annual report 2014
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777 main street, suite 1000 i Fort Worth, texas 76102 i p (817) 348-1600 i www.hallmarkgp.com
Corporate Information
BoarD oF Directors
Mark E. Schwarz
executive chairman
Scott T. Berlin
managing Director,
Brown, Gibbons, lang & company
James H. Graves
partner, erwin, Graves & associates, lp
Jim W. Henderson
Chairman & Chief Executive Officer
assuredpartners, inc.
manaGement team
Mark E. Schwarz
executive chairman
Naveen Anand
President & Chief Executive Officer
Kevin T. Kasitz
executive vice president &
president of standard commercial
Jeffrey R. Passmore
senior vice president &
Chief Accounting Officer
Donald E. Meyer
president of e&s specialty
James A. Damonte
president of primary & excess casualty,
professional liability & aviation
Michael P. Binns
president of personal lines
inDepenDent reGistereD puBlic
accountants
Ernst & Young LLP
425 Houston street
suite 600
Ft. Worth, texas 76102
stock sYmBol
Hallmark Financial services, inc.
common stock is listed on the
nasDaQ Global market under
the symbol “HALL.”
transFer aGent
Securities Transfer Corporation
2591 Dallas parkway
suite 102
Frisco, texas 75034
(469) 633-0101
leGal counsel
McGuire, Craddock & Strother, P.C.
2501 n. Harwood
suite 1800,
Dallas, texas 75201
stockHolDer meetinG
the annual meeting of stockholders will be
held at 10:00 a.m. cDt on may 29, 2015 in the
training center on the concourse level at 777
main street, Ft. Worth, texas 76102.
corporate HeaDQuarters
Hallmark Financial services, inc.
777 main street
suite 1000
Ft. Worth, texas 76102
(817) 348-1600
www.hallmarkgrp.com
Hallmark's Business Plan
is to operate as a diversified underwriter of niche property and casualty
insurance products. this plan is executed by wholly owned business
units, each with a separate specialty product focus.
Our Corporate Strategy
is to create a “Best-in-class” specialty insurance company focused on
under writing profitability and long-term growth of stockholders’ book
value per share. our specialty product focus and niche market strategy
enable us to develop and retain in-house underwriting expertise and spe-
cialized market knowledge, which helps differentiate Hallmark from our
competitors. each business unit tailors its products and product distribu-
tion to the unique nature of the risk and coverages they provide.
Our Financial Goal
is to earn a consistent underwriting profit and build long-term share-
holder value by focusing on profitability and operating efficiency versus
topline premium growth and market share.
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$27,863
$24,575
$25,000
$20,000
$15,000
$13.11
$14
$12
$13,429
$10
$12,899
$10,000
$9,186
$9.191
$7,403
$8,245
$3,524
2005
2006
2007 2008 2009 2010 2011 2012
2013 2014
$5,000
$0
($5,000)
($10,000)
$8
$6
$4
$2
$0
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S
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“
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($10,891)
Past performance is no guarantee of future performance.
Premium Breakdown by Hallmark Business Units’ components
2004
2005
2006
2007
2008
2009
2010
2011
2012
2013
2014
Other
Programs
$85
Excess &
Umbrella
$12,679
E&S
Specialty
$126,255
E&S
Specialty
$121,390
E&S
Specialty
$108,145
General
Aviation
$30,235
General
Aviation
$29,607
General
Aviation
$25,145
Workers
Compensation
$3,116
Workers
Compensation
$7,977
Workers
Compensation
$9,089
Workers
Compensation
$10,408
Other
Programs
$247
Excess &
Umbrella
$25,007
E&S
Specialty
$94,948
General
Aviation
$24,029
Other
Programs
$2,108
Excess &
Umbrella
$33,762
Other
Programs
$11,473
Excess &
Umbrella
$40,687
Other
Programs
$8,773
Excess &
Umbrella
$51,847
Other
Programs
$10,529
Excess &
Umbrella
$57,972
E&S
Specialty
$122,412
E&S
Specialty
$159,223
E&S
Specialty
$212,255
E&S
Specialty
$235,774
General
Aviation
$20,451
General
Aviation
$18,690
General
Aviation
$18,188
General
Aviation
$15,496
Excess &
Umbrella
$28,089
E&S
Specialty
$101,094
General
Aviation
$22,538
Standard
Commercial
$75,808
Standard
Commercial
$81,721
Standard
Commercial
$91,679
Standard
Commercial
$90,988
Standard
Commercial
$80,193
Standard
Commercial
$72,511
Standard
Commercial
$67,844
Standard
Commercial
$66,304
Standard
Commercial
$69,113
Standard
Commercial
$78,057
Standard
Commercial
$74,271
Personal
Lines
$43,497
Personal
Lines
$36,345
Personal
Lines
$45,135
Personal
Lines
$55,919
Personal
Lines
$60,834
Personal
Lines
$71,708
Personal
Lines
$95,292
Personal
Lines
$96,226
Personal
Lines
$77,068
Personal
Lines
$76,772
Personal
Lines
$63,992
$119,305
$118,066
$293,304
$297,904
$287,081
$288,450
$314,857
$344,379
$384,231
$454,981
$468,442
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Highlights
For the Years Ended December 31, ($ in thousands, except per share amounts)
For the Years Ended December 31, ($ in thousands, except per share amounts)
Operating Results
Gross premiums written
Net premiums earned
Net operating income (loss)
Net income (loss) attributable to Hallmark
Per Share
Net income—diluted
Book value
Weighted average shares outstanding—diluted
2014
2013
2012
2011
2010
$473,218
321,217
18,782
13,429
$ 460,027
360,541
11,080
8,245
$ 389,842
319,436
3,374
3,524
$ 354,881
293,041
(19,787)
(10,891)
$ 320,973
278,271
8,371
7,403
$ 0.69
$ 13.11
19,366
$ 0.43
$ 12.36
19,361
$ 0.18
$ 11.45
19,269
$ (0.55)
$ 11.19
19,673
$ 0.37
$ 11.69
20,175
Selected Balance Sheet Items
Total cash and investments
Total assets
Reserves for unpaid loss and loss
adjustment expenses
Unearned premiums
Total liabilities
Total stockholders’ equity
GAAP Ratios
Loss ratio
Expense ratio
Combined ratio
$650,128
$980,869
$ 615,181
$ 909,023
$ 539,212
$ 790,468
$ 508,471
$ 746,059
$ 498,237
$ 736,557
$ 415,135
$ 196,826
$ 728,832
$ 252,037
$ 382,640
$ 185,303
$ 670,905
$ 238,118
$ 313,416
$ 162,502
$ 569,931
$ 220,537
$ 296,945
$ 146,104
$ 529,203
$ 215,572
$ 251,677
$ 140,965
$ 499,919
$ 235,278
65.4%
30.5%
95.9%
72.5%
29.2%
101.7%
70.9%
30.8%
101.7%
81.6%
30.8%
112.4%
72.8%
29.6%
102.4%
Letter from Our Chairman
MARk E. SCHWARz
In 2014, Hallmark’s book value per share increased 6% to $13.11.
It was a year characterized by moderate growth, steadily improving
earnings and important initiatives taken to further improve the
value of our company and its performance in future periods.
Hallmark’s 2014 gross premiums written increased 3% to $473
million, while policies in-force declined 12%. Premium growth
came primarily from rate increases rather than expansion as
improved pricing was achieved across nearly all our businesses,
with the highest increases realized in our Specialty Commercial
and Personal Segments. Net premiums written decreased 10%
to $324 million due to the full-year effect of a quota share rein-
surance agreement entered into during 2013. This quota share
agreement was reduced in 2014 and its impact on net premi-
ums will reverse in future periods. Despite the decrease in net
premiums, income before tax (excluding realized investment
gains) increased dramatically to roughly $19 million from less
than $1 million in the prior year. This increase in profitability is
due to a 95.9% combined ratio, a much anticipated improve-
ment in results compared to the prior four years, and marks a
return to profitable consolidated underwriting results.
Hallmark’s 2014 total investment return was nearly $16 million
or 3.3%, roughly equivalent to our book yield. At times, returns
on insurance float may seem unexciting, but they add up. Our
cumulative total return over the past 5 years has been $113 mil-
lion, equivalent to 45% of current book value on a pretax basis.
Total investments and cash increased 6% to $650 million, or
approximately $34 per share. Net cash provided by operations
was $34 million in 2014 and year-end cash balances totaled
$143 million. Over the past few years our cash balances have
more than doubled as the amount of incoming cash exceeded
new investment commitments. This year, for the first time in
recent history, incoming cash was offset with new investment
purchases.
In 2014, our equities performed in line with stock market aver-
ages and our fixed income portfolio underperformed bond indic-
ies, owing to our significantly shorter duration. It should be
noted that, in an up market, we will always underperform if our
duration is shorter than benchmarks. This is precisely what
occurred in 2014 as interest rates declined. The 10-year U.S.
Treasury, with a modest plus 2% yield, produced an 11% total
return, mostly due to price appreciation. The extent to which this
bond math works in reverse is easily illustrated by considering
the 30-year U.S. Treasury, which currently yields 2.6%. If long
rates were to rise to 5%, a not unreasonable level, this bond
69%
Cash & Investments
Debt Securities
Cash & Equivalents
Equities
69%
22%
9%
would suffer a devastating 40% loss – not an outcome generally
expected with a risk-free government security. The risk today’s
yield curve poses to the insurance industry is not without prece-
dent. There was a period, around 1980, when many major prop-
erty and casualty insurers had unrealized losses on their bond
portfolios that exceeded their surplus. At the time, held-to-matu-
rity accounting treatment, which allows bonds to be carried at
amortized cost without realizing price declines, was widely
employed. If these losses had been marked to market, the com-
panies would have been rendered insolvent. While such insol-
vencies were avoided through accounting convention, these
companies suffered a painful constraint on financial flexibility for
many years. The situation confronting our industry today could
lead to similar scenarios, a fate we are focused on avoiding, but
which comes with the opportunity cost of foregoing higher cur-
rent investment income associated with longer duration
securities.
The value of an insurance company derives from its two primary
sources of earnings – underwriting profits and investment
returns. It should be noted that both of these sources of earn-
ings continue to suffer from lingering effects of the recent Great
Recession.
The Federal Reserve policy of artificially depressing interest
rates to historically low levels for an extended period of time has
greatly reduced the value of insurance float. By example, our
investment income was $12 million this year compared to $16
million in 2008, despite owning more investment securities than
ever before. The decline we have experienced in our investment
income is shared by the insurance industry, where aggregate
investment income remains significantly below pre-recession
levels. While interest rates may remain low longer than any of us
might imagine, inevitably higher rates are likely to occur. When
this happens, higher yields, in conjunction with ongoing growth
in invested assets, will accelerate increases in investment
income causing insurance float to regain lost value. In our case,
a 1.5% increase in yield on $500 million of invested assets
would produce $7.5 million additional investment income. If
$7.5 million were capitalized at 10% on a pretax basis, it would
result in $75 million of incremental value, equal to 30% of our
current book equity.
Weighing on the underwriting side of the insurance company
earnings equation, economic sectors critical to our industry
remain well below their pre-recession peaks. In particular, the
construction sector – both private and public, both residential
and non-residential – while moving in a positive direction
remains well below pre-recession levels. While the manufactur-
ing sector has exceeded its pre-recession peak and is expand-
ing, it is doing so at a slow rate and has recently softened. Auto
sales have recovered but remain below average volume levels
predating the crisis. The energy sector has recently slowed dra-
matically. All of these sectors produce a vast amount of insur-
able exposures written by our industry. Recovery and continued
strength across these sectors will contribute to growth in insur-
able exposures written by Hallmark, including commercial prop-
erty, commercial auto, excess and many liability coverages.
Hallmark commenced its insurance operations in 1990, when it
acquired, through several acquisitions, a small group of insur-
ance related entities. Today, 25 years later, our company has
total assets of nearly $1 billion, annual premiums approaching
$500 million and approximately 400 employees. The journey
over this period has been one of constant evolution and change.
Just as the capital requirements to support growth have
increased, so too have the managerial talents needed to provide
leadership for a growing organization. As we progress towards
our goal of becoming a larger, more profitable company, we must
match increased investment in financial capital with greater
investment in human capital.
Recent leadership changes have significantly strengthened our
management team and produced speedy actions needed to
improve functional controls, aggressively address unprofitable
segments, focus our strategies, reduce persistent small CAT vol-
atility, and commence overdue investment in technology needed
to enhance our commercial and personal lines platforms.
Related to this last item, many industries, including ours, are
going through transformations driven by information technology.
Better customer-level information and sophisticated analytics
are among factors that will impact future success. As we go for-
ward, we will continue to invest in ways that advance our com-
petitive advantages in underwriting, better serve our marketplace
constituencies and foster strong analytical capabilities.
In addition to stepped up investments in people and technology,
we continue to look for opportunities to generate greater produc-
tivity and create value through improved processes, efficiency
gains and better execution. As our organization has expanded,
meaningful savings may be possible through better utilization of
Cash & Investments
($ in millions)
$700
$600
$500
$400
$300
$200
$100
$0
$650
2010 2011 2012 2013 2014
shared services across our operations and centralizing certain
key functions, while continuing to preserve the benefits of a
decentralized system.
2014 ended with our sixth consecutive quarter of underwriting
results, evidencing the return to overall profitable underwriting
that began mid-2013 and has characterized our longer-term his-
tory. In 2015, we will continue to accelerate the activities and
initiatives we have been pursuing this year. We believe these
changes will contribute to meaningful improvement in underwrit-
ing profitability in the new year. Separately, continued strength in
the economy should positively influence growth across most
lines of business written by Hallmark.
We also ended 2014 with the highest year-end share price since
the peak level attained in 2007. The price action in our stock this
year reflects some degree of catch-up in valuation. Logic sug-
gests demonstrating further improvement in our earnings growth
and return on equity offers reason for additional share price
appreciation in the future.
As always, we will continue to persistently pursue our objectives
of expanding and enhancing the value of our current operations,
finding suitable acquisitions at sensible prices and identifying
investment opportunities that carry acceptable levels of risk and
offer possibility of meaningful gains.
Mark E. Schwarz
Executive Chairman of the Board
April 16, 2015
Letter from Our President & CEO
NAvEEN ANAND
For 2014, our company reported a 95.9% combined ratio, as
compared to 101.7% for fiscal 2013, and a year-end book value
per share of $13.11, a 6% increase for the period.
The underwriting results show a marked improvement on a year-
over-year basis and have been driven by actions taken across
the entire portfolio. We continue to improve our underwriting
quality and have accelerated our focus on the development of
our Specialty segments and taken steps to mitigate the volatility
that has impacted our business in past years.
I joined Hallmark Financial Services in September of 2014 and
have had the opportunity to conduct a thorough review of our
businesses and capabilities. With the continued execution of
our strategic direction, investments in expertise and technology,
and strengthened operational control and guidance, I am confi-
dent that we can create a larger, more profitable “best-in-class”
specialty insurance group. I am personally thrilled to be a part
of the organization.
Looking back on the year, there are a few highlights that I’d like
to comment on:
Improved Underwriting
2014 marked six consecutive quarters of underwriting profitabil-
ity. Many actions have been taken across the portfolio to drive
this improvement. Rate increases across all of our key busi-
nesses were achieved in 2014 and were the primary driver of
our growth. We walked away from new and renewal customers
where we could not achieve our targeted pricing. We have
aggressively and appropriately addressed profit-challenged seg-
ments and geographies across our entire portfolio. In order to
sustain and continue to improve our results, we are making sig-
nificant data and analytics investments across the organization
to enhance our pricing and underwriting decisions. We are also
strengthening the company’s core analytic capabilities through
the application of new and existing technologies, enhanced man-
agement skills and continuing education.
Product Portfolio
Hallmark is comprised of three reporting segments with a diverse and balanced portfolio of seven product-specific components.
Three Reporting Product Segments
HALLMARK FINANCIAL SERVICES, INC.
SPECIALTY COMMERCIAL SEGMENT
STANDARD COMMERCIAL SEGMENT
PERSONAL
SEGMENT
Primary & Excess
Casualty
E&S
Specialty
Standard
Commercial P&C
Workers
Compensation
Personal
Lines
Professional
Liability
Aviation/
Space
Personal Segment
Standard Commercial Segment
In our specialty personal lines portfolio, we have now exited
nineteen states and focused our efforts on fourteen go-forward
states. In these go-forward states, we see good prospects to
achieve underwriting profitability and growth. Additionally, we
have exited or significantly reduced our portfolio of ancillary
products such as homeowners, dwelling fire and motorcycle pol-
icies. These products lacked scale, were distracting us from our
core products, and were potential drivers of volatility. This action
has allowed us to sharpen our focus on our key product lines of
non-standard automobile policies and companion renters
packages.
We are also investing in the future and implementing a new tech-
nology platform that brings significantly greater pricing sophisti-
cation and claims management discipline to the Personal
Segment and will allow us to grow profitably for years to come.
Personal Lines Operating Trends
In Standard Commercial, where recent years’ results have been
impacted by severe convective storm activity, we continued to
mitigate volatility by reducing exposure to these types of events.
This has been accomplished through tighter underwriting and
risk selection guidelines, the use of coverage restrictions and
higher deductibles, and improved reinsurance structures. We
are also implementing enhanced risk modeling and mapping
tools to improve the way we manage risk aggregation moving
forward.
In addition to the work being done on risk aggregation manage-
ment, we are also evolving our underwriting appetite from a gen-
eralist view to a more focused strategy targeting specific industry
segments. The targeted segments are those that have histori-
cally provided profitable results and offer favorable demograph-
ics for future growth. This strategy includes the development of
specialized products to serve the unique needs of each industry
segment. This specialty approach should allow us to improve
margins and add significant value to our distribution partners
and customers.
While there is still more to be done in the evolution of our stan-
dard commercial business these changes are beginning to pay
off. For 2014, our Standard Commercial Segment improved to a
98.6% combined ratio as compared to 104% for the prior year.
We see a bright future for this business.
Standard Commercial Operating Trends
Specialty Commercial Segment
Investment in Expertise
Our Specialty Commercial Segment turned in another year of
strong performance. Hallmark started down the road towards a
specialty focus a few years ago and has now accelerated our
development into a national, diversified, US-focused specialty
insurer. This segment now represents over two-thirds of our
total premium and achieved a combined ratio result of 91.1% in
2014, as compared to a 96.4% for fiscal 2013. We continue to
emphasize profitable growth in our niche specialty lines where
we enjoy strong market positions and profit opportunities.
I firmly believe that consistent and prolonged success as a spe-
cialty insurer is driven by expertise. In order for us to become a
best-in-class specialty insurer, we will need to continually invest
in building our human capital across the organization. This
includes investments in training and developing our current
teams, as well as attracting and retaining additional talented
individuals necessary to build an integrated, energized, highly
motivated, performance driven team that works collaboratively
and drives a high performance culture. I am confident that spe-
cialized and focused expertise will drive results and significantly
improve our competitive position.
Specialty Commercial Operating Trends
Looking Ahead
In the year ahead, we will continue to seek organic growth oppor-
tunities, as well as opportunities to improve our underwriting
margins. We will continue to sharpen our focus within our cur-
rent books of business and position them for sustained profit-
able growth. I expect that we will also look to differentiate
ourselves by enhancing our specialty portfolio through the addi-
tion of products that are market leading, innovative and relevant
to our targeted customers.
Each year brings its own set of challenges, whether they are
driven by macro-economic or geo-political issues, natural
catastrophes or other events. While I do not know what those
challenges will be, I do believe that Hallmark is on firm footing to
meet them head on.
I very much appreciate your support of Hallmark and I hope you
share in my optimism for a bright future.
Conservative Financial Management
Through the course of 2014, we improved our financial position
and strengthened our balance sheet. We have maintained our
conservative loss reserve position and overall saw modest favor-
able development on our loss reserves. In terms of capital man-
agement, we increased our statutory surplus by 7% last year to
$210 million and our overall capitalization position improved to
$309 million from $295 million in 2013. We have maintained
modest financial leverage with a 18.4% debt to capital ratio.
Naveen Anand
President and Chief Executive Officer
April 15, 2015
Portfolio Breakdown
Gross Premiums Written
($ in millions)
2%
4%
14%
14%
2014
50%
16%
E&S Specialty
Standard Commercial
Personal Lines
Primary & Excess Casualty /
Professional Liailty
General Aviation/Space
& Satellite
Workers Compensation
$500
$450
$400
$350
$300
$250
$200
$150
$100
$50
$0
$473
2009 2010 2011 2012 2013 2014
Segment Breakdown
Hallmark continued our emphasis on niche specialty product lines in 2014, where we have benefited from good market positions
and unique profit opportunities. The Specialty Commercial Segment accounted for nearly 70% in the product portfolio for 2014.
2002
2003
2004
2005
2006
2007
2008
2009
2010
2011
2012
2013
2014
Personal
36%
Personal
31%
Personal
45%
Personal
100%
Standard
Comm.
64%
Standard
Comm.
69%
Standard
Comm.
55%
Personal
16%
Personal
19%
Personal
21%
Personal
25%
Personal
30%
Personal
28%
Standard
Comm.
31%
Standard
Comm.
30%
Standard
Comm.
28%
Standard
Comm.
25%
Standard
Comm.
22%
Standard
Comm.
20%
Specialty
Comm.
53%
Specialty
Comm.
51%
Specialty
Comm.
51%
Specialty
Comm.
50%
Specialty
Comm.
52%
Specialty
Comm.
48%
Personal
20%
Personal
17%
Personal
14%
Standard
Comm.
19%
Standard
Comm.
20%
Specialty
Comm.
64%
Specialty
Comm.
60%
Standard
Comm.
18%
Specialty
Comm.
68%
10-K Financial Report
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-K
(Mark One)
ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the fiscal year ended DECEMBER 31, 2014
Or
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from _________________________ to _________________________________
Commission file number 001-11252
Hallmark Financial Services, Inc.
(Exact name of registrant as specified in its charter)
Nevada
(State or Other Jurisdiction of Incorporation or Organization)
777 Main Street, Suite 1000, Fort Worth, Texas
(Address of Principal Executive Offices)
87-0447375
(I.R.S. Employer Identification No.)
76102
(Zip Code)
Registrant's Telephone Number, Including Area Code: (817) 348-1600
Securities registered pursuant to Section 12(b) of the Act:
Title of Each Class
Common Stock $.18 par value
Name of Each Exchange on Which Registered
Nasdaq Global Market
Securities registered pursuant to Section 12(g) of the Act: None
Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.
Yes No
Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act.
Yes No
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the
Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.
Yes No
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any,
every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this
chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post
such files).
Yes No
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein,
and will not be contained, to the best of the registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K.
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer or a
smaller reporting company. See definition of “accelerated filer”, “large accelerated filer” and “smaller reporting
company” in Rule 12b-2 of the Exchange Act. (Check one):
Large accelerated filer
Smaller reporting company
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes
No
Non-accelerated filer
Accelerated filer
State the aggregate market value of the voting and non-voting common equity held by non-affiliates computed by
reference to the price at which the common equity was last sold, or the average bid and asked price of such common
equity, as of the last business day of the registrant’s most recently completed second fiscal quarter. $151.0 million
Indicate the number of shares outstanding of each of the registrant's classes of common stock, as of the latest practicable
date. 19,229,307 shares of common stock, $.18 par value per share, outstanding as of March 12, 2015.
1
DOCUMENTS INCORPORATED BY REFERENCE
The information required by Part III is incorporated by reference from the Registrant's definitive proxy statement to be
filed with the Commission pursuant to Regulation 14A not later than 120 days after the end of the fiscal year covered by
this report.
Unless the context requires otherwise, in this Form 10-K the term “Hallmark” refers solely to Hallmark Financial Services,
Inc. and the terms “we,” “our,” and “us” refer to Hallmark and its subsidiaries. The direct and indirect subsidiaries of
Hallmark are referred to in this Form 10-K in the manner identified in the chart under “Item 1. Business – Operational
Structure.”
Risks Associated with Forward-Looking Statements Included in this Form 10-K
This Form 10-K contains certain forward-looking statements within the meaning of the Private Securities Litigation
Reform Act of 1995, which are intended to be covered by the safe harbors created thereby. Forward-looking statements
include statements which are predictive in nature, which depend upon or refer to future events or conditions, or which
include words such as “expect,” “anticipate,” “intend,” “plan,” “believe,” “estimate” or similar expressions. 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. Statements regarding the following subjects are
forward-looking by their nature:
•
•
•
•
•
•
•
our business and growth strategies;
our performance goals;
our projected financial condition and operating results;
our understanding of our competition;
industry and market trends;
the impact of technology on our products, operations and business; and
any other statements or assumptions that are not historical facts.
The forward-looking statements included in this Form 10-K are based on current expectations that involve numerous risks
and uncertainties. Assumptions relating to these forward-looking statements involve judgments with respect to, among
other things, future economic, competitive and market conditions, legislative initiatives, 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 these forward-looking statements
are reasonable, any of the assumptions could be inaccurate and, therefore, there can be no assurance that the forward-
looking statements included in this Form 10-K will prove to be accurate. In light of the significant uncertainties inherent in
these forward-looking statements, the inclusion of such information should not be regarded as a representation that our
objectives and plans will be achieved.
2
Item 1. Business.
Who We Are
PART I
We are a diversified property/casualty insurance group that serves businesses and individuals in specialty and niche
markets.
We offer standard commercial insurance, specialty commercial insurance and personal insurance in selected market
subcategories that are characteristically low-severity and predominately short-tailed risks. We focus on marketing,
distributing, underwriting and servicing property/casualty insurance products that require specialized underwriting
expertise or market knowledge. We believe this approach provides us the best opportunity to achieve favorable policy
terms and pricing. The insurance policies we produce are written by our six insurance company subsidiaries as well as
unaffiliated insurers.
We market, distribute, underwrite and service our property/casualty insurance products primarily through five business
units, each of which has a specific focus. Our Standard Commercial P&C business unit primarily handles standard
commercial insurance and occupational accident insurance, our Workers Compensation business unit specializes in small
and middle market workers compensation business, and our E&S Commercial business unit handles primarily commercial
insurance products and services in the excess and surplus lines market. Our Hallmark Select business unit offers (i)
general aviation insurance products and services, (ii) low and middle market commercial umbrella and excess liability
insurance, (iii) medical professional liability insurance products and services and (iv) satellite launch insurance products.
Our Personal Lines business unit focuses on non-standard personal automobile insurance and complementary personal
insurance products and services.
Each business unit has its own management team with significant experience in distributing products to its target
markets and proven success in achieving underwriting profitability and providing efficient claims management. Each
business unit is responsible for marketing, distribution, underwriting and claims management while we provide capital
management, reinsurance, actuarial,
legal services and other
administrative support at the parent level. We believe this approach optimizes our operating results by allowing us to
effectively penetrate our selected specialty and niche markets while maintaining operational controls, managing risks,
controlling overhead and efficiently allocating our capital across business units. We expect future growth to be derived
from organic growth in the premium production of our existing business units and selected opportunistic acquisitions
that meet our criteria.
investment, financial reporting, technology and
What We Do
We market commercial and personal lines of property/casualty insurance products which are tailored to the risks and
coverages required by the insured. We believe that most of our target markets are underserved by larger
property/casualty insurers because of the specialized nature of the underwriting required. We are able to offer these
products profitably as a result of the expertise of our experienced underwriters. We also believe our long-standing
relationships with independent general agencies and retail agents and the service we provide differentiate us from larger
property/casualty insurers.
Our Standard Commercial P&C business unit primarily underwrites
low-severity, short-tailed commercial
property/casualty insurance products in the standard market. These products have historically produced stable loss
results and include general liability, commercial automobile, commercial property and umbrella coverages. Our Standard
Commercial P&C business unit currently markets its products through a network of 358 independent agents primarily
serving businesses in the non-urban areas of Texas, New Mexico, Oregon, Idaho, Montana, Washington, Utah, Wyoming,
Arkansas, Hawaii and Missouri. In addition our Standard Commercial P&C business unit offers occupational accident
coverage in Texas through an underwriting agency that specializes in the occupational accident insurance market.
Our Workers Compensation business unit offers small and middle market workers compensation insurance products. Our
Workers Compensation business unit currently markets its products through a network of 108 independent agents in
Texas and Montana, with a predominate portion of its distribution in Texas.
Our E&S Commercial business unit primarily offers commercial property/casualty insurance products in the excess and
surplus lines market. Excess and surplus lines insurance provides coverage for difficult to place risks that do not fit the
3
underwriting criteria of insurers operating in the standard market. Our E&S Commercial business unit focuses on middle
market commercial risks that do not meet the underwriting requirements of standard insurers due to factors such as loss
history, number of years in business, minimum premium size and types of business operation. Our E&S Commercial
business unit primarily writes commercial automobile, general liability, commercial property and excess casualty. Our
E&S Commercial business unit markets its products in 26 states through 9 wholesale brokers, a program underwriter and
83 general agency offices, as well as 162 independent retail agents in Texas and Oregon.
Our Hallmark Select business unit offers small and middle market commercial excess liability, umbrella and general
liability insurance on both an admitted and non-admitted basis; general aviation property/casualty insurance primarily
for private and small commercial aircraft and airports; satellite launch property/casualty insurance products; and medical
professional liability insurance on an excess and surplus lines basis. The small and middle market commercial excess
liability, umbrella and general liability insurance underwritten by our Hallmark Select business unit focuses primarily on
trucking, specialty automobile, and non-fleet automobile coverage. Typical risks range from one power unit to fleets of
up to 200 power units. Our Hallmark Select business unit markets these products through 113 wholesale brokers in 49
states. The aircraft liability and hull insurance products underwritten by our Hallmark Select business unit are targeted to
transitional or non-standard pilots who may have difficulty obtaining insurance from a standard carrier. Airport liability
insurance is marketed to smaller, regional airports. Our Hallmark Select business unit markets these general aviation
insurance products through 182 independent specialty brokers in 48 states. The satellite launch property/casualty
policies produced by our Hallmark Select business unit are marketed through underwriting agencies with technical
knowledge of space insurance. We can retain up to $2.0 million per risk for satellite launches and in-orbit coverage for up
to 12 months. The medical professional liability insurance underwritten on an excess and surplus basis by our Hallmark
Select business unit focuses on healthcare professionals that do not meet the underwriting requirements of standard
insurers due to factors such as loss history, number of years in business, minimum premium size and types of business
operation. Our Hallmark Select business unit markets these medical professional liability insurance products through 21
wholesale brokers in 49 states.
Our Personal Lines business unit offers non-standard personal automobile policies, which generally provide the minimum
limits of liability coverage mandated by state law to drivers who find it difficult to obtain insurance from standard carriers
due to various factors including age, driving record, claims history or limited financial resources. Our Personal Lines
business unit also provides a renters insurance product that complements our non-standard auto offering and fits well in
our distribution channel. During the fourth quarter of 2014, our Personal Lines business unit discontinued the low value
dwelling/homeowner’s and manufactured homes insurance products it previously offered. Our Personal Lines business
unit markets these policies through 3,302 independent retail agents in 14 states.
Our insurance company subsidiaries are American Hallmark Insurance Company of Texas (“AHIC”), Hallmark Insurance
Company (“HIC”), Hallmark Specialty Insurance Company (“HSIC”), Hallmark County Mutual Insurance Company (“HCM”),
Hallmark National Insurance Company (“HNIC”) and Texas Builders Insurance Company (“TBIC”). AHIC, HIC, HSIC and
HNIC have entered into a pooling arrangement, pursuant to which AHIC retains 30% of the net premiums written by any
of them, HIC retains 27% of the net premiums written by any of them, HSIC retains 30% of the net premiums written by
any of them and HNIC retains 13% of the net premiums written by any of them. A.M. Best Company (“A.M. Best”), a
nationally recognized insurance industry rating service and publisher, has pooled its ratings of these four insurance
company subsidiaries and assigned a financial strength rating of “A–” (Excellent) and an issuer credit rating of “a-” to each
of these individual insurance company subsidiaries and to the pool formed by these four insurance company subsidiaries.
Also, A.M. Best has assigned a financial strength rating of “A–” (Excellent) and an issuer credit rating of “a-” to HCM. A.M.
Best does not assign a financial strength rating or an issuer credit rating to TBIC.
Our five business units are segregated into three reportable industry segments for financial accounting purposes. The
Standard Commercial Segment consists of the Standard Commercial P&C business unit and the Workers Compensation
business unit. The Specialty Commercial Segment includes our E&S Commercial business unit and Hallmark Select
business unit, as well as certain specialty risk programs (“Specialty Programs”) which are managed at the parent level.
The Personal Segment consists solely of our Personal Lines business unit. The following table displays the gross premiums
written and net premiums by these reportable segments for affiliated and unaffiliated insurers for the years ended
December 31, 2014, 2013 and 2012.
4
Gross Premiums Written:
Standard Commercial Segment
Specialty Commercial Segment
Personal Segment
Total
Net Premiums Written:
Standard Commercial Segment
Specialty Commercial Segment
Personal Segment
Total
$
$
$
$
2014
Year Ended December 31,
2013
(dollars in thousands)
2012
84,679 $
324,547
63,992
473,218 $
76,912 $
230,638
16,802
324,352 $
87,147 $
296,108
76,772
460,027 $
79,466 $
235,655
45,644
360,765 $
77,091
235,695
77,056
389,842
70,091
186,053
76,345
332,489
5
Operational Structure
Our insurance company subsidiaries retain a portion of the premiums produced by our business units. The following chart
reflects the operational structure of our organization, including the subsidiaries comprising our business units and the
business units included in each reportable segment as of December 31, 2014.
Hallmark Financial Services, Inc.
(“Hallmark”)
Standard Commercial Segment
Personal Segment
Specialty Commercial Segment
Standard Commercial
P&C
§
American Hallmark
Insurance Services, Inc.
(“American Hallmark
Insurance Services”)
§
TBIC Holding
Corporation
(“TBIC Holding”)
TBIC Risk Management,
Inc. (“TBICRM”)
Effective Claims
Management, Inc.
(“ECM”)
§
Texas Builders
Insurance Company
§
§
Workers Compensation
Personal Lines
E&S Commercial
Hallmark Select
§
§
American Hallmark
General Agency Inc.
(d/b/a Hallmark
Insurance Company)
Hallmark Claims
Services, Inc. (d/b/a
Hallmark Insurance
Company)
§
§
§
Hallmark Specialty
Underwriters, Inc.
(”HSU”)
TGA Special Risk, Inc.
(“TGASRI”)
Pan American
Acceptance Corporation
(“PAAC”)
§
§
§
§
§
Aerospace Insurance
Managers, Inc.
(“Aerospace Insurance
Managers”)
Aerospace Special Risk,
Inc. (“ASRI”)
Aerospace Claims
Management Group,
Inc. (“ACMG”)
Heath XS, LLC
(“HXS”)
Hardscrabble Data
Solutions, LLC
(“HDS”)
American Hallmark Insurance
Company of Texas
Hallmark Insurance Company
Hallmark County Mutual
Insurance Company
Texas Builders
Insurance Company
Hallmark Specialty
Insurance Company
Hallmark National
Insurance Company
Standard Commercial Segment
The Standard Commercial Segment of our business includes our Standard Commercial P&C business unit and our Workers
Compensation business unit. During 2014, our Standard Commercial P&C business unit accounted for approximately 88%
and our Workers Compensation business unit accounted for the remaining 12% of the aggregate premiums produced by
the Standard Commercial Segment.
Standard Commercial P&C business unit. Our Standard Commercial P&C business unit markets, underwrites and services
standard commercial lines insurance primarily in the non-urban areas of Texas, New Mexico, Idaho, Oregon, Montana,
Washington, Utah, Wyoming, Arkansas, Hawaii and Missouri. The subsidiaries comprising our Standard Commercial P&C
business unit include American Hallmark Insurance Services, a regional managing general agency, and ECM, a claims
administration company. American Hallmark Insurance Services targets customers that are in low-severity classifications
in the standard commercial market, which as a group have relatively stable loss results. The typical customer is a small to
midsize business with a policy that covers property, general liability and automobile exposures. Our Standard Commercial
P&C business unit underwriting criteria exclude lines of business and classes of risks that are considered to be high-
severity or volatile, or which involve significant latent injury potential or other long-tailed liability exposures. ECM
administers the claims on the insurance policies produced by American Hallmark Insurance Services. In addition our
Standard Commercial P&C business unit offers occupational accident coverage in Texas through an underwriting agency
6
that is a specialist in the occupational accident insurance market. Products offered by our Standard Commercial P&C
business unit include the following:
•
Commercial automobile. Commercial automobile insurance provides third-party bodily injury and property
damage coverage and first-party property damage coverage against losses resulting from the ownership,
maintenance or use of automobiles and trucks in connection with an insured’s business.
• General liability. General liability insurance provides coverage for third-party bodily injury and property
damage claims arising from accidents occurring on the insured’s premises or from their general business
operations.
• Umbrella. Umbrella insurance provides coverage for third-party liability claims where the loss amount
exceeds coverage limits provided by the insured’s underlying general liability and commercial automobile
policies.
•
•
•
Commercial property. Commercial property insurance provides first-party coverage for the insured’s real
property, business personal property, and business interruption losses caused by fire, wind, hail, water
damage, theft, vandalism and other insured perils.
Commercial multi-peril. Commercial multi-peril insurance provides a combination of property and liability
coverage that can include commercial automobile coverage on a single policy.
Business owner’s. Business owner’s insurance provides a package of coverage designed for small to midsize
businesses with homogeneous risk profiles. Coverage includes general liability, commercial property and
commercial automobile.
• Occupational accident. Occupational accident insurance provides an alternative to statutory workers
compensation insurance in Texas. Coverage includes medical, short term disability and accidental death and
dismemberment.
Our Standard Commercial P&C business unit markets its property/casualty insurance products through 358 independent
agencies operating in its target markets. Our Standard Commercial P&C business unit applies a strict agent selection
process and seeks to provide its independent agents some degree of non-contractual geographic exclusivity. Our
Standard Commercial P&C business unit also strives to provide its independent agents with convenient access to product
information and personalized service. As a result, the Standard Commercial P&C business unit has historically maintained
excellent relationships with its producing agents, as evidenced by the 22 year average tenure of the 15 agency groups
that each produced more than $1.0 million in premium during the year ended December 31, 2014. During 2014, the top
ten agency groups produced approximately 37%, and no individual agency group produced more than 9%, of the total
premium volume of our Standard Commercial P&C business unit.
Our Standard Commercial P&C business unit writes most risks on a package basis using a commercial multi-peril policy or
a business owner’s policy. Umbrella policies are written only when our Standard Commercial P&C business unit also
writes the insured’s underlying general liability and commercial automobile coverage. Through December 31, 2005, our
Standard Commercial P&C business unit marketed policies on behalf of Clarendon National Insurance Company
(“Clarendon”), a third-party insurer. Our Standard Commercial P&C business unit earns a commission based on a
percentage of the earned premium it produced for Clarendon. The commission percentage is determined by the
underwriting results of the policies produced. Our Standard Commercial P&C business unit presently markets all new and
renewal policies exclusively for AHIC.
All of the commercial policies written by our Standard Commercial P&C business unit are for a term of 12 months. If the
insured is unable or unwilling to pay for the entire premium in advance, we provide an installment payment plan that
requires the insured to pay 20% or 25% down and the remaining payments over eight months. We charge installment
fees of up to $7.50 per payment for the installment payment plan.
Workers Compensation business unit. Our Workers Compensation business unit markets, underwrites and services
workers compensation insurance in Texas and Montana. The subsidiaries comprising our Workers Compensation business
unit include TBIC Holding which has two wholly-owned subsidiaries, TBIC, a Texas domiciled workers compensation
insurance carrier and TBICRM, which provides risk management services to customers of TBIC. Our Workers
7
Compensation business unit markets its products through 108 independent agencies operating in Texas and Montana,
with a predominate portion of its distribution in Texas. During 2014, the top ten agency groups produced approximately
59%, and no individual agency group produced more than 20%, of the total premium volume of our Workers
Compensation business unit.
Specialty Commercial Segment
The Specialty Commercial Segment of our business includes our E&S Commercial business unit and our Hallmark Select
business unit, as well as certain Specialty Programs which are managed at the parent level. During 2014, our E&S
Commercial business unit accounted for approximately 73% of the aggregate premiums produced by the Specialty
Commercial Segment, with our commercial umbrella and excess liability, general aviation, medical professional liability
and satellite launch insurance products handled by our Hallmark Select business unit accounting for 18%, 5%, 2% and 1%,
respectively. Our Specialty Programs accounted for the remaining 1% of the premium produced by the Specialty
Commercial Segment during 2014.
E&S Commercial business unit. Our E&S Commercial business unit markets, underwrites, finances and services
commercial lines insurance in 26 states with a particular emphasis on commercial automobile, general liability and
commercial property risks produced on an excess and surplus lines basis. Excess and surplus lines insurance provides
coverage for difficult to place risks that do not fit the underwriting criteria of insurers operating in the standard market.
The subsidiaries comprising our E&S Commercial business unit include HSU, which is a regional managing general
underwriter, TGASRI which is a Texas managing general agency, and PAAC, which provides premium financing for policies
marketed by HSU and certain unaffiliated general and retail agents. HSU accounts for approximately 99% of the premium
volume financed by PAAC.
Our E&S Commercial business unit focuses on middle market commercial risks that do not meet the underwriting
requirements of traditional standard insurers due to issues such as loss history, number of years in business, minimum
premium size and types of business operation. During 2014, commercial automobile, general liability and commercial
property accounted for approximately 83%, 12% and 4%, respectively, of the premiums produced by our E&S Commercial
business unit. Target risks for commercial automobile insurance are business auto and trucking for hire fleets, excluding
hazardous or flammable materials haulers. Target risks for general liability insurance are small business risk exposures
including artisan contractors, sales and service organizations, and building and premises liability exposures. Target risks
for commercial property insurance are low- to mid-value structures including office buildings, mercantile shops,
restaurants and rental dwellings, in each case with aggregate property limits of less than $500,000. The commercial
insurance products offered by our E&S Commercial business unit include the following:
•
Commercial automobile. Commercial automobile insurance provides third-party bodily injury and property
damage coverage and first-party property damage coverage against losses resulting from the ownership,
maintenance or use of automobiles and trucks in connection with an insured’s business.
• General liability. General liability insurance provides coverage for third-party bodily injury and property
damage claims arising from accidents occurring on the insured’s premises or from their general business
operations.
•
•
•
Commercial property. Commercial property insurance provides first-party coverage for the insured’s real
property, business personal property, theft and business interruption losses caused by fire, wind, hail, water
damage, vandalism and other insured perils. Windstorm, hurricane and hail are generally excluded in coastal
areas.
Commercial excess liability. Commercial excess liability insurance is designed to provide an extra layer of
protection for bodily injury, personal and advertising injury, or property damage losses above the primary
layer of commercial automobile, general liability and employer’s liability insurance. The excess insurance does
not begin until the limits of liability in the primary layer have been exhausted. The excess layer provides not
only higher limits, but catastrophic protection from large losses.
Commercial umbrella. Commercial umbrella insurance protects businesses for bodily injury, personal and
advertising injury, or property damage claims in excess of the limits of their primary commercial automobile,
general liability and employers liability policies, and for some claims excluded by their primary policies
(subject to a deductible). Umbrella insurance provides not only higher limits, but catastrophic protection for
large losses.
8
Our E&S Commercial business unit markets its products in 26 states through 9 wholesale brokers, a program underwriter
and 83 general agency offices, as well as 162 independent retail agents in Texas and Oregon. Our E&S Commercial
business unit strives to simplify the placement of its excess and surplus lines policies by providing our general agents with
a web rating portal which allows for instantaneous quoting and signature-ready applications which can be emailed or
faxed to its independent retail agents. During 2014, general agents produced 81%, the program underwriter produced
13%, retail agents produced 4% and wholesale brokers produced 2% of total premiums produced by our E&S Commercial
business unit. During 2014, the top ten general agents produced approximately 46%, the top ten wholesale brokers
produced approximately 2% and no general agent produced more than 9%, of the total premium volume of our E&S
Commercial business unit. During the same period, the top ten retail agents produced approximately 3%, and no retail
agent produced more than 1%, of the total premium volume of our E&S Commercial business unit.
Through 2008, all business of our E&S Commercial business unit was produced under a fronting agreement with member
companies of the Republic Group (“Republic”), which granted our E&S Commercial business unit the authority to develop
underwriting programs, set rates, appoint retail and general agents, underwrite risks, issue policies and adjust and pay
claims. We assumed 70% of the risk under this arrangement in 2008. In 2009, our E&S Commercial business unit wrote a
portion of its policies under a fronting arrangement with Republic pursuant to which we assumed 100% of the risk.
Commission revenue was generated under the fronting agreement on the portion of premiums not assumed by AHIC. An
additional commission may be earned if certain loss ratio targets are met. Additional revenue was generated from fully
earned policy fees and installment billing fees charged on legacy personal lines products. Since 2010, in states where we
were not yet licensed to offer a non-admitted product, we utilized a fronting arrangement with a third party pursuant to
which we assumed all of the risk and then retroceded a portion of the risk to third party reinsurers.
The majority of the commercial policies written by our E&S Commercial business unit are for a term of 12 months.
Exceptions include certain commercial automobile policies that are written for a term that coincides with the annual
harvest of crops and special event general liability policies that are written for the term of the event, which is generally
one to two days. Commercial lines policies are paid in full up front or financed with various premium finance companies,
including PAAC.
Hallmark Select business unit. Our Hallmark Select business unit offers small and middle market commercial excess
liability, umbrella and general liability insurance on both an admitted and non-admitted basis focusing primarily on
trucking, specialty automobile, and non-fleet automobile coverage, general aviation property/casualty insurance
primarily for private and small commercial aircraft and airports, satellite launch insurance products and medical
professional liability insurance on an excess and surplus lines basis.
The small and middle market commercial excess liability, umbrella and general liability insurance underwritten by our
Hallmark Select business unit is offered on an admitted and non-admitted basis in 49 states. Limits of liability offered are
from $1,000,000 to $5,000,000 in coverage in excess of the primary carrier’s limits of liability. The principal focus of the
excess & umbrella insurance products offered is transportation, specifically trucking for hire, specialty automobile and
non-fleet automobile coverage. The Hallmark Select business unit also provides umbrella and excess liability coverage for
small to midsize businesses in class categories such as contracting, manufacturing, hospitality and service. The majority
of the excess & umbrella and general liability insurance policies written by our Hallmark Select business unit are on an
annual basis. However, exceptions are common in an attempt to have policy effective dates coincide with those of the
primary insurance policies. Policy premiums are due in full 30 days from the inception date of the policy. Our excess &
umbrella insurance and general liability insurance products are offered through 113 wholesale brokers. During 2014, the
top ten wholesale brokers accounted for 48% of our excess & umbrella and general liability premium volume, with no
single wholesale broker accounting for more than 15%. During 2014, commercial excess liability risks accounted for 91%
of the premiums, with the remaining 9% coming from commercial umbrella and general liability risks. The commercial
excess & umbrella and general liability insurance products offered by our Hallmark Select business unit include the
following:
•
•
Commercial excess liability. Commercial excess liability insurance is designed to provide an extra layer of
protection for bodily injury, personal and advertising injury, or property damage losses above the primary
layer of commercial automobile, general liability and employer’s liability insurance. The excess insurance does
not begin until the limits of liability in the primary layer have been exhausted. The excess layer provides not
only higher limits, but catastrophic protection from large losses.
Commercial umbrella. Commercial umbrella insurance protects businesses for bodily injury, personal and
9
advertising injury, or property damage claims in excess of the limits of their primary commercial automobile,
general liability and employers liability policies, and for some claims excluded by their primary policies
(subject to a deductible). Umbrella insurance provides not only higher limits, but catastrophic protection for
large losses.
•
Commercial general liability. General liability insurance provides coverage for third-party bodily injury and
property damage claims arising from accidents occurring on the insured’s premises or from their general
business operations.
We presently cede 80% of the excess & umbrella and general liability risk on policies written by our Hallmark Select
business unit.
Our Hallmark Select business unit markets, underwrites and services general aviation property/casualty insurance in 48
states. The subsidiaries marketing our general aviation insurance products include Aerospace Insurance Managers, which
markets standard aviation coverages, ASRI, which markets excess and surplus lines aviation coverages, and ACMG, which
handles claims management. Aerospace Insurance Managers is one of only a few similar entities in the U.S. and has
focused on developing a well-defined niche centering on transitional pilots, older aircraft and small airports and aviation-
related businesses. In addition, our Hallmark Select business unit offers satellite launch property/casualty policies
marketed through underwriting agencies with technical knowledge of space insurance. The general aviation and satellite
launch products offered by our Hallmark Select business unit include the following:
•
Aircraft. Aircraft insurance provides third-party bodily injury and property damage coverage and first-party
hull damage coverage against losses resulting from the ownership, maintenance or use of aircraft.
• Airport liability. Airport liability insurance provides coverage for third-party bodily injury and property
damage claims arising from accidents occurring on airport premises or from their operations.
•
Satellite. We can retain up to $2.0 million per risk for satellite launches and in-orbit coverage for up to 12
months.
Our Hallmark Select business unit distributes its general aviation insurance products through 182 aviation specialty
brokers. These specialty brokers submit to Aerospace Insurance Managers requests for aviation insurance quotations
received from the states in which we operate and our Hallmark Select business unit selectively determines the risks fitting
its target niche for which it will prepare a quote. During 2014, the top ten independent specialty brokers produced
approximately 30%, and no broker produced more than 6%, of the total general aviation premium volume of our
Hallmark Select business unit. Our Hallmark Select business unit independently develops, underwrites and prices each
general aviation coverage written. We target pilots who may lack experience in the type of aircraft they have acquired or
are transitioning between types of aircraft. We also target pilots who may be over the age limits of other insurers. We do
not accept aircraft that are used for hazardous purposes such as crop dusting or heli-skiing. Liability limits are controlled,
with approximately 87% of the aircraft written in 2014 bearing per-occurrence limits of $1,000,000 and per-passenger
limits of $100,000 or less. The average insured aircraft hull value for aircraft written in 2014 was approximately $137,000.
All general aviation policies produced by our Hallmark Select business unit are written through our insurance company
subsidiaries.
Our Hallmark Select business unit markets medical professional liability insurance on an excess and surplus lines basis.
Medical professional liability insurance provides coverage for third-party bodily injury claims resulting from professional
services provided by physicians, surgeons, podiatrists and medical entities. Our Hallmark Select business unit distributes
its medical professional liability insurance products through 21 wholesale brokers in 49 states.
Specialty Programs. Our Specialty Programs consist of fronting and agency arrangements which are managed at the
parent level. The Specialty Programs business presently consists primarily of a fronting arrangement in Texas for a third
party insurance company.
Personal Segment / Personal Lines Business Unit
The Personal Segment of our business consists solely of our Personal Lines business unit. Our Personal Lines business unit
markets and services non-standard personal automobile policies and renters insurance in 14 states. We conduct this
business under the name Hallmark Insurance Company. Hallmark Insurance Company provides management, policy and
10
claims administration services to HIC and includes the operations of American Hallmark General Agency, Inc. and
Hallmark Claims Services, Inc. Our non-standard personal automobile insurance generally provides for the minimum
limits of liability coverage mandated by state laws to drivers who find it difficult to purchase automobile insurance from
standard carriers as a result of various factors, including driving record, vehicle, age, claims history, or limited financial
resources. Products offered by our Personal Lines business unit include the following:
•
Personal automobile. Personal automobile insurance is the primary product offered by our Personal Lines
business unit. Our policies typically provide coverage to individuals for bodily injury and property damage at
the minimum limits required by law, and for physical damage to an insured’s own vehicle from collision and
various other perils. In addition, many states require policies to provide for first party personal injury
protection, frequently referred to as no-fault coverage.
•
Renters. Renters insurance provides coverage for the contents of a renter’s home or apartment and for
liability. Renter’s policies are similar to homeowners insurance, except they do not cover the structure.
During the fourth quarter of 2014, the Personal Lines business unit discontinued the low value dwelling/homeowner’s
and manufactured homes insurance products it previously offered. Our Personal Lines business unit markets its products
through 3,302 independent retail agents operating in its target geographic markets. Non-standard automobile
represented 93% of the premiums produced during 2014. Our Personal Lines business unit qualifies new agent
appointments in order to establish an efficient network of independent agents to effectively penetrate its highly
competitive markets. Our Personal Lines business unit periodically evaluates its independent agents and discontinues the
appointment of agents whose production history does not satisfy certain standards. During 2014, the top ten
independent agency groups produced approximately 30%, and no individual agency group produced more than 8%, of
the total premium volume of our Personal Lines business unit.
During 2014, personal automobile liability coverage accounted for approximately 82% and personal automobile physical
damage coverage accounted for the remaining 18% of the total non-standard automobile premiums produced by our
Personal Lines business unit. Our most common policy term is a six month policy. We do offer additional terms of one-,
two-, three- and twelve-month policies in certain markets. Our typical non-standard personal automobile customer is
unable or unwilling to pay a full or half year premium in advance. Accordingly, we currently offer a direct bill program
where the premiums are directly billed to the insured on a monthly basis. We charge installment fees for each payment
under the direct bill program. Our Personal Lines business unit markets its products in 14 states directly for HIC, AHIC,
HCM and HNIC.
Our Competitive Strengths
We believe that we enjoy the following competitive strengths:
•
•
•
Specialized market knowledge and underwriting expertise. All of our business units possess extensive
knowledge of the specialty and niche markets in which they operate, which we believe allows them to
effectively structure and market their property/casualty insurance products. Our Personal Lines business
unit has a thorough understanding of the unique characteristics of the non-standard personal automobile
market. Our Standard Commercial P&C business unit and Workers Compensation business unit have
significant underwriting experience in their target markets for standard commercial property/casualty
insurance products. In addition, our E&S Commercial business unit and Hallmark Select business unit have
developed specialized underwriting expertise which enhances their ability to profitably underwrite non-
standard property/casualty insurance coverages.
Tailored market strategies. Each of our business units has developed its own customized strategy for
penetrating the specialty or niche markets in which it operates. These strategies include distinctive
product structuring, marketing, distribution, underwriting and servicing approaches by each business unit.
As a result, we are able to structure our property/casualty insurance products to serve the unique risk and
coverage needs of our insureds. We believe these market-specific strategies enable us to provide policies
tailored to the target customer that are appropriately priced and fit our risk profile.
Superior agent and customer service. We believe performing the underwriting, billing, customer service
11
and claims management functions at the business unit level allows us to provide superior service to both
our independent agents and insured customers. The easy-to-use interfaces and responsiveness of our
business units enhance their relationships with the independent agents who sell our policies. We also
believe our consistency in offering our insurance products through hard and soft markets helps to build
and maintain the loyalty of our independent agents. Our customized products, flexible payment plans and
prompt claims processing are similarly beneficial to our insureds.
• Market diversification. We believe operating
in various specialty and niche segments of the
property/casualty insurance market diversifies both our revenues and our risks. We also believe our
business units generally operate on different market cycles, producing more earnings stability than if we
focused entirely on one product. As a result of the pooling arrangement among four of our insurance
company subsidiaries, we are able to efficiently allocate our capital among these various specialty and
niche markets in response to market conditions and expansion opportunities. We believe this market
diversification reduces our risk profile and enhances our profitability.
•
Experienced management team. Our senior corporate management has an average of over 20 years of
insurance experience. In addition, our business units have strong management teams, with an average of
more than 20 years of insurance industry experience for the heads of our business units and an average of
more than 15 years of underwriting experience for our underwriters. Our management has significant
experience in all aspects of property/casualty insurance, including underwriting, claims management,
actuarial analysis, reinsurance and regulatory compliance. In addition, Hallmark’s senior management has a
strong track record of acquiring businesses that expand our product offerings and improve our profitability
profile.
Our Strategy
We strive to become a “Best in Class” specialty insurance company offering products in specialty and niche markets
through the following strategies:
•
•
•
Focusing on underwriting discipline and operational efficiency. We seek to consistently generate an
underwriting profit on the business we write in hard and soft markets. Our business units have a strong
track record of underwriting discipline and operational efficiency, which we seek to continue. We believe
that in soft markets our competitors often offer policies at a low or negative underwriting profit in order to
maintain or increase their premium volume and market share. In contrast, we seek to write business based
on its profitability rather than focusing solely on premium production. To that end, we provide financial
incentives to many of our underwriters and independent agents based on underwriting profitability.
Achieving organic growth in our existing business lines. We believe we can achieve organic growth in our
existing business lines by consistently providing our insurance products through market cycles, expanding
geographically, expanding our product offerings, expanding our agency relationships and further
penetrating our existing customer base. We believe our extensive market knowledge and strong agency
relationships position us to compete effectively in our various specialty and niche markets. We also believe
there is a significant opportunity to expand some of our existing business lines into new geographical areas
and through new agency relationships while maintaining our underwriting discipline and operational
efficiency. In addition, we believe there is an opportunity for some of our business units to further
penetrate their existing customer bases with additional products offered by other business units.
Pursuing selected, opportunistic acquisitions. We seek to opportunistically acquire insurance organizations
that operate in specialty or niche property/casualty insurance markets that are complementary to our
existing operations. We seek to acquire companies with experienced management teams, stable loss
results and strong track records of underwriting profitability and operational efficiency. Where appropriate,
we intend to ultimately retain profitable business produced by the acquired companies that would
otherwise be retained by unaffiliated insurers. Our management has significant experience in evaluating
potential acquisition targets, structuring transactions to ensure continued success and integrating acquired
companies into our operational structure.
• Maintaining a strong balance sheet. We seek to maintain a strong balance sheet by employing
conservative investment, reinsurance and reserving practices and to measure our performance based on
12
long-term growth in book value per share.
Distribution
We market our property/casualty insurance products predominately through independent general agents, retail agents
and specialty brokers. Therefore, our relationships with independent agents and brokers are critical to our ability to
identify, attract and retain profitable business. Each of our business units has developed its own tailored approach to
establishing and maintaining its relationships with these independent distributors of our products. These strategies focus
on providing excellent service to our agents and brokers, maintaining a consistent presence in our target niche and
specialty markets through hard and soft market cycles and fairly compensating the agents and brokers who market our
products. Our business units also regularly evaluate independent general and retail agents based on the underwriting
profitability of the business they produce and their performance in relation to our objectives.
Except for the products of our Hallmark Select business unit, the distribution of property/casualty insurance products by
our business units is geographically concentrated. For the twelve months ended December 31, 2014, five states
accounted for approximately 65% of the gross premiums written by our insurance company subsidiaries. The following
table reflects the geographic distribution of our insured risks, as represented by direct and assumed premiums written by
our business segments for the twelve months ended December 31, 2014.
State
Texas
Louisiana
Arizona
New Mexico
Oregon
All other states
Standard
Commercial
Segment
Specialty
Commercial
Segment
Personal
Segment
Total
Percent of
Total
$
(dollars in thousands)
33,864 $
-
-
9,047
14,211
27,557
183,796 $
24,347
1,125
986
886
113,407
17,745 $
-
17,506
5,097
-
23,644
235,405
24,347
18,631
15,130
15,097
164,608
49.8%
5.1%
3.9%
3.2%
3.2%
34.8%
Total gross premiums written $
84,679 $
324,547 $
63,992 $
473,218
Percent of total
Underwriting
17.9%
68.6%
13.5%
100.0%
The underwriting process employed by our business units involves securing an adequate level of underwriting
information, identifying and evaluating risk exposures and then pricing the risks we choose to accept. Each of our
business units offering commercial, healthcare professional or aviation insurance products employs its own underwriters
with in-depth knowledge of the specific niche and specialty markets targeted by that business unit. We employ a
disciplined underwriting approach that seeks to provide policies appropriately tailored to the specified risks and to adopt
price structures that will be supported in the applicable market. Our experienced commercial, healthcare professional
and aviation underwriters have developed underwriting principles and processes appropriate to the coverages offered by
their respective business units.
We believe that managing the underwriting process through our business units capitalizes on the knowledge and
expertise of their personnel in specific markets and results in better underwriting decisions. All of our underwriters have
established limits of underwriting authority based on their level of experience. We also provide financial incentives to
many of our underwriters based on underwriting profitability.
To better diversify our revenue sources and manage our risk, we seek to maintain an appropriate business mix among our
business units. At the beginning of each year, we establish a target net loss ratio for each business unit. We then monitor
the actual net loss ratio on a monthly basis. If any line of business fails to meet its target net loss ratio, we seek input
from our underwriting, actuarial and claims management personnel to develop a corrective action plan. Depending on
the particular circumstances, that plan may involve tightening underwriting guidelines, increasing rates, modifying
13
product structure, re-evaluating independent agency relationships or discontinuing unprofitable coverages or classes of
risk.
An insurance company’s underwriting performance is traditionally measured by its statutory loss and loss adjustment
expense ratio, its statutory expense ratio and its statutory combined ratio. The statutory loss and loss adjustment
expense ratio, which is calculated as the ratio of net losses and loss adjustment expenses (“LAE”) incurred to net
premiums earned, helps to assess the adequacy of the insurer’s rates, the propriety of its underwriting guidelines and the
performance of its claims department. The statutory expense ratio, which is calculated as the ratio of underwriting and
operating expenses to net premiums written, assists in measuring the insurer’s cost of processing and managing the
business. The statutory combined ratio, which is the sum of the statutory loss and LAE ratio and the statutory expense
ratio, is indicative of the overall profitability of an insurer’s underwriting activities, with a combined ratio of less than
100% indicating profitable underwriting results.
The following table shows, for the periods indicated, (i) our gross premiums written (in thousands); and (ii) our
underwriting results as measured by the net statutory loss and LAE ratio, the statutory expense ratio, and the statutory
combined ratio.
Year Ended December 31,
2014
2013
2012
Gross premiums written
$
473,218 $
460,027 $
389,842
Statutory loss & LAE ratio
Statutory expense ratio
Statutory combined ratio
64.8%
33.1%
97.9%
72.2%
34.7%
106.9%
72.0%
33.5%
105.5%
These statutory ratios do not reflect the deferral of policy acquisition costs, investment income, premium finance
revenues, or the elimination of inter-company transactions required by U.S. generally accepted accounting principles
(“GAAP”).
The premium-to-surplus percentage measures the relationship between net premiums written in a given period
(premiums written, less returned premiums and reinsurance ceded to other carriers) to policyholders surplus (admitted
assets less liabilities), determined on the basis of statutory accounting practices prescribed or permitted by insurance
regulatory authorities. State insurance department regulators expect insurance companies to maintain a premium-to-
surplus percentage of not more than 300%. For the years ended December 31, 2014, 2013 and 2012, our consolidated
premium-to-surplus ratios were 154%, 184% and 188%, respectively.
Claims Management and Administration
We believe that effective claims management is critical to our success and that our claims management process is cost-
effective, delivers the appropriate level of claims service and produces superior claims results. Our claims management
philosophy emphasizes the delivery of courteous, prompt and effective claims handling and embraces responsiveness to
policyholders and agents. Our claims strategy focuses on thorough investigation, timely evaluation and fair settlement of
covered claims while consistently maintaining appropriate case reserves. We seek to compress the cycle time of claim
resolution in order to control both loss and claim handling cost. We also strive to control legal expenses by negotiating
competitive rates with defense counsel and vendors, establishing litigation budgets and monitoring invoices.
Each of our business units maintains its own dedicated staff of specialized claims personnel to manage and administer
claims arising under policies produced through their respective operations. The claims process is managed through a
combination of experienced claims managers, seasoned claims supervisors, trained staff adjusters and independent
adjustment or appraisal services, when appropriate. All adjusters are licensed in those jurisdictions for which they handle
claims that require licensing. Limits on settlement authority are established for each claims supervisor and staff adjuster
based on their level of experience. Certain independent adjusters have limited authority to settle claims. Claim exposures
are periodically and systematically reviewed by claim supervisors and managers as a method of quality and loss control.
Large loss exposures are reviewed at least quarterly with senior management of the business unit and monitored by
Hallmark senior management.
14
Claims personnel receive in-house training and are required to attend various continuing education courses pertaining to
topics such as best practices, fraud awareness, legal environment, legislative changes and litigation management.
Depending on the criteria of each business unit, our claims adjusters are assigned a variety of claims to enhance their
knowledge and ensure their continued development in efficiently handling claims. As of December 31, 2014, our business
units had a total of 91 claims managers, supervisors and adjusters with an average experience of approximately 16 years.
Analysis of Losses and LAE
Our consolidated financial statements include an estimated reserve for unpaid losses and LAE. We estimate our reserve
for unpaid losses and LAE by using case-basis evaluations and statistical projections, which include inferences from both
losses paid and losses incurred. We also use recent historical cost data and periodic reviews of underwriting standards
and claims management practices to modify the statistical projections. We give consideration to the impact of inflation in
determining our loss reserves, but do not discount reserve balances.
The amount of reserves represents our estimate of the ultimate cost of all unpaid losses and LAE incurred. These
estimates are subject to the effect of trends in claim severity and frequency. We regularly review the estimates and
adjust them as claims experience develops and new information becomes known. Such adjustments are included in
current operations, including increases and decreases, net of reinsurance, in the estimate of ultimate liabilities for
insured events of prior years.
Changes in loss development patterns and claim payments can significantly affect the ability of insurers to estimate
reserves for unpaid losses and related expenses. We seek to continually improve our loss estimation process by refining
our ability to analyze loss development patterns, claim payments and other information within a legal and regulatory
environment that affects development of ultimate liabilities. Future changes in estimates of claim costs may adversely
affect future period operating results. However, such effects cannot be reasonably estimated currently.
15
Reconciliation of reserve for unpaid losses and LAE. The following table provides a reconciliation of our beginning and
ending reserve balances on a net-of-reinsurance basis for the years ended December 31, 2014, 2013 and 2012, to the
gross-of-reinsurance amounts reported in our balance sheets at December 31, 2014, 2013 and 2012.
Reserve for unpaid losses and LAE, net of reinsurance
recoverables, January 1
Provision for losses and LAE for claims occurring in the current
period
(Decrease) increase in reserve for unpaid losses and LAE for
claims occurring in prior periods
Payments for losses and LAE, net of reinsurance:
Current period
Prior periods
Reserve for unpaid losses and LAE at December 31, net of
reinsurance recoverable
Reinsurance recoverable on unpaid losses and LAE at December
31
Reserve for unpaid losses and LAE at December 31, gross of
reinsurance
As of and for Year Ended December 31
2014
2013
2012
(dollars in thousands)
$
312,468 $
263,832 $
254,901
215,258
251,391
230,089
(5,203)
9,954
(3,675)
(76,231)
(101,897)
(107,945)
(123,100)
(110,812)
(109,538)
323,192
312,468
263,832
91,943
70,172
49,584
$
415,135 $
382,640 $
313,416
The $5.2 million favorable development, $10.0 million unfavorable development and $3.7 million favorable development
in prior accident years recognized in 2014, 2013 and 2012, respectively, represent normal changes in our loss reserve
estimates. In 2014 and 2012, the aggregate loss reserve estimates for prior years were decreased to reflect favorable loss
development when the available information indicated a reasonable likelihood that the ultimate losses would be less
than the previous estimates. In 2013, the aggregate loss reserve estimates for prior years were increased to reflect
unfavorable loss development when the available information indicated a reasonable likelihood that the ultimate losses
would be more than the previous estimates. Generally, changes in reserves are caused by variations between actual
experience and previous expectations and by reduced emphasis on the Bornhuetter-Ferguson method due to the aging of
the accident years. (See “Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations
- Critical Accounting Estimates and Judgments - Reserves for unpaid losses and loss adjustment expenses.”)
The $5.2 million decrease in reserves for unpaid losses and LAE recognized in 2014 was attributable to $7.2 million
favorable development on claims incurred in the 2013 accident year, $4.4 million unfavorable development on claims
incurred in the 2012 accident year and $2.4 million favorable development on claims incurred in the 2011 and prior
accident years. Our Standard Commercial P&C business unit, Personal Lines business unit, Workers Compensation
business unit and Hallmark Select business unit accounted for $4.1 million, $2.9 million, $1.9 million and $1.0 million,
respectively, of the decrease in reserves recognized during 2014. The decrease in reserves for our Standard Commercial
P&C business unit was primarily related to our commercial auto and general liability lines of business. The decrease in
reserves for our Personal Lines business unit was primarily attributable to the 2013 accident year. The decrease in
reserves for our Workers Compensation business unit was attributable to the 2013, 2012 and 2011 and prior accident
years. The decrease in reserves for our Hallmark Select business unit was primarily related to $0.9 million favorable
development in our commercial excess liability line of business and $0.4 million favorable development in our medical
professional liability products, partially offset by a $0.3 million unfavorable development in our general aviation line of
business. These favorable developments were partially offset by unfavorable development of $4.7 million in our E&S
Commercial business unit primarily related to our commercial auto liability and general liability lines of business.
16
The $10.0 million increase in reserves for unpaid losses and LAE recognized in 2013 was attributable to $5.0 million
unfavorable development on claims incurred in the 2012 accident year, $1.7 million unfavorable development on claims
incurred in the 2011 accident year and $3.3 million unfavorable development on claims incurred in the 2010 and prior
accident years. Our E&S Commercial business unit and Personal Lines business unit accounted for $16.0 million and $1.8
million of the increase in reserves recognized during 2013. The increase in reserves for our E&S Commercial business unit
was primarily related to commercial auto liability line of business. The increase in reserves for our Personal Lines
business unit was primarily related to personal auto in the 2012 accident year. These unfavorable developments were
partially offset by favorable prior years’ loss development of $3.7 million in our Standard Commercial P&C business unit,
$2.6 million in our Hallmark Select business unit and $1.5 million in our Workers Compensation business unit. The
decrease in reserves for our Standard Commercial P&C business unit was primarily related to commercial auto and
general liability line of business. The decrease in reserves for our Hallmark Select business unit was driven by $2.3 million
of favorable claims development in the 2011 and prior accident years related to our aircraft liability lines of business,
partially offset by $0.1 million unfavorable claims development in the 2012 accident year related to our aircraft hull
coverage. Further contributing to the decrease in reserves for our Hallmark Select business unit was $0.4 million of
favorable claims development in our excess & umbrella lines of business. The decrease in reserves for our Workers
Compensation business unit was related to the 2012 and 2011 accident years.
The $3.7 million decrease in reserves for unpaid losses and LAE recognized in 2012 was attributable to $0.4 million
favorable development on claims incurred in the 2011 accident year, $0.8 million favorable development on claims
incurred in the 2010 accident year and $2.5 million favorable development on claims incurred in the 2009 and prior
accident years. Our Standard Commercial P&C business unit, Hallmark Select business unit and E&S Commercial business
unit accounted for $3.7 million, $3.3 million and $0.3 million, respectively, of the decrease in reserves recognized during
2012. The decrease in reserves for our Standard Commercial P&C business unit was primarily related to commercial auto,
commercial property and general liability lines of business. The decrease in reserves for our Hallmark Select business unit
was primarily related to our aircraft liability lines of business. The decrease in reserves for our E&S Commercial business
unit was primarily related to general liability. These favorable developments were partially offset by unfavorable prior
years’ loss development of $3.6 million in our Personal Lines business unit related to auto liability claims spread
throughout various states and our low value dwelling/homeowners line of business.
Analysis of loss and LAE reserve development. The following table shows the development of our loss reserves, net of
reinsurance, for years ended December 31, 2004 through 2014. Section A of the table shows the estimated liability for
unpaid losses and LAE, net of reinsurance, recorded at the balance sheet date for each of the indicated years. This liability
represents the estimated amount of losses and LAE for claims arising in prior years that are unpaid at the balance sheet
date, including losses that have been incurred but not yet reported to us. Section B of the table shows the re-estimated
amount of the previously recorded liability, based on experience as of the end of each succeeding year. The estimate is
increased or decreased as more information becomes known about the frequency and severity of claims.
Cumulative Redundancy/ (Deficiency) (Section C of the table) represents the aggregate change in the estimates over all
prior years. Thus, changes in ultimate development estimates are included in operations over a number of years,
minimizing the significance of such changes in any one year.
17
ANALYSIS OF LOSS AND LAE DEVELOPMENT
As of and for Year Ended December 31
A. Reserve for unpaid loss & LAE,
net of reinsurance recoverables $
17,700 $
25,997 $
72,801 $ 120,849 $
150,025 $
176,250 $
213,723 $
254,901 $
263,832 $
312,468 $
323,192
2004 2005 2006 2007
2008 2009 2010 2011 2012 2013 2014
B. Net reserve re-estimated as of:
One year later
Two years later
15,300 24,820 66,387 119,034
151,645
185,440
230,089
251,226
273,786
307,265
15,473 24,903 68,490 118,646
155,155
183,689
226,856
256,198
275,778
Three years later
13,962 23,144 68,809 120,444
154,738
181,268
230,145
253,814
Four years later
Five years later
Six years later
Seven years later
Eight years later
Nine years later
Ten years later
C. Net cumulative (deficiency)
redundancy
D. Cumulative amount of claims
paid, net of reserve recoveries
One year later
Two years later
Three years later
Four years later
Five years later
Six years later
Seven years later
Eight years later
Nine years later
Ten years later
Net reserve-December 31
Reinsurance recoverables
14,166 23,455 69,847 119,771
155,520
185,848
227,555
13,163 24,425 71,879 123,949
158,842
184,995
17,857 25,403 78,396 128,006
159,151
17,597 30,704 79,939 128,907
17,605 32,395 80,439
18,108 32,825
18,005
(305) (6,828) (7,638) (8,058) (9,126) (8,745)
(13,832)
1,087
(11,946)
5,203
8,073 16,721 30,061 50,458 64,810 73,647
105,848
109,538
110,812
123,100
12,004 22,990 46,860 78,314 95,385
13,113 24,562 58,322 93,286
13,750 27,231 65,084 105,251
121,222
156,176
163,803
174,684
146,956
162,704
188,044
207,484
200,637
120,133
131,912
13,102 28,833 71,082 112,029
140,618
172,330
17,498 30,367 75,225 118,171
146,581
17,557 31,058 75,141 122,410
17,551 33,171 83,865
17,915 34,552
18,158
17,700 25,997 72,801 120,849
1,948
324
4,763
150,025
176,250
213,723
323,192
4,489 6,338 8,412 37,954 42,044 49,584 70,172 91,943
254,901
263,832
312,468
Gross reserve-December 31
19,648 26,321 77,564 125,338
156,363
184,662
251,677
296,945
313,416
382,640
415,135
Net re-estimated reserve
Re-estimated reinsurance
bl
18,005 32,825 80,439 128,907
1,050
1,776
6,704
159,151
7,919 10,400
184,995
227,555
253,814
275,778
307,265
9,178 37,977 42,190 49,664 68,599
Gross re-estimated reserve
19,055 34,601 87,143 136,826
169,551
194,173
265,532
296,004
325,442
375,864
Gross cumulative redundancy
(deficiency)
$
593
$ (8,280) $ (9,579) $
(11,488) $
(13,188) $ (9,511) $
(13,855) $
941
(12,026) $ 6,776
$
18
Reinsurance
We reinsure a portion of the risk we underwrite in order to control our exposure to losses and to protect our 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. Our
reinsurance facilities are subject to annual renewal. In order to mitigate credit risk to reinsurance companies, most of our
reinsurance recoverable balance as of December 31, 2014 was with reinsurers that had an A.M. Best rating of “A-” or
better. We also mitigate our credit risk for the remaining reinsurance recoverable by obtaining letters of credit.
The following table presents our gross and net premiums written and earned and reinsurance recoveries for each of the
last three years (in thousands).
Gross premiums written
Ceded premiums written
Net premiums written
Gross premiums earned
Ceded premiums earned
Net premiums earned
Reinsurance recoveries
Year Ended December 31
2014
2013
2012
473,218 $
(148,866)
460,027 $
(99,262)
389,842
(57,353)
324,352 $
360,765 $
332,489
461,694 $
(140,477)
437,226 $
(76,685)
373,849
(54,413)
321,217 $
360,541 $
319,436
99,911 $
45,456 $
29,014
$
$
$
$
$
We currently reinsure the following exposures on business generated by our business units:
•
Property catastrophe. Our property catastrophe reinsurance reduces the financial impact a catastrophe could
have on our commercial and personal property insurance lines. Catastrophes might include multiple claims and
policyholders. Catastrophes include hurricanes, windstorms, earthquakes, hailstorms, explosions, severe winter
weather and fires. Our property catastrophe reinsurance is excess-of-loss reinsurance, which provides us
reinsurance coverage for losses in excess of an agreed-upon amount. We utilize catastrophe models to assist in
determining appropriate retention and limits to purchase. Effective July 1, 2014 the terms of our property
catastrophe reinsurance are:
o We retain the first $3.0 million of property catastrophe losses; and
o Our reinsurers reimburse us 100% for any loss occurrence in excess of our $3.0 million retention up to
$32.0 million for each catastrophic occurrence, subject to an aggregate limit of $64.0 million.
• Commercial property. Our commercial property reinsurance is excess-of-loss coverage intended to reduce the
financial impact a single-event or catastrophic loss may have on our results. The terms of our commercial
property reinsurance are:
19
o We retain the first $1.0 million of loss for each commercial property risk;
o Our reinsurers reimburse us for the next $5.0 million for each commercial property risk, and $10.0
million for all commercial property risk involved in any one occurrence, in all cases subject to an
aggregate limit of $30.0 million for all commercial property losses occurring during the treaty period;
and
o
Individual risk facultative reinsurance is purchased on any commercial property with limits above $6.0
million.
•
Commercial casualty. Our commercial casualty reinsurance is excess-of-loss coverage intended to reduce the
financial impact a single-event loss may have on our results. The terms of our commercial casualty reinsurance
are:
o We retain the first $1.0 million of any commercial liability risk; and
o Our reinsurers reimburse us for the next $5.0 million for each commercial liability risk.
• Aviation. We purchase proportional reinsurance where we currently cede 80% of the risk to reinsurers on the
aviation risks produced in all states by our Hallmark Select business unit.
• Occupational Accident. We purchase excess-of-loss reinsurance coverage for the occupational accident
insurance product produced by our Standard Commercial P&C business unit. The terms of our occupational
accident reinsurance are:
o We retain the first $1.0 million of any occupational accident risk; and
o
Our reinsurers reimburse us for the next $5.0 million for each occupational accident risk up to $10.0
million for each occurrence.
• Workers Compensation. We purchase excess of loss reinsurance specific to the workers compensation risks
underwritten by our Workers Compensation business unit. The terms of our workers compensation reinsurance
are:
o We retain the first $1.0 million of each workers compensation loss; and
o Our reinsurers reimburse us 100% for the next $14.0 million for each workers compensation loss,
subject to a maximum limit of $10.0 million for any one person and an aggregate limit of $28.0 million
for all workers compensation losses.
Person
•
Personal Property. Effective March 1, 2014, we purchased proportional reinsurance where we cede 80% of the
risks to reinsurers on the low value dwelling/homeowners, renters and manufactured homes coverages
produced in all states by our Personal Lines business unit. For policies written effective February 1, 2013
through February 28, 2014, we ceded 60% of these risks to reinsurers.
•
•
Personal Auto. Effective October 1, 2014 we purchased proportional reinsurance where we cede 50% of the
risks to reinsurers on the nonstandard automobile risks produced in certain states by our Personal Lines
business unit. For policies written effective October 1, 2013 through September 30, 2014, we ceded 90% of
these risks to reinsurers.
Standard Commercial P&C. We purchase proportional reinsurance where we currently cede 100% of the risks to
reinsurers on the equipment breakdown coverage on our commercial multi-peril property and business owner’s
risks and on the employment practices liability coverage on certain commercial multi-peril, general liability and
business owner’s risks.
Hallmark
•
Excess & Umbrella. We purchase proportional reinsurance where we currently retain 20% of each risk and cede
the remaining 80% to reinsurers on the commercial umbrella and excess liability insurance produced by our
Hallmark Select business unit.
20
•
Professional Liability. Effective June 1, 2014, we purchased excess of loss reinsurance on our medical
professional liability risks produced by our Hallmark Select business unit. The terms of our professional liability
reinsurance are as follows:
o We retain the first $1.0 million of any professional liability risk; and
o Our reinsurers reimburse us for the next $2.0 million for each professional liability loss occurrence.
Prior to June 1, 2014, we purchased proportional reinsurance on our medical professional liability risks
produced by our Hallmark Select business unit where we retained 60% of each risk and ceded the remaining
40% to the reinsurers.
•
E&S Commercial. We purchase facultative reinsurance on our commercial umbrella and excess liability risks
produced by our E&S Commercial business unit where we currently retain 10% of the first $1.0 million of risk
and cede the remaining 90% to reinsurers. We currently cede to reinsurers 100% of our commercial umbrella
and excess liability risks in excess of $1.0 million. Effective May 1, 2014 we purchased proportional reinsurance
on the commercial auto liability risks produced by a program underwriter in our E&S Commercial business unit
where we retain 20% of each risk and cede the remaining 80% to reinsurers.
• Hallmark County Mutual. HCM is used to front certain lines of business in our Specialty Commercial and
Personal Segments in Texas. In addition, HCM is used to front business produced by unaffiliated third parties.
HCM does not retain any business.
Investment Portfolio
Our investment objective is to maximize current yield while maintaining safety of capital together with sufficient liquidity
for ongoing insurance operations. Our investment portfolio is composed of fixed-income and equity securities. As of
December 31, 2014, we had total invested assets of $507.2 million. If market rates were to increase by 1%, the fair value
of our fixed-income securities as of December 31, 2014 would decrease by approximately $13.4 million. The following
table shows the fair values of various categories of fixed-income securities, the percentage of the total fair value of our
invested assets represented by each category and the tax equivalent book yield based on fair value of each category of
invested assets as of December 31, 2014 and 2013.
As of December 31, 2014
Fair
Value
Percent of
Total
Yield
As of December 31, 2013
Percent of
Total
Fair
Value
Yield
(in thousands)
(in thousands)
Category:
$
Corporate bonds
Collateralized corporate bank loans
Municipal bonds
US Treasury securities and
obligations of U.S. Government
Mortgage backed
29,442
113,649
162,329
93,305
52,060
6.5%
25.2%
36.0%
20.7%
11.6%
3.5% $
4.0%
4.5%
43,875
102,178
157,552
0.7%
2.3%
78,753
27,737
10.7%
24.9%
38.4%
19.2%
6.8%
3.8%
4.0%
5.0%
0.5%
2.7%
Total
$
450,785
100.0%
3.3% $
410,095
100.0%
3.6%
The weighted average credit rating for our fixed-income portfolio, using ratings assigned by Standard and Poor’s Rating
Services (a division of the McGraw-Hill Companies, Inc.), was A- at December 31, 2014. The following table shows the
distribution of our fixed-income portfolio by Standard and Poor’s rating as a percentage of total fair value as of December
31, 2014 and 2013:
21
Rating:
"AAA"
"AA"
"A"
"BBB"
"BB"
"B"
"CCC"
"NR"
Total
As of
December 31, 2014
As of
December 31, 2013
8.1%
43.7%
8.1%
15.3%
17.7%
3.2%
0.0%
3.9%
100.0%
0.9%
33.7%
22.4%
18.9%
18.6%
4.5%
0.7%
0.3%
100.0%
The following table shows the composition of our fixed-income portfolio by remaining time to maturity as of December
31, 2014 and 2013.
As of December 31, 2014
As of December 31, 2013
Fair Value
(in thousands)
Percentage of
Total
Fair Value
Percentage of
Total
Fair Value
Fair Value
(in thousands)
Remaining time to maturity:
Less than one year
One to five years
Five to ten years
More than ten years
Mortgage-backed
Total
$
$
50,329
185,525
109,925
52,946
52,060
450,785
11.2% $
41.2%
24.4%
11.7%
11.5%
100.0% $
71,969
163,006
108,761
38,622
27,737
410,095
17.6%
39.7%
26.5%
9.4%
6.8%
100.0%
Our investment strategy is to conservatively manage our investment portfolio by investing primarily in readily
marketable, investment-grade, fixed-income securities. As of December 31, 2014, 11% of our investment portfolio was
invested in equity securities. Our investment portfolio is managed internally. We regularly review our portfolio for
declines in value. For fixed maturity investments that are considered other-than-temporarily impaired and that we do not
intend to sell and will not be required to sell, we separate the amount of the impairment into the amount that is credit
related (credit loss component) and the amount due to all other factors. The credit loss component is recognized in
earnings and is the difference between the investment’s amortized cost basis and the present value of its expected future
cash flows. The remaining difference between the investment’s fair value and the present value of future expected cash
flows is recognized in other comprehensive income.
The following table details the net unrealized gain balance by invested asset category as of December 31, 2014.
22
Category
Corporate bonds
Collateralized corporate bank loans
Municipal bonds
Equity securities
U.S. Treasury securities and obligations of U.S. Government
Mortgage-backed
Total
Net Unrealized Gain Balance
(in thousands)
$
$
799
(1,709)
783
31,084
25
117
31,099
As part of our overall investment strategy, we also maintain an integrated cash management system utilizing on-line
banking services and daily overnight investment accounts to maximize investment earnings on all available cash.
Technology
The majority of our technology systems are based on products licensed from insurance-specific technology vendors that
have been substantially customized to meet the unique needs of our various business units. Our technology systems
primarily consist of integrated central processing computers, a series of server-based computer networks and various
communications systems that allow our various operations to share systems solutions and communicate to the corporate
office in a timely, secure and consistent manner. We maintain backup facilities and systems through a contract with a
leading provider of computer disaster recovery services. Each business unit bears the information services expenses
specific to its operations as well as a portion of the corporate services expenses. Increases to vendor license and service
fees are capped per annum.
We believe the implementation of our various technology systems has increased our efficiency in the processing of our
business, resulting in lower operating costs. Additionally, our systems enable us to provide a high level of service to our
agents and policyholders by processing our business in a timely and efficient manner, communicating and sharing data
with our agents and providing a variety of methods for the payment of premiums. We believe these systems have also
improved the accumulation and analysis of information for our management.
Ratings
Many insurance buyers, agents and brokers use the ratings assigned by A.M. Best and other rating agencies to assist
them in assessing the financial strength and overall quality of the companies from which they are considering purchasing
insurance. A.M. Best has pooled its ratings of our AHIC, HIC, HSIC and HNIC subsidiaries and assigned a financial strength
rating of “A-” (Excellent) and an issuer credit rating of “a-” to each of these individual insurance company subsidiaries and
to the pool formed by the four insurance company subsidiaries. A.M. Best has also assigned a financial strength rating of
“A-” (Excellent) and an issuer credit rating of “a-” to HCM. A.M. Best does not assign a financial strength rating or an
issuer credit rating to TBIC. An “A–” rating is the fourth highest of 15 rating categories used by A.M. Best. In evaluating an
insurer’s financial and operating performance, A.M. Best reviews the company’s profitability, indebtedness and liquidity,
as well as its book of business, the adequacy and soundness of its reinsurance, the quality and estimated fair value of its
assets, the adequacy of its loss reserves, the adequacy of its surplus, its capital structure, the experience and competence
of its management and its market presence. A.M. Best’s ratings reflect its opinion of an insurer’s financial strength,
operating performance and ability to meet its obligations to policyholders and are not an evaluation directed at investors
or recommendations to buy, sell or hold an insurer’s stock.
Competition
23
The property/casualty insurance market, our primary source of revenue, is highly competitive and, except for regulatory
considerations, has very few barriers to entry. According to A.M. Best, there were 3,087 property/casualty insurance
companies and 2,134 property/casualty insurance groups operating in North America as of July 14, 2014. Our Standard
Commercial P&C business unit competes with a variety of large national standard commercial lines carriers such as
Liberty Mutual Group, Travelers Companies, Inc., Cincinnati Financial Corporation and The Hartford Financial Services
Group, as well as numerous smaller regional companies. The primary competition for the occupational accident insurance
product offered by our Standard Commercial P&C unit includes such carriers as Great American Insurance Group, One
Beacon Insurance Company, North American Insurance Company and Service Lloyds. The primary competition for our
Workers Compensation business unit includes such carriers as Texas Mutual Insurance Company, Service Lloyds Insurance
Company, Employers Insurance Company, The Hartford Financial Services Group and FirstComp Insurance Company. The
primary competition for our E&S Commercial business unit includes such carriers as Atlantic Casualty Insurance Company,
Colony Insurance Company, National Casualty Company, National Liability & Fire Insurance Company, Northland
Insurance Company, Scottsdale Insurance Company and Progressive County Mutual. Our Hallmark Select business unit
considers its primary competition for our excess & umbrella and general liability insurance products to include such
carriers as American International Group, Inc., First Mercury Insurance Company, Axis Insurance Company, XL Specialty
Insurance, W.R. Berkley Corporation and, to a lesser extent, a number of national standard lines carriers such as Travelers
Companies, Inc. and Liberty Mutual Group. The primary competitors for our general aviation insurance products
produced by our Hallmark Select business unit are Phoenix Aviation Managers, Starr Aviation, Chartis, United States
Specialty Insurance Company, W. Brown & Company, United States Aircraft Insurance Group, Global Aerospace and
Allianz Aviation Managers. The primary competition for the medical professional liability insurance products produced by
our Hallmark Select business unit are Admiral Insurance Company, Catlin Insurance Company, CNA Financial Corporation,
Evanston Insurance Company, Kinsale Insurance Company, Lexington Insurance Company, ProAssurance Corporation,
RSUI Group and TDC Companies. Although our Personal Lines business unit competes with large national insurers such as
Allstate Corporation, GEICO Corporation and Progressive Insurance Company, as a participant in the non-standard
personal automobile marketplace its competition is most directly associated with numerous regional companies and
managing general agencies. Our competitors include entities that have, or are affiliated with entities that have, greater
financial and other resources than we have.
Generally, we compete on price, customer service, coverages offered, claims handling, financial stability, agent
commission and support, customer recognition and geographic coverage. We compete with companies who use
independent agents, captive agent networks, direct marketing channels or a combination thereof.
Insurance Regulation
AHIC, HCM and TBIC are domiciled in Texas, HIC and HNIC are domiciled in Arizona and HSIC is domiciled in Oklahoma.
Therefore, our insurance operations are regulated by the Texas Department of Insurance, the Arizona Department of
Insurance and the Oklahoma Insurance Department, as well as the applicable insurance department of each state in
which we issue policies. Our insurance company subsidiaries are required to file quarterly and annual statements of their
financial condition prepared in accordance with statutory accounting practices with the insurance departments of their
respective states of domicile and the applicable insurance department of each state in which they write business. The
financial conditions of our insurance company subsidiaries, including the adequacy of surplus, loss reserves and
investments, are subject to review by the insurance department of their respective states of domicile.
Periodic financial and market conduct examinations. The insurance departments of the states of domicile for our
insurance company subsidiaries have broad authority to enforce insurance laws and regulations through examinations,
administrative orders, civil and criminal enforcement proceedings, and suspension or revocation of an insurer’s certificate
of authority or an agent’s license. The state insurance departments that have jurisdiction over our insurance company
subsidiaries may conduct on-site visits and examinations of the insurance companies' affairs, especially as to their
financial condition, ability to fulfill their obligations to policyholders, market conduct, claims practices and compliance
with other laws and applicable regulations. Typically, these examinations are conducted every three to five years. In
addition, if circumstances dictate, regulators are authorized to conduct special or target examinations of insurance
companies to address particular concerns or issues. The results of these examinations can give rise to injunctive relief,
regulatory orders requiring remedial or other corrective action on the part of the company that is the subject of the
examination, assessment of fines, or other penalties against that company. In extreme cases, including actual or pending
insolvency, the insurance department may take over, or appoint a receiver to take over, the management or operations
of an insurer or an agent’s business or assets.
24
Guaranty funds. All insurance companies are subject to assessments for state-administered funds that cover the claims
and expenses of insolvent or impaired insurers. The size of the assessment is determined each year by the total claims on
the fund that year. Each insurer is assessed a pro rata share based on its direct premiums written in that state. Payments
to the fund may generally be recovered by the insurer through deductions from its premium taxes over a specified period
of years.
Transactions between insurance companies and their affiliates. Hallmark is also regulated as an insurance holding
company by the Texas Department of Insurance, the Arizona Department of Insurance and the Oklahoma Insurance
Department. Financial transactions between Hallmark or any of its affiliates and our insurance company subsidiaries are
subject to regulation. Transactions between our insurance company subsidiaries and their affiliates generally must be
disclosed to state regulators, and prior regulatory approval generally is required before any material or extraordinary
transaction may be consummated or any management agreement, services agreement, expense sharing arrangement or
other contract providing for the rendering of services on a regular, systematic basis is implemented. State regulators may
refuse to approve or may delay approval of such a transaction, which may impact our ability to innovate or operate
efficiently.
Dividends. Dividends and distributions to Hallmark by our insurance company subsidiaries are restricted by the insurance
regulations of the respective state in which each insurance company subsidiary is domiciled. As property/casualty
insurance companies domiciled in the state of Texas, AHIC and TBIC may only pay dividends from unassigned surplus
funds. In addition, AHIC and TBIC must obtain the approval of the Texas Department of Insurance before the payment of
extraordinary dividends, which are defined as dividends or distributions of cash or other property the fair market value of
which combined with the fair market value of each other dividend or distribution made in the preceding 12 months
exceeds the greater of: (1) statutory net income as of the prior December 31st or (2) 10% of statutory policyholders’
surplus as of the prior December 31. HIC and HNIC, both domiciled in Arizona, may pay dividends out of that part of its
available surplus funds that is derived from realized net profits on its business. Without prior written approval from the
Arizona Department of Insurance, HIC and HNIC may not pay extraordinary dividends, which are defined as dividends or
distributions of cash or other property the fair market value of which combined with the fair market value of each other
dividend or distribution made in the preceding 12 months exceeds the lesser of: (1) 10% of statutory policyholders’
surplus as of the prior December 31 or (2) net investment income as of the prior December 31. HSIC, domiciled in
Oklahoma, may only pay dividends out of that part of its available surplus funds that is derived from realized net profits
on its business. Without prior written approval from the Oklahoma Insurance Department, HSIC may not pay
extraordinary dividends, which are defined as dividends or distributions of cash or other property the fair market value of
which combined with the fair market value of each other dividend or distribution made in the preceding 12 months
exceeds the greater of: (1) 10% of statutory policyholders’ surplus as of the prior December 31 or (2) statutory net
income as of the prior December 31, not including realized capital gains. As a county mutual, dividends from HCM are
payable to policyholders.
Risk-based capital requirements. The National Association of Insurance Commissioners requires property/casualty
insurers to file a risk-based capital calculation according to a specified formula. The purpose of the formula is twofold: (1)
to assess the adequacy of an insurer’s statutory capital and surplus based upon a variety of factors such as potential risks
related to investment portfolio, ceded reinsurance and product mix; and (2) to assist state regulators under the RBC for
Insurers Model Act by providing thresholds at which a state commissioner is authorized and expected to take regulatory
action. As of December 31, 2014, the adjusted capital under the risk-based capital calculation of each of our insurance
company subsidiaries substantially exceeded the minimum requirements.
Required licensing. Our non-insurance company subsidiaries are subject to and in compliance with the licensing
requirements of the department of insurance in each state in which they produce business. These licenses govern, among
other things, the types of insurance coverages, agency and claims services and products that we may offer consumers in
these states. Such licenses typically are issued only after we file an appropriate application and satisfy prescribed criteria.
Generally, each state requires one officer to maintain an agent license. Claims adjusters employed by us are also subject
to the licensing requirements of each state in which they conduct business. Each employed claim adjuster either holds or
has applied for the required licenses. Our premium finance subsidiaries are subject to licensing, financial reporting and
certain financial requirements imposed by the Texas Department of Insurance, as well as regulations promulgated by the
Texas Office of Consumer Credit Commissioner.
Regulation of insurance rates and approval of policy forms. The insurance laws of most states in which our subsidiaries
operate require insurance companies to file insurance rate schedules and insurance policy forms for review and approval.
State insurance regulators have broad discretion in judging whether our rates are adequate, not excessive and not
25
unfairly discriminatory and whether our policy forms comply with law. The speed at which we can change our rates
depends, in part, on the method by which the applicable state’s rating laws are administered. Generally, state insurance
regulators have the authority to disapprove our rates or request changes in our rates.
Restrictions on cancellation, non-renewal or withdrawal. Many states have laws and regulations that limit an insurance
company’s ability to exit a market. For example, certain states limit an automobile insurance company’s ability to cancel
or not renew policies. Some states prohibit an insurance company from withdrawing from one or more lines of business
in the state, except pursuant to a plan approved by the state insurance department. In some states, this applies to
significant reductions in the amount of insurance written, not just to a complete withdrawal. State insurance
departments may disapprove a plan that may lead to market disruption.
Investment restrictions. We are subject to state laws and regulations that require diversification of our investment
portfolios and that limit the amount of investments in certain categories. Failure to comply with these laws and
regulations would cause non-conforming investments to be treated as non-admitted assets for purposes of measuring
statutory surplus and, in some instances, would require divestiture.
Trade practices. The manner in which we conduct the business of insurance is regulated by state statutes in an effort to
prohibit practices that constitute unfair methods of competition or unfair or deceptive acts or practices. Prohibited
practices include disseminating false information or advertising; defamation; boycotting, coercion and intimidation; false
statements or entries; unfair discrimination; rebating; improper tie-ins with lenders and the extension of credit; failure to
maintain proper records; failure to maintain proper complaint handling procedures; and making false statements in
connection with insurance applications for the purpose of obtaining a fee, commission or other benefit.
Unfair claims practices. Generally, insurance companies, adjusting companies and individual claims adjusters are
prohibited by state statutes from engaging in unfair claims practices on a flagrant basis or with such frequency to indicate
a general business practice. Examples of unfair claims practices include:
•
•
•
•
•
•
•
•
•
•
misrepresenting pertinent facts or insurance policy provisions relating to coverages at issue;
failing to acknowledge and act reasonably promptly upon communications with respect to claims
arising under insurance policies;
failing to adopt and implement reasonable standards for the prompt investigation and settlement of
claims arising under insurance policies;
failing to affirm or deny coverage of claims within a reasonable time after proof of loss statements
have been completed;
attempting to settle a claim for less than the amount to which a reasonable person would have
believed such person was entitled;
attempting to settle claims on the basis of an application that was altered without notice to, or
knowledge and consent of, the insured;
compelling insureds to institute suits to recover amounts due under policies by offering substantially
less than the amounts ultimately recovered in suits brought by them;
refusing to pay claims without conducting a reasonable investigation;
making claim payments to an insured without indicating the coverage under which each payment is
being made;
delaying the investigation or payment of claims by requiring an insured, claimant or the physician of
either to submit a preliminary claim report and then requiring the subsequent submission of formal
proof of loss forms, both of which submissions contain substantially the same information;
26
failing, in the case of claim denials or offers of compromise or settlement, to promptly provide a
reasonable and accurate explanation of the basis for such actions; and
not attempting in good faith to effectuate prompt, fair and equitable settlements of claims in which
liability has become reasonably clear.
•
•
Employees
As of December 31, 2014, we employed 393 people on a full-time basis. None of our employees are represented by labor
unions. We consider our employee relations to be good.
Available Information
The Company’s executive offices are located at 777 Main Street, Suite 1000 Fort Worth, Texas 76102. The Company’s
mailing address is 777 Main Street, Suite 1000 Fort Worth, Texas 76102. Its telephone number is (817) 348-1600. The
Company’s website address is www.hallmarkgrp.com. The Company files annual, quarterly and current reports, proxy
statements and other information and documents with the U.S. Securities and Exchange Commission (the “SEC”), which
are made available to read and copy at the SEC’s Public Reference Room at 100 F Street, N.E., Washington, D.C. 20549.
You may obtain information on the operation of the Public Reference Room by contacting the SEC at 1-800-SEC-0330.
Reports filed with the SEC are also made available at www.sec.gov. The Company makes available free of charge on its
website its annual report on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K and amendments to
those reports filed with or furnished to the SEC pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 as
soon as reasonably practical after it electronically files them with or furnishes them to the SEC.
Item 1A. Risk Factors.
Our success depends on our ability to price accurately the risks we underwrite.
Our results of operations and financial condition depend on our ability to underwrite and set premium rates accurately
for a wide variety of risks. Adequate rates are necessary to generate premiums sufficient to pay losses, loss settlement
expenses and underwriting expenses and to earn a profit. To price our products accurately, we must collect and properly
analyze a substantial amount of data; develop, test and apply appropriate pricing techniques; closely monitor and timely
recognize changes in trends; and project both severity and frequency of losses with reasonable accuracy. Our ability to
undertake these efforts successfully, and as a result price our products accurately, is subject to a number of risks and
uncertainties, some of which are outside our control, including:
•
•
•
•
the availability of sufficient reliable data and our ability to properly analyze available data;
the uncertainties that inherently characterize estimates and assumptions;
our selection and application of appropriate pricing techniques; and
changes in applicable legal liability standards and in the civil litigation system generally.
Consequently, we could underprice risks, which would adversely affect our profit margins, or we could overprice risks,
which could reduce our sales volume and competitiveness. In either case, our profitability could be materially and
adversely affected.
Our results may fluctuate as a result of cyclical changes in the property/casualty insurance industry.
Our revenue is primarily attributable to property/casualty insurance, which as an industry is cyclical in nature and has
historically been characterized by soft markets followed by hard markets. A soft market is a period of relatively high levels
of price competition, less restrictive underwriting standards and generally low premium rates. A hard market is a period
of capital shortages resulting in lack of insurance availability, relatively low levels of competition, more selective
underwriting of risks and relatively high premium rates. If we find it necessary to reduce premiums or limit premium
27
increases due to competitive pressures on pricing in a softening market, we may experience a reduction in our premiums
written and in our profit margins and revenues, which could adversely affect our financial results.
Estimating reserves is inherently uncertain. If our loss reserves are not adequate, it will have an unfavorable impact on
our results.
We maintain loss reserves to cover our estimated ultimate liability for unpaid losses and LAE for reported and unreported
claims incurred as of the end of each accounting period. Reserves represent management’s estimates of what the
ultimate settlement and administration of claims will cost and are not reviewed by an independent actuary. These
estimates, which generally involve actuarial projections, are based on management’s assessment of facts and
circumstances then known, as well as estimates of future trends in claim severity and frequency, judicial theories of
liability, and other factors. These variables are affected by both internal and external events, such as changes in claims
handling procedures, inflation, judicial trends and legislative changes. Many of these factors are not quantifiable.
Additionally, there may be a significant lag between the occurrence of an event and the time it is reported to us. The
inherent uncertainties of estimating reserves are greater for certain types of liabilities, particularly those in which the
various considerations affecting the type of claim are subject to change and in which long periods of time may elapse
before a definitive determination of liability is made. Reserve estimates are continually refined in a regular and ongoing
process as experience develops and further claims are reported and settled. Adjustments to reserves are reflected in the
results of the periods in which such estimates are changed. For example, a 1% change in December 31, 2014 unpaid
losses and LAE would have produced a $4.2 million change to pretax earnings. Our gross loss and LAE reserves totaled
$415.1 million at December 31, 2014. Our loss and LAE reserves, net of reinsurance recoverable on unpaid loss and LAE,
were $323.2 million at that date. Because setting reserves is inherently uncertain, there can be no assurance that the
current reserves will prove adequate.
Our failure to maintain favorable financial strength ratings could negatively impact our ability to compete successfully.
Third-party rating agencies assess and rate the claims-paying ability of insurers based upon criteria established by the
agencies. AHIC, HIC, HSIC and HNIC have entered into a pooling arrangement, pursuant to which AHIC retains 30% of the
net premiums written by any of them, HIC retains 27% of the net premiums written by any of them, HSIC retains 30% of
the net premiums written by any of them and HNIC retains 13% of the net premiums written by any of them. A.M. Best
has pooled its ratings of these four insurance company subsidiaries and assigned a financial strength rating of “A–”
(Excellent) and an issuer credit rating of “a-” to each of these individual insurance company subsidiaries and to the pool
formed by these four insurance company subsidiaries. Also, A.M. Best has assigned HCM a financial strength rating of “A–
” (Excellent) and an issuer credit rating of “a-”. A.M. Best does not assign a financial strength rating or an issuer credit
rating to TBIC.
These financial strength ratings are used by policyholders, insurers, reinsurers and insurance and reinsurance
intermediaries as an important means of assessing the financial strength and quality of insurers. These ratings are not
evaluations directed to potential purchasers of our common stock and are not recommendations to buy, sell or hold our
common stock. Our ratings are subject to change at any time and could be revised downward or revoked at the sole
discretion of the rating agencies. We believe that the ratings assigned by A.M. Best are an important factor in marketing
our products. Our ability to retain our existing business and to attract new business in our insurance operations depends
largely on these ratings. Our failure to maintain our ratings, or any other adverse development with respect to our
ratings, could cause our current and future independent agents and insureds to choose to transact their business with
more highly rated competitors. If A.M. Best downgrades our ratings or publicly indicates that our ratings are under
review, it is likely that we would not be able to compete as effectively with our competitors, and our ability to sell
insurance policies could decline. If that happened, our sales and earnings would decrease. For example, many of our
agencies and insureds have guidelines that require us to have an A.M. Best financial strength rating of “A-” (Excellent) or
higher. A reduction of our A.M. Best rating below “A-” would prevent us from issuing policies to insureds or potential
insureds with such ratings requirements.
Lenders and reinsurers also use our A.M. Best ratings as a factor in deciding whether to transact business with us. The
failure of our insurance company subsidiaries to maintain their current ratings could dissuade a lender or reinsurance
company from conducting business with us or might increase our interest or reinsurance costs. In addition, a ratings
downgrade by A.M. Best below “A-” would require us to post collateral in support of our obligations under certain of our
reinsurance agreements pursuant to which we assume business.
The loss of key executives could disrupt our business.
28
Our success will depend in part upon the continued service of certain key executives. Our success will also depend on our
ability to attract and retain additional executives and personnel. We do not have employment agreements with our Chief
Executive Officer or any of our other executive officers. The loss of key personnel, or our inability to recruit and retain
additional qualified personnel, could cause disruption in our business and could prevent us from fully implementing our
business strategies, which could materially and adversely affect our business, growth and profitability.
Our industry is very competitive, which may unfavorably impact our results of operations.
The property/casualty insurance market, our primary source of revenue, is highly competitive and, except for regulatory
considerations, has very few barriers to entry. According to A.M. Best, there were 3,087 property/casualty insurance
companies and 2,134 property/casualty insurance groups operating in North America as of July 14, 2014. Our competitors
include entities that have, or are affiliated with entities that have, greater financial and other resources than we have. In
addition, competitors may attempt to increase market share by lowering rates. In that case, we could experience
reductions in our underwriting margins, or sales of our insurance policies could decline as customers purchase lower-
priced products from our competitors. Losing business to competitors offering similar products at lower prices, or having
other competitive advantages, could adversely affect our results of operations.
Our results may be unfavorably impacted if we are unable to obtain adequate reinsurance.
As part of our overall risk and capacity management strategy, we purchase reinsurance for significant amounts of risk,
especially catastrophe risks that we and our insurance company subsidiaries underwrite. Our catastrophe and non-
catastrophe reinsurance facilities are generally subject to annual renewal. We may be unable to maintain our current
reinsurance facilities or to obtain other reinsurance facilities in adequate amounts and at favorable rates. The amount,
availability and cost of reinsurance are subject to prevailing market conditions beyond our control, and may affect our
ability to write additional premiums as well as our profitability. If we are unable to obtain adequate reinsurance
protection for the risks we have underwritten, we will either be exposed to greater losses from these risks or we will
reduce the level of business that we underwrite, which will reduce our revenue.
If the companies that provide our reinsurance do not pay our claims in a timely manner, we could incur severe losses.
We purchase reinsurance by transferring, or ceding, part of the risk we have assumed to a reinsurance company in
exchange for part of the premium we receive in connection with the risk. Although reinsurance makes the reinsurer liable
to us to the extent the risk is transferred or ceded to the reinsurer, it does not relieve us of our liability to our
policyholders. Accordingly, we bear credit risk with respect to our reinsurers. We cannot assure that our reinsurers will
pay all of our reinsurance claims, or that they will pay our claims on a timely basis. At December 31, 2014, we had a total
of $163.1 million due us from reinsurers, including $109.7 million of recoverables from losses and $53.4 million in ceded
unearned premiums. The largest amount due us from a single reinsurer as of December 31, 2014 was $20.4 million
reinsurance and premium recoverable from Swiss Reinsurance America Corporation. If any of our reinsurers are unable or
unwilling to pay amounts they owe us in a timely fashion, we could suffer a significant loss or a shortage of liquidity,
which would have a material adverse effect on our business and results of operations.
Catastrophic losses are unpredictable and may adversely affect our results of operations, liquidity and financial
condition.
Property/casualty insurance companies are subject to claims arising out of catastrophes that may have a significant effect
on their results of operations, liquidity and financial condition. Catastrophes can be caused by various events, including
hurricanes, windstorms, earthquakes, hail storms, explosions, severe winter weather and fires, and may include man-
made events, such as terrorist attacks. The incidence, frequency, and severity of catastrophes are inherently
unpredictable. The extent of losses from a catastrophe is a function of both the total amount of insured exposure in the
area affected by the event and the severity of the event.
Claims from catastrophic events could reduce our net income, cause substantial volatility in our financial results for any
fiscal quarter or year or otherwise adversely affect our financial condition, liquidity or results of operations. Catastrophes
may also negatively affect our ability to write new business. Increases in the value and geographic concentration of
insured property and the effects of inflation could increase the severity of claims from catastrophic events in the future.
Catastrophe models may not accurately predict future losses.
29
Along with other insurers in the industry, we use models developed by third-party vendors in assessing our exposure to
catastrophe losses that assume various conditions and probability scenarios. However, these models do not necessarily
accurately predict future losses or accurately measure losses currently incurred. Catastrophe models, which have been
evolving since the early 1990s, use historical information about various catastrophes and detailed information about our
in-force business. While we use this information in connection with our pricing and risk management activities, there are
limitations with respect to their usefulness in predicting losses in any reporting period. Examples of these limitations are
significant variations in estimates between models and modelers and material increases and decreases in model results
due to changes and refinements of the underlying data elements and assumptions. Such limitations lead to questionable
predictive capability and post-event measurements that have not been well understood or proven to be sufficiently
reliable. In addition, the models are not necessarily reflective of company or state-specific policy language, demand surge
for labor and materials or loss settlement expenses, all of which are subject to wide variation by catastrophe. Because the
occurrence and severity of catastrophes are inherently unpredictable and may vary significantly from year to year,
historical results of operations may not be indicative of future results of operations.
We are subject to comprehensive regulation, and our results may be unfavorably impacted by these regulations.
We are subject to comprehensive governmental regulation and supervision. Most insurance regulations are designed to
protect the interests of policyholders rather than of the stockholders and other investors of the insurance companies.
These regulations, generally administered by the department of insurance in each state in which we do business, relate
to, among other things:
•
•
•
•
•
•
•
•
•
•
•
•
•
•
•
approval of policy forms and rates;
standards of solvency, including risk-based capital measurements, which are a measure developed by
the National Association of Insurance Commissioners and used by the state insurance regulators to
identify insurance companies that potentially are inadequately capitalized;
licensing of insurers and their agents;
restrictions on the nature, quality and concentration of investments;
restrictions on the ability of insurance company subsidiaries to pay dividends;
restrictions on transactions between insurance company subsidiaries and their affiliates;
requiring certain methods of accounting;
periodic examinations of operations and finances;
the use of non-public consumer information and related privacy issues;
the use of credit history in underwriting and rating;
limitations on the ability to charge policy fees;
the acquisition or disposition of an insurance company or of any company controlling an insurance
company;
involuntary assignments of high-risk policies, participation in reinsurance facilities and underwriting
associations, assessments and other governmental charges;
restrictions on the cancellation or non-renewal of policies and, in certain jurisdictions, withdrawal from
writing certain lines of business;
prescribing the form and content of records of financial condition to be filed;
30
•
•
requiring reserves for unearned premium, losses and other purposes; and
with respect to premium finance business, the federal Truth-in-Lending Act and similar state statutes.
In states where specific statutes have not been enacted, premium finance is generally subject to state
usury laws that are applicable to consumer loans.
State insurance departments also conduct periodic examinations of the affairs of insurance companies and require filing
of annual and other reports relating to the financial condition of insurance companies, holding company issues and other
matters. Our business depends on compliance with applicable laws and regulations and our ability to maintain valid
licenses and approvals for our operations. Regulatory authorities may deny or revoke licenses for various reasons,
including violations of regulations. Changes in the level of regulation of the insurance industry or changes in laws or
regulations themselves or interpretations by regulatory authorities could have a material adverse affect on our
operations. In addition, we could face individual, group and class-action lawsuits by our policyholders and others for
alleged violations of certain state laws and regulations. Each of these regulatory risks could have an adverse effect on our
profitability.
State statutes limit the aggregate amount of dividends that our subsidiaries may pay Hallmark, thereby limiting its
funds to pay expenses and dividends.
Hallmark is a holding company and a legal entity separate and distinct from its subsidiaries. As a holding company
without significant operations of its own, Hallmark’s principal sources of funds are dividends and other sources of funds
from its subsidiaries. State insurance laws limit the ability of Hallmark’s insurance company subsidiaries to pay dividends
and require our insurance company subsidiaries to maintain specified minimum levels of statutory capital and surplus.
The aggregate maximum amount of dividends permitted by law to be paid by an insurance company does not necessarily
define an insurance company’s actual ability to pay dividends. The actual ability to pay dividends may be further
constrained by business and regulatory considerations, such as the impact of dividends on surplus, by our competitive
position and by the amount of premiums that we can write. Without regulatory approval, the aggregate maximum
amount of dividends that could be paid to Hallmark in 2015 by our insurance company subsidiaries is $16.2 million. State
insurance regulators have broad discretion to limit the payment of dividends by insurance companies and Hallmark’s
right to participate in any distribution of assets of one of our insurance company subsidiaries is subject to prior claims of
policyholders and creditors except to the extent that its rights, if any, as a creditor are recognized. Consequently,
Hallmark’s ability to pay debts, expenses and cash dividends to our stockholders may be limited.
Our insurance company subsidiaries are subject to minimum capital and surplus requirements. Failure to meet these
requirements could subject us to regulatory action.
Our insurance company subsidiaries are subject to minimum capital and surplus requirements imposed under the laws of
their respective states of domicile and each state in which they issue policies. Any failure by one of our insurance
company subsidiaries to meet minimum capital and surplus requirements imposed by applicable state law will subject it
to corrective action, which may include requiring adoption of a comprehensive financial plan, revocation of its license to
sell insurance products or placing the subsidiary under state regulatory control. Any new minimum capital and surplus
requirements adopted in the future may require us to increase the capital and surplus of our insurance company
subsidiaries, which we may not be able to do.
We are subject to assessments and other surcharges from state guaranty funds, mandatory reinsurance arrangements
and state insurance facilities, which may reduce our profitability.
Virtually all states require insurers licensed to do business therein to bear a portion of the unfunded obligations of
impaired or insolvent insurance companies. These obligations are funded by assessments, which are levied by guaranty
associations within the state, up to prescribed limits, on all member insurers in the state on the basis of the
proportionate share of the premiums written by member insurers in the lines of business in which the impaired, insolvent
or failed insurer was engaged. Accordingly, the assessments levied on us by the states in which we are licensed to write
insurance may increase as we increase our premiums written. In addition, as a condition to the ability to conduct
business in certain states, insurance companies are required to participate in mandatory reinsurance funds. The effect of
these assessments and mandatory reinsurance arrangements, or changes in them, could reduce our profitability in any
given period or limit our ability to grow our business.
31
We monitor developments with respect to various state facilities, such as the Texas FAIR Plan and the Texas Windstorm
Insurance Association. The impact of any catastrophe experience on these facilities could result in the facilities
recognizing a financial deficit or a financial deficit greater than the level currently estimated. They may, in turn, have the
ability to assess participating insurers when financial deficits occur, adversely affecting our results of operations. While
these facilities are generally designed so that the ultimate cost is borne by policyholders, the exposure to assessments
and the availability of recoupments or premium rate increases from these facilities may not offset each other in our
financial statements. Moreover, even if they do offset each other, they may not offset each other in financial statements
for the same fiscal period due to the ultimate timing of the assessments and recoupments or premium rate increases, as
well as the possibility of policies not being renewed in subsequent years.
Adverse securities market conditions can have a significant and negative impact on our investment portfolio.
Our results of operations depend in part on the performance of our invested assets. As of December 31, 2014, 89% of our
investment portfolio was invested in fixed-income securities. Certain risks are inherent in connection with fixed-income
securities, including loss upon default and price volatility in reaction to changes in interest rates and general market
factors. In general, the fair value of a portfolio of fixed-income securities increases or decreases inversely with changes in
the market interest rates, while net investment income realized from future investments in fixed-income securities
increases or decreases along with interest rates. In addition, 35% of our fixed-income securities have call or prepayment
options. This subjects us to reinvestment risk should interest rates fall and issuers call their securities. Furthermore,
actual net investment income and/or cash flows from investments that carry prepayment risk, such as mortgage-backed
and other asset-backed securities, may differ from those anticipated at the time of investment as a result of interest rate
fluctuations. An investment has prepayment risk when there is a risk that cash flows from the repayment of principal
might occur earlier than anticipated because of declining interest rates or later than anticipated because of rising interest
rates. The fair value of our fixed-income securities as of December 31, 2014 was $450.8 million. If market interest rates
were to increase 1%, the fair value of our fixed-income securities would decrease by approximately $13.4 million as of
December 31, 2014. The calculated change in fair value was determined using duration modeling assuming no
prepayments.
In addition to the general risks described above, although 75% of our portfolio is investment-grade, our fixed-income
securities are nonetheless subject to credit risk. If any of the issuers of our fixed-income securities suffer financial
setbacks, the ratings on the fixed-income securities could fall (with a concurrent fall in market value) and, in a worst case
scenario, the issuer could default on its obligations. As of December 31, 2014, Hallmark had $0.3 million exposed in its
investment portfolio to sub-prime mortgages and $52.1 million total exposure in mortgage-backed securities. Future
changes in the fair value of our available-for-sale securities will be reflected in other comprehensive income.
Similar treatment is not available for liabilities. Therefore, interest rate fluctuations could adversely affect our
stockholders’ equity, total comprehensive income and/or cash flows.
We rely on independent agents and specialty brokers to market our products and their failure to do so would have a
material adverse effect on our results of operations.
We market and distribute our insurance programs exclusively through independent insurance agents and specialty
insurance brokers. As a result, our business depends in large part on the marketing efforts of these agents and brokers
and on our ability to offer insurance products and services that meet the requirements of the agents, the brokers and
their customers. However, these agents and brokers are not obligated to sell or promote our products and many sell or
promote competitors’ insurance products in addition to our products. Some of our competitors have higher financial
strength ratings, offer a larger variety of products, set lower prices for insurance coverage and/or offer higher
commissions than we do. Therefore, we may not be able to continue to attract and retain independent agents and
brokers to sell our insurance products. The failure or inability of independent agents and brokers to market our insurance
products successfully could have a material adverse impact on our business, financial condition and results of operations.
We may experience difficulty in integrating acquisitions into our operations.
The successful integration of any newly acquired businesses into our operations will require, among other things, the
retention and assimilation of their key management, sales and other personnel; the coordination of their lines of
insurance products and services; the adaptation of their technology, information systems and other processes; and the
retention and transition of their customers. Unexpected difficulties in integrating any acquisition could result in increased
expenses and the diversion of management time and resources. If we do not successfully integrate any acquired business
32
into our operations, we may not realize the anticipated benefits of the acquisition, which could have a material adverse
impact on our financial condition and results of operations. Further, any potential acquisitions may require significant
capital outlays and, if we issue equity or convertible debt securities to pay for an acquisition, the issuance may be dilutive
to our existing stockholders.
Our internal controls are not fail-safe.
We continually enhance our operating procedures and internal controls to effectively support our business and comply
with our regulatory and financial reporting requirements. As a result of the inherent limitations in all control systems, no
system of controls can provide absolute assurance that all control objectives have been or will be met, and that every
instance of error or fraud has been or will be detected. A control system, no matter how well conceived and operated,
can provide only reasonable, not absolute, assurance that the objectives of the control system are met. These inherent
limitations include the realities that judgments in decision-making can be faulty and that breakdowns can occur because
of simple error or mistake. Additionally, controls can be circumvented by individual acts or by collusion of two or more
persons. The design of any system of controls is based in part upon assumptions about the likelihood of future events,
and there can be no assurance that any design will succeed in achieving its stated goals under all potential future
conditions. Internal controls may also become inadequate because of changes in conditions, or the degree of compliance
with policies or procedures may deteriorate. Further, the design of a control system must reflect resource constraints,
and the benefits of controls must be considered relative to their costs. As a result of the inherent limitations in a cost-
effective control system, misstatement due to error or fraud may occur and not be detected. Accordingly, our internal
controls and procedures are designed to provide reasonable, not absolute, assurance that the control objectives are met.
Our geographic concentration ties our performance to the business, economic and regulatory conditions of certain
states.
The following states accounted for 65% of our gross written premiums for 2014: Texas (50%), Louisiana (5%), Arizona
(4%), New Mexico (3%) and Oregon (3%). Our revenues and profitability are subject to the prevailing regulatory, legal,
economic, political, demographic, competitive, weather and other conditions in the principal states in which we do
business. Changes in any of these conditions could make it less attractive for us to do business in such states and would
have a more pronounced effect on us compared to companies that are more geographically diversified. In addition, our
exposure to severe losses from localized natural perils, such as windstorms or hailstorms, is increased in those areas
where we have written significant numbers of property/casualty insurance policies.
The exclusions and limitations in our policies may not be enforceable.
Many of the policies we issue include exclusions or other conditions that define and limit coverage, which exclusions and
conditions are designed to manage our exposure to certain types of risks and expanding theories of legal liability. In
addition, many of our policies limit the period during which a policyholder may bring a claim under the policy, which
period in many cases is shorter than the statutory period under which these claims can be brought by our policyholders.
While these exclusions and limitations help us assess and control our loss exposure, it is possible that a court or
regulatory authority could nullify or void an exclusion or limitation, or legislation could be enacted modifying or barring
the use of these exclusions and limitations. This could result in higher than anticipated losses and LAE by extending
coverage beyond our underwriting intent or increasing the number or size of claims, which could have a material adverse
effect on our operating results. In some instances, these changes may not become apparent until sometime after we
have issued the insurance policies that are affected by the changes. As a result, the full extent of liability under our
insurance contracts may not be known for many years after a policy is issued.
We rely on our information technology and telecommunications systems and the failure or disruption of these systems
could disrupt our operations and adversely affect our results of operations.
Our business is highly dependent upon the successful and uninterrupted functioning of our information technology and
telecommunications systems. We rely on these systems to process new and renewal business, provide customer service,
make claims payments and facilitate collections and cancellations, as well as to perform actuarial and other analytical
functions necessary for pricing and product development. Our systems could fail of their own accord or might be
disrupted by factors such as natural disasters, power disruptions or surges, computer hackers or terrorist attacks. Failure
or disruption of these systems for any reason could interrupt our business and adversely affect our results of operations.
33
Cyber security risks in particular are evolving and include malicious software, unauthorized access to data and other
electronic security breaches. We have not experienced cyber security attacks in the past and believe that we have
adopted appropriate measures to mitigate potential risks to our information technology systems. However, the timing,
nature and scope of cyber security attacks are difficult to predict and prevent. Therefore, we could be subject to
operational delays, compromised confidential or proprietary information, destruction or corruption of data, manipulation
or improper use of our systems and networks, financial losses from remedial actions and/or damage to our reputation
from cyber security attacks. A cyber security attack on our information technology systems could disrupt our business
and adversely affect our results of operations and financial position.
Global climate change may have an adverse effect on our financial statements.
Although uncertainty remains as to the nature and effect of greenhouse gas emissions, we could suffer losses if global
climate change results in an increase in the frequency and severity of natural disasters. As with traditional natural
disasters, claims arising from these incidents could increase our exposure to losses and have a material adverse impact on
our business, results of operations, and/or financial condition.
Item 1B. Unresolved Staff Comments.
Not applicable
Item 2. Properties.
Our corporate headquarters and Standard Commercial P&C business unit are located at 777 Main Street, Suite 1000, Fort
Worth, Texas. The suite is located in a high-rise office building and contains 27,808 square feet of space. The rent is
currently $48,664 per month pursuant to a lease which expires June 30, 2022.
Our Workers Compensation business unit is presently located at 11612 Bee Caves Road, Austin, Texas. The suite is
located in a low-rise office building and contains 8,373 square feet of space of which 1,037 square feet is sub-leased. The
gross rent is currently $17,269 per month pursuant to a lease which expires October 31, 2017.
Our E&S Commercial business unit is presently located at 7550 IH-10 West, San Antonio, Texas. These leased premises
consist of a 16,599 square foot office suite and 800 square feet of storage space. The rent is currently $32,632 per month
pursuant to a lease that expires November 30, 2020.
Our Hallmark Select business unit is located at 15280 Addison Road, Suite 250, Addison, Texas. The suite is located in a
low-rise office building and contains an aggregate of 8,219 square feet of space. The rent is currently $9,564 per month
pursuant to a lease that expires July 31, 2018. Our Hallmark Select business unit also maintains branch offices in the
following locations:
Location
Monthly Rent
Lease Expiration
Atlanta, Georgia
$1,200
May 31, 2015
Glendale, California
$2,500
July 31, 2015
Chicago, Illinois
$8,472
April 30, 2017
Our Personal Lines business unit is located at 6500 Pinecrest, Suite 100, Plano, Texas. The suite is located in a one story
office building and contains 23,941 square feet of space. The rent is currently $27,931 per month pursuant to a lease that
expires December 31, 2020.
34
Item 3. Legal Proceedings.
We are engaged in various legal proceedings that are routine in nature and incidental to our business. None of these
proceedings, either individually or in the aggregate, are believed, in our opinion, likely to have a material adverse effect
on our consolidated financial position or our results of operations.
Item 4. Mine Safety Disclosures.
Not applicable.
35
PART II
Item 5. Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of
Equity Securities.
Market for Common Stock
Our common stock is currently traded on the Nasdaq Global Market under the symbol “HALL.” The following table shows
the high and low sales prices of our common stock on the Nasdaq Global Market for each quarter since January 1, 2013.
Period
Year Ended December 31, 2014:
First quarter
Second quarter
Third quarter
Fourth quarter
Year Ended December 31, 2013:
First quarter
Second quarter
Third quarter
Fourth quarter
Holders
High Sale
Low Sale
$
$
9.25 $
11.06
11.05
12.43
9.67 $
9.40
10.03
9.52
8.15
8.05
8.66
9.96
8.36
8.03
8.18
8.05
As of March 2, 2015, there were 1,855 shareholders of record of our common stock.
Dividends
Hallmark has never paid dividends on its common stock. Our board of directors intends to continue this policy for the
foreseeable future in order to retain earnings for development of our business.
Hallmark is a holding company and a legal entity separate and distinct from its subsidiaries. As a holding company,
Hallmark is dependent on dividend payments and management fees from its subsidiaries to pay dividends and make
other payments. State insurance laws limit the ability of our insurance company subsidiaries to pay dividends to
Hallmark. As property/casualty insurance companies domiciled in the state of Texas, AHIC and TBIC are limited in the
payment of dividends to Hallmark in any 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. 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 net investment 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. As a county mutual, dividends from HCM are payable
to policyholders.
36
Equity Compensation Plan Information
The following table sets forth information regarding shares of our common stock authorized for issuance under our
equity compensation plans as of December 31, 2014.
Number of securities to be
issued upon exercise of
outstanding options, warrants
and rights
Weighted-average
exercise price of
outstanding options,
warrants and rights
Number of securities
remaining available for future
issuance under equity
compensation plans
[excluding securities reflected
in column (a)](1)
(a)
(b)
(c)
1,062,134 $
-
1,062,134 $
9.51
-
9.51
358,850
-
358,850
Plan Category
Equity compensation plans approved by
security holders
Equity compensation plans not approved by
security holders
Total
(1) Securities remaining available for future issuance are net of a maximum of 427,824 shares of common stock issuable
pursuant to outstanding restricted stock units, subject to applicable vesting requirements and performance criteria. See
Note 13 to the audited consolidated financial statements included in this report.
Issuer Repurchases
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.
The following table furnishes information for purchases made pursuant to the Stock Repurchase Plan during the quarter
ended December 31, 2014:
Cumulative Number of
Shares Purchased as
Part of Publicly
Announced Plan
Average Price
Paid Per Share
Maximum
Number of
Shares that May
Yet Be
Purchased
Under the Plan
(b)
(c)
(d)
Total Number of
Shares Purchased
(a)
October 1st - October 31st
November 1st – November 30th
December 1st – December 31st
39,683
$ 10.35
-
-
$ -
$ -
1,807,003
1,807,003
1,807,003
2,192,997
2,192,997
2,192,997
37
Performance Graph
The following graph compares the five year cumulative total return provided shareholders on Hallmark’s common stock
relative to the cumulative total returns of the NASDAQ Composite Index, the NASDAQ Insurance Index, and the S&P
Property & Casualty Insurance Index. An investment of $100 (with reinvestment of all dividends) is assumed to have been
made in our common stock and in each index on December 31, 2009 and its relative performance is tracked through
December 31, 2014.
COMPARISON OF 5 YEAR CUMULATIVE TOTAL RETURN*
Among Hallmark Financial Services, Inc., the NASDAQ Composite Index,
the S&P Property & Casualty Insurance Index,
and the NASDAQ Insurance Index
$250
$200
$150
$100
$50
$0
12/09
12/10
12/11
12/12
12/13
12/14
Hallmark Financial Services, Inc.
NASDAQ Composite
S&P Property & Casualty Insurance
NASDAQ Insurance
*$100 invested on 12/31/09 in stock or index, including reinvestment of dividends.
Fiscal year ending December 31.
Copyright© 2015 S&P, a division of The McGraw-Hill Companies Inc. All rights
reserved.
38
Item 6. Selected Financial Data
Statement of Operations Data:
Gross premiums written
Ceded premiums written
Net premiums written
Change in unearned premiums
Net premiums earned
Investment income, net of expenses
Net realized gains
Finance charges
Commission and fees
Other income
Total revenues
Loss and loss adjustment expenses
Operating expenses
Interest expense
Amortization of intangible assets
Total expenses
Income (loss) before tax
Income tax expense (benefit)
Net income (loss)
Less: Net income attributable to non-
controlling interest
Net income (loss) attributable to
Hallmark Financial Services, Inc.
Net income (loss) per share attributable
to Hallmark Financial Services, Inc.
common stockholders:
Year Ended December 31
2014
2013
2012
2011
2010
(in thousands, except per share data)
$
473,218 $
(148,866)
324,352
(3,135)
321,217
460,027 $
(99,262)
360,765
(224)
360,541
389,842 $
(57,353)
332,489
(13,053)
319,436
354,881 $
(51,005)
303,876
(10,835)
293,041
12,383
134
5,279
(1,694)
47
337,366
210,055
101,427
4,576
2,526
318,584
12,884
10,540
5,830
(487)
120
389,428
261,345
109,289
4,599
3,115
378,348
18,782
5,353
13,429
11,080
2,835
8,245
15,293
1,943
5,957
(1,145)
316
341,800
226,414
103,792
4,634
3,586
338,426
3,374
(474)
3,848
15,880
3,633
6,826
3,175
216
322,771
239,235
95,106
4,631
3,586
342,558
(19,787)
(8,954)
(10,833)
320,973
(39,332)
281,641
(3,370)
278,271
14,849
8,402
7,054
(1,575)
59
307,060
202,544
87,882
4,598
3,665
298,689
8,371
863
7,508
-
-
324
58
105
13,429
8,245
3,524
(10,891)
7,403
Basic
Diluted
$
$
0.70 $
0.43 $
0.18 $
(0.55) $
0.69 $
0.43 $
0.18 $
(0.55) $
0.37
0.37
39
As of December 31, 2014
Balance Sheet Items:
2014
2013
2012
2011
2010
Total investments
Total assets
Reserves for unpaid loss and loss
adjustment expenses
Unearned premiums
Total liabilities
Total stockholders' equity
$
$
$
$
$
$
507,229 $
980,869 $
461,325 $
909,023 $
445,360 $
790,468 $
424,628 $
746,059 $
432,441
736,557
415,135 $
382,640 $
313,416 $
296,945 $
251,677
196,826 $
185,303 $
162,502 $
146,104 $
140,965
728,832 $
252,037 $
670,905 $
238,118 $
569,931 $
220,537 $
529,203 $
215,572 $
499,919
235,278
Book value per share
$
13.11 $
12.36 $
11.45 $
11.19 $
11.69
Item 7. 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-K” for a discussion of some of the uncertainties, risks and assumptions associated with these statements.
Overview
Hallmark is an insurance holding company which, 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. We pursue our business activities
primarily through subsidiaries whose operations are organized into business units and are supported by our insurance
carrier subsidiaries.
Our insurance activities are organized by business units into the following reportable segments:
•
•
Standard Commercial Segment. The Standard Commercial Segment includes the standard lines commercial
property/casualty and occupational accident insurance products and services handled by our Standard
Commercial P&C business unit and the workers compensation insurance products handled by our Workers
Compensation business unit. Our Standard Commercial P&C business unit is comprised of our American
Hallmark Insurance Services and ECM subsidiaries. Our Workers Compensation business unit is comprised of our
TBIC Holdings, TBIC and TBICRM subsidiaries.
Specialty Commercial Segment. Our Specialty Commercial Segment includes the excess and surplus lines
commercial property/casualty insurance products and services handled by our E&S Commercial business unit
and the general aviation, satellite launch, commercial umbrella and excess liability and medical professional
liability insurance products and services handled by our Hallmark Select business unit, as well as certain
Specialty Programs which are managed at the parent level. Our E&S Commercial business unit is comprised of
our HSU, PAAC and TGASRI subsidiaries. Our Hallmark Select business unit is comprised of our Aerospace
Insurance Managers, ASRI, ACMG, HXS and HDS subsidiaries.
•
Personal Segment. The Personal Segment includes the non-standard personal automobile, low value
dwelling/homeowners, renters and manufactured homes insurance products and services handled by our
Personal Lines business unit that is comprised of American Hallmark General Agency, Inc. and Hallmark Claims
40
Services, Inc., both of which do business as Hallmark Insurance Company.
The retained premium produced by these reportable segments is supported by our American Hallmark Insurance
Company of Texas, Hallmark Specialty Insurance Company, Hallmark Insurance Company, Hallmark National Insurance
Company and Texas Builders Insurance Company insurance subsidiaries. In addition, control and management of
Hallmark County Mutual 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.
AHIC, HIC, HSIC and HNIC have entered into a pooling arrangement pursuant to which AHIC retains 30% of the net
premiums written by any of them, HIC retains 27% of the net premiums written by any of them, HSIC retains 30% of the
net premiums written by any of them and HNIC retains 13% of the net premiums written by any of them. Neither HCM
nor TBIC is a party to the intercompany pooling arrangement.
Critical Accounting Estimates and Judgments
The significant accounting policies requiring our estimates and judgments are discussed below. Such estimates and
judgments are based on historical experience, changes in laws and regulations, observance of industry trends and
information received from third parties. While the estimates and judgments associated with the application of these
accounting policies may be affected by different assumptions or conditions, we believe the estimates and judgments
associated with the reported consolidated financial statement amounts are appropriate in the circumstances. For
additional discussion of our accounting policies, see Note 1 to the audited consolidated financial statements included in
this report.
Impairment of investments. We complete a detailed analysis each quarter to assess whether any decline in the fair value
of any investment below cost is deemed other-than-temporary. All securities with an unrealized loss are reviewed. We
recognize an impairment loss when an investment’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.
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 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.
Equity Investments: Some of the factors considered in evaluating whether a decline in fair value for an equity investment
is other-than-temporary include: (1) our ability and intent to retain the investment for a period of time sufficient to allow
for an anticipated recovery in value; (2) the recoverability of cost; (3) the length of time and extent to which the fair value
has been less than cost; and (4) the financial condition and near-term and long-term prospects for the issuer, including
the relevant industry conditions and trends, and implications of rating agency actions and offering prices. When it is
determined that an equity investment is other-than-temporarily impaired, the security is written down to fair value, and
the amount of the impairment is included in earnings as a realized investment loss. The fair value then becomes the new
cost basis of the investment, and any subsequent recoveries in fair value are recognized at disposition. We recognize a
realized loss when impairment is deemed to be other-than-temporary even if a decision to sell an equity investment has
not been made. When we decide to sell a temporarily impaired available-for-sale equity investment and we do not
expect the fair value of the equity investment to fully recover prior to the expected time of sale, the investment is
deemed to be other-than-temporarily impaired in the period in which the decision to sell is made.
Fair values of financial instruments. Accounting Standards Codification (“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
41
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
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 stock and preferred stock.
Level 2 investment securities include corporate bonds, collateralized corporate bank loans, municipal bonds, U.S.
Treasury securities, other obligations of the U.S. Government and mortgage-backed securities for which quoted prices are
not available on active exchanges for identical instruments. We use a third party pricing service 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 service and have determined that they result in fair values consistent with the requirements of ASC 820 for
Level 2 investment securities. We have not adjusted any prices received from third-party pricing sources.
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.
Deferred policy acquisition costs. Policy acquisition costs (mainly commission, underwriting and marketing expenses)
that vary with and are primarily related to the successful acquisition of new and renewal insurance contracts are deferred
and charged to operations over periods in which the related premiums are earned. Ceding commissions from reinsurers,
which include expense allowances, are deferred and recognized over the period premiums are earned for the underlying
policies reinsured.
The method followed in computing deferred policy acquisition costs limits the amount of such deferred costs to their
estimated realizable value. A premium deficiency exists if the sum of expected claim costs and claim adjustment
expenses, unamortized acquisition costs, and maintenance costs exceeds related unearned premiums and expected
investment income on those unearned premiums, as computed on a product line basis. We routinely evaluate the
realizability of deferred policy acquisition costs. At December 31, 2014 and 2013, there was no premium deficiency
related to deferred policy acquisition costs.
Goodwill. Goodwill is tested for impairment at the reporting unit level (operating segment or one level below an
operating segment) on an annual basis (October 1) and between annual tests if an event occurs or circumstances change
that would more likely than not reduce the fair value of a reporting unit below its carrying value. For purposes of
evaluating goodwill for impairment, we have determined that our reporting units are the same as our business units
except for the Hallmark Select business unit for which reporting units are at the component level (“one level below”). Our
consolidated balance sheet as of December 31, 2014 includes goodwill of acquired businesses of $44.7 million that is
42
assigned to our business units as follows: Standard Commercial P&C business unit - $2.1 million; E&S Commercial
business unit - $19.8 million; Hallmark Select business unit- $17.4 million (comprised of $7.7 million for the excess &
umbrella component and $9.7 million for the general aviation and satellite component); and Personal Lines business unit
- $5.4 million. This amount has been recorded as a result of prior business acquisitions accounted for under the
acquisition method of accounting. Under ASC 350, “Intangibles- Goodwill and Other,” goodwill is tested for impairment
annually. We completed our last annual test for impairment on the first day of the fourth quarter of 2014 and
determined that there was no impairment.
A significant amount of judgment is required in performing goodwill impairment tests. Such tests include estimating the
fair value of our reporting units. As required by ASC 350, we compare the estimated fair value of each reporting unit with
its carrying amount, including goodwill. Under ASC 350, fair value refers to the amount for which the entire reporting unit
may be bought or sold.
The determination of fair value was based on an income approach utilizing discounted cash flows. The valuation
methodology utilized is subject to key judgments and assumptions. Estimates of fair value are inherently uncertain and
represent management’s reasonable expectation regarding future developments. These estimates and the judgments
and assumptions upon which the estimates are based will, in all likelihood, differ in some respects from actual future
results. Declines in estimated fair value could result in goodwill impairments in future periods which could materially
adversely affect our results of operations or financial position.
The income approach to determining fair value computed the projections of the cash flows that the reporting unit is
expected to generate converted into a present value equivalent through discounting. Significant assumptions in the
income approach model include income projections, discount rates and terminal growth values. The income projections
reflect an improved premium rate environment across most of our lines of business that continued throughout 2014. The
income projections also include loss and LAE assumptions which reflect recent historical claim trends and the movement
towards a more favorable pricing environment. The income projections also include assumptions for expense growth and
investment yields which are based on business plans for each of our business units. The discount rate was based on a risk
free rate plus a beta adjusted equity risk premium and specific company risk premium. The assumptions were based on
historical experience, expectations of future performance, expected market conditions and other factors requiring
judgment and estimates. While we believe the assumptions used in these models were reasonable, the inherent
uncertainty in predicting future performance and market conditions may change over time and influence the outcome of
future testing.
The fair values of each of our business units were in excess of their respective carrying values, including goodwill, as a
result of our annual test for impairment during the fourth quarter 2014. However, a 7% decline in the fair value of our
Standard Commercial P&C business unit, a 13% decline in the fair value of our E&S Commercial business unit, a 28%
decline in the fair value of our Personal Lines business unit, a 52% decline in the fair value of our excess & umbrella
component or a 12% decline in the fair value of our general aviation and satellite component would have caused the
carrying value of the respective reporting unit to be in excess of its fair value, resulting in the need to perform the second
step of impairment testing prescribed by ASC 350, which could have resulted in an impairment to our goodwill.
The market capitalization of Hallmark’s common stock has been below book value during 2014. We consider our market
capitalization in assessing the reasonableness of the fair values estimated for our business units in connection with our
goodwill impairment testing. We believe the current financial market conditions, as well as the limited daily trading
volume of Hallmark shares has resulted in a decrease in our market capitalization that is not representative of a long-
term decrease in value. The valuation analysis discussed above supports our view that goodwill was not impaired at
October 1, 2014. Through December 31, 2014, there were no indicators of impairment.
While we believe the estimates and assumptions used in determining the fair value of our business units were
reasonable, actual results could vary materially. If our actual results are not consistent with our estimates and
assumptions used to calculate fair value, we may be required to perform the second step of impairment testing
prescribed by ASC 350 in future periods and impairment of goodwill could result. We cannot predict future events that
might impact the fair value of our business units and goodwill impairment. Such events include, but are not limited to,
increased competition in insurance markets and global economic changes.
Deferred income tax assets and liabilities. 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
43
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. A valuation allowance is provided against our deferred tax
assets to the extent that we do not believe it is more likely than not that future taxable income will be adequate to
realize these future tax benefits.
Reserves for unpaid losses and LAE. Reserves for unpaid losses and LAE are established for claims that have already been
incurred by the policyholder but which we have not yet paid. Unpaid losses and LAE represent the estimated ultimate net
cost of all reported and unreported losses incurred through each balance sheet date. The reserves for unpaid losses and
LAE are estimated using individual case-basis valuations and statistical analyses. These reserves are revised periodically
and are subject to the effects of trends in loss severity and frequency. (See “Item 1. Business – Analysis of Losses and
LAE” and “-Analysis of Loss and LAE Reserve Development.”)
Although considerable variability is inherent in such estimates, we believe that our reserves for unpaid losses and LAE are
adequate. Due to the inherent uncertainty in estimating unpaid losses and LAE, the actual ultimate amounts may differ
from the recorded amounts. A small percentage change could result in a material effect on reported earnings. For
example, a 1% change in December 31, 2014 reserves for unpaid losses and LAE would have produced a $4.2 million
change to pretax earnings. The estimates are continually reviewed and adjusted as experience develops or new
information becomes known. Such adjustments are included in current operations.
An actuarial range of ultimate unpaid losses and LAE is developed independent of management’s best estimate and is
only used to assess the reasonableness of that estimate. There is no exclusive method for determining this range, and
judgment enters into the process. The primary actuarial technique utilized is a loss development analysis in which
ultimate losses are projected based upon historical development patterns. The primary assumption underlying this loss
development analysis is that the historical development patterns will be a reasonable predictor of the future
development of losses for accident years which are less mature. An alternate actuarial technique, known as the
Bornhuetter-Ferguson method, combines an analysis of loss development patterns with an initial estimate of expected
losses or loss ratios. This approach is most useful for recent accident years. In addition to assuming the stability of loss
development patterns, this technique is heavily dependent on the accuracy of the initial estimate of expected losses or
loss ratios. Consequently, the Bornhuetter-Ferguson method is primarily used to confirm the results derived from the loss
development analysis.
The range of unpaid losses and LAE estimated by our actuary as of December 31, 2014 was $356.1 million to $438.1
million. Our best estimate of unpaid losses and LAE as of December 31, 2014 is $415.1 million. Our carried reserve for
unpaid losses and LAE as of December 31, 2014 is comprised of $223.1 million in case reserves and $192.0 million in
incurred but not reported reserves. In setting this estimate of unpaid losses and LAE, we have assumed, among other
things, that current trends in loss frequency and severity will continue and that the actuarial analysis was empirically
valid. We have established a best estimate of unpaid losses and LAE, which is approximately $18.0 million higher than the
midpoint or 94.8% of the high end of the actuarial range at December 31, 2014 as compared to $19.5 million above the
midpoint or 98.5% of the high end of the actuarial range at December 31, 2013. We expect our best estimate to move
within the actuarial range from year to year due to changes in our operations and changes within the marketplace. Due
to the inherent uncertainty in reserve estimates, there can be no assurance that the actual losses ultimately experienced
will fall within the actuarial range. However, because of the breadth of the actuarial range, we believe that it is
reasonably likely that actual losses will fall within such range.
Our reserve requirements are also interrelated with product pricing and profitability. We must price our products at a
level sufficient to fund our policyholder benefits and still remain profitable. Because claim expenses represent the single
largest category of our expenses, inaccuracies in the assumptions used to estimate the amount of such benefits can result
in our failing to price our products appropriately and to generate sufficient premiums to fund our operations.
Recognition of profit sharing commissions. Profit sharing commission is calculated and recognized when the loss ratio, as
determined by a qualified actuary, deviates from contractual targets. We receive a provisional commission as policies are
produced as an advance against the later determination of the profit sharing commission actually earned. The profit
sharing commission is an estimate that varies with the estimated loss ratio and is sensitive to changes in that estimate.
The following table details the profit sharing commission revenue sensitivity of the Standard Commercial P&C business
unit to the actual ultimate loss ratio for each effective quota share treaty at 5.0% above and below the current estimate,
which we believe is a reasonably likely range of variance ($ in thousands).
44
Provisional loss ratio
Estimated ultimate loss ratio recorded at
December 31, 2014
Treaty Effective Dates
7/1/2001
7/1/2002
7/1/2003
7/1/2004
60.0%
63.5%
59.0%
64.5%
59.0%
61.2%
64.2%
66.0%
Effect of actual 5.0% above estimated loss ratio at
December 31, 2014
-
- $
(3,360) $
(3,790)
Effect of actual 5.0% below estimated loss ratio at
December 31, 2014
$
1,850 $
3,055 $
2,734 $
3,790
The following table details the profit sharing commission revenue sensitivity of the E&S Commercial business unit for
each effective quota share treaty at 5.0% above and below the current estimate, which we believe is a reasonably likely
range of variance ($ in thousands).
Provisional loss ratio
Estimated ultimate loss ratio recorded at December 31,
2014
Effect of actual 5.0% above estimated loss ratio at
December 31, 2014
Effect of actual 5.0% below estimated loss ratio at
December 31, 2014
$
$
Results of Operations
Treaty Effective Dates
1/1/2006
1/1/2007
1/1/2008
65.0%
65.0%
58.7%
63.6%
65.0%
59.5%
(3,096) $
(658) $
(1,618)
2,911 $
2,351 $
1,618
Comparison of Years ended December 31, 2014 and December 31, 2013
Management overview. During fiscal 2014, our total revenues were $337.4 million, representing an approximately 13%
decrease over the $389.4 million in total revenues for fiscal 2013. The decrease in revenue was primarily attributable to
lower net earned premiums in our Personal Segment due to a new quota share reinsurance contract entered into during
the fourth quarter of 2013 on our non-standard automobile risk produced in certain states. Further contributing to the
decrease in revenue were significant realized gains recognized in our investment portfolio for the year ended December
31, 2013, lower net investment income and adverse profit share commission revenue adjustments in our Standard
Commercial Segment for the year ended December 31, 2014.
The decrease in revenue for the year ended December 31, 2014 was offset by decreased loss and LAE of $51.3
million as compared to the same period of 2013. During the twelve months ended December 31, 2014 we recorded $5.2
million of favorable prior year loss development. During the twelve months ended December 31, 2013 we recorded
$10.0 million of unfavorable prior year loss development. The decrease in loss and LAE occurred despite a $4.8 million
increase in net catastrophe losses to $15.0 million during the year ended December 31, 2014 from $10.2 million reported
for the same period of 2013. Other operating expenses also decreased due mostly to decreased production related
expenses in our Specialty Commercial Segment and Personal Segment, partially offset by $3.0 million of costs related to
higher salary and related expenses due mostly to increased incentive compensation accruals compared to the prior
period, $0.7 million of CEO transition costs and $0.2 million of costs related to a previously announced public debt
offering.
45
We reported net income of $13.4 million for the year ended December 31, 2014, as compared to net income of $8.2
million for the year ended December 31, 2013. On a diluted per share basis, net income was $0.69 per share for fiscal
2014 as compared to net income of $0.43 per share for fiscal 2013.
Segment information
The following is additional business segment information for the years ended December 31, 2014 and 2013 (in
thousands):
Year Ended December 31, 2014
Standard
Commercial Segment
Specialty Commercial
Segment
Personal Segment
Corporate
Consolidated
2014
2013
2014
2013
2014
2013
2014
2013
2014
2013
84,679 $ 87,147 $ 324,547 $ 296,108 $ 63,992 $ 76,772 $
- $
- $ 473,218 $ 460,027
(7,767)
(7,681)
(93,909)
(60,453)
(47,190)
(31,128)
Net premiums written
76,912
79,466
230,638
235,655 16,802
45,644
Change in unearned
premiums
1,399
(1,290)
(1,815)
(17,090)
(2,719)
18,156
Net premiums earned
78,311
78,176
228,823
218,565 14,083
63,800
-
-
-
-
-
(148,866)
(99,262)
-
324,352
360,765
-
(3,135)
(224)
-
321,217
360,541
Gross premiums written $
Ceded premiums
written
Total revenues
81,464
83,306
241,920
229,734 20,404
71,081
(6,422)
5,307
337,366
389,428
Losses and loss
adjustment expenses
51,130
56,143
149,961
152,546
8,964
52,656
-
-
210,055
261,345
Pre-tax income (loss)
4,595
1,980
34,237
19,527
1,226
(3,416)
(21,276)
(7,011)
18,782
11,080
Net loss ratio (1)
65.3%
71.8%
65.5%
33.3%
32.2%
25.6%
98.6% 104.0%
91.1%
82.5%
63.7%
69.8%
26.6%
43.3%
26.7%
96.4% 107.0% 109.2%
65.4%
72.5%
30.5%
29.2%
95.9%
101.7%
Net expense ratio (1)
Net combined ratio (1)
Favorable (Unfavorable)
Prior Year Development
6,033
5,235
(3,721)
(13,381)
2,891
(1,808)
5,203
(9,954)
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.
Standard Commercial Segment.
Gross premiums written for the Standard Commercial Segment were $84.7 million for the year ended December 31,
2014, which was $2.4 million, or approximately 3%, less than the $87.1 million reported for the same period in 2013. Net
premiums written were $76.9 million for the year ended December 31, 2014 as compared to $79.5 million reported for
the same period in 2013. The decrease in premium volume was primarily due to decreased premium production in our
Standard Commercial P&C business unit.
Total revenue for the Standard Commercial Segment of $81.5 million for the year ended December 31, 2014 was $1.8
million less than the $83.3 million reported during the year ended December 31, 2013. This 2% decrease in total revenue
46
was mostly due to an increased adverse profit share commission revenue adjustment of $1.6 million and lower net
investment income of $0.3 million, partially offset by higher net earned premiums of $0.1 million.
Our Standard Commercial Segment reported pre-tax income of $4.6 million for the year ended December 31, 2014 which
was $2.6 million higher than the $2.0 million reported for the same period of 2013. The increase in pre-tax income for the
Standard Commercial Segment was the result of lower loss and LAE of $5.0 million, partially offset by higher operating
expenses of $0.6 million primarily consisting of higher professional services and higher salary and related expenses. The
increase in pre-tax income for the Standard Commercial Segment was further partially offset by the decreased revenue
discussed above.
The net loss ratio for the year ended December 31, 2014 was 65.3% as compared to the 71.8% reported for the year
ended December 31, 2013. The gross loss ratio before reinsurance was 71.7% for the year ended December 31, 2014 as
compared to 67.8% for the prior year. The increase in the gross loss ratio was primarily due to $16.9 million of gross
catastrophe losses for the year ended December 31, 2014 as compared to $6.0 million for the same period during 2013.
The net loss ratio improved primarily due to $10.7 million of ceded loss recoveries during the year ended December 31,
2014 as compared to $2.1 million reported for the same period in 2013. The Standard Commercial Segment reported
$13.4 million of net catastrophe losses for the year ended December 31, 2014 as compared to $6.0 million for the same
period during 2013.
Specialty Commercial Segment.
Gross premiums written for the Specialty Commercial Segment were $324.5 million for the year ended December 31,
2014, which was $28.4 million, or approximately 10%, more than the $296.1 million reported for the same period in
2013. Net premiums written were $230.6 million for the year ended December 31, 2014 as compared to $235.7 million
reported for the same period in 2013. The lower net premiums written was primarily due to a quota share reinsurance
agreement entered into during the third quarter of 2013 in our Hallmark Select business unit on our general aviation line
of business and a quota share agreement entered into during the second quarter of 2014 on business produced by a
program underwriter in our E&S Commercial business unit.
The $241.9 million of total revenue for the year ended December 31, 2014 was $12.2 million higher than the $229.7
million reported for 2013. This 5% increase in revenue was due to higher net premiums earned of $10.3 million due
predominately to increased production discussed above. Further contributing to this increased revenue was higher net
investment income of $1.6 million and higher commissions and fees revenue of $0.3 million.
Pre-tax income for the Specialty Commercial Segment of $34.2 million for the year ended December 31, 2014 was $14.7
million higher than the $19.5 million reported for the same period in 2013. The increase in pre-tax income was primarily
due to the increased revenue discussed above, lower loss and LAE expenses of $2.6 million and lower amortization of
intangible assets of $0.3 million, partially offset by higher operating expenses of $0.4 million. Our E&S Commercial
business unit reported a $0.2 million decrease in loss and LAE for the year ended December 31, 2014 as compared to the
same period of 2013. In addition, our Hallmark Select business unit reported a $2.3 million decrease in loss and LAE which
consisted of (a) a $7.1 million decrease in loss and LAE primarily due to increased reinsurance recoveries on the general
aviation quota share agreement entered into during the third quarter of 2013, (b) a $2.1 million increase in loss and LAE
due to increased premium production in our commercial umbrella and excess liability line of business, (c) a $0.8 million
increase in loss and LAE attributable to our medical professional liability insurance products and (d) a $1.9 million
increase in loss and LAE in our satellite insurance products due primarily to the increased occurrence of insured satellite
losses during the year. The increase in operating expense was the combined result of higher salary and related expenses
of $1.5 million due primarily to increased incentive compensation accruals and higher other operating expenses of $0.4
million partially offset by lower production related expenses of $1.3 million due to increased ceding commissions on the
quota share reinsurance agreements discussed above and lower professional services of $0.2 million.
The Specialty Commercial Segment reported a net loss ratio of 65.5% for the year ended December 31, 2014 as compared
to 69.8% for the same period during 2013. The gross loss ratio before reinsurance was 65.7% for the year ended
December 31, 2014 as compared to 68.5% for the same period in 2013. The lower gross and net loss ratio included $3.7
million of unfavorable prior year loss reserve development for the year ended December 31, 2014 as compared to $13.4
million of unfavorable prior year loss reserve development for the same period during 2013. The Specialty Commercial
Segment reported $1.0 million in net catastrophe losses for the year ended December 31, 2014 as compared to $1.6
million for the same period of 2013. The Specialty Commercial Segment reported a net expense ratio of 25.6% for the
year ended December 31, 2014 as compared to 26.6% reported for the same period the prior year. The decrease in the
47
net expense ratio is due primarily to the effect of increased net earned premium on fixed operating expenses and the
increased ceding commission on quota share reinsurance agreements discussed above.
Personal Segment.
Gross premiums written for the Personal Segment were $64.0 million for the year ended December 31, 2014, which was
$12.8 million less than the $76.8 million reported for the same period in 2013. Net premiums written for our Personal
Segment were $16.8 million for the year ended December 31, 2014, which was a decrease of $28.8 million, or 63%, from
the $45.6 million reported for the same period of 2013. The decrease in gross premiums written was due mostly to
reduced business in our discontinued states and programs to focus on our ongoing core profitable business. The decrease
in net premium written was due mostly to a new quota share reinsurance contract entered into during the fourth quarter
of 2013 on our non-standard automobile risks produced in certain states.
Total revenue for the Personal Segment decreased 71% to $20.4 million for the year ended December 31, 2014 from
$71.1 million the prior year. Lower net premiums earned of $49.7 million, lower net investment income of $0.4 million,
decreased finance charges of $0.5 million and decreased other income of $0.1 million were the primary reasons for the
decrease in revenue for the period.
Our Personal Segment reported pre-tax income of $1.2 million for the year ended December 31, 2014 as compared to a
pre-tax loss of $3.4 million for the same period of 2013. The pre-tax income was the result of decreased losses and LAE of
$43.7 million and lower operating expenses of $11.3 million, primarily due to lower production related expenses driven
by increased ceding commission on the quota share agreements entered into during 2013, as well as lower amortization
of intangible assets of $0.3 million. These increases in pre-tax income were partially offset by the decreased revenue
discussed above.
The Personal Segment reported a net loss ratio of 63.7% for the year ended December 31, 2014 as compared to 82.5% for
2013. The gross loss ratio before reinsurance was 70.1% for the year ended December 31, 2014 as compared to 80.6% for
the same period in 2013. The lower gross and net loss ratios were primarily the result of favorable prior year net loss
reserve development. The loss and LAE for the year ended December 31, 2014 included $2.9 million of favorable prior
years’ net loss reserve development as compared to $1.8 million of unfavorable prior years’ net loss reserve development
for the same period of 2013. The Personal Segment reported $0.6 million of net catastrophe losses for the year ended
December 31, 2014 as compared to $2.6 million for the same period in 2013. The Personal Segment reported a net
expense ratio of 43.3% for the year ended December 31, 2014 as compared to 26.7% for the same period of 2013. The
increase in the expense ratio was due predominately to the impact of the quota share reinsurance agreement entered
into during the fourth quarter of 2013.
Corporate.
Total revenue for Corporate decreased by $11.7 million for the year ended December 31, 2014 as compared to the same
period the prior year. This decrease in total revenue was due primarily to lower net realized gains on our investment
portfolio of $10.4 million as compared to the same period of the prior year and lower net investment income of $1.3
million for the year ended December 31, 2014 as compared to the same period of the prior year.
Corporate pre-tax loss was $21.3 million for the year ended December 31, 2014 as compared to a $7.0 million pre-tax loss
for the same period the prior year. The increase in pre-tax loss was the result of decreased revenue and higher operating
expenses of $2.6 million during the year ended December 31, 2014 as compared to the same period the prior year due
primarily to $0.8 million higher salary and related costs due mostly to increased incentive compensation accruals
compared to the prior period, $0.7 million of CEO transition costs, $0.2 million of costs related to a previously announced
public debt offering, $0.4 million of professional service fee expense and $0.5 million due primarily to increases recorded
to the expected earn-out payable in conjunction with the previous acquisition of TBIC.
Comparison of Years ended December 31, 2013 and December 31, 2012
Management overview. During fiscal 2013, our total revenues were $389.4 million, representing an approximately 14%
increase over the $341.8 million in total revenues for fiscal 2012. The growth in revenue was primarily attributable to
increased premium production and resulting earned premium driven largely from our Specialty Commercial Segment and
our Standard Commercial Segment. Further contributing to the increase in revenue were higher net realized gains on our
investment portfolio and a lower adverse profit share commission revenue adjustment in our Standard Commercial
48
Segment. These increases in revenue were partially offset by lower net investment income and lower year to date earned
premium in our Personal Segment due mostly to the impact of discontinued products and a reduction of premium
written in underperforming states.
The increase in revenue for the year ended December 31, 2013 was accompanied by increased loss and LAE of $34.9
million as compared to the same period of 2012. During the twelve months ended December 31, 2013 we recorded
$10.0 million of unfavorable prior year loss development. During the twelve months ended December 31, 2012 we
recorded $3.7 million of favorable prior year loss development. The increase in loss and LAE occurred despite a $1.5
million decrease in catastrophe losses to $10.2 million during the year ended December 31, 2013 from $11.7 million
reported for the same period of 2012. Other operating expenses also increased due mostly to increased production
related expenses in our E&S Commercial business unit.
We reported net income of $8.2 million for the year ended December 31, 2013, as compared to net income of $3.5
million for the year ended December 31, 2012. On a diluted per share basis, net income attributable to Hallmark was
$0.43 per share for fiscal 2013 as compared to net income of $0.18 per share for fiscal 2012.
Segment information.
The following is additional business segment information for the years ended December 31, 2013 and 2012 (in
thousands):
Year Ended December 31, 2013
Standard Commercial
Segment
Specialty Commercial
Segment
Personal Segment
Corporate
Consolidated
2013
2012
2013
2012
2013
2012
2013
2012
2013
2012
Gross premiums written $
Ceded premiums
written
87,147 $ 77,091 $ 296,108 $ 235,695 $ 76,772 $
77,056 $
- $
- $
460,027 $ 389,842
(7,681)
(7,000)
(60,453)
(49,642)
(31,128)
(711)
Net premiums written
79,466
70,091
235,655
186,053 45,644
76,345
Change in unearned
premiums
(1,290)
(936)
(17,090)
(17,223) 18,156
5,106
Net premiums earned
78,176
69,155
218,565
168,830 63,800
81,451
-
-
-
-
-
(99,262)
(57,353)
-
360,765
332,489
-
(224)
(13,053)
-
360,541
319,436
Total revenues
83,306
73,119
229,734
178,917 71,081
89,149
5,307
615
389,428
341,800
Losses and loss
adjustment expenses
Pre-tax income (loss),
net of non-controlling
interest
Net loss ratio (1)
Net expense ratio (1)
Net combined ratio (1)
Favorable (Unfavorable)
Prior Year Development
56,143
52,828
152,546
103,980 52,656
69,606
-
-
261,345
226,414
1,980
(2,486)
19,527
25,932
(3,416)
(8,535)
(7,011)
(11,861)
11,080
3,050
71.8%
76.4%
32.2%
33.2%
104.0% 109.6%
69.8%
26.6%
96.4%
82.5% 85.5%
61.6%
28.3%
26.7% 28.5%
89.9% 109.2% 114.0%
72.5%
29.2%
70.9%
30.8%
101.7%
101.7%
5,235
3,744
(13,381)
3,577
(1,808)
(3,646)
(9,954)
3,675
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.
49
Standard Commercial Segment.
Gross premiums written for the Standard Commercial Segment were $87.1 million for the year ended December 31,
2013, which was $10.0 million, or approximately 13%, more than the $77.1 million reported for the same period in 2012.
Net premiums written were $79.5 million for the year ended December 31, 2013 as compared to $70.1 million reported
for the same period in 2012. The increase in premium volume was primarily due to increased premium production in
both our Standard Commercial P&C and Workers Compensation business units.
Total revenue for the Standard Commercial Segment of $83.3 million for the year ended December 31, 2013 was $10.2
million more than the $73.1 million reported during the year ended December 31, 2012. This increase in total revenue
was the result of increased net earned premiums of $9.0 million, higher net investment income of $0.1 million and a $1.1
million lower adverse profit share commission revenue adjustment during the year ended December 31, 2013 as
compared to the same period during 2012.
Our Standard Commercial Segment reported pre-tax income was $2.0 million for the year ended December 31, 2013 as
compared to a pre-tax loss of $2.5 million for the same period of 2012. The increased revenue discussed above was the
primary driver of the increased pre-tax income for the year ended December 31, 2013, partially offset by higher loss and
LAE of $3.3 million and higher operating expenses of $2.4 million consisting primarily of higher production related
expenses due to increased premium production.
The net loss ratio for the year ended December 31, 2013 was 71.8% as compared to the 76.4% reported for 2012. The
gross loss ratio before reinsurance was 67.8% for the year ended December 31, 2013 as compared to 74.8% for the prior
year. The lower gross and net loss ratios for the year ended December 31, 2013 were aided by lower catastrophe losses
coupled with increased favorable prior year loss reserve development. The net loss ratios for the years ended December
31, 2013 and 2012 included catastrophe losses of $6.0 million and $9.5 million, respectively. During the years ended
December 31, 2013 and 2012, the Standard Commercial Segment reported favorable loss reserve development of $5.2
million and $3.7 million, respectively. The Standard Commercial Segment reported a net expense ratio of 32.2% for the
year ended December 31, 2013 as compared to 33.2% reported for the same period the prior year. The decrease in net
expense ratio was due primarily to the increased premium volume.
Specialty Commercial Segment.
Gross premiums written for the Specialty Commercial Segment were $296.1 million for the year ended December 31,
2013, which was $60.4 million, or 26%, more than the $235.7 million reported for the same period in 2012. Net premiums
written were $235.7 million for the year ended December 31, 2013 as compared to $186.1 million reported for the same
period in 2012. The increase in premium volume was due to increased premium production in both our E&S Commercial
and Hallmark Select business units.
The $229.7 million of total revenue for the year ended December 31, 2013 was $50.8 million higher than the $178.9
million reported for 2012. This 28% increase in revenue was due to higher net premiums earned of $49.7 million due
predominately to increased production discussed above. Further contributing to this increased revenue was higher net
investment income of $1.6 million partially offset by lower profit share commission revenue adjustment of $0.5 million
for the year ended December 31, 2013 as compared to the same period of 2012.
Pre-tax income for the Specialty Commercial Segment of $19.5 million for the year ended December 31, 2013 was $6.4
million lower than the $25.9 million reported for the same period in 2012. The decrease in pre-tax income was primarily
due to higher loss and LAE expenses of $48.6 million and higher operating expenses of $9.4 million, partially offset by
lower amortization of intangible assets of $0.5 million, lower non-controlling interest of $0.3 million and the increased
revenue discussed above. Our E&S Commercial business unit reported a $45.7 million increase in loss and LAE due
primarily to increased premium volume and $16.0 million of unfavorable prior year loss reserve development as
compared to $0.3 million of favorable development during the same period of 2012. In addition, our Hallmark Select
business unit reported a $2.9 million increase in loss and LAE which consisted of (a) a $1.4 million increase in loss and LAE
due to increased premium production in our commercial umbrella and excess liability line of business, (b) a $2.5 million
increase in loss and LAE primarily due to large loss volatility in our aircraft hull coverage during fiscal 2013, (c) a $0.3
million increase in loss and LAE attributable to our medical professional liability insurance products and (d) a $1.3 million
decrease in loss and LAE in our satellite insurance products due primarily to decreased premium volume as well as lower
50
current accident year loss trends. The increase in operating expense was the combined result of increased production
related expenses of $8.7 million, higher salary and related expenses of $0.4 million, higher professional service fees of
$0.5 million partially offset by lower other operating expenses of $0.2 million.
The Specialty Commercial Segment reported a net loss ratio of 69.8% for the year ended December 31, 2013 as compared
to 61.6% for the same period during 2012. The gross loss ratio before reinsurance was 68.5% for the year ended
December 31, 2013 as compared to 61.1% for the same period in 2012. The higher gross and net loss ratios included
$13.4 million of unfavorable prior year loss reserve development for the year ended December 31, 2013 as compared to
$3.6 million of favorable prior year loss reserve development for the same period during 2012. The Specialty Commercial
Segment reported a net expense ratio of 26.6% for the year ended December 31, 2013 as compared to 28.3% reported
for the same period the prior year. The decrease in the net expense ratio was due primarily to increased net premium
volume.
Personal Segment.
Gross premiums written for the Personal Segment were $76.8 million for the year ended December 31, 2013, which was
$0.3 million less than the $77.1 million reported for the same period in 2012. Net premiums written for our Personal
Segment were $45.6 million in the year ended December 31, 2013, which was a decrease of $30.7 million, or 40%, from
the $76.3 million reported for the same period of 2012. The decrease in net premium written was due mostly to exiting
certain underperforming states and programs and quota share reinsurance contracts entered into during the first quarter
of 2013 on our low value dwelling/homeowners, renters, and manufactured homes lines of business and during the
fourth quarter of 2013 on our non- standard automobile risks produced in certain states.
Total revenue for the Personal Segment decreased 20% to $71.1 million for the year ended December 31, 2013 from
$89.1 million the prior year. Lower net premiums earned of $17.7 million and lower net investment income of $0.4
million, partially offset by higher other income of $0.1 million, were the primary reason for the decrease in revenue for
the period.
Our Personal Segment reported a pre-tax loss of $3.4 million for the year ended December 31, 2013 as compared to a
pre-tax loss of $8.5 million for the same period of 2012. The lower pre-tax loss was the result of lower losses and LAE of
$16.9 million and lower operating expenses of $6.2 million, primarily due to lower production related expenses driven by
increased ceding commission on the quota share agreements entered into during 2013. The decline in pre-tax loss was
partially offset by lower revenue discussed above.
The Personal Segment reported a net loss ratio of 82.5% for the year ended December 31, 2013 as compared to 85.5% for
2012. The gross loss ratio before reinsurance was 80.6% for the year ended December 31, 2013 as compared to 85.6% for
the same period in 2012. The lower gross and net loss ratio were primarily the result of lower current accident year loss
trends as well as lower unfavorable prior year loss reserve development for the year ended December 31, 2013 as
compared to the same period of 2012. Loss and LAE during the years ended December 31, 2013 and 2012 included
unfavorable prior years’ loss reserve development of $1.8 million and $3.6 million, respectively. The Personal Segment
reported a net expense ratio of 26.7% for the year ended December 31, 2013 as compared to 28.5% for the same period
of 2012. The decrease in the expense ratio was due predominately to lower production related expenses.
Corporate.
Total revenue for Corporate was $5.3 million for the year ended December 31, 2013 as compared to $0.6 million for the
same period of 2012. Net realized gains recognized on our investment portfolio were $10.5 million for the year ended
December 31, 2013 as compared to $1.9 million during the same period during 2012. Net investment income decreased
$3.7 million for the year ended December 31, 2013 as compared to the same period during 2012. Other income
decreased $0.2 million for the year ended December 31, 2013 as compared to the same period during 2012.
Corporate pre-tax loss was $7.0 million for the year ended December 31, 2013 as compared to a $11.9 million pre-tax loss
for the same period the prior year. The decrease in pre-tax loss was the result of the increased revenue discussed above
and lower operating expenses of $0.2 million due primarily to lower salary and related expenses during the year ended
December 31, 2013 as compared to the same period the prior year.
51
Liquidity and Capital Resources
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 December 31, 2014, Hallmark had $11.8
million in unrestricted cash and cash equivalents. Unrestricted cash and cash equivalents of our non-insurance
subsidiaries were $5.3 million as of December 31, 2014. As of that date, our insurance subsidiaries held $113.9 million of
cash and cash equivalents as well as $450.8 million in debt securities with an average modified duration of 3.0 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 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. 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
net investment 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. For all our insurance companies, dividends may only be paid from unassigned surplus funds. During 2015,
the aggregate ordinary dividend capacity of these subsidiaries is $24.3 million, of which $16.2 million is available to
Hallmark. As a county mutual, dividends from HCM are payable to policyholders. During the year ended December 31,
2014, our insurance company subsidiaries paid $8.0 million in dividends to Hallmark. None of our insurance company
subsidiaries paid a dividend during the year ended December 31, 2013.
The state insurance departments also regulate financial transactions between our insurance subsidiaries and their
affiliated companies. Applicable regulations require approval of management fees, expense sharing contracts and similar
transactions. The net amount paid in management fees by our insurance subsidiaries to Hallmark and our non-insurance
company subsidiaries was $1.1 million, $8.2 million and $9.0 million during each of 2014, 2013 and 2012, respectively.
Statutory capital and surplus is calculated as statutory assets less statutory liabilities. The various state insurance
departments that regulate our insurance company subsidiaries require us to maintain a minimum statutory capital and
surplus. As of December 31, 2014, our insurance company subsidiaries reported statutory capital and surplus of $210.0
million, substantially greater than the minimum requirements for each state. Each of our insurance company subsidiaries
is also required to satisfy certain risk-based capital requirements. (See, “Item 1. Business – Insurance Regulation – Risk-
based Capital Requirements.”). As of December 31, 2014, the adjusted capital under the risk-based capital calculation of
each of our insurance company subsidiaries substantially exceeded the minimum requirements. Our total statutory
premium-to-surplus percentage for the years ended December 31, 2014 and 2013 was 154% and 184%, respectively.
Comparison of December 31, 2014 to December 31, 2013
On a consolidated basis, our cash and investments, excluding restricted cash and investments, at December 31, 2014
were $638.2 million compared to $603.0 million at December 31, 2013. Cash flow from operations and an increase in
investment fair values were the primary reasons for this increase.
Comparison of Years Ended December 31, 2014 and December 31, 2013
Net cash provided by our consolidated operating activities was $33.7 million for the year ended December 31, 2014
compared to $68.3 million for the year ended December 31, 2013. The decrease in operating cash flow was primarily due
to increased ceded premium payments, partially offset by lower net paid losses and increased collected provisional
ceding commission.
Cash used in investing activities during the year ended December 31, 2014 was $42.2 million as compared to $11.8
million for the prior year. The increase in cash used in investing activities was primarily attributable to a $68.0 million
decrease in maturities, sales and redemptions of investment securities, partially offset by a $33.7 million decrease in
52
purchases of investment securities, a $0.1 million decrease in purchases of property and equipment and a $3.8 million
decrease in cash flow into restricted cash accounts.
Cash used in financing activities during the year ended December 31, 2014 was $2.1 million as a result of a $1.5 million
repayment on our revolving credit facility and $1.8 million related to the repurchase of our common stock, partially offset
by $1.2 million related to proceeds from the exercise of employee stock options. There were no financing cash flow
activities during the year ended December 31, 2013.
Credit Facilities
Our First Restated Credit Agreement with The Frost National Bank dated January 27, 2006, as amended to date, provides
a revolving credit facility of $15.0 million. We pay interest on the outstanding balance at our election at a rate of the
prime rate or LIBOR plus 2.5%. We pay an annual fee of 0.25% of the average daily unused balance of the credit facility.
We pay letter of credit fees at the rate of 1.00% per annum. Our obligations under the revolving credit facility are secured
by a security interest in the capital stock of all of our subsidiaries, guarantees of all of our subsidiaries and the pledge of
all of our non-insurance company assets. The revolving credit facility contains covenants that, among other things,
require us to maintain certain financial and operating ratios and restrict certain distributions, transactions and
organizational changes. We are in compliance with all of our covenants. As of December 31, 2014, we had no outstanding
borrowings under this revolving credit facility.
Subordinated Debt Securities
On June 21, 2005, we entered into a trust preferred securities transaction pursuant to which we issued $30.9 million
aggregate principal amount of subordinated debt securities due in 2035. To effect the transaction, we formed Hallmark
Statutory Trust I (“Trust I”) as a Delaware statutory trust. Trust I issued $30.0 million of preferred securities to investors
and $0.9 million of common securities to us. Trust I used the proceeds from these issuances to purchase the
subordinated debt securities. Our Trust I subordinated debt securities bear an initial interest rate of 7.725% until June 15,
2015, at which time interest will adjust quarterly to the three-month LIBOR rate plus 3.25 percentage points. Trust I pays
dividends on its preferred securities at the same rate. Under the terms of our Trust I subordinated debt securities, we pay
interest only each quarter and the principal of the note at maturity. The subordinated debt securities are uncollateralized
and do not require maintenance of minimum financial covenants. As of December 31, 2014, the balance of our Trust I
subordinated debt was $30.9 million.
On August 23, 2007, we entered into a trust preferred securities transaction pursuant to which we issued $25.8 million
aggregate principal amount of subordinated debt securities due in 2037. To effect the transaction, we formed Hallmark
Statutory Trust II (“Trust II”) as a Delaware statutory trust. Trust II issued $25.0 million of preferred securities to investors
and $0.8 million of common securities to us. Trust II used the proceeds from these issuances to purchase the
subordinated debt securities. Our Trust II subordinated debt securities bear an initial interest rate of 8.28% until
September 15, 2017, at which time interest will adjust quarterly to the three-month LIBOR rate plus 2.90 percentage
points. Trust II pays dividends on its preferred securities at the same rate. Under the terms of our Trust II subordinated
debt securities, we pay interest only each quarter and the principal of the note at maturity. The subordinated debt
securities are uncollateralized and do not require maintenance of minimum financial covenants. As of December 31,
2014, the balance of our Trust II subordinated debt was $25.8 million.
Long-Term Contractual Obligations
Set forth below is a summary of long-term contractual obligations as of December 31, 2014. Amounts represent
estimates of gross undiscounted amounts payable over time. In addition, certain unpaid losses and LAE are ceded to
others under reinsurance contracts and are, therefore, recoverable. Such potential recoverables are not reflected in the
table.
53
Estimated Payments by Period (in thousands)
Total
2015
2016-2017 2018-2019 After 2019
Subordinated debt securities
$
56,702 $
- $
- $
- $
56,702
Interest on subordinated debt securities
Unpaid losses and LAE (1)
Operating leases
Purchase obligations
75,409
415,135
10,940
3,083
4,388
169,468
1,922
2,154
7,761
145,310
3,659
929
6,477
43,512
2,927
-
56,783
56,845
2,432
-
(1) The payout pattern for unpaid losses and LAE is based upon historical payment patterns and does not represent
actual contractual obligations. The timing and amount ultimately paid will likely vary from these estimates.
Based on 2015 budgeted and year-to-date cash flow information, we believe that we have sufficient liquidity to meet our
projected insurance obligations, operational expenses and capital expenditure requirements for the next 12 months.
Effects of Inflation
We do not believe that inflation has a material effect on our results of operations, except for the effect that inflation may
have on interest rates and claim costs. The effects of inflation are considered in pricing and estimating reserves for
unpaid losses and LAE. The actual effects of inflation on results of operations are not known until claims are ultimately
settled. In addition to general price inflation, we are exposed to the upward trend in the judicial awards for damages. We
attempt to mitigate the effects of inflation in the pricing of policies and establishing reserves for losses and LAE.
54
Item 7A. Quantitative and Qualitative Disclosures About Market Risk.
We believe that interest rate risk, credit risk and equity risk are the types of market risk to which we are principally
exposed.
Interest rate risk. Our investment portfolio consists largely of investment-grade, fixed-income securities, all of which are
classified as available-for-sale. Accordingly, the primary market risk exposure to these securities is interest rate risk. In
general, the fair value of a portfolio of fixed-income securities increases or decreases inversely with changes in market
interest rates, while net investment income realized from future investments in fixed-income securities increases or
decreases along with interest rates. The fair value of our fixed-income securities as of December 31, 2014 was $450.8
million. The effective duration of our portfolio as of December 31, 2014 was 3.0 years. Should interest rates increase
1.0%, our fixed-income investment portfolio would be expected to decline in market value by 3.0%, or $13.4 million,
representing the effective duration multiplied by the change in market interest rates. Conversely, a 1.0% decline in
interest rates would be expected to result in a 3.0%, or $13.4 million, increase in the fair value of our fixed-income
investment portfolio.
Credit risk. An additional exposure to our fixed-income securities portfolio is credit risk. We attempt to manage the credit
risk by investing primarily in investment-grade securities and limiting our exposure to a single issuer. As of December 31,
2014, our fixed-income investments were in the following: U.S. Treasury bonds – 20.7%; municipal bonds – 36.0%;
collateralized corporate bank loans – 25.2%; corporate bonds – 6.5%; and asset-backed – 11.6%. As of December 31,
2014, 75.2% of our fixed-income securities were rated investment-grade by nationally recognized statistical rating
organizations.
We are also subject to credit risk with respect to reinsurers to whom we have ceded underwriting risk. Although a
reinsurer is liable for losses to the extent of the coverage it assumes, we remain obligated to our policyholders in the
event that the reinsurers do not meet their obligations under the reinsurance agreements. In order to mitigate credit risk
to reinsurance companies, most of our reinsurance recoverable balance as of December 31, 2014 was with reinsurers
having an A.M. Best rating of “A-” or better.
Equity price risk. Investments in equity securities that are subject to equity price risk made up 11.1% of our portfolio as of
December 31, 2014. The carrying values of equity securities are based on quoted market prices as of the balance sheet
date. Market prices are subject to fluctuation and, consequently, the amount realized in the subsequent sale of an
investment may significantly differ from the reported fair value. Fluctuation in the market price of a security may result
from perceived changes in the underlying economic characteristics of the issuer, the relative price of alternative
investments and general market conditions. Furthermore, amounts realized in the sale of a particular security may be
affected by the relative quantity of the security being sold.
The fair value of our equity securities as of December 31, 2014 was $56.4 million. The fair value of our equity securities
would increase or decrease by $16.9 million assuming a hypothetical 30% increase or decrease in market prices as of the
balance sheet date. This would increase or decrease stockholders’ equity by 4.4%. The selected hypothetical change does
not reflect what should be considered the best or worsed case scenario.
Item 8. Financial Statements and Supplementary Data.
The following consolidated financial statements of Hallmark and its subsidiaries are filed as part of this report.
Description
Report of Independent Registered Public Accounting Firm
Consolidated Balance Sheets at December 31, 2014 and 2013
Consolidated Statements of Operations for the Years Ended December 31, 2014, 2013 and 2012
Consolidated Statements of Comprehensive Income for the Years Ended December 31, 2014, 2013
and 2012
Consolidated Statements of Stockholders’ Equity for the Years Ended
December 31, 2014, 2013 and 2012
Consolidated Statements of Cash Flows for the Years Ended
December 31, 2014, 2013 and 2012
Notes to Consolidated Financial Statements
Financial Statement Schedules
Page Number
F-2
F-3
F-4
F-5
F-6
F-7
F-8
F-43
55
Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure.
None.
Item 9A. Controls and Procedures.
Evaluation of Disclosure 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 three month period ended December 31, 2014, there were no changes in internal control over financial
reporting that have materially affected, or are reasonably likely to materially affect, our internal control over financial
reporting.
Management’s Report on Internal Control over Financial Reporting
Management is responsible for establishing and maintaining adequate “internal control over financial reporting,” as such
phrase is defined in Exchange Act Rule 13a-15(f). Under the supervision and with the participation of management,
including our Chief Executive Officer and Chief Accounting Officer, an evaluation of the effectiveness of our internal
control over financial reporting was conducted based upon the framework in Internal Control-Integrated Framework
issued by the Committee of Sponsoring Organizations of the Treadway Commission (2013 Framework). Based upon that
evaluation, management has concluded that our internal control over financial reporting was effective as of December
31, 2014.
Ernst & Young LLP, the independent registered public accounting firm that audited our consolidated financial statements
as of December 31, 2014 included in this Annual Report on Form 10-K, has issued an attestation report on our internal
control over financial reporting as of December 31, 2014. The Ernst & Young LLP attestation report, which expresses an
unqualified opinion on the effectiveness of our internal control over financial reporting as of December 31, 2014, is
included in this Item under the heading “ Report of Independent Registered Public Accounting Firm.”
56
Report of Independent Registered Public Accounting Firm
The Board of Directors and Stockholders of
Hallmark Financial Services, Inc. and subsidiaries
We have audited Hallmark Financial Services, Inc. and subsidiaries’ (the Company) internal control over financial
reporting as of December 31, 2014, based on criteria established in Internal Control-Integrated Framework issued by
the Committee of Sponsoring Organizations of the Treadway Commission (2013 Framework) (the COSO criteria). The
Company’s management is responsible for maintaining effective internal control over financial reporting and for its
assessment of the effectiveness of internal control over financial reporting included in the accompanying
Management’s Report on Internal Control over Financial Reporting. Our responsibility is to express an opinion on the
Company’s internal control over financial reporting based on our audit.
We conducted our audit in accordance with the standards of the Public Company Accounting Oversight Board
(United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about
whether effective internal control over financial reporting was maintained in all material respects. Our audit
included obtaining an understanding of internal control over financial reporting, assessing the risk that a material
weakness exists, testing and evaluating the design and operating effectiveness of internal control based on the
assessed risk, and performing such other procedures as we considered necessary in the circumstances. We believe
that our audit provides a reasonable basis for our opinion.
A company’s internal control over financial reporting is a process designed to provide reasonable assurance
regarding the reliability of financial reporting and the preparation of financial statements for external purposes in
accordance with generally accepted accounting principles. A company’s internal control over financial reporting
includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail,
accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable
assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance
with generally accepted accounting principles, and that receipts and expenditures of the company are being made
only in accordance with authorizations of management and directors of the company; and (3) provide reasonable
assurance regarding prevention or timely detection of unauthorized acquisition, use or disposition of the company’s
assets that could have a material effect on the financial statements.
Because of its inherent limitations, internal control over financial reporting may not prevent or detect
misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that
controls may become inadequate because of changes in conditions, or that the degree of compliance with the
policies or procedures may deteriorate.
In our opinion, Hallmark Financial Services, Inc. and subsidiaries maintained, in all material respects, effective
internal control over financial reporting as of December 31, 2014, based on the COSO criteria.
We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United
States), the consolidated balance sheets of Hallmark Financial Services, Inc. and subsidiaries as of December 31,
2014 and 2013, and the related consolidated statements of operations, comprehensive income, stockholders’
equity, and cash flows for each of the three years in the period ended December 31, 2014 of Hallmark Financial
Services, Inc. and subsidiaries and our report dated March 12, 2015 expressed an unqualified opinion thereon.
/s/ Ernst & Young LLP
Fort Worth, Texas
March 12, 2015
57
Item 9B. Other Information.
None.
Item 10. Directors, Executive Officers and Corporate Governance.
PART III
The information required by Item 10 is incorporated by reference from the Registrant’s definitive proxy statement to be
filed with the Securities and Exchange Commission pursuant to Regulation 14A not later than 120 days after the end of
the fiscal year covered by this report.
Item 11. Executive Compensation.
The information required by Item 11 is incorporated by reference from the Registrant’s definitive proxy statement to be
filed with the Securities and Exchange Commission pursuant to Regulation 14A not later than 120 days after the end of
the fiscal year covered by this report.
Item 12. Security Ownership of Certain Beneficial Owners and Management and Related Stockholder
Matters.
The information required by Item 12 is incorporated by reference from the Registrant’s definitive proxy statement to be
filed with the Securities and Exchange Commission pursuant to Regulation 14A not later than 120 days after the end of
the fiscal year covered by this report.
Item 13. Certain Relationships and Related Transactions, and Director Independence.
The information required by Item 13 is incorporated by reference from the Registrant’s definitive proxy statement to be
filed with the Securities and Exchange Commission pursuant to Regulation 14A not later than 120 days after the end of
the fiscal year covered by this report.
Item 14. Principal Accounting Fees and Services.
The information required by Item 14 is incorporated by reference from the Registrant's definitive proxy statement to be
filed with the Securities and Exchange Commission pursuant to Regulation 14A not later than 120 days after the end of
the fiscal year covered by this report.
58
Item 15. Exhibits, Financial Statement Schedules.
PART IV
(a)(1)
(a)(2)
(a)(3)
Financial Statements
The following consolidated financial statements, notes thereto and related information are included in
Item 8 of this report:
Report of Independent Registered Public Accounting Firm
Consolidated Balance Sheets at December 31, 2014 and 2013
Consolidated Statements of Operations for the Years Ended December 31, 2014, 2013 and 2012
Consolidated Statements of Comprehensive Income for the Years Ended December 31, 2014, 2013 and
2012
Consolidated Statements of Stockholders’ Equity for the Years Ended December 31, 2014, 2013 and 2012
Consolidated Statements of Cash Flows for the Years Ended December 31, 2014, 2013 and 2012
Notes to Consolidated Financial Statements
Financial Statement Schedules
The following financial statement schedules are included in this report:
Schedule II – Condensed Financial Information of Registrant (Parent Company Only)
Schedule III – Supplemental Insurance Information
Schedule IV – Reinsurance
Schedule VI – Supplemental Information Concerning Property-Casualty Insurance Operations
Exhibit Index
The following exhibits are either filed with this report or incorporated by reference:
Exhibit
Number
3.1
3.2
4.1
4.2
4.3
4.4
4.5
4.6
4.7
Description
Restated Articles of Incorporation of the registrant (incorporated by reference to Exhibit 3.1 to Amendment No.
1 to the registrant’s Registration Statement on Form S-1 [Registration No. 333-136414] filed September 8,
2006).
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 filed October 1, 2007).
Specimen certificate for common stock, $0.18 par value, of the registrant (incorporated by reference to Exhibit
4.1 to Amendment No. 1 to the registrant’s Registration Statement on Form S-1 [Registration No. 333-136414]
filed September 8, 2006).
Indenture dated June 21, 2005, between Hallmark Financial Services, Inc. and JPMorgan Chase Bank, National
Association (incorporated by reference to Exhibit 4.1 to the registrant’s Current Report on Form 8-K filed June
27, 2005).
Amended and Restated Declaration of Trust of Hallmark Statutory Trust I dated as of June 21, 2005, among
Hallmark Financial Services, Inc., as sponsor, Chase Bank USA, National Association, as Delaware trustee, and
JPMorgan Chase Bank, National Association, as institutional trustee, and Mark Schwarz and Mark Morrison, as
administrators (incorporated by reference to Exhibit 4.2 to the registrant’s Current Report on Form 8-K filed
June 27, 2005).
Form of Junior Subordinated Debt Security Due 2035 (included in Exhibit 4.2 above).
Form of Capital Security Certificate (included in Exhibit 4.3 above).
First Restated Credit Agreement dated January 27, 2006, between Hallmark Financial Services, Inc. and The Frost
National Bank (incorporated by reference to Exhibit 4.1 to the registrant’s Current Report on Form 8-K filed
February 2, 2006).
Indenture dated as of August 23, 2007, between Hallmark Financial Services, Inc. and The Bank of New York
Trust Company, National Association (incorporated by reference to Exhibit 4.1 to the registrant’s Current Report
59
4.8
4.9
4.10
4.11
4.12
4.13
4.14
4.15
4.16
4.17
4.18
10.1
10.2
10.3
10.4
on Form 8-K filed August 24, 2007).
Amended and Restated Declaration of Trust of Hallmark Statutory Trust II dated as of August 23, 2007, among
Hallmark Financial Services, Inc., as sponsor, The Bank of New York (Delaware), as Delaware trustee, and The
Bank of New York Trust Company, National Association, as institutional trustee, and Mark Schwarz and Mark
Morrison, as administrators (incorporated by reference to Exhibit 4.2 to the registrant’s Current Report on Form
8-K filed August 24, 2007).
Form of Junior Subordinated Debt Security Due 2037 (included in Exhibit 4.7 above).
Form of Capital Security Certificate (included in Exhibit 4.8 above).
Fifth Amendment to First Restated Credit Agreement among Hallmark Financial Services, Inc. and its subsidiaries
and The Frost National Bank dated February 20, 2008 (incorporated by reference to Exhibit 99.1 to the
registrant’s Current Report on Form 8-K filed February 25, 2008).
Sixth Amendment to First Restated Credit Agreement among Hallmark Financial Services, Inc. and its subsidiaries
and The Frost National Bank dated January 21, 2010 (incorporated by reference to Exhibit 99.1 to the
registrant’s Current Report on Form 8-K filed January 25, 2010).
Seventh Amendment to First Restated Credit Agreement among Hallmark Financial Services, Inc. and its
subsidiaries and The Frost National Bank dated May 27, 2010 (incorporated by reference to Exhibit 10.1 to the
registrant’s Current Report on Form 8-K filed June 17, 2010).
Eighth Amendment to First Restated Credit Agreement among Hallmark Financial Services, Inc. and its
subsidiaries and The Frost National Bank dated March 21, 2011 (incorporated by reference to Exhibit 10.1 to the
registrant’s Current Report on Form 8-K filed March 21, 2011).
Ninth Amendment to First Restated Credit Agreement among Hallmark Financial Services, Inc. and its
subsidiaries and Frost Bank dated July 10, 2012 (incorporated by reference to Exhibit 10.1 to the registrant’s
Current Report on Form 8-K filed July 12, 2012).
Tenth Amendment to First Restated Credit Agreement among Hallmark Financial Services, Inc. and its
subsidiaries and Frost Bank dated September 30, 2012 (incorporated by reference to Exhibit 10.1 to the
registrant’s Current Report on Form 8-K filed October 1, 2012).
Eleventh Amendment to First Restated Credit Agreement among Hallmark Financial Services, Inc. and its
subsidiaries and Frost Bank dated July 26, 2013 (incorporated by reference to Exhibit 10.1 to the registrant’s
Current Report on Form 8-K filed July 30, 2013).
Twelfth Amendment to First Restated Credit Agreement among Hallmark Financial Services, Inc. and its
subsidiaries and Frost Bank dated August 8, 2014 (incorporated by reference to Exhibit 10.1 to the registrant’s
Current Report on Form 8-K filed August 12, 2014).
Office Lease for 6500 Pinecrest, Plano, Texas, dated July 22, 2008, between Hallmark Financial Services, Inc. and
Legacy Tech IV Associates, Limited Partnership (incorporated by reference to Exhibit 99.1 to the registrant’s
Current Report on Form 8-K filed July 29, 2008).
Lease Agreement for 777 Main Street, Fort Worth, Texas, dated June 12, 2003 between Hallmark Financial
Services, Inc. and Crescent Real Estate Funding I, L.P. (incorporated by reference to Exhibit 10(a) to the
registrant’s Quarterly Report on Form 10-QSB for the quarter ended June 30, 2003).
Office Lease by and between SAOP Northwest Center, L.P. and Hallmark Specialty Underwriters, Inc. dated
January 29, 2010 (incorporated by reference to Exhibit 10.1 to the registrant’s Current Report on Form 8-K filed
February 2, 2010).
Office Lease by and between Minol Center, L.P. and Aerospace Insurance Managers, Inc. dated August 9, 2010
(incorporated by reference to Exhibit 99.1 to the registrant’s Current Report on Form 8-K filed August 17, 2010).
60
10.5
10.6
10.7*
10.8*
10.9*
Office Lease by and between Civic Opera, L.P. and Hallmark Specialty Underwriters, Inc. dated December 27,
2010 (incorporated by reference to Exhibit 10.1 to the registrant’s Current Report on Form 8-K filed January 4,
2011).
First Amendment to Office Lease between MS Crescent One SPV, LLC and Hallmark Financial Services, Inc., dated
February 28, 2011 (incorporated by reference to Exhibit 10.1 to the registrant’s Current Report on Form 8-K filed
March 1, 2011).
Form of Indemnification Agreement between Hallmark Financial Services, Inc. and its officers and directors,
adopted July 19, 2002 (incorporated by reference to Exhibit 10(c) to the registrant’s Quarterly Report on Form
10-QSB for the quarter ended September 30, 2002).
Hallmark Financial Services, Inc. 2005 Long Term Incentive Plan (incorporated by reference to Exhibit 10.1 to the
registrant’s Current Report on Form 8-K filed June 3, 2005).
Form of Incentive Stock Option Grant Agreement (incorporated by reference to Exhibit 10.2 to the registrant’s
Current Report on Form 8-K filed June 3, 2005).
10.10*
Form of Non-Qualified Stock Option Agreement (incorporated by reference to Exhibit 10.3 to the registrant’s
Current Report on Form 8-K filed June 3, 2005).
10.11
Guarantee Agreement dated as of June 21, 2005, by Hallmark Financial Services, Inc. for the benefit of the
holders of trust preferred securities (incorporated by reference to Exhibit 10.1 to the registrant’s Current Report
on Form 8-K filed June 27, 2005).
10.12*
Hallmark Financial Services, Inc. Amended and Restated 2005 Long Term Incentive Plan (incorporated by
reference to Exhibit 10.1 to the registrant’s Current Report on Form 8-K filed June 3, 2013).
10.13*
Form of Restricted Stock Unit Award Agreement(incorporated by reference to Exhibit 10.13 to the registrant’s
Form 10-K filed March 12, 2014).
10.14
10.15
Guarantee Agreement dated as of August 23, 2007, by Hallmark Financial Services, Inc. for the benefit of the
holders of trust preferred securities (incorporated by reference to Exhibit 10.1 to the registrant’s Current Report
on Form 8-K filed August 24, 2007).
Stock Purchase Agreement dated March 25, 2011, between American Hallmark Insurance Company of Texas and
Robert C. Siddons, Stephen W. Gurasich, Andrew J. Reynolds, Paul W. Keller, Kerry A. Keller and Austin
Engineering Co., Inc. (incorporated by reference to Exhibit 10.1 to the registrant’s Current Report on Form 8-K
dated March 25, 2011).
10.16*
Letter agreement dated August 13, 2014, between Hallmark Financial Services, Inc. and Naveen Anand
(incorporated by reference to Exhibit 10.1 to the registrant’s Current Report on Form 8-K filed August 15, 2014).
21+
List of subsidiaries of the registrant.
23 (a)+
Consent of Independent Registered Public Accounting Firm.
31(a)+
Certification of principal executive officer required by Rule 13a-14(a) or Rule 15d-14(b).
31(b)+
Certification of principal financial officer required by Rule 13a-14(a) or Rule 15d-14(b).
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.
61
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.
* Management contract or compensatory plan or arrangement.
+ Filed herewith.
62
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused
this report to be signed on its behalf by the undersigned, thereunto duly authorized.
SIGNATURES
Date:
March 12, 2015
Date:
March 12, 2015
HALLMARK FINANCIAL SERVICES, INC.
(Registrant)
By: /s/ Naveen Anand
Naveen Anand, Chief Executive Officer and
President
By:
/s/ Jeffrey R. Passmore
Jeffrey R. Passmore, Chief Accounting Officer and Senior
Vice President
Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following
persons on behalf of the registrant and in the capacities and on the dates indicated.
Date:
March 12, 2015
/s/ Naveen Anand
Date:
March 12, 2015
Naveen Anand, Chief Executive Officer and
President (Principal Executive Officer)
/s/ Jeffrey R. Passmore
Jeffrey R. Passmore, Chief Accounting Officer and Senior
Vice President (Principal Financial Officer and Principal
Accounting Officer)
Date:
March 12, 2015
/s/ Mark E. Schwarz
Mark E. Schwarz, Executive Chairman
Date:
March 12, 2015
Date:
March 12, 2015
Date:
March 12, 2015
/s/ James H. Graves
James H. Graves, Director
/s/ Jim W. Henderson
Jim W. Henderson, Director
/s/ Scott T. Berlin
Scott T. Berlin, Director
63
Exhibit 21
Subsidiaries of Hallmark Financial Services, Inc.
Name of Subsidiary
Jurisdiction of Incorporation
o Aerospace Claims Management Group, Inc.*
o Aerospace Flight, Inc.*
o Aerospace Holdings, LLC*
o Aerospace Insurance Managers, Inc.*
o Aerospace Special Risk, Inc.*
o American Hallmark General Agency, Inc.
(d/b/a Hallmark Insurance Company)
o American Hallmark Insurance Company of Texas*
o American Hallmark Insurance Services, Inc.*
o CYR Insurance Management Company*
o Effective Claims Management, Inc.*
o Hallmark Claims Service, Inc.
(d/b/a Hallmark Insurance Company)
o Hallmark County Mutual Insurance Company*
(controlled through a management agreement)
o Hallmark Finance Corporation*
o Hallmark Insurance Company*
o Hallmark National Insurance Company*
o Hallmark Specialty Insurance Company*
o Hardscrabble Data Solutions, LLC*
o Heath XS, LLC*
o Pan American Acceptance Corporation*
o TBIC Holding Corporation, Inc.*
o TBIC Risk Management, Inc.*
o Texas Builders Insurance Company*
o Hallmark Specialty Underwriters, Inc.*
o TGA Special Risk, Inc.*
* Conducts business under its corporate name.
Texas
Texas
Texas
Texas
Texas
Texas
Texas
Texas
Texas
Texas
Texas
Texas
Texas
Arizona
Arizona
Oklahoma
New Jersey
New Jersey
Texas
Texas
Texas
Texas
Texas
Texas
64
Exhibit 23(a)
Consent Of Independent Registered Public Accounting Firm
We consent to the incorporation by reference in the following Registration Statements:
(1) Registration Statement (Form S-8 No. 333-41220) pertaining to the Hallmark Financial Services, Inc. 1991 Key
Employee Stock Option Plan, Hallmark Financial Services, Inc. 1994 Key Employee Long Term Incentive Plan
and Hallmark Financial Services, Inc. 1994 Non-Employee Director Stock Option Plan;
(2) Registration Statement (Form S-8 No. 333-140000) pertaining to Hallmark Financial Services, Inc. 2005 Long
Term Incentive Plan;
(3) Registration Statement (Form S-8 No. 333-160050) pertaining to Hallmark Financial Services, Inc. 2005 Long
Term Incentive Plan;
(4) Registration Statement (Form S-3 No. 333-171696) and related Prospectus pertaining to the registration of
3,274,830 shares of common stock; and
(5) Registration Statement (Form S-3 No. 333-196613) and related Prospectus pertaining to the registration of
$30,000,000 of senior unsecured debt securities;
of our reports dated March 12, 2015, with respect to the consolidated financial statements and schedules of Hallmark
Financial Services, Inc. and subsidiaries and the effectiveness of internal control over financial reporting of Hallmark
Financial Services, Inc. and subsidiaries included in this Annual Report (Form 10-K) for the year ended December 31,
2014.
Fort Worth, Texas
March 12, 2015
/s/ Ernst & Young LLP
65
Exhibit 31(a)
CERTIFICATIONS
I, Naveen Anand, certify that:
1.
I have reviewed this annual report on Form 10-K of Hallmark Financial Services, Inc.;
2. Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a
material fact necessary to make the statements made, in light of the circumstances under which such statements were
made, not misleading with respect to the period covered by this report;
3. Based on my knowledge, the financial statements, and other financial information included in this report, fairly
present in all material respects the financial condition, results of operations and cash flows of the Registrant as of, and
for, the periods presented in this report;
4. The Registrant’s other certifying officer and I are responsible for establishing and maintaining disclosure
controls and procedures [as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)] and internal control over financial
reporting [as defined in Exchange Act Rules 13a-15(f) and 15d-15(f)] for the Registrant and have:
a)
designed such disclosure controls and procedures, or caused such disclosure controls and procedures
to be designed under our supervision, to ensure that material information relating to the Registrant, including its
consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this
report is being prepared;
b)
designed such internal control over financial reporting, or caused such internal control over financial
reporting to be designed under our supervision, to provide reasonable assurance regarding the reliability of financial
reporting and the preparation of financial statements for external purposes in accordance with generally accepted
accounting principles;
c)
evaluated the effectiveness of the Registrant’s disclosure controls and procedures and presented in
this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period
covered by this report based on such evaluation; and
d)
disclosed in this report any change in the Registrant’s internal control over financial reporting that
occurred during the Registrant’s most recent fiscal quarter (the Registrant’s fourth fiscal quarter in the case of an annual
report) that has materially affected, or is reasonably likely to materially affect, the Registrant’s internal control over
financial reporting; and
5.
The Registrant’s other certifying officer and I have disclosed, based on our most recent evaluation of internal
control over financial reporting, to the Registrant’s auditors and the audit committee of the Registrant’s board of
directors (or persons performing the equivalent functions):
a)
all significant deficiencies and material weaknesses in the design or operation of internal control over
financial reporting which are reasonably likely to adversely affect the Registrant’s ability to record, process, summarize
and report financial information; and
b)
any fraud, whether or not material, that involves management or other employees who have a
significant role in the Registrant’s internal control over financial reporting.
Date: March 12, 2015
/s/ Naveen Anand
Naveen Anand, Chief Executive Officer
66
Exhibit 31(b)
CERTIFICATIONS
I, Jeffrey R. Passmore, certify that:
1.
I have reviewed this annual report on Form 10-K of Hallmark Financial Services, Inc.;
2. Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a
material fact necessary to make the statements made, in light of the circumstances under which such statements were
made, not misleading with respect to the period covered by this report;
3. Based on my knowledge, the financial statements, and other financial information included in this report, fairly
present in all material respects the financial condition, results of operations and cash flows of the Registrant as of, and
for, the periods presented in this report;
4. The Registrant’s other certifying officer and I are responsible for establishing and maintaining disclosure
controls and procedures [as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)] and internal control over financial
reporting [as defined in Exchange Act Rules 13a-15(f) and 15d-15(f)] for the Registrant and have:
a)
designed such disclosure controls and procedures, or caused such disclosure controls and procedures
to be designed under our supervision, to ensure that material information relating to the Registrant, including its
consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this
report is being prepared;
b)
designed such internal control over financial reporting, or caused such internal control over financial
reporting to be designed under our supervision, to provide reasonable assurance regarding the reliability of financial
reporting and the preparation of financial statements for external purposes in accordance with generally accepted
accounting principles;
c)
evaluated the effectiveness of the Registrant’s disclosure controls and procedures and presented in
this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period
covered by this report based on such evaluation; and
d)
disclosed in this report any change in the Registrant’s internal control over financial reporting that
occurred during the Registrant’s most recent fiscal quarter (the Registrant’s fourth fiscal quarter in the case of an annual
report) that has materially affected, or is reasonably likely to materially affect, the Registrant’s internal control over
financial reporting; and
5.
The Registrant’s other certifying officer and I have disclosed, based on our most recent evaluation of internal
control over financial reporting, to the Registrant’s auditors and the audit committee of the Registrant’s board of
directors (or persons performing the equivalent functions):
a)
all significant deficiencies and material weaknesses in the design or operation of internal control over
financial reporting which are reasonably likely to adversely affect the Registrant’s ability to record, process, summarize
and report financial information; and
b)
any fraud, whether or not material, that involves management or other employees who have a
significant role in the Registrant’s internal control over financial reporting.
Date: March 12, 2015
/s/ Jeffrey R. Passmore
Jeffrey R. Passmore, Chief Accounting Officer
67
Exhibit 32(a)
CERTIFICATION PURSUANT TO 18 U.S.C. § 1350
I, Naveen Anand, Chief Executive Officer of Hallmark Financial Services, Inc. (the "Company"), hereby certify
that the accompanying annual report on Form 10-K for the fiscal year ended December 31, 2014, and filed with the
Securities and Exchange Commission on the date hereof (the "Report"), fully complies with the requirements of
Section 13(a) or 15(d) of the Securities Exchange Act of 1934, as amended. I further certify that the information contained
in the Report fairly presents, in all material respects, the financial condition and results of operations of the Company.
Date: March 12, 2015
/s/ Naveen Anand
Naveen Anand,
Chief Executive Officer
68
Exhibit 32(b)
CERTIFICATION PURSUANT TO 18 U.S.C. § 1350
I, Jeffrey R. Passmore, Chief Accounting Officer of Hallmark Financial Services, Inc. (the "Company"), hereby
certify that the accompanying annual report on Form 10-K for the fiscal year ended December 31, 2014, and filed with
the Securities and Exchange Commission on the date hereof (the "Report"), fully complies with the requirements of
Section 13(a) or 15(d) of the Securities Exchange Act of 1934, as amended. I further certify that the information contained
in the Report fairly presents, in all material respects, the financial condition and results of operations of the Company.
Date: March 12, 2015
/s/ Jeffrey R. Passmore
Jeffrey R. Passmore,
Chief Accounting Officer
69
HALLMARK FINANCIAL SERVICES, INC. AND SUBSIDIARIES
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
Description
Report of Independent Registered Public Accounting Firm
Consolidated Balance Sheets at December 31, 2014 and 2013
Consolidated Statements of Operations for the Years Ended December 31, 2014, 2013 and 2012
Consolidated Statements of Comprehensive Income for the Years Ended December 31, 2014, 2013 and 2012
Consolidated Statements of Stockholders’ Equity for the Years Ended December 31, 2014, 2013 and 2012
Consolidated Statements of Cash Flows for the Years Ended December 31, 2014, 2013 and 2012
Notes to Consolidated Financial Statements
Financial Statement Schedules
Page
Number
F-2
F-3
F-4
F-5
F-6
F-7
F-8
F-43
F-1
Report Of Independent Registered Public Accounting Firm
The Board of Directors and Stockholders of
Hallmark Financial Services, Inc. and subsidiaries
We have audited the accompanying consolidated balance sheets of Hallmark Financial Services, Inc. and subsidiaries (the Company)
as of December 31, 2014 and 2013, and the related consolidated statements of operations, comprehensive income, stockholders’
equity, and cash flows for each of the three years in the period ended December 31, 2014. Our audits also included the financial
statement schedules listed in Item 15(a)(2). These financial statements and schedules are the responsibility of the Company’s
management. Our responsibility is to express an opinion on these financial statements and schedules based on our audits.
We conducted our audits in accordance with the auditing standards of the Public Company Accounting Oversight Board (United
States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial
statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and
disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates
made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a
reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly, in all material respects, the consolidated financial position
of Hallmark Financial Services, Inc. and subsidiaries at December 31, 2014 and 2013, and the consolidated results of their
operations and their cash flows for each of the three years in the period ended December 31, 2014, in conformity with U.S.
generally accepted accounting principles. Also, in our opinion, the related financial statement schedules, when considered in
relation to the basic financial statements taken as a whole, present fairly, in all material respects, the information set forth therein.
We also have audited in accordance with the standards of the Public Company Accounting Oversight Board (United States),
Hallmark Financial Services, Inc. and subsidiaries internal control over financial reporting as of December 31, 2014, based on
criteria established in Internal Control-Integrated Framework issued by the Committee of Sponsoring Organizations of the
Treadway Commission (2013 Framework) and our report dated March 12, 2015 expressed an unqualified opinion thereon.
/s/ Ernst & Young LLP
Fort Worth, Texas
March 12, 2015
F-2
HALLMARK FINANCIAL SERVICES, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
December 31, 2014 and 2013
($ in thousands)
2014
2013
$
$
$
ASSETS
Investments:
Debt securities, available-for-sale,
at fair value (cost; $450,770 in 2014 and $408,627 in 2013)
Equity securities, available-for-sale,
at fair value (cost; $25,360 in 2014 and $24,902 in 2013)
Total investments
Cash and cash equivalents
Restricted cash
Ceded unearned premiums
Premiums receivable
Accounts receivable
Receivable for securities
Reinsurance recoverable
Deferred policy acquisition costs
Goodwill
Intangible assets, net
Prepaid expenses
Other assets
Total assets
LIABILITIES AND STOCKHOLDERS’ EQUITY
Liabilities:
Revolving credit facility payable
Subordinated debt securities
Reserves for unpaid losses and loss adjustment expenses
Unearned premiums
Reinsurance balances payable
Pension liability
Payable for securities
Federal income tax payable
Deferred federal income taxes, net
Accounts payable and other accrued expenses
Total liabilities
Commitments and contingencies (Note 16)
Stockholders’ equity:
Common stock, $.18 par value, authorized 33,333,333 shares; issued 20,872,831
shares in 2014 and 2013
Additional paid-in capital
Retained earnings
Accumulated other comprehensive income
Treasury stock (1,655,306 shares in 2014 and 1,609,374 in 2013), at cost
Total stockholders’ equity
450,785 $
56,444
507,229
130,985
11,914
53,376
71,003
3,141
932
109,719
20,746
44,695
17,427
1,823
7,879
980,869 $
- $
56,702
415,135
196,826
26,403
2,619
1,321
968
3,092
25,766
728,832
3,757
123,194
119,638
17,801
(12,353)
252,037
Total liabilities and stockholders’ equity
$
980,869 $
The accompanying notes are an integral part of the consolidated financial statements
F-3
410,095
51,230
461,325
141,666
12,190
44,988
71,157
2,382
1,320
76,818
22,586
44,695
19,953
1,531
8,412
909,023
1,473
56,702
382,640
185,303
20,598
1,433
206
719
2,825
19,006
670,905
3,757
122,827
106,209
16,883
(11,558)
238,118
909,023
HALLMARK FINANCIAL SERVICES, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
For the years ended December 31, 2014, 2013 and 2012
($ in thousands, except per share amounts)
Gross premiums written
Ceded premiums written
Net premiums written
Change in unearned premiums
Net premiums earned
Investment income, net of expenses
Net realized gains
Finance charges
Commission and fees
Other income
Total revenues
Losses and loss adjustment expenses
Operating expenses
Interest expense
Amortization of intangible assets
Total expenses
Income before tax
Income tax expense (benefit)
Net income
Less: Net income attributable to non-controlling interest
Net income attributable to Hallmark Financial Services, Inc.
Net income per share attributable to Hallmark Financial Services, Inc.
common stockholders:
Basic
Diluted
2014
2013
2012
473,218 $
(148,866)
324,352
(3,135)
321,217
12,383
134
5,279
(1,694)
47
337,366
210,055
101,427
4,576
2,526
318,584
18,782
5,353
13,429
-
460,027 $
(99,262)
360,765
(224)
360,541
12,884
10,540
5,830
(487)
120
389,428
261,345
109,289
4,599
3,115
378,348
11,080
2,835
8,245
-
389,842
(57,353)
332,489
(13,053)
319,436
15,293
1,943
5,957
(1,145)
316
341,800
226,414
103,792
4,634
3,586
338,426
3,374
(474)
3,848
324
13,429 $
8,245 $
3,524
0.70 $
0.69 $
0.43 $
0.43 $
0.18
0.18
$
$
$
$
The accompanying notes are an integral part of the consolidated financial statements
F-4
HALLMARK FINANCIAL SERVICES, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
For the years ended December 31, 2014, 2013 and 2012
($ In thousands)
Net income
Other comprehensive income:
Change in net actuarial (loss) gain
Tax effect on change in net actuarial (loss) gain
Unrealized holding gains arising during the period
Tax effect on unrealized holding gains arising during the period
Reclassification adjustment for gains included in net income
Tax effect on reclassification adjustment for gains included in net
income
Other comprehensive income, net of tax
$
Comprehensive income
Less: comprehensive income attributable to non-controlling interest
Comprehensive income attributable to Hallmark Financial Services,
Inc.
$
2014
2013
2012
$
13,429 $
8,245 $
3,848
(1,723)
603
3,543
(1,240)
(408)
143
918
14,347 $
-
2,268
(794)
22,094
(7,733)
(10,540)
3,689
8,984
17,229 $
-
14,347 $
17,229 $
37
(13)
4,388
(1,536)
(2,189)
766
1,453
5,301
324
4,977
The accompanying notes are an integral part of the consolidated financial statements
F-5
HALLMARK FINANCIAL SERVICES, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY
For the years ended December 31, 2014, 2013 and 2012
($ In thousands)
Number
of Shares Par Value
Additional
Paid-In
Capital
Retained
Earnings
Accumulated
Other
Comprehensive
Income
Treasury
Stock
Number
of
Shares
Total
Stockholders'
Equity
Balance at January 1, 2012
20,873 $
3,757
$
122,487 $ 94,440 $
6,446
Equity incentive plan activity
Accretion of redeemable non-
controlling interest
Net income
Other comprehensive income, net
of tax
-
-
-
-
Balance at December 31, 2012
Equity incentive plan activity
Net income
Other comprehensive income, net
of tax
20,873 $
3,757
-
-
-
-
380
-
-
-
-
$
-
-
-
(392)
-
-
3,524
-
-
1,453
122,475 $ 97,964 $
7,899
352
-
-
8,245
-
-
8,984
$
-
-
-
$
-
-
(11,558) 1,609 $
215,572
-
-
-
-
-
-
-
-
(11,558) 1,609 $
-
-
-
-
-
-
(11,558) 1,609 $
(1,805)
-
1,010
-
181
-
(135)
-
380
(392)
3,524
1,453
220,537
352
8,245
8,984
238,118
(1,805)
222
1,155
13,429
Balance at December 31, 2013
20,873 $
3,757
$
122,827 $
106,209 $
16,883
$
Acquisition of treasury stock
Equity incentive plan activity
Stock options exercised
Net income
Other comprehensive income, net
of tax
-
-
-
-
-
-
-
-
-
-
-
222
145
-
-
-
-
-
13,429
-
-
-
-
-
918
-
-
918
Balance at December 31, 2014
20,873 $
3,757 $
123,194 $
119,638 $
17,801
$
(12,353) 1,655 $
252,037
The accompanying notes are an integral part of the consolidated financial statements
F-6
HALLMARK FINANCIAL SERVICES, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
For the years ended December 31, 2014, 2013 and 2012
($ in thousands)
Cash flows from operating activities:
Net income
Adjustments to reconcile net income to cash provided by operating activities:
2014
2013
2012
$
13,429 $
8,245 $
3,848
Depreciation and amortization expense
Deferred federal income taxes
Net realized gains
Share-based payments expense
Change in ceded unearned premiums
Change in premiums receivable
Change in accounts receivable
Change in deferred policy acquisition costs
Change in unpaid losses and loss adjustment expenses
Change in unearned premiums
Change in reinsurance recoverable
Change in reinsurance balances payable
Change in current federal income tax payable
Change in all other liabilities
Change in all other assets
Net cash provided by operating activities
Cash flows from investing activities:
Purchases of property and equipment, net
Net transfers from (into) restricted cash
Purchases of investment securities
Maturities, sales and redemptions of investment securities
Net cash used in investing activities
Cash flows from financing activities:
Activity under revolving credit facility, net
Redemption of non-controlling interest
Distribution to non-controlling interest
Payment of contingent consideration
Proceeds from exercise of employee stock options
Purchase of treasury shares
Net cash used in financing activities
(Decrease) Increase in cash and cash equivalents
Cash and cash equivalents at beginning of year
Cash and cash equivalents at end of year
Supplemental cash flow information:
Interest paid
Income taxes (paid) recovered
Supplemental schedule of non-cash activities:
Change in receivable for securities related to investment disposals that settled after the
balance sheet date
Change in payable for securities related to investment purchases that settled after the
balance sheet date
3,224
(393)
(134)
222
(8,388)
154
(759)
1,840
32,495
11,523
(32,901)
5,805
249
7,946
(628)
33,684
4,300
(257)
(10,540)
352
(22,577)
(4,474)
728
2,325
69,224
22,801
(24,848)
13,268
(799)
(6,551)
17,141
68,338
4,421
(2,851)
(1,943)
380
(2,941)
(13,170)
836
(2,357)
16,471
16,398
(9,236)
4,191
8,256
5,396
5,983
33,682
(546)
276
(188,749)
146,777
(42,242)
(673)
(3,483)
(222,399)
214,738
(11,817)
(107)
665
(167,626)
148,968
(18,100)
(1,473)
-
-
-
1,155
(1,805)
(2,123)
(10,681)
141,666
130,985 $
-
-
-
-
-
-
-
56,521
85,145
141,666 $
(2,577)
(1,700)
(281)
(350)
-
-
(4,908)
10,674
74,471
85,145
(4,576) $
(4,599) $
(4,656)
(5,497) $
(3,891) $
5,879
388 $
(1,317) $
2,614
1,115 $
206 $
(203)
$
$
$
$
$
The accompanying notes are an integral part of the consolidated financial statements
F-7
HALLMARK FINANCIAL SERVICES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Years ended December 31, 2014, 2013, and 2012
1. Accounting Policies:
General
Hallmark Financial Services, Inc. (“Hallmark” and, together with subsidiaries, the “Company”, “we,” “us” or “our”) is an insurance
holding company engaged 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.
We pursue our business activities primarily through subsidiaries whose operations are organized into five business units that are
supported by our insurance company subsidiaries. Our Standard Commercial P&C business unit handles commercial insurance
products and services and is comprised of American Hallmark Insurance Services, Inc. (“American Hallmark Insurance Services”) and
Effective Claims Management, Inc. (“ECM”). Our Workers Compensation business unit specializes in small and middle market workers
compensation business and is comprised of TBIC Holding Corporation, Inc. (“TBIC Holding”), Texas Builders Insurance Company
(“TBIC”) and TBIC Risk Management (“TBICRM”). Our E&S Commercial business unit handles primarily commercial insurance products
and services and is comprised of Hallmark Specialty Underwriters, Inc. (“HSU”), Pan American Acceptance Corporation (“PAAC”) and
TGA Special Risk, Inc. (“TGASRI”). Our Hallmark Select business unit offers (i) general aviation insurance products and services, (ii) low
and middle market commercial umbrella and excess liability insurance, (iii) medical professional liability insurance products and
services, and (iv) satellite launch insurance products. Our Hallmark Select business unit is comprised of Aerospace Insurance
Managers, Inc. (“Aerospace Insurance Managers”), Aerospace Special Risk, Inc. (“ASRI”), Aerospace Claims Management Group, Inc.
(“ACMG”), Heath XS, LLC (“HXS”) and Hardscrabble Data Solutions, LLC (“HDS”). Our Personal Lines business unit handles personal
insurance products and services and is comprised of American Hallmark General Agency, Inc. and Hallmark Claims Services, Inc. (both
of which do business as Hallmark Insurance Company). Our insurance company subsidiaries supporting these business units are
American Hallmark Insurance Company of Texas (“AHIC”), Hallmark Insurance Company (“HIC”), Hallmark Specialty Insurance
Company (“HSIC”), Hallmark County Mutual Insurance Company (“HCM”), Hallmark National Insurance Company (“HNIC”) and TBIC.
These five business units are segregated into three reportable industry segments for financial accounting purposes. The Standard
Commercial Segment includes our Standard Commercial P&C business unit and our Workers Compensation business unit. The
Specialty Commercial Segment includes our E&S Commercial business unit and our Hallmark Select business unit, as well as certain
specialty risk programs (“Specialty Programs”) which are managed by Hallmark. The Personal Segment consists solely of our Personal
Lines business unit.
Basis of Presentation
The accompanying consolidated financial statements include the accounts and operations of Hallmark and its subsidiaries.
Intercompany accounts and transactions have been eliminated. The accompanying consolidated financial statements have been
prepared in conformity with U.S. generally accepted accounting principles (“GAAP”) which, as to our insurance company subsidiaries,
differ from statutory accounting practices prescribed or permitted for insurance companies by insurance regulatory authorities.
Use of Estimates in the Preparation of Financial Statements
Our preparation of financial statements in conformity with GAAP requires management to make estimates and assumptions that
affect our reported amounts of assets and liabilities at the dates of the financial statements and our reported amounts of revenues
and expenses during the reporting periods. Management evaluates its estimates and assumptions on an ongoing basis using historical
experience and other factors, including the current economic environment, which management believes to be reasonable under the
circumstances. We adjust such estimates and assumptions when facts and circumstances dictate. Since future events and their effects
cannot be determined with precision, actual results could differ significantly from these estimates. Changes in estimates resulting
from continuing changes in the economic environment may be reflected in the financial statements in future periods.
Fair Value of Financial Instruments
F-8
HALLMARK FINANCIAL SERVICES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Years ended December 31, 2014, 2013, and 2012
Fair value estimates are made at a point in time, based on relevant market data as well as the best information available about the
financial instruments. Fair value estimates for financial instruments for which no or limited observable market data is available are
based on judgments regarding current economic conditions, credit and interest rate risk. These estimates involve significant
uncertainties and judgments and cannot be determined with precision. As a result, such calculated fair value estimates may not be
realizable in a current sale or immediate settlement of the instrument. In addition, changes in the underlying assumptions used in the
fair value measurement technique, including discount rate and estimates of future cash flows, could significantly affect these fair
value estimates.
Cash and Cash Equivalents: The carrying amounts reported in the balance sheet for these instruments approximate their fair values.
Restricted Cash: The carrying amount for restricted cash reported in the balance sheet approximates the fair value.
Revolving Credit Facility Payable: The carrying value of our bank revolving credit facility approximates the fair value based on the
current interest rate.
Subordinated debt securities: Our trust preferred securities are reported at carry value of $56.7 million and $56.7 million, and have a
fair value of $47.6 million and $53.2 million, as of December 31, 2014 and 2013, respectively. The fair value of our trust preferred
securities is based on discounted cash flows using current yields to maturity of 8.0% and 8.0% as of December 31, 2014 and 2013,
respectively, which are based on similar issues to discount future cash flows and would be included in Level 3 of the fair value
hierarchy if they were reported at fair value.
For reinsurance balances, premiums receivable, federal income tax payable, other assets and other liabilities, the carrying amounts
approximate fair value because of the short maturity of such financial instruments.
Investments
Debt and equity securities available for sale are reported at fair value. Unrealized gains and losses are recorded as a component of
stockholders’ equity, net of related tax effects. Equity securities that are determined to have other-than-temporary impairment are
recognized as a loss on investments in the consolidated statements of operations. Debt securities that are determined to have other-
than-temporary impairment are recognized as a loss on investments in the consolidated statements of operations for the portion that
is related to credit deterioration with the remaining portion recognized in other comprehensive income. Debt security premiums and
discounts are amortized into earnings using the effective interest method. Maturities of debt securities and sales of equity securities
are recorded in receivable for securities until the cash is settled. Purchases of debt and equity securities are recorded in payable for
securities until the cash is settled.
Realized investment gains and losses are recognized in operations on the specific identification method.
Cash and Cash Equivalents
We consider all highly liquid investments with an original maturity of three months or less to be cash equivalents.
Restricted Cash
We collect premiums from customers and, after deducting authorized commissions, remit these premiums to the Company’s
consolidated insurance subsidiaries. Unremitted insurance premiums are held in a fiduciary capacity until disbursed to the Company’s
consolidated insurance subsidiaries.
Premiums Receivable
Premiums receivable represent amounts due from policyholders or independent agents for premiums written and uncollected. These
balances are carried at net realizable value.
Reinsurance
We are routinely involved in reinsurance transactions with other companies. Reinsurance premiums, losses and loss adjustment
expenses (“LAE”) are accounted for on bases consistent with those used in accounting for the original policies issued and the terms of
the reinsurance contracts. (See Note 7.)
F-9
HALLMARK FINANCIAL SERVICES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Years ended December 31, 2014, 2013, and 2012
Deferred Policy Acquisition Costs
Policy acquisition costs (mainly commission, underwriting and marketing expenses) that are directly related to the successful
acquisition of new and renewal insurance contracts are deferred and charged to operations over periods in which the related
premiums are earned. The method followed in computing deferred policy acquisition costs limits the amount of such deferred costs
to their estimated realizable value. In determining estimated realizable value, the computation gives effect to the premium to be
earned, expected investment income, losses and LAE and certain other costs expected to be incurred as the premiums are earned. If
the computation results in an estimated net realizable value less than zero, a liability will be accrued for the premium deficiency.
During 2014, 2013 and 2012, we deferred $39.1 million, $55.0 million and $62.2 million of policy acquisition costs and amortized
$40.9 million, $57.3 million and $59.8 million of deferred policy acquisition costs, respectively. Therefore, the net (amortization)
deferrals of policy acquisition costs were ($1.8) million, ($2.3) million and $2.4 million for 2014, 2013 and 2012, respectively.
Business Combinations
We account for business combinations using the acquisition method of accounting pursuant to Accounting Standards Codification
(“ASC”) 805, “Business Combinations.” The base cash purchase price plus the estimated fair value of any non-cash or contingent
consideration given for an acquired business is allocated to the assets acquired (including identified intangible assets) and liabilities
assumed based on the estimated fair values of such assets and liabilities. The excess of the fair value of the total consideration given
for an acquired business over the aggregate net fair values assigned to the assets acquired and liabilities assumed is recorded as
goodwill. Contingent consideration is recognized as a liability at fair value as of the acquisition date with subsequent fair value
adjustments recorded in the consolidated statements of operations. The valuation of contingent consideration requires assumptions
regarding anticipated cash flows, probabilities of cash flows, discount rates and other factors. Significant judgment is employed in
determining the propriety of these assumptions as of the acquisition date and for each subsequent period. Accordingly, future
business and economic conditions, as well as changes in any of the assumptions, can materially impact the amount of contingent
consideration expense we record in any given period. Indirect and general expenses related to business combinations are expensed
as incurred.
Goodwill and Intangible Assets, net
We account for our goodwill and intangible assets according to ASC 350, “Intangibles – Goodwill and Other.” ASC 350 (1) prohibits the
amortization of goodwill and indefinite-lived intangible assets, (2) requires testing of goodwill and indefinite-lived intangible assets on
an annual basis for impairment (and more frequently if the occurrence of an event or circumstance indicates an impairment), (3)
requires testing of definite-lived intangible assets if the occurrence of an event or circumstances indicates an impairment, (4) requires
that reporting units be identified for the purpose of assessing potential future impairments of goodwill, and (5) removes the forty-
year limitation on the amortization period of intangible assets that have finite lives. We have elected to perform our goodwill
impairment test on the first day of the fourth quarter, October 1, of each year.
Leases
We have several leases, primarily for office facilities and computer equipment, which expire in various years through 2022. Some of
these leases include rent escalation provisions throughout the term of the lease. We expense the average annual cost of the lease
with the difference to the actual rent invoices recorded as deferred rent which is classified in accounts payable and other accrued
expenses on our consolidated balance sheets.
F-10
HALLMARK FINANCIAL SERVICES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Years ended December 31, 2014, 2013, and 2012
Property and Equipment
Property and equipment (including leasehold improvements), aggregating $14.8 million and $14.3 million, at December 31, 2014 and
2013, respectively, which is included in other assets, is recorded at cost and is depreciated using the straight-line method over the
estimated useful lives of the assets (three to ten years). Depreciation expense for 2014, 2013 and 2012 was $0.7 million, $1.2 million
and $1.2 million, respectively. Accumulated depreciation was $13.2 million and $12.5 million at December 31, 2014 and 2013,
respectively.
Variable Interest Entities
On June 21, 2005, we formed Hallmark Statutory Trust I (“Trust I”), an unconsolidated trust subsidiary, for the sole purpose of issuing
$30.0 million in trust preferred securities. Trust I used the proceeds from the sale of these securities and our initial capital
contribution to purchase $30.9 million of subordinated debt securities from Hallmark. The debt securities are the sole assets of Trust
I, and the payments under the debt securities are the sole revenues of Trust I.
On August 23, 2007, we formed Hallmark Statutory Trust II (“Trust II”), an unconsolidated trust subsidiary, for the sole purpose of
issuing $25.0 million in trust preferred securities. Trust II used the proceeds from the sale of these securities and our initial capital
contribution to purchase $25.8 million of subordinated debt securities from Hallmark. The debt securities are the sole assets of Trust
II, and the payments under the debt securities are the sole revenues of Trust II.
We evaluate on an ongoing basis our investments in Trust I and Trust II (collectively, (the “Trusts”)) and we do not have variable
interests in the Trusts. Therefore, the Trusts are not consolidated in our consolidated financial statements.
We are also involved in the normal course of business with variable interest entities primarily as a passive investor in mortgage-
backed securities and certain collateralized corporate bank loans issued by third party variable interest entities. The maximum
exposure to loss with respect to these investments is limited to the investment carrying values included in the consolidated balance
sheets.
Losses and Loss Adjustment Expenses
Losses and LAE represent the estimated ultimate net cost of all reported and unreported losses incurred through December 31, 2014,
2013 and 2012. The reserves for unpaid losses and LAE are estimated using individual case-basis valuations and statistical analyses.
These estimates are subject to the effects of trends in loss severity and frequency. Although considerable variability is inherent in
such estimates, we believe that the reserves for unpaid losses and LAE are adequate. The estimates are continually reviewed and
adjusted as experience develops or new information becomes known. Such adjustments are included in current operations.
Redeemable Non-Controlling Interest
We accreted the redeemable non-controlling interest to its redemption value from the date of issuance to the redemption date using
the interest method. Changes in redemption value were considered a change in accounting estimate. We follow the two class method
of computing earnings per share. We treat only the portion of the periodic adjustment to the redeemable non-controlling interest
carrying amount that reflects a redemption in excess of fair value as being akin to an actual dividend. Effective September 30, 2012,
we exercised our call option and acquired the remaining 20% membership interests in the subsidiaries for $1.7 million.
Recognition of Premium Revenues
Insurance premiums are earned pro rata over the terms of the policies. Insurance policy fees are earned as of the effective date of the
policy. Upon cancellation, any unearned premium is refunded to the insured. Insurance premiums written include gross policy fees of
$11.5 million, $13.2 million and $11.8 million for the years ended December 31, 2014, 2013, and 2012, respectively. Insurance
premiums on monthly reporting workers’ compensation policies are earned on the conclusion of the monthly coverage period.
Deposit premiums for workers’ compensation policies are earned upon the expiration of the policy.
F-11
HALLMARK FINANCIAL SERVICES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Years ended December 31, 2014, 2013, and 2012
Finance Charges
We receive premium installment fees for each direct bill payment from policyholders. Installment fee income is classified as finance
charges on the consolidated statement of operations and is recognized as the fee is invoiced.
Relationship with Third Party Insurers
Through December 31, 2005, our Standard Commercial P&C business unit marketed policies on behalf of Clarendon National
Insurance Company (“Clarendon”), a third-party insurer. Through December 31, 2008, all business of our E&S Commercial business
unit was produced under a fronting agreement with member companies of the Republic Group (“Republic”), a third-party insurer.
These insurance contracts on third party paper are accounted for under agency accounting. Ceding commissions and other fees
received under these arrangements were classified as unearned commission revenue until earned pro rata over the terms of the
policies.
Profit sharing commission is calculated and recognized when the loss ratio, as determined by a qualified actuary, deviates from
contractual targets. We received a provisional commission as policies were produced as an advance against the later determination of
the profit sharing commission actually earned. The profit sharing commission is an estimate that varies with the estimated loss ratio
and is sensitive to changes in that estimate. Profit share commission is classified as commissions and fees on the consolidated
statement of operations
The following table details the profit sharing commission provisional loss ratio compared to the estimated ultimate loss ratio for each
effective quota share treaty between the Standard Commercial P&C business unit and Clarendon.
Provisional loss ratio
Estimated ultimate loss ratio
recorded at December 31, 2014
7/1/2001
7/1/2002
60.0%
63.5%
59.0%
64.5%
7/1/2003
59.0%
61.2%
7/1/2004
64.2%
66.0%
Treaty Effective Dates
As of December 31, 2014, we had a payable of $1.3 million on these profit share treaties. The payable or receivable is the difference
between the cash received to date and the recognized commission revenue based on the estimated ultimate loss ratio.
The following table details the profit sharing commission revenue provisional loss ratio compared to the estimated ultimate loss ratio
for the effective quota share treaty between the E&S Commercial business unit and Republic.
1/1/2006
1/1/2007
1/1/2008
Treaty Effective Dates
Provisional loss ratio
Estimated ultimate loss ratio recorded at
December 31, 2014
65.0%
58.7%
65.0%
63.6%
65.0%
59.5%
As of December 31, 2014, we had a net payable of $0.7 million on these profit share treaties. The payable or receivable is the
difference between the cash received to date and the recognized commission revenue based on the estimated ultimate loss ratio.
F-12
HALLMARK FINANCIAL SERVICES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Years ended December 31, 2014, 2013, and 2012
Agent Commissions
We pay monthly commissions to agents based on written premium produced, but generally recognize the expense pro rata over the
term of the policy. If the policy is cancelled prior to its expiration, the unearned portion of the agent commission is refundable to us.
The unearned portion of commissions paid to agents is included in deferred policy acquisition costs.
We annually pay a profit sharing commission to our independent agency force based upon the results of the business produced by
each agent. We estimate and accrue this liability to commission expense in the year the business is produced.
Commission expense is classified as other operating expenses in the consolidated statement of operations.
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.
Earnings Per Share
The computation of earnings per share is based upon the weighted average number of common shares outstanding during the period
plus the effect of common shares potentially issuable (in periods in which they have a dilutive effect), primarily from stock options.
(See Notes 11 and 13.)
Adoption of New Accounting Pronouncements
In May 2014, the FASB issued guidance which revises the criteria for revenue recognition. Insurance contracts are excluded from the
scope of the new guidance. 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, 2016 and is to be applied retrospectively. The Company is in
the process of evaluating the impact of adoption, which is not expected to be material to the Company’s results of operations and
financial position.
F-13
HALLMARK FINANCIAL SERVICES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Years ended December 31, 2014, 2013, and 2012
2.
Investments:
The amortized cost and estimated fair value of investments in debt and equity securities by category is as follows (in thousands):
Amortized Cost
Gross
Unrealized
Gains
Gross
Unrealized
Losses
Fair Value
As of December 31, 2014
U.S. Treasury securities and obligations of U.S. Government
Corporate bonds
Collateralized corporate bank loans
Municipal bonds
Mortgage-backed
Total debt securities
Total equity securities
$
93,280 $
28,643
115,358
161,546
51,943
450,770
25,360
29 $
884
206
2,384
487
3,990
31,086
Total debt and equity securities
$
476,130 $
35,076 $
As of December 31, 2013
U.S. Treasury securities and obligations of U.S. Government
Corporate bonds
Collateralized corporate bank loans
Municipal bonds
Mortgage-backed
Total debt securities
Total equity securities
$
78,894 $
42,946
102,053
156,950
27,784
408,627
24,902
24 $
1,379
614
2,577
460
5,054
26,642
(4) $
(85)
(1,915)
(1,601)
(370)
(3,975)
(2)
(3,977) $
(165) $
(450)
(489)
(1,975)
(507)
(3,586)
(314)
93,305
29,442
113,649
162,329
52,060
450,785
56,444
507,229
78,753
43,875
102,178
157,552
27,737
410,095
51,230
Total debt and equity securities
$
433,529 $
31,696 $
(3,900) $
461,325
F-14
HALLMARK FINANCIAL SERVICES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Years ended December 31, 2014, 2013, and 2012
Major categories of net investment income are summarized as follows (in thousands):
U.S. Treasury securities and obligations of U.S. Government
Corporate bonds
Collateralized corporate bank loans
Municipal bonds
Mortgage-backed
Equity securities
Cash and cash equivalents
Investment expenses
Investment income, net of expenses
Twelve Months Ended December 31
2014
2013
2012
$
$
395 $
1,378
4,400
5,232
995
509
230
13,139
(756)
12,383 $
143 $
2,341
4,653
5,245
737
484
157
13,760
(876)
12,884 $
53
4,218
5,261
5,616
106
534
246
16,034
(741)
15,293
No investments in any entity or its affiliates exceeded 10% of stockholders’ equity at December 31, 2014 or 2013.
Major categories of net realized gains on investments are summarized as follows (in thousands):
U.S. Treasury securities and obligations of U.S. Government
Corporate bonds
Collateralized corporate bank loans
Municipal bonds
Mortgage-backed
Equity securities
Gain on investments
Other-than-temporary impairments
Net realized gain
Twelve Months Ended December 31
2014
2013
2012
$
$
- $
263
109
(140)
32
144
408
(274)
134 $
- $
853
373
(156)
-
9,470
10,540
-
10,540 $
-
13
391
(441)
-
2,226
2,189
(246)
1,943
We realized gross gains on investments of $0.6 million, $10.9 million, and $2.9 million during the years ended December 31, 2014, 2013
and 2012, respectively. We realized gross losses on investments of $0.2 million, $0.4 million and $0.7 million during the years ended
December 31, 2014, 2013 and 2012, respectively. We recorded proceeds from the sale of investment securities of $15.3 million, $33.4
million and $12.4 million during the years ended December 31, 2014, 2013 and 2012, respectively. Realized investment gains and losses
are recognized in operations on the specific identification method.
F-15
HALLMARK FINANCIAL SERVICES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Years ended December 31, 2014, 2013, and 2012
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 December 31, 2014 and December 31, 2013 (in thousands):
12 months or less
Longer than 12 months
Total
As of December 31, 2014
Fair Value
Unrealized
Losses
Fair Value
Unrealized
Losses
Fair Value
Unrealized
Losses
$
U.S. Treasury securities and
obligations of U.S. Government
Corporate bonds
Collateralized corporate bank
Municipal bonds
Mortgage-backed
Total debt securities
Total equity securities
Total debt and equity securities
$
15,005 $
7,552
64,712
50,546
20,469
158,284
129
158,413 $
(4) $
(85)
(824)
(945)
(365)
(2,223)
(2)
(2,225) $
- $
-
8,898
15,684
2,966
27,548
-
27,548 $
- $
-
(1,091)
(656)
(5)
(1,752)
15,005 $
7,552
73,610
66,230
23,435
185,832
-
(1,752) $
129
185,961 $
(4)
(85)
(1,915)
(1,601)
(370)
(3,975)
(2)
(3,977)
12 months or less
Longer than 12 months
Total
As of December 31, 2013
Fair Value
Unrealized
Losses
Fair Value
Unrealized
Losses
Fair Value
Unrealized
Losses
$
U.S. Treasury securities and
obligations of U.S. Government
Corporate bonds
Collateralized corporate bank
Municipal bonds
Mortgage-backed
Total debt securities
Total equity securities
Total debt and equity securities
$
47,162 $
5,649
23,026
35,719
1,383
112,939
316
113,255 $
(165) $
(56)
(422)
(413)
(229)
(1,285)
(2)
(1,287) $
- $
4,421
6,968
34,684
4,840
50,913
2,721
53,634 $
- $
(394)
(67)
(1,562)
(278)
(2,301)
(312)
(2,613) $
47,162 $
10,070
29,994
70,403
6,223
163,852
3,037
166,889 $
(165)
(450)
(489)
(1,975)
(507)
(3,586)
(314)
(3,900)
At December 31, 2014, the gross unrealized losses more than twelve months old were attributable to 24 debt security positions. At
December 31, 2013, the gross unrealized losses more than twelve months old were attributable to 84 debt security positions. We consider
these losses as a temporary decline in value as they are predominately on bonds that we do not intend to sell and do not believe we will
be required to sell prior to recovery of our amortized cost basis. We see no other indications that the decline in values of these securities is
other-than-temporary.
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.
F-16
HALLMARK FINANCIAL SERVICES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Years ended December 31, 2014, 2013, and 2012
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 impairments on our equity securities portfolio or changes regarding retention strategies for
certain equity securities.
We complete a detailed analysis each quarter to assess whether any decline in the fair value of any investment below cost is deemed
other-than-temporary. All securities with an unrealized loss are reviewed. We recognize an impairment loss when an investment'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 other-than-temporary losses on our debt securities portfolio of $0.3 million during 2014.
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 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.
Equity Investments: Some of the factors considered in evaluating whether a decline in fair value for an equity investment is other-than-
temporary include: (1) our ability and intent to retain the investment for a period of time sufficient to allow for an anticipated recovery in
value; (2) the recoverability of cost; (3) the length of time and extent to which the fair value has been less than cost; and (4) the financial
condition and near-term and long-term prospects for the issuer, including the relevant industry conditions and trends, and implications of
rating agency actions and offering prices. When it is determined that an equity investment is other-than-temporarily impaired, the security
is written down to fair value, and the amount of the impairment is included in earnings as a realized investment loss. The fair value then
becomes the new cost basis of the investment, and any subsequent recoveries in fair value are recognized at disposition. We recognize a
realized loss when impairment is deemed to be other-than-temporary even if a decision to sell an equity investment has not been made.
When we decide to sell a temporarily impaired available-for-sale equity investment and we do not expect the fair value of the equity
investment to fully recover prior to the expected time of sale, the investment is deemed to be other-than-temporarily impaired in the
period in which the decision to sell is made.
The amortized cost and estimated fair value of debt securities at December 31, 2014 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.
Due in one year or less
Due after one year through five years
Due after five years through ten years
Due after ten years
Mortgage-backed
Amortized Cost
Fair Value
(in thousands)
49,977 $
185,036
111,008
52,806
51,943
450,770 $
50,329
185,525
109,925
52,946
52,060
450,785
$
$
We have certain of our securities pledged 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 $20.3 million at December 31, 2014 and a carrying value of $29.1 million at
December 31, 2013.
F-17
HALLMARK FINANCIAL SERVICES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Years ended December 31, 2014, 2013, and 2012
3. Fair Value:
ASC 820 defines fair value, establishes a consistent framework for measuring fair value and expands disclosure requirements about
fair value measurements. ASC 820, among other things, requires us to maximize the use of observable inputs and minimize the use of
unobservable inputs when measuring fair value. In addition, ASC 820 precludes the use of block discounts when measuring the fair
value of instruments traded in an active market, which were previously applied to large holdings of publicly traded equity securities.
We determine the fair value of our financial instruments based on the fair value hierarchy established in ASC 820. In accordance with
ASC 820, we utilize the following fair value hierarchy:
•
•
•
Level 1: quoted prices in active markets for identical assets;
Level 2: inputs to the valuation methodology include quoted prices for similar assets and liabilities in active markets,
inputs of identical assets for less active markets, and inputs that are observable for the asset or liability, either directly
or indirectly, for substantially the full term of the instrument; and
Level 3: inputs to the valuation methodology that are unobservable for the asset or liability.
This hierarchy requires the use of observable market data when available.
Under ASC 820, we determine fair value based on the price that would be received for an asset or paid to transfer a liability in an
orderly transaction between market participants on the measurement date. It is our policy to maximize the use of observable inputs
and minimize the use of unobservable inputs when developing fair value measurements, in accordance with the fair value hierarchy
described above. Fair value measurements for assets and liabilities where there exists limited or no observable market data are
calculated based upon our pricing policy, the economic and competitive environment, the characteristics of the asset or liability and
other factors as appropriate. These estimated fair values may not be realized upon actual sale or immediate settlement of the asset
or liability.
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.
Level 2 investment securities include corporate bonds, collateralized corporate bank loans, municipal bonds, U.S. Treasury securities,
other obligations of the U.S. Government and mortgage-backed securities for which quoted prices are not available on active
exchanges for identical instruments. We use third party pricing services to determine fair values for each Level 2 investment security
in all asset classes. Since quoted prices in active markets for identical assets are not available, these prices are determined using
observable market information such as quotes from less active markets and/or quoted prices of securities with similar characteristics,
among other things. We have reviewed the processes used by the pricing services and have determined that they result in fair values
consistent with the requirements of ASC 820 for Level 2 investment securities. We have not adjusted any prices received from third
party pricing services. There were no transfers between Level 1 and Level 2 securities.
In cases where there is limited activity or less transparency around inputs to the valuation, investment securities are classified within
Level 3 of the valuation hierarchy. Level 3 investments are valued based on the best available data in order to approximate fair value.
This data may be internally developed and consider risk premiums that a market participant would require. Investment securities
classified within Level 3 include other less liquid investment securities.
F-18
HALLMARK FINANCIAL SERVICES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Years ended December 31, 2014, 2013, and 2012
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
December 31, 2014 and December 31, 2013 (in thousands).
U.S. Treasury securities and obligations of U.S. Government
Corporate bonds
Collateralized corporate bank loans
Municipal bonds
Mortgage-backed
Total debt securities
Total equity securities
Total debt and equity securities
U.S. Treasury securities and obligations of U.S. Government
Corporate bonds
Collateralized corporate bank loans
Municipal bonds
Mortgage-backed
Total debt securities
Total equity securities
Total debt and equity securities
As of December 31, 2014
Quoted Prices in
Active Markets for
Identical Assets
(Level 1)
Other
Observable
Inputs (Level 2)
Unobservable
Inputs (Level 3)
Total
$
$
- $
-
-
-
-
-
56,444
56,444 $
93,305 $
29,442
113,402
147,978
52,060
436,187
-
436,187 $
- $
-
247
14,351
-
14,598
-
14,598 $
93,305
29,442
113,649
162,329
52,060
450,785
56,444
507,229
As of December 31, 2013
Quoted Prices in
Active Markets for
Identical Assets
Other
Observable
Inputs (Level 2)
Unobservable
Inputs (Level 3)
Total
$
$
- $
-
-
-
-
-
51,230
51,230 $
78,753 $
43,875
101,585
140,628
27,737
392,578
-
392,578 $
- $
-
593
16,924
-
17,517
-
17,517 $
78,753
43,875
102,178
157,552
27,737
410,095
51,230
461,325
F-19
HALLMARK FINANCIAL SERVICES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Years ended December 31, 2014, 2013, and 2012
Due to significant unobservable inputs into the valuation model for certain municipal bonds and a collateralized corporate bank loan in
illiquid markets, we classified these as level 3 in the fair value hierarchy. We used an income approach in order to derive an estimated fair
value of the municipal bonds classified as Level 3, which included inputs such as expected holding period, benchmark swap rate,
benchmark discount rate and a discount rate premium for illiquidity. The fair value of the collateralized corporate bank loan classified as
level 3 is based on discounted cash flows using current yield to maturity of 9.0%, which is based on the relevant spread over LIBOR for this
particular loan to discount future cash flows. Significant changes in the unobservable inputs in the fair value measurement of our
municipal bonds and collateralized corporate bank loan could result in a significant change in the fair value measurement.
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 year ended December 31, 2014 and 2013 (in thousands).
Beginning balance as of January 1
Sales
Settlements
Purchases
Issuances
Total realized/unrealized gains included in net income
Net gains included in other comprehensive income
Transfers into Level 3
Transfers out of Level 3
Ending balance as of December 31
4. Goodwill and Intangible Assets:
$
$
2014
2013
17,517 $
(3,490)
-
-
-
-
571
-
-
14,598 $
19,668
(3,157)
-
-
-
-
1,006
-
-
17,517
Effective August 29, 2008, we acquired 80% of the issued and outstanding membership interests in Heath XS, LLC and Hardscrabble
Data Solutions, LLC for consideration of $15.0 million. In connection with the acquisition, we executed an operating agreement for
each subsidiary. The operating agreements granted us the right to purchase the remaining 20% membership interests in the
subsidiaries and granted an affiliate of the seller the right to require us to purchase such remaining membership interests. Effective
September 30, 2012, we exercised our call option and acquired the remaining 20% membership interests in the subsidiaries for $1.7
million.
Effective July 1, 2011, we acquired all of the issued and outstanding capital stock of TBIC Holding for initial consideration of $1.6
million paid in cash on July 1, 2011. In addition, a holdback purchase price of $350 thousand was paid during the third quarter of
2012. A contingent purchase price of up to $3.0 million may become payable following 16 full calendar quarters after closing based
upon a formula contained in the acquisition agreement. We recorded a bargain purchase gain of $165 thousand on the acquisition
which was reported in other income. The gain resulted from the difference in the estimated purchase price and the fair value of the
net assets acquired and liabilities assumed as of July 1, 2011.
Goodwill is tested for impairment at the reporting unit level (operating segment or one level below an operating segment) on an
annual basis (October 1) and between annual tests if an event occurs or circumstances change that would more likely than not reduce
the fair value of a reporting unit below its carrying value. For purposes of evaluating goodwill for impairment, we have determined
that our reporting units are the same as our business units except for the Hallmark Select business unit for which reporting units are
at the component level (“one level below”). Our consolidated balance sheet as of December 31, 2014 includes goodwill of acquired
businesses of $44.7 million that is assigned to our business units as follows: Standard Commercial P&C business unit - $2.1 million;
E&S Commercial business unit - $19.8 million; Hallmark Select business unit- $17.4 million (comprised of $7.7 million for the excess &
umbrella component and $9.7 million for the general aviation and satellite component); and Personal Lines business unit - $5.4
million. This amount has been recorded as a result of prior business acquisitions accounted for under the acquisition method of
accounting. Under ASC 350, “Intangibles- Goodwill and Other,” goodwill is tested for impairment annually. We completed our last
annual test for impairment on the first day of the fourth quarter of 2014 and determined that there was no impairment.
F-20
HALLMARK FINANCIAL SERVICES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Years ended December 31, 2014, 2013, and 2012
The income approach to determining fair value computed the projections of the cash flows that the reporting unit was expected to
generate converted into a present value equivalent through discounting. Significant assumptions in the income approach model
included income projections, discount rates and terminal growth values. The income projections reflect an improved premium rate
environment across most of our lines of business that continued throughout 2014. The income projections also included loss and LAE
assumptions which reflected recent historical claim trends and the movement towards a more favorable pricing environment. The
income projections also included assumptions for expense growth and investment yields which were based on business plans for each
of our business units. The discount rate was based on a risk free rate plus a beta adjusted equity risk premium and specific company
risk premium. The assumptions were based on historical experience, expectations of future performance, expected market conditions
and other factors requiring judgment and estimates. While we believe the assumptions used in these models were reasonable, the
inherent uncertainty in predicting future performance and market conditions may change over time and influence the outcome of
future testing.
During 2014, 2013, and 2012, we completed the first step prescribed by ASC 350 for testing for impairment and determined that
there was no impairment.
We have obtained various intangible assets from several acquisitions since 2002. The table below details the gross and net carrying
amounts of these assets by major category (in thousands):
Gross Carrying Amount:
Customer/agent relationships
Tradename
Management agreement
Non-compete & employment agreements
Insurance licenses
Total gross carrying amount
Accumulated Amortization:
Customer/agent relationships
Tradename
Management agreement
Non-compete & employment agreements
Total accumulated amortization
$
December 31
2014
2013
32,177 $
3,440
3,232
4,235
1,300
44,384
(17,561)
(1,929)
(3,232)
(4,235)
(26,957)
32,177
3,440
3,232
4,235
1,300
44,384
(15,322)
(1,700)
(3,232)
(4,177)
(24,431)
Total net carrying amount
$
17,427 $
19,953
F-21
HALLMARK FINANCIAL SERVICES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Years ended December 31, 2014, 2013, and 2012
Insurance licenses are not amortized because they have an indefinite life. We amortize definite-lived intangible assets straight line
over their respective lives. The estimated aggregate amortization expense for definite-lived intangible assets for the next five years is
as follows (in thousands):
2015
2016
2017
2018
2019
$
$
$
$
$
2,468
2,468
2,468
2,468
2,468
The weighted average amortization period for definite-lived intangible assets by major class is as follows:
Tradename
Customer relationships
Management agreement
Non-compete agreements
The aggregate weighted average period to amortize these assets is approximately 13 years.
Years
15
15
4
5
F-22
HALLMARK FINANCIAL SERVICES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Years ended December 31, 2014, 2013, and 2012
5. Other Assets:
The following table details our other assets as of December 31, 2014 and 2013 (in thousands):
Profit sharing commission receivable
Accrued investment income
Debt issuance costs
Investment in unconsolidated trust subsidiaries
Fixed assets
Other assets
2014
2013
$
$
274 $
2,974
1,104
1,702
1,620
205
7,879 $
6. Reserves for Unpaid Losses and Loss Adjustment Expenses:
Activity in the reserves for unpaid losses and LAE is summarized as follows (in thousands):
Balance at January 1
Less reinsurance recoverable
Net Balance at January 1
Incurred related to:
Current year
Prior years
Total incurred
Paid related to:
Current year
Prior years
Total paid
Net Balance at December 31
Plus reinsurance recoverable
Balance at December 31
2014
2013
2012
$
$
382,640 $
70,172
312,468
215,258
(5,203)
210,055
76,231
123,100
199,331
323,192
91,943
415,135 $
313,416 $
49,584
263,832
251,391
9,954
261,345
101,897
110,812
212,709
312,468
70,172
382,640 $
641
3,030
1,156
1,702
1,773
110
8,412
296,945
42,044
254,901
230,089
(3,675)
226,414
107,945
109,538
217,483
263,832
49,584
313,416
The $5.2 million favorable development, $10.0 million unfavorable development and $3.7 million favorable development in prior accident
years recognized in 2014, 2013 and 2012, respectively, represent normal changes in our loss reserve estimates. In 2014 and 2012, the
aggregate loss reserve estimates for prior years were decreased to reflect favorable loss development when the available information
indicated a reasonable likelihood that the ultimate losses would be less than the previous estimates. In 2013, the aggregate loss reserve
estimates for prior years were increased to reflect unfavorable loss development when the available information indicated a reasonable
likelihood that the ultimate losses would be more than the previous estimates. Generally, changes in reserves are caused by variations
between actual experience and previous expectations and by reduced emphasis on the Bornhuetter-Ferguson method due to the aging of
the accident years.
F-23
HALLMARK FINANCIAL SERVICES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Years ended December 31, 2014, 2013, and 2012
The $5.2 million decrease in reserves for unpaid losses and LAE recognized in 2014 was attributable to $7.2 million favorable development
on claims incurred in the 2013 accident year, $4.4 million unfavorable development on claims incurred in the 2012 accident year and $2.4
million favorable development on claims incurred in the 2011 and prior accident years. Our Standard Commercial P&C business unit,
Personal Lines business unit, Workers Compensation business unit and Hallmark Select business unit accounted for $4.1 million, $2.9
million, $1.9 million and $1.0 million, respectively, of the decrease in reserves recognized during 2014. The decrease in reserves for our
Standard Commercial P&C business unit was primarily related to our commercial auto and general liability lines of business. The decrease
in reserves for our Personal Lines business unit was primarily attributable to the 2013 accident year. The decrease in reserves for our
Workers Compensation business unit was attributable to the 2013, 2012 and 2011 and prior accident years. The decrease in reserves for
our Hallmark Select business unit was primarily related to $0.9 million favorable development in our commercial excess liability line of
business and $0.4 million favorable development in our medical professional liability products, partially offset by a $0.3 million
unfavorable development in our general aviation line of business. These favorable developments were partially offset by unfavorable
development of $4.7 million in our E&S Commercial business unit primarily related to our commercial auto liability and general liability
lines of business.
The $10.0 million increase in reserves for unpaid losses and LAE recognized in 2013 was attributable to $5.0 million unfavorable
development on claims incurred in the 2012 accident year, $1.7 million unfavorable development on claims incurred in the 2011 accident
year and $3.3 million unfavorable development on claims incurred in the 2010 and prior accident years. Our E&S Commercial business
unit and Personal Lines business unit accounted for $16.0 million and $1.8 million of the increase in reserves recognized during 2013. The
increase in reserves for our E&S Commercial business unit was primarily related to commercial auto liability line of business. The increase
in reserves for our Personal Lines business unit was primarily related to personal auto in the 2012 accident year. These unfavorable
developments were partially offset by favorable prior years’ loss development of $3.7 million in our Standard Commercial P&C business
unit, $2.6 million in our Hallmark Select business unit and $1.5 million in our Workers Compensation business unit. The decrease in
reserves for our Standard Commercial P&C business unit was primarily related to commercial auto and general liability line of business.
The decrease in reserves for our Hallmark Select business unit was driven by $2.3 million of favorable claims development in the 2011 and
prior accident years related to our aircraft liability lines of business, partially offset by $0.1 million unfavorable claims development in the
2012 accident year related to our aircraft hull coverage. Further contributing to the decrease in reserves for our Hallmark Select business
unit was $0.4 million of favorable claims development in our excess & umbrella lines of business. The decrease in reserves for our Workers
Compensation business unit was related to the 2012 and 2011 accident years.
The $3.7 million decrease in reserves for unpaid losses and LAE recognized in 2012 was attributable to $0.4 million favorable development
on claims incurred in the 2011 accident year, $0.8 million favorable development on claims incurred in the 2010 accident year and $2.5
million favorable development on claims incurred in the 2009 and prior accident years. Our Standard Commercial P&C business unit,
Hallmark Select business unit and E&S Commercial business unit accounted for $3.7 million, $3.3 million and $0.3 million, respectively, of
the decrease in reserves recognized during 2012. The decrease in reserves for our Standard Commercial P&C business unit was primarily
related to commercial auto, commercial property and general liability lines of business. The decrease in reserves for our Hallmark Select
business unit was primarily related to our aircraft liability lines of business. The decrease in reserves for our E&S Commercial business unit
was primarily related to general liability. These favorable developments were partially offset by unfavorable prior years’ loss development
of $3.6 million in our Personal Lines business unit related to auto liability claims spread throughout various states and our low value
dwelling/homeowners line of business.
7. 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 December 31, 2014
was with reinsurers that had an A.M. Best rating of “A-” or better. We also mitigate our credit risk for the remaining reinsurance
recoverable by obtaining letters of credit.
F-24
HALLMARK FINANCIAL SERVICES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Years ended December 31, 2014, 2013, and 2012
The following table presents our gross and net premiums written and earned and reinsurance recoveries for each of the last three years (in
thousands):
Premium Written :
Direct
Assumed
Ceded
Premium Earned:
Direct
Assumed
Ceded
Reinsurance recoveries
2014
2013
2012
$
$
$
$
$
473,233 $
(15)
(148,866)
324,352 $
461,367 $
327
(140,477)
321,217 $
458,020 $
2,007
(99,262)
360,765 $
434,022 $
3,204
(76,685)
360,541 $
99,911 $
45,456 $
385,624
4,218
(57,353)
332,489
369,735
4,114
(54,413)
319,436
29,014
Included in reinsurance recoverable on the consolidated balance sheets are paid loss recoverables of $17.0 million and $6.1 million as of
December 31, 2014 and 2013, respectively.
We currently reinsure the following exposures on business generated by our business units:
•
Property catastrophe. Our property catastrophe reinsurance reduces the financial impact a catastrophe could have on our
commercial and personal property insurance lines. Catastrophes might include multiple claims and policyholders. Catastrophes
include hurricanes, windstorms, earthquakes, hailstorms, explosions, severe winter weather and fires. Our property catastrophe
reinsurance is excess-of-loss reinsurance, which provides us reinsurance coverage for losses in excess of an agreed-upon
amount. We utilize catastrophe models to assist in determining appropriate retention and limits to purchase. Effective July 1,
2014 the terms of our property catastrophe reinsurance are:
and
o We retain the first $3.0 million of property catastrophe losses; and
o
Our reinsurers reimburse us 100% for any loss occurrence in excess of our $3.0 million retention up to $32.0 million
for each catastrophic occurrence, subject to an aggregate limit of $64.0 million.
•
Commercial property. Our commercial property reinsurance is excess-of-loss coverage intended to reduce the financial impact a
single-event or catastrophic loss may have on our results. The terms of our commercial property reinsurance are:
o We retain the first $1.0 million of loss for each commercial property risk;
o Our reinsurers reimburse us for the next $5.0 million for each commercial property risk, and $10.0 million for all
commercial property risk involved in any one occurrence, in all cases subject to an aggregate limit of $30.0 million for
all commercial property losses occurring during the treaty period; and
o
Individual risk facultative reinsurance is purchased on any commercial property with limits above $6.0 million.
•
Commercial casualty. Our commercial casualty reinsurance is excess-of-loss coverage intended to reduce the financial impact a
single-event loss may have on our results. The terms of our commercial casualty reinsurance are:
F-25
HALLMARK FINANCIAL SERVICES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Years ended December 31, 2014, 2013, and 2012
o We retain the first $1.0 million of any commercial liability risk; and
o
Our reinsurers reimburse us for the next $5.0 million for each commercial liability risk.
•
Aviation. We purchase proportional reinsurance where we currently cede 80% of the risk to reinsurers on the aviation risks
produced in all states by our Hallmark Select business unit.
• Occupational Accident. We purchase excess-of-loss reinsurance coverage for the occupational accident insurance product
produced by our Standard Commercial P&C business unit. The terms of our occupational accident reinsurance are:
o We retain the first $1.0 million of any occupational accident risk; and
o Our reinsurers reimburse us for the next $5.0 million for each occupational accident risk up to $10.0 million for each
occurrence.
• Workers Compensation. We purchase excess of loss reinsurance specific to the workers compensation risks underwritten by our
Workers Compensation business unit. The terms of our workers compensation reinsurance are:
o We retain the first $1.0 million of each workers compensation loss; and
o Our reinsurers reimburse us 100% for the next $14.0 million for each workers compensation loss, subject to a
maximum limit of $10.0 million for any one person and an aggregate limit of $28.0 million for all workers
compensation losses.
Personal Property. Effective March 1, 2014, we purchased proportional reinsurance where we cede 80% of the risks to
reinsurers on the low value dwelling/homeowners, renters and manufactured homes coverages produced in all states by our
Personal Lines business unit. For policies written effective February 1, 2013 through February 28, 2014, we ceded 60% of these
risks to reinsurers.
Personal Auto. . Effective October 1, 2014 we purchased proportional reinsurance where we cede 50% of the risks to reinsurers
on the nonstandard automobile risks produced in certain states by our Personal Lines business unit. For policies written effective
October 1, 2013 through September 30, 2014, we ceded 90% of these risks to reinsurers.
Standard Commercial P&C. We purchase proportional reinsurance where we currently cede 100% of the risks to reinsurers on
the equipment breakdown coverage on our commercial multi-peril property and business owners risks and on the employment
practices liability coverage on certain commercial multi-peril, general liability and business owners risks.
Excess & Umbrella. We purchase proportional reinsurance where we currently retain 20% of each risk and cede the remaining
80% to reinsurers on the commercial umbrella and excess liability insurance produced by our Hallmark Select business unit.
•
•
•
•
•
Professional Liability. Effective June 1, 2014, we purchased excess of loss reinsurance on our medical professional liability risks
produced by our Hallmark Select business unit. The terms of our professional liability reinsurance are as follows:
o We retain the first $1.0 million of any professional liability risk; and
o Our reinsurers reimburse us for the next $2.0 million for each professional liability loss occurrence.
Prior to June 1, 2014, we purchased proportional reinsurance on our medical professional liability risks produced by our
Hallmark Select business unit where we retained 60% of each risk and ceded the remaining 40% to reinsurers.
•
E&S Commercial. We purchase facultative reinsurance on our commercial umbrella and excess liability risks produced by our
E&S Commercial business unit where we currently retain 10% of the first $1.0 million of risk and cede the remaining 90% to
reinsurers. We currently cede to reinsurers 100% of our commercial umbrella and excess liability risks in excess of $1.0 million.
Effective May 1, 2014, we purchased proportional reinsurance on the commercial auto liability risks produced by a program
underwriter in our E&S Commercial business unit where we retain 20% of each risk and cede the remaining 80% to reinsurers.
•
Hallmark County Mutual. HCM is used to front certain lines of business in our Specialty Commercial and Personal Segments in
Texas. In addition, HCM is used to front business produced by unaffiliated third parties. HCM does not retain any business.
F-26
HALLMARK FINANCIAL SERVICES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Years ended December 31, 2014, 2013, and 2012
8. Revolving Credit Facility and Notes Payable:
Our First Restated Credit Agreement with The Frost National Bank dated January 27, 2006, as amended to date, provides a revolving
credit facility of $15.0 million. We pay interest on the outstanding balance at our election at a rate of the prime rate or LIBOR plus
2.5%. We pay an annual fee of 0.25% of the average daily unused balance of the credit facility. We pay letter of credit fees at the rate
of 1.00% per annum. Our obligations under the revolving credit facility are secured by a security interest in the capital stock of all of
our subsidiaries, guarantees of all of our subsidiaries and the pledge of all of our non-insurance company assets. The revolving credit
facility contains covenants that, among other things, require us to maintain certain financial and operating ratios and restrict certain
distributions, transactions and organizational changes. As of December 31, 2014, we were in compliance with all of our covenants. As
of December 31, 2014 we had no outstanding borrowings under this revolving credit facility. As of December 31, 2013, the balance
on the revolving note was $1.5 million.
9. Subordinated Debt Securities:
On June 21, 2005, we entered into a trust preferred securities transaction pursuant to which we issued $30.9 million aggregate
principal amount of subordinated debt securities due in 2035. To effect the transaction, we formed Trust I as a Delaware statutory
trust. Trust I issued $30.0 million of preferred securities to investors and $0.9 million of common securities to us. Trust I used the
proceeds from these issuances to purchase the subordinated debt securities. Our Trust I subordinated debt securities bear an initial
interest rate of 7.725% until June 15, 2015, at which time interest will adjust quarterly to the three-month LIBOR rate plus 3.25
percentage points. Trust I pays dividends on its preferred securities at the same rate. Under the terms of our Trust I subordinated
debt securities, we pay interest only each quarter and the principal of the note at maturity. The subordinated debt securities are
uncollaterized and do not require maintenance of minimum financial covenants. As of December 31, 2014, the balance of our Trust I
subordinated debt was $30.9 million.
On August 23, 2007, we entered into a trust preferred securities transaction pursuant to which we issued $25.8 million aggregate
principal amount of subordinated debt securities due in 2037. To effect the transaction, we formed Trust II as a Delaware statutory
trust. Trust II issued $25.0 million of preferred securities to investors and $0.8 million of common securities to us. Trust II used the
proceeds from these issuances to purchase the subordinated debt securities. Our Trust II subordinated debt securities bear an initial
interest rate of 8.28% until September 15, 2017, at which time interest will adjust quarterly to the three-month LIBOR rate plus 2.90
percentage points. Trust II pays dividends on its preferred securities at the same rate. Under the terms of our Trust II subordinated
debt securities, we pay interest only each quarter and the principal of the note at maturity. The subordinated debt securities are
uncollaterized and do not require maintenance of minimum financial covenants. As of December 31, 2014, the balance of our Trust II
subordinated debt was $25.8 million.
10. Segment Information:
We pursue our business activities primarily through subsidiaries whose operations are organized into producing units and are
supported by our insurance carrier subsidiaries. Our non-carrier insurance activities are organized by business units into the following
reportable segments:
•
•
Standard Commercial Segment. The Standard Commercial Segment
lines commercial
property/casualty and occupational accident insurance products and services handled by our Standard Commercial P&C
business unit and the workers compensation insurance products handled by our Workers Compensation business unit. Our
Standard Commercial P&C business unit is comprised of our American Hallmark Insurance Services and ECM subsidiaries.
Our Workers Compensation business unit is comprised of our TBIC Holdings, TBIC and TBICRM subsidiaries.
includes the standard
Specialty Commercial Segment. The Specialty Commercial Segment includes the excess and surplus lines commercial
property/casualty insurance products and services handled by our E&S Commercial business unit and the general aviation,
commercial umbrella and excess liability, medical professional liability and satellite launch insurance products and services
handled by our Hallmark Select business unit, as well as certain Specialty Programs which are managed at the parent level.
Our E&S Commercial business unit is comprised of our HSU, PAAC and TGASRI subsidiaries. Our Hallmark Select business
F-27
HALLMARK FINANCIAL SERVICES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Years ended December 31, 2014, 2013, and 2012
unit is comprised of our Aerospace Insurance Managers, ASRI, ACMG, HXS and HDS subsidiaries.
•
Personal Segment. The Personal Segment includes the non-standard personal automobile and renters insurance products
and services handled by our Personal Lines business unit which is comprised of American Hallmark General Agency, Inc.
and Hallmark Claims Services, Inc., both of which do business as Hallmark Insurance Company. During the fourth quarter
of 2014, our Personal Lines business unit discontinued the low value dwelling/homeowner’s and manufactured homes
insurance products it previously offered.
The retained premium produced by these reportable segments is supported by our AHIC, HSIC, HIC, HNIC and TBIC insurance
company subsidiaries. In addition, control and management of 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.
AHIC, HIC, HSIC and HNIC have entered into a pooling arrangement, pursuant to which AHIC retains 30% of the net premiums written
by any of them, HIC retains 27% of the net premiums written by any of them, HSIC retains 30% of the net premiums written by any of
them and HNIC retains 13% of the net premiums written by any of them. Neither HCM nor TBIC is a party to the intercompany pooling
arrangement.
F-28
HALLMARK FINANCIAL SERVICES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Years ended December 31, 2014, 2013, and 2012
The following is additional business segment information for the twelve months ended December 31, 2014, 2013 and 2012 (in thousands):
Revenues
Standard Commercial Segment
Specialty Commercial Segment
Personal Segment
Corporate
Consolidated
Depreciation and Amortization Expense
Standard Commercial Segment
Specialty Commercial Segment
Personal Segment
Corporate
Consolidated
Interest Expense
Standard Commercial Segment
Specialty Commercial Segment
Personal Segment
Corporate
Consolidated
Tax Expense (Benefit)
Standard Commercial Segment
Specialty Commercial Segment
Personal Segment
Corporate
Consolidated
Pre-tax Income (Loss), net of non-controlling interest
Standard Commercial Segment
Specialty Commercial Segment
Personal Segment
Corporate
Consolidated
2014
2013
2012
81,464 $
241,920
20,404
(6,422)
337,366 $
83,306 $
229,734
71,081
5,307
389,428 $
73,119
178,917
89,149
615
341,800
183 $
2,503
515
23
3,224 $
- $
-
-
4,576
4,576 $
622 $
9,690
(574)
(4,385)
5,353 $
201 $
2,896
1,111
92
4,300 $
- $
-
-
4,599
4,599 $
312 $
3,613
(398)
(692)
2,835 $
186
2,892
1,230
113
4,421
-
-
-
4,634
4,634
372
1,875
(968)
(1,753)
(474)
4,595 $
34,237
1,226
(21,276)
18,782 $
1,980 $
19,527
(3,416)
(7,011)
11,080 $
(2,486)
25,932
(8,535)
(11,861)
3,050
$
$
$
$
$
$
$
$
$
$
F-29
HALLMARK FINANCIAL SERVICES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Years ended December 31, 2014, 2013, and 2012
The following is additional business segment information as of the following dates (in thousands):
Assets
Standard Commercial Segment
Specialty Commercial Segment
Personal Segment
Corporate
Consolidated
11. Earnings Per Share:
December 31
2014
2013
$
$
145,355 $
590,852
222,183
22,479
980,869 $
142,143
536,894
210,825
19,161
909,023
We have adopted the provisions of ASC 260, “Earnings Per Share,” requiring presentation of both basic and diluted earnings per
share. A reconciliation of the numerators and denominators of the basic and diluted per share calculations is presented below (in
thousands, except per share amounts):
Numerator for both basic and diluted earnings per share:
Net income attributable to Hallmark Financial Services, Inc.
$
13,429 $
8,245 $
3,524
2014
2013
2012
Denominator, basic shares
Effect of dilutive securities:
Stock-based compensation awards
Denominator, diluted shares
Basic earnings per share:
Diluted earnings per share:
19,197
19,263
19,263
169
19,366
98
19,361
6
19,269
$
$
0.70 $
0.69 $
0.43 $
0.18
0.43 $
0.18
We had 544,999 shares, 779,999 shares and 794,999 shares of common stock potentially issuable upon exercise of employee stock
options for years ended December 31, 2014, 2013 and 2012, respectively, that were excluded from the weighted average number of
shares outstanding on a diluted basis because the effect of such options would be anti-dilutive. These instruments expire at varying
times from 2016 to 2021.
F-30
HALLMARK FINANCIAL SERVICES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Years ended December 31, 2014, 2013, and 2012
12. Regulatory Capital Restrictions:
Hallmark, as a holding company, is dependent on dividend payments and management fees from its subsidiaries to fund its operating
expenses, debt obligations and capital needs, including the ability to pay dividends to its stockholders. Hallmark has never paid
dividends on its common stock. Hallmark intends to continue this policy for the foreseeable future in order to retain earnings for
development of its business. There are no regulatory or contractual restrictions on the ability of Hallmark to pay dividends other than
customary default provisions and the impact of any dividend payment on financial ratio covenants in certain credit agreements.
However, there are restrictions on the ability of Hallmark’s insurance carrier subsidiaries to transfer funds to the holding company.
The amount of retained earnings that is unrestricted for the payment of dividends by Hallmark to its shareholders was $32.5 million
as of December 31, 2014.
AHIC and TBIC, domiciled in Texas, are limited in the payment of dividends to their stockholders in any 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. 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 net investment 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. For all our insurance companies, dividends may only be paid from
unassigned surplus funds. During 2015, the aggregate ordinary dividend capacity of these subsidiaries is $24.3 million, of which $16.2
million is available to Hallmark. As a county mutual, dividends from HCM are payable to policyholders. During the year ended
December 31, 2014, our insurance company subsidiaries paid $8.0 million in dividends to Hallmark. None of our insurance company
subsidiaries paid a dividend during the year ended December 31, 2013. The total restricted net assets of our insurance company
subsidiaries as of December 31, 2014, was approximately $219.5 million.
The state insurance departments also regulate financial transactions between our insurance subsidiaries and their affiliated
companies. Applicable regulations require approval of management fees, expense sharing contracts and similar transactions. The net
amount paid in management fees by our insurance subsidiaries to Hallmark and our non-insurance company subsidiaries was $1.1
million, $8.2 million and $9.0 million during each of 2014, 2013 and 2012, respectively.
Statutory capital and surplus is calculated as statutory assets less statutory liabilities. The various state insurance departments that
regulate our insurance company subsidiaries require us to maintain a minimum statutory capital and surplus. As of December 31,
2014 and 2013, our insurance company subsidiaries reported statutory capital and surplus of $210.0 million and $196.3 million,
respectively, substantially greater than the minimum requirements for each state. For the years ended December 31, 2014, 2013,
2012, respectively, our insurance company subsidiaries reported statutory net income of $22.3 million, $6.1 million and $3.1 million,
respectively.
The National Association of Insurance Commissioners requires property/casualty insurers to file a risk-based capital calculation
according to a specified formula. The purpose of the formula is twofold: (1) to assess the adequacy of an insurer’s statutory capital
and surplus based upon a variety of factors such as potential risks related to investment portfolio, ceded reinsurance and product
mix; and (2) to assist state regulators under the RBC for Insurers Model Act by providing thresholds at which a state commissioner is
authorized and expected to take regulatory action. As of December 31, 2014, the adjusted capital under the risk-based capital
calculation of each of our insurance company subsidiaries substantially exceeded the minimum requirements.
F-31
HALLMARK FINANCIAL SERVICES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Years ended December 31, 2014, 2013, and 2012
13. 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. There are 2,000,000 shares authorized for issuance under the 2005 LTIP.
As of December 31, 2014, there were outstanding incentive stock options to purchase 757,977 shares of our common stock, non-
qualified stock options to purchase 304,157 shares of our common stock and restricted stock units representing the right to receive
up to 427,824 shares of our common stock. There are 358,850 shares reserved for future issuance under the 2005 LTIP. 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.
Stock Options:
Incentive stock options granted under the 2005 LTIP prior to 2009 vest 10%, 20%, 30% and 40% on the first, second, third and fourth
anniversary dates of the grant, respectively, and terminate five to ten years from the date of grant. Incentive stock options granted in
2009 and one grant of 5,000 incentive stock options in 2011 vest in equal annual increments on each of the first seven anniversary
dates and terminate ten years from the date of grant. One grant of 25,000 incentive stock options in 2010 vests in equal annual
increments on each of the first three anniversary dates and terminates ten years from the date of grant. Non-qualified stock options
granted under the 2005 LTIP generally vest 100% six months after the date of grant and terminate ten years from the date of grant.
One grant of 200,000 non-qualified stock options in 2009 vests in equal annual increments on each of the first seven anniversary
dates and terminates ten years from the date of grant.
A summary of the status of our stock options as of December 31, 2014 and changes during the year then ended is presented below:
Outstanding at January 1, 2014
Granted
Exercised
Forfeited or expired
Outstanding at December 31, 2014
Exercisable at December 31, 2014
Number of Shares
Weighted Average
Exercise Price
Remaining
Contractual Term
(Years)
Aggregate
Instrinsic Value
($000)
1,387,489 $
-
(135,359) $
(189,996) $
1,062,134 $
948,561 $
9.66
8.53
11.29
9.51
9.85
3.3 $
3.2 $
2,877
2,260
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):
Intrinsic value of options exercised
Cost of share-based payments (non-cash)
Income tax benefit of share-based payments recognized in income
2014
2013
2012
$
$
$
412 $
173 $
30 $
- $
207 $
30 $
-
380
38
As of December 31, 2014, there was $0.2 million of total unrecognized compensation cost related to non-vested stock options
granted under our plans, of which $0.2 million is expected to be recognized in 2015, $44 thousand is expected to be recognized in
2016 and $3 thousand is expected to be recognized in 2017.
F-32
HALLMARK FINANCIAL SERVICES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Years ended December 31, 2014, 2013, and 2012
The fair value of each stock option granted is estimated on the date of grant using the Black-Scholes option pricing model. Expected
volatilities are based on the historical volatility of Hallmark’s and similar companies’ common stock for a period equal to the expected
term. The risk-free interest rates for periods within the contractual term of the options are based on rates for U.S. Treasury Notes
with maturity dates corresponding to the options’ expected lives on the dates of grant. Expected term is determined based on the
simplified method as we do not have sufficient historical exercise data to provide a basis for estimating the expected term. There
were no stock options granted in 2014, 2013 or 2012.
Restricted Stock Units:
The 2005 LTIP was amended by the stockholders on May 30, 2013 to authorize the grant of restricted stock units, in addition to the
other types of awards available thereunder. Restricted stock units represent the right to receive shares of common stock upon the
satisfaction of vesting requirements, performance criteria and other terms and conditions. On July 27, 2012 and April 10, 2013, an
aggregate of 129,463 and 122,823 restricted stock units, respectively, were conditionally granted to certain employees of the
Company subject to shareholder approval of the amendments to the 2005 LTIP at the May 30, 2013 shareholder meeting. One
conditional grant of 9,280 restricted stock units was forfeited prior to approval at the shareholder meeting. Subsequently on
September 8, 2014, an aggregate of 175,983 restricted stock units were granted to certain employees.
The performance criteria for all restricted stock units require that the Company achieve certain compound average annual growth
rates in book value per share 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. In addition, certain restricted stock units contain an additional performance
criteria related to the attainment of an average combined ratio percentage over the vesting period. If and to the extent specified
performance criteria have been achieved, the restricted stock units granted on July 27, 2012 will vest on March 31, 2015, the
restricted stock units granted on April 10, 2013 vest on March 31, 2016, the restricted stock units granted on September 8, 2014
(except for one grant) vest on March 31, 2017 and one grant of restricted stock units granted on September 8, 2014 vests on March
31, 2018. Grantees of restricted stock units do not have any rights of a stockholder of the Company, and do not participate in any
distributions to common stockholders of the Company, until the award fully vests upon satisfaction of the vesting schedule,
performance criteria and other conditions set forth in the agreement. Therefore, the unvested restricted stock units do not contain
nonforfeitable rights to dividend equivalent payments and are not considered participating securities for the purposes of ASC 260,
“Earnings Per Share.”
Compensation cost is measured as an amount equal to the fair value of the restricted stock units 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 the
Company’s best estimate of the ultimate achievement level. The grant date fair value of the restricted stock units granted in 2012
and 2013 is $9.20 per unit. The grant date fair value of the restricted stock units granted in 2014 is $9.66 per unit. The Company
incurred compensation expense of $49 thousand and $145 thousand related to the restricted stock units during the year ended
December 31, 2014 and 2013, respectively. The Company recorded an income tax benefit of $17 thousand and $51 thousand related
to the restricted stock units during the year ended December 31, 2014 and 2013, respectively.
A summary of the status of our restricted stock units as of December 31, 2014 and changes during the year then ended is presented
below:
Nonvested at January 1, 2014
Granted
Vested
Forfeited
Nonvested at December 31, 2014
F-33
Number of Restricted
Stock Units
236,851
175,983
-
(127,618)
285,216
HALLMARK FINANCIAL SERVICES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Years ended December 31, 2014, 2013, and 2012
As of December 31, 2014, there was $0.9 million of total unrecognized compensation cost related to non-vested restricted stock
units granted under our 2005 LTIP, of which $0.4 million is expected to be recognized in 2015, $0.3 million is expected to be
recognized in 2016, $0.2 million is expected to be recognized in 2017 and $32 thousand is expected to be recognized in 2018.
14. Retirement Plans:
Certain employees of the Standard Commercial Segment were participants in a defined cash balance plan covering all full-time
employees who had completed at least 1,000 hours of service. This plan was frozen in March 2001 in anticipation of distribution of
plan assets to members upon plan termination. All participants were vested when the plan was frozen.
The following tables provide detail of the changes in benefit obligations, components of benefit costs, weighted-average assumptions,
and plan assets for the retirement plan as of and for the twelve months ending December 31, 2014, 2013 and 2012 (in thousands)
using a measurement date of December 31.
F-34
HALLMARK FINANCIAL SERVICES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Years ended December 31, 2014, 2013, and 2012
Assumptions (end of period):
Discount rate used in determining benefit obligation
Rate of compensation increase
Reconciliation of funded status (end of period):
Accumulated benefit obligation
Projected benefit obligation
Fair value of plan assets
Funded status
Net actuarial loss
Accumulated other comprehensive loss
Prepaid pension cost
Net amount recognized as of December 31
Changes in projected benefit obligation:
Benefit obligation as of beginning of period
Interest cost
Actuarial liability (gain)/loss
Benefits paid
2014
2013
2012
3.86%
N/A
4.49%
N/A
3.89%
N/A
$
$
$
$
$
(13,909) $
(12,284) $
(13,439)
(13,909) $
11,290
(2,619) $
(12,284) $
10,851
(1,433) $
(13,439)
9,754
(3,685)
(4,000)
(4,000)
1,381
(2,277)
(2,277)
844
(4,545)
(4,545)
860
(2,619) $
(1,433) $
(3,685)
12,284 $
532
1,947
(854)
13,439 $
505
(824)
(836)
12,990
564
700
(815)
Benefit obligation as of end of period
$
13,909 $
12,284 $
13,439
Change in plan assets:
Fair value of plan assets as of beginning of period
Actual return on plan assets (net of expenses)
Employer contributions
Benefits paid
Fair value of plan assets as of end of period
Net periodic pension cost:
Service cost - benefits earned during the period
Interest cost on projected benefit obligation
Expected return on plan assets
Recognized actuarial loss
Net periodic pension cost
Discount rate
Expected return on plan assets
Rate of compensation increase
$
10,851 $
760
533
(854)
9,754 $
1,565
368
(836)
$
11,290 $
10,851 $
$
- $
- $
532
(698)
162
505
(615)
495
$
(4) $
385 $
4.49%
6.50%
N/A
3.89%
6.50%
N/A
9,019
839
711
(815)
9,754
-
564
(584)
482
462
4.50%
6.50%
N/A
F-35
HALLMARK FINANCIAL SERVICES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Years ended December 31, 2014, 2013, and 2012
Estimated future benefit payments by fiscal year (in thousands):
2015
2016
2017
2018
2019
2020-2024
$
$
$
$
$
$
923
913
913
909
896
4,279
As of December 31, 2014, the fair value of the plan assets was composed of cash and cash equivalents of $0.4 million, debt securities
of $3.7 million and equity securities of $7.2 million.
Our investment objectives are to preserve capital and to achieve long-term growth through a favorable rate of return equal to or
greater than 5% over the long-term (60 year) average inflation rate as measured by the consumer price index. The objective of the
equity portion of the portfolio is to achieve a return in excess of the Standard & Poor’s 500 index. The objective of the fixed income
portion of the portfolio is to add stability, consistency, safety and total return to the total fund portfolio.
We prohibit investments in options, futures, precious metals, short sales and purchase on margin. We also restrict the investment in
fixed income securities to “A” rated or better by Moody’s or Standard & Poor’s rating services and restrict investments in common
stocks to only those that are listed and actively traded on one or more of the major United States stock exchanges, including
NASDAQ. We manage to an asset allocation of 45% to 75% in equity securities. An investment in any single stock issue is restricted to
5% of the total portfolio value and 90% of the securities held in mutual or commingled funds must meet the criteria for common
stocks.
To develop the expected long-term rate of return on assets assumption, we consider the historical returns and the future
expectations for returns for each asset class, as well as the target asset allocation of the pension portfolio. This resulted in the
selection of the 6.5% long-term rate of return on assets assumption. The expected return on plan assets uses the fair market value as
of December 31, 2014. To develop the discount rate used in determining the benefit obligation we used the Wells Fargo AA Pension
Discount Curve at the measurement date to match the timing and amounts of projected future benefits. A corridor approach is used
to amortize actuarial gains and losses. We are applying the 10% threshold set forth in ASC 715. In addition, since all accrued benefits
under the plan are frozen, we are amortizing the unrecognized gains and losses outside of the corridor by the average life expectancy
of the plan participants.
We are not required to make a contribution to the defined benefit cash balance plan during 2015. We expect our 2015 periodic
pension cost to be $(0.1) million, the components of which are interest cost of $0.5 million, expected return on plan assets of ($0.7)
million and amortization of actuarial loss of $0.1 million.
The following table shows the weighted-average asset allocation for the defined benefit cash balance plan held as of December 31,
2014 and 2013.
Asset Category:
Debt securities
Equity securities
Other
Total
F-36
December 31
2014
2013
33%
64%
3%
100%
32%
65%
3%
100%
HALLMARK FINANCIAL SERVICES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Years ended December 31, 2014, 2013, and 2012
Effective January 1, 2008, we determine the fair value of our financial instruments based on the fair value hierarchy established in
ASC 820. (See Note 3.)
The following table presents, for each of the fair value hierarchy levels, our plan assets that are measured at fair value on a recurring
basis at December 31, 2014 and December 31, 2013 (in thousands).
As of December 31, 2014
Debt securities
Equity securities
Total
Quoted Prices in Active
Markets for Identical
Assets (Level 1)
Other Observable
Inputs
(Level 2)
Unobservable Inputs
(Level 3)
$
$
- $
7,230
7,230 $
3,718 $
-
3,718 $
- $
-
- $
Total
3,718
7,230
10,948
As of December 31, 2013
Quoted Prices in Active
Markets for Identical
Assets (Level 1)
Other Observable
Inputs (Level 2)
Unobservable Inputs
(Level 3)
Debt securities
Equity securities
Total
$
$
- $
7,080
7,080 $
3,448 $
-
3,448 $
Total
3,448
7,080
10,528
- $
-
- $
Our plan assets also include cash and cash equivalents of $0.4 million and $0.3 million at December 31, 2014 and 2013, respectively,
and are carried at cost which approximates fair value.
We sponsor two defined contribution plans. Under these plans, employees may contribute a portion of their compensation on a tax-
deferred basis, and we may contribute a discretionary amount each year. We contributed $0.3 million, $0.3 million and $0.1 million
for the years ended December 31, 2014, 2013 and 2012, respectively.
F-37
HALLMARK FINANCIAL SERVICES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Years ended December 31, 2014, 2013, and 2012
15.
Income Taxes:
The composition of deferred tax assets and liabilities and the related tax effects as of December 31, 2014 and 2013, are as
follows (in thousands):
Deferred tax liabilities:
Deferred policy acquisition costs
Net unrealized holding gain on investments
Agency relationship
Intangible assets
Goodwill
Fixed assets
Other
Total deferred tax liabilities
Deferred tax assets:
Unearned premiums
Alternative minimum tax
Amortization of non-compete agreements
Pension liability
Net operating loss carry-forward
Unpaid loss and loss adjustment expense
Rent reserve
Reinsurance payable
Bonus accrual
Investment impairments
Other
Total deferred tax assets
2014
2013
$
(7,261) $
(10,886)
(75)
(5,613)
(479)
(432)
(133)
(24,879)
10,042
-
357
1,400
518
6,871
355
387
809
625
423
21,787
(7,905)
(9,730)
(85)
(6,129)
(325)
(499)
(263)
(24,936)
9,822
442
417
797
611
8,173
366
238
215
660
370
22,111
Deferred federal income taxes, net
$
(3,092) $
(2,825)
A reconciliation of the income tax provisions based on the statutory tax rate to the provision reflected in the consolidated
financial statements for the years ended December 31, 2014, 2013 and 2012, is as follows (in thousands):
Computed expected income tax expense at statutory regulatory tax rate
Meals and entertainment
Tax exempt interest
Dividends received deduction
State taxes (net of federal benefit)
Other
Income tax expense (benefit)
Current income tax expense
Deferred tax benefit
Income tax expense (benefit)
2014
2013
2012
$
$
$
$
6,574 $
27
(1,276)
(107)
259
(124)
5,353 $
5,746 $
(393)
5,353 $
3,878 $
25
(1,314)
(101)
276
71
2,835 $
3,092 $
(257)
2,835 $
1,181
28
(1,631)
(111)
298
(239)
(474)
2,377
(2,851)
(474)
F-38
HALLMARK FINANCIAL SERVICES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Years ended December 31, 2014, 2013, and 2012
We have available, for federal income tax purposes, unused net operating loss of approximately $1.5 million at December 31,
2014. The losses were acquired as part of the HIC and HCM acquisitions and may be used to offset future taxable income.
Utilization of the losses is limited under Internal Revenue Code Section 382. The Internal Revenue Code provides that effective
with tax years beginning September 1997, the carry-back and carry-forward periods are 2 years and 20 years, respectively, with
respect to newly generated operating losses. The net operating losses will expire if unused, as follows (in thousands):
Year
2021
2022
2028
2029
2031
2032
2033
2034
$
$
325
878
2
25
45
77
73
56
1,481
We are no longer subject to U.S. federal, state, local or non-U.S. income tax examinations by tax authorities for years prior to
2011. The Company recognizes interest and penalties related to uncertain tax positions in income tax expense. There were no
uncertain tax positions at December 31, 2014.
F-39
HALLMARK FINANCIAL SERVICES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Years ended December 31, 2014, 2013, and 2012
16.
Commitments and Contingencies:
We have several leases, primarily for office facilities and computer equipment, which expire in various years through 2022.
Certain of these leases contain renewal options. Rental expense amounted to $2.3 million, $2.2 million and $2.3 million for the
years ended December 31, 2014, 2013, and 2012, respectively.
Future minimum lease payments under non-cancelable operating leases as of December 31, 2014 are as follows (in thousands):
Year
2015
2016
2017
2018
2019
2020 and thereafter
Total minimum lease payments
$
$
1,922
1,887
1,772
1,494
1,433
2,432
10,940
From time to time, assessments are levied on us by the guaranty association of the states where we offer our insurance products.
Such assessments are made primarily to cover the losses of policyholders of insolvent or rehabilitated insurers. Since these
assessments can generally be recovered through a reduction in future premium taxes paid, we capitalize the assessments that can
be recovered as they are paid and amortize the capitalized balance against our premium tax expense. We did not receive an
assessment during 2014. We paid an assessment of $29 thousand in 2013.
We are engaged in legal proceedings in the ordinary course of business, none of which, either individually or in the aggregate, are
believed likely to have a material adverse effect on our consolidated financial position or results of operations, in the opinion of
management. The various legal proceedings to which we are a party are routine in nature and incidental to our business.
F-40
HALLMARK FINANCIAL SERVICES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Years ended December 31, 2014, 2013, and 2012
17.
Changes in Accumulated Other Comprehensive Income Balances:
The changes in accumulated other comprehensive income balances as of December 31, 2014, 2013, and 2012 were as follows (in
thousands):
Pension
Liability
Unrealized
Gains (Loss)
Accumulated Other
Comprehensive
Income (Loss)
Balance at January 1, 2012
Other comprehensive income:
Change in net actuarial gain
Tax effect on change in net actuarial gain
Unrealized holding gains arising during the period
Tax effect on unrealized gains arising during the period
Reclassification adjustment for gains included in net realized gains
Tax effect on reclassification adjustment for gains included in income tax
expense
Other comprehensive income, net of tax
$
(2,978) $
9,424 $
37
(13)
-
-
-
-
4,388
(1,536)
-
(2,189)
-
24
766
1,429
Balance at December 31, 2012
Other comprehensive income:
Change in net actuarial gain
Tax effect on change in net actuarial gain
Unrealized holding gains arising during the period
Tax effect on unrealized gains arising during the period
$
(2,954) $
10,853 $
2,268
(794)
-
-
-
-
22,094
(7,733)
6,446
37
(13)
4,388
(1,536)
(2,189)
766
1,453
7,899
2,268
(794)
22,094
(7,733)
Reclassification adjustment for gains included in net realized gains
Tax effect on reclassification adjustment for gains included in income tax
expense
Other comprehensive income, net of tax
Balance at December 31, 2013
Other comprehensive income:
Change in net actuarial gain
Tax effect on change in net actuarial gain
Unrealized holding gains arising during the period
Tax effect on unrealized gains arising during the period
Reclassification adjustment for gains included in net realized gains
Tax effect on reclassification adjustment for gains included in income tax
expense
Other comprehensive income, net of tax
-
(10,540)
(10,540)
-
1,474
3,689
7,510
$
(1,480) $
18,363 $
(1,723)
603
-
-
-
-
(1,120)
-
-
3,543
(1,240)
(408)
143
2,038
3,689
8,984
16,883
(1,723)
603
3,543
(1,240)
(408)
143
918
Balance at December 31, 2014
$
(2,600) $
20,401 $
17,801
F-41
HALLMARK FINANCIAL SERVICES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Years ended December 31, 2014, 2013, and 2012
18.
Concentrations of Credit Risk:
We maintain cash and cash equivalents in accounts with seven financial institutions in excess of the amount insured by the
Federal Deposit Insurance Corporation. We monitor the financial stability of the depository institutions regularly and do not
believe excessive risk of depository institution failure existed at December 31, 2014.
We are also subject to credit risk with respect to reinsurers to whom we have ceded underwriting risk. Although a reinsurer is
liable for losses to the extent of the coverage it assumes, we remain obligated to our policyholders in the event that the
reinsurers do not meet their obligations under the reinsurance agreements. In order to mitigate credit risk to reinsurance
companies, we monitor the financial condition of reinsurers on an ongoing basis and review our reinsurance arrangements
periodically. Most of our reinsurance recoverable balances as of December 31, 2014 were with reinsurers that had an A.M. Best
rating of “A-” or better. We also mitigate our credit risk for the remaining reinsurance recoverable by obtaining letters of credit.
19.
Unaudited Selected Financial Quarterly Information:
Following is a summary of the unaudited interim results of operations for the years ended December 31, 2014 and 2013 (in
thousands, except per share data). In the opinion of management, all adjustments necessary to present fairly the results of
operations for such periods have been made.
2014
2013
Total revenue
Total expense
Income (loss) before tax
Income tax expense (benefit)
Net income (loss)
Q1
87,109 $
Q2
80,836 $
Q3
81,417 $ 88,004 $
Q4
Q1
93,141 $
$
Q2
99,299 $ 108,613 $
Q3
Q4
80,697
6,412
1,864
4,548
$
78,794
2,042
391
1,651 $
76,689
4,728
1,265
3,463
82,404
5,600
1,833
3,767 $
90,978
2,163
469
1,694 $
104,616
(5,317)
(2,166)
(3,151) $
99,141
9,472
3,198
6,274 $
88,375
83,613
4,762
1,334
3,428
Basic earnings (loss) per share:
$
0.24 $
0.09 $
0.18 $
0.20 $
0.09 $
(0.16) $
0.33 $
0.18
Diluted earnings (loss) per share:
$
0.23 $
0.09 $
0.18 $
0.19 $
0.09 $
(0.16) $
0.32 $
0.18
F-42
Schedule II – Condensed Financial Information of Registrant (Parent Company Only)
FINANCIAL STATEMENT SCHEDULES
HALLMARK FINANCIAL SERVICES, INC.
BALANCE SHEETS
December 31, 2014 and 2013
(In thousands)
ASSETS
Cash and cash equivalents
Investment in subsidiaries
Deferred federal income taxes
Other assets
2014
2013
$
11,839 $
325,608
747
4,061
8,063
316,295
930
3,729
$
342,255 $
329,017
LIABILITIES AND STOCKHOLDERS’ EQUITY
Liabilities:
Revolving credit facility payable
Subordinated debt securities
Current federal income tax payable
Accounts payable and other accrued expenses
$
Stockholders’ equity:
Common stock, $.18 par value, authorized 33,333,333 shares; issued 20,872,831 shares in
2014 and in 2013
Capital in excess of par value
Retained earnings
Accumulated other comprehensive income
Treasury stock (1,655,306 shares in 2014 and 1,609,374 in 2013), at cost
Total stockholders’ equity
Total liabilities and stockholders’ equity
- $
56,702
64
33,452
90,218
3,757
123,194
119,638
17,801
(12,353)
252,037
1,473
56,702
3,353
29,371
90,899
3,757
122,827
106,209
16,883
(11,558)
238,118
$
342,255 $
329,017
See accompanying report of independent registered public accounting firm.
F-43
Schedule II (Continued) – Condensed Financial Information of Registrant (Parent Company Only)
HALLMARK FINANCIAL SERVICES, INC.
STATEMENTS OF OPERATIONS
For the years ended December 31, 2014, 2013 and 2012
(In thousands)
Investment income (loss), net of expenses
$
133 $
(190) $
2014
2013
2012
Dividend income from subsidiaries
Management fee income
Operating expenses
Interest expense
Amortization of intangible assets
8,000
9,614
17,747
9,759
4,576
-
-
8,518
8,328
7,764
4,599
-
(181)
-
8,485
8,304
8,079
4,634
17
Income (loss) before equity in undistributed earnings (loss) of subsidiaries
and income tax benefit
Income tax benefit
14,335
12,363
12,730
3,412
(4,035)
(1,623)
(1,227)
(4,426)
(1,627)
Income (loss) before equity in undistributed earnings of subsidiaries
5,035
(2,808)
(2,799)
Equity in undistributed share of earnings in subsidiaries
8,394
11,053
6,323
Net income
Comprehensive income
$
$
13,429 $
8,245 $
3,524
14,347 $
17,229 $
4,977
See accompanying report of independent registered public accounting firm.
F-44
Schedule II (Continued) – Condensed Financial Information of Registrant (Parent Company Only)
FINANCIAL STATEMENT SCHEDULES
HALLMARK FINANCIAL SERVICES, INC.
STATEMENTS OF CASH FLOWS
For the years ended December 31, 2014, 2013 and 2012
(In thousands)
Cash flows from operating activities:
Net income
2014
2013
2012
$
13,429 $
8,245 $
3,524
Adjustments to reconcile net income to cash provided by operating activities:
Depreciation and amortization expense
Deferred income tax expense (benefit)
Undistributed share of earnings of subsidiaries
Change in current federal income tax (recoverable)payable
Change in all other liabilities
Change in all other assets
Net cash provided by operating activities
Cash flows from investing activities:
Purchases of property and equipment, net
Net cash used in investing activities
Cash flows from financing activities:
Proceeds from exercise of employee stock options
Purchase of treasury shares
Activity under revolving credit facility, net
Net cash used in financing activities
Increase (decrease) in cash and cash equivalents
Cash and cash equivalents at beginning of year
68
183
(8,394)
(3,290)
4,081
(131)
5,946
(47)
(47)
1,155
(1,805)
(1,473)
(2,123)
3,776
8,063
92
1,182
(11,053)
(3,694)
12,232
63
7,067
(116)
(116)
-
-
-
-
6,951
1,112
113
(1,725)
(6,323)
4,030
357
450
426
(46)
(46)
-
-
(2,577)
(2,577)
(2,197)
3,309
Cash and cash equivalents at end of year
$
11,839 $
8,063 $
1,112
Supplemental cash flow information:
Interest paid
Income taxes (paid) recovered
$
$
(4,576) $
(4,599) $
(4,656)
(1,481) $
(1,285) $
3,932
See accompanying report of independent registered public accounting firm.
F-45
Schedule III - Supplementary Insurance Information
(In thousands)
Column A
Segment
2014
Column B
Column C
Column D Column E Column F Column G Column H
Column I
Column J Column K
Deferred
Policy
Acquisition
Costs
Future Policy
Benefits, Losses,
Claims, and Loss
Adjustment
Expenses
Other
Policy
Claims and
Benefits
Payable
Unearned
Premiums
Premium
Revenue
Net
Investment
Income
Benefits,
Claims,
Losses and
Settlement
Expenses
Amortization
of Deferred
Policy
Acquisition
Costs
Other
Operating
Expenses
Net
Premiums
Written
Personal Segment
$
729 $
29,595 $
15,483 $
- $
14,083 $
1,633 $
8,964 $
9,315 $
9,977 $
16,802
Standard Commercial Segment
Specialty Commercial Segment
Corporate
Consolidated
2013
5,892
14,125
-
109,672
34,822
275,868
146,521
-
-
-
-
-
78,311
4,663
51,130
3,389
25,479
76,912
228,823
12,643
149,961
28,186
53,851
230,638
-
(6,556)
-
-
10,279
-
$
20,746 $
415,135 $
196,826 $
- $
321,217 $
12,383 $
210,055 $
40,890 $
99,586 $
324,352
Personal Segment
$
660 $
38,294 $
17,989 $
- $
63,800 $
2,065 $
52,656 $
17,759 $
16,957 $
45,644
Standard Commercial Segment
Specialty Commercial Segment
Corporate
Consolidated
2012
6,124
15,802
-
111,473
36,309
232,873
131,005
-
-
-
-
-
78,176
5,031
56,143
8,254
25,313
79,466
218,565
11,021
152,546
31,264
56,974
235,655
-
(5,233)
-
-
7,720
-
$
22,586 $
382,640 $
185,303 $
- $
360,541 $
12,884 $
261,345 $
57,277 $
106,964 $
360,765
Personal Segment
$
4,952 $
40,387 $
21,125 $
- $
81,451 $
2,449 $
69,606 $
17,250 $
26,413 $
76,345
Standard Commercial Segment
Specialty Commercial Segment
Corporate
Consolidated
5,968
13,991
-
103,610
35,073
169,419
106,304
-
-
-
-
-
69,155
4,925
52,828
10,825
22,742
70,091
168,830
9,435
103,980
31,730
49,170
186,053
-
(1,516)
-
-
7,825
-
$
24,911 $
313,416 $
162,502 $
- $
319,436 $
15,293 $
226,414 $
59,805 $
106,150 $
332,489
See accompanying report of independent registered public accounting firm.
F-46
Schedule IV – Reinsurance
(In thousands)
Year Ended December 31, 2014
Life insurance in force
Premiums
Life insurance
Accident and health insurance
Property and liability insurance
Title Insurance
Total premiums
Year Ended December 31, 2013
Life insurance in force
Premiums
Life insurance
Accident and health insurance
Property and liability insurance
Title Insurance
Total premiums
Year Ended December 31, 2012
Life insurance in force
Premiums
Life insurance
Accident and health insurance
Property and liability insurance
Title Insurance
Total premiums
FINANCIAL STATEMENT SCHEDULES
Column B Gross
Amount
Column C Ceded to
Other Companies
Column D Assumed
from Other
Companies
Column E Net
Amount
Column F
Percentage of
Amount Assumed
to Net
$
$
$
$
$
$
$
$
$
- $
- $
- $
-
- $
-
461,367
-
461,367 $
- $
-
140,477
-
140,477 $
- $
-
327
-
327 $
-
-
321,217
-
321,217
- $
- $
- $
-
- $
-
434,022
-
434,022 $
- $
-
76,685
-
76,685 $
- $
-
3,204
-
3,204 $
-
-
360,541
-
360,541
- $
- $
- $
-
- $
-
369,735
-
369,735 $
- $
-
54,413
-
54,413 $
- $
-
4,114
-
4,114 $
-
-
319,436
-
319,436
0.10%
0.10%
0.89%
0.89%
1.29%
1.29%
See accompanying report of independent registered public accounting firm.
F-47
FINANCIAL STATEMENT SCHEDULES
Schedule VI - Supplemental Information Concerning Property-Casualty Insurance Operations
(In thousands)
Column A
Column B Column C Column D Column E Column F Column G
Column H
Column I
Column J
Column K
Deferred
Policy
Acquisition
Costs
Reserves for
Unpaid
Claims and
Claim
Adjustment
Discount if
any,
Deducted In
Column C
Unearned
Premiums
Earned
Premiums
Net
Investment
Income
Claims and Claim
Adjustment Expenses
Incurred Related to
Amortization of
Deferred Policy
Acquisitions
Costs
Paid Claims
and Claims
Adjustment
Expenses
Net
Premiums
Written
(1) Current
Year
(2) Prior
Years
Affiliation With
Registrant
(a) Consolidated
property-casualty
Entities
2014
2013
2012
$
$
$
20,746 $
22,586 $
24,911 $
415,135 $
382,640 $
313,416 $
- $
- $
- $
196,826 $
185,303 $
162,502 $
321,217 $
360,541 $
319,436 $
12,383 $
12,884 $
15,293 $
215,258 $
251,391 $
230,089 $
(5,203) $
9,954 $
(3,675) $
40,890 $
57,277 $
59,805 $
199,331 $
212,709 $
217,483 $
324,352
360,765
332,489
See accompanying report of independent registered public accounting firm.
F-48
(This page intentionally left blank.)
Corporate Information
BoarD oF Directors
Mark E. Schwarz
executive chairman
Scott T. Berlin
managing Director,
Brown, Gibbons, lang & company
James H. Graves
partner, erwin, Graves & associates, lp
Jim W. Henderson
Chairman & Chief Executive Officer
assuredpartners, inc.
manaGement team
Mark E. Schwarz
executive chairman
Naveen Anand
President & Chief Executive Officer
Kevin T. Kasitz
executive vice president &
president of standard commercial
Jeffrey R. Passmore
senior vice president &
Chief Accounting Officer
Donald E. Meyer
president of e&s specialty
James A. Damonte
president of primary & excess casualty,
professional liability & aviation
Michael P. Binns
president of personal lines
inDepenDent reGistereD puBlic
accountants
Ernst & Young LLP
425 Houston street
suite 600
Ft. Worth, texas 76102
stock sYmBol
Hallmark Financial services, inc.
common stock is listed on the
nasDaQ Global market under
the symbol “HALL.”
transFer aGent
Securities Transfer Corporation
2591 Dallas parkway
suite 102
Frisco, texas 75034
(469) 633-0101
leGal counsel
McGuire, Craddock & Strother, P.C.
2501 n. Harwood
suite 1800,
Dallas, texas 75201
stockHolDer meetinG
the annual meeting of stockholders will be
held at 10:00 a.m. cDt on may 29, 2015 in the
training center on the concourse level at 777
main street, Ft. Worth, texas 76102.
corporate HeaDQuarters
Hallmark Financial services, inc.
777 main street
suite 1000
Ft. Worth, texas 76102
(817) 348-1600
www.hallmarkgrp.com
Hallmark's Business Plan
is to operate as a diversified underwriter of niche property and casualty
insurance products. this plan is executed by wholly owned business
units, each with a separate specialty product focus.
Our Corporate Strategy
is to create a “Best-in-class” specialty insurance company focused on
under writing profitability and long-term growth of stockholders’ book
value per share. our specialty product focus and niche market strategy
enable us to develop and retain in-house underwriting expertise and spe-
cialized market knowledge, which helps differentiate Hallmark from our
competitors. each business unit tailors its products and product distribu-
tion to the unique nature of the risk and coverages they provide.
Our Financial Goal
is to earn a consistent underwriting profit and build long-term share-
holder value by focusing on profitability and operating efficiency versus
topline premium growth and market share.
)
0
0
0
$
(
E
M
O
C
N
I
T
E
N
$27,863
$24,575
$25,000
$20,000
$15,000
$13.11
$14
$12
$13,429
$10
$12,899
$10,000
$9,186
$9.191
$7,403
$8,245
$3,524
2005
2006
2007 2008 2009 2010 2011 2012
2013 2014
$5,000
$0
($5,000)
($10,000)
$8
$6
$4
$2
$0
B
O
O
K
V
A
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U
E
P
E
R
S
H
A
R
E
“
H
A
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L
”
($10,891)
Past performance is no guarantee of future performance.
annual report 2014
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777 main street, suite 1000 i Fort Worth, texas 76102 i p (817) 348-1600 i www.hallmarkgp.com