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Contract
Binding
Specialty
Brokerage
Personal Lines
Standard Commercial*
2014
2015
2016
*
)
E
O
R
(
y
t
i
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-20%
16%
8%
6%
16%
9%
-2%
14%
11%
-17%
FY 2014
FY 2015
FY 2016
Specialty Commercial
Standard Commercial
Personal Lines
Naveen Anand
President and Chief Executive Officer
April 12, 2016
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, 2016
Or
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from _________________________ to _________________________________
Commission file number 001-11252
Hallmark Financial Services, Inc.
(Exact name of registrant as specified in its charter)
Nevada
(State or Other Jurisdiction of Incorporation or Organization)
777 Main Street, Suite 1000, Fort Worth, Texas
(Address of Principal Executive Offices)
87-0447375
(I.R.S. Employer Identification No.)
76102
(Zip Code)
Registrant's Telephone Number, Including Area Code: (817) 348-1600
Securities registered pursuant to Section 12(b) of the Act:
Title of Each Class
Common Stock $.18 par value
Name of Each Exchange on Which Registered
Nasdaq Global Market
Securities registered pursuant to Section 12(g) of the Act: None
Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.
Yes No
Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act.
Yes No
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the
Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to
file such reports), and (2) has been subject to such filing requirements for the past 90 days.
Yes No
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every
Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter)
during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).
Yes No
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will
not be contained, to the best of the registrant's knowledge, in definitive proxy or information statements incorporated by
reference in Part III of this Form 10-K or any amendment to this Form 10-K.
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer or a
smaller reporting company. See definition of “accelerated filer”, “large accelerated filer” and “smaller reporting company” in
Rule 12b-2 of the Exchange Act. (Check one):
Large accelerated filer
Smaller reporting company
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes No
Non-accelerated filer
Accelerated filer
State the aggregate market value of the voting and non-voting common equity held by non-affiliates computed by reference to
the price at which the common equity was last sold, or the average bid and asked price of such common equity, as of the last
business day of the registrant’s most recently completed second fiscal quarter. $ 157.3 million
Indicate the number of shares outstanding of each of the registrant's classes of common stock, as of the latest practicable date.
18,616,982 shares of common stock, $.18 par value per share, outstanding as of March 9, 2017.
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,” “us” and the “Company” 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 specialty commercial insurance, standard 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
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 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, the Workers Compensation operating unit no longer markets or retains any risk on new or
renewal policies. 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 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
coverages. Our MGA Commercial Products operating unit markets its products in 22 states through 12 wholesale brokers and
90 general agency offices, as well as 63 independent retail agents in Texas and Oregon.
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,
3
manufacturing, hospitality and service (non-transportation). Typical risks range from one power unit to fleets of up to 200
power units and up to $150 million in receipts (non-construction) or $75 million in receipts (construction) from operations.
Public entity excess coverage is also offered on an insurance and reinsurance basis for cities, counties and other public entities
with populations up to 1,000,000. Our Specialty Commercial operating unit markets these excess & umbrella products through
132 wholesale brokers in all 50 states. The aircraft liability and hull insurance products underwritten by our Specialty
Commercial operating unit target standard general aviation aircraft risks. Airport liability insurance is marketed to smaller,
regional airports. Our Specialty Commercial operating unit markets these general aviation insurance products through 173
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 lines basis by our Specialty Commercial operating unit focuses on
standard risk healthcare professionals as well as those who 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. In
addition to healthcare professionals, our Specialty Commercial operating unit also underwrites medical professional liability for
medical facilities. These are generally outpatient facilities such as surgery centers, imaging centers, labs, home health agencies,
and other non-hospital facilities providing medical services. 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 36
wholesale brokers in 50 states.
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 330 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. Effective June 1, 2016, we no longer market new or
renewal occupational accident policies.
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 actively markets and services these policies through 3,488 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 Specialty
Commercial Segment includes our MGA Commercial Products operating unit and Specialty Commercial operating unit. The
Standard Commercial Segment consists of the Standard Commercial P&C operating unit and the Workers Compensation
operating unit. 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, 2016, 2015 and 2014.
4
Gross Premiums Written:
Specialty Commercial Segment
Standard Commercial Segment
Personal Segment
Total
Net Premiums Written:
Specialty Commercial Segment
Standard Commercial Segment
Personal Segment
Total
$
$
$
$
2016
Year Ended December 31,
2015
(dollars in thousands)
2014
388,914 $
76,891
83,272
549,077 $
249,072 $
68,490
44,267
361,829 $
351,050 $
81,892
81,281
514,223 $
241,775 $
71,097
44,072
356,944 $
324,547
84,679
63,992
473,218
230,638
76,912
16,802
324,352
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, 2016.
Specialty Commercial Segment
The Specialty Commercial Segment of our business includes our MGA Commercial Products operating unit and our Specialty
Commercial operating unit. During 2016, our MGA Commercial Products operating unit accounted for 56% and our Specialty
Commercial operating unit accounted for 44% of the aggregate premiums produced by the Specialty Commercial Segment.
MGA Commercial Products operating unit. Our MGA Commercial Products operating unit markets, underwrites, finances and
services commercial lines insurance in 22 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 87% 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 2016, commercial automobile, general liability and all other property &
casualty accounted for 86%, 10% 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
6
case with aggregate property limits of less than $1,000,000. 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 22 states through 12 wholesale brokers and 90 general
agency offices, as well as 63 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 2016, general agents produced 90%, retail agents produced 3% and wholesale brokers produced 7% of
total premiums produced by our MGA Commercial Products operating unit. During 2016, the top ten general agents produced
40%, the twelve wholesale brokers produced 7% and no general agent produced more than 9%, of the total premium volume of
our MGA Commercial Products operating unit. During the same period, the top ten retail agents produced 3%, 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, public entity 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. Certain specialty programs are also managed by our
Specialty Commercial operating unit.
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 all 50 states plus the District of Columbia. Limits
7
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 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. During 2016, the top ten wholesale brokers accounted for 43% of our primary
and excess casualty premium volume, with no single wholesale broker accounting for more than 10%. During 2016, commercial
transportation excess liability risks accounted for 82% of the premiums, with the remaining 18% coming from non-
transportation commercial excess, public entity 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 employer’s liability policies, and for some claims excluded by their primary policies (subject to a
deductible). Umbrella insurance provides not only higher limits, but catastrophic protection for large losses.
Commercial general liability. General liability insurance provides coverage for third-party bodily injury and
property damage claims arising from accidents occurring on the insured’s premises or from their general business
operations.
We 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 173 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 2016, the top ten independent specialty brokers produced 35%, 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 standard general aviation risks for both commercial (non-airline) and non-commercial uses. 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 2016 bearing per-occurrence limits of $1,000,000 and per-passenger limits of $100,000 or less. The average insured
8
aircraft hull value for aircraft written in 2016 was approximately $125,000. 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, as well as outpatient medical facilities. Our
Specialty Commercial operating unit distributes its medical professional liability insurance products through 26 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 36 wholesale brokers in 50 states. We presently cede 80% 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.
The specialty programs within our Specialty Commercial operating unit consist of fronting and agency arrangements, as well as
a program underwriter. The specialty programs business presently consists primarily of a fronting arrangement in Texas for a
third party insurance company and a program underwriter writing primarily commercial auto liability and physical damage risk
in 18 states.
Standard Commercial Segment
The Standard Commercial Segment of our business includes our Standard Commercial P&C operating unit and our Workers
Compensation operating unit. Effective July 1, 2015, our Workers Compensation operating unit no longer markets or retains
any risk on new or renewal policies. During 2016, our Standard Commercial P&C operating unit accounted for 99% and our
Workers Compensation operating unit accounted for the remaining 1% 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. Effective June 1, 2016, we no longer market new or renewal occupational accident
policies. Products offered by our Standard Commercial P&C 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.
•
•
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.
9
•
•
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. Effective June 1, 2016, we no longer market new or renewal occupational accident policies.
Occupational accident
Our Standard Commercial P&C operating unit markets its property/casualty insurance products through 330 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 18 agency groups that each
produced more than $1.0 million in premium during the year ended December 31, 2016. During 2016, the top ten agency
groups produced 39%, and no individual agency group produced more than 9%, 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 include 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.
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. During the
fourth quarter of 2014, the 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 provides
management, policy and claims administration services and includes the operations of American Hallmark General Agency, Inc.
and Hallmark Claims Services, Inc. Our non-standard personal automobile insurance generally provides for the minimum limits
of liability coverage mandated by state laws to drivers who find it difficult to purchase automobile insurance from standard
carriers as a result of various factors, including driving record, vehicle, age, claims history, or limited financial resources.
Products offered by our 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.
10
• 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 3,488 independent retail agents operating in its target
geographic markets. Non-standard automobile represented 97% of the premiums produced during 2016. 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 2016, the top ten independent agency groups produced 23%, and no individual agency group produced more
than 4%, of the total premium volume of our Specialty Personal Lines operating unit.
During 2016, personal automobile liability coverage accounted for 74% and personal automobile physical damage coverage
accounted for the remaining 26% 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 on a limited basis. 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.
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.
11
•
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.
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.
12
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, 2016, five states accounted for
59% 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, 2016.
State
Texas
Louisiana
Arizona
Oklahoma
New Mexico
All other states
$
Specialty
Commercial
Segment
Standard
Commercial
Segment
Personal
Segment
Total
Percent of
Total
187,500 $
24,618
2,140
11,938
1,138
161,580
(dollars in thousands)
22,139 $
23,094 $
-
-
-
8,544
46,208
-
22,430
10,581
10,047
17,120
232,733
24,618
24,570
22,519
19,729
224,908
42.4%
4.5%
4.5%
4.1%
3.5%
41.0%
Total gross premiums written
$
388,914 $
76,891 $
83,272 $
549,077
Percent of total
Underwriting
70.8%
14.0%
15.2%
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.
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.
13
Year Ended December 31,
2016
2015
2014
Gross premiums written
$
549,077 $
514,223 $
473,218
Net statutory loss & LAE ratio
Net statutory expense ratio
Net statutory combined ratio
71.2%
29.4%
100.6%
65.4%
30.6%
96.0%
64.8%
33.1%
97.9%
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, 2016, 2015 and 2014, our consolidated premium-to-surplus ratios
were 146%, 144% and 154%, 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, 2016, our operating units had a total of 86
claims managers, supervisors and adjusters with an average experience of approximately 16 years.
Analysis of Losses and LAE
Our consolidated financial statements include an estimated reserve for unpaid losses and LAE. We estimate our reserve for
unpaid losses and LAE by using case-basis evaluations and statistical projections, which include inferences from both losses paid
and losses incurred. We also use recent historical cost data and periodic reviews of underwriting standards and claims
management practices to modify the statistical projections. We give consideration to the impact of inflation in determining our
loss reserves, but do not discount reserve balances.
The amount of reserves represents our estimate of the ultimate cost of all unpaid losses and LAE incurred. These estimates are
subject to the effect of trends in claim severity and frequency. We regularly review the estimates and adjust them as claims
14
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.
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, 2016, 2015 and 2014, to the gross-of-
reinsurance amounts reported in our balance sheets at December 31, 2016, 2015 and 2014.
As of and for Year Ended December 31
2016
2015
(dollars in thousands)
2014
Reserve for unpaid losses and LAE, net of reinsurance recoverables,
January 1
$
348,087 $
323,192 $
312,468
Provision for losses and LAE for claims occurring in the current period
246,080
237,102
215,258
Increase (decrease) in reserve for unpaid losses and LAE for claims
occurring in prior periods
7,608
(6,953)
(5,203)
Payments for losses and LAE, net of reinsurance:
Current period
Prior periods
Reserve for unpaid losses and LAE at December 31, net of
reinsurance recoverable
Reinsurance recoverable on unpaid losses and LAE at
December 31
Reserve for unpaid losses and LAE at December 31, gross of
reinsurance
(93,067)
(83,132)
(76,231)
(150,378)
(122,122)
(123,100)
358,330
348,087
323,192
123,237
102,791
91,943
$
481,567 $
450,878 $
415,135
The $7.6 million unfavorable net development, $7.0 million favorable net development and $5.2 million favorable net
development in prior accident years recognized in 2016, 2015 and 2014, respectively, represent normal changes in our loss
reserve estimates. In 2016, 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. 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. 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 $7.6 million increase in prior period reserves for unpaid losses and LAE recognized in 2016 was attributable to $5.3 million
favorable net development on claims incurred in the 2015 accident year, $3.9 million unfavorable net development on claims
incurred in the 2014 accident year and $9.0 million unfavorable net development on claims incurred in the 2013 and prior
accident years. Our MGA Commercial Products operating unit, Specialty Personal Lines operating unit and Specialty
Commercial operating unit accounted for $11.3 million, $5.0 million, and $1.2 million, respectively, of the increase in prior
period reserves recognized during 2016. The increase in reserves for our MGA Commercial operating unit was primarily related
to our commercial auto liability line of business. The increase in reserves for our Specialty Personal Lines operating unit was
primarily attributable to the 2015, 2014 and 2013 and prior accident years. The increase in reserves for our Specialty
15
Commercial operating unit was primarily related to $0.9 million unfavorable development in our medical professional liability
products and $0.7 million related to our commercial auto liability specialty program, partially offset by $0.3 million favorable
development in our general aviation line of business and $0.1 million favorable development in our commercial excess liability
line of business. These unfavorable developments were partially offset by favorable development of $6.6 million in our
Standard Commercial P&C operating unit and $3.3 in our Workers Compensation operating unit. 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
prior period reserves for our Workers Compensation operating unit was attributable to the 2015, 2014, 2013 and prior accident
years.
The $7.0 million decrease in prior period 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 and Specialty Commercial operating unit
accounted for $5.4 million, $2.0 million and $3.4 million, respectively, of the decrease in prior period 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 $1.4 million in our commercial auto liability specialty program, $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. 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 and unfavorable development of $1.2 million in our MGA Commercial Products operating unit primarily related to
our commercial auto liability line of business.
The $5.2 million decrease in prior period 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 $1.6 million, respectively, of the
decrease in prior period 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, $0.6 million related to our commercial auto liability specialty program 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 $5.3 million in our MGA Commercial Products operating unit primarily related to our commercial auto liability
and general liability lines of business.
Analysis of loss and LAE reserve development. The following table shows the development of our loss reserves, net of
reinsurance, for years ended December 31, 2006 through 2016. 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.
16
ANALYSIS OF LOSS AND LAE DEVELOPMENT
As of and for Year Ended December 31
2006
2007
2008
2009
2010
2011
2012
2013
2014
2015
2016
72,801 $
120,849 $
150,025 $ 176,250 $ 213,723 $
254,901 $
263,832 $
312,468 $
323,192 $ 348,087 $
358,330
66,387
119,034 151,645 185,440 230,089 251,226 273,786 307,265 316,239 355,695
68,490
118,646 155,155 183,689 226,856 256,198 275,778 307,793 329,158
68,809
120,444 154,738 181,268 230,145 253,814 274,704 316,766
69,847
119,771 155,520 185,848 227,555 251,968 272,542
71,879
123,949 158,842 184,995 227,357 250,349
78,396
128,006 159,151 185,666 239,551
79,939
128,907 159,747 194,083
80,439
129,724 161,843
81,737
131,311
87,568
(14,767) (10,462) (11,818)
(17,833)
(25,828)
4,552
(8,710)
(4,298)
(5,966)
(7,608)
30,061
46,860
50,458 64,810 73,647 105,848 109,538 110,812 123,100 122,122 150,378
78,314 95,385 121,222 156,176 163,803 174,684 194,925 209,484
58,322
93,286 120,133 146,956 188,044 200,637 209,619 261,379
65,084
105,251 131,912 162,704 207,484 216,349 238,192
71,082
112,029 140,618 172,330 220,627 229,408
75,225
118,171 146,581 179,880 226,459
75,141
122,410 152,232 185,104
83,865
126,144 156,844
85,724
128,671
87,292
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
D. Cumulative amount of claims
paid, net of reserve recoveries
One year later
Two years later
Three years later
Four years later
Five years later
Six years later
Seven years later
Eight years later
Nine years later
Ten years later
Net reserve-December 31
72,801
120,849 150,025 176,250 213,723 254,901 263,832 312,468 323,192 348,087
358,330
Reinsurance recoverables
4,763
4,489
6,338
8,412 37,954 42,044
49,584
70,172 91,943 102,791 123,237
Gross reserve-December 31
77,564
125,338 156,363 184,662 251,677 296,945 313,416 382,640 415,135 450,878
481,567
Net re-estimated reserve
Re-estimated reinsurance
recoverable
87,568
131,311
161,843 194,083 239,551 250,349 272,542 316,766 329,158 355,695
7,048
6,494
7,975
7,123
27,053
35,971
40,685
63,474
85,436 107,616
Gross re-estimated reserve
94,616
137,805
169,818 201,206 266,604 286,320 313,227 380,240 414,594 463,311
Gross cumulative redundancy
(deficiency)
(17,052) $ (12,467) $ (13,455) $ (16,544) $ (14,927) $ 10,625 $
$
189
$
2,400
$
541
$ (12,433)
17
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, 2016 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
2016
2015
2014
549,077 $
(187,248)
514,223 $
(157,279)
473,218
(148,866)
361,829 $
356,944 $
324,352
524,229 $
(170,859)
353,370 $
116,057 $
494,643 $
(145,562)
461,694
(140,477)
349,081 $
321,217
89,892 $
99,911
$
$
$
$
$
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, equity securities and other investments.
As of December 31, 2016, we had total invested assets of $654.1 million. If market rates were to increase by 1%, the fair value
of our fixed-income securities as of December 31, 2016 would decrease by approximately $17.8 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,
2016 and 2015.
18
As of December 31, 2016
Fair
Value
Percent of
Total
Yield
As of December 31, 2015
Percent of
Total
Fair
Value
Yield
(in thousands)
(in thousands)
Category:
Corporate bonds
$
Collateralized corporate bank loans
Municipal bonds
US Treasury securities and obligations
of U.S. Government
Mortgage backed
226,062
106,009
163,895
42,022
59,469
37.8%
17.8%
27.4%
7.0%
10.0%
3.0% $
3.5%
4.4%
121,709
81,596
192,368
1.2%
2.4%
76,269
59,383
22.9%
15.4%
36.2%
14.3%
11.2%
3.0%
4.6%
2.7%
0.8%
2.0%
Total
$
597,457
100.0%
3.3% $
531,325
100.0%
2.7%
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 BBB+ at December 31, 2016. 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, 2016 and 2015:
As of
December 31, 2016
As of
December 31, 2015
Rating:
"AAA"
"AA"
"A"
"BBB"
"BB"
"B"
"CCC"
"CC"
"NR"
Total
10.1%
34.8%
10.2%
27.9%
9.8%
0.8%
2.0%
0.0%
4.4%
100.0%
9.5%
22.4%
7.4%
39.8%
12.6%
0.9%
0.1%
1.6%
5.7%
100.0%
19
The following table shows the composition of our fixed-income portfolio by remaining time to maturity as of December 31,
2016 and 2015.
As of December 31, 2016
As of December 31, 2015
Fair Value
(in thousands)
Percentage of
Total
Fair Value
Percentage of
Total
Fair Value
Fair Value
(in thousands)
Remaining time to maturity:
Less than one year
One to five years
Five to ten years
More than ten years
Mortgage-backed
$
97,849
272,168
115,248
52,723
59,469
16.4% $
45.5%
19.3%
8.8%
10.0%
76,560
234,213
101,387
59,782
59,383
14.4%
44.1%
19.1%
11.2%
11.2%
Total
$
597,457
100.0% $
531,325
100.0%
Our investment strategy is to conservatively manage our investment portfolio by investing primarily in readily marketable,
investment-grade, fixed-income securities. As of December 31, 2016, 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, 2016.
Category
U.S. Treasury securities and obligations of U.S. Government
Corporate bonds
Collateralized corporate bank loans
Municipal bonds
Mortgage-backed
Equity securities
Other investments
Total
Net Unrealized Gain Balance
(in thousands)
$
$
46
1,147
789
(2,005)
(304)
20,262
1,188
21,123
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.
20
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 3,037 property/casualty insurance companies
and 2,062 property/casualty insurance groups operating in North America as of July 12, 2016. The primary competition for our
MGA Commercial Products operating unit includes such carriers as Canal Insurance Company, Global Hawk Insurance Company,
National Casualty Company, National Liability & Fire Insurance Company, Northland Insurance Company, Progressive County
Mutual, State National Insurance Company and Underwriters at Lloyds of London. 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 Chubb Westchester, Aspen Insurance, Axis Insurance Company, Endurance Specialty Holdings, Ltd., Liberty Insurance
Underwriters and Markel Insurance Company. 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. Although our Specialty Personal Lines operating unit competes with large national insurers such as Allstate Corporation,
GEICO Corporation and Progressive Insurance Company, as a participant in the non-standard personal automobile marketplace
21
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 their available surplus funds that is derived from realized net
profits on their business. Without prior written approval from the Arizona Department of Insurance, HIC and HNIC may not pay
extraordinary dividends, which are defined as dividends or distributions of cash or other property the fair market value of which
combined with the fair market value of each other dividend or distribution made in the preceding 12 months exceeds the lesser
of: (1) 10% of statutory policyholders’ surplus as of the prior December 31 or (2) net investment income as of the prior
December 31. HSIC, domiciled in Oklahoma, may only pay dividends out of that part of its available surplus funds that is derived
from realized net profits on its business. Without prior written approval from the Oklahoma Insurance Department, HSIC may
22
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, 2016, 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.
23
Unfair claims practices. Generally, insurance companies, adjusting companies and individual claims adjusters are prohibited by
state statutes from engaging in unfair claims practices on a flagrant basis or with such frequency to indicate a general business
practice. Examples of unfair claims practices include:
•
•
•
•
•
•
•
•
•
•
•
•
misrepresenting pertinent facts or insurance policy provisions relating to coverages at issue;
failing to acknowledge and act reasonably promptly upon communications with respect to claims arising
under insurance policies;
failing to adopt and implement reasonable standards for the prompt investigation and settlement of claims
arising under insurance policies;
failing to affirm or deny coverage of claims within a reasonable time after proof of loss statements have
been completed;
attempting to settle a claim for less than the amount to which a reasonable person would have believed
such person was entitled;
attempting to settle claims on the basis of an application that was altered without notice to, or knowledge
and consent of, the insured;
compelling insureds to institute suits to recover amounts due under policies by offering substantially less
than the amounts ultimately recovered in suits brought by them;
refusing to pay claims without conducting a reasonable investigation;
making claim payments to an insured without indicating the coverage under which each payment is being
made;
delaying the investigation or payment of claims by requiring an insured, claimant or the physician of either
to submit a preliminary claim report and then requiring the subsequent submission of formal proof of loss
forms, both of which submissions contain substantially the same information;
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, 2016, we employed 420 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.
24
Item 1A. Risk Factors.
Our success depends on our ability to price accurately the risks we underwrite.
Our results of operations and financial condition depend on our ability to underwrite and set premium rates accurately for a
wide variety of risks. Adequate rates are necessary to generate premiums sufficient to pay losses, loss settlement expenses and
underwriting expenses and to earn a profit. To price our products accurately, we must collect and properly analyze a substantial
amount of data; develop, test and apply appropriate pricing techniques; closely monitor and timely recognize changes in
trends; and project both severity and frequency of losses with reasonable accuracy. Our ability to undertake these efforts
successfully, and as a result price our products accurately, is subject to a number of risks and uncertainties, some of which are
outside our control, including:
•
•
•
•
the availability of sufficient reliable data and our ability to properly analyze available data;
the uncertainties that inherently characterize estimates and assumptions;
our selection and application of appropriate pricing techniques; and
changes in applicable legal liability standards and in the civil litigation system generally.
Consequently, we could underprice risks, which would adversely affect our profit margins, or we could overprice risks, which
could reduce our sales volume and competitiveness. In either case, our profitability could be materially and adversely affected.
Our results may fluctuate as a result of cyclical changes in the property/casualty insurance industry.
Our revenue is primarily attributable to property/casualty insurance, which as an industry is cyclical in nature and has
historically been characterized by soft markets followed by hard markets. A soft market is a period of relatively high levels of
price competition, less restrictive underwriting standards and generally low premium rates. A hard market is a period of capital
shortages resulting in lack of insurance availability, relatively low levels of competition, more selective underwriting of risks and
relatively high premium rates. If we find it necessary to reduce premiums or limit premium 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, 2016 unpaid losses and LAE would have produced a $4.8 million change to pretax earnings. Our gross
loss and LAE reserves totaled $481.6 million at December 31, 2016. Our loss and LAE reserves, net of reinsurance recoverable
on unpaid loss and LAE, were $358.3 million at that date. Because setting reserves is inherently uncertain, there can be no
assurance that the current reserves will prove adequate.
25
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 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 3,037 property/casualty insurance companies
and 2,062 property/casualty insurance groups operating in North America as of July 12, 2016. 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
26
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.
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, 2016, we had a total of $229.3 million due us from reinsurers,
including $147.8 million of recoverables from losses and $81.5 million in ceded unearned premiums. The largest amount due us
from a single reinsurer as of December 31, 2016 was $51.9 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;
27
•
•
•
•
•
•
•
•
•
•
•
•
•
•
•
licensing of insurers and their agents;
restrictions on the nature, quality and concentration of investments;
restrictions on the ability of insurance company subsidiaries to pay dividends;
restrictions on transactions between insurance company subsidiaries and their affiliates;
requiring certain methods of accounting;
periodic examinations of operations and finances;
the use of non-public consumer information and related privacy issues;
the use of credit history in underwriting and rating;
limitations on the ability to charge policy fees;
the acquisition or disposition of an insurance company or of any company controlling an insurance
company;
involuntary assignments of high-risk policies, participation in reinsurance facilities and underwriting
associations, assessments and other governmental charges;
restrictions on the cancellation or non-renewal of policies and, in certain jurisdictions, withdrawal from
writing certain lines of business;
prescribing the form and content of records of financial condition to be filed;
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
28
Hallmark in 2017 by our insurance company subsidiaries is $19.4 million. State insurance regulators have broad discretion to
limit the payment of dividends by insurance companies and Hallmark’s right to participate in any distribution of assets of one of
our insurance company subsidiaries is subject to prior claims of policyholders and creditors except to the extent that its rights,
if any, as a creditor are recognized. Consequently, Hallmark’s ability to pay debts, expenses and cash dividends to our
stockholders may be limited.
Our insurance company subsidiaries are subject to minimum capital and surplus requirements. Failure to meet these
requirements could subject us to regulatory action.
Our insurance company subsidiaries are subject to minimum capital and surplus requirements imposed under the laws of their
respective states of domicile and each state in which they issue policies. Any failure by one of our insurance company
subsidiaries to meet minimum capital and surplus requirements imposed by applicable state law will subject it to corrective
action, which may include requiring adoption of a comprehensive financial plan, revocation of its license to sell insurance
products or placing the subsidiary under state regulatory control. Any new minimum capital and surplus requirements adopted
in the future may require us to increase the capital and surplus of our insurance company subsidiaries, which we may not be
able to do.
We are subject to assessments and other surcharges from state guaranty funds, mandatory reinsurance arrangements and
state insurance facilities, which may reduce our profitability.
Virtually all states require insurers licensed to do business therein to bear a portion of the unfunded obligations of impaired or
insolvent insurance companies. These obligations are funded by assessments, which are levied by guaranty associations within
the state, up to prescribed limits, on all member insurers in the state on the basis of the proportionate share of the premiums
written by member insurers in the lines of business in which the impaired, insolvent or failed insurer was engaged. Accordingly,
the assessments levied on us by the states in which we are licensed to write insurance may increase as we increase our
premiums written. In addition, as a condition to the ability to conduct business in certain states, insurance companies are
required to participate in mandatory reinsurance funds. The effect of these assessments and mandatory reinsurance
arrangements, or changes in them, could reduce our profitability in any given period or limit our ability to grow our business.
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, 2016, 91% 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, 30% 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, 2016 was $597.5 million. If market interest rates were to increase 1%, the fair value of our fixed-income
securities would decrease by approximately $17.8 million as of December 31, 2016. The calculated change in fair value was
determined using duration modeling assuming no prepayments.
In addition to the general risks described above, although 79% 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
29
the fixed-income securities could fall (with a concurrent fall in market value) and, in a worst case scenario, the issuer could
default on its obligations. As of December 31, 2016, Hallmark had $0.1 million in its investment portfolio exposed to sub-prime
mortgages and $59.5 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 business 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 acquisition may require significant capital outlay 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 59% of our gross written premiums for 2016: Texas (42%), Louisiana (5%), Arizona (4%),
Oklahoma (4%) and New Mexico (4%). 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.
30
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 $50,981 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 $34,073 per
month pursuant to a lease that expires November 30, 2020.
31
Our Specialty Commercial operating unit is located at 13727 Noel Road, Dallas, Texas. These leased premises consist of 15,072
square feet of office space. The rent is currently $28,574 per month pursuant to a lease that expires November 30, 2022. Our
Specialty Commercial operating unit also maintains branch offices in the following locations:
Location
Monthly Rent
Lease Expiration
Atlanta, Georgia
$12,052
November 30, 2022
Glendale, California
$2,570
July 31, 2020
Chicago, Illinois
$8,900
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.
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 disputed the calculation of the amount paid and, pursuant to the terms of the acquisition agreement, an
independent actuary was engaged to resolve this matter. In accordance with the report of the independent actuary, we
accrued during the second quarter of 2016 and paid during the third quarter of 2016 an additional $1.8 million to the sellers.
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, 2016 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.
32
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, 2015.
Period
Year Ended December 31, 2016:
First quarter
Second quarter
Third quarter
Fourth quarter
Year Ended December 31, 2015:
First quarter
Second quarter
Third quarter
Fourth quarter
Holders
High Sale
Low Sale
$
$
11.98 $
12.01
11.93
12.09
12.67 $
12.15
11.87
13.29
9.79
9.50
9.71
9.77
9.50
10.46
9.33
11.19
As of March 1, 2017, there were 1,679 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.
33
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, 2016.
Plan Category
Equity compensation plans approved by security
holders
Equity compensation plans not approved by
security holders
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)
624,231 $
9.14
1,707,039
-
-
-
Total
624,231 $
9.14
1,707,039
(1) Securities remaining available for future issuance are net of a maximum of 292,961 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, 2016:
Total Number of
Shares Purchased
(a)
Average Price
Paid Per Share
(b)
October 1st - October 31st
November 1st – November 30th
December 1st – December 31st
31,408
$ 10.34
-
-
$ -
$ -
Cumulative Number of
Shares Purchased as Part
of Publicly Announced
Plan
(c)
2,590,133
2,590,133
2,590,133
Maximum
Number of
Shares that May
Yet Be Purchased
Under the Plan
(d)
1,409,867
1,409,867
1,409,867
34
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, 2011 and its relative performance is tracked through December 31, 2016.
35
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 (losses) 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 before tax
Income tax expense (benefit)
Net income
Less: Net income attributable to non-
controlling interest
Net income attributable to Hallmark
Financial Services, Inc.
Net income per share attributable to
Hallmark Financial Services, Inc. common
stockholders:
Year Ended December 31
2016
2015
2014
2013
2012
(in thousands, except per share data)
$
549,077 $
(187,248)
361,829
(8,459)
353,370
514,223 $
(157,279)
356,944
(7,863)
349,081
473,218 $
(148,866)
324,352
(3,135)
321,217
460,027 $
(99,262)
360,765
(224)
360,541
16,342
(369)
4,977
1,427
205
375,952
253,688
106,769
4,549
2,468
367,474
8,478
1,952
6,526
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
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
12,884
10,540
5,830
(487)
120
389,428
261,345
109,289
4,599
3,115
378,348
11,080
2,835
8,245
389,842
(57,353)
332,489
(13,053)
319,436
15,293
1,943
5,957
(1,145)
316
341,800
226,414
103,792
4,634
3,586
338,426
3,374
(474)
3,848
-
-
-
-
324
6,526
21,863
13,429
8,245
3,524
Basic
Diluted
$
$
0.35 $
1.14 $
0.70 $
0.43 $
0.34 $
1.13 $
0.69 $
0.43 $
0.18
0.18
36
Balance Sheet Items:
2016
2015
2014
2013
2012
As of December 31
Total investments
Total assets (1)
Reserves for unpaid loss and loss
adjustment expenses
Unearned premiums
Total liabilities (1)
Total stockholders' equity
Book value per share
$
$
$
$
$
$
$
654,119 $
1,162,460 $
578,829 $
1,075,547 $
507,229 $
979,765 $
461,325 $
907,867 $
445,360
789,261
481,567 $
450,878 $
415,135 $
382,640 $
313,416
241,254 $
216,407 $
196,826 $
185,303 $
162,502
896,724 $
265,736 $
813,521 $
262,026 $
727,728 $
252,037 $
669,749 $
238,118 $
568,724
220,537
14.28 $
13.72 $
13.11 $
12.36 $
11.45
(1) Amounts have been adjusted for the adoption of ASU 2015-03 which requires that debt issuance costs related to a
recognized debt liability be presented in the balance sheet as a direct deduction from the carrying amount of that
debt liability, consistent with debt discounts, (See, “Simplifying the Presentation of Debt Issuance Costs” in Note 1 to
the audited consolidated financial statements, included in this report.)
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:
•
•
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. Certain specialty programs are also managed by our Specialty Commercial operating unit. 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.
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 June 1, 2016, we no longer market new or renewal occupational accident policies. Effective
July 1, 2015, the Workers Compensation operating unit no longer retains any risk on new or renewal policies. Our
37
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.
•
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.
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.
38
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
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, preferred stock and the equity warrant
classified as Other Investments.
Level 2 investment securities include corporate bonds, collateralized corporate bank loans, municipal bonds, U.S. Treasury
securities, other obligations of the U.S. Government and mortgage-backed securities for which quoted prices are not available
on active exchanges for identical instruments. We use 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, 2016 and 2015, there was no premium deficiency related to deferred policy acquisition costs.
Goodwill. Goodwill is tested for impairment at the reporting unit level (operating unit or one level below an operating unit) 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
39
unit for which reporting units are at the component level (“one level below”). Our consolidated balance sheet as of December
31, 2016 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 2016 and determined that there was no impairment.
A significant amount of judgment is required in performing goodwill impairment tests. Such tests include estimating the fair
value of our reporting units. As required by ASC 350, we compare the estimated fair value of each reporting unit with its
carrying amount, including goodwill. Under ASC 350, fair value refers to the amount for which the entire reporting unit may be
bought or sold.
The determination of fair value was based on an income approach utilizing discounted cash flows. The valuation methodology
utilized is subject to key judgments and assumptions. Estimates of fair value are inherently uncertain and represent
management’s reasonable expectation regarding future developments. These estimates and the judgments and assumptions
upon which the estimates are based will, in all likelihood, differ in some respects from actual future results. Declines in
estimated fair value could result in goodwill impairments in future periods which could materially adversely affect our results of
operations or financial position.
The income approach to determining fair value computed the projections of the cash flows that the reporting unit is expected
to generate converted into a present value equivalent through discounting. Significant assumptions in the income approach
model include income projections, discount rates and terminal growth values. The income projections reflect an improved
premium rate environment across most of our lines of business that continued throughout 2016. 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 2016. However, a 10% decline in the fair value of our Standard
Commercial P&C operating unit, a 7% decline in the fair value of our MGA Commercial Products operating unit, a 6% decline in
the fair value of our Specialty Personal Lines operating unit, a 49% decline in the fair value of our excess & umbrella component
or a 16% 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 2016. 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, 2016. Through
December 31, 2016, 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
40
cumulative temporary differences based on when and how they are expected to affect the tax return. Deferred tax assets and
liabilities are adjusted for tax rate changes. A valuation allowance is provided against our deferred tax assets to the extent that
we do not believe it is more likely than not that future taxable income will be adequate to realize these future tax benefits.
Reserves for unpaid losses and LAE. Reserves for unpaid losses and LAE are established for claims that have already been
incurred by the policyholder but which we have not yet paid. Unpaid losses and LAE represent the estimated ultimate net cost
of all reported and unreported losses incurred through each balance sheet date. The reserves for unpaid losses and LAE are
estimated using individual case-basis valuations and statistical analyses. These reserves are revised periodically and are subject
to the effects of trends in loss severity and frequency. (See “Item 1. Business – Analysis of Losses and LAE” and “-Analysis of
Loss and LAE Reserve Development.”)
Although considerable variability is inherent in such estimates, we believe that our reserves for unpaid losses and LAE are
adequate. Due to the inherent uncertainty in estimating unpaid losses and LAE, the actual ultimate amounts may differ from
the recorded amounts. A small percentage change could result in a material effect on reported earnings. For example, a 1%
change in December 31, 2016 reserves for unpaid losses and LAE would have produced a $4.8 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, 2016 was $390.9 million to $498.7 million. Our
best estimate of unpaid losses and LAE as of December 31, 2016 is $481.6 million. Our carried reserve for unpaid losses and LAE
as of December 31, 2016 is comprised of $254.8 million in case reserves and $226.8 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 $36.8 million higher than the midpoint, or 96.6% of the high end, of the actuarial range at
December 31, 2016 as compared to $30.1 million above the midpoint, or 96.9% of the high end, of the actuarial range at
December 31, 2015. We expect our best estimate to move within the actuarial range from year to year due to changes in our
operations and changes within the marketplace. Due to the inherent uncertainty in reserve estimates, there can be no
assurance that the actual losses ultimately experienced will fall within the actuarial range. However, because of the breadth of
the actuarial range, we believe that it is reasonably likely that actual losses will fall within such range.
Our reserve requirements are also interrelated with product pricing and profitability. We must price our products at a level
sufficient to fund our policyholder benefits and still remain profitable. Because claim expenses represent the single largest
category of our expenses, inaccuracies in the assumptions used to estimate the amount of such benefits can result in our failing
to price our products appropriately and to generate sufficient premiums to fund our operations.
Recognition of profit sharing commissions. Profit sharing commission is calculated and recognized when the loss ratio, as
determined by a qualified actuary, deviates from contractual targets. We receive a provisional commission as policies are
produced as an advance against the later determination of the profit sharing commission actually earned. The profit sharing
commission is an estimate that varies with the estimated loss ratio and is sensitive to changes in that estimate.
41
The following table details the profit sharing commission revenue sensitivity of the Standard Commercial P&C operating unit to
the actual ultimate loss ratio for each effective quota share treaty at 5.0% above and below the current estimate, which we
believe is a reasonably likely range of variance ($ in thousands).
Provisional loss ratio
Estimated ultimate loss ratio recorded at
December 31, 2016
Treaty Effective Dates
7/1/2001
7/1/2002
7/1/2003
7/1/2004
7/1/2005
60.0%
59.0%
59.0%
64.2%
64.2%
63.5%
64.5%
61.2%
66.1%
61.0%
Effect of actual 5.0% above estimated loss
ratio at December 31, 2016
$
- $
- $
(3,360) $
(3,790) $
(546)
Effect of actual 5.0% below estimated loss
ratio at December 31, 2016
$
1,850 $
3,055 $
2,734 $
3,790 $
546
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, 2016
Effect of actual 5.0% above estimated loss ratio at December
31, 2016
Effect of actual 5.0% below estimated loss ratio at December
31, 2016
$
$
Results of Operations
Treaty Effective Dates
1/1/2006
1/1/2007
1/1/2008
65.0%
65.0%
59.1%
65.0%
65.0%
60.6%
(3,096) $
- $
(1,430)
3,096 $
2,351 $
1,618
Comparison of Years ended December 31, 2016 and December 31, 2015
Management overview. During fiscal 2016, our total revenues were $376.0 million, which was $3.6 million more than the
$372.4 million in total revenues for fiscal 2015. During the year ended December 31, 2016, our income before tax was $8.5
million as compared to $31.9 million during the same period of 2015.
This increase in revenue was primarily attributable to higher net premiums earned, higher net investment income and higher
commission and fee revenue, partially offset by realized losses recognized on our investment portfolio during the current
period as compared to realized gains recognized during the same period the prior year and lower finance charges.
The increased net earned premiums were primarily attributable to higher net premiums written in our Specialty Commercial
Segment and the favorable impact of increased retention under a quota share reinsurance agreement in our Personal Segment
effective October 1, 2014, partially offset by the adverse impact on the Standard Commercial Segment of ceding substantially
all unearned workers’ compensation premiums effective July 1, 2015.
The decrease in income before tax for the year ended December 31, 2016 was due primarily to increased loss and LAE of $23.5
million, higher operating expenses of $2.8 million and higher interest expense of $0.6 million, partially offset by the increased
revenue discussed above. The increase in loss and LAE was primarily the result of unfavorable net prior year loss reserve
development and higher current accident year loss trends in our Specialty Commercial Segment and Personal Segment, partially
42
offset by higher favorable net prior year loss reserve development in our Standard Commercial Segment. During the twelve
months ended December 31, 2016, we recorded unfavorable prior year net loss reserve development of $7.6 million as
compared to $7.0 million of favorable prior year net loss reserve development for the same period of 2015. We incurred an
aggregate of $11.0 million of net catastrophe losses during the year ended December 31, 2016 as compared to $9.3 million for
the same period the prior year. Other operating expenses increased during the year ended December 31, 2016 primarily as the
result of increased salary and related expenses in our Specialty Commercial Segment and a $1.8 million payment to settle the
earn-out related to the previous acquisition of TBIC accrued during the second quarter of 2016, partially offset by lower
production related expenses predominately in our Specialty Commercial Segment. The increase in interest expense was due to
interest on our Facility B revolving credit facility entered into during the fourth quarter of 2015.
We reported net income of $6.5 million for the year ended December 31, 2016, as compared to net income of $21.9 million for
the year ended December 31, 2015. On a diluted per share basis, net income was $0.34 per share for fiscal 2016 as compared
to net income of $1.13 per share for fiscal 2015.
Segment information
The following is additional business segment information for the years ended December 31, 2016 and 2015 (in thousands):
Year Ended December 31
Specialty Commercial
Segment
Standard Commercial
Segment
Personal Segment
Corporate
Consolidated
2016
2015
2016
2015
2016
2015
2016
2015
2016
2015
Gross premiums written $ 388,914 $ 351,050 $
76,891 $
81,892 $ 83,272 $ 81,281 $
- $
- $ 549,077 $ 514,223
Ceded premiums written (139,842) (109,275) (8,401)
(10,795) (39,005) (37,209)
-
- (187,248) (157,279)
Net premiums written
249,072
241,775
68,490
71,097
44,267
44,072
Change in unearned
premiums
(7,182)
(4,135)
(980)
1,516
(297)
(5,244)
Net premiums earned
241,890
237,640
67,510
72,613
43,970
38,828
-
-
-
-
361,829
356,944
-
(8,459)
(7,863)
-
353,370
349,081
Total revenues
255,897
249,910
71,966
76,864
49,826
45,538
(1,737)
90
375,952
372,402
Losses and loss
adjustment expenses
169,125
148,664
41,173
47,071
43,390
34,414
-
-
253,688
230,149
Pre-tax income (loss)
24,417
40,277
8,866
6,687
(6,839)
(885)
(17,966)
(14,193)
8,478
31,886
Net loss ratio (1)
Net expense ratio (1)
Net combined ratio (1)
69.9%
25.3%
95.2%
62.6%
25.6%
88.2%
61.0%
33.0%
94.0%
98.7%
88.6%
64.8%
32.6%
21.5%
19.0%
97.4% 120.2% 107.6%
71.8%
65.9%
28.0%
28.0%
99.8%
93.9%
Favorable (Unfavorable)
Prior Year Development
(12,502)
2,147
9,901
7,416
(5,007)
(2,610)
(7,608)
6,953
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.
43
Specialty Commercial Segment.
Gross premiums written for the Specialty Commercial Segment were $388.9 million for the year ended December 31, 2016,
which was $37.9 million, or 11%, more than the $351.0 million reported for the same period in 2015. Net premiums written
were $249.1 million for the year ended December 31, 2016 as compared to $241.8 million reported for the same period in
2015. 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 $255.9 million of total revenue for the year ended December 31, 2016 was $6.0 million higher than the $249.9 million
reported for 2015. This 2% increase in revenue was due to higher net premiums earned of $4.3 million due predominately to
increased production discussed above. Further contributing to this increased revenue was higher net investment income of
$1.4 million, higher commission and fees of $0.3 million and higher other income of $0.1 million, partially offset by lower
finance charges of $0.1 million.
Pre-tax income for the Specialty Commercial Segment of $24.4 million for the year ended December 31, 2016 was $15.9 million
lower than the $40.3 million reported for the same period in 2015. This decrease in pre-tax income was primarily due to higher
loss and LAE expenses of $20.5 million and higher operating expense of $1.4 million, partially offset by the increased revenue
discussed above.
Our MGA Commercial Products operating unit reported a $16.5 million increase in loss and LAE due primarily to $11.3 million of
unfavorable prior year net loss reserve development recognized during the year ended December 31, 2016 as compared to $1.2
million of unfavorable prior year net loss reserve development recognized for the same period the prior year, as well as higher
current accident year loss trends. Our Specialty Commercial operating unit reported a $2.1 million increase in loss and LAE
which consisted of (a) a $1.6 million increase in loss and LAE attributable to our medical professional liability insurance
products, (b) a $0.8 million increase in loss and LAE in our commercial umbrella and primary/excess liability line of business, (c)
a $0.8 million increase in loss and LAE attributable to our primary/excess property insurance products, partially offset by (d) a
$1.1 million decrease in loss and LAE attributable to our satellite launch insurance line of business due primarily to favorable
current accident year loss trend. Our specialty programs reported a $1.9 million increase in loss and LAE due primarily to $0.7
million of unfavorable prior year net loss reserve development recognized during the year ended December 31, 2016 as
compared to $1.4 million of favorable prior year net loss reserve development recognized for the same period the prior year.
The increase of $1.4 million in operating expense was the combined result of increased salary and related expenses of $3.8
million, higher travel related expenses of $0.2 million, higher occupancy and other expenses of $0.9 million and higher
professional service fee expenses of $0.1 million, partially offset by lower production related expenses of $3.6 million due
primarily to increased ceding commissions in our Specialty Commercial operating unit.
The Specialty Commercial Segment reported a net loss ratio of 69.9% for the year ended December 31, 2016 as compared to
62.6% for the same period during 2015. The gross loss ratio before reinsurance was 67.3% for the year ended December 31,
2016 as compared to 61.6% for the same period in 2015. The higher gross and net loss ratio included $12.5 million of
unfavorable prior year net loss reserve development for the year ended December 31, 2016 as compared to $2.1 million of
favorable prior year net loss reserve development for the same period during 2015, as well as higher current accident year loss
trends.
Standard Commercial Segment.
Gross premiums written for the Standard Commercial Segment were $76.9 million for the year ended December 31, 2016,
which was $5.0 million, or 6%, less than the $81.9 million reported for the same period in 2015. Net premiums written were
$68.5 million for the year ended December 31, 2016 as compared to $71.1 million reported for the same period in 2015. The
decrease in premium volume was primarily due to lower premium production in our Workers Compensation operating unit due
to the renewal rights agreement entered into during the second quarter of 2015 and subsequently amended during the third
quarter of 2015 to cede substantially all of the unearned premium effective July 1, 2015.
Total revenue for the Standard Commercial Segment of $72.0 million for the year ended December 31, 2016 was $4.9 million
less than the $76.9 million reported during the year ended December 31, 2015. This 6% decrease in total revenue was mostly
due to the Workers Compensation operating unit experiencing both a $0.6 million gain during the year ended December 31,
2015 in connection with the transfer of renewal rights and a $5.1 million decrease in net premiums earned during 2016
primarily as a result of ceding substantially all unearned premiums as of July 1, 2015 and lower net investment income of $0.2
million. These decreases in revenue were partially offset by a decreased adverse profit share commission revenue adjustment
of $1.0 million.
44
Our Standard Commercial Segment reported pre-tax income of $8.9 million for the year ended December 31, 2016 which was
$2.2 million higher than the $6.7 million reported for the same period of 2015. Lower loss and LAE of $5.9 million was the
primary driver for the higher pre-tax income, as well as lower operating expenses of $1.2 million, partially offset by the
decreased revenue discussed above.
The net loss ratio for the year ended December 31, 2016 was 61.0% as compared to the 64.8% reported for the year ended
December 31, 2015. The gross loss ratio before reinsurance was 59.6% for the year ended December 31, 2016 as compared to
63.4% for the prior year. The lower gross and net loss ratios resulted primarily from lower premium volume, lower current
accident year non-catastrophe loss trends and increased favorable net loss reserve development partially offset by higher
current accident year catastrophe losses. The net loss ratios for the year ended December 31, 2016 include $8.4 million of
catastrophe related losses. The net loss ratios for the year ended December 31, 2015 include $7.8 million of catastrophe related
losses. During the year ended December 31, 2016 and 2015, the Standard Commercial Segment reported favorable prior year
net loss reserve development of $9.9 million and $7.4 million, respectively. The Standard Commercial Segment reported a net
expense ratio of 33.0% for the year ended December 31, 2016 as compared to 32.6% for the same period of 2015. The increase
in the expense ratio was primarily due to the runoff of our Workers Compensation operating unit and the discontinued
marketing of new and renewal occupational accident policies during 2016.
Personal Segment.
Gross premiums written for the Personal Segment were $83.3 million for the year ended December 31, 2016, which was $2.0
million more than the $81.3 million reported for the same period in 2015. Net premiums written for our Personal Segment
were $44.3 million for the year ended December 31, 2016, which was an increase of $0.2 million from the $44.1 million
reported for the same period of 2015.
Total revenue for the Personal Segment increased 9% to $49.8 million for the year ended December 31, 2016 from $45.5
million the prior year. The $4.3 million increase in revenue was primarily due to higher net premiums earned of $5.1 million due
mostly to increased retention under a quota share reinsurance agreement effective October 1, 2014 and higher net investment
income of $0.1 million, partially offset by lower finance charges of $0.9 million.
Our Personal Segment reported a pre-tax loss of $6.8 million for the year ended December 31, 2016 as compared to pre-tax
loss of $0.9 million for the same period of 2015. The pre-tax loss was the result of increased losses and LAE of $9.0 million and
increased operating expenses of $1.2 million, partially offset by the increased revenue discussed above.
The Personal Segment reported a net loss ratio of 98.7% for the year ended December 31, 2016 as compared to 88.6% for the
same period in 2015. The gross loss ratio before reinsurance was 94.8% for the year ended December 31, 2016 as compared to
80.8% for the same period in 2015. The higher gross and net loss ratios were primarily the result of unfavorable prior year net
loss reserve development of $5.0 million for the year ended December 31, 2016 as compared to unfavorable prior year net loss
reserve development of $2.6 million for the same period of 2015, as well as higher current accident year loss trends. The
increase in operating expenses of $1.2 million was the combined result of $0.4 million increase in other operating expenses
driven by our investment in technology, a $0.3 million increase in production related expenses, a $0.4 million increase in salary
and related expenses and a $0.1 million increase in professional service fees and occupancy expenses. The Personal Segment
reported a net expense ratio of 21.5% for the year ended December 31, 2016 as compared to 19.0% for the same period of
2015.
Corporate.
Total revenue for Corporate decreased by $1.8 million for the year ended December 31, 2016 as compared to the same period
the prior year. This decrease in total revenue was due to net realized losses recognized on our investment portfolio of $0.4
million for the year ended December 31, 2016 as compared to the net realized gains of $2.5 million for the same period of
2015, partially offset by higher net investment income of $1.1 million.
Corporate pre-tax loss was $18.0 million for the year ended December 31, 2016 as compared to pre-tax loss of $14.2 million for
the same period of 2015. The increase in pre-tax loss was primarily due to the decreased revenue discussed above, higher
operating expenses of $1.3 million and increased interest expense of $0.6 million. The increase in operating expenses of $1.3
million was due primarily to an additional $1.8 million earn-out paid in conjunction with the previous acquisition of TBIC and
higher other operating expenses of $0.1 million, partially offset by lower salary and related expenses of $0.4 million due
primarily to lower incentive compensation expense in 2016, lower professional service fee expense of $0.1 million and lower
45
travel and related expenses of $0.1 million. The increase in interest expense of $0.6 million was due primarily to the interest
expense under Facility B, partially offset by a reduction in interest expense due to the transition from a fixed interest rate to a
lower floating interest rate as of June 15, 2015 on our Trust I subordinated debt securities.
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.
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.
46
Segment information.
The following is additional business segment information for the years ended December 31, 2015 and 2014 (in thousands):
Year Ended December 31
Specialty Commercial
Segment
Standard Commercial
Segment
Personal Segment
Corporate
Consolidated
2015
2014
2015
2014
2015
2014
2015
2014
2015
2014
Gross premiums written $ 351,050 $
324,547 $
81,892 $
84,679 $ 81,281 $ 63,992 $
- $
- $ 514,223 $ 473,218
Ceded premiums written
(109,275)
(93,909)
(10,795)
(7,767)
(37,209)
(47,190)
Net premiums written
241,775
230,638
71,097
76,912
44,072
16,802
Change in unearned
premiums
(4,135)
(1,815)
1,516
1,399
(5,244)
(2,719)
Net premiums earned
237,640
228,823
72,613
78,311
38,828
14,083
-
-
-
-
-
(157,279)
(148,866)
-
356,944
324,352
-
(7,863)
(3,135)
-
349,081
321,217
Total revenues
249,910
241,920
76,864
81,464
45,538
20,404
90
(6,422)
372,402
337,366
Losses and loss
adjustment expenses
148,664
149,961
47,071
51,130
34,414
8,964
-
-
230,149
210,055
Pre-tax income (loss)
40,277
34,237
6,687
4,595
(885)
1,226
(14,193)
(21,276)
31,886
18,782
Net loss ratio (1)
Net expense ratio (1)
Net combined ratio (1)
Favorable (Unfavorable)
Prior Year Development
62.6%
25.6%
88.2%
65.5%
25.6%
91.1%
64.8%
32.6%
97.4%
88.6%
63.7%
65.3%
33.3%
19.0%
43.3%
98.6% 107.6% 107.0%
65.9%
28.0%
93.9%
65.4%
30.5%
95.9%
2,147
(3,721)
7,416
6,033
(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.
47
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 Specialty Commercial operating units, including our specialty programs.
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 $2.8 million increase in loss and LAE for the year ended December 31,
2015 as compared to the same period of 2014. Our MGA Commercial Products operating unit reported $1.2 million of
unfavorable prior year loss reserve development during the year ended December 31, 2015 as compared to $5.3 million of
unfavorable prior year loss reserve development reported 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. Our specialty
programs reported a $3.2 million decrease in loss and LAE due primarily to $1.4 million of favorable prior year net loss reserve
development recognized during the year ended December 31, 2015 as compared to $0.6 million of favorable prior year net loss
reserve development recognized for the same period the prior year as well as the impact of a quota share agreement entered
into during the second quarter of 2014. 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.
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 written 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
lower net premiums earned in our Standard Commercial P&C operating unit, as well as lower net investment income of $1.0
48
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.
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.
49
Liquidity and Capital Resources
Sources and Uses of Funds
Our sources of funds are from insurance-related operations, financing activities and investing activities. Major sources of funds
from operations include premiums collected (net of policy cancellations and premiums ceded), commissions and processing and
service fees. As a holding company, Hallmark is dependent on dividend payments and management fees from its subsidiaries to
meet operating expenses and debt obligations. As of December 31, 2016, Hallmark had $9.0 million in unrestricted cash and
cash equivalents. Unrestricted cash and cash equivalents of our non-insurance subsidiaries were $6.1 million as of December
31, 2016. As of that date, our insurance subsidiaries held $64.5 million of cash and cash equivalents as well as $597.5 million in
debt securities with an average modified duration of 3.0 years. Accordingly, we do not anticipate selling long-term debt
instruments to meet any liquidity needs.
AHIC and TBIC, domiciled in Texas, are limited in the payment of dividends to their stockholders in any 12-month period,
without the prior written consent of the Texas Department of Insurance, to the greater of statutory net income for the prior
calendar year or 10% of statutory policyholders’ surplus as of the prior year end. HIC and HNIC, both domiciled in Arizona, are
limited in the payment of dividends to the lesser of 10% of prior year policyholders’ surplus or prior year's net investment
income, without prior written approval from the Arizona Department of Insurance. HSIC, domiciled in Oklahoma, is limited in
the payment of dividends to the greater of 10% of prior year policyholders’ surplus or prior year’s statutory net income, not
including realized capital gains, without prior written approval from the Oklahoma Insurance Department. For all our insurance
companies, dividends may only be paid from unassigned surplus funds. During 2017, the aggregate ordinary dividend capacity
of these subsidiaries is $28.0 million, of which $19.4 million is available to Hallmark. As a county mutual, dividends from HCM
are payable to policyholders. During the years ended December 31, 2016 and 2015 our insurance company subsidiaries paid
$10.5 million and $8.0 million, respectively, 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 $1.1 million, $1.3 million and $1.1 million during each of 2016, 2015 and 2014, 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, 2016, our insurance company subsidiaries reported statutory capital and surplus of $248.4 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, 2016, 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, 2016 and 2015 was 146% and 144%, respectively.
Comparison of December 31, 2016 to December 31, 2015
On a consolidated basis, our cash and investments, excluding restricted cash and investments, at December 31, 2016 were
$733.8 million compared to $693.3 million at December 31, 2015. The primary reasons for this increase in unrestricted cash and
investments were cash flow from operations, unsettled investment trades and an increase in investment fair values, partially
offset by increase in capital expenditures, the repurchase of our common stock and a contingent purchase price payment to the
sellers of TBIC Holding.
Comparison of Years Ended December 31, 2016 and December 31, 2015
Net cash provided by our consolidated operating activities was $30.9 million for the year ended December 31, 2016 compared
to $52.9 million for the year ended December 31, 2015. The decrease in operating cash flow was primarily due to increased
paid losses including timing of reinsurance claim settlements, partially offset by increased net collected premium, lower taxes
paid, lower net paid operating expenses and higher collected net investment income.
Cash used in investing activities during the year ended December 31, 2016 was $58.2 million as compared to $96.3 million for
the prior year. The decrease in cash used by investing activities during the year ended December 31, 2016 was comprised of a
decrease in purchases of debt and equity securities of $24.1 million and an increase of $16.9 million in maturities, sales and
50
redemptions of investment securities, partially offset by an increase in purchases of property and equipment of $0.7 million
and a decrease in transfers from restricted cash of $2.2 million
Cash used in financing activities during the year ended December 31, 2016 was $7.4 million as a result of $6.1 million related to
the repurchase of our common stock and $1.8 million payment of the settlement of contingent consideration to the sellers of
TBIC, partially offset by $0.5 million related to proceeds from the exercise of employee stock options. 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.
Credit Facilities
Our Second Restated Credit Agreement with Frost Bank (“Frost”) dated June 30, 2015, reinstated the credit facility with Frost
which expired by its terms on April 30, 2015. The Second Restated Credit Agreement also amended certain provisions of the
credit facility and restated the agreement with Frost in its entirety. The Second Restated Credit Agreement provides a $15.0
million revolving credit facility (“Facility A”), with a $5.0 million letter of credit sub-facility. The outstanding balance of the
Facility A bears interest at a rate equal to the prime rate or LIBOR plus 2.5%, at our election. We pay an annual fee of 0.25% of
the average daily unused balance of Facility A and letter of credit fees at the rate of 1.00% per annum. As of December 31,
2016, we had no outstanding borrowings under Facility A.
On December 17, 2015, we entered into a First Amendment to Second Restated Credit Agreement and a Revolving Facility B
Agreement (the “Facility B Agreement”) with Frost to provide a new $30.0 million revolving credit facility (“Facility B”), in
addition to Facility A. On November 1, 2016, we amended the Facility B Agreement with Frost to extend by one year the
termination date for draws under Facility B and the maturity date for amounts outstanding thereunder. We paid Frost a
commitment fee of $75,000 when Facility B was established and an additional $30,000 fee when Facility B was extended.
We may use Facility B loan proceeds solely for the purpose of making capital contributions to AHIC and HIC. As amended, we
may borrow, repay and reborrow under Facility B until December 17, 2018, at which time all amounts outstanding under
Facility B are converted to a term loan. Through December 17, 2018, we pay Frost a quarterly fee of 0.25% per annum of the
average daily unused balance of Facility B. Facility B bears interest at a rate equal to the prime rate or LIBOR plus 3.00%, at our
election. Until December 17, 2018, 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, 2018 are converted to a term loan payable in quarterly
installments over five years based on a seven year amortization of principal plus accrued interest. All remaining principal and
accrued interest on Facility B become due and payable on December 17, 2023. As of December 31, 2016, we had $30.0 million
outstanding under Facility B.
The obligations under both Facility A and Facility B are secured by a security interest in the capital stock of AHIC and HIC. Both
Facility A and Facility B contain covenants that, among other things, require us to maintain certain financial and operating ratios
and restrict certain distributions, transactions and organizational changes. As of December 31, 2016, we were in compliance
with all of these covenants.
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, 2016, the principal balance of our Trust I subordinated debt was $30.9 million and the interest rate was
4.21% 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
51
$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, 2016, the principal balance of our Trust II subordinated debt
was $25.8 million.
Long-Term Contractual Obligations
Set forth below is a summary of long-term contractual obligations as of December 31, 2016. 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.
Revolving credit facility payable
Interest on revolving credit facility payable
Subordinated debt securities (1)
Interest on subordinated debt securities
Unpaid losses and LAE (2)
$
Operating leases (3)
Purchase obligations
Estimated Payments by Period (in thousands)
Total
2017
2018-2019
2020-2021
After 2022
30,000 $
8,201
56,702
61,577
481,567
9,279
7,997
- $
1,554
-
3,795
183,473
2,281
3,358
3,214 $
3,025
-
6,874
161,174
3,822
3,798
8,572 $
2,276
-
6,159
61,398
2,835
750
18,214
1,346
56,702
44,749
75,522
341
91
(1) The subordinated debt securities excludes unamortized debt issuance costs of $1.0 million.
(2) 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.
(3) Minimum payments have not been reduced by minimum sublease rentals of $0.5 million due in the future under
noncancelable subleases.
Based on 2017 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.
52
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, 2016 was $597.5 million. The effective duration
of our portfolio as of December 31, 2016 was 3.0 years. Should interest rates increase 1.0%, our fixed-income investment
portfolio would be expected to decline in market value by 3.0%, or $17.8 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
$17.8 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, 2016, our
fixed-income investments were in the following: U.S. Treasury bonds – 7.0%; municipal bonds – 27.4%; collateralized corporate
bank loans – 17.8%; corporate bonds – 37.8%; and mortgage-backed – 10.0%. As of December 31, 2016, 79% 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, 2016 was with reinsurers having an A.M. Best
rating of “A-” or better.
Equity price risk. Investments in equity securities and our other investments that are subject to equity price risk made up 8.7%
of our portfolio as of December 31, 2016. The carrying values of equity securities and our other investments 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 and other investments as of December 31, 2016 was $56.7 million. The fair value of these
securities would increase or decrease by $17.0 million assuming a hypothetical 30% increase or decrease in market prices as of
the balance sheet date. This would increase or decrease stockholders’ equity by 4.2%. 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, 2016 and 2015
Consolidated Statements of Operations for the Years Ended December 31, 2016, 2015 and 2014
Consolidated Statements of Comprehensive Income (Loss) for the Years Ended December 31, 2016,
2015 and 2014
Consolidated Statements of Stockholders’ Equity for the Years Ended
December 31, 2016, 2015 and 2014
Consolidated Statements of Cash Flows for the Years Ended
December 31, 2016, 2015 and 2014
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-48
53
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, 2016, 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, 2016.
Ernst & Young LLP, the independent registered public accounting firm that audited our consolidated financial statements as of
December 31, 2016 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, 2016. 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, 2016, is included in this Item under the
heading “ Report of Independent Registered Public Accounting Firm.”
54
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, 2016, 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, 2016, 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, 2016 and
2015, and the related consolidated statements of operations, comprehensive income (loss), stockholders’ equity and cash
flows for each of the three years in the period ended December 31, 2016 of Hallmark Financial Services, Inc. and
subsidiaries and our report dated March 9, 2017 expressed an unqualified opinion thereon.
/s/ Ernst & Young LLP
Fort Worth, Texas
March 9, 2017
55
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.
56
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, 2016 and 2015
Consolidated Statements of Operations for the Years Ended December 31, 2016, 2015 and 2014
Consolidated Statements of Comprehensive Income (Loss) for the Years Ended December 31, 2016, 2015 and
2014
Consolidated Statements of Stockholders’ Equity for the Years Ended December 31, 2016, 2015 and 2014
Consolidated Statements of Cash Flows for the Years Ended December 31, 2016, 2015 and 2014
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
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).
57
4.7
4.8
4.9
4.10
4.11
4.12
4.13
10.1
10.2
10.3
10.4
10.5
10.6
Amended and Restated Declaration of Trust of Hallmark Statutory Trust II dated as of August 23, 2007, among
Hallmark Financial Services, Inc., as sponsor, The Bank of New York (Delaware), as Delaware trustee, and The
Bank of New York Trust Company, National Association, as institutional trustee, and Mark Schwarz and Mark
Morrison, as administrators (incorporated by reference to Exhibit 4.2 to the registrant’s Current Report on Form
8-K filed August 24, 2007).
Form of Junior Subordinated Debt Security Due 2037 (included in Exhibit 4.7 above).
Form of Capital Security Certificate (included in Exhibit 4.8 above).
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).
First Amendment to Revolving Facility B Agreement between Hallmark Financial Services, Inc. and Frost Bank
dated November 1, 2016 (incorporated by reference to Exhibit 10.1 to the registrant’s Current Report on Form 8-
K filed November 2, 2016).
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).
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).
Assignment and Assumption of Lease Agreement and Bill of Sale between Equitymetrix, LLC and Hallmark
Financial Services, Inc. dated March 1, 2016 (incorporated by reference to Exhibit 10.1 to the registrant’s Current
Report on Form 8-K filed March 2, 2016).
Lease between Musref 13727 Noel, L.P. and Equitymetrix, LLC dated March 25, 2009, as amended by First
Amendment to Lease between Musref 13727 Noel, L.P. and Equitymetrix, LLC dated February 3, 2010, Second
Amendment to Lease between Musref 13727 Noel, L.P. and Equitymetrix, LLC dated July 2, 2013, and Third
Amendment to Lease between Musref 13727 Noel, L.P. and Equitymetrix, LLC dated February 25, 2014
(incorporated by reference to Exhibit 10.2 to the registrant’s Current Report on Form 8-K filed March 2, 2016).
10.7*
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).
58
10.8*
10.9*
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).
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
Form 10-K for the year ended December 31, 2013).
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*
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 21, 2015).
Form of Confidentiality and Non-Solicitation Agreement dated May 29, 2015, between Hallmark Financial
Services, Inc. and certain employees of the Company (incorporated by reference to Exhibit 10.23 to the
registrant’s Form 10-K for the year ended December 31, 2015).
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.
59
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.
Item 16. Form 10–K Summary.
Not Applicable.
60
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 9, 2017
Date:
March 9, 2017
HALLMARK FINANCIAL SERVICES, INC.
(Registrant)
By: /s/ Naveen Anand
Naveen Anand, Chief Executive Officer and
President
By:
/s/ Jeffrey R. Passmore
Jeffrey R. Passmore, Chief Accounting Officer and Senior
Vice President
Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following
persons on behalf of the registrant and in the capacities and on the dates indicated.
Date:
March 9, 2017
/s/ Naveen Anand
Date:
March 9, 2017
Naveen Anand, Chief Executive Officer and
President (Principal Executive Officer)
/s/ Jeffrey R. Passmore
Jeffrey R. Passmore, Chief Accounting Officer and Senior
Vice President (Principal Financial Officer and Principal
Accounting Officer)
Date:
Date:
Date:
Date:
March 9, 2017
/s/ Mark E. Schwarz
Mark E. Schwarz, Executive Chairman
March 9, 2017
March 9, 2017
March 9, 2017
/s/ James H. Graves
James H. Graves, Director
/s/ Mark E. Pape
Mark E. Pape, Director
/s/ Scott T. Berlin
Scott T. Berlin, Director
61
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.
o
d/b/a Hallmark Specialty Personal Lines
o American Hallmark Insurance Company of Texas
o American Hallmark Insurance Services, Inc.
d/b/a Hallmark Commercial Insurance Solutions
CYR Insurance Management Company
Effective Claims Management, Inc.
o
o
o Hallmark Claims Service, Inc.
o Hallmark County Mutual Insurance Company*
o Hallmark Finance Corporation
o Hallmark Insurance Company
d/b/a Hallmark American Insurance Company
o
o
d/b/a Hallmark E&S
d/b/a Hallmark E&S Insurance Services, LLC
o Hallmark National Insurance Company
o Hallmark Specialty Insurance Company
o Hardscrabble Data Solutions, LLC
o Heath XS, LLC
o
o
Pan American Acceptance Corporation
o
TBIC Holding Corporation, Inc.
o
TBIC Risk Management, Inc.
o
Texas Builders Insurance Company
o
o Hallmark Specialty Underwriters, Inc.
o
TGA Special Risk, Inc.
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
* Controlled through a management agreement.
62
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. 333-140000) pertaining to Hallmark Financial Services, Inc. 2005 Long Term
Incentive Plan;
(2) Registration Statement (Form S-8 No. 333-160050) pertaining to Hallmark Financial Services, Inc. 2005 Long Term
Incentive Plan;
(3) Registration Statement (Form S-3 No. 333-196613) and related Prospectus pertaining to the registration of
$30,000,000 of senior unsecured debt securities; and
(4) Registration Statement (Form S-8 No. 333-210078) pertaining to Hallmark Financial Services, Inc. 2015 Long Term
Incentive Plan;
of our reports dated March 9, 2017, 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, 2016.
/s/ Ernst & Young LLP
Fort Worth, Texas
March 9, 2017
63
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 9, 2017
/s/ Naveen Anand
Naveen Anand, Chief Executive Officer
64
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 9, 2017
/s/ Jeffrey R. Passmore
Jeffrey R. Passmore, Chief Accounting Officer
65
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, 2016, 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 9, 2017
/s/ Naveen Anand
Naveen Anand,
Chief Executive Officer
66
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, 2016, 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 9, 2017
/s/ Jeffrey R. Passmore
Jeffrey R. Passmore,
Chief Accounting Officer
67
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, 2016 and 2015
Consolidated Statements of Operations for the Years Ended December 31, 2016, 2015 and 2014
Consolidated Statements of Comprehensive Income (Loss) for the Years Ended December 31, 2016, 2015
and 2014
Consolidated Statements of Stockholders’ Equity for the Years Ended December 31, 2016, 2015 and
2014
Consolidated Statements of Cash Flows for the Years Ended December 31, 2016, 2015 and 2014
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-48
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, 2016 and 2015, and the related consolidated statements of operations, comprehensive income
(loss), stockholders’ equity and cash flows for each of the three years in the period ended December 31, 2016. 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 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, 2016 and 2015, and the consolidated results of
their operations and their cash flows for each of the three years in the period ended December 31, 2016, 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, 2016, 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 9, 2017 expressed an unqualified opinion thereon.
/s/ Ernst & Young LLP
Fort Worth, Texas
March 9, 2017
F-2
HALLMARK FINANCIAL SERVICES, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
December 31, 2016 and 2015
($ in thousands)
2016
2015
ASSETS
Investments:
Debt securities, available-for-sale,
at fair value (cost; $597,784 in 2016 and $538,629 in 2015)
Equity securities, available-for-sale,
at fair value (cost; $31,449 in 2016 and $24,524 in 2015)
Other investments (cost; $3,763 in 2016 and $427 in 2015)
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 (less unamortized debt issuance cost of $1,001 in 2016
Reserves for unpaid losses and loss adjustment expenses
Unearned premiums
Reinsurance balances payable
Pension liability
Payable for securities
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 2016 and 2015
Additional paid-in capital
Retained earnings
Accumulated other comprehensive income
Treasury stock (2,260,849 shares in 2016 and 1,775,512 in 2015), at cost
$
$
$
597,457 $
531,325
51,711
4,951
654,119
79,632
7,327
81,482
89,715
2,269
3,047
147,821
19,193
44,695
12,491
1,365
3,951
1,552
13,801
1,162,460 $
30,000 $
55,701
481,567
241,254
46,488
2,203
14,215
25,296
896,724
3,757
123,166
148,027
10,371
(19,585)
265,736
47,050
454
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
10,192
1,075,547
30,000
55,649
450,878
216,407
33,741
2,496
1,097
23,253
813,521
3,757
123,480
141,501
7,418
(14,130)
262,026
Total stockholders’ equity
Total liabilities and stockholders’ equity
$
1,162,460 $
1,075,547
The accompanying notes are an integral part of the consolidated financial statements
F-3
HALLMARK FINANCIAL SERVICES, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
For the years ended December 31, 2016, 2015 and 2014
($ 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 (losses) 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
2016
2015
2014
549,077 $
(187,248)
361,829
(8,459)
353,370
16,342
(369)
4,977
1,427
205
375,952
253,688
106,769
4,549
2,468
367,474
8,478
1,952
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
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
6,526 $
21,863 $
13,429
0.35 $
0.34 $
1.14 $
1.13 $
0.70
0.69
$
$
$
$
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, 2016, 2015 and 2014
($ In thousands)
Net income
Other comprehensive income (loss):
Change in net actuarial (loss) gain
Tax effect on change in net actuarial (loss) gain
Unrealized holding gains (losses) arising during the period
Tax effect on unrealized holding gains (losses) arising
during the period
Reclassification adjustment for gains included in net
income
Tax effect on reclassification adjustment for gains
included in net income
Other comprehensive income (loss), net of tax
2016
2015
2014
$
6,526 $
21,863 $
13,429
(145)
51
6,019
(2,107)
(1,331)
466
2,953
43
(15)
(10,191)
3,567
(5,826)
2,039
(10,383)
(1,723)
603
3,543
(1,240)
(408)
143
918
Comprehensive income
$
9,479 $
11,480 $
14,347
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, 2016, 2015 and 2014
($ In thousands)
Number
of
Shares Par Value
Additional
Paid-In
Capital
Accumulated
Other
Comprehensive
Income
Retained
Earnings
Treasury
Stock
Number
of
Shares
Total
Stockholders'
Equity
Balance at January 1, 2014
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,
f
-
-
-
-
-
-
-
-
-
-
-
222
145
-
-
-
-
-
13,429
-
-
-
-
-
(1,805)
-
1,010
-
-
181
(1,805)
-
(135)
-
-
222
1,155
13,429
918
918
Balance at December 31, 2014
20,873 $ 3,757
$ 123,194 $ 119,638 $
17,801
$ (12,353) 1,655 $ 252,037
Acquisition of treasury stock
Equity incentive plan activity
Shares issued under employee
Net income
Other comprehensive loss, net of
tax
-
-
-
-
-
-
-
-
-
-
-
383
(97)
-
-
-
-
-
21,863
-
-
-
-
(2,532)
-
755
-
221
-
(100)
-
(2,532)
383
658
21,863
-
(10,383)
-
-
(10,383)
Balance at December 31, 2015
20,873 $ 3,757
$ 123,480 $ 141,501 $
7,418
$ (14,130) 1,776 $ 262,026
Acquisition of treasury stock
Equity incentive plan activity
Shares issued under employee
Net income
Other comprehensive income,
net of tax
-
-
-
-
-
-
-
-
-
-
-
(118)
(196)
-
-
-
-
6,526
-
-
-
-
(6,117)
-
662
-
562
-
(77)
-
(6,117)
(118)
466
6,526
-
-
2,953
-
-
2,953
Balance at December 31, 2016
20,873 $ 3,757
$ 123,166 $ 148,027 $
10,371
$ (19,585) 2,261 $ 265,736
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, 2016, 2015 and 2014
($ in thousands)
Cash flows from operating activities:
Net income
2016
2015
2014
$
6,526 $
21,863 $
13,429
Adjustments to reconcile net income to cash provided by operating activities:
Depreciation and amortization expense
Deferred federal income taxes
Net realized losses (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 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 (used in) provided by financing activities
Decrease 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
3,894
405
369
(118)
(16,388)
(6,339)
(264)
1,173
30,689
24,847
(33,534)
12,747
(2,172)
3,586
5,433
30,854
3,516
(1,030)
(2,503)
383
(11,718)
(12,373)
1,136
380
35,743
19,581
(4,568)
7,338
(2,747)
(1,368)
(697)
52,936
(4,340)
1,195
(241,374)
186,286
(58,233)
(3,608)
3,392
(265,482)
169,409
(96,289)
-
-
(1,784)
466
(6,117)
(7,435)
(34,814)
114,446
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
7,998
(680)
33,684
(546)
276
(188,749)
146,777
(42,242)
(1,473)
-
-
1,155
(1,805)
(2,123)
(10,681)
141,666
$
$
$
$
$
79,632 $
114,446 $
130,985
4,287 $
3,906 $
3,718 $
13,800 $
4,576
5,497
7,377 $
(9,492) $
388
13,118 $
(224) $
1,115
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, 2016, 2015, and 2014
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 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 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 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
Specialty Commercial Segment includes our MGA Commercial Products operating unit and our Specialty Commercial
operating unit. The Standard Commercial Segment includes our Standard Commercial P&C operating unit and our Workers
Compensation operating unit. 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.
Reclassifications
Certain prior year amounts have been reclassfied to conform with current year presentation.
F-8
HALLMARK FINANCIAL SERVICES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Years ended December 31, 2016, 2015, and 2014
Use of Estimates in the Preparation of Financial Statements
Our preparation of financial statements in conformity with GAAP requires management to make estimates and
assumptions that affect our reported amounts of assets and liabilities at the dates of the financial statements and our
reported amounts of revenues and expenses during the reporting periods. Management evaluates its estimates and
assumptions on an ongoing basis using historical experience and other factors, including the current economic
environment, which management believes to be reasonable under the circumstances. We adjust such estimates and
assumptions when facts and circumstances dictate. Since future events and their effects cannot be determined with
precision, actual results could differ significantly from these estimates. Changes in estimates resulting from continuing
changes in the economic environment may be reflected in the financial statements in future periods.
Fair Value of Financial Instruments
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: Our revolving credit facility with Frost Bank had a carried value of $30.0 million and a fair
value of $30.2 million as of December 31, 2016. The fair value is based on discounted cash flows using a discount rate
derived from LIBOR spot rates plus a market spread resulting in discount rates ranging between 3.3% to 4.5% for each
future payment date. This revolving credit facility would be included in Level 3 of the fair value hierarchy if it was reported
at fair value.
Subordinated debt securities: Our trust preferred securities are reported at carry value of $55.7 million and $55.6 million,
and had a fair value of $44.2 million and $44.2 million, as of December 31, 2016 and 2015, 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, 2016 and 2015, 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.
Other investments consists of an equity warrant which is reported at fair value. Unrealized gains and losses are reported
in the statement of operations as a component of net realized gains (losses).
Realized investment gains and losses are recognized in operations on the specific identification method.
F-9
HALLMARK FINANCIAL SERVICES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Years ended December 31, 2016, 2015, and 2014
Cash and Cash Equivalents
We consider all highly liquid investments with an original maturity of three months or less to be cash equivalents.
Restricted Cash
We collect premiums from customers and, after deducting authorized commissions, remit these premiums to the
Company’s consolidated insurance subsidiaries. Unremitted insurance premiums are held in a fiduciary capacity until
disbursed to the Company’s consolidated insurance subsidiaries.
Premiums Receivable
Premiums receivable represent amounts due from policyholders or independent agents for premiums written and
uncollected. These balances are carried at net realizable value.
Reinsurance
We are routinely involved in reinsurance transactions with other companies. Reinsurance premiums, losses and loss
adjustment expenses (“LAE”) are accounted for on bases consistent with those used in accounting for the original policies
issued and the terms of the reinsurance contracts. (See Note 7.)
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 2016, 2015 and 2014, we deferred $37.9
million, $32.3 million and $39.1 million of policy acquisition costs and amortized $39.1 million, $32.7 million and $40.9
million of deferred policy acquisition costs, respectively. Therefore, the net (amortization) deferrals of policy acquisition
costs were ($1.2) million, ($0.4) million and ($1.8) million for 2016, 2015 and 2014, 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.” Under ASC
350, Intangible assets with a finite life are amortized over the estimated useful life of the asset. Goodwill and intangible
assets with an indefinite useful life are not amortized. Goodwill and intangible assets are tested for impairment on an
annual basis or more frequently if events or changes in circumstances indicate that the carrying amount may not be
recoverable. For goodwill, we may perform a qualitative test to determine whether it is more likely than not that the fair
F-10
HALLMARK FINANCIAL SERVICES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Years ended December 31, 2016, 2015, and 2014
value of a reporting unit is less than its carrying amount as a basis for determining whether it is necessary to perform the
quantitative goodwill impairment test. The first step of the quantitative test is to identify if a potential impairment exists
by comparing the fair value of a reporting unit with its carrying amount, including goodwill (“Step 1”). If the fair value of a
reporting unit exceeds its carrying value amount, goodwill of the reporting unit is not considered to have a potential
impairment and the second step is not necessary. However, if the carrying amount of the reporting unit exceeds its fair
value, the second step (“Step 2”) is performed to determine if goodwill is impaired and to measure the amount of
impairment loss to recognize, if any. Step 2 compares the implied fair value of goodwill with the carrying amount of
goodwill. If the implied value of goodwill is less than the carrying amount of goodwill, it is written down to its fair value
with a corresponding expense reflected in the Consolidated Statements of Income. The implied goodwill is calculated
based on a hypothetical purchase price allocation, similar to the requirements in the accounting guidance for business
combinations, whereby the implied fair value of the reporting unit is allocated to the fair value of the assets and liabilities
of the reporting unit. 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.
Property and Equipment
Property and equipment (including leasehold improvements), aggregating $22.2 million and $17.9 million, at December
31, 2016 and 2015, 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 2016, 2015 and
2014 was $1.4 million, $1.0 million and $0.7 million, respectively. Accumulated depreciation was $15.1 million and $13.7
million at December 31, 2016 and 2015, 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, 2016 and 2015. 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.
F-11
HALLMARK FINANCIAL SERVICES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Years ended December 31, 2016, 2015, and 2014
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 $9.8 million, $11.2 million and $11.5 million for the years ended December 31, 2016, 2015, and
2014, 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 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, 2016
Treaty Effective Dates
7/1/2001
7/1/2002
60.0%
63.5%
59.0%
64.5%
7/1/2003
59.0%
61.2%
7/1/2004
7/1/2005
64.2%
66.1%
64.2%
61.0%
As of December 31, 2016, we had a payable of $0.6 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, 2016
65.0%
59.1%
65.0%
65.0%
65.0%
60.6%
Treaty Effective Dates
1/1/2006
1/1/2007
1/1/2008
F-12
HALLMARK FINANCIAL SERVICES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Years ended December 31, 2016, 2015, and 2014
As of December 31, 2016, we had a net payable of $1.1 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 operating expenses in the consolidated statements of operations.
Income Taxes
We file a consolidated federal income tax return. Deferred federal income taxes reflect the future tax consequences of
differences between the tax basis of assets and liabilities and their financial reporting amounts at each year end. Deferred
taxes are recognized using the liability method, whereby tax rates are applied to cumulative temporary differences based
on when and how they are expected to affect the tax return. Deferred tax assets and liabilities are adjusted for tax rate
changes in effect for the year in which these temporary differences are expected to be recovered or settled.
Earnings Per Share
The computation of earnings per share is based upon the weighted average number of common shares outstanding during
the period plus the effect of common shares potentially issuable (in periods in which they have a dilutive effect), primarily
from stock options. (See Notes 11 and 13.)
Adoption of New Accounting Pronouncements
In 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 April 2015, the FASB issued ASU 2015-03, “Simplifying the Presentation of Debt Issuance Costs,” which amends the
guidance in Accounting Standards Codification Topic 835-30 “Interest-Imputation of Interest.” ASU 2015-03 requires that
debt issuance costs related to a recognized debt liability be presented in the balance sheet as a direct deduction from the
carrying amount of that debt liability, consistent with debt discounts. For public business entities, the guidance was
effective for annual and interim periods beginning after December 15, 2015. We adopted this guidance effective January 1,
2016 and adjusted our prior period balances to reflect the adoption of this guidance.
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 losses and loss 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 have adopted this standard as of the effective date, and the
adoption had no impact on our financial statements other than to provide for additional footnote disclosures.
Recently Issued 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
F-13
HALLMARK FINANCIAL SERVICES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Years ended December 31, 2016, 2015, and 2014
and is to be applied retrospectively. Revenue from insurance contracts is excluded from the scope of this new guidance
and as a result, adoption of this guidance is not expected to have a material impact on our results of operations or
financial position.
In January 2016, the FASB issued ASU 2016-01, “Recognition and Measurement of Financial Assets and Financial Liabilities”
(Subtopic 825-10). ASU 2016-01 will require equity investments that are not consolidated or accounted for under the
equity method of accounting to be measured at fair value with changes in fair value recognized in net income. This ASU
will also require us to assess the ability to realize our deferred tax assets (“DTAs”) related to an available-for-sale debt
security in combination with our other DTAs. The ASU will be effective for fiscal years beginning after December 15, 2017,
including interim periods within those fiscal years. While we continue to evaluate the impact of this ASU, we anticipate the
standard will increase the volatility of our consolidated statements of income, resulting from the remeasurement of our
equity investments.
In February 2016, the FASB issued ASU 2016-02, “Leases” (Topic 842). ASU 2016-02 requires organizations that lease assets
to recognize on the balance sheet the assets and liabilities for the rights and obligations created by those leases.
Additionally, the ASU modifies current guidance for lessors' accounting. The ASU is effective for interim and annual
reporting periods beginning on or after January 1, 2019, with early adoption permitted. We do not anticipate that this ASU
will have a material impact on our results of operations, but we anticipate an increase to the value of our assets and
liabilities related to leases, with no material impact to equity.
In June 2016, the FASB issued ASU 2016-13, “Measurement of Credit Losses on Financial Instruments” (Topic 326). ASU
2016-13 requires organizations to estimate credit losses on certain types of financial instruments, including receivables
and available-for-sale debt securities, by introducing an approach based on expected losses. The expected loss approach
will require entities to incorporate considerations of historical information, current information and reasonable and
supportable forecasts. The ASU is effective for fiscal years beginning after December 15, 2019, including interim periods
within those fiscal years. The ASU requires a modified retrospective transition method and early adoption is permitted. We
are currently evaluating the impact that the adoption of the ASU will have on our financial results and disclosures, but do
not anticipate that any such potential impact would be material.
F-14
HALLMARK FINANCIAL SERVICES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Years ended December 31, 2016, 2015, and 2014
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, 2016
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 other investments
Total investments
As of December 31, 2015
Amortized
Cost
Gross
Unrealized
Gains
Gross
Unrealized
Losses
Fair Value
41,976 $
224,915
105,220
165,900
59,773
597,784
31,449
3,763
66 $
1,722
959
956
49
3,752
21,052
1,188
(20) $
(575)
(170)
(2,961)
(353)
(4,079)
(790)
-
42,022
226,062
106,009
163,895
59,469
597,457
51,711
4,951
$
632,996 $
25,992 $
(4,869) $
654,119
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 other investments
76,323 $
122,894
83,434
196,446
59,532
538,629
24,524
427
7 $
637
44
1,888
155
2,731
23,364
27
(61) $
(1,822)
(1,882)
(5,966)
(304)
(10,035)
(838)
-
76,269
121,709
81,596
192,368
59,383
531,325
47,050
454
Total investments
$
563,580 $
26,122 $
(10,873) $
578,829
F-15
HALLMARK FINANCIAL SERVICES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Years ended December 31, 2016, 2015, and 2014
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
Other investments
Cash and cash equivalents
Investment expenses
Investment income, net of expenses
Twelve Months Ended December 31
2016
2015
2014
$
$
594 $
5,573
3,190
5,442
1,320
638
-
277
17,034
(692)
16,342 $
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
No investments in any entity or its affiliates exceeded 10% of stockholders’ equity at December 31, 2016 or 2015.
Major categories of net realized gains (losses) on investments are summarized as follows (in thousands):
Twelve Months Ended December 31
2016
2015
2014
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
Unrealized gain on other investments
Other-than-temporary impairments
$
- $
(264)
(86)
(189)
(1)
1,871
1,331
1,188
(2,888)
- $
-
126
(83)
240
5,543
5,826
-
(3,323)
Net realized (losses) gains
$
(369) $
2,503 $
-
263
109
(140)
32
144
408
-
(274)
134
We realized gross gains on investments of $2.1 million, $6.7 million, and $0.6 million during the years ended December 31,
2016, 2015 and 2014, respectively. We realized gross losses on investments of $0.8 million, $0.9 million and $0.2 million during
the years ended December 31, 2016, 2015 and 2014, respectively. We recorded proceeds from the sale of investment securities
of $28.5 million, $51.7 million and $15.3 million during the years ended December 31, 2016, 2015 and 2014, respectively.
Realized investment gains and losses are recognized in operations on the specific identification method.
F-16
HALLMARK FINANCIAL SERVICES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Years ended December 31, 2016, 2015, and 2014
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, 2016 and December 31, 2015 (in thousands):
12 months or less
Longer than 12 months
Total
As of December 31, 2016
Fair Value
Unrealized
Losses
Fair Value
Unrealized
Losses
Fair Value
Unrealized
Losses
$
U.S. Treasury securities and
obligations of U.S. Government
Corporate bonds
Collateralized corporate bank
Municipal bonds
Mortgage-backed
Total debt securities
7,037 $
86,592
2,637
70,633
29,475
196,374
(20) $
(575)
(7)
(1,327)
(348)
(2,277)
- $
-
8,314
13,574
2,430
24,318
- $
-
(163)
(1,634)
(5)
(1,802)
7,037 $
86,592
10,951
84,207
31,905
220,692
(20)
(575)
(170)
(2,961)
(353)
(4,079)
Total equity securities
4,109
(483)
2,037
(307)
6,146
(790)
Total other investments
-
-
-
-
-
-
Total investments
$
200,483 $
(2,760) $
26,355 $
(2,109) $
226,838 $
(4,869)
12 months or less
Longer than 12 months
Total
As of December 31, 2015
Fair Value
Unrealized
Losses
Fair Value
Unrealized
Losses
Fair Value
Unrealized
Losses
$
U.S. Treasury securities and
obligations of U.S. Government
Corporate bonds
Collateralized corporate bank
Municipal bonds
Mortgage-backed
Total debt securities
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)
Total other investments
-
-
-
-
-
-
6,584
(838)
-
-
Total investments
$
291,131 $
(5,269) $
28,890 $
(5,604) $
320,021 $
(10,873)
At December 31, 2016, the gross unrealized losses more than twelve months old were attributable to 28 debt security positions
and one equity position. At December 31, 2015, the gross unrealized losses more than twelve months old were attributable to
39 debt security positions. We consider these losses as a temporary decline in value as they are predominately on securities
that we do not intend to sell and do not believe we will be required to sell prior to recovery of our amortized cost basis. We see
no other indications that the decline in values of these securities is other-than-temporary.
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
F-17
HALLMARK FINANCIAL SERVICES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Years ended December 31, 2016, 2015, and 2014
that the performance of certain issuers of these debt securities will be worse than currently expected resulting in future write-
downs within our portfolio of debt securities.
Also, as a result of the challenging market conditions, we expect the volatility in the valuation of our equity securities to
continue in the foreseeable future. This volatility may lead to 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 $2.9 million during 2016. Of the $2.9 million other-than-temporary impairments recorded for fiscal 2016,
$2.6 million relate to credit losses on certain senior and subordinated municipal bonds. We utilized the most recent
restructuring offer for each of the senior and subordinated bonds to estimate the credit loss portion of the other-than-
temporary impairments.
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.
Details regarding the carrying value of the other invested assets portfolio as of December 31, 2016 and 2015 were as follows:
Investment Type
Equity warrant
Total other investments
2016
2015
$
$
4,951 $
4,951 $
454
454
We acquired this equity warrant in an active market and it entitles us to buy the underlying common stock of a publicly traded
company at a fixed exercise price until the expiration date of January 19, 2021.
F-18
HALLMARK FINANCIAL SERVICES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Years ended December 31, 2016, 2015, and 2014
The amortized cost and estimated fair value of debt securities at December 31, 2016 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)
97,836 $
272,190
114,461
53,524
59,773
597,784 $
97,849
272,168
115,248
52,723
59,469
597,457
$
$
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 $21.1 million at December 31, 2016 and a
carrying value of $17.6 million at December 31, 2015.
F-19
HALLMARK FINANCIAL SERVICES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Years ended December 31, 2016, 2015, and 2014
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 and the equity
warrant classified as Other Investments.
Level 2 investment securities include corporate bonds, collateralized corporate bank loans, municipal bonds, U.S. Treasury
securities, other obligations of the U.S. Government and mortgage-backed securities for which quoted prices are not
available on active exchanges for identical instruments. We use third party pricing services to determine fair values for
each Level 2 investment security in all asset classes. Since quoted prices in active markets for identical assets are not
available, these prices are determined using observable market information such as quotes from less active markets
and/or quoted prices of securities with similar characteristics, among other things. We have reviewed the processes used
by the pricing services and have determined that they result in fair values consistent with the requirements of ASC 820 for
Level 2 investment securities. We have not adjusted any prices received from third party pricing 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-20
HALLMARK FINANCIAL SERVICES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Years ended December 31, 2016, 2015, and 2014
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, 2016 and December 31, 2015 (in thousands).
As of December 31, 2016
Quoted Prices in
Active Markets for
Identical Assets
(Level 1)
Other
Observable
Inputs (Level 2)
Unobservable
Inputs (Level 3)
Total
U.S. Treasury securities and obligations of U.S.
$
Corporate bonds
Collateralized corporate bank loans
Municipal bonds
Mortgage-backed
Total debt securities
Total equity securities
Total other investments
Total investments
$
- $
-
-
-
-
-
51,445
4,951
56,396 $
42,022 $
226,062
106,009
158,216
59,469
591,778
-
-
591,778 $
- $
-
-
5,679
-
5,679
266
-
5,945 $
42,022
226,062
106,009
163,895
59,469
597,457
51,711
4,951
654,119
As of December 31, 2015
Quoted Prices in
Active Markets for
Identical Assets
Other
Observable
Inputs (Level 2)
Unobservable
Inputs (Level 3)
Total
U.S. Treasury securities and obligations of U.S.
$
Corporate bonds
Collateralized corporate bank loans
Municipal bonds
Mortgage-backed
Total debt securities
Total equity securities
Total other investments
Total investments
$
- $
-
-
-
-
-
47,050
454
47,504 $
76,269 $
121,709
81,596
178,281
59,383
517,238
- $
-
-
14,087
-
14,087
76,269
121,709
81,596
192,368
59,383
531,325
-
-
47,050
-
517,238 $
-
14,087 $
454
578,829
F-21
HALLMARK FINANCIAL SERVICES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Years ended December 31, 2016, 2015, and 2014
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 these 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, 2016 and 2015 (in thousands).
Beginning balance as of January 1
Sales
Settlements
Purchases
Issuances
Total realized/unrealized gains included in net income
Net losses 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:
$
$
2016
2015
14,087 $
-
(8,825)
-
-
417
-
266
-
5,945 $
14,598
(370)
-
-
-
-
(141)
-
-
14,087
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 during the
second quarter of 2015 in Other Income in the Consolidated Statement 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 during the third quarter of 2015 in Other Income
in the Consolidated Statement of Operations as a result of this Amendment No.1.
Goodwill is tested for impairment at the reporting unit level (operating unit or one level below an operating unit) 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, 2016 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
F-22
HALLMARK FINANCIAL SERVICES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Years ended December 31, 2016, 2015, and 2014
completed our last annual test for impairment on the first day of the fourth quarter of 2016 and determined that there
was no impairment.
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
reflected an improved premium rate environment across most of our lines of business that continued throughout 2016.
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 2016, 2015, and 2014, we completed the first step prescribed by ASC 350 for testing for impairment and
determined that there was no impairment.
We have obtained various intangible assets from several acquisitions since 2002. The table below details the gross and net
carrying amounts of these assets by major category (in thousands):
Gross Carrying Amount:
Customer/agent relationships
Tradename
Management agreement
Non-compete & employment agreements
Insurance licenses
Total gross carrying amount
Accumulated Amortization:
Customer/agent relationships
Tradename
Management agreement
Non-compete & employment agreements
Total accumulated amortization
December 31
2016
2015
$
32,177 $
3,440
3,232
4,235
1,300
44,384
(22,038)
(2,388)
(3,232)
(4,235)
(31,893)
Total net carrying amount
$
12,491 $
32,177
3,440
3,232
4,235
1,300
44,384
(19,799)
(2,159)
(3,232)
(4,235)
(29,425)
14,959
F-23
HALLMARK FINANCIAL SERVICES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Years ended December 31, 2016, 2015, and 2014
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):
2017
2018
2019
2020
2021
$
$
$
$
$
2,468
2,468
2,468
2,468
503
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.
5. Other Assets:
The following table details our other assets as of December 31, 2016 and 2015 (in thousands):
Years
15
15
4
5
Profit sharing commission receivable
Credit Facility B issuance costs
Accrued investment income
Investment in unconsolidated trust subsidiaries
Fixed assets
Other assets
2016
2015
$
$
251 $
109
4,599
1,702
6,947
193
13,801 $
228
92
3,876
1,702
4,120
174
10,192
F-24
HALLMARK FINANCIAL SERVICES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Years ended December 31, 2016, 2015, and 2014
6. Reserves for Losses and Loss Adjustment Expenses:
Activity in the consolidated 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
2016
2015
2014
$
$
450,878 $
102,791
348,087
246,080
7,608
253,688
93,067
150,378
243,445
358,330
123,237
481,567 $
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
The $7.6 million unfavorable net development, $7.0 million favorable net development and $5.2 million favorable net
development in prior accident years recognized in 2016, 2015 and 2014, respectively, represent normal changes in our loss
reserve estimates. In 2016, 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. 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. 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.
The $7.6 million increase in prior period reserves for unpaid losses and LAE recognized in 2016 was attributable to $5.3 million
favorable net development on claims incurred in the 2015 accident year, $3.9 million unfavorable net development on claims
incurred in the 2014 accident year and $9.0 million unfavorable net development on claims incurred in the 2013 and prior
accident years. Our MGA Commercial Products operating unit, Specialty Personal Lines operating unit and Specialty
Commercial operating unit accounted for $11.3 million, $5.0 million, and $1.2 million, respectively, of the increase in prior
period reserves recognized during 2016. The increase in reserves for our MGA Commercial operating unit was primarily related
to our commercial auto liability line of business. The increase in reserves for our Specialty Personal Lines operating unit was
primarily attributable to the 2015, 2014 and 2013 and prior accident years. The increase in reserves for our Specialty
Commercial operating unit was primarily related to $0.9 million unfavorable development in our medical professional liability
products and $0.7 million related to our commercial auto liability specialty program, partially offset by $0.3 million favorable
development in our general aviation line of business and $0.1 million favorable development in our commercial excess liability
line of business. These unfavorable developments were partially offset by favorable development of $6.6 million in our
Standard Commercial P&C operating unit and $3.3 in our Workers Compensation operating unit. 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
prior period reserves for our Workers Compensation operating unit was attributable to the 2015, 2014, 2013 and prior accident
years.
F-25
HALLMARK FINANCIAL SERVICES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Years ended December 31, 2016, 2015, and 2014
Short-Duration Contract Disclosures
ASU 2015-09, “Disclosures about Short-Duration Contracts” (Topic 944), requires insurers to make disclosures about their
liability for unpaid claims and claim adjustment expenses for short-duration insurance contracts. These disclosures include
tables showing incurred and paid claims development information (net of reinsurance and excluding unallocated loss
adjustment expenses) which are disaggregated based on the characteristics of the insurance contracts that the insurer writes
and other factors specific to the reporting entity. The information should be disclosed by accident year for the number of years
claims typically remain outstanding, but need not be more than 10 years, including a reconciliation of the disaggregated
information to the consolidated statement of financial position. The basis for our disaggregation of this information is by each
of our three reportable segments. See Note 10, “Segment Information,” for additional information regarding our three
reportable segments.
Reserves for Incurred But Not Reported (“IBNR”) Claims
Reserves for IBNR claims are based on the estimated ultimate cost of settling claims, including the effects of inflation and other
social and economic factors, using past experience adjusted for current trends and any other factors that would modify past
experience. We use a variety of statistical and actuarial techniques to analyze current claims costs, including frequency and
severity data and prevailing economic, social and legal factors. Each such method has its own set of assumptions and outputs,
and each has strengths and weaknesses in different areas. Since no single estimation method is superior to another method in
all situations, the methods and assumptions used to project loss reserves will vary by coverage and product. We use what we
believe to be the most appropriate set of actuarial methods and assumptions for each product line grouping and coverage.
While the loss projection methods may vary by product line and coverage, the general approach for calculating IBNR remains
the same: ultimate losses are forecasted first, and that amount is reduced by the amount of cumulative paid claims and case
reserves. Reserves established in prior years are adjusted as loss experience develops and new information becomes available.
Adjustments to previously estimated reserves are reflected in the results of operations in the year in which they are made.
As described above, various actuarial methods are utilized to determine the reserves for losses and LAE recorded in our
Consolidated Balance Sheets. Weightings of methods at a detailed level may change from evaluation to evaluation based on a
number of observations, measures, and time elements. There were no significant changes to the methods and assumptions
underlying our consolidated reserve estimations and selections as of December 31, 2016.
Methodology for Determining Cumulative Number of Reported Claims
A claim file is created when the Company is notified of an actual demand for payment, notified of an event that may lead to a
demand for payment or when it is determined that a demand for payment could possibly lead to a future demand for payment
on another coverage on the same policy or on another policy. The cumulative number of reported claims is predominately
measured at a coverage level by occurrence, with the exception of our Specialty Commercial operating unit which is
predominately measured at the claim level. Reported occurrences that do not result in a liability are included in reported
claims. The Company does not generate claim counts for ceded business.
Incurred & Paid Claims Development Disclosures
The following tables provide information about incurred and cumulative paid losses and allocated loss adjustment expenses
(“ALAE”), net of reinsurance for our three reportable segments, our Specialty Commercial Segment, our Standard Commercial
Segment and our Personal Segment. The incurred and paid losses by accident year information presented for all segments in
the below tables for calendar years prior to 2016 is required supplementary information and is unaudited. The following tables
also include IBNR reserves plus expected development on reported claims and the cumulative number of reported claims as of
December 31, 2016 ($ in thousands):
F-26
HALLMARK FINANCIAL SERVICES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Years ended December 31, 2016, 2015, and 2014
Specialty Commercial Segment
Incurred Claims and Allocated Claim Adjustment Expenses, Net of Reinsurance
As of December
Accident
Year
For the Years Ended December 31,
Cumulative
Number of
Reported
Claims
IBNR
2007
2008
2009
2010
Unaudited
2011
2012
2013
2014
2015
2016
2016
2016
55,617 56,150 58,143 57,923
60,950 62,679 61,196
74,187 78,089
88,679
2007 $ 51,458 $ 52,141 $ 51,813 $ 52,673 $ 50,158 $ 49,654 $ 49,096 $ 49,056 $ 49,290 $
2008
2009
2010
2011
2012
2013
2014
2015
2016
55,425
59,635
78,003
90,713
55,157
59,831
77,593
91,059
55,457
59,988
77,972
89,737
56,579
59,471
75,695
87,558
68
(102)
87
1,227
1,641
2,020
2,127
6,547
49,544 $
55,864
61,361
77,631
87,793
116,320
143,983
138,842
146,610
151,494
6,095
7,367
5,456
4,999
5,782
7,337
9,188
10,049
10,707
10,424
Accident
Year
2007 $
2008
2009
2010
2011
2012
2013
2014
2015
2016
Total
$
1,029,442
Cumulative Paid Claims and Allocated Claim Adjustment Expenses, Net of Reinsurance
2007
2008
2009
2010
2011
2012
2013
2014
2015
2016
For the Years Ended December 31,
Unaudited
18,851 $
33,504 $
24,134
41,344 $
37,803
21,259
44,861 $
44,903
34,411
24,818
47,453 $
51,280
45,757
45,234
27,454
48,612 $
53,723
53,135
58,139
53,509
37,655
48,612 $
53,577
56,791
68,625
71,697
60,923
40,475
48,783 $
54,080
57,641
73,398
80,004
82,066
76,366
42,097
48,860 $
54,909
59,149
74,513
83,787
97,680
101,725
73,631
39,515
49,025
55,372
60,785
75,787
84,936
109,060
126,025
99,521
74,906
41,397
$ 776,814
(26)
Total
All outstanding liabilities before 2007, net of reinsurance
Liabilities for claims and claim adjustment expenses, net of reinsurance
$ 252,602
(1
F-27
HALLMARK FINANCIAL SERVICES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Years ended December 31, 2016, 2015, and 2014
Standard Commercial Segment
Incurred Claims and Allocated Claim Adjustment Expenses, Net of Reinsurance
Accident
Year
For the Years Ended December 31,
As of December 31,
Cumulative
Number of
Reported
Claims
IBNR
2007
2008
2009
2010
Unaudited
2011
2012
2013
2014
2015
2016
2016
2016
2007 $
2008
2009
2010
2011
2012
2013
2014
2015
2016
$ 45,280 $ 42,632 $ 42,898 $ 41,814 $ 39,476 $ 37,894 $ 36,798 $
49,452 47,557 46,762 45,556 42,758 41,597 40,387
44,719 45,674 46,772 46,778 45,970 44,159
45,263 45,235 44,847 43,164 43,459
60,236 56,489 55,156 49,268
51,998 52,554 48,222
55,482 57,528
55,488
37,321 $ 36,419 $
39,195
40,001
43,107
43,851
42,175
42,426
47,423
47,266
44,272
45,990
53,174
56,703
53,568
55,808
49,857
49,571
46,880
576
1,826
2,102
2,252
3,387
5,144
6,379
8,979
11,946
16,885
3,156
3,246
2,632
2,903
4,364
3,212
3,910
3,531
3,129
2,554
Total
$
456,070
Accident
Year
2007 $
2008
2009
2010
2011
2012
2013
2014
2015
2016
Cumulative Paid Claims and Allocated Claim Adjustment Expenses, Net of Reinsurance
2007
2008
2009
2010
2011
2012
2013
2014
2015
2016
For the Years Ended December 31,
Unaudited
13,883 $
20,362 $
17,182
25,484 $
25,624
15,242
28,908 $
29,058
28,313
21,302
31,311 $
32,523
32,075
28,342
24,899
32,288 $
34,056
35,818
30,957
35,119
23,445
32,949 $
34,762
38,316
33,428
38,909
32,203
23,123
33,561 $
35,360
40,389
37,166
40,301
34,789
36,411
24,255
33,982 $
36,276
40,575
39,115
41,140
37,191
41,809
37,122
19,085
34,483
36,859
40,629
39,706
42,441
38,526
44,475
41,514
34,245
21,508
$ 374,386
538
Total
All outstanding liabilities before 2007, net of reinsurance
Liabilities for claims and claim adjustment expenses, net of reinsurance
$
82,222
F-28
HALLMARK FINANCIAL SERVICES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Years ended December 31, 2016, 2015, and 2014
Personal Segment
Incurred Claims and Allocated Claim Adjustment Expenses, Net of Reinsurance
Accident
Year
For the Years Ended December 31,
As of December 31,
Cumulative
Number of
Reported
Claims
IBNR
2007
2008
2009
2010
Unaudited
2011
2012
2013
2014
2015
2016
2016
2016
2007 $ 28,774 $ 31,603 $ 31,252 $ 31,485 $ 31,651 $ 31,931 $ 32,272 $ 32,517 $
2008
2009
2010
2011
2012
2013
2014
2015
2016
36,247 36,976 38,329 39,412 39,793 40,170 40,239
40,436 42,092 46,244 47,977 48,930 49,694
63,862 78,294 80,765 84,724 83,903
75,746 77,652 87,810 86,757
58,604 73,795 70,552
55,706 59,132
5,452
32,528 $ 32,528 $
40,324
49,772
84,252
86,804
71,513
60,100
5,340
23,104
40,369
49,891
84,591
86,948
72,042
60,211
6,243
25,682
32,260
-
-
-
6
(28)
50
234
406
1,813
6,638
15,814
17,353
21,052
30,179
31,612
23,937
23,461
19,275
23,234
21,134
Total
490,765
$
Cumulative Paid Claims and Allocated Claim Adjustment Expenses, Net of Reinsurance
Accident
Year
For the Years Ended December 31,
Unaudited
2007
2008
2009
2010
2011
2012
2013
2014
2015
2016
2007 $ $ 18,106 $
2008
2009
2010
2011
2012
2013
2014
2015
2016
27,757 $
20,005
30,043 $
32,555
23,306
30,975 $
36,782
37,621
38,643
31,355 $
38,925
44,689
67,755
46,416
31,523 $
39,511
47,967
75,199
67,939
37,860
32,056 $
40,210
49,287
82,624
83,497
64,278
45,901
31,213 $
40,309
49,539
83,511
85,533
68,849
54,514
2,515
32,531 $
40,323
49,704
84,111
86,217
70,807
58,047
4,418
11,570
32,530
40,347
49,853
84,556
86,593
71,995
59,775
5,631
22,281
21,669
$ 475,230
Total
All outstanding liabilities before 2007, net of reinsurance
9
Liabilities for claims and claim adjustment expenses, net of reinsurance
$
15,544
F-29
HALLMARK FINANCIAL SERVICES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Years ended December 31, 2016, 2015, and 2014
The reconciliation of the net incurred and paid development tables to the liability for unpaid losses and LAE in our Consolidated
Balance Sheets is as follows (in thousands):
Net outstanding liabilities for losses and LAE
Specialty Commercial Segment
Standard Commercial Segment
Personal Segment
Liabilities for unpaid losses and allocated loss adjustment expenses, net of reinsurance
Reinsurance recoverable on unpaid losses and LAE
Specialty Commercial Segment
Standard Commercial Segment
Personal Segment
Total reinsurance recoverable on unpaid losses and LAE
Unallocated loss adjustment expenses
Specialty Commercial Segment
Standard Commercial Segment
Personal Segment
Total unallocated loss adjustment expenses
$
2016
252,602
82,222
15,544
350,368
102,597
8,540
12,100
123,237
3,831
3,031
1,100
7,962
Total reserves for unpaid losses and loss adjustment expenses
$
481,567
Claims Duration
The following table provides supplementary unaudited information about the annual percentage payout of incurred losses and
ALAE, net of reinsurance, as of December 31, 2016:
Average Annual Percentage Payout of Incurred Claims by Age, Net of Reinsurance (1)
Unaudited
Year 1
Year 2
Year 3
Year 4
Year 5
Year 6
Year 7
Year 8
Year 9 Year 10
Specialty Commercial Segment
32.4%
24.8%
17.4%
12.0%
6.0%
1.2%
1.2%
1.5%
0.5%
-0.3%
Standard Commercial Segment
Personal Segment
44.6%
51.5%
23.0%
29.2%
8.7%
10.9%
6.6%
4.3%
5.0%
1.4%
3.3%
0.8%
1.3%
0.7%
1.4%
-0.7%
1.3%
1.9%
-1.4%
0.0%
(
(1) The average annual percentage payout is calculated from a paid losses and ALAE development pattern based on an
actuarial analysis of the paid losses and ALAE movements by accident year for each disaggregation category. The
paid losses and ALAE development pattern provides the expected percentage of ultimate losses and ALAE to be paid
in each year. The pattern considers all accident years included in the claims development tables.
F-30
HALLMARK FINANCIAL SERVICES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Years ended December 31, 2016, 2015, and 2014
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, 2016 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):
Premium Written :
Direct
Assumed
Ceded
Premium Earned:
Direct
Assumed
Ceded
Reinsurance recoveries
2016
2015
2014
$
$
$
$
$
549,077 $
-
(187,248)
361,829 $
524,229 $
-
(170,859)
353,370 $
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
116,057 $
89,892 $
99,911
Included in reinsurance recoverable on the consolidated balance sheets are paid loss recoverables of $24.4 million and $11.1
million as of December 31, 2016 and 2015, respectively.
8. Revolving Credit Facility and Notes Payable:
Our Second Restated Credit Agreement with Frost Bank (“Frost”) dated June 30, 2015, reinstated the credit facility with Frost
which expired by its terms on April 30, 2015. The Second Restated Credit Agreement also amended certain provisions of the
credit facility and restated the agreement with Frost in its entirety. The Second Restated Credit Agreement provides a $15.0
million revolving credit facility (“Facility A”), with a $5.0 million letter of credit sub-facility. The outstanding balance of the
Facility A bears interest at a rate equal to the prime rate or LIBOR plus 2.5%, at our election. We pay an annual fee of 0.25% of
the average daily unused balance of Facility A and letter of credit fees at the rate of 1.00% per annum. As of December 31,
2016, we had no outstanding borrowings under Facility A.
On December 17, 2015, we entered into a First Amendment to Second Restated Credit Agreement and a Revolving Facility B
Agreement (the “Facility B Agreement”) with Frost to provide a new $30.0 million revolving credit facility (“Facility B”), in
addition to Facility A. On November 1, 2016, we amended the Facility B Agreement with Frost to extend by one year the
termination date for draws under Facility B and the maturity date for amounts outstanding thereunder. We paid Frost a
commitment fee of $75,000 when Facility B was established and an additional $30,000 fee when Facility B was extended.
We may use Facility B loan proceeds solely for the purpose of making capital contributions to AHIC and HIC. As amended, we
may borrow, repay and reborrow under Facility B until December 17, 2018, at which time all amounts outstanding under
Facility B are converted to a term loan. Through December 17, 2018, we pay Frost a quarterly fee of 0.25% per annum of the
F-31
HALLMARK FINANCIAL SERVICES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Years ended December 31, 2016, 2015, and 2014
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, 2018, 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, 2018 are converted to a term loan payable in quarterly
installments over five years based on a seven year amortization of principal plus accrued interest. All remaining principal and
accrued interest on Facility B become due and payable on December 17, 2023. As of December 31, 2016 and 2015, respectively,
we had $30.0 million outstanding under Facility B.
The obligations under both Facility A and Facility B are secured by a security interest in the capital stock of AHIC and HIC. Both
Facility A and Facility B contain covenants that, among other things, require us to maintain certain financial and operating ratios
and restrict certain distributions, transactions and organizational changes. As of December 31, 2016, we were in compliance
with all of these covenants.
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, 2016, the principal balance of our Trust I subordinated debt was $30.9 million and the interest rate was 4.21%
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, 2016, the principal balance of our Trust II subordinated debt was $25.8 million.
F-32
HALLMARK FINANCIAL SERVICES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Years ended December 31, 2016, 2015, and 2014
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:
•
•
•
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. Certain specialty programs are also managed by our Specialty
Commercial operating unit. 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.
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 June 1, 2016, we no longer market new or renewal occupational accident
policies. 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.
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.
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-33
HALLMARK FINANCIAL SERVICES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Years ended December 31, 2016, 2015, and 2014
The following is additional business segment information for the twelve months ended December 31, 2016, 2015 and 2014 (in
thousands):
Revenues
Specialty Commercial Segment
Standard Commercial Segment
Personal Segment
Corporate
Consolidated
Depreciation and Amortization Expense
Specialty Commercial Segment
Standard Commercial Segment
Personal Segment
Corporate
Consolidated
Interest Expense
Specialty Commercial Segment
Standard Commercial Segment
Personal Segment
Corporate
Consolidated
Tax Expense (Benefit)
Specialty Commercial Segment
Standard Commercial Segment
Personal Segment
Corporate
Consolidated
Pre-tax Income (Loss)
Specialty Commercial Segment
Standard Commercial Segment
Personal Segment
Corporate
Consolidated
2016
2015
2014
$
255,897 $
71,966
49,826
(1,737)
249,910 $
76,864
45,538
90
241,920
81,464
20,404
(6,422)
$
375,952 $
372,402 $
337,366
$
$
$
$
$
2,579 $
101
1,070
144
3,894 $
- $
-
-
4,549
4,549 $
2,537 $
136
779
64
3,516 $
- $
-
-
3,906
3,906 $
2,503
183
515
23
3,224
-
-
-
4,576
4,576
7,886 $
3,011
(3,821)
(5,124)
11,609 $
1,436
(1,345)
(1,677)
9,690
622
(574)
(4,385)
$
1,952 $
10,023 $
5,353
$
24,417 $
8,866
(6,839)
(17,966)
40,277 $
6,687
(885)
(14,193)
34,237
4,595
1,226
(21,276)
$
8,478 $
31,886 $
18,782
F-34
HALLMARK FINANCIAL SERVICES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Years ended December 31, 2016, 2015, and 2014
The following is additional business segment information as of the following dates (in thousands):
Assets
Specialty Commercial Segment
Standard Commercial Segment
Personal Segment
Corporate
Consolidated
11. Earnings Per Share:
December 31
2016
2015
$
$
734,763 $
164,295
241,686
21,716
1,162,460 $
660,263
156,722
239,632
18,930
1,075,547
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:
2016
2015
2014
$
6,526 $
21,863 $
13,429
18,780
19,211
19,197
161
18,941
194
19,405
169
19,366
$
$
0.35 $
0.34 $
1.14 $
0.70
1.13 $
0.69
We had 272,500 shares, 267,500 shares and 544,999 shares of common stock potentially issuable upon exercise of
employee stock options for years ended December 31, 2016, 2015 and 2014, 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 2017 to 2021.
F-35
HALLMARK FINANCIAL SERVICES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Years ended December 31, 2016, 2015, and 2014
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 $68.4 million as of December 31, 2016.
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 2017, the
aggregate ordinary dividend capacity of these subsidiaries is $28.0 million, of which $19.4 million is available to Hallmark.
As a county mutual, dividends from HCM are payable to policyholders. During the years ended December 31, 2016 and
2015 our insurance company subsidiaries paid $10.5 million and $8.0 million, respectively, in dividends to Hallmark. The
total restricted net assets of our insurance company subsidiaries as of December 31, 2016, was $197.3 million.
The state insurance departments also regulate financial transactions between our insurance subsidiaries and their
affiliated companies. Applicable regulations require approval of management fees, expense sharing contracts and similar
transactions. The net amount paid in management fees by our insurance subsidiaries to Hallmark and our non-insurance
company subsidiaries was $1.1 million, $1.3 million and $1.1 million during each of 2016, 2015 and 2014, 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, 2016 and 2015, our insurance company subsidiaries reported statutory capital and surplus of
$248.4 million and $247.2 million, respectively, substantially greater than the minimum requirements for each state. For
the years ended December 31, 2016, 2015, 2014, respectively, our insurance company subsidiaries reported statutory net
income of $8.7 million, $24.6 million and $22.3 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, 2016, the adjusted capital under the risk-based capital calculation of each of our insurance company subsidiaries
substantially exceeded the minimum requirements.
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, 2016, there were outstanding incentive stock options to purchase 335,074 shares of our common stock,
non-qualified stock options to purchase 289,157 shares of our common stock and restricted stock units representing the
right to receive up to 151,901 shares of our common stock. The exercise price of all such outstanding stock options is equal
to the fair market value of our common stock on the date of grant.
Our 2015 Long Term Incentive Plan (“2015 LTIP”) was approved by shareholders on May 29, 2015. There are 2,000,000
shares authorized for issuance under the 2015 LTIP. As of December 31, 2016, restricted stock units representing the right
F-36
HALLMARK FINANCIAL SERVICES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Years ended December 31, 2016, 2015, and 2014
to receive up to 292,961 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, 2016.
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, 2016 and changes during the year then ended is
presented below:
Outstanding at January 1, 2016
Granted
Exercised
Forfeited or expired
Outstanding at December 31, 2016
Exercisable at December 31, 2016
Number of
Shares
Weighted Average
Exercise Price
869,113 $
-
(70,000) $
(174,882) $
624,231 $
624,231 $
9.51
6.66
11.96
9.14
9.14
Average
Remaining
Contractual
Term (Years)
Aggregate
Instrinsic Value
($000)
1.7 $
1.7 $
1,714
1,714
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
$
$
$
250 $
38 $
8 $
393 $
157 $
30 $
412
173
30
2016
2015
2014
As of December 31, 2016, there was no unrecognized compensation cost related to non-vested stock options granted
under our plans which is expected to be recognized in the future.
The fair value of each stock option granted is estimated on the date of grant using the Black-Scholes option pricing model.
Expected volatilities are based on the historical volatility of Hallmark’s and similar companies’ common stock for a period
equal to the expected
term. The risk-free interest rates for periods within the contractual term of the options are based on rates for U.S.
Treasury Notes with maturity dates corresponding to the options’ expected lives on the dates of grant. Expected term is
determined based on the simplified method as we do not have sufficient historical exercise data to provide a basis for
estimating the expected term. There were no stock options granted in 2016, 2015 or 2014.
F-37
HALLMARK FINANCIAL SERVICES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Years ended December 31, 2016, 2015, and 2014
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 under the 2005 LTIP. On May 29, 2015, an aggregate of 103,351
restricted stock units were granted to certain employees under the 2015 LTIP. Subsequently on July 22, 2016, an
aggregate of 122,770 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 unit grants 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. On April 1, 2016, 7,144 shares of common stock were issued with
respect to 7,144 restricted stock units which were granted on April 10, 2013 and vested on March 31, 2016. If and to the
extent specified performance criteria have been achieved, 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, the restricted stock units granted on May 29, 2015 will vest on March 31, 2018 and the restricted stock
units granted on July 22, 2016 will vest on March 31, 2019.
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.
The grant date fair value of the restricted stock units granted in 2016 is $11.41 per unit. We incurred compensation
(benefit) expense of ($156) thousand, $226 thousand and $49 thousand related to restricted stock units during the year
ended December 31, 2016, 2015 and 2014, respectively. We recorded income tax (expense) benefit of ($55) thousand,
$79 thousand and $17 thousand related to restricted stock units during the year ended December 31, 2016, 2015 and
2014, respectively.
F-38
HALLMARK FINANCIAL SERVICES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Years ended December 31, 2016, 2015, and 2014
A summary of the status of our restricted stock units as of December 31, 2016 and changes during the year then ended is
presented below:
Nonvested at January 1, 2016
Granted
Vested
Forfeited
Nonvested at December 31, 2016
Number of
Restricted Stock
Units
296,571
122,770
(7,144)
(115,623)
296,574
As of December 31, 2016, there was $141 thousand of total unrecognized compensation cost related to unvested
restricted stock units granted under our 2005 LTIP and 2015 LTIP, of which $80 thousand is expected to be recognized in
2017, $50 thousand is expected to be recognized in 2018 and $11 thousand is expected to be recognized in 2019.
F-39
HALLMARK FINANCIAL SERVICES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Years ended December 31, 2016, 2015, and 2014
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, 2016, 2015
and 2014 (in thousands) using a measurement date of December 31.
2016
2015
2014
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 loss/(gain)
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
$
$
$
$
$
$
$
$
$
3.88%
N/A
4.12%
N/A
3.86%
N/A
(12,618) $
(12,915) $
(13,909)
(12,618) $
10,415
(2,203) $
(12,915) $
10,419
(2,496) $
(13,909)
11,290
(2,619)
(4,102)
(4,102)
1,899
(3,957)
(3,957)
1,461
(4,000)
(4,000)
1,381
(2,203) $
(2,496) $
(2,619)
12,915 $
512
19
(828)
13,909 $
518
(646)
(866)
12,284
532
1,947
(854)
12,618 $
12,915 $
13,909
10,419 $
415
409
(828)
11,290 $
(5)
-
(866)
10,851
760
533
(854)
10,415 $
10,419 $
11,290
- $
- $
512
(653)
112
518
(701)
103
-
532
(698)
162
(4)
4.49%
6.50%
N/A
$
(29) $
(80) $
4.12%
6.50%
N/A
3.86%
6.50%
N/A
F-40
HALLMARK FINANCIAL SERVICES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Years ended December 31, 2016, 2015, and 2014
Estimated future benefit payments by fiscal year (in thousands):
2017
2018
2019
2020
2021
2022-2026
$
$
$
$
$
$
884
883
875
862
863
4,071
As of December 31, 2016, 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, 2016. To develop the discount rate used in determining the benefit obligation we used
the BPS&M 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 expect that we will not be required to make a contribution to the defined benefit cash balance plan during 2017. We
expect our 2017 periodic pension cost to be $(63) thousand, the components of which are interest cost of $444 thousand,
expected return on plan assets of ($649) thousand and amortization of actuarial loss of $142 thousand.
F-41
HALLMARK FINANCIAL SERVICES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Years ended December 31, 2016, 2015, and 2014
The following table shows the weighted-average asset allocation for the defined benefit cash balance plan held as of
December 31, 2016 and 2015.
Asset Category:
Debt securities
Equity securities
Other
Total
December 31
2016
2015
33%
64%
3%
100%
33%
64%
3%
100%
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, 2016 and December 31, 2015 (in thousands).
As of December 31, 2016
Quoted Prices in
Active Markets for
Identical Assets (Level
1)
Other
Observable
Inputs
(Level 2)
Unobservable Inputs
(Level 3)
Total
Debt securities
Equity securities
Total
$
$
- $
6,653
6,653 $
3,438 $
-
3,438 $
- $
-
- $
3,438
6,653
10,091
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
Debt securities
Equity securities
Total
Our plan assets also include cash and cash equivalents of $0.3 million and $0.3 million at December 31, 2016 and
2015, respectively, and are carried at cost which approximates fair value.
We sponsor a defined contribution plan. Under this plan, employees may contribute a portion of their compensation
on a tax-deferred basis, and we may contribute a discretionary amount each year. We contributed $0.4 million, $0.3
million and $0.3 million for the years ended December 31, 2016, 2015 and 2014, respectively
F-42
HALLMARK FINANCIAL SERVICES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Years ended December 31, 2016, 2015, and 2014
15.
Income Taxes:
The composition of deferred tax assets and liabilities and the related tax effects as of December 31, 2016 and 2015,
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
Bond amortization
Bonus accrual
Investment impairments
Other
Total deferred tax assets
$
2016
2015
(6,717) $
(7,395)
(56)
(4,623)
(559)
(1,106)
(435)
(20,891)
11,184
238
1,436
319
6,208
247
434
291
1,419
480
22,256
(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
Deferred federal income taxes, net
$
1,365 $
3,360
We concluded that no valuation allowance was necessary to provide against our deferred tax assets as of December 31, 2016.
F-43
HALLMARK FINANCIAL SERVICES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Years ended December 31, 2016, 2015, and 2014
A reconciliation of the income tax provisions based on the 35% statutory tax rate to the provision reflected in the consolidated
financial statements for the years ended December 31, 2016, 2015 and 2014, 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 expense (benefit)
Income tax expense
2016
2015
2014
$
$
$
$
2,967 $
81
(1,164)
(133)
203
(2)
11,160 $
32
(1,259)
(141)
176
55
6,574
27
(1,276)
(107)
259
(124)
1,952 $
10,023 $
5,353
1,547 $
405
11,053 $
(1,030)
5,746
(393)
1,952 $
10,023 $
5,353
We have available, for federal income tax purposes, unused net operating loss of $0.9 million at December 31, 2016. 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
2036
$
553
2
25
45
77
73
59
33
44
911
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
2013. The Company recognizes interest and penalties related to uncertain tax positions in income tax expense. There were no
uncertain tax positions at December 31, 2016.
F-44
HALLMARK FINANCIAL SERVICES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Years ended December 31, 2016, 2015, and 2014
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 $2.5 million, $2.2 million and $2.3
million for the years ended December 31, 2016, 2015, and 2014, respectively.
Future minimum lease payments under non-cancelable operating leases as of December 31, 2016 are as follows (in
thousands):
Year
2017
2018
2019
2020
2021
2022 and thereafter
Total minimum lease payments (a)
$
$
2,281
1,948
1,874
1,841
994
341
9,279
(a) Minimum lease payments have not been reduced by minimum sublease rentals of $0.5
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 paid an
assessment of $0.1 million in 2016. There were no assessments during 2015.
In November 2015, one of the subsidiaries in our MGA Commercial operating unit, Hallmark Specialty Underwriters, Inc.
(“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 legislature 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 has asserted 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, 2016 related to this matter.
F-45
HALLMARK FINANCIAL SERVICES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Years ended December 31, 2016, 2015, and 2014
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.
17.
Changes in Accumulated Other Comprehensive Income Balances:
The changes in accumulated other comprehensive income balances as of December 31, 2016, 2015, and 2014 were as
follows (in thousands):
Balance at January 1, 2014
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
Balance at December 31, 2015
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
Pension
Liability
Unrealized
Gains (Loss)
Accumulated Other
Comprehensive
Income (Loss)
$
(1,480) $
18,363 $
16,883
(1,723)
603
-
-
-
-
3,543
(1,240)
-
(408)
-
(1,120)
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)
$
(2,572) $
9,990 $
(145)
51
-
-
-
-
(94)
-
-
6,019
(2,107)
(1,331)
466
3,047
43
(15)
(10,191)
3,567
(5,826)
2,039
(10,383)
7,418
(145)
51
6,019
(2,107)
(1,331)
466
2,953
Balance at December 31, 2016
$
(2,666) $
13,037 $
10,371
F-46
HALLMARK FINANCIAL SERVICES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Years ended December 31, 2016, 2015, and 2014
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, 2016.
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, 2016 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, 2016 and
2015 (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.
2016
2015
Total revenue
Total expense
Income (loss) before tax
Income tax expense (benefit)
Q1
Q3
Q2
$ 90,028 $ 91,052 $ 97,618 $
Q4
Q2
97,254 $ 91,450 $ 97,197 $ 93,684 $ 90,071
84,039 89,565 90,442 103,428 83,761 87,922 83,849 84,984
5,087
1,641
9,275
2,899
1,487
421
Q4
Q3
Q1
7,176 (6,174)
2,128 (2,512)
5,048 (3,662) $
7,689
2,346
5,343
5,989
1,915
4,074
9,835
3,137
6,698
6,376 $
3,446
Net income (loss)
$
1,066 $
Basic earnings (loss) per share: $
0.21 $
0.06 $
0.27 $
(0.20) $
0.28 $
0.33 $
0.35 $
0.18
Diluted earnings (loss) per
share:
$
0.21 $
0.06 $
0.27 $
(0.20) $
0.28 $
0.33 $
0.35 $
0.17
F-47
FINANCIAL STATEMENT SCHEDULES
Schedule II – Condensed Financial Information of Registrant (Parent Company Only)
HALLMARK FINANCIAL SERVICES, INC.
BALANCE SHEETS
December 31, 2016 and 2015
(In thousands)
ASSETS
Cash and cash equivalents
Investment in subsidiaries
Deferred federal income taxes
Federal income tax recoverable
Other assets
Total assets
LIABILITIES AND STOCKHOLDERS’ EQUITY
Liabilities:
Revolving credit facility payable
Subordinated debt securities (less unamortized debt issuance cost of $1,001 in 2016 and $1,053
in 2015)
Current federal income tax payable
Accounts payable and other accrued expenses
Total liabilities
Stockholders’ equity:
2016
2015
$
9,034 $
363,078
333
2,756
3,878
8,014
361,769
942
-
3,435
$
379,079 $
374,160
$
30,000 $
30,000
55,701
-
27,642
113,343
55,649
72
26,413
112,134
Common stock, $.18 par value, authorized 33,333,333 shares; issued 20,872,831 shares in 2016
and in 2015
Additional paid-in capital
Retained earnings
Accumulated other comprehensive income
Treasury stock (2,260,849 shares in 2016 and 1,775,512 in 2015), at cost
3,757
123,166
148,027
10,371
3,757
123,480
141,501
7,418
(19,585)
(14,130)
265,736
262,026
$
379,079 $
374,160
Total stockholders’ equity
Total liabilities and stockholders’ equity
See accompanying report of independent registered public accounting firm.
F-48
FINANCIAL STATEMENT SCHEDULES
Schedule II (Continued) – Condensed Financial Information of Registrant (Parent Company Only)
HALLMARK FINANCIAL SERVICES, INC.
STATEMENTS OF OPERATIONS
For the years ended December 31, 2016, 2015 and 2014
(In thousands)
2016
2015
2014
Investment income, net of expenses
Dividend income from subsidiaries
Management fee income
Total revenues
Operating expenses
Interest expense
Total expenses
Income before equity in undistributed earnings (loss) of
subsidiaries and income tax benefit
Income tax benefit
$
70 $
120 $
10,500
10,711
21,281
9,878
4,549
14,427
8,000
10,053
18,173
10,222
3,906
14,128
6,854
4,045
(1,315)
(1,273)
Income before equity in undistributed earnings (loss) of
subsidiaries
8,169
5,318
Equity in undistributed share of (loss) earnings in subsidiaries
(1,643)
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
$
$
6,526 $
21,863 $
13,429
9,479 $
11,480 $
14,347
See accompanying report of independent registered public accounting firm.
F-49
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, 2016, 2015 and 2014
(In thousands)
Cash flows from operating activities:
Net income
Adjustments to reconcile net income to cash provided by (used in)
operating activities:
Depreciation and amortization expense
Deferred income tax expense (benefit)
Undistributed share of loss (earnings) of subsidiaries
Change in current federal income tax (recoverable) payable
Change in all other liabilities
Change in all other assets
2016
2015
2014
$
6,526 $
21,863 $
13,429
148
609
1,643
(2,828)
1,228
814
65
(195)
(16,545)
8
(7,080)
188
Net cash provided by (used in) operating activities
8,140
(1,696)
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 (used in) provided by financing activities
Increase (decrease) in cash and cash equivalents
Cash and cash equivalents at beginning of year
(1,469)
-
(1,469)
466
(6,117)
-
-
(5,651)
1,020
8,014
(159)
(30,000)
(30,159)
658
(2,532)
30,000
(96)
28,030
(3,825)
11,839
68
183
(8,394)
(3,290)
4,134
(184)
5,946
(47)
-
(47)
1,155
(1,805)
(1,473)
-
(2,123)
3,776
8,063
Cash and cash equivalents at end of year
$
9,034 $
8,014 $
11,839
Supplemental cash flow information:
Interest paid
Income taxes paid (recovered)
$
$
4,287 $
3,906 $
4,576
904 $
(1,086) $
1,481
See accompanying report of independent registered public accounting firm.
F-50
FINANCIAL STATEMENT SCHEDULES
Schedule III - Supplementary Insurance Information
(In thousands)
Column A
Column B Column C
Column D Column E Column F Column G Column H
Column I
Column J Column K
Segment
Future Policy
Benefits,
Losses,
Claims, and
Loss
Adjustment
Expenses
Deferred
Policy
Acquisition
Costs
Other
Policy
Claims and
Benefits
Payable
Unearned
Premiums
Net
Investment
Income
Premium
Revenue
Benefits,
Claims,
Losses and
Settlement
Expenses
Amortization
of Deferred
Policy
Acquisition
Costs
Other
Operating
Expenses
Net
Premiums
Written
2016
Specialty
Commercial
Standard
Commercial
Personal
Segment
$ 11,961
$ 358,961
$ 185,634 $
5,849
93,793
34,334
1,383
28,813
21,286
Corporate
-
-
-
Consolidated
$ 19,193
$ 481,567
$ 241,254 $
2015
Specialty
Commercial
Standard
Commercial
Personal
Segment
$ 13,501
$ 314,975
$ 161,730 $
5,633
105,971
33,701
1,232
29,932
20,976
Corporate
-
-
-
Consolidated
$ 20,366
$ 450,878
$ 216,407 $
2014
Specialty
Commercial
Standard
Commercial
Personal
$ 14,125
$ 275,868
$ 146,521 $
5,892
729
109,672
29,595
34,822
15,483
-
Corporate
-
-
Consolidated
$ 20,746
$ 415,135
$ 196,826 $
-
-
-
-
-
-
-
-
-
-
-
-
-
-
-
$ 241,890 $ 12,962 $ 169,125
$ 27,474
$ 58,678 $ 249,072
67,510
3,471
41,173
12,199
22,117 68,490
43,970
1,276
43,390
(597)
13,119 44,267
-
(1,367)
-
-
11,682
-
$ 353,370 $ 16,342 $ 253,688
$ 39,076
$ 105,596 $ 361,829
$ 237,640 $ 11,524 $ 148,664
$ 23,371
$ 58,212 $ 241,775
72,613
3,623
47,071
4,237
22,820 71,097
38,828
1,235
34,414
5,066
12,205 44,072
-
(2,413)
-
-
10,377
-
$ 349,081 $ 13,969 $ 230,149
$ 32,674
$ 103,614 $ 356,944
$ 228,823 $ 12,643 $ 149,961
$ 28,186
$ 53,851 $ 230,638
78,311
14,083
-
4,663
1,633
51,130
8,964
(6,556)
-
3,389
9,315
-
25,479 76,912
9,977 16,802
10,279
-
$ 321,217 $ 12,383 $ 210,055
$ 40,890
$ 99,586 $ 324,352
See accompanying report of independent registered public accounting firm.
F-51
FINANCIAL STATEMENT SCHEDULES
Schedule IV – Reinsurance
(In thousands)
Year Ended December 31, 2016
Life insurance in force
Premiums
Life insurance
Accident and health insurance
Property and liability insurance
Title Insurance
Column B Gross
Amount
Column C Ceded to
Other Companies
Column D Assumed
from Other
Companies
Column E Net
Amount
Column F
Percentage of
Amount Assumed
to Net
$
$
- $
- $
- $
-
- $
-
524,229
-
- $
-
170,859
-
- $
-
-
-
-
-
353,370
-
0.00%
Total premiums
$
524,229 $
170,859 $
- $
353,370
0.00%
Year Ended December 31, 2015
Life insurance in force
Premiums
Life insurance
Accident and health insurance
Property and liability insurance
Title Insurance
$
$
- $
- $
- $
-
- $
-
494,643
-
- $
-
145,562
-
- $
-
-
-
-
-
349,081
-
0.00%
Total premiums
$
494,643 $
145,562 $
- $
349,081
0.00%
Year Ended December 31, 2014
Life insurance in force
Premiums
Life insurance
Accident and health insurance
Property and liability insurance
Title Insurance
Total premiums
$
$
$
- $
- $
- $
-
- $
-
461,367
-
461,367 $
- $
-
140,477
-
140,477 $
- $
-
327
-
327 $
-
-
321,217
-
321,217
0.10%
0.10%
See accompanying report of independent registered public accounting firm.
F-52
Schedule VI - Supplemental Information Concerning Property-Casualty Insurance Operations
FINANCIAL STATEMENT SCHEDULES
(In thousands)
Column A
Column B Column C Column D 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
Claims and Claim
Adjustment Expenses
Incurred Related to
(2) Prior
Years
(1) Current
Year
Amortization of
Deferred Policy
Acquisitions
Costs
Paid Claims
and Claims
Adjustment
Expenses
Net
Premiums
Written
Affiliation With
Registrant
(a) Consolidated
property-casualty
Entities
2016
2015
2014
$
$
$
19,193 $ 481,567 $
20,366 $ 450,878 $
20,746 $ 415,135 $
- $ 241,254 $ 353,370 $
- $ 216,407 $ 349,081 $
- $ 196,826 $ 321,217 $
16,342 $ 246,080 $
13,969 $ 237,102 $
12,383 $ 215,258 $
7,608 $
(6,953) $
(5,203) $
39,076 $
32,674 $
40,890 $
243,445 $ 361,829
205,254 $ 356,944
199,331 $ 324,352
See accompanying report of independent registered public accounting firm.
F-53