Premium Breakdown by Hallmark Business Units’ components
76%
Cash & Investments
($ in millions)
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, 2015
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):
arge accelerated filer
maller reporting company
Non‐accelerated filer
Accelerated filer
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b‐2 of the Exchange Act). Yes No
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. 19,007,727 shares of
common stock, $.18 par value per share, outstanding as of March 10, 2016.
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 subsidiaries whose
operations are organized into product‐specific operating units that are supported by our insurance company subsidiaries. Our
Standard Commercial P&C operating unit offers industry‐specific commercial insurance products and services in the standard
market. Our Workers Compensation operating unit specializes in small and middle market workers compensation business.
Effective July 1, 2015, this operating unit no longer markets or retains any risk on new or renewal policies. Our MGA
Commercial Products operating unit offers commercial insurance products and services in the excess and surplus lines market.
Our Specialty Commercial operating unit offers general aviation and satellite launch insurance products and services, low and
middle market commercial umbrella and primary/excess liability insurance, medical professional liability insurance products
and services, and primary/excess commercial property coverages for both catastrophe and non‐catastrophe exposures. Our
Specialty Personal Lines operating unit offers non‐standard personal automobile and renters insurance products and services.
Each operating 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 operating unit is
responsible for marketing, distribution, underwriting and claims management while we provide capital management,
reinsurance, actuarial, investment, financial reporting, technology and 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 operating units. We expect future growth to be derived from organic growth in the premium
production of our existing operating units and selected opportunistic acquisitions that meet our criteria.
What We Do
We market commercial and personal lines 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 operating 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 operating unit
currently markets its products through a network of 347 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 operating unit offers occupational accident coverage in Texas through an
underwriting agency that specializes in the occupational accident insurance market.
Our MGA Commercial Products operating 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
underwriting criteria of insurers operating in the standard market. Our MGA Commercial Products operating 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 MGA Commercial
Products operating unit primarily writes commercial automobile, general liability, commercial property and excess casualty.
Our MGA Commercial Products operating unit markets its products in 27 states through 9 wholesale brokers, a program
underwriter and 89 general agency offices, as well as 110 independent retail agents in Texas and Oregon.
3
Our Specialty Commercial operating 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; medical
professional liability insurance on an excess and surplus lines basis; and primary/excess commercial property coverages on an
excess and surplus lines basis for both catastrophe and non‐catastrophe exposures. The principal focus of the excess &
umbrella insurance products offered is transportation (trucking for hire and specialty automobile coverage). The Specialty
Commercial operating unit also provides excess liability coverage for small to midsize businesses in class categories such as
contracting, manufacturing, hospitality and service (non‐transportation). Typical risks range from one power unit to fleets of
up to 200 power units and up to $75M in receipts (non‐construction) or $30M in receipts (construction) from operations. Our
Specialty Commercial operating unit markets these excess & umbrella products through 132 wholesale brokers in 50 states.
The aircraft liability and hull insurance products underwritten by our Specialty Commercial operating 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 Specialty Commercial operating unit markets these general aviation
insurance products through 182 independent specialty brokers in 48 states. The satellite launch property/casualty policies
produced by our Specialty Commercial operating 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 Specialty Commercial
operating 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
Specialty Commercial operating unit markets these medical professional liability insurance products through 23 wholesale
brokers in 49 states. The primary/excess commercial property coverages underwritten by our Specialty Commercial operating
unit specializes in shared and layered accounts on a non‐admitted basis which target regional and national property programs.
Our Specialty Commercial operating unit markets these products through 60 wholesale brokers in 42 states.
Our Specialty Personal Lines operating 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 Specialty
Personal Lines operating 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 Specialty Personal Lines operating unit
discontinued the low value dwelling/homeowner’s and manufactured homes insurance products it previously offered. Our
Specialty Personal Lines operating unit markets these policies through 3,702 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 34% of the net premiums written by any of them,
HIC retains 32% of the net premiums written by any of them, HSIC retains 24% of the net premiums written by any of them
and HNIC retains 10% 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.
These operating units are segregated into three reportable industry segments for financial accounting purposes. The Standard
Commercial Segment consists of the Standard Commercial P&C operating unit and the Workers Compensation operating unit.
The Specialty Commercial Segment includes our MGA Commercial Products operating unit and Specialty Commercial
operating unit, as well as certain specialty risk programs (“Specialty Programs”) which are managed at the parent level. The
Personal Segment consists solely of our Specialty Personal Lines operating unit. The following table displays the gross
premiums written and net premiums written by these reportable segments for affiliated and unaffiliated insurers for the years
ended December 31, 2015, 2014 and 2013.
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
$
$
$
$
2015
Year Ended December 31,
2014
(dollars in thousands)
2013
81,892 $
351,050
81,281
514,223 $
71,097 $
241,775
44,072
356,944 $
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
5
Operational Structure
Our insurance company subsidiaries retain a portion of the premiums produced by our operating units. The following chart
reflects the operational structure of our organization, including the subsidiaries comprising our operating units and the
operating units included in each reportable segment as of December 31, 2015.
Standard Commercial Segment
The Standard Commercial Segment of our business includes our Standard Commercial P&C operating unit and our Workers
Compensation operating unit. During 2015, our Standard Commercial P&C operating unit accounted for 92% and our Workers
Compensation operating unit accounted for the remaining 8% of the aggregate premiums produced by the Standard
Commercial Segment.
Standard Commercial P&C operating unit. Our Standard Commercial P&C operating 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
operating 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
operating 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
operating unit offers occupational accident coverage in Texas through an underwriting agency that is a specialist in the
occupational accident insurance market. Products offered by our Standard Commercial P&C operating unit include the
following:
6
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.
insurance provides an alternative to statutory workers
compensation insurance in Texas. Coverage includes medical, short term disability and accidental death and
dismemberment.
Occupational accident
Our Standard Commercial P&C operating unit markets its property/casualty insurance products through 347 independent
agencies operating in its target markets. Our Standard Commercial P&C operating 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 operating 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 operating unit has historically maintained excellent
relationships with its producing agents, as evidenced by the 23 year average tenure of the 16 agency groups that each
produced more than $1.0 million in premium during the year ended December 31, 2015. During 2015, the top ten agency
groups produced 37%, and no individual agency group produced more than 10%, of the total premium volume of our Standard
Commercial P&C operating unit.
Our Standard Commercial P&C operating 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 operating unit also writes the
insured’s underlying general liability and commercial automobile coverage. Through December 31, 2005, our Standard
Commercial P&C operating unit marketed policies on behalf of Clarendon National Insurance Company (“Clarendon”), a third‐
party insurer. Our Standard Commercial P&C operating 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 operating unit presently markets all new and renewal policies exclusively for AHIC.
All of the commercial policies written by our Standard Commercial P&C operating 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 operating unit. Effective July 1, 2015, this operating unit no longer markets or retains any risk on new
or renewal policies. The subsidiaries comprising our Workers Compensation operating unit included TBIC Holding which has
two wholly‐owned subsidiaries, TBIC, a Texas domiciled workers compensation insurance carrier and TBICRM, which provided
risk management services to customers of TBIC. The run‐off of existing policies issued by TBIC is being administered by an
independent third party.
7
Specialty Commercial Segment
The Specialty Commercial Segment of our business includes our MGA Commercial Products operating unit and our Specialty
Commercial operating unit, as well as certain Specialty Programs which are managed at the parent level. During 2015, our
MGA Commercial Products operating unit accounted for 70% of the aggregate premiums produced by the Specialty
Commercial Segment, with our commercial umbrella and excess liability, general aviation, medical professional liability,
satellite launch and primary/excess commercial property insurance products accounting for 19%, 5%, 2%, 2% and 1%,
respectively. Our Specialty Programs accounted for the remaining 1% of the premium produced by the Specialty Commercial
Segment during 2015.
MGA Commercial Products operating unit. Our MGA Commercial Products operating unit markets, underwrites, finances and
services commercial lines insurance in 27 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 MGA Commercial Products operating 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 99% of the premium volume financed by PAAC.
Our MGA Commercial Products operating 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 2015, commercial automobile, general liability and all other property &
casualty accounted for 87%, 9% and 4%, respectively, of the premiums produced by our MGA Commercial Products operating
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 MGA Commercial Products operating 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.
Our MGA Commercial Products operating unit markets its products in 27 states through 9 wholesale brokers, a program
underwriter and 89 general agency offices, as well as 110 independent retail agents in Texas and Oregon. Our MGA
Commercial Products operating 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 2015, general agents produced 79%, the program underwriter
produced 15%, retail agents produced 3% and wholesale brokers produced 3% of total premiums produced by our MGA
Commercial Products operating unit. During 2015, the top ten general agents produced 37%, the nine wholesale brokers
produced 3% and no general agent produced more than 9%, of the total premium volume of our MGA Commercial Products
8
operating unit. During the same period, the top ten retail agents produced 2%, and no retail agent produced more than 1%, of
the total premium volume of our MGA Commercial Products operating unit.
Through 2008, all business of our MGA Commercial Products operating unit was produced under a fronting agreement with
member companies of the Republic Group (“Republic”), which granted our MGA Commercial Products operating 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 MGA Commercial Products
operating 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 MGA Commercial Products operating 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.
Specialty Commercial operating unit. Our Specialty Commercial operating 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, medical professional liability insurance
on an excess and surplus lines basis and primary/excess commercial property coverage for both catastrophe and non‐
catastrophe exposures on an excess and surplus lines basis.
The small and middle market commercial excess liability, umbrella and general liability insurance underwritten by our
Specialty Commercial operating unit is offered on an admitted and non‐admitted basis in 49 states plus the District of
Columbia. Limits of liability offered are from $1,000,000 to $5,000,000 (transportation) and $1,000,000 to $10,000,000 (non‐
transportation) 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 Specialty Commercial operating 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 Specialty Commercial operating 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 132 wholesale brokers. During 2015, the top ten wholesale brokers
accounted for 46% of our excess & umbrella and general liability premium volume, with no single wholesale broker accounting
for more than 15%. During 2015, commercial transportation excess liability risks accounted for 89% of the premiums, with the
remaining 11% coming from non‐transportation commercial excess and general liability risks. The commercial excess &
umbrella and general liability insurance products offered by our Specialty Commercial operating 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
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.
9
We generally cede 80% of the excess & umbrella and general liability risk on policies presently written by our Specialty
Commercial operating unit.
Our Specialty Commercial operating 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 Specialty Commercial operating 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 Specialty Commercial operating 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.
We presently cede 80% of the general aviation risk on policies written by our Specialty Commercial operating unit.
Our Specialty Commercial operating 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 Specialty Commercial operating unit selectively determines the risks fitting its
target niche for which it will prepare a quote. During 2015, the top ten independent specialty brokers produced 32%, and no
broker produced more than 5%, of the total general aviation premium volume of our Specialty Commercial operating unit. Our
Specialty Commercial operating 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 89% of the aircraft written in 2015
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 2015 was approximately $126,000. All general aviation policies produced by our Specialty
Commercial operating unit are written through our insurance company subsidiaries.
Our Specialty Commercial operating 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 Specialty Commercial operating unit
distributes its medical professional liability insurance products through 23 wholesale brokers in 49 states.
Our Specialty Commercial operating unit markets primary/excess commercial property coverages, on a non‐admitted basis, for
both catastrophe and non‐catastrophe exposures. Our Specialty Commercial operating unit distributes its primary/excess
commercial property insurance products through 60 wholesale brokers in 42 states. We presently cede 90% of the
primary/excess commercial property risk on policies underwritten by our insurance companies and we receive a fee on the
portion of the business written as a cover‐holder through a Lloyds Syndicate.
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 / Specialty Personal Lines operating unit
The Personal Segment of our business consists solely of our Specialty Personal Lines operating unit. Our Specialty Personal
Lines operating unit markets and services non‐standard personal automobile policies and renters insurance in 14 states.
low value
During the fourth quarter of 2014, the Specialty Personal Lines operating unit discontinued the
dwelling/homeowner’s and manufactured homes insurance products it previously offered. Our Specialty Personal Lines
operating unit provides management, policy and claims administration services to HIC and includes the operations of
10
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 Specialty Personal Lines operating unit include the
following:
Personal automobile. Personal automobile insurance is the primary product offered by our Specialty Personal
Lines operating unit. Our policies typically provide third‐party 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.
We presently cede 50% of the personal automobile risk on policies written by our Specialty Personal Lines operating unit.
Our Specialty Personal Lines operating unit markets its products through 3,702 independent retail agents operating in its
target geographic markets. Non‐standard automobile represented 98% of the premiums produced during 2015. Our Specialty
Personal Lines operating unit qualifies new agent appointments in order to establish an efficient network of independent
agents to effectively penetrate its highly competitive markets. Our Specialty Personal Lines operating unit periodically
evaluates its independent agents and discontinues the appointment of agents whose production history does not satisfy
certain standards. During 2015, the top ten independent agency groups produced 27%, and no individual agency group
produced more than 8%, of the total premium volume of our Specialty Personal Lines operating unit.
During 2015, personal automobile liability coverage accounted for 78% and personal automobile physical damage coverage
accounted for the remaining 22% of the total non‐standard automobile premiums produced by our Specialty Personal Lines
operating unit. Our most common policy term is a six month policy. We 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 Specialty Personal Lines operating 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 operating 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 Specialty Personal Lines
operating unit has a thorough understanding of the unique characteristics of the non‐standard personal
automobile market. Our Standard Commercial P&C operating unit has significant underwriting experience in its
target market for standard commercial property/casualty insurance products. In addition, our MGA Commercial
Products operating unit and Specialty Commercial operating 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 operating 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 operating 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.
11
Superior agent and customer service. We believe performing the underwriting, billing, customer service and
claims management functions at the operating 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 operating
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 operating 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 operating units have strong management teams, with an average of
more than 20 years of insurance industry experience for the heads of our operating 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 operating 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 operating units to further penetrate their existing customer
bases with additional products offered by other operating 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 long‐term growth
in book value per share.
12
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 operating 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 operating
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 Specialty Commercial operating unit, the distribution of property/casualty insurance products
by our operating units is geographically concentrated. For the twelve months ended December 31, 2015, five states accounted
for 63% 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, 2015.
Standard
Commercial
Segment
Specialty
Commercial
Segment
Personal
Segment
Total
Percent of
Total
State
Texas
Louisiana
Arizona
Oklahoma
New Mexico
All other states
$
29,741 $
‐
‐
‐
8,821
43,330
(dollars in thousands)
188,955 $
24,576
1,443
8,724
997
126,355
21,733 $
‐
20,697
9,145
7,584
22,122
Total gross premiums written
$
81,892 $
351,050 $
81,281 $
Percent of total
Underwriting
15.9%
68.3%
15.8%
46.7%
4.8%
4.3%
3.5%
3.4%
37.3%
240,429
24,576
22,140
17,869
17,402
191,807
514,223
100.0%
The underwriting process employed by our operating 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 operating 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 operating 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 operating units.
We believe that managing the underwriting process through our operating 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
operating units. At the beginning of each year, we establish a target net loss ratio for each operating 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 product structure, re‐
evaluating independent agency relationships or discontinuing unprofitable coverages or classes of risk.
13
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 net statutory expense ratio, and the net statutory combined
ratio of our insurance company subsidiaries.
Year Ended December 31,
2015
2014
2013
Gross premiums written
$
514,223 $
473,218 $
460,027
Net statutory loss & LAE ratio
Net statutory expense ratio
Net statutory combined ratio
65.4%
30.6%
96.0%
64.8%
33.1%
97.9%
72.2%
34.7%
106.9%
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, 2015, 2014 and 2013, our consolidated premium‐to‐surplus ratios
were 144%, 154% and 184%, 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 operating 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 operating unit and monitored by Hallmark senior management.
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 operating 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, 2015, our operating units had a total of
100 claims managers, supervisors and adjusters with an average experience of approximately 15 years.
14
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, 2015, 2014 and 2013, to the gross‐of‐
reinsurance amounts reported in our balance sheets at December 31, 2015, 2014 and 2013.
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
As of and for Year Ended December 31
2015
2014
2013
(dollars in thousands)
$
323,192 $
312,468 $
263,832
237,102
215,258
251,391
(6,953)
(5,203)
9,954
(83,132)
(76,231)
(101,897)
(122,122)
(123,100)
(110,812)
Reserve for unpaid losses and LAE at December 31, net of
reinsurance recoverable
348,087
323,192
312,468
Reinsurance recoverable on unpaid losses and LAE at December 31
102,791
91,943
70,172
Reserve for unpaid losses and LAE at December 31, gross of
reinsurance
$
450,878 $
415,135 $
382,640
The $7.0 million favorable development, $5.2 million favorable development and $10.0 million unfavorable development in
prior accident years recognized in 2015, 2014 and 2013, respectively, represent normal changes in our loss reserve estimates.
In 2015 and 2014, 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 $7.0 million decrease in reserves for unpaid losses and LAE recognized in 2015 was attributable to $7.4 million favorable
development on claims incurred in the 2014 accident year, $1.5 million unfavorable development on claims incurred in the
2013 accident year and $1.1 million favorable development on claims incurred in the 2012 and prior accident years. Our
Standard Commercial P&C operating unit, Workers Compensation operating unit, Specialty Commercial operating unit and our
MGA Commercial Products operating unit accounted for $5.4 million, $2.0 million, $2.0 million and $0.2 million, respectively,
of the decrease in reserves recognized during 2015. The decrease in reserves for our Standard Commercial P&C operating unit
was primarily related to our general liability lines of business. The decrease in reserves for our Workers Compensation
operating unit was attributable to the 2014, 2013 and 2012 and prior accident years. The decrease in reserves for our
Specialty Commercial operating unit was primarily related to $0.9 million favorable development in our general aviation line of
business, $0.8 million favorable development in our medical professional liability products and $0.3 million favorable
development in our commercial excess liability line of business. The decrease in reserves in our MGA Commercial Products
operating unit primarily related to our commercial auto liability and general liability lines of business. These favorable
developments were partially offset by unfavorable development of $2.6 million in our Specialty Personal Lines operating unit
primarily attributable to the 2014 accident year.
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
16
2012 accident year and $2.4 million favorable development on claims incurred in the 2011 and prior accident years. Our
Standard Commercial P&C operating unit, Specialty Personal Lines operating unit, Workers Compensation operating unit and
Specialty Commercial operating 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 operating unit was
primarily related to our commercial auto and general liability lines of business. The decrease in reserves for our Specialty
Personal Lines operating unit was primarily attributable to the 2013 accident year. The decrease in reserves for our Workers
Compensation operating unit was attributable to the 2013, 2012 and 2011 and prior accident years. The decrease in reserves
for our Specialty Commercial operating 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 MGA Commercial Products operating 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 MGA Commercial Products operating unit and Specialty Personal Lines operating unit accounted for $16.0
million and $1.8 million of the increase in reserves recognized during 2013. The increase in reserves for our MGA Commercial
Products operating unit was primarily related to commercial auto liability line of business. The increase in reserves for our
Specialty Personal Lines operating 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
operating unit, $2.6 million in our Specialty Commercial operating unit and $1.5 million in our Workers Compensation
operating unit. The decrease in reserves for our Standard Commercial P&C operating unit was primarily related to commercial
auto and general liability lines of business. The decrease in reserves for our Specialty Commercial operating 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 Specialty Commercial operating unit was $0.4 million of
favorable claims development in our excess & umbrella lines of business. The decrease in reserves for our Workers
Compensation operating unit was related to the 2012 and 2011 accident years.
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, 2005 through 2015. 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
2005
2006
2007
2008
2009
2010
2011
2012
2013 2014
2015
25,997 $
72,801 $ 120,849 $ 150,025 $ 176,250 $ 213,723 $ 254,901 $ 263,832 $ 312,468 $ 323,192 $ 348,087
$
24,820 66,387 119,034
151,645
185,440
230,089
251,226
273,786
307,265
316,239
24,903 68,490 118,646
155,155
183,689
226,856
256,198
275,778
307,793
23,144 68,809 120,444
154,738
181,268
230,145
253,814
274,704
23,455 69,847 119,771
155,520
185,848
227,555
251,968
24,425 71,879 123,949
25,403 78,396 128,006
158,842
184,995
227,357
159,151
185,666
30,704 79,939 128,907
159,747
32,395 80,439 129,724
32,825 81,737
33,403
A. Reserve for unpaid loss & LAE,
net of reinsurance recoverables
B. Net reserve re‐estimated as of:
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
C. Net cumulative (deficiency)
redundancy
(7,406) (8,936) (8,875)
(9,722)
(9,416)
(13,634)
2,933
(10,872)
4,675
6,953
D. Cumulative amount of claims
paid, net of reserve recoveries
through:
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
16,721 30,061 50,458
22,990 46,860 78,314
24,562 58,322 93,286
27,231 65,084 105,251
28,833 71,082 112,029
30,367 75,225 118,171
31,058 75,141 122,410
33,171 83,865 126,144
34,552 85,724
35,423
25,997 72,801 120,849
4,763 4,489
324
122,122
123,100
194,925
110,812
174,684
209,619
64,810
73,647
105,848
109,538
95,385
121,222
156,176
120,133
146,956
188,044
131,912
162,704
207,484
140,618
172,330
220,627
163,803
200,637
216,349
146,581
179,880
152,232
150,025
176,250
213,723
254,901
6,338
8,412
37,954
42,044
312,468
263,832
323,192
49,584 70,172 91,943
348,087
102,791
Gross reserve‐December 31
26,321
77,564 125,338
156,363
184,662
251,677
296,945
313,416
382,640
415,135
450,878
Net re‐estimated reserve
Re‐estimated reinsurance
recoverable
33,403
81,737 129,724
159,747
185,666
227,357
251,968
274,704
307,793
316,239
1,776
6,704
7,919
8,627
10,156
35,968
40,755
50,631 65,443 93,541
Gross re‐estimated reserve
35,179
88,441 137,643
168,374
195,822
263,325
292,723
325,335
373,236
409,780
Gross cumulative redundancy
(deficiency)
$ (8,858) $
(10,877) $
(12,305) $
(12,011) $
(11,160) $
(11,648) $ 4,222 $
(11,919) $ 9,404 $ 5,355
18
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, 2015 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).
Year Ended December 31
2015
2014
2013
514,223 $
(157,279)
473,218 $
(148,866)
356,944 $
324,352 $
494,643 $
(145,562)
461,694 $
(140,477)
349,081 $
321,217 $
89,892 $
99,911 $
460,027
(99,262)
360,765
437,226
(76,685)
360,541
45,456
$
$
$
$
$
Gross premiums written
Ceded premiums written
Net premiums written
Gross premiums earned
Ceded premiums earned
Net premiums earned
Reinsurance recoveries
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, 2015, we had total invested assets of $578.8 million. If market rates were to increase by 1%, the fair value of our fixed‐
income securities as of December 31, 2015 would decrease by approximately $16.6 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 of each category of invested assets as of December 31, 2015
and 2014.
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As of December 31, 2015
As of December 31, 2014
Fair
Value
Percent of
Total
Yield
Fair
Value
Percent of
Total
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
$
121,709
81,596
192,368
76,269
59,383
22.9%
15.4%
36.2%
14.3%
11.2%
3.0% $
4.6%
2.7%
29,442
113,649
162,329
0.8%
2.0%
93,305
52,060
6.5%
25.2%
36.0%
20.7%
11.6%
3.5%
4.0%
4.5%
0.7%
2.3%
Total
$
531,325
100.0%
2.7% $
450,785
100.0%
3.3%
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 AA at December 31, 2015. 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,
2015 and 2014:
As of
December 31, 2015
As of
December 31, 2014
Rating:
"AAA"
"AA"
"A"
"BBB"
"BB"
"B"
"CCC"
"NR"
Total
8.1%
43.7%
8.1%
15.3%
17.7%
3.2%
0.0%
3.9%
100.0%
10.1%
34.8%
10.2%
27.9%
9.8%
0.8%
2.0%
4.4%
100.0%
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The following table shows the composition of our fixed‐income portfolio by remaining time to maturity as of December 31,
2015 and 2014.
As of December 31, 2015
As of December 31, 2014
Fair Value
(in thousands)
Percentage of
Total
Fair Value
Percentage of
Total
Fair Value
Fair Value
(in thousands)
76,560
234,213
101,387
59,782
59,383
531,325
14.4% $
44.1%
19.1%
11.2%
11.2%
50,329
185,525
109,925
52,946
52,060
11.2%
41.2%
24.4%
11.7%
11.5%
100.0% $
450,785
100.0%
Remaining time to maturity:
Less than one year
One to five years
Five to ten years
More than ten years
Mortgage‐backed
Total
$
$
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, 2015, 8% 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, 2015.
Category
Corporate bonds
Collateralized corporate bank loans
Municipal bonds
Mortgage‐backed
U.S. Treasury securities and obligations of U.S. Government
Equity securities
Total
Net Unrealized Gain Balance
(in thousands)
$
$
(1,185)
(1,838)
(4,078)
(149)
(54)
22,553
15,249
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.
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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 operating 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 operating 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
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 3,059 property/casualty insurance
companies and 2,089 property/casualty insurance groups operating in North America as of July 13, 2015. Our Standard
Commercial P&C operating 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 MGA Commercial
Products operating unit includes such carriers as Atlantic Casualty Insurance Company, Colony Insurance Company, National
Casualty Company, National Liability & Fire Insurance Company, Nationwide Specialty Insurance Company, Northland
Insurance Company, and Progressive County Mutual. Our Specialty Commercial operating 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, Navigators, and
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 Specialty
Commercial operating 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 Specialty Commercial operating 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. The primary
competition for our primary/excess commercial property insurance products includes such carriers as ACE Westchester, Aspen
Insurance, Axis Insurance Company, Endurance Specialty Holdings, Ltd., Liberty Insurance Underwriters and Markel Insurance
Company. Although our Specialty Personal Lines operating unit competes with large national insurers such as Allstate
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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.
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 31 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
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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, 2015, 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 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:
24
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;
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, 2015, we employed 411 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.
25
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 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, 2015 unpaid losses and LAE would have produced a $4.5 million change to pretax earnings. Our gross
loss and LAE reserves totaled $450.9 million at December 31, 2015. Our loss and LAE reserves, net of reinsurance recoverable
on unpaid loss and LAE, were $348.1 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 34% of the net
premiums written by any of them, HIC retains 32% of the net premiums written by any of them, HSIC retains 24% of the net
premiums written by any of them and HNIC retains 10% of the net premiums written by any of them. A.M. Best has pooled its
26
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.
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. 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 3,059 property/casualty insurance
companies and 2,089 property/casualty insurance groups operating in North America as of July 13, 2015. 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 be required to reduce the level of
business that we underwrite, which will reduce our revenue.
27
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, 2015, we had a total of $179.4 million due us from
reinsurers, including $114.3 million of recoverables from losses and $65.1 million in ceded unearned premiums. The largest
amount due us from a single reinsurer as of December 31, 2015 was $34.1 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.
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;
28
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;
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 2016 by our insurance company subsidiaries is $18.5 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
29
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.
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, 2015, 92% 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, 34% 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, 2015 was $531.3 million. If market interest rates were to increase 1%, the fair value of our fixed‐income
securities would decrease by approximately $16.6 million as of December 31, 2015. The calculated change in fair value was
determined using duration modeling assuming no prepayments.
In addition to the general risks described above, although 83% 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
30
issuer could default on its obligations. As of December 31, 2015, Hallmark had $0.2 million in its investment portfolio exposed
to sub‐prime mortgages and $59.4 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 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 63% of our gross written premiums for 2015: Texas (47%), Louisiana (5%), Arizona (4%),
Oklahoma (4%) and New Mexico (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.
31
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.
Cybersecurity risks in particular are evolving and include malicious software, unauthorized access to data and other electronic
security breaches. We have not experienced cybersecurity 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
cybersecurity 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 cybersecurity attacks. A cybersecurity
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, Standard Commercial P&C operating unit and Workers Compensation operating 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 $49,823 per month pursuant to a lease which expires June 30, 2022.
Our MGA Commercial Products operating 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 $33,348 per
month pursuant to a lease that expires November 30, 2020.
Our Specialty Commercial operating 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 $9,931 per month
32
pursuant to a lease that expires July 31, 2018. Our Specialty Commercial operating unit also maintains branch offices in the
following locations:
Location
Monthly Rent
Lease Expiration
Atlanta, Georgia
$6,314
June 29, 2017
Glendale, California
$2,495
July 31, 2020
Chicago, Illinois
$8,683
April 30, 2017
Our Specialty Personal Lines operating 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.
33
Item 3. Legal Proceedings.
During the third quarter of 2015 we paid $1.2 million in fulfillment of the contingent purchase price with the sellers of TBIC
Holding. The sellers have disputed the calculation of the amount paid and assert that an additional $1.8 million is due. We
disagree with this assertion and believe that our calculation of the contingent purchase price was substantially correct.
Pursuant to the terms of the acquisition agreement, an independent actuary has been engaged to resolve this matter.
In November 2015, HSU was informed by the Texas Comptroller of Public Accounts that a surplus lines tax audit covering the
period January 1, 2010 through December 31, 2013 was complete. HSU frequently acts as a managing general underwriter
(“MGU”) authorized to underwrite policies on behalf of Republic Vanguard Insurance Company and HSIC, both Texas eligible
surplus lines insurance carriers. In its role as the MGU, HSU underwrites policies on behalf of these carriers while other
agencies located in Texas (generally referred to as “producing agents”) deliver the policies to the insureds and collect all
premiums due from the insureds. During the period under audit, the producing agents also collected the surplus lines
premium taxes due on the policies from the insureds, held them in trust, and timely remitted those taxes to the Comptroller.
We believe this system for collecting and paying the required surplus lines premium taxes complies in all respects with the
Texas Insurance Code and other regulations, which clearly require that the same party who delivers the policies and collects
the premiums will also collect premium taxes, hold premium taxes in trust, and pay premium taxes to the Comptroller. It also
complies with long standing industry practice. In addition, effective January 1, 2012 the Texas Legislators enacted House Bill
3410 (HB3410) which allows an MGU to contractually pass the collection, payment and administration of surplus lines taxes
down to another Texas licensed surplus line agent.
The Comptroller asserts that HSU is liable for the surplus lines premium taxes related to policy transactions and premiums
collected from surplus lines insureds during January 1, 2010 through December 31, 2011, the period prior to the passage of
HB3410, and that HSU therefore owes $2.5 million in premium taxes, as well as $0.7 million in penalties and interest for the
audit period.
We disagree with the Comptroller and intend to vigorously fight their assertion that HSU is liable for the surplus lines premium
taxes. We are currently in negotiations with the Comptroller to settle the matter. However, we are presently unable to
reasonably estimate the possible loss or legal costs that are likely to arise out of the surplus lines tax audit or any future
proceedings relating to this matter. Therefore we have not accrued any amount as of December 31, 2015 related to this
matter.
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.
34
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, 2014.
Period
Year Ended December 31, 2015:
First quarter
Second quarter
Third quarter
Fourth quarter
Year Ended December 31, 2014:
First quarter
Second quarter
Third quarter
Fourth quarter
Holders
High Sale
Low Sale
$
$
12.67 $
12.15
11.87
13.29
9.25 $
11.06
11.05
12.43
9.50
10.46
9.33
11.19
8.15
8.05
8.66
9.96
As of March 2, 2016, there were 2,285 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.
35
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, 2015.
Plan Category
Equity compensation plans approved by
security holders
Equity compensation plans not approved by
security holders
Total
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)
869,113 $
‐
869,113 $
9.51
‐
9.51
1,844,973
‐
1,844,973
(1) Securities remaining available for future issuance are net of a maximum of 155,027 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, 2015:
October 1st ‐ October 31st
November 1st – November 30th
December 1st – December 31st
Total Number of
Shares Purchased
(a)
‐
‐
51,975
Maximum
Number of
Shares that May
Yet Be Purchased
Under the Plan
(d)
2,024,323
2,024,323
1,972,348
Cumulative Number of
Shares Purchased as Part
of Publicly Announced
Plan
(c)
1,975,677
1,975,677
2,027,652
Average Price
Paid Per Share
(b)
$ ‐
$ ‐
$ 11.97
36
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, 2010 and its relative performance is tracked through December 31, 2015.
37
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
2015
2014
2013
2012
2011
(in thousands, except per share data)
$
514,223 $
(157,279)
473,218 $
(148,866)
356,944
(7,863)
324,352
(3,135)
460,027 $
(99,262)
360,765
(224)
349,081
321,217
360,541
13,969
2,503
5,952
213
684
12,383
134
5,279
(1,694)
47
12,884
10,540
5,830
(487)
120
389,842 $
(57,353)
332,489
(13,053)
319,436
15,293
1,943
5,957
(1,145)
316
354,881
(51,005)
303,876
(10,835)
293,041
15,880
3,633
6,826
3,175
216
372,402
337,366
389,428
341,800
322,771
230,149
103,993
3,906
2,468
210,055
101,427
4,576
2,526
261,345
109,289
4,599
3,115
340,516
318,584
378,348
31,886
10,023
21,863
18,782
5,353
13,429
11,080
2,835
8,245
226,414
103,792
4,634
3,586
338,426
3,374
(474)
3,848
239,235
95,106
4,631
3,586
342,558
(19,787)
(8,954)
(10,833)
‐
‐
‐
324
58
21,863
13,429
8,245
3,524
(10,891)
Basic
Diluted
$
$
1.14 $
0.70 $
0.43 $
1.13 $
0.69 $
0.43 $
0.18 $
0.18 $
(0.55)
(0.55)
38
Balance Sheet Items:
2015
2014
2013
2012
2011
As of December 31
Total investments
Total assets
Reserves for unpaid loss and loss
adjustment expenses
Unearned premiums
Total liabilities
Total stockholders' equity
Book value per share
$
$
$
$
$
$
$
578,829 $
507,229 $
461,325 $
1,076,600 $
980,869 $
909,023 $
445,360 $
790,468 $
424,628
746,059
450,878 $
415,135 $
382,640 $
313,416 $
296,945
216,407 $
196,826 $
185,303 $
162,502 $
146,104
814,574 $
728,832 $
670,905 $
262,026 $
252,037 $
238,118 $
569,931 $
220,537 $
529,203
215,572
13.72 $
13.11 $
12.36 $
11.45 $
11.19
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 operating units and are supported by our insurance carrier subsidiaries.
Our insurance activities are organized by operating 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 operating unit and the workers compensation insurance products handled by our Workers Compensation
operating unit. Effective July 1, 2015, the Workers Compensation operating unit no longer retains any risk on new or
renewal policies. Our Standard Commercial P&C operating unit is comprised of our American Hallmark Insurance
Services and ECM subsidiaries. Our Workers Compensation operating 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 MGA Commercial Products operating
unit and the general aviation, satellite launch, commercial umbrella and primary/excess liability, medical
professional liability and primary/excess commercial property insurance products and services handled by our
Specialty Commercial operating unit, as well as certain specialty risk programs which are managed at the parent
level. Our MGA Commercial Products operating unit is comprised of our HSU, PAAC and TGASRI subsidiaries. Our
Specialty Commercial operating unit is comprised of our Aerospace Insurance Managers, ASRI, ACMG, HXS and HDS
subsidiaries.
Personal Segment. Our Personal Segment includes the non‐standard personal automobile and renters insurance
products and services handled by our Specialty Personal Lines operating unit. During the fourth quarter of 2014, our
Specialty Personal Lines operating unit discontinued the low value dwelling/homeowners and manufactured homes
insurance products it previously offered. Our Specialty Personal Lines operating unit is comprised of our AHGA and
HCS subsidiaries.
39
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 34% of the net premiums
written by any of them, HIC retains 32% of the net premiums written by any of them, HSIC retains 24% of the net premiums
written by any of them and HNIC retains 10% 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, observation 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 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
40
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, 2015 and 2014, 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 operating units except for the Specialty
Commercial operating unit for which reporting units are at the component level (“one level below”). Our consolidated balance
sheet as of December 31, 2015 includes goodwill of acquired businesses of $44.7 million that is assigned to our operating units
as follows: Standard Commercial P&C operating unit ‐ $2.1 million; MGA Commercial Products operating unit ‐ $19.8 million;
Specialty Commercial operating unit‐ $17.4 million (comprised of $7.7 million for the primary/excess & umbrella component
and $9.7 million for the general aviation and satellite component); and Specialty Personal Lines operating 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 2015 and determined that there was no impairment.
41
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 2015. 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 operating 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 operating units were in excess of their respective carrying values, including goodwill, as a result
of our annual test for impairment during the fourth quarter 2015. However, a 8% decline in the fair value of our Standard
Commercial P&C operating unit, a 9% decline in the fair value of our MGA Commercial Products operating unit, a 15% decline
in the fair value of our Specialty Personal Lines operating unit, a 57% decline in the fair value of our excess & umbrella
component or a 20% 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 2015. We consider our market
capitalization in assessing the reasonableness of the fair values estimated for our operating 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, 2015. Through
December 31, 2015, there were no indicators of impairment.
While we believe the estimates and assumptions used in determining the fair value of our operating 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
operating 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 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
42
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, 2015 reserves for unpaid losses and LAE would have produced a $4.5 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, 2015 was $465.4 million to $376.1 million.
Our best estimate of unpaid losses and LAE as of December 31, 2015 is $450.9 million. Our carried reserve for unpaid losses
and LAE as of December 31, 2015 is comprised of $227.1 million in case reserves and $223.8 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 $30.1 million higher than the midpoint, or 96.9% of the high end, of the
actuarial range at December 31, 2015 as compared to $18.0 million above the midpoint, or 94.8% of the high end, of the
actuarial range at December 31, 2014. We expect our best estimate to move within the actuarial range from year to year due
to changes in our operations and changes within the marketplace. Due to the inherent uncertainty in reserve estimates, there
can be no assurance that the actual losses ultimately experienced will fall within the actuarial range. However, because of the
breadth of the actuarial range, we believe that it is reasonably likely that actual losses will fall within such range.
Our reserve requirements are also interrelated with product pricing and profitability. We must price our products at a level
sufficient to fund our policyholder benefits and still remain profitable. Because claim expenses represent the single largest
category of our expenses, inaccuracies in the assumptions used to estimate the amount of such benefits can result in our
failing to price our products appropriately and to generate sufficient premiums to fund our operations.
Recognition of profit sharing commissions. Profit sharing commission is calculated and recognized when the loss ratio, as
determined by a qualified actuary, deviates from contractual targets. We receive a provisional commission as policies are
produced as an advance against the later determination of the profit sharing commission actually earned. The profit sharing
commission is an estimate that varies with the estimated loss ratio and is sensitive to changes in that estimate.
The following table details the profit sharing commission revenue sensitivity of the Standard Commercial P&C operating unit
to the actual ultimate loss ratio for each effective quota share treaty at 5.0% above and below the current estimate, which we
believe is a reasonably likely range of variance ($ in thousands).
43
Treaty Effective Dates
7/1/2001
7/1/2002
7/1/2003
7/1/2004
Provisional loss ratio
Estimated ultimate loss ratio recorded at December
31, 2015
60.0%
63.5%
59.0%
64.5%
59.0%
61.6%
64.2%
66.1%
Effect of actual 5.0% above estimated loss ratio at
December 31, 2015
$
‐ $
‐ $
(3,092) $
(3,790)
Effect of actual 5.0% below estimated loss ratio at
December 31, 2015
$
1,850 $
3,055 $
2,823 $
3,790
The following table details the profit sharing commission revenue sensitivity of the MGA Commercial Products operating 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, 2015
Effect of actual 5.0% above estimated loss ratio at December
31, 2015
Effect of actual 5.0% below estimated loss ratio at December
31, 2015
$
$
Results of Operations
Treaty Effective Dates
1/1/2006
1/1/2007
1/1/2008
65.0%
65.0%
58.8%
64.0%
65.0%
59.7%
(3,096) $
(470) $
(1,618)
2,960 $
2,351 $
1,618
Comparison of Years ended December 31, 2015 and December 31, 2014
Management overview. During fiscal 2015, our total revenues were $372.4 million, representing a 10% increase over the
$337.4 million in total revenues for fiscal 2014. This increase in revenue was primarily attributable to higher net premiums
earned, higher net investment income, higher realized gains recognized on our investment portfolio and lower adverse profit
share commission adjustments in our Standard Commercial Segment. The increased net earned premiums were primarily
attributable to increased retained premium under a renewed quota share reinsurance agreement effective October 1, 2014 in
our Personal Segment and to increased premium production in our Personal Segment and our MGA Commercial Products
operating unit.
The increase in revenue for the year ended December 31, 2015 was partially offset by increased loss and LAE of $20.1 million
as compared to the same period of 2014. The increase in loss and LAE was primarily the result of an increase in retained losses
in our Personal Segment under the renewed quota share reinsurance agreement. During the twelve months ended December
31, 2015, we recorded favorable prior year net loss reserve development of $7.0 million as compared to $5.2 million of
favorable prior year net loss reserve development for the same period of 2014. Also partially offsetting the increased revenue
was increased other operating expenses due mostly to higher production related expenses in our Personal Segment due to the
impact of the change in terms of the quota share reinsurance agreement and increased salary and related expenses in our
Specialty Commercial and Corporate Segments.
44
We reported net income of $21.9 million for the year ended December 31, 2015, as compared to net income of $13.4 million
for the year ended December 31, 2014. On a diluted per share basis, net income was $1.13 per share for fiscal 2015 as
compared to net income of $0.69 per share for fiscal 2014.
Segment information
The following is additional business segment information for the years ended December 31, 2015 and 2014 (in thousands):
Year Ended December 31
Standard Commercial
Segment
Specialty Commercial
Segment
Personal Segment
Corporate
Consolidated
2015
2014
2015
2014
2015
2014
2015
2014
2015
2014
Gross premiums written $
81,892 $ 84,679 $ 351,050 $ 324,547 $ 81,281 $ 63,992 $
‐ $
‐ $ 514,223 $ 473,218
Ceded premiums written
(10,795)
(7,767)
(109,275)
(93,909) (37,209) (47,190)
Net premiums written
71,097
76,912
241,775
230,638
44,072
16,802
Change in unearned
premiums
1,516
1,399
(4,135)
(1,815)
(5,244)
(2,719)
Net premiums earned
72,613
78,311
237,640
228,823
38,828
14,083
‐
‐
‐
‐
‐
(157,279)
(148,866)
‐
356,944
324,352
‐
(7,863)
(3,135)
‐
349,081
321,217
Total revenues
76,864
81,464
249,910
241,920
45,538
20,404
90
(6,422)
372,402
337,366
Losses and loss
adjustment expenses
47,071
51,130
148,664
149,961
34,414
8,964
‐
‐
230,149
210,055
Pre‐tax income (loss)
6,687
4,595
40,277
34,237
(885)
1,226
(14,193)
(21,276)
31,886
18,782
Net loss ratio (1)
64.8%
65.3%
62.6%
Net expense ratio (1)
32.6%
33.3%
25.6%
Net combined ratio (1)
97.4%
98.6%
88.2%
63.7%
88.6%
65.5%
25.6%
19.0%
43.3%
91.1% 107.6% 107.0%
65.9%
65.4%
28.0%
30.5%
93.9%
95.9%
Favorable (Unfavorable)
Prior Year Development
7,416
6,033
2,147
(3,721)
(2,610)
2,891
6,953
5,203
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 $81.9 million for the year ended December 31, 2015,
which was $2.8 million, or 3%, less than the $84.7 million reported for the same period in 2014. The decrease in gross
premium was primarily due to lower premium production in our Workers Compensation operating unit due to a renewal
rights agreement which ceded 100% of the unearned premium effective July 1, 2015. Net premiums written were $71.1
million for the year ended December 31, 2015 as compared to $76.9 million reported for the same period in 2014. The lower
net premiums were primarily due to the workers compensation renewal rights agreement.
Total revenue for the Standard Commercial Segment of $76.9 million for the year ended December 31, 2015 was $4.6 million
less than the $81.5 million reported during the year ended December 31, 2014. This 6% decrease in total revenue was mostly
due to a $5.7 million decrease in net premiums earned as a result of the workers compensation renewal rights agreement and
45
lower net premiums earned in our Standard Commercial P&C operating unit, as well as lower net investment income of $1.0
million, partially offset by a decreased adverse profit share commission revenue adjustment of $1.5 million and a $0.6 million
gain on the sale of our workers compensation renewal rights.
Our Standard Commercial Segment reported pre‐tax income of $6.7 million for the year ended December 31, 2015 which was
$2.1 million higher than the $4.6 million reported for the same period of 2014. Lower loss and LAE of $4.1 million was the
primary driver for the higher pre‐tax income, as well as lower operating expenses of $2.6 million, partially offset by the
decreased revenue discussed above.
The net loss ratio for the year ended December 31, 2015 was 64.8% as compared to the 65.3% reported for the year ended
December 31, 2014. The gross loss ratio before reinsurance was 63.4% for the year ended December 31, 2015 as compared to
71.7% for the prior year. The improvement in the gross and net loss ratios was driven primarily by lower net catastrophe
losses. The gross and net loss ratios for the year ended December 31, 2015 included $7.8 million of net catastrophe related
losses compared to $13.4 million of net catastrophe related losses for the same period the prior year. During the year ended
December 31, 2015 the Standard Commercial Segment reported $7.4 million of favorable loss development as compared to
$6.0 million reported for the same period of 2014.
Specialty Commercial Segment.
Gross premiums written for the Specialty Commercial Segment were $351.0 million for the year ended December 31, 2015,
which was $26.5 million, or 8%, more than the $324.5 million reported for the same period in 2014. Net premiums written
were $241.8 million for the year ended December 31, 2015 as compared to $230.6 million reported for the same period in
2014. The increase in gross and net premiums written was due to increased premium production in both our MGA Commercial
Products and our Specialty Commercial operating units.
The $249.9 million of total revenue for the year ended December 31, 2015 was $8.0 million higher than the $241.9 million
reported for 2014. This 3% increase in revenue was due to higher net premiums earned of $8.8 million due predominately to
increased production discussed above. Further contributing to this increased revenue was higher commission and fees of $0.3
million and higher other income of $0.1 million, partially offset by lower net investment income of $1.1 million and lower
finance charges of $0.1 million.
Pre‐tax income for the Specialty Commercial Segment of $40.3 million for the year ended December 31, 2015 was $6.1 million
higher than the $34.2 million reported for the same period in 2014. The increase in pre‐tax income was primarily due to the
increased revenue discussed above, lower loss and LAE expenses of $1.3 million and lower amortization of intangible assets of
$0.1 million, partially offset by higher operating expenses of $3.3 million.
Our MGA Commercial Products operating unit reported a $0.4 million decrease in loss and LAE due primarily to $0.2 million of
favorable prior year loss reserve development recognized during the year ended December 31, 2015 as compared to $4.7
million of adverse prior year loss reserve development recognized for the same period the prior year. Our Specialty
Commercial operating unit reported a $0.9 million decrease in loss and LAE which consisted of (a) a $2.3 million decrease in
loss and LAE in our general aviation and satellite launch insurance products due primarily to $0.9 million of favorable prior
year loss reserve development recognized during the year ended December 31, 2015 as compared to $0.3 million of adverse
prior year loss reserve development recognized for the same period the prior year, (b) a $0.5 million increase in loss and LAE
due primarily to $0.6 million lower favorable prior year net loss reserve development recognized during the year ended
December 31, 2015 as compared to the same period during 2014 in our commercial umbrella and primary/excess liability line
of business, and (c) a $0.9 million increase in loss and LAE attributable to our medical professional liability insurance products.
The increase of $3.3 million in operating expense was primarily the combined result of the year to date expenses to start up
our primary/excess property coverage business of $1.9 million, increased salary and related expenses of $1.2 million, higher
professional service fees of $0.3 million, increased travel related expenses of $0.1 million and higher other operating expenses
of $0.2 million, partially offset by lower production related expense of $0.4 million primarily in our commercial umbrella and
primary/excess liability line of business.
The Specialty Commercial Segment reported a net loss ratio of 62.6% for the year ended December 31, 2015 as compared to
65.5% for the same period during 2014. The gross loss ratio before reinsurance was 61.6% for the year ended December 31,
2015 as compared to 65.7% for the same period in 2014. The lower gross and net loss ratio included $2.1 million of favorable
prior year loss reserve development for the year ended December 31, 2015 as compared to $3.7 million of unfavorable prior
year loss reserve development for the same period during 2014.
46
Personal Segment.
Gross premiums written for the Personal Segment were $81.3 million for the year ended December 31, 2015, which was $17.3
million more than the $64.0 million reported for the same period in 2014. Net premiums written for our Personal Segment
were $44.1 million for the year ended December 31, 2015, which was an increase of $27.3 million, or 162%, from the $16.8
million reported for the same period of 2014. The increase in the gross premiums written was due mostly to increased
production in our ongoing core states. The increase in net premium written was due mostly to increased retained premium
under a renewed quota share reinsurance agreement effective October 1, 2014.
Total revenue for the Personal Segment increased 123% to $45.5 million for the year ended December 31, 2015 from $20.4
million the prior year. Increased net premiums earned of $24.7 million and higher finance charges of $0.8 million were the
primary reasons for the increase in revenue for the period, partially offset by decreased net investment income of $0.4
million.
Our Personal Segment reported a pre‐tax loss of $0.9 million for the year ended December 31, 2015 as compared to pre‐tax
income of $1.2 million for the same period of 2014. The pre‐tax loss was the result of increased losses and LAE of $25.5 million
and increased operating expenses of $1.7 million, partially offset by the increased revenue discussed above.
The Personal Segment reported a net loss ratio of 88.6% for the year ended December 31, 2015 as compared to 63.7% for
2014. The gross loss ratio before reinsurance was 80.8% for the year ended December 31, 2015 as compared to 70.1% for the
same period in 2014. The higher gross and net loss ratios were primarily the result of unfavorable prior year net loss reserve
development of $2.6 million for the year ended December 31, 2015 as compared to favorable prior year net loss reserve
development of $2.9 million for the same period of 2014. The Personal Segment reported a net expense ratio of 19.0% for the
year ended December 31, 2015 as compared to 43.3% for the same period of 2014. The decrease in the expense ratio was due
predominately to the impact of the renewed quota share reinsurance agreement.
Corporate.
Total revenue for Corporate increased by $6.5 million for the year ended December 31, 2015 as compared to the same period
the prior year. This increase in total revenue was due primarily to higher net investment income of $4.1 million as compared
to the same period the prior year and higher net realized gains on our investment portfolio of $2.4 million recognized during
the year ended December 31, 2015 as compared to the same period of 2014.
Corporate pre‐tax loss was $14.2 million for the year ended December 31, 2015 as compared to a $21.3 million pre‐tax loss for
the same period the prior year. The improvement in pre‐tax loss was primarily due to the increased revenue discussed above
and lower interest expense of $0.7 million due to the lower floating interest rate effective June 15, 2015 on our Trust I
subordinated debt securities. (See, “Liquidity and Capital Resources‐ Subordinated Debt Securities.”) This improvement in pre‐
tax loss was partially offset by higher operating expenses of $0.1 million primarily as a result of higher salary and related costs
of $0.5 million due primarily to increased incentive compensation accruals compared to the prior period, partially offset by
lower professional service fees of $0.3 million and lower other operating expenses of $0.1 million.
Comparison of Years ended December 31, 2014 and December 31, 2013
Management overview. During fiscal 2014, our total revenues were $337.4 million, representing a 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
47
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.
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
Standard Commercial
Segment
Specialty Commercial
Segment
Personal Segment
Corporate
Consolidated
2014
2013
2014
2013
2014
2013
2014
2013
2014
2013
Gross premiums written $
84,679 $ 87,147 $ 324,547 $ 296,108 $ 63,992 $ 76,772 $
‐ $
‐ $ 473,218 $ 460,027
Ceded premiums written
(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
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%
Net expense ratio (1)
33.3%
32.2%
Net combined ratio (1)
98.6% 104.0%
65.5%
25.6%
91.1%
69.8%
26.6%
96.4%
63.7%
82.5%
43.3%
26.7%
107.0% 109.2%
65.4%
30.5%
72.5%
29.2%
95.9%
101.7%
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 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 operating
unit.
48
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 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 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 Specialty Commercial operating 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 MGA
Commercial Products operating 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 commission and fee 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 MGA Commercial Products operating 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 Specialty Commercial operating 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
49
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 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.
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
50
subsidiaries to meet operating expenses and debt obligations. As of December 31, 2015, Hallmark had $8.0 million in
unrestricted cash and cash equivalents. Unrestricted cash and cash equivalents of our non‐insurance subsidiaries were $14.4
million as of December 31, 2015. As of that date, our insurance subsidiaries held $92.0 million of cash and cash equivalents as
well as $531.3 million in debt securities with an average modified duration of 3.1 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 2016, the aggregate ordinary
dividend capacity of these subsidiaries is $27.6 million, of which $18.5 million is available to Hallmark. As a county mutual,
dividends from HCM are payable to policyholders. During both the years ended December 31, 2015 and 2014 our insurance
company subsidiaries paid $8.0 million in dividends to Hallmark.
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 $1.3 million, $1.1 million and $8.2 million during each of 2015, 2014 and 2013, 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, 2015, our insurance company subsidiaries reported statutory capital and surplus of $247.2 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, 2015, 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, 2015 and 2014 was 144% and 154%, respectively.
Comparison of December 31, 2015 to December 31, 2014
On a consolidated basis, our cash and investments, excluding restricted cash and investments, at December 31, 2015 were
$693.3 million compared to $638.2 million at December 31, 2014. Cash flow from operations and the proceeds from Revolving
Facility B during the fourth quarter of 2015 were the primary reasons for this increase.
Comparison of Years Ended December 31, 2015 and December 31, 2014
Net cash provided by our consolidated operating activities was $52.9 million for the year ended December 31, 2015 compared
to $33.7 million for the year ended December 31, 2014. The increase in operating cash flow was primarily due to increased
premiums collected net of reinsurance due primarily to an increase in retained business, as well as lower net paid losses,
partially offset by higher operating expenses and income taxes paid.
Cash used in investing activities during the year ended December 31, 2015 was $96.3 million as compared to $42.2 million for
the prior year. The increase in cash used in investing activities was primarily attributable to a $76.7 million increase in
purchases of investment securities and a $3.1 million increase in purchases of property and equipment, partially offset by a
$22.6 million increase in maturities, sales and redemptions of investment securities and a $3.1 million increase in cash flow
from restricted cash accounts.
Cash provided by financing activities during the year ended December 31, 2015 was $26.8 million as a result of $29.9 million
proceeds, net of debt issuance costs, from our Revolving Facility B during the fourth quarter of 2015 and $0.6 million related
to proceeds from the exercise of employee stock options, partially offset by $2.5 million related to the repurchase of our
common stock and $1.2 million related to the contingent purchase price payment to the sellers of TBIC Holding. 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.
51
Credit Facilities
Our Second Restated Credit Agreement with The Frost National Bank (“Frost”) dated June 30, 2015, reinstates the credit
facility with Frost which expired by its terms on April 30, 2015. The Second Restated Credit Agreement also amends certain
provisions of the credit facility and restates the agreement with Frost in its entirety. The Second Restated Credit Agreement
provides a $15.0 million revolving credit facility, with a $5.0 million letter of credit sub‐facility. The outstanding balance of the
revolving credit facility bears interest at a rate equal to the prime rate or LIBOR plus 2.5%, at our election. We pay an annual
fee of 0.25% of the average daily unused balance of the credit facility and letter of credit fees at the rate of 1.00% per
annum. 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, 2015, we were
in compliance with all of our covenants and had no outstanding borrowings under this revolving credit facility.
On December 17, 2015, we entered into a First Amendment to Second Restated Credit Agreement (the “First Amendment”)
and a Revolving Facility B Agreement (the “Facility B Agreement”) with Frost. The First Amendment amended the existing
Second Restated Credit Agreement with Frost to incorporate the additional credit facility reflected by the Facility B
Agreement.
The Facility B Agreement provides a new $30.0 million revolving credit facility (“Facility B”), in addition to the existing $15.0
million revolving credit facility with Frost. We may use Facility B loan proceeds solely for the purpose of making capital
contributions to AHIC and HIC. We may borrow, repay and reborrow under the Facility B until December 17, 2017, at which
time all amounts outstanding under the Facility B are converted to a term loan. In connection with Facility B, we paid Frost a
one‐time commitment fee of $75,000 and will pay Frost an additional quarterly fee through December 17, 2017 of 0.25% per
annum of the average daily unused balance of Facility B. Facility B bears interest at a rate equal to the prime rate or LIBOR plus
3.00%, at our election. Until December 17, 2017, interest only on amounts from time to time outstanding under Facility B are
payable quarterly. Any amounts outstanding on Facility B as of December 17, 2017 are converted to a term loan payable in
quarterly installments over five years based on a seven year amortization of principal plus accrued interest. All remaining
principal and accrued interest become due and payable on December 17, 2022. The obligations under Facility B are secured by
the same collateral as the existing credit facility, being a security interest in the capital stock of AHIC and HIC. Facility B is
subject to the same covenants as the existing credit facility. As of December 31, 2015, we had $30.0 million outstanding under
Facility B.
Subordinated Debt Securities
On June 21, 2005, we entered into a trust preferred securities transaction pursuant to which we issued $30.9 million
aggregate principal amount of subordinated debt securities due in 2035. To effect the transaction, we formed a Delaware
statutory trust, Hallmark Statutory Trust I (“Trust I”). Trust I issued $30.0 million of preferred securities to investors and $0.9
million of common securities to us. Trust I used the proceeds from these issuances to purchase the subordinated debt
securities. The initial interest rate on our Trust I subordinated debt securities was 7.725% until June 15, 2015, after which
interest adjusts quarterly to the three‐month LIBOR rate plus 3.25 percentage points. Trust I pays dividends on its preferred
securities at the same rate. Under the terms of our Trust I subordinated debt securities, we pay interest only each quarter and
the principal of the note at maturity. The subordinated debt securities are uncollaterized and do not require maintenance of
minimum financial covenants. As of December 31, 2015, the balance of our Trust I subordinated debt was $30.9 million and
the interest rate was 3.76% per annum.
On August 23, 2007, we entered into a trust preferred securities transaction pursuant to which we issued $25.8 million
aggregate principal amount of subordinated debt securities due in 2037. To effect the transaction, we formed 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, 2015, the balance of our Trust II subordinated debt was
$25.8 million.
52
Long‐Term Contractual Obligations
Set forth below is a summary of long‐term contractual obligations as of December 31, 2015. 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.
Estimated Payments by Period (in thousands)
Total
2016
2017‐2018
2019‐2020
After 2020
Revolving credit facility payable
$
30,000 $
‐ $
3,214 $
Interest on revolving credit facility payable
Subordinated debt securities
Interest on subordinated debt securities
7,757
56,702
69,455
1,470
2,861
‐
‐
3,786
6,852
Unpaid losses and LAE (1)
450,878
181,623
152,027
Operating leases (2)
Purchase obligations
9,466
4,589
2,065
2,457
3,462
1,071
8,571 $
2,153
‐
6,132
47,444
2,924
790
18,215
1,273
56,702
52,685
69,784
1,015
271
(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.
(2) Minimum payments have not been reduced by minimum sublease rentals of $0.6 million due in the future under
noncancelable subleases.
Based on 2016 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.
53
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, 2015 was $531.3 million. The effective duration
of our portfolio as of December 31, 2015 was 3.1 years. Should interest rates increase 1.0%, our fixed‐income investment
portfolio would be expected to decline in market value by 3.0%, or $16.6 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 $16.6 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, 2015, our
fixed‐income investments were in the following: U.S. Treasury bonds – 14.3%; municipal bonds – 36.2%; collateralized
corporate bank loans – 15.4%; corporate bonds – 22.9%; and asset‐backed – 11.2%. As of December 31, 2015, 83% 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, 2015 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 8.2% of our portfolio as of
December 31, 2015. 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, 2015 was $47.5 million. The fair value of our equity securities would
increase or decrease by $14.3 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 3.5%. The selected hypothetical change does not reflect
what should be considered the best or worst 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, 2015 and 2014
Consolidated Statements of Operations for the Years Ended December 31, 2015, 2014 and 2013
Consolidated Statements of Comprehensive Income (Loss) for the Years Ended December 31, 2015,
2014 and 2013
Consolidated Statements of Stockholders’ Equity for the Years Ended
December 31, 2015, 2014 and 2013
Consolidated Statements of Cash Flows for the Years Ended
December 31, 2015, 2014 and 2013
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
54
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, 2015, 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, 2015.
Ernst & Young LLP, the independent registered public accounting firm that audited our consolidated financial statements as of
December 31, 2015 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, 2015. 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, 2015, is included in this Item under the
heading “ Report of Independent Registered Public Accounting Firm.”
55
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, 2015, 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, 2015, 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, 2015 and
2014, 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, 2015 of Hallmark Financial Services, Inc. and
subsidiaries and our report dated March 10, 2016 expressed an unqualified opinion thereon.
/s/ Ernst & Young LLP
Fort Worth, Texas
March 10, 2016
56
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.
57
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, 2015 and 2014
Consolidated Statements of Operations for the Years Ended December 31, 2015, 2014 and 2013
Consolidated Statements of Comprehensive Income (Loss) for the Years Ended December 31, 2015, 2014 and
2013
Consolidated Statements of Stockholders’ Equity for the Years Ended December 31, 2015, 2014 and 2013
Consolidated Statements of Cash Flows for the Years Ended December 31, 2015, 2014 and 2013
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).
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
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
58
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).
Second Restated Credit Agreement among Hallmark Financial Services, Inc., American Hallmark Insurance
Company of Texas, Hallmark Insurance Company and Frost Bank dated June 30, 2015 (incorporated by reference
to Exhibit 10.1 to the registrant’s Current Report on Form 8‐K filed July 2, 2015).
First Amendment to Second Restated Credit Agreement among Hallmark Financial Services, Inc., American
Hallmark Insurance Company of Texas, Hallmark Insurance Company and Frost Bank dated December 17, 2015
(incorporated by reference to Exhibit 10.1 to the registrant’s Current Report on Form 8‐K filed December 21,
2015).
Revolving Facility B Agreement between Hallmark Financial Services, Inc. and Frost Bank dated December 17,
2015 (incorporated by reference to Exhibit 10.2 to the registrant’s Current Report on Form 8‐K filed December
21, 2015).
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).
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. 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).
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).
4.8
4.9
4.10
4.11
4.12
10.1
10.2
10.3
10.4
10.5
10.6
10.7*
10.8*
10.9*
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*
Form of Restricted Stock Unit Award Agreement (incorporated by reference to Exhibit 10.13 to the registrant’s
59
Form 10‐K filed March 12, 2014).
10.12*
Hallmark Financial Services, Inc. 2015 Long Term Incentive Plan (incorporated by reference to Exhibit 10.1 to the
registrant’s Current Report on Form 8‐K filed June 2, 2015).
10.13*
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 2, 2015).
10.14*
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 2, 2015).
10.15*
Form of Restricted Stock Unit Award Agreement (incorporated by reference to Exhibit 10.4 to the registrant’s
Form 8‐K filed June 2, 2015).
10.16
10.17
10.18
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).
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).
10.19*
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).
10.20
10.21
10.22
First Amendment to Lease Agreement between BRI 1849 Legacy, LLC and Hallmark Financial Services, Inc. dated
January 1, 2015 (incorporated by reference to Exhibit 10.1 to the registrant’s Current Report on Form 8‐K filed
January 20, 2015).
Asset and Renewal Rights Acquisition Agreement dated April 8, 2015, by and among American Hallmark
Insurance Company, Inc., TBIC Holdings, Inc. and Texas Builders Insurance Company of Texas, as Sellers, and
Redpoint Comp Holdings LLC, as Purchaser (incorporated by reference to Exhibit 99.1 to the registrant’s Current
Report on Form 8‐K filed April 9, 2015).
Amendment No. 1 to Asset and Renewal Rights Acquisition Agreement by and among American Hallmark
Insurance Company, Inc., TBIC Holdings, Inc. and Texas Builders Insurance Company of Texas, as Sellers, and
Redpoint Comp Holdings LLC, as Purchaser, dated September 15, 2015 (incorporated by reference to Exhibit
99.1 to the registrant’s Current Report on Form 8‐K filed September 18, 2015).
10.23*+
Form of Confidentiality and Non‐Solicitation Agreement dated May 29, 2015, between Hallmark Financial
Services, Inc. and certain employees of the Company.
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.
60
32(b)+
Certification of principal financial officer pursuant to 18 U.S.C. 1350.
101 INS+
XBRL Instance Document.
101 SCH+
XBRL Taxonomy Extension Schema Document.
101 CAL+
XBRL Taxonomy Extension Calculation Linkbase Document.
101 LAB+
XBRL Taxonomy Extension Label Linkbase Document.
101 PRE+
XBRL Taxonomy Extension Presentation Linkbase Document.
101 DEF+
XBRL Taxonomy Extension Definition Linkbase Document.
Management contract or compensatory plan or arrangement.
*
+Filed herewith.
61
SIGNATURES
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.
Date:
March 10, 2016
By: /s/ Naveen Anand
HALLMARK FINANCIAL SERVICES, INC.
(Registrant)
Date:
March 10, 2016
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 10, 2016
Date:
March 10, 2016
Date:
Date:
Date:
Date:
March 10, 2016
March 10, 2016
March 10, 2016
March 10, 2016
/s/ Naveen Anand
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)
/s/ Mark E. Schwarz
Mark E. Schwarz, Executive Chairman
/s/ James H. Graves
James H. Graves, Director
/s/ Jim W. Henderson
Jim W. Henderson, Director
/s/ Scott T. Berlin
Scott T. Berlin, Director
62
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
63
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 10, 2016, 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, 2015.
Fort Worth, Texas
March 10, 2016
/s/ Ernst & Young LLP
64
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 10, 2016
/s/ Naveen Anand
Naveen Anand, Chief Executive Officer
65
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 10, 2016
/s/ Jeffrey R. Passmore
Jeffrey R. Passmore, Chief Accounting Officer
66
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, 2015, 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 10, 2016
/s/ Naveen Anand
Naveen Anand,
Chief Executive Officer
67
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, 2015, 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 10, 2016
/s/ Jeffrey R. Passmore
Jeffrey R. Passmore,
Chief Accounting Officer
68
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, 2015 and 2014
Consolidated Statements of Operations for the Years Ended December 31, 2015, 2014 and 2013
Consolidated Statements of Comprehensive Income (Loss) for the Years Ended December 31, 2015, 2014 and 2013
Consolidated Statements of Stockholders’ Equity for the Years Ended December 31, 2015, 2014 and 2013
Consolidated Statements of Cash Flows for the Years Ended December 31, 2015, 2014 and 2013
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, 2015 and 2014, 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, 2015. 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, 2015 and 2014, and the consolidated results of their
operations and their cash flows for each of the three years in the period ended December 31, 2015, 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, 2015, 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 10, 2016 expressed an unqualified opinion thereon.
/s/ Ernst & Young LLP
Fort Worth, Texas
March 10, 2016
F‐2
HALLMARK FINANCIAL SERVICES, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
December 31, 2015 and 2014
($ in thousands)
ASSETS
Investments:
Debt securities, available‐for‐sale,
at fair value (cost; $538,629 in 2015 and $450,770 in 2014)
Equity securities, available‐for‐sale,
at fair value (cost; $24,951 in 2015 and $25,360 in 2014)
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
Deferred federal income taxes, net
Federal income tax recoverable
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 2015 and 2014
Additional paid‐in capital
Retained earnings
Accumulated other comprehensive income
Treasury stock (1,775,512 shares in 2015 and 1,655,306 in 2014), at cost
Total stockholders’ equity
2015
2014
$
531,325 $
$
$
47,504
578,829
114,446
8,522
65,094
83,376
2,005
10,424
114,287
20,366
44,695
14,959
3,360
1,779
3,213
11,245
1,076,600 $
30,000 $
56,702
450,878
216,407
33,741
2,496
1,097
‐
‐
23,253
814,574
3,757
123,480
141,501
7,418
(14,130)
262,026
Total liabilities and stockholders’ equity
$
1,076,600 $
The accompanying notes are an integral part of the consolidated financial statements
F‐3
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
980,869
HALLMARK FINANCIAL SERVICES, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
For the years ended December 31, 2015, 2014 and 2013
($ 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
Net income
Net income per share:
Basic
Diluted
2015
2014
2013
514,223 $
(157,279)
356,944
(7,863)
349,081
13,969
2,503
5,952
213
684
372,402
230,149
103,993
3,906
2,468
340,516
31,886
10,023
21,863 $
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
1.14 $
1.13 $
0.70 $
0.69 $
0.43
0.43
$
$
$
$
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 (LOSS)
For the years ended December 31, 2015, 2014 and 2013
($ In thousands)
Net income
Other comprehensive (loss) income:
Change in net actuarial gain (loss)
Tax effect on change in net actuarial gain (loss)
Unrealized holding (losses) gains arising during the period
Tax effect on unrealized holding (losses) 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 (loss) income, net of tax
2015
2014
2013
$
21,863 $
13,429 $
8,245
43
(15)
(10,191)
3,567
(5,826)
2,039
(10,383)
(1,723)
603
3,543
(1,240)
(408)
143
918
2,268
(794)
22,094
(7,733)
(10,540)
3,689
8,984
Comprehensive income
$
11,480 $
14,347 $
17,229
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, 2015, 2014 and 2013
($ In thousands)
Number
of
Shares
Additional
Paid‐In
Capital
Retained
Earnings
Par Value
Accumulated
Other
Comprehensive
Income
Treasury
Stock
Number
of
Shares
Total
Stockholders'
Equity
Balance at January 1, 2013
Equity incentive plan activity
Net income
Other comprehensive income, net of tax
20,873 $
‐
‐
‐
3,757
$ 122,475 $ 97,964
$
7,899
‐
‐
‐
352
‐
‐
‐
8,245
‐
8,984
$ (11,558)
‐
‐
‐
‐
‐
1,609 $ 220,537
‐
‐
‐
352
8,245
8,984
Balance at December 31, 2013
20,873 $ 3,757 $ 122,827 $
106,209 $
16,883
$
(11,558)
1,609 $
238,118
Acquisition of treasury stock
Equity incentive plan activity
Stock options exercised
Net income
Other comprehensive income, net of tax
‐
‐
‐
‐
‐
‐
‐
‐
‐
‐
‐
222
145
‐
‐
‐
‐
‐
13,429
‐
918
‐
‐
‐
‐
(1,805)
‐
1,010
‐
‐
181
‐
(135)
‐
‐
(1,805)
222
1,155
13,429
918
Balance at December 31, 2014
Acquisition of treasury stock
Equity incentive plan activity
Shares issued under employee benefit
Net income
Other comprehensive loss, net of tax
20,873 $
‐
‐
‐
‐
‐
3,757
$ 123,194 $ 119,638 $
‐
‐
‐
21,863
‐
‐
383
(97)
‐
‐
‐
‐
‐
‐
‐
17,801
(10,383)
$ (12,353)
(2,532)
‐
755
‐
‐
‐
‐
‐
‐
(2,532)
1,655 $ 252,037
221
‐
(100)
‐
‐
383
658
21,863
(10,383)
Balance at December 31, 2015
20,873 $
3,757
$ 123,480 $ 141,501 $
7,418
$ (14,130)
1,776 $ 262,026
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, 2015, 2014 and 2013
($ in thousands)
Cash flows from operating activities:
Net income
Adjustments to reconcile net income to cash provided by operating activities:
2015
2014
2013
$
21,863 $
13,429 $
8,245
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 (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 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
Payment of debt issuance costs
Payment of contingent consideration
Proceeds from exercise of employee stock options
Purchase of treasury shares
Net cash provided by (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
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
3,516
(1,030)
(2,503)
383
(11,718)
(12,373)
1,136
380
35,743
19,581
(4,568)
7,338
(2,747)
(1,420)
(645)
52,936
(3,608)
3,392
(265,482)
169,409
(96,289)
30,000
(96)
(1,216)
658
(2,532)
26,814
(16,539)
130,985
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
(546)
276
(188,749)
146,777
(42,242)
(1,473)
‐
‐
1,155
(1,805)
(2,123)
(10,681)
141,666
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
(673)
(3,483)
(222,399)
214,738
(11,817)
‐
‐
‐
‐
‐
‐
56,521
85,145
$
$
$
$
$
114,446 $
130,985 $
141,666
3,906 $
4,576 $
13,800 $
5,497 $
4,599
3,891
(9,492) $
388 $
(1,317)
(224) $
1,115 $
206
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, 2015, 2014, and 2013
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 market, distribute, underwrite and service our property/casualty insurance products primarily through subsidiaries whose
operations are organized into product‐specific operating units that are supported by our insurance company subsidiaries. Our
Standard Commercial P&C operating 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 operating 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”). Effective July
1, 2015, this operating unit no longer markets or retains any risk on new or renewal policies. Our MGA Commercial Products
operating 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 Specialty Commercial
operating 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, (iv) satellite launch insurance products, and (v)
primary/excess commercial property coverages for both catastrophe and non‐catastrophe exposures. Our Specialty Commercial
operating 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 Specialty Personal Lines operating unit handles personal insurance products and services and is comprised of American Hallmark
General Agency, Inc. (“AHGA”) and Hallmark Claims Services, Inc. (“HCS”). Our insurance company subsidiaries supporting these
operating 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 operating units are segregated into three reportable industry segments for financial accounting purposes. The Standard
Commercial Segment includes our Standard Commercial P&C operating unit and our Workers Compensation operating unit. The
Specialty Commercial Segment includes our MGA Commercial Products operating unit and our Specialty Commercial operating unit,
as well as certain specialty risk programs (“Specialty Programs”) which are managed at the parent level. The Personal Segment
consists solely of our Specialty Personal Lines operating 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.
F‐8
HALLMARK FINANCIAL SERVICES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Years ended December 31, 2015, 2014, and 2013
Fair Value of Financial Instruments
Fair value estimates are made at a point in time, based on relevant market data as well as the best information available about the
financial instruments. Fair value estimates for financial instruments for which no or limited observable market data is available are
based on judgments regarding current economic conditions, credit and interest rate risk. These estimates involve significant
uncertainties and judgments and cannot be determined with precision. As a result, such calculated fair value estimates may not be
realizable in a current sale or immediate settlement of the instrument. In addition, changes in the underlying assumptions used in the
fair value measurement technique, including discount rate and estimates of future cash flows, could significantly affect these fair
value estimates.
Cash and Cash Equivalents: The carrying amounts reported in the balance sheet for these instruments approximate their fair values.
Restricted Cash: The carrying amount for restricted cash reported in the balance sheet approximates the fair value.
Revolving Credit Facility Payable: 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 $45.3 million and $47.6 million, as of December 31, 2015 and 2014, 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, 2015 and 2014,
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.
F‐9
HALLMARK FINANCIAL SERVICES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Years ended December 31, 2015, 2014, and 2013
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.)
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 2015, 2014 and 2013, we deferred $32.3 million, $39.1 million and $55.0 million of policy acquisition costs and amortized
$32.7 million, $40.9 million and $57.3 million of deferred policy acquisition costs, respectively. Therefore, the net (amortization)
deferrals of policy acquisition costs were ($0.4) million, ($1.8) million and ($2.3) million for 2015, 2014 and 2013, 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, 2015, 2014, and 2013
Property and Equipment
Property and equipment (including leasehold improvements), aggregating $17.9 million and $14.8 million, at December 31, 2015 and
2014, 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 2015, 2014 and 2013 was $1.0 million, $0.7 million
and $1.2 million, respectively. Accumulated depreciation was $13.7 million and $13.2 million at December 31, 2015 and 2014,
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, 2015,
2014 and 2013. 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.
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
$11.2 million, $11.5 million and $13.2 million for the years ended December 31, 2015, 2014, and 2013, 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.
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 operating unit marketed policies on behalf of Clarendon National
Insurance Company (“Clarendon”), a third‐party insurer. Through December 31, 2008, all business of our MGA Commercial Products
operating 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
F‐11
HALLMARK FINANCIAL SERVICES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Years ended December 31, 2015, 2014, and 2013
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 operating unit and Clarendon.
Provisional loss ratio
Estimated ultimate loss ratio recorded at December 31,
2015
Treaty Effective Dates
7/1/2001
7/1/2002
60.0%
63.5%
59.0%
64.5%
7/1/2003
59.0%
61.6%
7/1/2004
64.2%
66.1%
As of December 31, 2015, we had a payable of $1.7 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.
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 MGA Commercial Products operating unit and Republic.
Provisional loss ratio
Estimated ultimate loss ratio recorded at December 31, 2015
Treaty Effective Dates
1/1/2006
1/1/2007
1/1/2008
65.0%
58.8%
65.0%
64.0%
65.0%
59.7%
As of December 31, 2015, we had a net payable of $0.3 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.
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.
F‐12
HALLMARK FINANCIAL SERVICES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Years ended December 31, 2015, 2014, and 2013
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, 2017 and is to be applied retrospectively. We are in the
process of evaluating the impact of adoption, which is not expected to be material to our results of operations or financial position.
In February 2015, the FASB issued ASU 2015‐02, "Amendments to the Consolidation Analysis" (Topic 810). ASU 2015‐02 changes the
analysis that a reporting entity must perform to determine whether entities should be consolidated if they are deemed variable
interest entities. It is effective for annual reporting periods, and interim periods within those years, beginning after December 15,
2015. We have adopted this standard as of the effective date, and the adoption did not impact our financial statements.
In May 2015, the FASB issued guidance which requires additional disclosures about short‐duration contracts for products in effect for
typically a year or less. The disclosures will focus on the liability for unpaid claims and claim adjustment expenses. This guidance is
effective for annual periods beginning after December 15, 2015 and interim periods within annual periods beginning after December
15, 2016. We are in the process of evaluating the impact of the adoption, which is not expected to be material to our results of
operations or financial position.
F‐13
HALLMARK FINANCIAL SERVICES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Years ended December 31, 2015, 2014, and 2013
2.
Investments:
The amortized cost and estimated fair value of investments in debt and equity securities by category is as follows (in thousands):
As of December 31, 2015
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
Amortized
Cost
Gross
Unrealized
Gains
Gross
Unrealized
Losses
Fair Value
76,323 $
122,894
83,434
196,446
59,532
538,629
24,951
7 $
(61) $
637
44
1,888
155
2,731
23,391
(1,822)
(1,882)
(5,966)
(304)
(10,035)
(838)
76,269
121,709
81,596
192,368
59,383
531,325
47,504
Total debt and equity securities
$
563,580 $
26,122 $
(10,873) $
578,829
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
(4) $
(85)
(1,915)
(1,601)
(370)
(3,975)
(2)
93,305
29,442
113,649
162,329
52,060
450,785
56,444
Total debt and equity securities
$
476,130 $
35,076 $
(3,977) $
507,229
F‐14
HALLMARK FINANCIAL SERVICES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Years ended December 31, 2015, 2014, and 2013
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
2015
2014
2013
$
$
670 $
1,435
4,727
5,901
1,288
673
148
14,842
(873)
13,969 $
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
No investments in any entity or its affiliates exceeded 10% of stockholders’ equity at December 31, 2015 or 2014.
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 gains
Twelve Months Ended December 31
2015
2014
2013
$
$
‐ $
‐
126
(83)
240
5,543
5,826
(3,323)
2,503 $
‐ $
263
109
(140)
32
144
408
(274)
134 $
‐
853
373
(156)
‐
9,470
10,540
‐
10,540
We realized gross gains on investments of $6.7 million, $0.6 million, and $10.9 million during the years ended December 31, 2015, 2014
and 2013, respectively. We realized gross losses on investments of $0.9 million, $0.2 million and $0.4 million during the years ended
December 31, 2015, 2014 and 2013, respectively. We recorded proceeds from the sale of investment securities of $51.7 million, $15.3
million and $33.4 million during the years ended December 31, 2015, 2014 and 2013, 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, 2015, 2014, and 2013
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, 2015 and December 31, 2014 (in thousands):
As of December 31, 2015
12 months or less
Longer than 12 months
Total
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 loans
Municipal bonds
Mortgage‐backed
$
Total debt securities
41,428 $
96,475
65,868
44,525
36,251
284,547
(61) $
(1,822)
(1,758)
(488)
(302)
(4,431)
‐ $
‐
3,532
25,310
48
28,890
‐ $
‐
(124)
(5,478)
(2)
(5,604)
41,428 $
96,475
69,400
69,835
36,299
313,437
(61)
(1,822)
(1,882)
(5,966)
(304)
(10,035)
Total equity securities
6,584
(838)
‐
‐
6,584
(838)
Total debt and equity securities
$
291,131 $
(5,269) $
28,890 $
(5,604) $
320,021 $
(10,873)
As of December 31, 2014
12 months or less
Longer than 12 months
Total
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 loans
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)
‐ $
‐
8,898
15,684
2,966
27,548
‐ $
‐
(1,091)
(656)
(5)
(1,752)
15,005 $
7,552
73,610
66,230
23,435
185,832
(2)
‐
(2,225) $
27,548 $
‐
(1,752) $
129
185,961 $
(4)
(85)
(1,915)
(1,601)
(370)
(3,975)
(2)
(3,977)
At December 31, 2015, the gross unrealized losses more than twelve months old were attributable to 39 debt security positions. At
December 31, 2014, the gross unrealized losses more than twelve months old were attributable to 24 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, 2015, 2014, and 2013
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 $3.3 million during 2015.
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, 2015 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)
76,739 $
236,507
106,046
59,805
59,532
538,629 $
76,560
234,213
101,387
59,782
59,383
531,325
$
$
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 $17.6 million at December 31, 2015 and a carrying value of $20.3 million at
December 31, 2014.
F‐17
HALLMARK FINANCIAL SERVICES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Years ended December 31, 2015, 2014, and 2013
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, 2015, 2014, and 2013
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, 2015 and December 31, 2014 (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, 2015
Quoted Prices in
Active Markets for
Identical Assets
(Level 1)
Other
Observable
Inputs (Level 2)
Unobservable
Inputs (Level 3)
$
$
- $
-
-
-
-
-
47,504
47,504 $
76,269 $
121,709
81,596
178,281
59,383
517,238
-
517,238 $
- $
-
-
14,087
-
14,087
-
14,087 $
As of December 31, 2014
Quoted Prices in
Active Markets for
Identical Assets
(Level 1)
Other
Observable
Inputs (Level 2)
Unobservable
Inputs (Level 3)
$
$
- $
-
-
-
-
-
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 $
Total
76,269
121,709
81,596
192,368
59,383
531,325
47,504
578,829
Total
93,305
29,442
113,649
162,329
52,060
450,785
56,444
507,229
F‐19
HALLMARK FINANCIAL SERVICES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Years ended December 31, 2015, 2014, and 2013
Due to significant unobservable inputs into the valuation model for certain municipal bonds 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. Significant changes in the unobservable inputs in the fair value measurement of our municipal bonds 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, 2015 and 2014 (in thousands).
Beginning balance as of January 1
Sales
Settlements
Purchases
Issuances
Total realized/unrealized gains included in net income
Net (losses) gains included in other comprehensive income
Transfers into Level 3
Transfers out of Level 3
Ending balance as of December 31
4. Acquisitions, Goodwill and Intangible Assets:
$
$
2015
2014
14,598 $
(370)
‐
‐
‐
‐
(141)
‐
‐
14,087 $
17,517
(3,490)
‐
‐
‐
‐
571
‐
‐
14,598
On June 30, 2015, Redpoint Comp Holdings LLC (“Purchaser”) acquired exclusive renewal rights to our current in‐force Texas workers
compensation policies, together with certain physical assets associated with the administration of such in‐force policies. In
consideration for such renewal rights and physical assets, Purchaser assumed certain office lease obligations and offered employment
to certain of our employees associated with the Workers Compensation operating unit. Purchaser also agreed to administer the run‐
off of all of our current workers compensation policies and claims for a period of three years. In connection with the transaction, we
made a one‐time payment to the Purchaser of $83,000. We also agreed not to compete in the workers compensation line of
insurance in the State of Texas (with certain exceptions) until after the assumed office lease obligations expire on October 31, 2017.
We recorded a gain of $0.2 million in Other Income in the Consolidated Statements of Operations on the sale of the renewal rights.
On September 15, 2015, we executed Amendment No. 1 to the sale agreement with the Purchaser. Pursuant to the Amendment, the
Purchaser has agreed to pay us an additional $115,000 and administer the run‐off of all of our workers compensation policies and
claims in perpetuity or through final conclusion (rather than for three years as contemplated by the original agreement) in
consideration of us assigning to Purchaser the commission on all unearned premiums on such policies as of July 1, 2015. We recorded
an additional gain of $0.4 million in Other Income in the Consolidated Statements of Operations as a result of this Amendment No.1.
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 operating units except for the Specialty Commercial operating unit for which reporting
units are at the component level (“one level below”). Our consolidated balance sheet as of December 31, 2015 includes goodwill of
acquired businesses of $44.7 million that is assigned to our operating units as follows: Standard Commercial P&C operating unit ‐ $2.1
million; MGA Commercial Products operating unit ‐ $19.8 million; Specialty Commercial operating unit‐ $17.4 million (comprised of
$7.7 million for the primary/excess & umbrella component and $9.7 million for the general aviation and satellite component); and
Specialty Personal Lines operating 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 2015 and
determined that there was no impairment.
F‐20
HALLMARK FINANCIAL SERVICES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Years ended December 31, 2015, 2014, and 2013
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 2015. 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 operating 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 2015, 2014, and 2013, we completed the first step prescribed by ASC 350 for testing for impairment and determined that
there was no impairment.
F‐21
HALLMARK FINANCIAL SERVICES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Years ended December 31, 2015, 2014, and 2013
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
Total net carrying amount
December 31
2015
2014
$
$
32,177 $
3,440
3,232
4,235
1,300
44,384
(19,799)
(2,159)
(3,232)
(4,235)
(29,425)
14,959 $
32,177
3,440
3,232
4,235
1,300
44,384
(17,561)
(1,929)
(3,232)
(4,235)
(26,957)
17,427
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):
2016
2017
2018
2019
2020
$
$
$
$
$
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/ agent 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, 2015, 2014, and 2013
5. Other Assets:
The following table details our other assets as of December 31, 2015 and 2014 (in thousands):
Profit sharing commission receivable
Accrued investment income
Debt issuance costs
Investment in unconsolidated trust subsidiaries
Fixed assets
Other assets
2015
2014
$
$
228 $
3,876
1,145
1,702
4,120
174
11,245 $
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
2015
2014
2013
$
$
415,135 $
91,943
323,192
237,102
(6,953)
230,149
83,132
122,122
205,254
348,087
102,791
450,878 $
382,640 $
70,172
312,468
215,258
(5,203)
210,055
76,231
123,100
199,331
323,192
91,943
415,135 $
274
2,974
1,104
1,702
1,620
205
7,879
313,416
49,584
263,832
251,391
9,954
261,345
101,897
110,812
212,709
312,468
70,172
382,640
The $7.0 million favorable development, $5.2 million favorable development and $10.0 million unfavorable development in prior accident
years recognized in 2015, 2014 and 2013, respectively, represent normal changes in our loss reserve estimates. In 2015 and 2014, 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, 2015, 2014, and 2013
The $7.0 million decrease in reserves for unpaid losses and LAE recognized in 2015 was attributable to $7.4 million favorable development
on claims incurred in the 2014 accident year, $1.5 million unfavorable development on claims incurred in the 2013 accident year and $1.1
million favorable development on claims incurred in the 2012 and prior accident years. Our Standard Commercial P&C operating unit,
Workers Compensation operating unit, Specialty Commercial operating unit and our MGA Commercial Products operating unit accounted
for $5.4 million, $2.0 million, $2.0 million and $0.2 million, respectively, of the decrease in reserves recognized during 2015. The decrease
in reserves for our Standard Commercial P&C operating unit was primarily related to our general liability lines of business. The decrease in
reserves for our Workers Compensation operating unit was attributable to the 2014, 2013 and 2012 and prior accident years. The
decrease in reserves for our Specialty Commercial operating unit was primarily related to $0.9 million favorable development in our
general aviation line of business, $0.8 million favorable development in our medical professional liability products and $0.3 million
favorable development in our commercial excess liability line of business. The decrease in reserves in our MGA Commercial Products
operating unit primarily related to our commercial auto liability and general liability lines of business. These favorable developments were
partially offset by unfavorable development of $2.6 million in our Specialty Personal Lines operating unit primarily attributable to the 2014
accident year.
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 operating unit,
Specialty Personal Lines operating unit, Workers Compensation operating unit and Specialty Commercial operating 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 operating unit was primarily related to our commercial auto and general liability lines of
business. The decrease in reserves for our Specialty Personal Lines operating unit was primarily attributable to the 2013 accident year.
The decrease in reserves for our Workers Compensation operating unit was attributable to the 2013, 2012 and 2011 and prior accident
years. The decrease in reserves for our Specialty Commercial operating 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 MGA Commercial Products operating 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 MGA Commercial Products
operating unit and Specialty Personal Lines operating unit accounted for $16.0 million and $1.8 million of the increase in reserves
recognized during 2013. The increase in reserves for our MGA Commercial Products operating unit was primarily related to commercial
auto liability line of business. The increase in reserves for our Specialty Personal Lines operating 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 operating unit, $2.6 million in our Specialty Commercial operating unit and $1.5 million in our
Workers Compensation operating unit. The decrease in reserves for our Standard Commercial P&C operating unit was primarily related to
commercial auto and general liability lines of business. The decrease in reserves for our Specialty Commercial operating 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 Specialty Commercial operating unit was $0.4 million of favorable claims development in our
primary/excess & umbrella lines of business. The decrease in reserves for our Workers Compensation operating unit was related to the
2012 and 2011 accident years.
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, 2015
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, 2015, 2014, and 2013
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
2015
2014
2013
$
$
$
$
$
514,223 $
‐
(157,279)
356,944 $
494,643 $
‐
(145,562)
349,081 $
473,233 $
(15)
(148,866)
324,352 $
461,367 $
327
(140,477)
321,217 $
89,892 $
99,911 $
458,020
2,007
(99,262)
360,765
434,022
3,204
(76,685)
360,541
45,456
Included in reinsurance recoverable on the consolidated balance sheets are paid loss recoverables of $11.1 million and $17.0 million as of
December 31, 2015 and 2014, respectively.
8. Revolving Credit Facility and Notes Payable:
Our Second Restated Credit Agreement with The Frost National Bank (“Frost”) dated June 30, 2015, reinstates the credit facility with
Frost which expired by its terms on April 30, 2015. The Second Restated Credit Agreement also amends certain provisions of the
credit facility and restates the agreement with Frost in its entirety. The Second Restated Credit Agreement provides a $15.0 million
revolving credit facility, with a $5.0 million letter of credit sub‐facility. The outstanding balance of the revolving credit facility bears
interest at a rate equal to the prime rate or LIBOR plus 2.5%, at our election. We pay an annual fee of 0.25% of the average daily
unused balance of the credit facility and letter of credit fees at the rate of 1.00% per annum. 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, 2015, we were in compliance with all of our covenants and had no
outstanding borrowings under this revolving credit facility.
On December 17, 2015, we entered into a First Amendment to Second Restated Credit Agreement (the “First Amendment”) and a
Revolving Facility B Agreement (the “Facility B Agreement”) with Frost. The First Amendment amended the existing Second Restated
Credit Agreement with Frost to incorporate the additional credit facility reflected by the Facility B Agreement.
The Facility B Agreement provides a new $30.0 million revolving credit facility (“Facility B”), in addition to the existing $15.0 million
revolving credit facility with Frost. We may use Facility B loan proceeds solely for the purpose of making capital contributions to AHIC
and HIC. We may borrow, repay and reborrow under the Facility B until December 17, 2017, at which time all amounts outstanding
under the Facility B are converted to a term loan. In connection with Facility B, we paid Frost a one‐time commitment fee of $75,000
and will pay Frost an additional quarterly fee through December 17, 2017 of 0.25% per annum of the average daily unused balance of
Facility B. Facility B bears interest at a rate equal to the prime rate or LIBOR plus 3.00%, at our election. Until December 17, 2017,
interest only on amounts from time to time outstanding under Facility B are payable quarterly. Any amounts outstanding on Facility B
as of December 17, 2017 are converted to a term loan payable in quarterly installments over five years based on a seven year
amortization of principal plus accrued interest. All remaining principal and accrued interest become due and payable on December
17, 2022. The obligations under Facility B are secured by the same collateral as the existing credit facility, being a security interest in
the capital stock of AHIC and HIC. Facility B is subject to the same covenants as the existing credit facility. As of December 31, 2015,
we had $30.0 million outstanding under Facility B.
F‐25
HALLMARK FINANCIAL SERVICES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Years ended December 31, 2015, 2014, and 2013
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. The initial interest rate on our Trust I subordinated debt
securities was 7.725% until June 15, 2015, after which interest adjusts quarterly to the three‐month LIBOR rate plus 3.25 percentage
points. Trust I pays dividends on its preferred securities at the same rate. Under the terms of our Trust I subordinated debt securities,
we pay interest only each quarter and the principal of the note at maturity. The subordinated debt securities are uncollaterized and
do not require maintenance of minimum financial covenants. As of December 31, 2015, the balance of our Trust I subordinated debt
was $30.9 million and the interest rate was 3.76% per annum.
On August 23, 2007, we entered into a trust preferred securities transaction pursuant to which we issued $25.8 million aggregate
principal amount of subordinated debt securities due in 2037. To effect the transaction, we formed Trust II as a Delaware statutory
trust. Trust II issued $25.0 million of preferred securities to investors and $0.8 million of common securities to us. Trust II used the
proceeds from these issuances to purchase the subordinated debt securities. 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, 2015, 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 operating units into the
following reportable segments:
lines commercial
Standard Commercial Segment. The Standard Commercial Segment
property/casualty and occupational accident insurance products and services handled by our Standard Commercial P&C
operating unit and the workers compensation insurance products handled by our Workers Compensation operating unit.
Effective July 1, 2015, the Workers Compensation operating unit no longer retains any risk on new or renewal policies. Our
Standard Commercial P&C operating unit is comprised of our American Hallmark Insurance Services and ECM subsidiaries.
Our Workers Compensation operating unit is comprised of our TBIC Holdings, TBIC and TBICRM subsidiaries.
includes the standard
Specialty Commercial Segment. Our Specialty Commercial Segment includes the excess and surplus lines commercial
property/casualty insurance products and services handled by our MGA Commercial Products operating unit and the
general aviation, satellite launch, commercial umbrella and primary/excess liability, medical professional liability and
primary/excess commercial property insurance products and services handled by our Specialty Commercial operating unit,
as well as the Specialty Programs managed at the parent level. Our MGA Commercial Products operating unit is comprised
of our HSU, PAAC and TGASRI subsidiaries. Our Specialty Commercial operating unit is comprised of our Aerospace
Insurance Managers, ASRI, ACMG, HXS and HDS subsidiaries.
Personal Segment. Our Personal Segment includes the non‐standard personal automobile and renters insurance products
and services handled by our Specialty Personal Lines operating unit. During the fourth quarter of 2014, our Specialty
Personal Lines operating unit discontinued the low value dwelling/homeowners and manufactured homes insurance
products it previously offered. Our Specialty Personal Lines operating unit is comprised of AHGA and HCS.
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.
F‐26
HALLMARK FINANCIAL SERVICES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Years ended December 31, 2015, 2014, and 2013
AHIC, HIC, HSIC and HNIC have entered into a pooling arrangement, pursuant to which AHIC retains 34% of the net premiums written
by any of them, HIC retains 32% of the net premiums written by any of them, HSIC retains 24% of the net premiums written by any of
them and HNIC retains 10% of the net premiums written by any of them. Neither HCM nor TBIC is a party to the intercompany pooling
arrangement.
F‐27
HALLMARK FINANCIAL SERVICES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Years ended December 31, 2015, 2014, and 2013
The following is additional business segment information for the twelve months ended December 31, 2015, 2014 and 2013 (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)
Standard Commercial Segment
Specialty Commercial Segment
Personal Segment
Corporate
Consolidated
2015
2014
2013
76,864 $
249,910
45,538
90
372,402 $
81,464 $
241,920
20,404
(6,422)
337,366 $
83,306
229,734
71,081
5,307
389,428
136 $
2,537
779
64
3,516 $
‐ $
‐
‐
3,906
3,906 $
1,436 $
11,609
(1,345)
(1,677)
10,023 $
6,687 $
40,277
(885)
(14,193)
31,886 $
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
4,595 $
34,237
1,226
(21,276)
18,782 $
1,980
19,527
(3,416)
(7,011)
11,080
$
$
$
$
$
$
$
$
$
$
F‐28
HALLMARK FINANCIAL SERVICES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Years ended December 31, 2015, 2014, and 2013
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
2015
2014
$
$
156,722 $
660,263
239,632
19,983
1,076,600 $
145,355
590,852
222,183
22,479
980,869
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
Denominator, basic shares
Effect of dilutive securities:
Stock‐based compensation awards
Denominator, diluted shares
Basic earnings per share:
Diluted earnings per share:
2015
2014
2013
$
21,863 $
13,429 $
8,245
19,211
194
19,405
1.14 $
1.13 $
19,197
19,263
169
19,366
98
19,361
0.70 $
0.43
0.69 $
0.43
$
$
We had 267,500 shares, 544,999 shares and 779,999 shares of common stock potentially issuable upon exercise of employee stock
options for years ended December 31, 2015, 2014 and 2013, 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‐29
HALLMARK FINANCIAL SERVICES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Years ended December 31, 2015, 2014, and 2013
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 $68.3 million
as of December 31, 2015.
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 2016, the aggregate ordinary dividend capacity of these subsidiaries is $27.6 million, of which $18.5
million is available to Hallmark. As a county mutual, dividends from HCM are payable to policyholders. During the year ended
December 31, 2015 and 2014, respectively, our insurance company subsidiaries paid $8.0 million in dividends to Hallmark. The total
restricted net assets of our insurance company subsidiaries as of December 31, 2015, was $193.7 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 $1.3
million, $1.1 million and $8.2 million during each of 2015, 2014 and 2013, 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,
2015 and 2014, our insurance company subsidiaries reported statutory capital and surplus of $247.2 million and $210.0 million,
respectively, substantially greater than the minimum requirements for each state. For the years ended December 31, 2015, 2014,
2013, respectively, our insurance company subsidiaries reported statutory net income of $24.6 million, $22.3 million and $6.1 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, 2015, the adjusted capital under the risk‐based capital
calculation of each of our insurance company subsidiaries substantially exceeded the minimum requirements.
F‐30
HALLMARK FINANCIAL SERVICES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Years ended December 31, 2015, 2014, and 2013
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 and expired by its terms on May 27, 2015. As of December 31, 2015,
there were outstanding incentive stock options to purchase 564,956 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 289,830 shares of our
common stock. The exercise price of all such outstanding stock options is equal to the fair market value of our common stock on the
date of grant.
A new equity compensation plan for our key employees and non‐employee directors, the 2015 Long Term Incentive Plan (“2015
LTIP”), was approved by shareholders on May 29, 2015. There are 2,000,000 shares authorized for issuance under the 2015 LTIP. As
of December 31, 2015, restricted stock units representing the right to receive up to 155,027 shares of our common stock were
outstanding under the 2015 LTIP. There were no stock option awards granted under the 2015 LTIP as of December 31, 2015.
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 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, 2015 and changes during the year then ended is presented below:
Outstanding at January 1, 2015
Granted
Exercised
Forfeited or expired
Outstanding at December 31, 2015
Exercisable at December 31, 2015
Number of Shares
Weighted Average
Exercise Price
Average
Remaining
Contractual Term
(Years)
Aggregate
Instrinsic Value
($000)
1,062,134 $
‐
(91,827) $
(101,194) $
869,113 $
817,328 $
9.51
7.17
11.67
9.51
9.69
2.5 $
2.5 $
2,120
1,857
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 $
393 $
157 $
30 $
412 $
173 $
30 $
‐
207
30
2015
2014
2013
As of December 31, 2015, there was $39 thousand of total unrecognized compensation cost related to non‐vested stock options
granted under our plans which is expected to be recognized in 2016.
F‐31
HALLMARK FINANCIAL SERVICES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Years ended December 31, 2015, 2014, and 2013
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 2015, 2014 or 2013.
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 awarded under the 2005 LTIP 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 of our employees 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. On May 29,
2015, an aggregate of 103,351 restricted stock units were granted to certain employees under the 2015 LTIP.
The performance criteria for all restricted stock units require that we 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. Grantees of restricted stock units do not have
any rights of a stockholder, and do not participate in any distributions to our common stockholders, until the award fully vests upon
satisfaction of the vesting schedule, performance criteria and other conditions set forth in their award agreement. Therefore,
unvested restricted stock units are not considered participating securities under ASC 260, “Earnings Per Share,” and are not included
in the calculation of basic or diluted earnings per share.
On April 1, 2015, 8,616 shares of common stock were issued with respect to 8,616 restricted stock units which were granted on July
27, 2012 and vested on March 31, 2015. If and to the extent specified performance criteria have been achieved, the restricted stock
units granted on April 10, 2013 will vest on March 31, 2016, the restricted stock units granted on September 8, 2014 (except for one
grant) will vest on March 31, 2017, one grant of restricted stock units granted on September 8, 2014 will vest on March 31, 2018 and
the restricted stock units granted on May 29, 2015 under the 2015 LTIP will vest on March 31, 2018.
Compensation cost is measured as an amount equal to the fair value of the restricted stock units on the date of grant and is expensed
over the vesting period if achievement of the performance criteria is deemed probable, with the amount of the expense recognized
based on our best estimate of the ultimate achievement level. The grant date fair value 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 grant date fair
value of the restricted stock units granted in 2015 is $11.10 per unit. We incurred compensation expense of $226 thousand, $49
thousand and $145 thousand related to restricted stock units during the year ended December 31, 2015, 2014 and 2013, respectively.
We recorded an income tax benefit of $79 thousand, $17 thousand and $51 thousand related to restricted stock units during the year
ended December 31, 2015, 2014 and 2013, respectively.
A summary of the status of our restricted stock units as of December 31, 2015 and changes during the year then ended is presented
below:
F‐32
HALLMARK FINANCIAL SERVICES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Years ended December 31, 2015, 2014, and 2013
Nonvested at January 1, 2015
Granted
Vested
Forfeited
Nonvested at December 31, 2015
Number of Restricted
Stock Units
285,216
103,351
(8,616)
(83,380)
296,571
As of December 31, 2015, there was $0.8 million of total unrecognized compensation cost related to unvested restricted stock units
granted under our 2005 LTIP and 2015 LTIP, of which $0.4 million is expected to be recognized in 2016, $0.3 million is expected to be
recognized in 2017 and $0.1 million 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, 2015, 2014 and 2013 (in thousands)
using a measurement date of December 31.
F‐33
HALLMARK FINANCIAL SERVICES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Years ended December 31, 2015, 2014, and 2013
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
Benefit obligation as of end of period
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
2015
2014
2013
4.12%
N/A
3.86%
N/A
4.49%
N/A
$
$
$
(12,915)
(12,915)
10,419
(2,496)
(3,957)
(3,957)
1,461
$
$
$
(13,909)
(13,909)
11,290
(2,619)
(4,000)
(4,000)
1,381
(12,284)
(12,284)
10,851
(1,433)
(2,277)
(2,277)
844
(2,496)
$
(2,619)
$
(1,433)
$
13,909
518
(646)
(866)
$
12,284
532
1,947
(854)
13,439
505
(824)
(836)
12,915
$
13,909
$
12,284
$
11,290
(5)
‐
(866)
$
10,851
760
533
(854)
9,754
1,565
368
(836)
10,419
$
11,290
$
10,851
$
‐
518
(701)
103
$
‐
532
(698)
162
‐
505
(615)
495
(80)
$
(4)
$
385
3.86%
6.50%
N/A
4.49%
6.50%
N/A
3.89%
6.50%
N/A
$
$
$
$
$
$
$
$
$
$
F‐34
HALLMARK FINANCIAL SERVICES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Years ended December 31, 2015, 2014, and 2013
Estimated future benefit payments by fiscal year (in thousands):
2016
2017
2018
2019
2020
2021‐2025
$
$
$
$
$
$
899
913
907
896
881
4,205
As of December 31, 2015, the fair value of the plan assets was composed of cash and cash equivalents of $0.3 million, debt securities
of $3.4 million and equity securities of $6.7 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, 2015. 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 2016. We expect our 2016 periodic
pension cost to be $(21) thousand, the components of which are interest cost of $512 thousand, expected return on plan assets of
($645) thousand and amortization of actuarial loss of $112 thousand.
The following table shows the weighted‐average asset allocation for the defined benefit cash balance plan held as of December 31,
2015 and 2014.
Asset Category:
Debt securities
Equity securities
Other
Total
F‐35
December 31
2015
2014
33%
64%
3%
100%
33%
64%
3%
100%
HALLMARK FINANCIAL SERVICES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Years ended December 31, 2015, 2014, and 2013
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, 2015 and December 31, 2014 (in thousands).
As of December 31, 2015
Quoted Prices in Active
Markets for Identical
Assets (Level 1)
Other Observable
Inputs
(Level 2)
Unobservable Inputs
(Level 3)
$
$
- $
6,697
6,697 $
3,423 $
-
3,423 $
- $
-
- $
Total
3,423
6,697
10,120
As of December 31, 2014
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
Debt securities
Equity securities
Total
Debt securities
Equity securities
Total
Our plan assets also include cash and cash equivalents of $0.3 million and $0.4 million at December 31, 2015 and 2014, 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 for each of the years ended
December 31, 2015, 2014 and 2013.
F‐36
HALLMARK FINANCIAL SERVICES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Years ended December 31, 2015, 2014, and 2013
15.
Income Taxes:
The composition of deferred tax assets and liabilities and the related tax effects as of December 31, 2015 and 2014, 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
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
$
2015
2014
(7,128) $
(5,339)
(66)
(5,118)
(519)
(861)
(367)
(19,398)
10,592
298
1,385
426
6,920
297
421
759
1,120
540
22,758
(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
Deferred federal income taxes, net
$
3,360 $
(3,092)
We concluded that no valuation allowance was necessary to provide against our deferred tax assets as of December 31, 2015.
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, 2015, 2014 and 2013, 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
Current income tax expense
Deferred tax benefit
Income tax expense
F‐37
2015
2014
2013
$
$
$
$
11,160 $
32
(1,259)
(141)
176
55
10,023 $
11,053 $
(1,030)
10,023 $
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
HALLMARK FINANCIAL SERVICES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Years ended December 31, 2015, 2014, and 2013
We have available, for federal income tax purposes, unused net operating loss of $1.2 million at December 31, 2015. 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
2022 $
2028
2029
2031
2032
2033
2034
2035
$
878
2
25
45
77
73
59
57
1,216
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
2012. The Company recognizes interest and penalties related to uncertain tax positions in income tax expense. There were no
uncertain tax positions at December 31, 2015.
F‐38
HALLMARK FINANCIAL SERVICES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Years ended December 31, 2015, 2014, and 2013
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 $2.2 million, $2.3 million and $2.2 million for the
years ended December 31, 2015, 2014, and 2013, respectively.
Future minimum lease payments under non‐cancelable operating leases as of December 31, 2015 are as follows (in thousands):
Year
2016
2017
2018
2019
2020
2021 and thereafter
Total minimum lease payments (a)
$
$
2,065
1,899
1,563
1,482
1,442
1,015
9,466
(a) Minimum lease payments have not been reduced by minimum sublease rentals of $0.6
million due in the future under noncancelable subleases.
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 2015 or 2014.
During the third quarter of 2015 we paid $1.2 million in fulfillment of the contingent purchase price with the sellers of TBIC
Holding. The sellers have disputed the calculation of the amount paid and assert that an additional $1.8 million is due. We
disagree with this assertion and believe that our calculation of the contingent purchase price was substantially correct. Pursuant
to the terms of the acquisition agreement, an independent actuary has been engaged to resolve this matter.
In November 2015, HSU was informed by the Texas Comptroller of Public Accounts that a surplus lines tax audit covering the
period January 1, 2010 through December 31, 2013 was complete. HSU frequently acts as a managing general underwriter
(“MGU”) authorized to underwrite policies on behalf of Republic Vanguard Insurance Company and HSIC, both Texas eligible
surplus lines insurance carriers. In its role as the MGU, HSU underwrites policies on behalf of these carriers while other agencies
located in Texas (generally referred to as “producing agents”) deliver the policies to the insureds and collect all premiums due
from the insureds. During the period under audit, the producing agents also collected the surplus lines premium taxes due on the
policies from the insureds, held them in trust, and timely remitted those taxes to the Comptroller. We believe this system for
collecting and paying the required surplus lines premium taxes complies in all respects with the Texas Insurance Code and other
regulations, which clearly require that the same party who delivers the policies and collects the premiums will also collect
premium taxes, hold premium taxes in trust, and pay premium taxes to the Comptroller. It also complies with long standing
industry practice. In addition, effective January 1, 2012 the Texas Legislators enacted House Bill 3410 (HB3410) which allows an
MGU to contractually pass the collection, payment and administration of surplus lines taxes down to another Texas licensed
surplus line agent.
The Comptroller asserts that HSU is liable for the surplus lines premium taxes related to policy transactions and premiums
collected from surplus lines insureds during January 1, 2010 through December 31, 2011, the period prior to the passage of
HB3410, and that HSU therefore owes $2.5 million in premium taxes, as well as $0.7 million in penalties and interest for the audit
period.
We disagree with the Comptroller and intend to vigorously fight their assertion that HSU is liable for the surplus lines premium
taxes. We are currently in negotiations with the Comptroller to settle the matter. However, we are presently unable to reasonably
F‐39
HALLMARK FINANCIAL SERVICES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Years ended December 31, 2015, 2014, and 2013
estimate the possible loss or legal costs that are likely to arise out of the surplus lines tax audit or any future proceedings relating
to this matter. Therefore we have not accrued any amount as of December 31, 2015 related to this matter.
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, 2015, 2014, and 2013
17.
Changes in Accumulated Other Comprehensive Income Balances:
The changes in accumulated other comprehensive income balances as of December 31, 2015, 2014, and 2013 were as follows (in
thousands):
Balance at January 1, 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
Balance at December 31, 2013
Other comprehensive income:
Change in net actuarial loss
Tax effect on change in net actuarial loss
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
Balance at December 31, 2014
Other comprehensive loss:
Change in net actuarial gain
Tax effect on change in net actuarial gain
Unrealized holding losses arising during the period
Tax effect on unrealized losses 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 loss, net of tax
Pension
Liability
Unrealized
Gains (Loss)
Accumulated Other
Comprehensive
Income (Loss)
$
(2,954) $
10,853 $
7,899
2,268
(794)
‐
‐
‐
‐
1,474
‐
‐
22,094
(7,733)
(10,540)
3,689
7,510
2,268
(794)
22,094
(7,733)
(10,540)
3,689
8,984
$
(1,480) $
18,363 $
16,883
(1,723)
603
‐
‐
‐
‐
(1,120)
‐
‐
3,543
(1,240)
(408)
143
2,038
(1,723)
603
3,543
(1,240)
(408)
143
918
$
(2,600) $
20,401 $
17,801
43
(15)
‐
‐
‐
‐
(10,191)
3,567
‐
(5,826)
‐
28
2,039
(10,411)
43
(15)
(10,191)
3,567
(5,826)
2,039
(10,383)
7,418
Balance at December 31, 2015
$
(2,572) $
9,990 $
F‐41
HALLMARK FINANCIAL SERVICES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Years ended December 31, 2015, 2014, and 2013
18.
Concentrations of Credit Risk:
We maintain cash and cash equivalents in accounts with four 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, 2015.
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, 2015 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, 2015 and 2014 (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.
2015
2014
Q1
Q2
Q3
Q4
Q1
Q2
Q3
Q4
Total revenue
Total expense
Income before tax
Income tax expense
Net income
$ 91,450 $ 97,197 $ 93,684 $ 90,071 $ 87,109 $ 80,836 $ 81,417 $ 88,004
82,404
5,600
1,833
80,697
6,412
1,864
83,849
9,835
3,137
76,689
4,728
1,265
83,761
7,689
2,346
78,794
2,042
391
84,984
5,087
1,641
87,922
9,275
2,899
$
5,343
6,376 $
6,698
3,446 $
4,548
1,651 $
3,463
3,767
Basic earnings per share:
$
0.28 $
0.33 $
0.35 $
0.18 $
0.24 $
0.09 $
0.18 $
0.20
Diluted earnings per share:
$
0.28 $
0.33 $
0.35 $
0.17 $
0.23 $
0.09 $
0.18 $
0.19
F‐42
Schedule II – Condensed Financial Information of Registrant (Parent Company Only)
FINANCIAL STATEMENT SCHEDULES
HALLMARK FINANCIAL SERVICES, INC.
BALANCE SHEETS
December 31, 2015 and 2014
(In thousands)
ASSETS
2015
2014
Cash and cash equivalents
Investment in subsidiaries
Deferred federal income taxes
Other assets
Total assets
LIABILITIES AND STOCKHOLDERS’ EQUITY
Liabilities:
Revolving credit facility payable
Subordinated debt securities
Current federal income tax payable
Accounts payable and other accrued expenses
Total liabilities
Stockholders’ equity:
Common stock, $.18 par value, authorized 33,333,333 shares; issued 20,872,831 shares in
Additional paid‐in capital
Retained earnings
Accumulated other comprehensive income
Treasury stock (1,775,512 shares in 2015 and 1,655,306 in 2014), at cost
Total stockholders’ equity
Total liabilities and stockholders’ equity
$
$
$
8,014 $
361,769
942
4,488
375,213 $
30,000 $
56,702
72
26,413
113,187
3,757
123,480
141,501
7,418
(14,130)
262,026
11,839
325,608
747
4,061
342,255
‐
56,702
64
33,452
90,218
3,757
123,194
119,638
17,801
(12,353)
252,037
$
375,213 $
342,255
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, 2015, 2014 and 2013
(In thousands)
2015
2014
2013
Investment income (loss), net of expenses
$
Dividend income from subsidiaries
Management fee income
Total revenues
Operating expenses
Interest expense
Total expenses
Income (loss) before equity in undistributed earnings (loss) of subsidiaries
and income tax benefit
Income tax benefit
Income (loss) before equity in undistributed earnings of subsidiaries
Equity in undistributed share of earnings in subsidiaries
120 $
8,000
10,053
18,173
10,222
3,906
14,128
4,045
(1,273)
5,318
16,545
133 $
8,000
9,614
17,747
9,759
4,576
14,335
3,412
(1,623)
5,035
8,394
Net income
Comprehensive income
$
$
21,863 $
13,429 $
11,480 $
14,347 $
See accompanying report of independent registered public accounting firm.
(190)
‐
8,518
8,328
7,764
4,599
12,363
(4,035)
(1,227)
(2,808)
11,053
8,245
17,229
F‐44
FINANCIAL STATEMENT SCHEDULES
Schedule II (Continued) – Condensed Financial Information of Registrant (Parent Company Only)
HALLMARK FINANCIAL SERVICES, INC.
STATEMENTS OF CASH FLOWS
For the years ended December 31, 2015, 2014 and 2013
(In thousands)
Cash flows from operating activities:
Net income
Adjustments to reconcile net income to cash provided by operating activities:
Depreciation and amortization expense
Deferred income tax (benefit) expense
Undistributed share of earnings of subsidiaries
Change in current federal income tax payable (recoverable)
Change in all other liabilities
Change in all other assets
Net cash (used in) provided by operating activities
Cash flows from investing activities:
Purchases of property and equipment, net
Capital contribution to subsidiaries
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
Payment of debt issuance costs
Net cash provided by (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 (recovered) paid
2015
2014
2013
$
21,863 $
13,429 $
8,245
65
(195)
(16,545)
8
(7,039)
147
(1,696)
(159)
(30,000)
(30,159)
658
(2,532)
30,000
(96)
28,030
(3,825)
11,839
8,014 $
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
11,839 $
3,906 $
4,576 $
(1,086) $
1,481 $
92
1,182
(11,053)
(3,694)
12,232
63
7,067
(116)
‐
(116)
‐
‐
‐
‐
‐
6,951
1,112
8,063
4,599
1,285
$
$
$
See accompanying report of independent registered public accounting firm.
F‐45
Schedule III ‐ Supplementary Insurance Information
(In thousands)
Column A
Segment
Column B Column C
Column D Column E Column F Column G Column H
Column I
Column J Column K
Future Policy
Benefits,
Losses,
Claims, and
Loss
Adjustment
Expenses
Deferred
Policy
Acquisition
Costs
Other
Policy
Claims
and
Benefits
Payable
Premium
Revenue
Unearned
Premiums
Benefits,
Claims,
Losses and
Settlement
Expenses
Amortization
of Deferred
Policy
Acquisition
Costs
Net
Investment
Income
Other
Operating
Expenses
Net
Premiums
Written
2015
Personal Segment
Standard Commercial
Specialty Commercial
Segment
Corporate
$
1,232 $
5,633
29,932 $
105,971
20,976 $
33,701
‐ $ 38,828 $
72,613
‐
1,235 $
3,623
34,414 $
47,071
5,066 $
4,237
12,205 $ 44,072
71,097
22,820
13,501
‐
314,975
‐
161,730
‐
‐ 237,640
‐
‐
11,524
(2,413)
148,664
‐
23,371
‐
58,212
10,377
241,775
‐
Consolidated
$
20,366 $
450,878 $
$
‐ $
$
13,969 $
$
32,674 $
$
2014
Personal Segment
Standard Commercial
Specialty Commercial
Segment
Corporate
$
729 $
29,595 $
5,892
109,672
15,483 $
34,822
‐ $ 14,083 $
78,311
‐
1,633 $
4,663
8,964 $
51,130
9,315 $
3,389
9,977 $ 16,802
76,912
25,479
14,125
‐
275,868
‐
146,521
‐
‐ 228,823
‐
‐
12,643
(6,556)
149,961
‐
28,186
‐
53,851
10,279
230,638
‐
Consolidated
$
20,746 $
415,135 $
$
‐ $
$
12,383 $
$
40,890 $
99,586 $
2013
Personal Segment
Standard Commercial
Specialty Commercial
Segment
Corporate
$
660 $
38,294 $
6,124
111,473
17,989 $
36,309
‐ $ 63,800 $
78,176
‐
2,065 $
5,031
52,656 $
56,143
17,759 $
8,254
16,957 $ 45,644
79,466
25,313
15,802
‐
232,873
‐
131,005
‐
‐ 218,565
‐
‐
11,021
(5,233)
152,546
‐
31,264
‐
56,974
7,720
235,655
‐
Consolidated
$
22,586 $
382,640 $
$
‐ $
$
12,884 $
$
57,277 $
$
See accompanying report of independent registered public accounting firm.
F‐46
Schedule IV – Reinsurance
(In thousands)
Year Ended December 31, 2015
Life insurance in force
Premiums
Life insurance
Accident and health insurance
Property and liability insurance
Title Insurance
Total premiums
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
FINANCIAL STATEMENT SCHEDULES
Column B Gross
Amount
Column C Ceded to
Other Companies
$
‐
‐
$
$
$
‐
‐
494,643
‐
‐
‐
145,562
‐
494,643
$
145,562
$
Column D Assumed
from Other
Companies
Column E Net
Amount
Column F
Percentage of
Amount Assumed
to Net
‐
$
‐
‐
‐
‐
‐
‐
$
‐
‐
349,081
‐
0.00%
$
349,081
0.00%
‐
$
‐
$
‐
$
‐
‐
‐
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
0.10%
0.10%
0.89%
0.89%
$
$
$
$
$
$
$
$
$
See accompanying report of independent registered public accounting firm.
F‐47
Schedule VI ‐ Supplemental Information Concerning Property‐Casualty Insurance Operations
FINANCIAL STATEMENT SCHEDULES
(In thousands)
Column A
Column B Column C Column Column E Column F Column G
Column H
Column I
Column J Column K
Reserves
for Unpaid
Claims and
Claim
Adjustment
Expenses
Discount
if any,
Deducted
In
Column C
Deferred
Policy
Acquisition
Costs
Unearned
Premiums
Earned
Premiums
Net
Investment
Income
Amortization
of Deferred
Policy
Acquisitions
Costs
Paid Claims
and Claims
Adjustment
Expenses
Net
Premiums
Written
Claims and Claim
Adjustment
Expenses Incurred
Related to
(1)
Current
(2) Prior
Years
Affiliation With
Registrant
(a)
Consolidated
property‐
2015
2014
2013
$ 20,366 $ 450,878 $
$ 20,746 $ 415,135 $
$ 22,586 $ 382,640 $
$
‐ $ 216,407 $ 349,081 $ 13,969 $ 237,102 $
‐ $ 196,826 $ 321,217 $ 12,383 $ 215,258 $
$
‐ $ 185,303 $ 360,541 $ 12,884 $ 251,391 $ 9,954 $
32,674 $ 205,254 $ 356,944
40,890 $ 199,331 $ 324,352
57,277 $ 212,709 $ 360,765
See accompanying report of independent registered public accounting firm.
F‐48
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