tax ~~income~~loss was primarily due to a $44.7 million impairment

36

Table of Contents

charge to goodwill and a $1.3 million charge to indefinite-lived intangible assets. In connection with its normal process for evaluating impairment triggering events, the Company determined that a significant decline in its market capitalization below its stockholders’ equity during the first quarter of 2020 indicated the impairment of the goodwill and indefinite-lived intangible assets included in our balance sheet. Further contributing to the pre-tax loss was higher interest expense of $0.2 million, as well as the lower revenue discussed ~~above,~~above. The pre-tax loss was partially ~~offset~~reduced by ~~higher~~lower operating expenses of ~~$2.7~~$0.8 million, primarily as a result of ~~increased~~decreased salary and related expenses of $2.7 million, largely due to incentive compensation accrual adjustments, and decreased travel and related expenses of $0.1 million, partially offset by higher professional ~~services,~~service expenses of $1.1 million, occupancy and ~~higher interest expense~~other general expenses of ~~$0.5~~$0.9 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 September 30, ~~2019, we~~2020, Hallmark and its non-insurance company subsidiaries had ~~$25.1~~$11.9 million in unrestricted cash and cash equivalents, ~~as well as $1.0~~including $4.5 million held in ~~debt securities, at the holding company~~premium and ~~our non-insurance subsidiaries.~~claim trust accounts. As of that date, our insurance subsidiaries held ~~$38.9~~$174.8 million of unrestricted cash and cash equivalents, as well as ~~$567.8~~$417.6 million in debt securities with an average modified duration of ~~1.5~~0.9 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‑month~~12-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’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 ~~2019,~~2020, the aggregate ordinary dividend capacity of these subsidiaries is ~~$33.9~~$22.6 million, of which ~~$22.9~~$15.8 million is available to Hallmark. As a county mutual, dividends from HCM are payable to policyholders. During the first nine months of ~~2019~~2020 and ~~2018,~~2019, our insurance company subsidiaries paid ~~$12.8~~$8.0 million and ~~$4.6~~$12.8 million in dividends to Hallmark, respectively. During the first nine months of 2020 our insurance subsidiaries paid $4.2 million in managements fees to Hallmark. During the first nine months of 2019 our insurance subsidiaries did not pay management fees to Hallmark.

Comparison of September 30, ~~2019~~2020 to December 31, ~~2018~~2019

On a consolidated basis, our cash (excluding restricted cash) and investments at September 30, ~~2019~~2020 were ~~$728.0~~$627.7 million compared to ~~$663.5~~$729.0 million at December 31, ~~2018.~~2019. The primary reasons for this ~~increase~~decrease in unrestricted cash and investments were ~~cash provided by operations, proceeds from our senior unsecured note offering, increases~~decreases in investment fair values and ~~proceeds from the exercise of employee stock options, partially offset by~~ ~~the repayment of the principal balance and accrued interest on our revolving credit facility, net~~ ~~purchases of fixed assets, and repurchases of common stock.~~cash used in operations.

Comparison of Nine Months Ended September 30, ~~2019~~2020 and September 30, ~~2018~~2019

During the nine months ended September 30, ~~2019,~~2020, our cash flow used by operations was $62.9 million compared to cash flow provided by operations ~~was~~of $22.9 ~~million compared to cash flow used by operations of $19.0~~ million during the same period the prior year. The cash flow ~~provided~~used by operations ~~during the first nine months of 2019~~ was driven by an increase in ~~collected~~ net ~~premiums, higher~~paid claims, which includes $92.6 million net reinsurance premium paid in connection with the loss portfolio transfer reinsurance agreement closed during the third quarter of 2020, increased paid operating expenses, lower collected investment income, lower collected commission and fee income and higher ~~collected finance charges. These increases in operating cash flow were~~interest paid, partially offset by increased ~~paid operating expense, increased federal income~~collected net premiums and lower taxes paid ~~and higher paid claims~~ during the nine months ended September 30, ~~2019~~2020 as compared to the same period the prior year.

Net cash ~~used~~provided by investing activities during the first nine months of ~~2019~~2020 was ~~$16.8~~$212.3 million as compared to net cash ~~provided~~used by investing activities of ~~$16.0~~$16.8 million during the first nine months of ~~2018.~~ 2019. The increase in cash ~~used~~ provided

37

Table of Contents

by investing activities during the first nine months of ~~2019~~2020 was primarily comprised of an increase of ~~$24.5 million in purchases of debt and equity securities, a decrease of $6.1~~$202.4 million in maturities, sales and redemptions of investment securities, ~~as well as~~ a ~~$2.2~~decrease of $24.3 million ~~increase~~in purchases of debt and equity securities and a $2.4 million decrease in purchases of fixed assets.

36

~~Table~~The Company did not report any net cash from financing activities during the first nine months of ~~Contents~~

2020. Cash provided by financing activities during the first nine months of 2019 was $19.2 million primarily as a result of net proceeds from our senior unsecured note offering of $49.0 million and proceeds from the exercise of employee stock options of $1.5 million, partially offset by the $30.0 million repayment of the principal balance on our revolving credit facility and $1.4 million in repurchases of our common stock. ~~Cash used in financing activities during the first nine months of 2018 was $1.2 million primarily as a result of repurchases of our common stock.~~

Revolving Credit Facilities

Our Second Restated Credit Agreement with Frost Bank (“Frost”) dated June 30, 2015, as amended, , provided 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 bore interest at a rate equal to the prime rate or LIBOR plus 2.5%, at our election. We paid 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. On August 19, 2019, we terminated Facility A.

The Second Restated Credit Agreement with Frost also provided a $30.0 million revolving credit facility (“Facility B”), in addition to Facility A. We used Facility B loan proceeds solely for the purpose of making capital contributions to AHIC and HIC. We paid a quarterly fee of 0.25% per annum of the average daily unused balance of Facility B. Facility B bore interest at a rate equal to the prime rate or LIBOR plus 3.00%, at our election. On August 19, 2019, we repaid the ~~$30~~$30.0 million principal balance and accrued interest on Facility B. Upon such repayment, we terminated Facility B.

Subordinated Debt Securities

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 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.

Each trust pays dividends on its preferred securities at the same rate each quarter as interest is paid on the junior subordinated debt securities. Under the terms of the ~~trust~~junior subordinated debt securities, we pay interest only each quarter and the principal of each note at maturity. The subordinated debt securities of each trust are uncollateralized and do not require maintenance of minimum financial covenants.

38

Table of Contents

The following table summarizes the nature and terms of the junior subordinated debt and trust preferred securities:


		Hallmark		Hallmark
		Statutory		Statutory
		Trust I		Trust II



						Trust I		Trust II

Issue date		June 21, 2005		August 23, 2007		June 21, 2005		August 23, 2007
Principal amount of trust preferred securities	$	30,000	$	25,000	$	30,000	$	25,000
Principal amount of junior subordinated debt securities	$	30,928	$	25,774	$	30,928	$	25,774
Maturity date of junior subordinated debt securities		June 15, 2035		September 15, 2037		June 15, 2035		September 15, 2037
Trust common stock	$	928	$	774	$	928	$	774
Interest rate, per annum		Three Month LIBOR + 3.25%		Three Month LIBOR + 2.90%		Three Month LIBOR + 3.25%		Three Month LIBOR + 2.90%
Current interest rate at September 30, 2019		5.37%		5.02%
Current interest rate at September 30, 2020						3.50%		3.15%

37

~~Table of Contents~~

Senior Unsecured Notes

On August 19, 2019, Hallmark issued $50.0 million of senior unsecured notes (“Notes”) due August 15, 2029. Interest on the Notes accrues at the rate of 6.25% per annum and is payable semi-annually in arrears commencing February 15, 2020. The Notes are not obligations of or guaranteed by any of Hallmark’s subsidiaries and are not subject to any sinking fund requirements. At Hallmark’s option, the Notes are redeemable, in whole or in part, prior to the stated maturity subject to certain provisions intended to make the holders of the Notes whole on scheduled interest and principal payments. The indenture governing the Notes contains certain covenants which, among other things, restrict Hallmark’s ability to incur additional indebtedness, make certain payments, create liens on the stock of certain subsidiaries, dispose of certain assets, or merge or consolidate with other entities. ~~As of September 30, 2019,~~ Hallmark ~~was~~is in compliance with all of these covenants.

Item 3. Quantitative and Qualitative Disclosures About Market Risk.

Not required for 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.

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

This Form ~~10‑Q~~10-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

39

Table of Contents

assurance that the forward-looking statements included in this Form ~~10‑Q~~10-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.

3840

Table of Contents

PART II

OTHER INFORMATION

Item 1. Legal Proceedings.

On May 5, 2020, a lawsuit styled Schulze v. Hallmark Financial Services, Inc., et. al (Case No. 3:20-cv-01130) was filed in the U.S. District Court for the Northern District of Texas, Dallas Division. The Company, its Chief Executive Officer and its former Chief Financial Officer are named defendants in the lawsuit brought on behalf of a putative class of shareholders who acquired Hallmark securities between March 5, 2019 and March 17, 2020. In general, the complaint alleges that the defendants violated the Securities Exchange Act of 1934 by failing to disclose that (a) the Company lacked effective internal controls over financial reporting related to its reserves for unpaid losses, (b) the Company improperly accounted for reserves for unpaid losses, (c) the Company would be forced to report $63.8 million of prior year net adverse loss development, (d) the Company would exit the contract binding line of its commercial automobile primary insurance business, and (e) the defendants’ positive statements about the Company’s business, operations and prospects were materially misleading and/or lacked a reasonable basis. An amended complaint was filed on September 30, 2020. Defendants’ responsive pleading is not yet due and has not been filed. The litigation is in its initial stages and we are unable to reasonably predict its potential outcome. The Company, however, believes that the lawsuit is without merit and intends to vigorously defend the claims. The Company’s current policy is to expense legal costs as incurred. Historically, the Company has not carried director and officer liability insurance and does not currently hold such a policy.

We are engaged in various other 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. Risk Factors.

There have been no material changes to the risk factors discussed in Item 1A to Part I of our Form 10-K for the fiscal year ended December 31, ~~2018.~~2019.

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 September 30, ~~2019.~~2020.

Item 3. Defaults Upon Senior Securities.

None.

Item 4. Mine Safety Disclosures.

None.

Item 5. Other Information.

None.

3941

Table of Contents

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‑1~~S-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‑K~~8-K filed March 28, 2017).

~~4.1~~ 10.1		~~Indenture~~Loss Portfolio Transfer Reinsurance Contract signed July 16, 2020 between American Hallmark ~~Financial Services, Inc.~~Insurance Company of Texas, Hallmark Specialty Insurance Company, Hallmark Insurance Company, Hallmark County Mutual Insurance Company and ~~The Bank of New York Mellon Trust~~Hallmark National Insurance Company ~~N.A. dated August 19, 2019~~and DARAG Bermuda Ltd. and DARAG Insurance (Guernsey) Limited (incorporated by reference to Exhibit ~~4.1~~10.1 to the registrant’s Current Report on Form 8-K filed July 17, 2020).

10.2		Services Agreement executed July 31, 2020 by and between American Hallmark Insurance Company of Texas, Hallmark Specialty Insurance Company, Hallmark Insurance Company, Hallmark National Insurance Company and Hallmark County Mutual Insurance Company and DARAG Bermuda Ltd. (incorporated by reference to Exhibit 10.1 to the registrant’s Current Report on Form 8-K filed August ~~21, 2019)~~4, 2020).

~~4.2~~10.3		~~First Supplemental Indenture between~~Trust Agreement dated July 31, 2020 among DARAG Bermuda Ltd. and DARAG Insurance (Guernsey) Limited, as grantors, American Hallmark ~~Financial Services, Inc.~~Insurance Company of Texas, Hallmark Specialty Insurance Company, Hallmark Insurance Company and Hallmark National Insurance Company, as beneficiaries, and The Bank of New York Mellon, ~~Trust Company, N.A. dated August 19, 2019~~as trustee (incorporated by reference to Exhibit ~~4.2~~10.2 to the registrant’s Current Report on Form 8-K filed August ~~21, 2019)~~4, 2020).

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.~~Document- the instance document does not appear in the Interactive Data File because its XBRL tags are embedded within the Inline XBRL 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.

Exhibit 104		Cover Page Interactive Data File - The cover page interactive data file does not appear in the Interactive Data File because its XBRL tags are embedded within the Inline XBRL document

42

Table of Contents

+

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 September 30, ~~2019~~2020 and December 31, ~~2018,~~2019, (ii) Consolidated Statements of Operations for the three months and nine months ended September 30, ~~2019~~2020 and ~~2018,~~2019, (iii) Consolidated Statements of Comprehensive Income for the three months and nine months ended September 30, ~~2019~~2020 and ~~2018,~~2019, (iv) Consolidated Statements of Stockholder’s Equity for the three months and nine months ended September 30, ~~2019~~2020 and ~~2018,~~2019, (v) Consolidated Statements of Cash Flows for the nine months ended September 30, ~~2019~~2020 and ~~2018~~2019 and (vi) related notes.

4043

Table of Contents

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, 2019~~5, 2020	/s/ Naveen Anand
	Naveen Anand, Chief Executive Officer and President


Date: November ~~7, 2019~~5, 2020	/s/ ~~Jeffrey R. Passmore~~Christopher J. Kenney
	~~Jeffrey R. Passmore,~~Christopher J. Kenney, Chief ~~Financial~~Accounting Officer and Senior Vice President

4144


Nevada	87-0447375
(State or other jurisdiction of	(I.R.S. Employer
Incorporation or organization)	Identification No.)

5420 Lyndon B. Johnson Freeway, Suite 1100, Dallas,Texas	75240

(Address of principal executive offices)	(Zip Code)




Title of each class	Trading Symbol(s)	Name of each exchange on which registered
Common Stock, $0.18 par value	HALL	Nasdaq Global Market


Large accelerated filer ☐	Accelerated filer ☒

Non-accelerated filer ☐	Smaller reporting company ☒	Emerging growth company ☐

	Page Number

Consolidated Balance Sheets at September 30, ~~2019~~2020 (unaudited) and December 31, ~~2018~~2019	3
Consolidated Statements of Operations (unaudited) for the three months and nine months ended September 30, ~~2019~~2020 and September 30, ~~2018~~2019	4
Consolidated Statements of Comprehensive Income (Loss) (unaudited) for the three months and nine months ended September 30, ~~2019~~2020 and September 30, ~~2018~~2019	5
Consolidated Statements of Stockholders’ Equity (unaudited) for the three months and nine months ended September 30, ~~2019~~2020 and September 30, ~~2018~~2019	6
Consolidated Statements of Cash Flows (unaudited) for the nine months ended September 30, ~~2019~~2020 and September 30, ~~2018~~2019	7
Notes to Consolidated Financial Statements (unaudited)	8


		September 30,		December 31,
	2019		2018
		(unaudited)
ASSETS
Investments:
Debt securities, available-for-sale, at fair value (amortized cost; $564,602 in 2019 and $550,268 in 2018)	$	568,831	$	545,870
Equity securities (cost; $68,737 in 2019 and $68,709 in 2018)		92,099		80,896
Other investments (cost; $3,763 in 2019 and $3,763 in 2018)		3,009		1,148
Total investments		663,939		627,914
Cash and cash equivalents		64,045		35,594
Restricted cash		1,697		4,877
Ceded unearned premiums		164,046		133,031
Premiums receivable		140,580		119,778
Accounts receivable		1,646		1,619
Receivable for securities		6,351		3,369
Reinsurance recoverable		313,552		252,029
Deferred policy acquisition costs		21,904		14,291
Goodwill		44,695		44,695
Intangible assets, net		5,706		7,555
Deferred federal income taxes, net		556		4,983
Prepaid expenses		1,551		2,588
Other assets		33,266		12,571
Total assets	$	1,463,534	$	1,264,894
LIABILITIES AND STOCKHOLDERS’ EQUITY
Liabilities:
Senior unsecured notes due 2029 (less unamortized debt issuance cost of $966 in 2019)	$	49,034	$	—
Revolving credit facility payable		—		30,000
Subordinated debt securities (less unamortized debt issuance cost of $859 in 2019 and $898 in 2018)		55,843		55,804
Reserves for unpaid losses and loss adjustment expenses		565,296		527,247
Unearned premiums		380,066		298,061
Reinsurance balances payable		61,799		67,328
Pension liability		1,410		2,018
Payable for securities		1,952		698
Federal income tax payable		680		4
Accounts payable and other accrued expenses		51,021		28,202
Total liabilities		1,167,101		1,009,362
Commitments and contingencies (Note 18)
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		123,095		123,168
Retained earnings		194,536		161,195
Accumulated other comprehensive income (loss)		246		(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		296,433		255,532
Total liabilities and stockholders’ equity	$	1,463,534	$	1,264,894