$14
$12
$10
$8
$6
$4
$2
$0
Premium Breakdown by Hallmark Business Units’ components
2007
2008
2009
2010
2011
2012
2013
2014
2015
2016
2017
E&S Specialty
Property
$2,824
E&S Specialty
Property
$12,242
E&S Specialty
Property
$30,214
Professional
Liability
$4,731
Professional
Liability
$5,488
Professional
Liability
$5,530
Professional
Liability
$7,383
Professional
Liability
$9,769
Professional
Liability
$39,892
Programs
$22,540
Programs
$24,767
Programs
$30,918
Programs
$33,900
Programs
$35,080
Programs
$33,171
Workers
Compensation
$3,116
Workers
Compensation
$7,977
Workers
Compensation
$9,089
Workers
Compensation
$10,408
Workers
Compensation
$6,510
Workers
Compensation
$490
Workers
Compensation
$0
)
s
d
n
a
s
u
o
h
t
n
i
$
(
d
e
c
u
d
o
r
P
s
m
u
i
m
e
r
P
s
s
o
r
G
Other
Programs
$85
Casualty*
$12,679
Contract
Binding
$108,145
General
Aviation
$25,145
Other
Programs
$247
Casualty*
$25,007
Contract
Binding
$94,948
General
Aviation
$24,029
Space &
Satellite
$2,108
Space &
Satellite
$6,742
Space &
Satellite
$3,285
Casualty*
$33,762
Casualty*
$40,687
Casualty*
$51,847
Contract
Binding
$122,412
General
Aviation
$20,451
Contract
Binding
$136,683
General
Aviation
$18,690
Contract
Binding
$187,488
General
Aviation
$18,188
Space &
Satellite
$4,999
Casualty*
$57,972
Contract
Binding
$204,856
General
Aviation
$15,496
Space &
Satellite
$6,906
Space &
Satellite
$6,715
Casualty*
$65,148
Casualty*
$85,084
Contract
Binding
$212,434
General
Aviation
$17,420
Contract
Binding
$215,870
General
Aviation
$20,045
Space &
Satellite
$6,495
Casualty*
$114,159
Contract
Binding
$212,481
General
Aviation
$24,389
Casualty*
$28,089
Contract
Binding
$101,094
General
Aviation
$22,538
Contract
Binding
$121,390
General
Aviation
$29,607
Standard
Commercial
$90,988
Standard
Commercial
$80,193
Standard
Commercial
$72,511
Standard
Commercial
$67,844
Standard
Commercial
$66,304
Standard
Commercial
$69,113
Standard
Commercial
$78,057
Standard
Commercial
$74,271
Standard
Commercial
$75,382
Standard
Commercial
$76,401
Standard
Commercial
$78,228
Personal
Lines
$55,919
Personal
Lines
$60,834
Personal
Lines
$71,708
Personal
Lines
$95,292
Personal
Lines
$96,226
Personal
Lines
$77,068
Personal
Lines
$76,772
Personal
Lines
$63,992
Personal
Lines
$81,281
Personal
Lines
$83,272
Personal
Lines
$61,214
$297,904
$287,081
$288,450
$314,857
$344,379
$384,231
$454,981
$468,442
$509,188
$544,968
$600,243
*Casualty includes our excess umbrella and general liability products produced by our Specialty Commercial operating unit.
Highlights
For the Years Ended December 31, ($ in thousands, except per share amounts)
For the Years Ended December 31, ($ in thousands, except per share amounts)
Operating Results
Gross premiums written
Net premiums earned
Income (loss) before tax
Net income (loss)
2017
2016
2015
2014
2013
$604,156
361,037
(16,572)
(11,553)
$549,077
353,370
8,478
6,526
$514,223
349,081
31,886
21,863
$473,218
321,217
18,782
13,429
$460,027
360,541
11,080
8,245
Per Share
$ (0.63)
Net income (loss)—diluted
Book value
$ 13.82
Weighted average shares outstanding—diluted 18,343
$ 0.34
$ 14.28
18,941
$ 1.13
$ 13.72
19,405
$ 0.69
$ 13.11
19,366
$ 0.43
$ 12.36
19,361
Selected Balance Sheet Items
Total investments and cash
Total assets
Reserves for unpaid loss and loss
adjustment expenses
Unearned premiums
Total liabilities
Total stockholders’ equity
GAAP Ratios
Loss ratio
Expense ratio
Combined ratio
$ 728,966
$1,231,126
$ 741,078
$ 701,797
$1,162,460 $1,075,547
$650,128
$979,765
$615,181
$907,867
$527,100
$276,642
$980,008
$251,118
$481,567
$241,254
$896,724
$265,736
$450,878
$216,407
$813,521
$262,026
$415,135
$196,826
$727,728
$252,037
$382,640
$185,303
$669,749
$238,118
79.9%
28.0%
107.9%
71.8%
28.0%
99.8%
65.9%
28.0%
93.9%
65.4%
30.5%
95.9%
72.5%
29.2%
101.7%
Cash & Investments
Debt Securities
83%
Cash & Equivalents 9%
7%
Equities
1%
Other Investments
83%
lative repurchases since 2008 total three million shares
at $27 million or an average price of $8.92 per share,
equivalent to 65% of our year end book value per share.
Three years ago we undertook a major reset with a
change in leadership. As a result, Hallmark is undeni-
ably a much better company today than it was then. Our
unsatisfactory financial results have not yet reflected the
magnitude of positive change that has been achieved
during this time. We have substantially strengthened
the senior leadership team, our underwriting talent and
the functional roles in the company. We have invested
in tools and technology. We have aggressively driven
greatly improved capability in our core insurance oper-
ations.
Our objective has been clear and unwavering – stabi-
lize profitability and create a more balanced, diversified
and valuable portfolio of specialty business. We have
made significant progress in these respects and remain
committed to deliver strong financial performance in the
future.
Mark E. Schwarz
Executive Chairman of the Board
April 10, 2018
Letter from Our Chairman
Mark E. Schwarz
Hallmark’s book value per share declined 3% in 2017.
It was a disappointing year because we failed to achieve
bottom line profitability, our primary objective, despite
making progress in many other important respects. We
remain clear in understanding the difference between ef-
forts and results. While our efforts were substantial, the
intended results were not achieved.
Hallmark was not the only property and casualty compa-
ny to experience poor financial results in 2017. Natural
catastrophes, storms and weather-related losses played
a big role in 2017, in what was the costliest year ever
for the insurance industry due to catastrophe losses that
exceeded $100 billion. Additionally, transportation lines
continued to produce poor results for many in the indus-
try – Hallmark included.
For Hallmark, the biggest obstacle to profitability in
2017 proved to be additional loss reserves taken for
prior years in our commercial auto line of business. Last
year we wrote about initiatives to improve pricing and
claims, the two most critical functions in an insurance
business. Our efforts were not complete. In retrospect,
it is obvious there was not enough premium generated in
years 2012-2016 to meet our margin expectations.
Significant and appropriate corrective actions, both in
leadership and organization, have now been taken. We
expect improved underwriting results will follow.
On the investment side of operations, our fixed income
portfolio performed in line with expectations given its
short duration and our equity portfolio realized an 18%
return. Our net investment income increased 15% to
nearly $19 million, an all time high. Total investments
and cash increased to $40.12 per share and have grown
at an average annual rate of 6% and 8% over the past
three- and five-year periods. Hallmark also repurchased
$5 million of its common shares during the year. Cumu-
Letter from Our President & CEO
Naveen Anand
While Hallmark made significant positive strides during
2017, our progress was masked by adverse prior year
loss development in our commercial and personal auto
lines. Adverse prior year loss development – primarily
from 2015 and prior accident years – accounted for 11.1
points of our 107.9% combined ratio in 2017.
Additionally, 2.1 points of the combined ratio were at-
tributable to catastrophe losses, primarily from the hurri-
canes that impacted Texas and Florida. However, despite
record industry catastrophe losses for 2017, our catastro-
phe loss ratio actually improved slightly as compared to
2016. I believe that Hallmark’s underlying fundamen-
tals are sound and position us for future success.
Commercial Auto Insurance Industry Challenges
The challenges in commercial and personal auto are not
limited to Hallmark. Industry losses in the commercial
auto segment have nearly quadrupled from $744.8 mil-
lion in 2011 to over $2.9 billion in 2016. Commercial
auto is now the loss leader for standard market insur-
ers. Many carriers have exited this line of business over
the last several years. Industry combined ratios have in-
creased from 94% in 2007 to a projected combined ratio
of 112% for 2017.
A combination of low gas prices, higher employment,
greater driving distractions, higher repair costs, rising
medical costs and increased claim litigation have result-
ed in significantly increased frequency and severity of
losses. We are seeing significantly more adverse verdicts
hitting policy limits, making this line a target for litiga-
tion and large claim settlements.
While these results are specific to commercial auto, per-
sonal auto has seen some of the same issues as well.
Impact to Hallmark’s Results from Industry
Commercial Auto Issues
Commercial auto industry trends have had an amplified
impact on Hallmark’s bottom line. The Company signifi-
cantly grew in the commercial auto segment starting in
2010 before leveling off in 2015. This line has represent-
ed approximately 50% of our gross premiums in the past
and even a larger portion of our net written premiums.
Combined with our personal auto business, a large por-
tion of our historical written premiums have come from
the auto lines. Additionally, the auto business is concen-
trated in a handful of southwestern states, with Texas
contributing a majority of the premium for these lines.
The industry loss ratio results in these states has been
higher than the rest of the country over the last 10 years.
Hallmark’s Response to the Industry Issues in Both
Personal & Commercial Auto
We have been aggressively addressing the challenges in
both commercial and personal auto lines.
In personal lines, we started the process in late 2014
by narrowing our focus to our core products of auto
and companion renter’s coverage. We put homeown-
ers, dwelling, fire, motorcycle, RV and other ancillary
coverages in runoff as they were sub-scale and had poor
performance, increasing the volatility in the segment’s
overall results. We then pared down from 33 states to
our current territory of 10 states. These remaining states
offer us the best opportunity for sustained profitability
and growth.
Additionally, we aggressively pushed for rate increas-
es in our remaining states and culled under-performing
risks and agents. We filed over 65 rate increases in the
various states over the last three years.
We also retooled our underwriting processes and pricing
capabilities starting in 2015 by developing and migrat-
ing to a new underwriting and claims technology plat-
form. This has allowed for much better pricing and risk
segmentation at the point of sale. We have seen signifi-
cantly improved results with this platform and improved
loss ratios from this effort.
Finally, we revamped the entire claims operation. This
has been a two-part process. We reviewed all our open
claims from older accident years and made sure they
reflected current trends based on developing frequen-
cy and severity trends. Additionally, we upgraded our
claims procedures to address claims sooner and reduce
the amount of litigation. This has resulted in large reduc-
tions in pending claims, as well as reductions in pending
and new suits.
The result of these efforts saw a year over year improve-
ment in the Personal Segment loss ratio of 14.7 points
(and 31.5 points on 4th quarter 2017 vs. 4th quarter
2016). While the expense ratio increased due to reduced
premium volume, we expect that to come in line over the
course of 2018.
Specialty Personal Lines
($000)
2014
2015
2016
2017
GWP
$63,992
$81,281
$83,272
$61,214
NWP
$16,802
$44,072
$44,267 $31,273
LR
ER
CR
63.7%
88.6%
98.7%
84.0%
43.3%
19.0%
21.5%
29.3%
107.0%
107.6%
120.2%
113.3%
In primary commercial auto, which is written by
Hallmark Specialty Underwriters, many of the same
challenges exist. Here too, we have been aggressively
addressing the increased frequency, severity and litiga-
tion trends. We have increased rates on all segments of
commercial auto over the last two years and have culled
underperforming accounts and brokers. We also exited
two states due to price inadequacy, foregoing new and
renewal business in these states to concentrate on more
profitable business.
As with personal auto, we have enhanced the claims op-
erations for our commercial auto operations. We con-
ducted comprehensive reviews of open claims in light of
developing frequency and severity trends. We also im-
proved the efficiency of our claims procedures in order
to address claims more quickly. We believe that these
measures will reduce our future exposure to the large
settlements and litigation that have driven adverse prior
year loss experience.
Additionally, as in personal lines and all other sectors,
we have transitioned the Hallmark’s claims operation
from decentralized units to a centralized approach with
appropriate investments in leadership and management.
As we move forward and get the prior year issues behind
us, I am confident we can get back to achieving accept-
able results in this line of business.
Developing our Specialty Commercial Segment Prod-
uct Portfolio
Since my arrival in late 2014, a key part of our strategy
has been to re-balance our outsized exposure to the auto
lines and develop additional specialty products to trans-
form the organization into an expertise-driven, diversi-
fied specialty insurer. I’m pleased to report that we’ve
made significant progress in this effort.
Over the course of the last three years, Hallmark has
transitioned from primarily a specialty auto business to
a more diversified specialty commercial portfolio. We
have enhanced our position in all of the specialty prod-
uct lines and have organically developed several new
products.
Since 2015, we have introduced the following new
product lines in our specialty commercial segment:
a. Primary & Excess Casualty for select
E&S Classes
b. Public Entity Excess Liability
c. Professional Liability for Healthcare Facilities
d. Hospital Professional Liability
e. Management Liability
f. Errors & Omissions
g. Shared & Layered Property
h. Primary Property for E&S segments
These new products complement our established
specialty products in:
a. Excess Transportation
b. Physician Medical Malpractice
c. General Aviation
d. Satellite Launch and Orbit
2014 Portfolio
2017 Portfolio
Specialty Commercial
(68.6%)
Professional Liability (1.2%)
Aviation/Space (4.3%)
Programs
(7.5%)
Excess,
Umbrella
& Primary
Casualty
(12.3%)
Standard
Commercial
(17.9%)
Personal
Lines
(13.5%)
Contract Binding
(43.3%)
Business
Owners
Policy (BOP)
(2.8%)
Standard
Commercial
(13.0%)
Commercial Package
Policy (CPP)
(9.1%)
Personal
Lines
(10.2%)
Renters
(0.4%)
Personal
Auto
(9.8%)
Contract Binding -
Transportation Package
(31.1%)
Specialty Commercial
(76.8%)
Space & Satellite (1.1%)
Monoline
(1.1%)
E&S Property
(5.0%)
Aviation
(4.1%)
Professional
Liability
(6.7%)
Programs
(5.5%)
Excess, Umbrella &
Primary Casualty
(19.0%)
Contract Binding
- E&S Package
(4.3%)
Fiscal 2014 Gross Premium Written of $473 million
Fiscal 2017 Gross Premium Written of $604 million,
including runoff lines.
Our specialty brokerage business is now the largest por-
tion of our portfolio with a track record of profitability
and growth.
The development of these expertise-driven specialty
products was achieved by deploying seasoned teams
with strong underwriting track records and close working
relationship with our reinsurance providers. These prod-
uct lines require specialized underwriting skills and cus-
tomer knowledge that allow us to differentiate Hallmark
in an otherwise crowded property and casualty industry.
Our small to large regional customer profile, along with a
disciplined approach to limits management and technical
pricing, enhances price adequacy for the long term and
sustainable profitability. As these portfolios continue to
mature, we expect to retain more risk and further increase
our income results.
Gross Premiums Written
($000,000)
Specialty
Brokerage
$250
$200
$150
$100
Contract
Binding
Standard Commercial*
$50
2014
Personal Lines
2015
2016
2017
*Standard Commercial excludes workers’ compensation
and non-subscription business that is in runoff.
Specialty Commercial
($000)
2014
2015
2016
2017
GWP
$324,547 $351,050 $388,914 $464,714
NWP
$230,638 $241,775 $249,072 $265,022
LR
ER
CR
65.5%
62.6%
69.9%
82.2%
25.6%
25.6%
25.3%
23.7%
91.1%
88.2%
95.2%
105.9%
Our Standard Commercial Segment
Our standard commercial portfolio has also evolved over
the last few years, and the transformation gained even
more momentum in 2017. In 2014, this portfolio reflect-
ed a “generalist” admitted market appetite that included
mono-line workers compensation and occupational acci-
dent business.
In 2015, we sold the renewal rights on the workers com-
pensation business because it was capital intensive and
sub-scale. Additionally, we terminated the occupational
accident business and put this in run-off in 2015, which
also contributed to the adverse prior year development
in 2017.
In the past, the portfolio had also been plagued by ca-
tastrophe losses coming from hail and severe convective
storm events. We addressed this by tightening our un-
derwriting guidelines and exiting from exposures where
loss issues had been prevalent. While catastrophe losses
Standard Commercial*
($000)
2014
2015
2016
2017
GWP
$67,959
$68,376
$71,137
$77,950
NWP
$61,159
$61,085
$63,473 $69,028
LR
ER
CR
68.8%
65.5%
62.9%
63.4%**
33.1%
32.6%
32.8%
34.5%
101.9%
98.1%
95.7%
97.9%**
* Excludes runoff lines (worker’s compensation and
occupational accident.)
** Includes 5.5 points of CAT loss impact primarily from
Hurricane Harvey.
in 2017 added 5.5 points to our combined ratio in this
segment, the losses were primarily due to a single event,
Hurricane Harvey. Our losses from convective storms
for this segment were down by over 75% in 2017 com-
pared to the prior year.
While we have fixed many of the underwriting issues in
the portfolio, we have also been active in transforming
the Standard Commercial Segment from a “generalist”
to a “specialist” focused on risk classes where we are po-
sitioned to achieve sustained profitable results. This tran-
sition includes developing proprietary coverage forms
and rates for our targeted customers. Furthermore, we
have added to our distribution channels in current states
and targeted new agents in each of our territories.
We are seeing growth momentum from these efforts. In
2018, we expanded our territory to 12 states by entering
Arizona in January.
We expect to thoughtfully add a few more states to our
territory each year.
In late 2017, we also launched our next generation tech-
nology platform to gain parity in the market and effec-
tively scale the business over time.
Expense Management
We have built new product lines, attracted significant tal-
ent at all levels and successfully completed major tech-
nology upgrades while keeping a keen eye on expenses.
The expense ratio in the organization has been flat at
28% for each of the last three years and has improved
from 30.5% in 2014. We have been disciplined in reduc-
ing costs wherever possible and judiciously re-investing
the savings into higher value opportunities.
Our underlying performance excluding adverse prior
year loss development and increasing net written premi-
ums from our profitable specialty brokerage portfolio, as
well as underwriting discipline and rate increases in our
challenged auto lines, gives me confidence that we have
turned the corner.
I thank you for your support.
Naveen Anand
President and Chief Executive Officer
April 10, 2018
Transformed Specialty Insurer
I’m very disappointed by our results of 2017. I believe
that the adverse prior year loss development from older
accident years has masked the incredible progress in the
organization.
Today, as I look at Hallmark, I see a company striving to
be a “best in class” specialty insurer focused on sustain-
able niche markets in under-served sectors. Our special-
ty product development and geographic diversification
is well underway.
2017 Geographic Diversification
Arkansas (2%)
Oregon (3%)
Montana (2%)
Tennessee (1%)
New Mexico (3%)
Oklahoma (3%)
Louisiana
(3%)
Arizona
(4%)
California
(6%)
Texas
(40%)
All Other
States
(33%)
Underwriting focus and talent levels across the organi-
zation have improved in all product and functional do-
mains. Our technology is becoming a strategic advan-
tage by allowing us to scale our business effectively and
providing greater insight into products and underwriting
results. Underwriting discipline along with rate increas-
es are setting the stage for better earnings, and we con-
tinue to push for more. We expect that the actions we
have taken on the auto portfolios will materialize into
better results going forward, as evidenced by more re-
cent accident year loss ratios.
Total Assets vs. Book Value Per Share
($000,000)
$14.28
BVPS
$13.82
BVPS
$13.72
BVPS
$13.11
BVPS
$1,200
$1,000
$12.36
BVPS
$800
$600
$400
$200
$0
$908
$980
$1,076
$1,162
$1,231
2013
2014
2015
2016
2017
Gross Written Premium
($000,000)
Combined Loss Ratio Comparison
107.9%
95.9%
93.9%
99.8%
4.7%
2.7%
2.2%
3.1%
11.1%
2.1%
92.8%
93.2%
94.5%
94.7%
$14.5
$14
$13.5
$13
$12.5
$12
$11.5
$11
100%
80%
60%
40%
20%
$600
$400
$200
$0
40%
30%
20%
10%
0%
*
)
E
O
R
(
y
t
i
u
q
E
n
O
n
r
u
t
e
R
-10%
-20%
$460
$473
$514
$549
$604
2013
2014
2015
2016
2017
0%
-1.6%
2014
-2.0%
2015
2016
2017
Accident Year Combined
Ratio excluding CATS
Catastrophe
Losses
Prior Year
Reserve
Development
ROE By Segment and Capital Allocation
41%
13%
8%
3%
25%
15%
8%
-2%
27%
27%
13%
8%
-17%
8%
-7%
-11%
Specialty
Commercial
Contract
Binding
Standard
Commercial**
Personal
Lines
*Return on equity
calculations for each
reportable segment
assumes allocated
capital based on our
consolidated pre-
mium leverage and
applies our consoli-
dated effective tax
rate to each segment.
**Excludes impact of
runoff lines (worker’s
compensation and
occupational acci-
dent).
2014
2015
2016
2017
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, 2017
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
Or
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)
Registrant's Telephone Number, Including Area Code: (817) 348-1600
Securities registered pursuant to Section 12(b) of the Act:
87-0447375
(I.R.S. Employer Identification No.)
76102
(Zip Code)
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
Non-accelerated filer
Accelerated filer
Emerging growth company
If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition
period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the
Exchange Act.
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes
No
1
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. $ 148.3 million
Indicate the number of shares outstanding of each of the registrant's classes of common stock, as of the latest practicable
date. 18,169,028 shares of common stock, $.18 par value per share, outstanding as of March 14, 2018.
2
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.
3
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 Contract Binding 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, financial 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 ceased marketing or retaining 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. Each operating unit is responsible for marketing, distribution
and underwriting while we provide capital management, claims 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 Contract Binding 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 Contract Binding 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 Contract Binding
operating unit primarily writes commercial automobile, general liability, commercial property and excess casualty
coverages. Our Contract Binding operating unit markets its products in 24 states through 11 wholesale brokers and 88
general agency offices, as well as 34 independent retail agents in Texas.
4
Our Specialty Commercial operating unit offers small and middle market commercial excess liability, umbrella, general
liability and public entity excess 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 and financial 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 and umbrella insurance products offered is transportation (trucking
for hire and specialty automobile coverage). The Specialty Commercial operating unit also provides excess liability
coverage for small to midsize businesses in class categories such as contracting, manufacturing, hospitality and service
(non-transportation). Typical risks range from one power unit to fleets of up to 200 power units and up to $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 and umbrella products through 136 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 188 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. Our
Specialty Commercial operating unit markets these products through 28 wholesale and retail brokers in 49 states. The
Specialty Commercial operating unit also provides medical professional liability to senior care facilities through a program
where a managing general agent underwrites on our behalf risks that meet specific underwriting criteria. The financial
professional liability insurance underwritten on an excess and surplus lines basis by our Specialty Commercial operating
unit focuses on management and professional liability products that include directors & officers, employment practices and
retirement and benefit plan fiduciary services for private, public and non-profit entities as well as miscellaneous professional
liability insurance for most non-financial institution service industries. Our Specialty Commercial operating unit distributes
its financial professional liability insurance products through 26 wholesale brokers in 49 states. The primary/excess
commercial property coverages underwritten by our Specialty Commercial operating unit specializes in shared and layered
accounts on a non-admitted basis which target regional and national property programs. Our Specialty Commercial
operating unit markets these products through 22 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 150 independent agency groups
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 provides
occupational accident coverage in Texas through an underwriting agency that specializes in the occupational accident
insurance market. Effective June 1, 2016, we ceased marketing new or renewal occupational accident policies.
Our Specialty Personal Lines operating unit primarily 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
5
offering and fits well in our distribution channel. Our Specialty Personal Lines operating unit markets and services these
policies through 3,575 independent retail agent locations in 10 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 Contract Binding 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, 2017, 2016 and 2015.
Gross Premiums Written:
Specialty Commercial Segment
Standard Commercial Segment
Personal Segment
Total
Net Premiums Written:
Specialty Commercial Segment
Standard Commercial Segment
Personal Segment
Total
$
$
$
$
Year Ended December 31,
2017
2016
2015
(dollars in thousands)
464,714 $
78,228
61,214
604,156 $
265,022 $
69,288
31,273
365,583 $
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
6
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, 2017.
7
Specialty Commercial Segment
The Specialty Commercial Segment of our business includes our Contract Binding operating unit and our Specialty
Commercial operating unit. During 2017, our Contract Binding operating unit accounted for 46% and our Specialty
Commercial operating unit accounted for 54% of the aggregate premiums produced by the Specialty Commercial Segment.
Contract Binding operating unit. Our Contract Binding operating unit markets, underwrites, finances and services
commercial lines insurance in 24 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 Contract Binding 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 89% of the premium volume
financed by PAAC.
Our Contract Binding 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 2017, commercial automobile, general liability and all other
property/casualty accounted for 88%, 9% and 3%, respectively, of the premiums produced by our Contract Binding
operating unit. Target risks for commercial automobile insurance are business auto and trucking for hire fleets, excluding
hazardous or flammable materials haulers. Target risks for general liability insurance are small business risk exposures
including artisan contractors, sales and service organizations, and building and premises liability exposures. Target risks for
commercial property insurance are low- to mid-value structures including office buildings, mercantile shops, restaurants
and rental dwellings, in each case with aggregate property limits of less than $1,000,000. The commercial insurance products
offered by our Contract Binding 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 Contract Binding operating unit markets its products in 24 states through 11 wholesale brokers and 88 general agency
offices, as well as 34 independent retail agents in Texas. Our Contract Binding 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
8
instantaneous quoting and signature-ready applications which can be emailed or faxed to its independent retail agents.
During 2017, general agents produced 86%, retail agents produced 3% and wholesale brokers produced 11% of total
premiums produced by our Contract Binding operating unit. During 2017, the top ten general agents produced 41%, the
eleven wholesale brokers produced 11% and no general agent produced more than 8%, of the total premium volume of our
Contract Binding operating unit. During the same period, the top ten retail agents produced 2%, and no retail agent produced
more than 1%, of the total premium volume of our Contract Binding operating unit.
The majority of the commercial policies written by our Contract Binding 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 excess liability and general liability insurance on both an admitted and
non-admitted basis. This operating unit focuses primarily on trucking, specialty automobile and non-fleet automobile
coverage, excess liability for most classes of public entity risks, general aviation property/casualty insurance primarily for
private and small commercial aircraft and airports, satellite launch insurance products, medical and financial 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 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 2017, the top ten wholesale
brokers accounted for 40% of our primary and excess casualty premium volume, with no single wholesale broker accounting
for more than 8%. During 2017, commercial transportation excess liability risks accounted for 72% of the premiums, with
the remaining 28% coming from non-transportation commercial excess, public entity and general liability risks.
The commercial excess, umbrella, general liability and public entity excess 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.
9
•
Public Entity Excess Liability. Public entity excess liability is designed to provide an extra layer of protection
for target classes of public entities for auto liability, general liability, public officials’ liability, wrongful acts,
employment practice liability, law enforcement liability, educators’ legal liability and related coverages.
We generally cede 80% of the commercial excess, umbrella, general liability and public entity excess 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 188 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 2017, the top ten independent specialty brokers produced
37%, and no broker produced more than 7%, 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 93% of the aircraft written in 2017 bearing per-occurrence limits of $1,000,000 and per-passenger limits of
$100,000 or less. The average insured aircraft hull value for aircraft written in 2017 was approximately $153,000. 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
28 wholesale brokers in 49 states. The Specialty Commercial operating unit also provides medical professional liability to
senior care facilities through a program where a managing general agent underwrites on our behalf risks that meet specific
underwriting criteria. We generally cede 73.5% of the medical professional liability risk on policies written by our Specialty
Commercial operating unit.
Our Specialty Commercial operating unit markets financial professional liability insurance on an excess and surplus lines
basis. Financial professional liability insurance provides liability insurance for management liability and professional
10
liability on a claim made basis. Our financial professional liability products target miscellaneous professional liability
classes. Our Specialty Commercial operating unit distributes its financial professional liability insurance products through
26 wholesale brokers in 49 states. We presently cede 40% of the financial professional liability risk on policies written by
our Specialty Commercial operating unit.
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 22 wholesale brokers in 50 states. We presently cede 70% of the
primary/excess commercial property risk on policies underwritten by our insurance companies and 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 17 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 ceased marketing or
retaining any risk on new or renewal policies. During 2017, our Standard Commercial P&C operating unit accounted for
substantially all of the 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 provided occupational accident coverage in Texas through an underwriting
agency that is a specialist in the occupational accident insurance market. Effective June 1, 2016, we ceased marketing 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.
11
•
Commercial multi-peril. Commercial multi-peril insurance provides a combination of property and liability
coverage that can include commercial automobile coverage on a single policy.
• Business owner’s. Business owner’s insurance provides a package of coverage designed for small to midsize
businesses with homogeneous risk profiles. Coverage includes general liability, commercial property and
commercial automobile.
• Occupational accident. Occupational accident insurance provides an alternative to statutory workers
compensation insurance in Texas. Coverage includes medical, short term disability and accidental death and
dismemberment. Effective June 1, 2016, we ceased marketing new or renewal occupational accident policies.
Our Standard Commercial P&C operating unit markets its property/casualty insurance products through 150 independent
agency groups 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 24 year average tenure of the 19 agency groups that each
produced more than $1.0 million in premium during the year ended December 31, 2017. During 2017, the top ten agency
groups produced 38%, and no individual agency group produced more than 8%, 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.
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 ceased marketing or retaining 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 10 states. Our
Specialty Personal Lines operating unit provides management, policy and claims administration services and includes the
operations of AHGA and HCS. 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.
12
• 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 60% 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 3,575 independent retail agent locations operating
in its target geographic markets. Non-standard automobile represented 96% of the premiums produced during 2017. 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 2017, the top ten independent agency locations produced 28%, and no individual agency
location produced more than 7%, of the total premium volume of our Specialty Personal Lines operating unit.
During 2017, personal automobile liability coverage accounted for 73% and personal automobile physical damage coverage
accounted for the remaining 27% 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 10 states directly for HIC, AHIC and HCM.
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 Contract Binding 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. 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 Specialty Personal Lines
operating unit has a thorough understanding of the unique characteristics of the non-standard personal
automobile market.
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 tailored to the needs of each operating unit 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
13
maintain the loyalty of our independent agents. Our customized products, flexible payment plans and prompt
claims processing are similarly beneficial to our insureds.
• Market diversification. We believe operating in various specialty and niche segments of the
property/casualty insurance market diversifies both our revenues and our risks. We also believe our operating
units generally operate on different market cycles, producing more earnings stability than if we focused
entirely on one product. As a result of the pooling arrangement among four of our insurance company
subsidiaries, we are able to efficiently allocate our capital among these various specialty and niche markets
in response to market conditions and expansion opportunities. We believe this market diversification reduces
our risk profile and enhances our profitability.
•
Experienced management team. Our senior corporate management has an average of over 20 years of
insurance experience. In addition, our operating units have strong management teams, with an average of
more than 20 years of insurance industry experience for the heads of our operating units and an average of
more than 15 years of underwriting experience for our underwriters. Our management has significant
experience in all aspects of property/casualty insurance, including underwriting, claims management,
actuarial analysis, reinsurance and regulatory compliance. In addition, Hallmark’s senior management has a
strong track record of acquiring businesses that expand our product offerings and improve our profitability
profile.
Our Strategy
We strive to become a “Best in Class” specialty insurance company offering products in specialty and niche markets through
the following strategies:
•
•
•
Focusing on underwriting discipline and operational efficiency. We seek to consistently generate an
underwriting profit on the business we write in hard and soft markets. Our operating units have a strong track
record of underwriting discipline and operational efficiency, which we seek to continue. We believe that in
soft markets our competitors often offer policies at a low or negative underwriting profit in order to maintain
or increase their premium volume and market share. In contrast, we seek to write business based on its
profitability rather than focusing solely on premium production. To that end, we provide financial incentives
to many of our underwriters and independent agents based on underwriting profitability.
Achieving organic growth in our existing business lines. We believe we can achieve organic growth in our
existing business lines by consistently providing our insurance products through market cycles, expanding
geographically, expanding our product offerings, expanding our agency relationships and further penetrating
our existing customer base. We believe our extensive market knowledge and strong agency relationships
position us to compete effectively in our various specialty and niche markets. We also believe there is a
significant opportunity to expand some of our existing business lines into new geographical areas and through
new agency relationships while maintaining our underwriting discipline and operational efficiency. In
addition, we believe there is an opportunity for some of our operating units to further penetrate their existing
customer bases with additional products offered by other operating units.
Pursuing selected, opportunistic acquisitions. We seek to opportunistically acquire insurance organizations
that operate in specialty or niche property/casualty insurance markets that are complementary to our existing
operations. We seek to acquire companies with experienced management teams, stable loss results and strong
track records of underwriting profitability and operational efficiency. Where appropriate, we intend to
ultimately retain profitable business produced by the acquired companies that would otherwise be retained by
unaffiliated insurers. Our management has significant experience in evaluating potential acquisition targets,
structuring transactions to ensure continued success and integrating acquired companies into our operational
structure.
14
• 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.
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, 2017, five states
accounted for approximately 56% 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, 2017.
State
Texas
California
Arizona
Oklahoma
Oregon
All other states
$
Specialty
Commercial
Segment
Standard
Commercial
Segment
Personal
Segment
Total
Percent of
Total
207,611 $
36,738
2,816
14,007
2,602
200,940
(dollars in thousands)
19,173 $
11,980 $
-
-
-
16,908
42,147
-
22,172
6,967
-
20,095
238,764
36,738
24,988
20,974
19,510
263,182
39.5%
6.1%
4.1%
3.5%
3.2%
43.6%
Total gross premiums written
$
464,714 $
78,228 $
61,214 $
604,156
Percent of total
Underwriting
76.9%
13.0%
10.1%
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, aviation or public entity 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
15
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.
2017
Year Ended December 31,
2016
2015
Gross premiums written
$
604,156 $
549,077 $
514,223
Net statutory loss & LAE ratio
Net statutory expense ratio
Net statutory combined ratio
79.1%
27.0%
106.1%
71.2%
29.4%
100.6%
65.4%
30.6%
96.0%
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, 2017, 2016 and 2015, our consolidated premium-to-surplus ratios
were 157%, 146% and 144%, 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.
16
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 centrally 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, 2017, we had a total of 87 claims
managers, supervisors and adjusters with an average experience of approximately 15 years.
Analysis of Losses and LAE
Our consolidated financial statements include an estimated reserve for unpaid losses and LAE. We estimate our reserve for
unpaid losses and LAE by using case-basis evaluations and statistical projections, which include inferences from both losses
paid and losses incurred. We also use recent historical cost data and periodic reviews of underwriting standards and claims
management practices to modify the statistical projections. We give consideration to the impact of inflation in determining
our loss reserves, but do not discount reserve balances.
The amount of reserves represents our estimate of the ultimate cost of all unpaid losses and LAE incurred. These estimates
are subject to the effect of trends in claim severity and frequency. We regularly review the estimates and adjust them as
claims experience develops and new information becomes known. Such adjustments are included in current operations,
including increases and decreases, net of reinsurance, in the estimate of ultimate liabilities for insured events of prior years.
Changes in loss development patterns and claim payments can significantly affect the ability of insurers to estimate reserves
for unpaid losses and related expenses. We seek to continually improve our loss estimation process by refining our ability
to analyze loss development patterns, claim payments and other information within a legal and regulatory environment that
affects development of ultimate liabilities. Future changes in estimates of claim costs may adversely affect future period
operating results. However, such effects cannot be reasonably estimated currently.
Additional information relating to our loss reserve development is included under Item 7, “Management’s Discussion and
Analysis of Financial Condition and Results of Operations,” and Note 6, “Reserves for Losses and Loss Adjustment
Expenses,” in the Notes to Consolidated Financial Statements.
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, 2017 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.
17
The following table presents our gross and net premiums written and earned and reinsurance recoveries for each of the last
three years (in thousands).
2017
Year Ended December 31
2016
2015
604,156 $
(238,573)
549,077 $
(187,248)
514,223
(157,279)
365,583 $
361,829 $
356,944
568,769 $
(207,732)
524,229 $
(170,859)
494,643
(145,562)
361,037 $
353,370 $
349,081
144,948 $
116,057 $
89,892
$
$
$
$
$
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 securities, equity securities and
other investments. As of December 31, 2017, we had total invested assets of $661.3 million. If market rates were to increase
by 1%, the fair value of our fixed-income securities as of December 31, 2017 would decrease by approximately $9.6 million.
The following table shows the fair values of various categories of fixed-income securities, the percentage of the total fair
value of our invested assets represented by each category and the tax equivalent book yield of each category of invested
assets as of December 31, 2017 and 2016.
As of December 31, 2017
As of December 31, 2016
Fair
Value
Percent of
Total
Yield
Fair
Value
Percent of
Total
Yield
(in thousands)
(in thousands)
279,073
46.1%
2.5% $
226,062
37.8%
3.0%
125,937
134,256
20.8%
22.2%
3.9%
2.9%
106,009
163,895
17.8%
27.4%
3.5%
4.4%
49,947
16,533
8.2%
2.7%
1.8%
2.6%
42,022
59,469
7.0%
10.0%
1.2%
2.4%
Category:
Corporate bonds
Collateralized corporate bank
loans
Municipal bonds
$
US Treasury securities and
obligations of U.S.
Government
Mortgage backed
Total
$
605,746
100.0%
2.9% $
597,457
100.0%
3.3%
18
The weighted average credit rating for our fixed-income portfolio was BBB+ at December 31, 2017. The following table
shows the distribution of our fixed-income portfolio by rating as a percentage of total fair value as of December 31, 2017
and 2016:
As of
December 31, 2017
As of
December 31, 2016
Rating:
"AAA"
"AA"
"A"
"BBB"
"BB"
"B"
"CCC"
"CC"
"D"
"NR"
Total
4.3%
20.3%
8.4%
46.3%
15.0%
1.3%
0.1%
0.0%
0.7%
3.6%
100.0%
9.5%
22.4%
7.4%
39.8%
12.6%
0.9%
0.1%
1.6%
0.0%
5.7%
100.0%
The following table shows the composition of our fixed-income portfolio by remaining time to maturity as of December 31,
2017 and 2016.
As of December 31, 2017
As of December 31, 2016
Percentage of
Total
Fair Value
Fair Value
(in thousands)
Fair Value
(in thousands)
Percentage of
Total
Fair Value
Remaining time to maturity:
Less than one year
One to five years
Five to ten years
More than ten years
Mortgage-backed
$
116,060
308,829
124,168
40,156
16,533
19.2% $
51.0%
20.5%
6.6%
2.7%
97,849
272,168
115,248
52,723
59,469
16.4%
45.5%
19.3%
8.8%
10.0%
Total
$
605,746
100.0% $
597,457
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, 2017, 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.
19
The following table details the net unrealized gain balance by invested asset category as of December 31, 2017.
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)
$
$
(141)
462
401
204
(179)
21,510
61
22,318
As part of our overall investment strategy, we also maintain an integrated cash management system utilizing on-line banking
services and daily overnight investment accounts to maximize investment earnings on all available cash.
Technology
The majority of our technology systems are based on products licensed from insurance-specific technology vendors that
have been substantially customized to meet the unique needs of our various operating units. Our technology systems
primarily consist of integrated central processing computers, a series of server-based computer networks and
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.
Our business is highly dependent upon the successful and uninterrupted functioning of our information technology systems.
Publicly reported cybersecurity intrusions have increased recently and the insurance sector as a whole is more exposed than
in the past. Cybersecurity threats extend from individual attempts to gain unauthorized access to our information technology
systems through coordinated, elaborate and targeted activity. We retain highly trained staff committed to the development
and maintenance of our information technology systems. We maintain and regularly review recovery plans which are
intended to enable us to restore critical systems with minimal disruption. We have established an information security
committee to oversee and steer risk management plans to manage these exposures on an ongoing basis. We also employ
comprehensive employee engagement and training programs to guard against the potential for malicious attempts to extort
sensitive information from our systems using social engineering techniques (also known as “phishing”) and have increased
our cyber liability insurance to seek to minimize our post-event financial impacts.
We recognize the potential for new risks arising alongside the benefits we derive from technological and digital
development. We employ technological security measures to prevent, detect and mitigate such threats, including
independent and in-house vulnerability assessments, access controls, data encryption, continuous monitoring of our
information technology networks and systems and maintenance of backup and protective systems. Nonetheless, the
infrastructure may be vulnerable to security incidents which could result in the disruption of business operations and the
corruption, unavailability, misappropriation or destruction of critical data and confidential information (both our own and
20
of third parties). The compromise of personal and confidential information could lead to legal liability or regulatory action
under evolving cybersecurity, data protection and privacy laws and regulations enacted in the various jurisdictions in which
we operate. In this respect on March 1, 2017, new cybersecurity rules were implemented by the New York Department of
Financial Services (the “NYS Cybersecurity Regulation”). These NYS Cybersecurity Regulations impose additional
regulatory requirements that seek to protect confidentiality, integrity and availability of information systems. We also
anticipate additional NAIC regulations as a result of the Insurance Data Security Model Law which will require insurers to
meet state requirements beyond those imposed by New York. The implementation of these various regulations impose
additional compliance obligations which have necessitated ongoing review of our policies and procedures.
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 3,008 property/casualty insurance
companies and 2,050 property/casualty insurance groups operating in North America as of July 12, 2017. The primary
competition for our Contract Binding operating unit includes such carriers as American Millennium Insurance Company,
Canal Insurance Company, Commercial Alliance Insurance Company, National Casualty Company, National Liability &
Fire Insurance Company, Northland Insurance Company, Progressive County Mutual, State National Insurance Company,
Prime 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 Old Republic Aviation Managers, Starr Aviation, American
International Group, Inc., 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 includes such carriers as Admiral
Insurance Company, Catlin Insurance Company, CNA Financial Corporation, Evanston Insurance Company, Iron Health,
Kinsale Insurance Company, Lexington Insurance Company, Medical Protective Insurance Company, One Beacon
Insurance Group, ProAssurance Corporation, RSUI Group and TDC Companies. The primary competition for the financial
professional liability insurance products produced by our Specialty Commercial operating unit are Admiral Insurance
Company, American International Group Companies, Argonaut Insurance Company, Berkley Insurance Company, CNA
Financial Corporation, Evanston Insurance Company, Kinsale Insurance Company, RSUI Group and XL Catlin Insurance
Company. 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
21
Financial Corporation and The Hartford Financial Services Group, as well as numerous smaller regional companies.
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 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
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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 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, 2017, 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.
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Trade practices. The manner in which we conduct the business of insurance is regulated by state statutes in an effort to
prohibit practices that constitute unfair methods of competition or unfair or deceptive acts or practices. Prohibited practices
include disseminating false information or advertising; defamation; boycotting, coercion and intimidation; false statements
or entries; unfair discrimination; rebating; improper tie-ins with lenders and the extension of credit; failure to maintain
proper records; failure to maintain proper complaint handling procedures; and making false statements in connection with
insurance applications for the purpose of obtaining a fee, commission or other benefit.
Unfair claims practices. Generally, insurance companies, adjusting companies and individual claims adjusters are
prohibited by state statutes from engaging in unfair claims practices on a flagrant basis or with such frequency to indicate a
general business practice. Examples of unfair claims practices include:
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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, 2017, we employed 418 people on a full-time basis. None of our employees are represented by labor
unions. We consider our employee relations to be good.
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Available Information
The Company’s executive offices are located at 777 Main Street, Suite 1000 Fort Worth, Texas 76102. The Company’s
mailing address is 777 Main Street, Suite 1000 Fort Worth, Texas 76102. Its telephone number is (817) 348-1600. The
Company’s website address is www.hallmarkgrp.com. The Company files annual, quarterly and current reports, proxy
statements and other information and documents with the U.S. Securities and Exchange Commission (the “SEC”), which
are made available to read and copy at the SEC’s Public Reference Room at 100 F Street, N.E., Washington, D.C. 20549.
You may obtain information on the operation of the Public Reference Room by contacting the SEC at 1-800-SEC-0330.
Reports filed with the SEC are also made available at www.sec.gov. The Company makes available free of charge on its
website its annual report on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K and amendments to
those reports filed with or furnished to the SEC pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 as
soon as reasonably practical after it electronically files them with or furnishes them to the SEC.
Item 1A. Risk Factors.
Our success depends on our ability to price accurately the risks we underwrite.
Our results of operations and financial condition depend on our ability to underwrite and set premium rates accurately for a
wide variety of risks. Adequate rates are necessary to generate premiums sufficient to pay losses, loss settlement expenses
and underwriting expenses and to earn a profit. To price our products accurately, we must collect and properly analyze a
substantial amount of data; develop, test and apply appropriate pricing techniques; closely monitor and timely recognize
changes in trends; and project both severity and frequency of losses with reasonable accuracy. Our ability to undertake these
efforts successfully, and as a result price our products accurately, is subject to a number of risks and uncertainties, some of
which are outside our control, including:
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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
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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, 2017 unpaid losses and LAE would have produced a $5.3 million change to
pretax earnings. Our gross loss and LAE reserves totaled $527.1 million at December 31, 2017. Our loss and LAE reserves,
net of reinsurance recoverable on unpaid loss and LAE, were $372.5 million at that date. Because setting reserves is
inherently uncertain, there can be no assurance that the current reserves will prove adequate.
Our failure to maintain favorable financial strength ratings could negatively impact our ability to compete
successfully.
Third-party rating agencies assess and rate the claims-paying ability of insurers based upon criteria established by the
agencies. AHIC, HIC, HSIC and HNIC have entered into a pooling arrangement, pursuant to which AHIC retains 34% of
the net premiums written by any of them, HIC retains 32% of the net premiums written by any of them, HSIC retains 24%
of the net premiums written by any of them and HNIC retains 10% of the net premiums written by any of them. A.M. Best
has pooled its 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
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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 3,008 property/casualty insurance
companies and 2,050 property/casualty insurance groups operating in North America as of July 12, 2017. Our competitors
include entities that have, or are affiliated with entities that have, greater financial and other resources than we have. In
addition, competitors may attempt to increase market share by lowering rates. In that case, we could experience reductions
in our underwriting margins, or sales of our insurance policies could decline as customers purchase lower-priced products
from our competitors. Losing business to competitors offering similar products at lower prices, or having other competitive
advantages, could adversely affect our results of operations.
Our results may be unfavorably impacted if we are unable to obtain adequate reinsurance.
As part of our overall risk and capacity management strategy, we purchase reinsurance for significant amounts of risk,
especially catastrophe risks that we and our insurance company subsidiaries underwrite. Our catastrophe and non-
catastrophe reinsurance facilities are generally subject to annual renewal. We may be unable to maintain our current
reinsurance facilities or to obtain other reinsurance facilities in adequate amounts and at favorable rates. The amount,
availability and cost of reinsurance are subject to prevailing market conditions beyond our control, and may affect our ability
to write additional premiums as well as our profitability. If we are unable to obtain adequate reinsurance protection for the
risks we have underwritten, we will either be exposed to greater losses from these risks or be required to reduce the level of
business that we underwrite, which will reduce our revenue.
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, 2017, we had a total of $295.2 million due us from
reinsurers, including $182.9 million of recoverables from losses and $112.3 million in ceded unearned premiums. The
largest amount due us from a single reinsurer as of December 31, 2017 was $55.5 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.
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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:
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approval of policy forms and rates;
standards of solvency, including risk-based capital measurements, which are a measure developed by the
National Association of Insurance Commissioners and used by the state insurance regulators to identify
insurance companies that potentially are inadequately capitalized;
licensing of insurers and their agents;
restrictions on the nature, quality and concentration of investments;
restrictions on the ability of insurance company subsidiaries to pay dividends;
restrictions on transactions between insurance company subsidiaries and their affiliates;
requiring certain methods of accounting;
periodic examinations of operations and finances;
the use of non-public consumer information and related privacy issues;
the use of credit history in underwriting and rating;
limitations on the ability to charge policy fees;
the acquisition or disposition of an insurance company or of any company controlling an insurance
company;
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involuntary assignments of high-risk policies, participation in reinsurance facilities and underwriting
associations, assessments and other governmental charges;
restrictions on the cancellation or non-renewal of policies and, in certain jurisdictions, withdrawal from
writing certain lines of business;
prescribing the form and content of records of financial condition to be filed;
requiring reserves for unearned premium, losses and other purposes; and
with respect to premium finance business, the federal Truth-in-Lending Act and similar state statutes.
In states where specific statutes have not been enacted, premium finance is generally subject to state
usury laws that are applicable to consumer loans.
State insurance departments also conduct periodic examinations of the affairs of insurance companies and require filing of
annual and other reports relating to the financial condition of insurance companies, holding company issues and other
matters. Our business depends on compliance with applicable laws and regulations and our ability to maintain valid licenses
and approvals for our operations. Regulatory authorities may deny or revoke licenses for various reasons, including
violations of regulations. Changes in the level of regulation of the insurance industry or changes in laws or regulations
themselves or interpretations by regulatory authorities could have a material adverse affect on our operations. In addition,
we could face individual, group and class-action lawsuits by our policyholders and others for alleged violations of certain
state laws and regulations. Each of these regulatory risks could have an adverse effect on our profitability.
State statutes limit the aggregate amount of dividends that our subsidiaries may pay Hallmark, thereby limiting its
funds to pay expenses and dividends.
Hallmark is a holding company and a legal entity separate and distinct from its subsidiaries. As a holding company without
significant operations of its own, Hallmark’s principal sources of funds are dividends and other sources of funds from its
subsidiaries. State insurance laws limit the ability of Hallmark’s insurance company subsidiaries to pay dividends and
require our insurance company subsidiaries to maintain specified minimum levels of statutory capital and surplus. The
aggregate maximum amount of dividends permitted by law to be paid by an insurance company does not necessarily define
an insurance company’s actual ability to pay dividends. The actual ability to pay dividends may be further constrained by
business and regulatory considerations, such as the impact of dividends on surplus, by our competitive position and by the
amount of premiums that we can write. Without regulatory approval, the aggregate maximum amount of dividends that
could be paid to Hallmark in 2018 by our insurance company subsidiaries is $19.7 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 any 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.
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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, 2017, 92% of our
investment portfolio was invested in fixed-income securities. Certain risks are inherent in connection with fixed-income
securities, including loss upon default and price volatility in reaction to changes in interest rates and general market factors.
In general, the fair value of a portfolio of fixed-income securities increases or decreases inversely with changes in the market
interest rates, while net investment income realized from future investments in fixed-income securities increases or
decreases along with interest rates. In addition, 23% 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, 2017 was $605.7 million. If market interest rates were to increase 1%, the fair value of our
fixed-income securities would decrease by approximately $9.6 million as of December 31, 2017. 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 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, 2017, Hallmark had $0.1 million in its investment portfolio
exposed to sub-prime mortgages and $16.5 million total exposure in mortgage-backed securities.
Future changes in the fair value of our available-for-sale fixed income 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.
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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 approximately 56% of our gross written premiums for 2017: Texas (40%), California
(6%), Arizona (4%), Oklahoma (3%) and Oregon (3%). Our revenues and profitability are subject to the prevailing
regulatory, legal, economic, political, demographic, competitive, weather and other conditions in the principal states in
which we do business. Changes in any of these conditions could make it less attractive for us to do business in such states
and would have a more pronounced effect on us compared to companies that are more geographically diversified. In
addition, our exposure to severe losses from localized natural perils, such as windstorms or hailstorms, is increased in those
areas where we have written significant numbers of property/casualty insurance policies.
31
The exclusions and limitations in our policies may not be enforceable.
Many of the policies we issue include exclusions or other conditions that define and limit coverage, which exclusions and
conditions are designed to manage our exposure to certain types of risks and expanding theories of legal liability. In addition,
many of our policies limit the period during which a policyholder may bring a claim under the policy, which period in many
cases is shorter than the statutory period under which these claims can be brought by our policyholders. While these
exclusions and limitations help us assess and control our loss exposure, it is possible that a court or regulatory authority
could nullify or void an exclusion or limitation, or legislation could be enacted modifying or barring the use of these
exclusions and limitations. This could result in higher than anticipated losses and LAE by extending coverage beyond our
underwriting intent or increasing the number or size of claims, which could have a material adverse effect on our operating
results. In some instances, these changes may not become apparent until sometime after we have issued the insurance
policies that are affected by the changes. As a result, the full extent of liability under our insurance contracts may not be
known for many years after a policy is issued.
We rely on our information technology and telecommunications systems and the failure or disruption of these
systems could disrupt our operations and adversely affect our results of operations.
Our business is highly dependent upon the successful and uninterrupted functioning of our information technology and
telecommunications systems. We rely on these systems to perform accounting, policy administration, actuarial and other
modeling functions necessary for underwriting business, as well as to process and make claims and other payments. Our
systems could fail of their own accord or might be disrupted by factors such as natural disasters, power disruptions or surges,
cybersecurity intrusions 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 successful 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 and Standard Commercial P&C 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 $52,140 per month pursuant to a lease which expires June 30, 2022.
32
Our Contract Binding 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 $34,798 per month
pursuant to a lease that expires November 30, 2020.
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 $29,202 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
Chicago, Illinois
Atlanta, Georgia
Jersey City, New Jersey
Glendale, California
$
$
$
$
12,227
12,052
5,036
2,627
June 30, 2020
November 30, 2022
December 31, 2020
July 31, 2020
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 $28,769 per month pursuant to a
lease that expires December 31, 2020.
Item 3. Legal Proceedings.
We are engaged in various legal proceedings that are routine in nature and incidental to our business. None of these
proceedings, either individually or in the aggregate, are believed, in our opinion, likely to have a material adverse effect on
our consolidated financial position or our results of operations.
Item 4. Mine Safety Disclosures.
Not applicable.
33
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, 2016.
Period
Year Ended December 31, 2017:
First quarter
Second quarter
Third quarter
Fourth quarter
Year Ended December 31, 2016:
First quarter
Second quarter
Third quarter
Fourth quarter
Holders
High Sale
Low Sale
$
$
11.98 $
11.62
11.83
11.76
11.98 $
12.01
11.93
12.09
10.14
9.94
9.91
9.95
9.79
9.50
9.71
9.77
As of March 1, 2018, there were 2,016 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.
34
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, 2017.
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)
406,731 $
7.85
1,498,971
-
406,731 $
-
7.85
-
1,498,971
Plan Category
Equity compensation plans approved by
security holders
Equity compensation plans not
approved by security holders
Total
(1) Securities remaining available for future issuance are net of a maximum of 501,029 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.
There were no purchases made pursuant to the Stock Repurchase Plan during the quarter ended December 31, 2017.
35
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, 2012 and its relative performance is tracked through
December 31, 2017.
36
Item 6. Selected Financial Data
Statement of Operations Data:
Gross premiums written
Ceded premiums written
Net premiums written
Change in unearned premiums
Net premiums earned
Investment income, net of expenses
Net realized gains
Other-than-temporary impairments
Finance charges
Commission and fees
Other income
Total revenues
Loss and loss adjustment expenses
Operating expenses
Interest expense
Amortization of intangible assets
Total expenses
(Loss) income before tax
Income tax (benefit) expense
Net (loss) income
Net (loss) income per share:
Basic
Diluted
Year Ended December 31
2017
2016
2015
2014
2013
(in thousands, except per share data)
$
604,156 $
(238,573)
365,583
(4,546)
361,037
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
18,874
5,672
(5,877)
3,867
1,679
269
385,521
288,308
106,805
4,512
2,468
402,093
(16,572)
(5,019)
(11,553)
16,342
2,519
(2,888)
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
5,826
(3,323)
5,952
213
684
372,402
230,149
103,993
3,906
2,468
340,516
31,886
10,023
21,863
12,383
408
(274)
5,279
(1,694)
47
337,366
210,055
101,427
4,576
2,526
318,584
18,782
5,353
13,429
460,027
(99,262)
360,765
(224)
360,541
12,884
10,540
-
5,830
(487)
120
389,428
261,345
109,289
4,599
3,115
378,348
11,080
2,835
8,245
$
$
(0.63) $
(0.63) $
0.35 $
0.34 $
1.14 $
1.13 $
0.70 $
0.69 $
0.43
0.43
37
Balance Sheet Items:
2017
2016
2015
2014
2013
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
$
$
$
$
$
$
$
661,333 $
654,119 $
578,829 $
507,229 $
461,325
1,231,126 $
1,162,460 $
1,075,547 $
979,765 $
907,867
527,100 $
481,567 $
450,878 $
415,135 $
382,640
276,642 $
241,254 $
216,407 $
196,826 $
185,303
980,008 $
896,724 $
813,521 $
727,728 $
669,749
251,118 $
265,736 $
262,026 $
252,037 $
238,118
13.82 $
14.28 $
13.72 $
13.11 $
12.36
(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.
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 Contract Binding operating unit and
the general aviation, satellite launch, commercial umbrella and primary/excess liability, medical and financial
professional liability and primary/excess commercial property insurance products and services handled by our
Specialty Commercial operating unit. Certain specialty programs are also managed by our Specialty Commercial
operating unit. Our Contract Binding 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
38
operating unit. Effective June 1, 2016, we ceased marketing new or renewal occupational accident policies.
Effective July 1, 2015, the Workers Compensation operating unit ceased retaining 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. 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
39
investment, and any subsequent recoveries in fair value are recognized at disposition. We recognize a realized loss when
impairment is deemed to be other-than-temporary even if a decision to sell an equity investment has not been made. When
we decide to sell a temporarily impaired available-for-sale equity investment and we do not expect the fair value of the
equity investment to fully recover prior to the expected time of sale, the investment is deemed to be other-than-temporarily
impaired in the period in which the decision to sell is made.
Fair values of financial instruments. Accounting Standards Codification (“ASC”) 820 defines fair value, establishes a
consistent framework for measuring fair value and expands disclosure requirements about fair value measurements. ASC
820, among other things, requires us to maximize the use of observable inputs and minimize the use of unobservable inputs
when measuring fair value. In addition, ASC 820 precludes the use of block discounts when measuring the fair value of
instruments traded in an active market, which were previously applied to large holdings of publicly traded equity securities.
We determine the fair value of our financial instruments based on the fair value hierarchy established in ASC 820. In
accordance with ASC 820, we utilize the following fair value hierarchy:
•
•
•
Level 1: quoted prices in active markets for identical assets;
Level 2: inputs to the valuation methodology include quoted prices for similar assets and liabilities in
active 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
40
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, 2017 and 2016, 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 unit for which reporting units are at the component level (“one level below”). Our consolidated
balance sheet as of December 31, 2017 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; Contract Binding operating unit - $19.9
million; Specialty Commercial operating unit - $17.4 million (comprised of $7.7 million for the primary/excess and umbrella
component and $9.7 million for the general aviation and satellite component); and Specialty Personal Lines operating unit
- $5.3 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 2017 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 2017. 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
(including factors such as prior year loss reserve development), expectations of future performance (including premium
growth rates, premium rate increases and loss costs), 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 2017. However, an 8% decline in the fair value of our
Standard Commercial P&C operating unit, a 5% decline in the fair value of our Contract Binding operating unit, a 6%
41
decline in the fair value of our Specialty Personal Lines operating unit, a 69% decline in the fair value of our excess and
umbrella component or a 23% 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 2017. 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 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, 2017. Through December 31, 2017, there were no indicators
of impairment.
While we believe the estimates and assumptions used in determining the fair value of our operating units were reasonable,
actual results could vary materially. If our actual results are not consistent with our estimates and assumptions used to
calculate fair value, we may be required to perform the second step of impairment testing prescribed by ASC 350 in future
periods and impairment of goodwill could result. We cannot predict future events that might impact the fair value of our
operating units and goodwill impairment. Such events include, but are not limited to, increased competition in insurance
markets and global economic changes.
Deferred income tax assets and liabilities. We file a consolidated federal income tax return. Deferred federal income taxes
reflect the future tax consequences of differences between the tax basis of assets and liabilities and their financial reporting
amounts at each year end. Deferred taxes are recognized using the liability method, whereby tax rates are applied to
cumulative temporary differences based on when and how they are expected to affect the tax return. Deferred tax assets and
liabilities are adjusted for tax rate changes. A valuation allowance is provided against our deferred tax assets to the extent
that we do not believe it is more likely than not that future taxable income will be adequate to realize these future tax
benefits.
Reserves for unpaid losses and LAE. Reserves for unpaid losses and LAE are established for claims that have already been
incurred by the policyholder but which we have not yet paid. Unpaid losses and LAE represent the estimated ultimate net
cost of all reported and unreported losses incurred through each balance sheet date. The reserves for unpaid losses and LAE
are estimated using individual case-basis valuations and statistical analyses. These reserves are revised periodically and are
subject to the effects of trends in loss severity and frequency. (See “Item 1. Business – Analysis of Losses and LAE” and
Note 6 to the audited consolidated financial statements included in this report.)
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, 2017 reserves for unpaid losses and LAE would have produced a $5.3 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.
42
The range of unpaid losses and LAE estimated by our actuary as of December 31, 2017 was $427.1 million to $547.4
million. Our best estimate of unpaid losses and LAE as of December 31, 2017 is $527.1 million. Our carried reserve for
unpaid losses and LAE as of December 31, 2017 is comprised of $268.9 million in case reserves and $258.2 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 $39.9 million higher than the midpoint, or 96.3% of the
high end, of the actuarial range at December 31, 2017 as compared to $36.8 million above the midpoint, or 96.6% of the
high end, of the actuarial range at December 31, 2016. 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.
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.
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).
Treaty Effective Dates
7/1/2001
7/1/2002
7/1/2003
7/1/2004
7/1/2005
Provisional loss ratio
60.0%
59.0%
59.0%
64.2%
64.2%
Estimated ultimate loss ratio recorded at
December 31, 2017
63.5%
64.5%
61.2%
66.2%
61.4%
Effect of actual 5.0% above estimated
loss ratio at December 31, 2017
$
-
$
-
$
(3,360) $
(3,790) $
(546)
Effect of actual 5.0% below estimated loss
ratio at December 31, 2017
$
1,850 $
3,055 $
2,734 $
3,790 $
546
43
Through 2008, all business of our Contract Binding operating unit was produced under a fronting agreement with member
companies of the Republic Group (“Republic”), which granted our Contract Binding 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 Contract Binding operating unit wrote a portion
of its policies under a fronting arrangement with Republic pursuant to which we assumed 100% of the risk. Our Contract
Binding operating unit earns a commission based on a percentage of the earned premium it produced for Republic which
was not assumed by AHIC. The commission percentage is determined by the underwriting results of the policies produced.
The following table details the profit sharing commission revenue sensitivity of the Contract Binding 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, 2017
Effect of actual 5.0% above estimated loss ratio at
December 31, 2017
Effect of actual 5.0% below estimated loss ratio at
December 31, 2017
Treaty Effective Dates
1/1/2006
1/1/2007
1/1/2008
65.0%
65.0%
65.0%
59.4%
65.6%
61.4%
$
(3,096) $
- $
(1,169)
$
3,096 $
2,082 $
1,618
Results of Operations
Comparison of Years ended December 31, 2017 and December 31, 2016
Management overview. During fiscal 2017, our total revenues were $385.5 million, which was $9.5 million more than the
$376.0 million in total revenues for fiscal 2016. During the year ended December 31, 2017, we reported a net loss before
tax of $16.6 million as compared to income before tax of $8.5 million during the same period of 2016.
This increase in revenue was primarily attributable to higher net earned premiums in our Specialty Commercial Segment,
partially offset by lower net earned premiums in our Standard Commercial Segment and our Personal Segment during the
year ended December 31, 2017 as compared to the same period during 2016. Net earned premiums for the year ended
December 31, 2017 include the impact of $1.3 million of ceded reinstatement premium attributable to Hurricane Harvey.
Further contributing to this increase in revenues was higher net investment income, higher commission and fee revenue and
higher net realized gains recognized on our investment portfolio during the year ended December 31, 2017 as compared to
the same period during 2016. These increases in revenue during the year ended December 31, 2017 were partially offset by
lower finance charges and higher other-than-temporary impairments of the investment portfolio.
The pre-tax loss reported for the year ended December 31, 2017 was due primarily to increased loss and LAE of $34.6
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 Contract Binding
operating unit. During the twelve months ended December 31, 2017, we recorded unfavorable prior year net loss reserve
development of $40.1 million as compared to $7.6 million of unfavorable prior year net loss reserve development for the
same period of 2016. The unfavorable prior year reserve development during the twelve months ended December 31, 2017
was primarily driven by the continued emergence of increased frequency and severity trends in our primary commercial
auto lines of business within our Contract Binding operating unit, which was representative of industry trends. These trends
44
had an amplified impact on our consolidated result because this is the largest line of retained business in our portfolio. We
incurred an aggregate of $7.8 million of net catastrophe losses during the year ended December 31, 2017 as compared to
$11.0 million for the same period the prior year. Operating expenses during the year ended December 31, 2017 were
unchanged from the same period during 2016 mostly as a result of a $1.8 million payment to settle the earn-out related to
the previous acquisition of TBIC during the second quarter of 2016 and lower production related expenses due primarily to
increased ceding commissions in our Specialty Commercial Segment, partially offset by increased salary and related
expenses and other operating expenses driven by our investment in technology for the year ended December 31, 2017 as
compared to the same periods during 2016.
We reported a net loss of $11.6 million for the year ended December 31, 2017, as compared to net income of $6.5 million
for the year ended December 31, 2016. On a diluted per share basis, net loss was $0.63 per share for fiscal 2017 as compared
to net income of $0.34 per share for fiscal 2016. Net loss for the year ended December 31, 2017 included a charge of $1.3
million from the revaluation of deferred tax balances from a 35% statutory tax rate to the new 21% statutory tax rate under
the Tax Cuts and Jobs Act of 2017.
45
Segment information
The following is additional business segment information for the years ended December 31, 2017 and 2016 (in thousands):
Year Ended December 31
Specialty Commercial
Segment
Standard Commercial
Segment
Personal Segment
Corporate
Consolidated
2017
2016
2017
2016
2017
2016
2017
2016
2017
2016
Gross premiums written
$
464,714 $
388,914 $
78,228 $
76,891 $
61,214 $
83,272 $
- $
- $
604,156 $
549,077
Ceded premiums written
(199,692)
(139,842)
(8,940)
(8,401)
(29,941)
(39,005)
Net premiums written
Change in unearned
premiums
265,022
249,072
69,288
68,490
31,273
44,267
(5,936)
(7,182)
(3,070)
(980)
4,460
(297)
Net premiums earned
259,086
241,890
66,218
67,510
35,733
43,970
-
-
-
-
-
(238,573)
(187,248)
-
365,583
361,829
-
(4,546)
(8,459)
-
361,037
353,370
Total revenues
277,946
255,897
70,302
71,966
40,462
49,826
(3,189)
(1,737)
385,521
375,952
Losses and loss adjustment
expenses
Pre-tax income (loss)
Net loss ratio (1)
Net expense ratio (1)
Net combined ratio (1)
213,050
-
2,012
82.2%
23.7%
105.9%
169,125
24,417
69.9%
25.3%
95.2%
45,227
-
2,440
68.3%
34.5%
102.8%
41,173
-
8,866
30,031
-
(3,058)
43,390
-
-
-
-
288,308
253,688
(6,839)
(17,966)
(17,966)
(16,572)
8,478
61.0%
33.0%
94.0%
84.0%
98.7%
29.3%
21.5%
113.3%
120.2%
79.9%
71.8%
28.0%
107.9%
28.0%
99.8%
Favorable (Unfavorable)
Prior Year Development
(40,477)
(12,502)
970
9,901
(598)
(5,007)
(40,105)
(7,608)
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.
Specialty Commercial Segment.
Gross premiums written for the Specialty Commercial Segment were $464.7 million for the year ended December 31, 2017,
which was $75.8 million, or 19%, more than the $388.9 million reported for the same period in 2016. Net premiums written
were $265.0 million for the year ended December 31, 2017 as compared to $249.1 million reported for the same period in
2016. The increase in gross and net premiums written was due to increased premium production in our Specialty
Commercial operating unit.
The $277.9 million of total revenue for the year ended December 31, 2017 was $22.0 million higher than the $255.9 million
reported for 2016. This increase in revenue was due to higher net premiums earned of $17.2 million due predominately to
increased earned premium in both our Specialty Commercial and Contract Binding operating units. Further contributing to
this increased revenue was higher net investment income of $3.8 million, higher commission and fees of $1.0 million and
higher other income of $0.1 million, partially offset by lower finance charges of $0.1 million.
46
Pre-tax income for the Specialty Commercial Segment of $2.0 million for the year ended December 31, 2017 was $22.4
million lower than the $24.4 million reported for the same period in 2016. This decrease in pre-tax income was primarily
due to higher loss and LAE expenses of $43.9 million and higher operating expense of $0.5 million, partially offset by the
increased revenue discussed above.
Our Contract Binding operating unit reported a $35.9 million increase in loss and LAE due primarily to $38.6 million of
unfavorable prior year net loss reserve development recognized during the year ended December 31, 2017 as compared to
$11.3 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 $8.0 million increase in loss
and LAE which consisted of (a) a $4.5 million increase in losses and LAE in our commercial umbrella and primary/excess
liability line of business, (b) a $2.1 million increase in losses and LAE attributable to our primary/excess property insurance
products due primarily to increased premium production and higher net catastrophe losses, (c) a $2.2 million increase in our
general aviation line of business, (d) a $0.1 million increase in losses and LAE in our satellite launch insurance line of
business, partially offset by (e) a $0.8 million decrease in losses and LAE attributable to our professional liability insurance
products and (f) a $0.1 million decrease in losses and LAE in our specialty programs. The $0.5 million increase in operating
expense was primarily the result of higher salary and related expenses of $3.3 million, higher occupancy and other operating
expenses of $0.7 million and higher travel related expenses of $0.2 million, partially offset by lower production related
expenses of $3.7 million due primarily to increased ceding commissions in our Specialty Commercial operating unit.
The Specialty Commercial Segment reported a net loss ratio of 82.2% for the year ended December 31, 2017 as compared
to 69.9% for the same period during 2016. The gross loss ratio before reinsurance was 76.5% for the year ended December
31, 2017 as compared to 67.3% for the same period in 2016. The higher gross and net loss ratios for the year ended December
31, 2017 were primarily the result of $40.5 million unfavorable prior year net loss reserve development recognized for the
year ended December 31, 2017 as compared to $12.5 million unfavorable prior year net loss reserve development for the
same period of 2016, as well as higher current accident year loss trends driven mostly by our commercial auto line of
business and increased net catastrophe losses. The net unfavorable prior year development for 2017 was primarily driven
by the continued emergence of increased frequency and severity trends for 2016 and prior accident years in the primary
commercial auto lines of business of our Contract Binding operating unit. Our Specialty Commercial operating unit
experienced net unfavorable development in general aviation primarily in the 2016, 2013 and 2010 and prior accident years,
commercial excess liability primarily in the 2013 accident year and specialty risk programs primarily in the 2015 and prior
accident years, partially offset by net favorable development in the medical professional liability and primary/excess
commercial property lines of business primarily in the 2016 accident years. The Specialty Commercial Segment reported
$3.8 million of net catastrophe losses during the year ended December 31, 2017, of which $1.3 million was attributable to
Hurricane Harvey, as compared to $1.6 million of net catastrophe losses during the same period of 2016. The Specialty
Commercial Segment reported a net expense ratio of 23.7% during the year ended December 31, 2017 as compared to
25.3% for the same period of 2016. The decrease in the expense ratio was due predominately to the impact of higher net
premiums earned as well as increased ceding commission in our Specialty Commercial operating unit.
Standard Commercial Segment.
Gross premiums written for the Standard Commercial Segment were $78.2 million for the year ended December 31, 2017,
which was $1.3 million, or 2%, more than the $76.9 million reported for the same period in 2016. The gross premiums
written for the Standard Commercial P&C operating unit increased $6.8 million, offset by a decrease of $5.0 million due to
the discontinued marketing of new and renewal occupational accident policies and a $0.5 million decrease in gross premiums
written due to the discontinued marketing of workers compensation policies. Net premiums written were $69.3 million for
the year ended December 31, 2017 as compared to $68.5 million reported for the same period in 2016. The net premiums
written include a $5.6 million increase in our Standard Commercial P&C operating unit for the year ended December 31,
2017 as compared to the same period during 2016, offset by a decrease in premium volume of $4.8 million due to the
discontinued marketing of new and renewal occupational accident policies. The net premiums written in our Standard
Commercial P&C Operating unit includes the impact of $0.7 million of ceded reinstatement premium attributable to
Hurricane Harvey.
47
Total revenue for the Standard Commercial Segment of $70.3 million for the year ended December 31, 2017 was $1.7
million less than the $72.0 million reported during the year ended December 31, 2016. This 2% decrease in total revenue
was mostly due to a $1.3 million decrease in net premiums earned primarily as a result of a $4.8 million decrease in net
premiums earned due to the discontinued marketing of new and renewal occupational accident policies, partially offset by
$3.5 million higher net premiums earned in our Standard Commercial P&C operating unit due to increased premium
production, which includes the impact of $0.7 million of ceded reinstatement premium attributable to Hurricane Harvey.
Further contributing to the decrease in revenue was lower commission and fees of $0.8 million, partially offset by higher
net investment income of $0.4 million for the year ended December 31, 2017 as compared to the same period in 2016.
Our Standard Commercial Segment reported pre-tax income of $2.4 million for the year ended December 31, 2017 was
$6.5 million lower than the $8.9 million reported for the same period of 2016. Higher loss and LAE of $4.1 million was the
primary driver for the lower pre-tax income, as well as higher operating expenses of $0.7 million and the decreased revenue
discussed above.
The net loss ratio for the year ended December 31, 2017 was 68.3% as compared to the 61.0% reported for the year ended
December 31, 2016. The gross loss ratio before reinsurance was 63.3% for the year ended December 31, 2017 as compared
to 59.6% for the prior year. Our Standard Commercial Segment’s net loss ratio included 4.9 additional loss ratio points
attributable to the discontinued workers compensation and occupational accident business for the year ended December 31,
2017 as compared to 1.7 fewer loss ratio points for the same period the prior year. During the year ended December 31,
2017 the Standard Commercial Segment reported favorable prior year net loss reserve development of $1.0 million as
compared to favorable prior year net loss reserve development of $9.9 million for the same period of 2016. During 2017,
our Standard Commercial P&C operating unit experienced net favorable development primarily in the general liability line
of business in the 2016 and prior accident years, partially offset by net unfavorable development in the 2016 and prior
accident years in the occupational accident line of business. The Standard Commercial Segment reported $3.6 million of
net catastrophe losses during the year ended December 31, 2017, of which $1.7 million was attributable to Hurricane Harvey,
as compared to $8.4 million of net catastrophe losses during the same period of 2016. The Standard Commercial Segment
reported a net expense ratio of 34.5% for the year ended December 31, 2017 as compared to 33.0% for the same period of
2016. The increase in the expense ratio is primarily due to increased salary and related expense of $0.9 million and increased
other general expenses of $0.6 million primarily due to investments in technology, as well as the decreased earned premium.
Personal Segment.
Gross premiums written for the Personal Segment were $61.2 million for the year ended December 31, 2017, which was
$22.1 million less than the $83.3 million reported for the same period in 2016. Net premiums written for our Personal
Segment were $31.3 million for the year ended December 31, 2017, which was a decrease of $13.0 million from the $44.3
million reported for the same period of 2016. The decline in gross and net written premiums was primarily due to the
intentional reduction in certain underperforming portions of this business to address loss ratio performance.
Total revenue for the Personal Segment decreased 19% to $40.4 million for the year ended December 31, 2017 from $49.8
million for the same period during 2016. The decrease in revenue was primarily due to lower net premiums earned of $8.2
million as a result of lower net premium volume discussed above, lower finance charges of $1.1 million and lower net
investment income of $0.1 million.
Our Personal Segment reported a pre-tax loss of $3.1 million for the year ended December 31, 2017 as compared to pre-tax
loss of $6.8 million for the same period of 2016. The lower pre-tax loss was the result of decreased losses and LAE of $13.3
million, partially offset by higher operating expenses of $0.2 million and the decreased revenue discussed above.
The Personal Segment reported a net loss ratio of 84.0% for the year ended December 31, 2017 as compared to 98.7% for
the same period of 2016. The gross loss ratio before reinsurance was 80.1% for the year ended December 31, 2017 as
compared to 94.8% for the same period in 2016. The lower gross and net loss ratios were primarily the result of lower
unfavorable prior year net loss reserve development of $0.6 million for the year ended December 31, 2017 as compared to
unfavorable development of $5.0 million for the same period in the prior year, as well as lower current accident year loss
48
trends. During 2017, net unfavorable development in our Specialty Personal Lines operating unit was mostly attributable to
the 2016, 2014, 2013 and 2010 and prior accident years, partially offset by favorable development in the 2015 and 2011
accident years. The Personal Segment reported $0.3 million of net catastrophe losses for the year ended December 31, 2017,
of which $0.1 million was attributable to Hurricane Harvey, as compared to $1.0 million of net catastrophe losses during
the same period of 2016. The Personal Segment reported a net expense ratio of 29.3% for the year ended December 31,
2017 as compared to 21.5% for the same period of 2016. The increase in the expense ratio was due predominately to lower
finance charges and lower net premiums earned.
Corporate.
Total revenue for Corporate decreased by $1.5 million for the year ended December 31, 2017 as compared to the same
period the prior year. This decrease in total revenue was due to lower net investment income of $1.6 million and higher
other-than-temporary impairments of the investment portfolio of $3.0 million, partially offset by a $3.2 million increase in
net realized gains recognized on our investment portfolio for the year ended December 31, 2017 as compared to the same
period of 2016.
Corporate pre-tax loss of $18.0 million for the year ended December 31, 2017 was unchanged from the same period of
2016. The pre-tax loss was primarily due to the decreased revenue discussed above, partially offset by lower operating
expenses of $1.5 million. The lower operating expenses of $1.5 million were primarily a result of an additional $1.8 million
earn-out payment in 2016 related to the previous acquisition of TBIC and lower salary and related expenses of $0.2 million
for the year ended December 31, 2017 as compared to the same period during 2016, partially offset by higher professional
service fees of $0.2 million and other operating expenses of $0.3 million.
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 and lower other-than-temporary impairments on our investment portfolio, partially offset by
lower realized gains recognized on our investment portfolio during fiscal 2016 as compared to fiscal 2015 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 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.
49
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):
Specialty Commercial
Segment
Standard Commercial
Segment
2016
2015
2016
2015
Personal Segment
2015
2016
Corporate
Consolidated
2016
2015
2016
2015
Year Ended December 31
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)
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
-
-
-
-
-
(187,248)
(157,279)
-
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
24,417
40,277
69.9%
25.3%
95.2%
62.6%
25.6%
88.2%
41,173
-
8,866
61.0%
33.0%
94.0%
47,071
6,687
64.8%
32.6%
97.4%
43,390
-
(6,839)
34,414
-
-
253,688
230,149
(885)
(17,966)
(14,193)
8,478
31,886
98.7%
21.5%
88.6%
19.0%
120.2%
107.6%
71.8%
28.0%
99.8%
65.9%
28.0%
93.9%
Pre-tax income (loss)
Net loss ratio (1)
Net expense ratio (1)
Net combined ratio (1)
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.
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 Contract Binding
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
50
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 Contract Binding 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.
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.
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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. During 2016, our Standard
Commercial P&C operating unit experienced net favorable development primarily in the general liability line of business
in the 2011-2015 accident years and the 2009 and prior accident years, partially offset by net unfavorable development in
the occupational accident line of business in the 2014 and 2015 accident years. Our Workers Compensation operating unit
experienced net favorable development in the 2015 and prior accident years. 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. During 2016, our Specialty Personal Lines operating unit experienced net unfavorable development attributable
to the 2015 and prior accident years in the private passenger auto liability line of business. 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 lower net realized gains recognized on our investment
portfolio of $3.3 million for the year ended December 31, 2016 as compared to the same period of 2015, partially offset by
higher net investment income of $1.1 million and lower other-than-temporary impairments of $0.4 million.
52
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 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.
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, 2017, we had $11.8 million in
unrestricted cash and cash equivalents, as well as $0.1 million in debt securities, at the holding company and our non-
insurance subsidiaries. As of that date, our insurance subsidiaries held $53.2 million of unrestricted cash and cash
equivalents as well as $605.6 million in debt securities with an average modified duration of 1.6 years. Accordingly, we do
not anticipate selling long-term debt instruments to meet any liquidity needs.
AHIC and TBIC, domiciled in Texas, are limited in the payment of dividends to their stockholders in any 12-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 2018, the aggregate ordinary
dividend capacity of these subsidiaries is $27.6 million, of which $19.7 million is available to Hallmark. As a county mutual,
dividends from HCM are payable to policyholders. During the years ended December 31, 2017 and 2016 our insurance
company subsidiaries paid $11.4 million and $10.5 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.
During 2017 our insurance subsidiaries did not pay management fees to Hallmark or our non-insurance company
subsidiaries. The net amount paid in management fees by our insurance subsidiaries to Hallmark and our non-insurance
company subsidiaries was $1.1 million and $1.3 million during 2016 and 2015, 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, 2017, our insurance company subsidiaries reported statutory capital and surplus of $233.3 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, 2017, 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, 2017 and 2016 was 157% and 146%, respectively.
53
Comparison of December 31, 2017 to December 31, 2016
On a consolidated basis, our cash and investments, excluding restricted cash and investments, at December 31, 2017 were
$726.3 million compared to $733.8 million at December 31, 2016. The primary reasons for the decrease in unrestricted cash
and investments were settlement of prior year investment trades, capital expenditures and repurchases of common stock,
partially offset by cash flow from operations.
Comparison of Years Ended December 31, 2017 and December 31, 2016
Net cash provided by our consolidated operating activities was $7.2 million for the year ended December 31, 2017 compared
to $30.9 million for the year ended December 31, 2016. The decrease in operating cash flow was primarily due to increased
paid losses including timing of reinsurance claim settlements, lower collected net premiums and lower finance charges
collected, partially offset by 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, 2017 was $16.8 million as compared to $58.2 million
for the prior year. The decrease in cash used by investing activities during the year ended December 31, 2017 was comprised
of an increase of $100.9 million in maturities, sales and redemptions of investment securities, a decrease in purchases of
property and equipment of $1.6 million and an increase in transfers from restricted cash of $3.5 million, partially offset by
an increase in purchases of debt and equity securities of $64.6 million.
Cash used in financing activities during the year ended December 31, 2017 was $5.1 million as a result of $5.3 million
related to the repurchase of our common stock, partially offset by $0.2 million related to proceeds from the exercise of
employee stock options. 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.
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, which expires on
June 30, 2018. The outstanding balance of the Facility A bears interest at a rate equal to the prime rate or LIBOR plus
2.5%, at our election. We pay an annual fee of 0.25% of the average daily unused balance of Facility A and letter of credit
fees at the rate of 1.00% per annum. All principal and accrued interest on Facility A becomes due and payable on June 30,
2018. As of December 31, 2017, 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. On December 20, 2017, we entered into a Second Amendment to Second Restated Credit Agreement and a Second
Amendment to Revolving Facility B Agreement with Frost. The Second Amendment to Second Restated Credit Agreement
revised certain definitions in the Second Restated Credit Agreement. The Second Amendment to Revolving Facility B
Agreement amended the Revolving Facility B Agreement to further extend by one year the termination date for draws
thereunder and the maturity date for amounts outstanding thereunder. During the fourth quarter of 2017 we accrued a
$30,000 fee payable to Frost 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, 2019, at which time all amounts outstanding under
54
Facility B are converted to a term loan. Through December 17, 2019, we pay Frost a quarterly fee of 0.25% per annum of
the average daily unused balance of Facility B. Facility B bears interest at a rate equal to the prime rate or LIBOR plus
3.00%, at our election. Until December 17, 2019, interest only on amounts from time to time outstanding under Facility B
are payable quarterly. Any amounts outstanding on Facility B as of December 17, 2019 are converted to a term loan payable
in quarterly installments over five years based on a seven year amortization of principal plus accrued interest. All remaining
principal and accrued interest on Facility B become due and payable on December 17, 2024. As of December 31, 2017, we
had $30.0 million outstanding under Facility B.
The obligations under both Facility A and Facility B are secured by a security interest in the capital stock of AHIC and
HIC. Both Facility A and Facility B contain covenants that, among other things, require us to maintain certain financial
and operating ratios and restrict certain distributions, transactions and organizational changes. We are in compliance with
or have obtained a waiver of 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 Hallmark
Statutory Trust I (“Trust I”) as a Delaware statutory trust. Trust I issued $30.0 million of preferred securities to investors
and $0.9 million of common securities to us. Trust I used the proceeds from these issuances to purchase the subordinated
debt securities. 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, 2017, the principal balance of our Trust I subordinated
debt was $30.9 million and the interest rate was 4.84% per annum.
On August 23, 2007, we entered into a trust preferred securities transaction pursuant to which we issued $25.8 million
aggregate principal amount of subordinated debt securities due in 2037. To effect the transaction, we formed Hallmark
Statutory Trust II (“Trust II”) as a Delaware statutory trust. Trust II issued $25.0 million of preferred securities to investors
and $0.8 million of common securities to us. Trust II used the proceeds from these issuances to purchase the subordinated
debt securities. Our Trust II subordinated debt securities bore an initial interest rate of 8.28% until September 15, 2017,
after which interest adjusts quarterly to the three-month LIBOR rate plus 2.90 percentage points. Trust II pays dividends on
its preferred securities at the same rate. Under the terms of our Trust II subordinated debt securities, we pay interest only
each quarter and the principal of the note at maturity. The subordinated debt securities are uncollateralized and do not require
maintenance of minimum financial covenants. As of December 31, 2017, the principal balance of our Trust II subordinated
debt was $25.8 million and the interest rate was 4.49% per annum.
Long-Term Contractual Obligations
Set forth below is a summary of long-term contractual obligations as of December 31, 2017. 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.
55
Estimated Payments by Period (in thousands)
Total
2018
2019-2020
2021-2022 After 2023
Revolving credit facility payable
$
30,000 $
- $
3,214 $
8,571 $
18,215
Interest on revolving credit facility payable
8,477
1,607
3,127
2,352
1,391
Subordinated debt securities (1)
56,702
-
-
-
56,702
Interest on subordinated debt securities
56,751
3,063
6,125
6,125
41,438
Unpaid losses and LAE (2)
Operating leases (3)
Purchase obligations
527,100
8,462
6,067
210,592
2,398
3,650
189,523
4,402
1,965
71,762
1,662
452
55,223
-
-
(1) The subordinated debt securities excludes unamortized debt issuance costs of $0.9 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 $35 thousand due in the future under non-cancelable subleases.
Based on 2018 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.
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, 2017 was $605.7
million. The effective duration of our portfolio as of December 31, 2017 was 1.6 years. Should interest rates increase 1.0%,
our fixed-income investment portfolio would be expected to decline in market value by 1.6%, or $9.6 million, representing
the effective duration multiplied by the change in market interest rates. Conversely, a 1.0% decline in interest rates would
be expected to result in a 1.6%, or $9.6 million, increase in the fair value of our fixed-income investment portfolio.
Credit risk. An additional exposure to our fixed-income securities portfolio is credit risk. We attempt to manage the credit
risk by investing primarily in investment-grade securities and limiting our exposure to a single issuer. As of December 31,
2017, our fixed-income investments were in the following: U.S. Treasury bonds – 8.2%; municipal bonds – 22.2%;
collateralized corporate bank loans –20.8%; corporate bonds – 46.1%; and mortgage-backed –2.7%. As of December 31,
2017, 79% of our fixed-income securities were rated investment-grade by nationally recognized statistical rating
organizations.
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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, 2017 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
8.4% of our portfolio as of December 31, 2017. 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, 2017 was $55.6 million. The fair value of
these securities would increase or decrease by $16.7 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 4.3%. The selected hypothetical
change does not reflect what should be considered the best or worst case scenario.
57
Item 8. Financial Statements and Supplementary Data.
The following consolidated financial statements of Hallmark and its subsidiaries are filed as part of this report.
3
Description
Reports of Independent Registered Public Accounting Firms
Consolidated Balance Sheets at December 31, 2017 and 2016
Consolidated Statements of Operations for the Years Ended December 31, 2017, 2016 and 2015
Consolidated Statements of Comprehensive Income (Loss) for the Years Ended December 31, 2017,
2016 and 2015
Consolidated Statements of Stockholders’ Equity for the Years Ended
December 31, 2017, 2016 and 2015
Consolidated Statements of Cash Flows for the Years Ended
December 31, 2017, 2016 and 2015
Notes to Consolidated Financial Statements
Financial Statement Schedules
Page Number
F-2
F-4
F-5
F-6
F-7
F-8
F-9
F-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, 2017, 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,
2017.
BDO USA, LLP, the independent registered public accounting firm that audited our consolidated financial statements as of
December 31, 2017 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, 2017. The BDO USA, LLP attestation report, which expresses an unqualified
opinion on the effectiveness of our internal control over financial reporting as of December 31, 2017, is included in this
Item under the heading “ Report of Independent Registered Public Accounting Firm.”
58
Report of Independent Registered Public Accounting Firm
Stockholders and Board of Directors
Hallmark Financial Services, Inc. and subsidiaries
Fort Worth, Texas
Opinion on Internal Control over Financial Reporting
We have audited Hallmark Financial Services, Inc. and subsidiaries’ (the “Company’s”) internal control over financial
reporting as of December 31, 2017, based on criteria established in Internal Control – Integrated Framework (2013) issued
by the Committee of Sponsoring Organizations of the Treadway Commission (the “COSO criteria”). In our opinion the
Company maintained, in all material respects, effective internal control over financial reporting as of December 31, 2017,
based on the COSO criteria.
We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States)
(“PCAOB”), the consolidated balance sheet of the Company as of December 31, 2017, the related consolidated statements
of operations, comprehensive income (loss), stockholders’ equity, and cash flows for the year ended December 31, 2017,
and the related notes and financial statement schedules listed in the accompanying index and our report dated March 14,
2018 expressed an unqualified opinion thereon.
Basis for Opinion
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 Item 9A,
“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 are a public accounting firm registered with the
PCAOB and are required to be independent with respect to the Company in accordance with U.S. federal securities laws
and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB.
We conducted our audit of internal control over financial reporting in accordance with the standards of the PCAOB. 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, and testing and evaluating the design and operating effectiveness of internal control based on the assessed
risk. Our audit also included performing such other procedures as we considered necessary in the circumstances. We believe
that our audit provides a reasonable basis for our opinion.
Definition and Limitations of Internal Control over Financial Reporting
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.
59
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.
/s/ BDO USA, LLP
Dallas, Texas
March 14, 2018
60
Item 9B. Other Information.
None.
61
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.
62
Item 15. Exhibits, Financial Statement Schedules.
(a)(1) Financial Statements
PART IV
The following consolidated financial statements, notes thereto and related information are included in Item 8
of this report:
Reports of Independent Registered Public Accounting Firms
Consolidated Balance Sheets at December 31, 2017 and 2016
Consolidated Statements of Operations for the Years Ended December 31, 2017, 2016 and 2015
Consolidated Statements of Comprehensive Income (Loss) for the Years Ended December 31, 2017, 2016 and
2015
Consolidated Statements of Stockholders’ Equity for the Years Ended December 31, 2017, 2016 and 2015
Consolidated Statements of Cash Flows for the Years Ended December 31, 2017, 2016 and 2015
Notes to Consolidated Financial Statements
(a)(2) 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
(a)(3) 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
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 March 28, 2017).
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).
63
4.6
4.7
4.8
4.9
4.10
4.11
4.12
4.13
4.14
4.15
10.1
10.2
10.3
Indenture dated as of August 23, 2007, between Hallmark Financial Services, Inc. and The Bank of
New York Trust Company, National Association (incorporated by reference to Exhibit 4.1 to the
registrant’s Current Report on Form 8-K filed August 24, 2007).
Amended and Restated Declaration of Trust of Hallmark Statutory Trust II dated as of August 23,
2007, among Hallmark Financial Services, Inc., as sponsor, The Bank of New York (Delaware), as
Delaware trustee, and The 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).
Second Amendment to Second Restated Credit Agreement between Hallmark Financial Services,
Inc. and Frost Bank dated December 20, 2017 (incorporated by reference to Exhibit 10.1 to the
registrant’s Current Report on Form 8-K filed December 20, 2017).
Second Amendment to Revolving Facility B Agreement between Hallmark Financial Services, Inc.
and Frost Bank dated December 20, 2017 (incorporated by reference to Exhibit 10.2 to the
registrant’s Current Report on Form 8-K filed December 20, 2017).
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).
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).
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
64
10.4
10.5
10.6
10.7
10.8*
10.9*
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).
Form of Indemnification Agreement between Hallmark Financial Services, Inc. and its officers and
directors, adopted July 19, 2002 (incorporated by reference to Exhibit 10(c) to the registrant’s
Quarterly Report on Form 10-QSB for the quarter ended September 30, 2002).
Hallmark Financial Services, Inc. Amended and Restated 2005 Long Term Incentive Plan
(incorporated by reference to Exhibit 10.1 to the registrant’s Current Report on Form 8-K filed June
3, 2013).
10.10*
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).
10.11*
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).
10.12*
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).
10.13*
10.14*
10.15*
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).
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).
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).
10.16*
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).
65
10.17
10.18
10.19*
10.20*
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).
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).
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.
23 (b)+
Consent of Independent Registered Public Accounting Firm.
31(a)+
Certification of principal executive officer required by Rule 13a-14(a) or Rule 15d-14(b).
31(b)+
Certification of principal financial officer required by Rule 13a-14(a) or Rule 15d-14(b).
32(a)+
Certification of principal executive officer pursuant to 18 U.S.C. 1350.
32(b)+
Certification of principal financial officer pursuant to 18 U.S.C. 1350.
101 INS+
XBRL Instance Document.
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.
66
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.
2
Date:
Date:
March 14, 2018
By: /s/ Naveen Anand
Naveen Anand, Chief Executive Officer and President
HALLMARK FINANCIAL SERVICES, INC.
(Registrant)
March 14, 2018
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 14, 2018
Date:
March 14, 2018
Date:
Date:
Date:
Date:
March 14, 2018
March 14, 2018
March 14, 2018
March 14, 2018
/s/ Naveen Anand
Naveen Anand, Chief Executive Officer and President
(Principal Executive Officer)
/s/ Jeffrey R. Passmore
Jeffrey R. Passmore, Chief Accounting Officer and Senior Vice
President (Principal Financial Officer and
Principal Accounting Officer)
/s/ Mark E. Schwarz
Mark E. Schwarz, Executive Chairman
/s/ James H. Graves
James H. Graves, Director
/s/ Mark E. Pape
Mark E. Pape, Director
/s/ Scott T. Berlin
Scott T. Berlin, Director
67
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.
o d/b/a Hallmark Commercial Insurance Solutions
o CYR Insurance Management Company
o Effective Claims Management, Inc.
o Hallmark Claims Service, Inc.
o Hallmark County Mutual Insurance Company*
o Hallmark Finance Corporation
o Hallmark Insurance Company
o d/b/a Hallmark American Insurance Company
o Hallmark National Insurance Company
o Hallmark Specialty Insurance Company
o Hardscrabble Data Solutions, LLC
o Heath XS, LLC
o d/b/a Hallmark E&S
o d/b/a Hallmark E&S Insurance Services, LLC
o Pan American Acceptance Corporation
o TBIC Holding Corporation, Inc.
o TBIC Risk Management, Inc.
o Texas Builders Insurance Company
o Hallmark Specialty Underwriters, Inc.
o TGA Special Risk, Inc.
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.
68
Exhibit 23(a)
Consent of Independent Registered Public Accounting Firm
Hallmark Financial Services, Inc. and subsidiaries
Fort Worth, Texas
We hereby consent to the incorporation by reference in the Registration Statements on Form S-8 (No. 333-140000), Form
S-8 (No. 333-160050) and Form S-8 (No. 333-210078) of Hallmark Financial Services, Inc. of our reports dated March 14,
2018, relating to the consolidated financial statements and financial statement schedules and the effectiveness of Hallmark
Financial Services Inc.’s internal control over financial reporting, which appear in this Form 10-K.
/s/ BDO USA, LLP
Dallas, Texas
March 14, 2018
69
Exhibit 23(b)
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; and
(3) Registration Statement (Form S-8 No. 333-210078) pertaining to Hallmark Financial Services, Inc. 2015 Long
Term Incentive Plan;
of our report dated March 9, 2017, with respect to the consolidated financial statements and schedules 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 14, 2018
70
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 14, 2018
/s/ Naveen Anand
Naveen Anand, Chief Executive Officer
71
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 14, 2018
/s/ Jeffrey R. Passmore
Jeffrey R. Passmore, Chief Accounting Officer
72
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, 2017, 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 14, 2018
/s/ Naveen Anand
Naveen Anand,
Chief Executive Officer
73
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, 2017, 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 14, 2018
/s/ Jeffrey R. Passmore
Jeffrey R. Passmore,
Chief Accounting Officer
74
HALLMARK FINANCIAL SERVICES, INC. AND SUBSIDIARIES
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
Description
Page Number
Reports of Independent Registered Public Accounting Firms
Consolidated Balance Sheets at December 31, 2017 and 2016
Consolidated Statements of Operations for the Years Ended December 31, 2017,
2016 and 2015
Consolidated Statements of Comprehensive Income (Loss) for the Years Ended
December 31, 2017, 2016 and 2015
Consolidated Statements of Stockholders’ Equity for the Years Ended
December 31, 2017, 2016 and 2015
Consolidated Statements of Cash Flows for the Years Ended December 31, 2017,
2016 and 2015
Notes to Consolidated Financial Statements
Financial Statement Schedules
F-2
F-4
F-5
F-6
F-7
F-8
F-9
F-53
F-1
Independent Registered Public Accounting Firm
Stockholders and Board of Directors
Hallmark Financial Services, Inc. and subsidiaries
Fort Worth, Texas
Opinion on the Consolidated Financial Statements
We have audited the accompanying consolidated balance sheet of Hallmark Financial Services, Inc. (the
“Company”) and subsidiaries as of December 31, 2017, the related consolidated statements of operations,
comprehensive income (loss), stockholders’ equity, and cash flows for the year ended December 31, 2017, and the
related notes and financial statement schedules listed in the accompanying index (collectively referred to as the
“consolidated financial statements”). In our opinion, the consolidated financial statements present fairly, in all
material respects, the financial position of the Company and subsidiaries at December 31, 2017, and the results of
their operations and their cash flows for the year ended December 31, 2017, in conformity with accounting
principles generally accepted in the United States of America.
We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United
States) (“PCAOB”), the Company's internal control over financial reporting as of December 31, 2017, based on
criteria established in Internal Control – Integrated Framework (2013) issued by the Committee of Sponsoring
Organizations of the Treadway Commission (“COSO”) and our report dated March 14, 2018 expressed an
unqualified opinion thereon.
Basis for Opinion
These consolidated financial statements are the responsibility of the Company’s management. Our responsibility is
to express an opinion on the Company’s consolidated financial statements based on our audit. We are a public
accounting firm registered with the PCAOB and are required to be independent with respect to the Company in
accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and
Exchange Commission and the PCAOB.
We conducted our audit in accordance with the standards of the PCAOB. Those standards require that we plan and
perform the audit to obtain reasonable assurance about whether the consolidated financial statements are free of
material misstatement, whether due to error or fraud.
Our audit included performing procedures to assess the risks of material misstatement of the consolidated financial
statements, whether due to error or fraud, and performing procedures that respond to those risks. Such procedures
included examining, on a test basis, evidence regarding the amounts and disclosures in the consolidated financial
statements. Our audit also included evaluating the accounting principles used and significant estimates made by
management, as well as evaluating the overall presentation of the consolidated financial statements. We believe that
our audit provides a reasonable basis for our opinion.
/s/ BDO USA, LLP
We have served as the Company's auditor since 2017.
Dallas, Texas
March 14, 2018
F-2
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 the related consolidated statements of operations,
comprehensive income (loss), stockholders’ equity and cash flows for each of the two 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 the consolidated
results of their operations and their cash flows for each of the two 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.
/s/ Ernst & Young LLP
Fort Worth, Texas
March 9, 2017
F-3
HALLMARK FINANCIAL SERVICES, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
December 31, 2017 and 2016 ($ in thousands)
ASSETS
Investments:
Debt securities, available-for-sale,
at fair value (amortized cost; $604,999 in 2017 and $597,784 in 2016)
Equity securities, available-for-sale,
at fair value (cost; $30,253 in 2017 and $31,449 in 2016)
Other investments (cost; $3,763 in 2017 and $3,763 in 2016)
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 $949 in 2017 and $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 2017
and 2016
Additional paid-in capital
Retained earnings
Accumulated other comprehensive income
Treasury stock (2,703,803 shares in 2017 and 2,260,849 in 2016), at cost
2017
2016
$
605,746 $
597,457
51,763
3,824
661,333
64,982
2,651
112,323
104,373
1,513
5,235
182,928
16,002
44,695
10,023
1,937
7,532
1,743
13,856
1,231,126 $
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 $
30,000
55,753
527,100
276,642
52,487
1,605
7,488
28,933
980,008
3,757
123,180
136,474
12,234
(24,527)
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
1,162,460
Total stockholders’ equity
Total liabilities and stockholders’ equity
251,118
1,231,126 $
$
The accompanying notes are an integral part of the consolidated financial statements
F-4
HALLMARK FINANCIAL SERVICES, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
For the years ended December 31, 2017, 2016 and 2015
($ in thousands, except per share amounts)
Gross premiums written
Ceded premiums written
Net premiums written
Change in unearned premiums
Net premiums earned
Investment income, net of expenses
Net realized gains
Other-than-temporary impairments
Finance charges
Commission and fees
Other income
Total revenues
Losses and loss adjustment expenses
Operating expenses
Interest expense
Amortization of intangible assets
Total expenses
(Loss) income before tax
Income tax (benefit) expense
Net (loss) income
Net (loss) income per share:
Basic
Diluted
2017
2016
2015
604,156 $
(238,573)
365,583
(4,546)
361,037
18,874
5,672
(5,877)
3,867
1,679
269
385,521
288,308
106,805
4,512
2,468
402,093
(16,572)
(5,019)
549,077 $
(187,248)
361,829
(8,459)
353,370
16,342
2,519
(2,888)
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
5,826
(3,323)
5,952
213
684
372,402
230,149
103,993
3,906
2,468
340,516
31,886
10,023
(11,553) $
6,526 $
21,863
(0.63) $
(0.63) $
0.35 $
0.34 $
1.14
1.13
$
$
$
$
The accompanying notes are an integral part of the consolidated financial statements
F-5
HALLMARK FINANCIAL SERVICES, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (LOSS)
For the years ended December 31, 2017, 2016 and 2015
($ In thousands)
Net (loss) income
Other comprehensive income (loss):
Change in net actuarial gain (loss)
Tax effect on change in net actuarial gain (loss)
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
2017
2016
2015
$
(11,553) $
6,526 $
21,863
548
(192)
9,117
(3,191)
(6,799)
2,380
1,863
(145)
51
6,019
(2,107)
(1,331)
466
2,953
9,479 $
43
(15)
(10,191)
3,567
(5,826)
2,039
(10,383)
11,480
Comprehensive (loss) income
$
(9,690) $
The accompanying notes are an integral part of the consolidated financial statements
F-6
HALLMARK FINANCIAL SERVICES, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY
For the years ended December 31, 2017, 2016 and 2015
(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, 2015
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 benefit plans
Net income
Other comprehensive loss, net of tax
-
-
-
-
-
-
-
-
-
-
-
383
(97)
-
-
-
-
-
21,863
-
-
-
-
-
(10,383)
(2,532)
-
755
-
-
-
(100)
-
-
221
(2,532)
Balance at December 31, 2015
Acquisition of treasury stock
Equity incentive plan activity
Shares issued under employee benefit plans
Net income
Other comprehensive income, net of tax
Balance at December 31, 2016
Acquisition of treasury stock
Equity incentive plan activity
Shares issued under employee benefit plans
Net loss
Other comprehensive income, net of tax
20,873 $
-
-
-
-
-
20,873 $
-
-
-
-
-
3,757 $
-
-
-
-
-
123,480 $
-
(118)
(196)
-
-
141,501 $
-
-
-
6,526
-
3,757 $
-
-
-
-
-
123,166 $
-
149
(135)
-
-
148,027 $
-
-
-
(11,553)
-
7,418
$
-
-
-
-
(14,130)
(6,117)
-
662
-
-
1,776 $
562
-
(77)
-
-
2,953
10,371
1,863
$
-
-
-
-
(19,585)
(5,308)
-
366
-
-
2,261 $
484
-
(41)
-
-
Balance at December 31, 2017
20,873 $
3,757 $
123,180 $
136,474 $
12,234
$
(24,527)
2,704 $
251,118
The accompanying notes are an integral part of the consolidated financial statements
F-7
383
658
21,863
(10,383)
262,026
(6,117)
(118)
466
6,526
2,953
265,736
(5,308)
149
231
(11,553)
1,863
HALLMARK FINANCIAL SERVICES, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
For the years ended December 31, 2017, 2016 and 2015
($ in thousands)
Cash flows from operating activities:
Net (loss) income
Adjustments to reconcile net (loss) income to cash provided by operating activities:
2017
2016
2015
$
(11,553) $
6,526 $
21,863
Depreciation and amortization expense
Deferred federal income taxes
Net realized gains
Other-than-temporary impairments
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
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 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
4,715
(1,575)
(5,672)
5,877
149
(30,841)
(14,658)
756
3,191
45,533
35,388
(35,107)
5,999
(3,581)
3,091
5,487
7,199
3,894
405
(2,519)
2,888
(118)
(16,388)
(6,339)
(264)
1,173
30,689
24,847
(33,534)
12,747
(2,172)
3,586
5,433
30,854
(2,705)
4,676
(305,930)
287,187
(16,772)
(4,340)
1,195
(241,374)
186,286
(58,233)
-
-
-
231
(5,308)
(5,077)
(14,650)
79,632
64,982 $
-
-
(1,784)
466
(6,117)
(7,435)
(34,814)
114,446
79,632 $
3,516
(1,030)
(5,826)
3,323
383
(11,718)
(12,373)
1,136
380
35,743
19,581
(4,568)
7,338
(2,747)
(1,368)
(697)
52,936
(3,608)
3,392
(265,482)
169,409
(96,289)
30,000
(96)
(1,216)
658
(2,532)
26,814
(16,539)
130,985
114,446
4,506 $
137 $
4,287 $
3,718 $
3,906
13,800
(2,188) $
7,377 $
(9,492)
(6,727) $
13,118 $
(224)
$
$
$
$
$
The accompanying notes are an integral part of the consolidated financial statements
F-8
HALLMARK FINANCIAL SERVICES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Years ended December 31, 2017, 2016, and 2015
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 Contract Binding 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 and financial 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. Certain specialty programs are also managed by our Specialty Commercial operating
unit. 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 ceased
marketing or retaining 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 Contract Binding 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.
F-9
HALLMARK FINANCIAL SERVICES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Years ended December 31, 2017, 2016, and 2015
Reclassifications
Certain prior year amounts have been reclassified to conform with current year presentation.
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, 2017 and 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 3.6% to 4.2% 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 $55.8 million and $55.7
million, and had a fair value of $43.7 million and $44.2 million, as of December 31, 2017 and 2016, 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, 2017 and 2016, 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.
F-10
HALLMARK FINANCIAL SERVICES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Years ended December 31, 2017, 2016, and 2015
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 first in-first out method.
Cash and Cash Equivalents
We consider all highly liquid investments with an original maturity of three months or less to be cash equivalents.
Restricted Cash
Restricted cash consists of amounts held in restricted accounts as collateral for certain reinsurance arrangements
with unaffiliated insurance companies, as well as premiums we collect from customers and, after deducting
authorized commissions, remit to third party insurers. Unremitted insurance premiums are held in a fiduciary
capacity until disbursed to the third party insurer.
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 2017, 2016 and
2015, we deferred $31.1 million, $37.9 million and $32.3 million of policy acquisition costs and amortized $34.3
F-11
HALLMARK FINANCIAL SERVICES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Years ended December 31, 2017, 2016, and 2015
million, $39.1 million and $32.7 million of deferred policy acquisition costs, respectively. Therefore, the net
(amortization) deferrals of policy acquisition costs were ($3.2) million, ($1.2) million and ($0.4) million for 2017,
2016 and 2015, 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 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.
F-12
HALLMARK FINANCIAL SERVICES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Years ended December 31, 2017, 2016, and 2015
Property and Equipment
Property and equipment (including leasehold improvements), aggregating $24.9 million and $22.2 million, at
December 31, 2017 and 2016, 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) or the life of the lease,
whichever is shorter. Depreciation expense for 2017, 2016 and 2015 was $2.2 million, $1.4 million and $1.0 million,
respectively. Accumulated depreciation was $17.3 million and $15.1 million at December 31, 2017 and 2016,
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, 2017 and 2016. The reserves for unpaid losses and LAE are estimated using individual case-basis
valuations and statistical analyses. These estimates are subject to the effects of trends in loss severity and frequency.
Although considerable variability is inherent in such estimates, we believe that the reserves for unpaid losses and
LAE are adequate. The estimates are continually reviewed and adjusted as experience develops or new information
becomes known. Such adjustments are included in current operations.
Recognition of Premium Revenues
Insurance premiums are earned pro rata over the terms of the policies. Insurance policy fees are earned as of the
effective date of the policy. Upon cancellation, any unearned premium is refunded to the insured. Insurance
premiums written include gross policy fees of $7.6 million, $9.8 million and $11.2 million for the years ended
December 31, 2017, 2016, and 2015, respectively. Insurance premiums on monthly reporting workers’
compensation policies are earned on the conclusion of the monthly coverage period. Deposit premiums for workers’
compensation policies are earned upon the expiration of the policy.
F-13
HALLMARK FINANCIAL SERVICES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Years ended December 31, 2017, 2016, and 2015
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 Contract Binding 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, 2017
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%
66.2%
61.4%
As of December 31, 2017, we had a net payable of $0.3 million on these profit share treaties. The payable or
receivable is the difference between the cash received to date and the recognized commission revenue based on the
estimated ultimate loss ratio.
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 Contract Binding operating unit and Republic.
Provisional loss ratio
Estimated ultimate loss ratio recorded at
December 31, 2017
Treaty Effective Dates
1/1/2006
1/1/2007
1/1/2008
65.0%
65.0%
65.0%
59.4%
65.6%
61.4%
F-14
HALLMARK FINANCIAL SERVICES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Years ended December 31, 2017, 2016, and 2015
As of December 31, 2017, we had a net payable of $0.5 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.
On December 22, 2017, the Tax Cuts and Jobs Act (“TCJA”) was enacted. Among many changes resulting from
TCJA, the new law (i) reduces the corporate tax rate to 21% effective January 1, 2018, (ii) eliminates the corporate
alternative minimum tax for tax years beginning after December 31, 2017, (iii) allows businesses to immediately
expense, for tax purposes, the cost of new investments in certain qualified depreciable assets, (iv) modifies the
computation of loss reserve discounting for tax purposes, (v) modifies the recognition of income rules by requiring
the recognition of income for certain items no later than the tax year in which an item is taken into account as
income on an applicable financial statement and (vi) significantly modifies the United States international tax
system. Net loss for the year ended December 31, 2017 included a charge of $1.3 million from the revaluation of
deferred tax balances from a 35% statutory tax rate to the new 21% statutory tax rate as a result of TCJA.
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 March 2016, the FASB issued ASU 2016-09, “Improvements to Employee Share-Based Payment Accounting”
(Topic 718). ASU 2016-09 simplifies the accounting for share-based payment award transactions including income
tax consequences, classification of awards as either equity or liabilities, classification on the statement of cash flows,
and accounting for forfeitures. The guidance was effective for annual periods beginning after December 15, 2016,
and interim periods within those fiscal years. Effective January 2017, we adopted this new guidance on stock
compensation which requires recognition of the excess tax benefits or deficiencies of share-based compensation
awards to employees through net income rather than through additional paid in capital. Adoption of this guidance
F-15
HALLMARK FINANCIAL SERVICES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Years ended December 31, 2017, 2016, and 2015
did not have a material impact on our financial results or disclosures. We elect to account for forfeitures as they
occur.
Recently Issued Accounting Pronouncements
On February 14, 2018, the FASB issued ASU 2018-02, ”Income Statement- Reporting Comprehensive Income
(Topic 220)” providing updated guidance that allows a reclassification of the stranded tax effects in accumulated
other comprehensive income (AOCI) resulting from the TCJA. Current guidance requires the effect of a change in
tax laws or rates on deferred tax balances to be reported in income from continuing operations in the accounting
period that includes the period of enactment, even if the related income tax effects were originally charged or
credited directly to AOCI. The amount of the reclassification would include the effect of the change in the U.S.
federal corporate income tax rate on the gross deferred tax amounts and related valuation allowances, if any, at the
date of the enactment of TCJA related to items in AOCI. The updated guidance is effective for reporting periods
beginning after December 15, 2018 and is to be applied retrospectively to each period in which the effect of the
TCJA related to items remaining in AOCI are recognized or at the beginning of the period of adoption. Early
adoption is permitted. The Company expects to adopt the updated guidance effective January 1, 2018. The
anticipated reclassification of the stranded tax effects out of AOCI and into retained earnings is $2.6 million. The
adoption will not affect the Company's results of operations, financial position, or liquidity.
In March 2017, the FASB issued ASU 2017-08, “Premium Amortization on Purchased Callable Securities”
(Subtopic 310-20). ASU 2017-08 is intended to enhance the accounting for amortization of premiums for purchased
callable debt securities. The guidance amends the amortization period for certain purchased callable debt securities
held at a premium. Securities that contain explicit, noncontingent call features that are callable at fixed prices and
on preset dates should shorten the amortization period for the premium to the earliest call date (and if the call option
is not exercised, the effective yield is reset using the payment terms of the debt security). The standard is effective
for fiscal years, and interim periods within those years, beginning after December 15, 2018, and is to be applied on
a modified retrospective basis through a cumulative-effect adjustment directly to retained earnings. We are currently
evaluating the impact that the adoption of ASU 2017-08 will have on our financial results and disclosures.
In January 2017, the FASB issued ASU 2017-01, “Clarifying the Definition of a Business” (Topic 715). ASU 2017-
01 is intended to assist entities with evaluating whether transactions should be accounted for as acquisitions (or
disposals) of assets or businesses. ASU 2017-01 is effective for annual periods beginning after December 15, 2017,
including interim periods within those annual periods. We do not expect the adoption of this standard to have a
material impact on our financial condition or results of operations.
In January 2017, the FASB issued ASU 2017-04, “Simplifying the Test for Goodwill Impairment” (Topic 350).
ASU 2017-04 requires only a one-step quantitative impairment test, whereby a goodwill impairment loss will be
measured as the excess of a reporting unit’s carrying amount over its fair value (not to exceed the total goodwill
allocated to that reporting unit). It eliminates Step 2 of the current two-step goodwill impairment test, under which
a goodwill impairment loss is measured by comparing the implied fair value of a reporting unit’s goodwill. The
ASU is effective for annual or any interim goodwill impairment tests in fiscal years beginning after December 15,
2019. The adoption of ASU 2017-04 is not expected to have a material impact on our financial results and
disclosures.
In November 2016, the FASB issued ASU 2016-18, “Statement of Cash Flows (Topic 230): Restricted Cash.” The
purpose of ASU 2016-18 is to eliminate the diversity in classifying and presenting changes in restricted cash in the
statement of cash flows. The new guidance requires restricted cash to be combined with cash and cash equivalents
when reconciling the beginning and ending balances of cash on the statement of cash flows, thereby no longer
requiring transactions such as transfers between restricted and unrestricted cash to be treated as a cash flow activity.
F-16
HALLMARK FINANCIAL SERVICES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Years ended December 31, 2017, 2016, and 2015
Further, the new guidance requires the nature of the restrictions to be disclosed, as well as a reconciliation between
the balance sheet and the statement of cash flows on how restricted and unrestricted cash are segregated. The new
guidance is effective fiscal years beginning after December 15, 2017, and interim periods within that fiscal year,
with early adoption permitted. The Company expects the adoption of this new guidance to have a material impact
on its statement of cash flows as restricted cash will be removed from the investing section and become a component
of cash and cash equivalents.
In August 2016, the FASB issued ASU 2016-15, “Classification of Certain Cash Receipts and Cash Payments”
(Topic 230). ASU 2016-15 will reduce diversity in practice on how eight specific cash receipts and payments are
classified on the statement of cash flows. The ASU will be effective for fiscal years beginning after December 15,
2017, including interim periods within those years. We do not expect the impact from the adoption of ASU 2016-
15 to be material to our financial results and disclosures.
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. ASU 2016-13 is effective for fiscal years beginning after
December 15, 2019, including interim periods within those fiscal years. ASU 2016-13 requires a modified
retrospective transition method and early adoption is permitted. We are currently evaluating the impact that the
adoption of this standard will have on our financial results and disclosures, but do not anticipate that any potential
impact would be material.
In February 2016, the FASB issued ASU 2016-02, “Leases” (Topic 842). ASU 2016-02 requires organizations that
lease assets to recognize on the balance sheet the assets and liabilities for the rights and obligations created by those
leases. Additionally, ASU 2016-02 modifies current guidance for lessors' accounting. ASU 2016-02 is effective for
interim and annual reporting periods beginning on or after January 1, 2019, with early adoption permitted. We do
not anticipate that this standard will have a material impact on our results of operations since most of our leases are
for office space with standard lease terms. However, we anticipate an increase to the value of our assets and
liabilities related to leases, with no material impact to equity.
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. ASU 2016-01 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. ASU 2016-01 will be effective for fiscal
years beginning after December 15, 2017, including interim periods within those fiscal years. We have evaluated
the impact of this standard and estimate no impact on shareholders’ equity from the cumulative reclassification
adjustment to retained earnings for unrealized gains (losses) as of the adoption date. However, we anticipate the
standard will increase the volatility of our consolidated statements of income, resulting from the remeasurement of
our equity investments.
In May 2014, the FASB issued guidance which revises the criteria for revenue recognition. Under the guidance, the
transaction price is attributed to underlying performance obligations in the contract and revenue is recognized as
the entity satisfies the performance obligations and transfers control of a good or service to the customer.
Incremental costs of obtaining a contract may be capitalized to the extent the entity expects to recover those costs.
The guidance is effective for reporting periods beginning after December 15, 2017 and is to be applied
retrospectively. Revenue from insurance contracts is excluded from the scope of this new guidance. While insurance
contracts are excluded from this guidance, policy fee income, billing and other fees and fee income related to
F-17
HALLMARK FINANCIAL SERVICES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Years ended December 31, 2017, 2016, and 2015
property business written as a cover-holder through a Lloyds Syndicate will be subject to this updated guidance.
We have evaluated the impact this guidance will have on our financial results and disclosures and do not anticipate
such impact being material based on the limited revenue streams subject to the guidance.
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, 2017
Amortized Cost
Gross
Unrealized
Gains
Gross
Unrealized
Losses
Fair Value
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, 2016
50,088 $
278,611
125,536
134,052
16,712
604,999
30,253
3,763
7 $
1,204
702
709
37
2,659
23,014
61
(148) $
(742)
(301)
(505)
(216)
(1,912)
(1,504)
-
49,947
279,073
125,937
134,256
16,533
605,746
51,763
3,824
$
639,015 $
25,734 $
(3,416) $
661,333
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
41,976 $
224,915
105,220
165,900
59,773
597,784
31,449
66 $
1,722
959
956
49
3,752
21,052
3,763
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
Total investments
$
632,996 $
25,992 $
(4,869) $
654,119
F-18
HALLMARK FINANCIAL SERVICES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Years ended December 31, 2017, 2016, and 2015
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
$
Twelve Months Ended December 31
2017
2016
2015
566 $
7,839
4,302
4,633
1,049
871
-
706
19,966
(1,092)
594 $
5,573
3,190
5,442
1,320
638
-
277
17,034
(692)
670
1,435
4,727
5,901
1,288
673
-
148
14,842
(873)
Investment income, net of expenses
$
18,874 $
16,342 $
13,969
No investments in any entity or its affiliates exceeded 10% of stockholders’ equity at December 31, 2017 or 2016.
Major categories of net realized gains (losses) on investments are summarized as follows (in thousands):
Twelve Months Ended December 31
2017
2016
2015
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 (loss) gain on other investments
Other-than-temporary impairments
$
- $
(468)
79
195
(9)
7,002
6,799
(1,127)
(5,877)
- $
(264)
(86)
(189)
(1)
1,871
1,331
1,188
(2,888)
Net realized (losses) gains
$
(205) $
(369) $
-
-
126
(83)
240
5,543
5,826
-
(3,323)
2,503
We realized gross gains on investments of $8.0 million, $2.1 million, and $6.7 million during the years ended
December 31, 2017, 2016 and 2015, respectively. We realized gross losses on investments of $1.2 million, $0.8
million and $0.9 million during the years ended December 31, 2017, 2016 and 2015, respectively. We recorded
proceeds from the sale of investment securities of $29.1 million, $28.5 million and $51.7 million during the years
ended December 31, 2017, 2016 and 2015, respectively. Realized investment gains and losses are recognized in
operations on the first in-first out method.
F-19
HALLMARK FINANCIAL SERVICES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Years ended December 31, 2017, 2016, and 2015
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, 2017 and December 31, 2016 (in thousands):
12 months or less
Longer than 12 months
Total
As of December 31, 2017
Fair Value
Unrealized
Losses
Fair Value
Unrealized
Losses
Fair Value
Unrealized
Losses
U.S. Treasury securities and
obligations of U.S. Government
Corporate bonds
Collateralized corporate bank loans
Municipal bonds
Mortgage-backed
$
Total debt securities
Total equity securities
Total other investments
28,825 $
176,061
30,008
35,200
6,419
276,513
(145) $
(736)
(280)
(370)
(127)
(1,658)
8,375
(1,504)
-
-
1,997 $
2,378
2,517
8,917
1,415
17,224
-
-
(3) $
(6)
(21)
(135)
(89)
(254)
-
-
30,822 $
178,439
32,525
44,117
7,834
293,737
8,375
-
(148)
(742)
(301)
(505)
(216)
(1,912)
(1,504)
-
Total investments
$
284,888 $
(3,162) $
17,224 $
(254) $
302,112 $
(3,416)
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 loans
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
Total equity securities
Total other investments
4,109
(483)
2,037
(307)
6,146
-
-
-
-
-
(20)
(575)
(170)
(2,961)
(353)
(4,079)
(790)
-
Total investments
$
200,483 $
(2,760) $
26,355 $
(2,109) $
226,838 $
(4,869)
At December 31, 2017, the gross unrealized losses more than twelve months old were attributable to 25 debt security
positions. At December 31, 2016, the gross unrealized losses more than twelve months old were attributable to 28
debt security positions and one equity position. 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. The gross unrealized losses on the debt security positions at December 31,
2017 were due predominately to normal market and interest rate fluctuations and we see no other indications that
the decline in values of these securities is other-than-temporary.
F-20
HALLMARK FINANCIAL SERVICES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Years ended December 31, 2017, 2016, and 2015
Based on evidence gathered through our normal credit evaluation process, we presently expect that all debt
securities held in our investment portfolio will be paid in accordance with their contractual terms. Nonetheless, it is
at least reasonably possible that the performance of certain issuers of these debt securities will be worse than
currently expected resulting in future write-downs within our portfolio of debt securities.
Also, as a result of the challenging market conditions, we expect the volatility in the valuation of our equity
securities to continue in the foreseeable future. This volatility may lead to changes regarding retention strategies for
certain equity securities.
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 $5.9 million during 2017, all related to credit losses
(none of the impairments were interest related) on certain senior and subordinated municipal bonds concentrated in
Puerto Rico. The fair value of the impaired securities was $4.4 million at December 31, 2017.
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, 2017 and 2016 were
as follows:
Investment Type
Equity warrant
Total other investments
2017
2016
$
$
3,824 $
3,824 $
4,951
4,951
F-21
HALLMARK FINANCIAL SERVICES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Years ended December 31, 2017, 2016, and 2015
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.
The amortized cost and estimated fair value of debt securities at December 31, 2017 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)
$
$
116,027 $
308,477
123,518
40,265
16,712
604,999 $
116,060
308,829
124,168
40,156
16,533
605,746
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 $26.2 million
at December 31, 2017 and a carrying value of $21.1 million at December 31, 2016.
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
F-22
HALLMARK FINANCIAL SERVICES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Years ended December 31, 2017, 2016, and 2015
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.
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, 2017 and December 31, 2016 (in thousands).
U.S. Treasury securities and obligations of
U.S. Government
Corporate bonds
Collateralized corporate bank loans
Municipal bonds
Mortgage-backed
Total debt securities
Total equity securities
Total other investments
Total investments
As of December 31, 2017
Quoted Prices in
Active Markets for
Identical Assets
(Level 1)
Other Observable
Inputs (Level 2)
Unobservable
Inputs (Level 3)
Total
$
$
- $
-
-
-
-
-
51,142
3,824
54,966 $
49,947 $
278,760
125,937
131,433
16,533
602,610
-
-
602,610 $
- $
313
-
2,823
-
3,136
621
-
3,757 $
49,947
279,073
125,937
134,256
16,533
605,746
51,763
3,824
661,333
F-23
HALLMARK FINANCIAL SERVICES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Years ended December 31, 2017, 2016, and 2015
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
$
$
- $
-
-
-
-
-
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
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
Due to significant unobservable inputs into the valuation model for certain municipal bonds, one corporate bond
and one equity security as of December 31, 2017 and certain municipal bonds and one equity security as of
December 31, 2016, we classified these as level 3 in the fair value hierarchy. We used an income approach in order
to derive an estimated fair value of the municipal bonds classified as Level 3, which included inputs such as expected
holding period, benchmark swap rate, benchmark discount rate and a discount rate premium for illiquidity. The
corporate bond is a convertible senior note and its fair value was estimated by the sum of the bond value using an
income approach discounting the scheduled interest and principal payments and the conversion feature utilizing a
binomial lattice model. We also estimated the fair value of the corporate bond utilizing an as-if converted basis into
the underlying securities. The equity security classified as Level 3 in the fair value hierarchy is an investment in a
non-public entity. Given the size of this investment and since there was not an observable market for the security,
we estimated its fair value as the fair value on the date we acquired the investment. Significant changes in the
unobservable inputs in the fair value measurement of these securities could result in a significant change in the fair
value measurement.
F-24
HALLMARK FINANCIAL SERVICES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Years ended December 31, 2017, 2016, and 2015
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, 2017 and 2016 (in
thousands).
2017
2016
Beginning balance as of January 1
Sales
Settlements
Purchases
Issuances
Total realized/unrealized gains included in net income
Net gain included in other comprehensive income
Transfers into Level 3
Transfers out of Level 3
$
5,945 $
-
(579)
775
-
616
-
-
(3,000)
14,087
-
(8,825)
-
-
417
-
266
-
Ending balance as of December 31
$
3,757 $
5,945
The transfer out of Level 3 during 2017 was due to one auction rate municipal bond that previously did not have a
successful auction and, therefore, was classified as Level 3 prior to the fourth quarter of 2017. As of December
31, 2017, this security had a successful auction at par. We account for transfers as they occur.
4. Acquisitions, Goodwill and Intangible Assets:
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 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
F-25
HALLMARK FINANCIAL SERVICES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Years ended December 31, 2017, 2016, and 2015
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, 2017 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; Contract
Binding operating unit - $19.9 million; Specialty Commercial operating unit- $17.4 million (comprised of $7.7
million for the primary/excess and umbrella component and $9.7 million for the general aviation and satellite
component); and Specialty Personal Lines operating unit - $5.3 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 2017 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 2017. The income projections also included loss and LAE assumptions which reflected recent historical
claim trends and the movement towards a more favorable pricing environment and improvement in mix of business
to better performing products. 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 (including factors such as prior year loss reserve development), expectations
of future performance (including premium growth rates, premium rate increases and loss costs), 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 2017, 2016, and 2015, 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. The table below details the gross and net
carrying amounts of these assets by major category (in thousands):
Gross Carrying Amount:
Customer/agent relationships
Tradename
Management agreement
Non-compete & employment agreements
Insurance licenses
Total gross carrying amount
Accumulated Amortization:
Customer/agent relationships
Tradename
Management agreement
Non-compete & employment agreements
Total accumulated amortization
Total net carrying amount
December 31
2017
2016
$
$
32,177 $
3,440
3,232
4,235
1,300
44,384
(24,276)
(2,618)
(3,232)
(4,235)
(34,361)
10,023 $
32,177
3,440
3,232
4,235
1,300
44,384
(22,038)
(2,388)
(3,232)
(4,235)
(31,893)
12,491
F-26
HALLMARK FINANCIAL SERVICES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Years ended December 31, 2017, 2016, and 2015
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):
2018
2019
2020
2021
2022
$
$
$
$
$
2,468
2,468
2,468
503
501
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
Years
15
15
4
5
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, 2017 and 2016 (in thousands):
Profit sharing commission receivable
Credit Facility B issuance costs
Accrued investment income
Investment in unconsolidated trust subsidiaries
Fixed assets
Other assets
2017
2016
252 $
122
4,859
1,702
6,726
195
13,856 $
251
109
4,599
1,702
6,947
193
13,801
$
$
F-27
HALLMARK FINANCIAL SERVICES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Years ended December 31, 2017, 2016, and 2015
6. Reserves for Losses and Loss Adjustment Expenses:
Activity in the consolidated reserves for unpaid losses and LAE is summarized as follows (in thousands):
2017
2016
2015
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
$
$
481,567 $
123,237
358,330
248,203
40,105
288,308
92,873
181,277
274,150
372,488
154,612
527,100 $
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
The $40.1 million unfavorable net development, $7.6 million unfavorable net development and $7.0 million
favorable net development in prior accident years recognized in 2017, 2016 and 2015, respectively, represent
changes in our loss reserve estimates. In 2017 and 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. The unfavorable prior year reserve development
during the twelve months ended December 31, 2017 was primarily driven by the continued emergence of increased
frequency and severity trends in our primary commercial auto lines of business within our Contract Binding
operating unit, which was representative of industry trends. In 2015, 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.
F-28
HALLMARK FINANCIAL SERVICES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Years ended December 31, 2017, 2016, and 2015
The impact from the unfavorable (favorable) net prior years’ loss development on each reporting segment is
presented below:
December 31,
2017
2016
Specialty Commercial Segment
$
40,477 $
Standard Commercial Segment
Personal Segment
Corporate
Total unfavorable net prior year development
(970)
598
-
$
40,105 $
12,502
(9,901)
5,007
-
7,608
The following describes the primary factors behind each segment’s prior accident year loss reserve development
for the years ended December 31, 2017 and 2016:
Year ended December 31, 2017:
• Specialty Commercial Segment. Our Contract Binding operating unit experienced net unfavorable
development in the 2016 and prior accident years primarily driven by the continued emergence of increased
frequency and severity trends in the commercial auto lines of business. Our Specialty Commercial operating
unit experienced net unfavorable development in general aviation primarily in the 2016, 2013 and 2011 and
prior accident years, commercial excess liability primarily in the 2013 accident year and specialty risk
programs primarily in the 2015 and prior accident years, partially offset by net favorable development in
the medical professional liability and primary/excess commercial property lines of business primarily in
the 2016 accident years.
• Standard Commercial Segment. Our Standard Commercial P&C operating unit experienced net favorable
development primarily in the general liability line of business in the 2016 and prior accident years, partially
offset by unfavorable development in the 2016 and prior accident years in the occupational accident line of
business.
• Personal Segment. Net unfavorable development in our Specialty Personal Lines operating unit was
mostly attributable to the 2016, 2014, 2013 and 2010 and prior accident years, partially offset by favorable
development in the 2015 and 2011 accident years.
Year ended December 31, 2016:
• Specialty Commercial Segment. Our Contract Binding operating unit experienced net unfavorable
development primarily in commercial auto liability in the 2014, 2013, 2012 and 2009 and prior accident
years. Our Specialty Commercial operating unit experienced net favorable development primarily in the
general aviation and commercial excess liability, partially offset by net unfavorable development in our
medical professional liability lines of business and specialty risk programs.
F-29
HALLMARK FINANCIAL SERVICES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Years ended December 31, 2017, 2016, and 2015
• Standard Commercial Segment. Our Standard Commercial P&C operating unit experienced net favorable
development primarily in the general liability line of business in the 2011-2015 accident years and the 2009
and prior accident years, partially offset by net unfavorable development in the occupational accident line
of business in the 2014 and 2015 accident years. Our Workers Compensation operating unit experienced
net favorable development in the 2015 and prior accident years.
• Personal Segment. Our Specialty Personal Lines operating unit experienced net unfavorable development
attributable to the 2015 and prior accident years in the private passenger auto liability line of business.
In the opinion of management, our reserves represent the best estimate of our ultimate liabilities, based on currently
known facts, current law, current technology and assumptions considered reasonable where facts are not known.
Due to the significant uncertainties and related management judgments, there can be no assurance that future
favorable or unfavorable loss development, which may be material, will not occur.
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. We have evaluated the disaggregation criteria and concluded that 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.
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
F-30
HALLMARK FINANCIAL SERVICES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Years ended December 31, 2017, 2016, and 2015
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, 2017 ($ in thousands):
F-31
HALLMARK FINANCIAL SERVICES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Years ended December 31, 2017, 2016, and 2015
Specialty Commercial Segment
Incurred Claims and Allocated Claim Adjustment Expenses, Net of Reinsurance
As of December 31,
Accident
Year
For the Years Ended December 31,
Unaudited
Cumulative
Number of
Reported
Claims
IBNR
2008
2009
2010
2011
2012
2013
2014
2015
2016
2017
2017
2017
60,950
62,679
74,187
61,196
78,089
88,679
2008 $ 55,617 $ 56,150 $ 58,143 $ 57,923 $ 56,579 $ 55,157 $ 55,425 $ 55,457 $ 55,864 $
2009
2010
2011
2012
2013
2014
2015
2016
2017
61,361
77,631
87,793
106,371 111,253 111,841 115,709 116,320
140,546 135,114 137,230 143,983
144,996 133,464 138,842
147,304 146,610
151,494
59,635
78,003
90,713
59,831
77,593
91,059
59,471
75,695
87,558
59,988
77,972
89,737
(534)
56,272 $
60
61,761
900
78,253
1,102
87,833
1,094
117,925
1,742
150,177
1,260
144,728
162,616
8,213
157,836 21,557
170,622 64,261
7,373
5,459
5,001
5,790
7,339
9,210
10,076
10,826
11,358
10,227
Total
$
1,188,023
Accident
Year
2008
2009
2010
2011
2012
2013
2014
2015
2016
2017
Cumulative Paid Claims and Allocated Claim Adjustment Expenses, Net of Reinsurance
2008
2009
2010
2011
2012
2013
2014
2015
2016
2017
For the Years Ended December 31,
Unaudited
$
24,134 $
37,803 $
21,259
44,903 $
34,411
24,818
51,280 $
45,757
45,234
27,454
53,723 $
53,135
58,139
53,509
37,655
53,577 $
56,791
68,625
71,697
60,923
40,475
54,080 $
57,641
73,398
80,004
82,066
76,366
42,097
54,909 $
59,149
74,513
83,787
97,680
101,725
73,631
39,515
55,372 $
60,785
75,787
84,936
109,060
126,025
99,521
74,906
41,397
Total
$
All outstanding liabilities before 2008, net of reinsurance
56,094
61,202
76,906
85,845
113,909
139,759
123,649
125,514
84,616
45,477
912,971
384
Liabilities for claims and claim adjustment expenses, net of reinsurance
$
275,436
(1
F-32
HALLMARK FINANCIAL SERVICES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Years ended December 31, 2017, 2016, and 2015
Standard Commercial Segment
Accident
Year
2008
2009
2010
2011
2012
2013
2014
2015
2016
2017
Accident
Year
2008 $
2009
2010
2011
2012
2013
2014
2015
2016
2017
Incurred Claims and Allocated Claim Adjustment Expenses, Net of Reinsurance
As of December 31,
For the Years Ended December 31,
Unaudited
Cumulative
Number of
Reported
Claims
IBNR
2008
2009
2010
2011
2012
2013
2014
2015
2016
2017
2017
2017
$ 49,452 $ 47,557 $ 46,762 $ 45,556 $ 42,758 $ 41,597 $ 40,387 $ 40,001 $
44,719
45,674
45,263
46,772
45,235
60,236
46,778
44,847
56,489
51,998
45,970
43,164
55,156
52,554
55,482
44,159
43,459
49,268
48,222
57,528
55,488
43,851
42,426
47,266
45,990
56,703
55,808
49,571
39,195 $ 38,294 $
43,107
42,175
47,423
44,272
53,174
53,568
49,857
46,880
42,168
42,880
46,841
42,986
52,076
53,882
50,053
48,182
41,393
701
1,082
1,265
2,038
2,505
4,317
5,602
8,768
11,673
18,099
3,256
2,635
2,914
4,370
3,219
3,920
3,555
3,165
2,779
2,330
Total
$
458,755
Cumulative Paid Claims and Allocated Claim Adjustment Expenses, Net of Reinsurance
2008
2009
2010
2011
2012
2013
2014
2015
2016
2017
For the Years Ended December 31,
Unaudited
17,182 $
25,624 $
15,242
29,058 $
28,313
21,302
32,523 $
32,075
28,342
24,899
34,056 $
35,818
30,957
35,119
23,445
34,762 $
38,316
33,428
38,909
32,203
23,123
35,360 $
40,389
37,166
40,301
34,789
36,411
24,255
36,276 $
40,575
39,115
41,140
37,191
41,809
37,122
19,085
36,859 $
40,629
39,706
42,441
38,526
44,475
41,514
34,245
21,508
Total
$
All outstanding liabilities before 2008, net of reinsurance
37,002
40,835
40,937
43,680
40,408
46,756
45,779
38,302
32,006
16,755
382,460
1,824
Liabilities for claims and claim adjustment expenses, net of reinsurance
$
78,119
F-33
HALLMARK FINANCIAL SERVICES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Years ended December 31, 2017, 2016, and 2015
Personal Segment
Incurred Claims and Allocated Claim Adjustment Expenses, Net of Reinsurance
Accident
Year
For the Years Ended December 31,
Unaudited
As of December 31,
Cumulative
Number of
Reported
Claims
IBNR
2008
2009
2010
2011
2012
2013
2014
2015
2016
2017
2017
2017
40,436
42,092
63,862
2008 $ 36,247 $ 36,976 $ 38,329 $ 39,412 $ 39,793 $ 40,170 $ 40,239 $ 40,324 $
46,244
2009
78,294
2010
2011
75,746
2012
2013
2014
2015
2016
2017
49,772
84,252
86,804
71,513
60,100
5,340
23,104
49,694
83,903
86,757
70,552
59,132
5,452
48,930
84,724
87,810
73,795
55,706
47,977
80,765
77,652
58,604
40,369 $ 40,401 $
49,891
84,591
86,948
72,042
60,211
6,243
25,682
32,260
49,971
84,808
86,853
72,037
60,379
6,699
25,307
32,893
23,342
-
-
-
-
-
69
239
642
1,309
4,253
17,354
21,054
30,180
31,614
23,938
23,468
19,297
23,512
24,988
17,532
Total
$
482,690
Accident
Year
2008 $
2009
2010
2011
2012
2013
2014
2015
2016
2017
Cumulative Paid Claims and Allocated Claim Adjustment Expenses, Net of Reinsurance
For the Years Ended December 31,
Unaudited
2008
2009
2010
2011
2012
2013
2014
2015
2016
2017
20,005 $
32,555 $
23,306
36,782 $
37,621
38,643
38,925 $
44,689
67,755
46,416
39,511 $
47,967
75,199
67,939
37,860
40,210 $
49,287
82,624
83,497
64,278
45,901
40,309 $
49,539
83,511
85,533
68,849
54,514
2,515
40,323 $
49,704
84,111
86,217
70,807
58,047
4,418
11,570
40,347 $
49,853
84,556
86,593
71,995
59,775
5,631
22,281
21,669
All outstanding liabilities before 2008, net of reinsurance
Liabilities for claims and claim adjustment expenses, net of reinsurance
Total
$
$
40,404
49,957
84,717
86,660
72,055
60,277
6,428
24,262
30,646
15,776
471,182
(3)
11,505
F-34
HALLMARK FINANCIAL SERVICES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Years ended December 31, 2017, 2016, and 2015
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
2017
2016
$
275,436 $
78,119
11,505
252,602
82,222
15,544
Liabilities for unpaid losses and allocated loss adjustment expenses, net of reinsurance
365,060
350,368
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
137,975
6,051
10,586
154,612
3,377
3,153
898
7,428
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
$
527,100 $
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, 2017:
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
30.5%
23.9%
19.0%
13.1%
6.6%
Standard Commercial Segment
Personal Segment
45.1%
52.0%
23.7%
28.6%
8.1%
10.8%
6.5%
5.6%
4.7%
1.3%
1.6%
3.7%
0.7%
1.5%
1.5%
0.3%
1.8%
1.8%
0.2%
0.7%
1.3%
1.0%
0.1%
1.7%
0.4%
(
(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-35
HALLMARK FINANCIAL SERVICES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Years ended December 31, 2017, 2016, and 2015
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, 2017 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
2017
2016
2015
$
601,780 $
2,376
549,077 $
-
514,223
-
(238,573)
(187,248)
(157,279)
$
365,583 $
361,829 $
356,944
$
$
$
567,089 $
1,680
524,229 $
-
494,643
-
(207,732)
(170,859)
(145,562)
361,037 $
353,370 $
349,081
144,948 $
116,057 $
89,892
Included in reinsurance recoverable on the consolidated balance sheets are paid loss recoverables of $28.2 million
and $24.4 million as of December 31, 2017 and 2016, 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, which expires on June 30, 2018. The outstanding balance of the Facility A bears interest at a rate
equal to the prime rate or LIBOR plus 2.5%, at our election. We pay an annual fee of 0.25% of the average daily
unused balance of Facility A and letter of credit fees at the rate of 1.00% per annum. All principal and accrued
interest on Facility A becomes due and payable on June 30, 2018. As of December 31, 2017, we had no outstanding
borrowings under Facility A.
F-36
HALLMARK FINANCIAL SERVICES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Years ended December 31, 2017, 2016, and 2015
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. On December 20, 2017, we entered into a Second Amendment
to Second Restated Credit Agreement and a Second Amendment to Revolving Facility B Agreement with Frost.
The Second Amendment to Second Restated Credit Agreement revised certain definitions in the Second Restated
Credit Agreement. The Second Amendment to Revolving Facility B Agreement amended the Revolving Facility B
Agreement to further extend by one year the termination date for draws thereunder and the maturity date for amounts
outstanding thereunder. During the fourth quarter of 2017 we accrued a $30,000 fee payable to Frost 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, 2019, at which time all amounts
outstanding under Facility B are converted to a term loan. Through December 17, 2019, we pay Frost a quarterly
fee of 0.25% per annum of the average daily unused balance of Facility B. Facility B bears interest at a rate equal
to the prime rate or LIBOR plus 3.00%, at our election. Until December 17, 2019, interest only on amounts from
time to time outstanding under Facility B are payable quarterly. Any amounts outstanding on Facility B as of
December 17, 2019 are converted to a term loan payable in quarterly installments over five years based on a seven
year amortization of principal plus accrued interest. All remaining principal and accrued interest on Facility B
become due and payable on December 17, 2024. As of December 31, 2017, we had $30.0 million outstanding under
Facility B.
The obligations under both Facility A and Facility B are secured by a security interest in the capital stock of AHIC
and HIC. Both Facility A and Facility B contain covenants that, among other things, require us to maintain certain
financial and operating ratios and restrict certain distributions, transactions and organizational changes. We are in
compliance with or have obtained a waiver of 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
Hallmark Statutory Trust I (“Trust I”) as a Delaware statutory trust. Trust I issued $30.0 million of preferred
securities to investors and $0.9 million of common securities to us. Trust I used the proceeds from these issuances
to purchase the subordinated debt securities. 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, 2017, the principal balance of our Trust I subordinated debt was $30.9 million and the interest rate
was 4.84% per annum.
On August 23, 2007, we entered into a trust preferred securities transaction pursuant to which we issued $25.8
million aggregate principal amount of subordinated debt securities due in 2037. To effect the transaction, we formed
Hallmark Statutory Trust II (“Trust II”) as a Delaware statutory trust. Trust II issued $25.0 million of preferred
securities to investors and $0.8 million of common securities to us. Trust II used the proceeds from these issuances
to purchase the subordinated debt securities. Our Trust II subordinated debt securities bore an initial interest rate of
8.28% until September 15, 2017, after which interest adjusts quarterly to the three-month LIBOR rate plus 2.90
F-37
HALLMARK FINANCIAL SERVICES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Years ended December 31, 2017, 2016, and 2015
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, 2017, the principal balance of our Trust II subordinated debt was $25.8 million and the interest
rate was 4.49% per annum.
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 Contract Binding
operating unit and the general aviation, satellite launch, commercial umbrella and primary/excess
liability, medical and financial professional liability and primary/excess commercial property
insurance products and services handled by our Specialty Commercial operating unit. Certain specialty
programs are also managed by our Specialty Commercial operating unit. Our Contract Binding
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 ceased marketing
new or renewal occupational accident policies. Effective July 1, 2015, the Workers Compensation
operating unit ceased retaining 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. 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-38
HALLMARK FINANCIAL SERVICES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Years ended December 31, 2017, 2016, and 2015
The following is additional business segment information for the twelve months ended December 31, 2017, 2016
and 2015 (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 (Benefit) Expense
Specialty Commercial Segment
Standard Commercial Segment
Personal Segment
Corporate
Consolidated
Pre-tax income (loss)
Specialty Commercial Segment
Standard Commercial Segment
Personal Segment
Corporate
Consolidated
2017
2016
2015
277,946 $
70,302
40,462
(3,189)
385,521 $
255,897 $
71,966
49,826
(1,737)
375,952 $
249,910
76,864
45,538
90
372,402
2,796 $
294
1,258
367
4,715 $
- $
-
-
4,512
4,512 $
(4,382) $
3,849
(676)
(3,810)
(5,019) $
2,012 $
2,440
(3,058)
(17,966)
(16,572) $
2,579 $
101
1,070
144
3,894 $
- $
-
-
4,549
4,549 $
7,886 $
3,011
(3,821)
(5,124)
1,952 $
24,417 $
8,866
(6,839)
(17,966)
8,478 $
2,537
136
779
64
3,516
-
-
-
3,906
3,906
11,609
1,436
(1,345)
(1,677)
10,023
40,277
6,687
(885)
(14,193)
31,886
$
$
$
$
$
$
$
$
$
$
F-39
HALLMARK FINANCIAL SERVICES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Years ended December 31, 2017, 2016, and 2015
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
2017
2016
$
810,133 $
162,152
232,441
26,400
1,231,126 $
$
734,763
164,295
241,686
21,716
1,162,460
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 (loss) income
$
(11,553) $
6,526 $
21,863
2017
2016
2015
Denominator, basic shares
Effect of dilutive securities:
Stock-based compensation awards
Denominator, diluted shares
Basic earnings per share:
Diluted earnings per share:
18,343
18,780
19,211
-
18,343
161
18,941
194
19,405
(0.63) $
0.35 $
1.14
(0.63) $
0.34 $
1.13
$
$
We had 406,731 shares, 272,500 shares and 267,500 shares of common stock potentially issuable upon exercise of
employee stock options for years ended December 31, 2017, 2016 and 2015, 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 2018 to 2020.
F-40
HALLMARK FINANCIAL SERVICES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Years ended December 31, 2017, 2016, and 2015
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
$63.7 million as of December 31, 2017.
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 2018, the aggregate ordinary dividend capacity of these subsidiaries is $27.6
million, of which $19.7 million is available to Hallmark. As a county mutual, dividends from HCM are payable to
policyholders. During the years ended December 31, 2017 and 2016 our insurance company subsidiaries paid $11.4
million and $10.5 million, respectively, in dividends to Hallmark. The total restricted net assets of our insurance
company subsidiaries as of December 31, 2017, was $187.4 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. Our insurance subsidiaries did not pay management fees to Hallmark and our non-insurance
company subsidiaries during 2017. The net amount paid in management fees by our insurance subsidiaries to
Hallmark and our non-insurance company subsidiaries was $1.1 million and $1.3 million during 2016 and 2015,
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, 2017 and 2016, our insurance company subsidiaries reported statutory capital and
surplus of $233.3 million and $248.4 million, respectively, substantially greater than the minimum requirements
for each state. For the years ended December 31, 2017, 2016, 2015, respectively, our insurance company
subsidiaries reported statutory net income of $1.9 million, $8.7 million and $24.6 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, 2017, the adjusted capital under the risk-based capital calculation of each of our insurance
company subsidiaries substantially exceeded the minimum requirements.
F-41
HALLMARK FINANCIAL SERVICES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Years ended December 31, 2017, 2016, and 2015
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, 2017, there were outstanding incentive stock options to purchase 147,574
shares of our common stock, non-qualified stock options to purchase 259,157 shares of our common stock and
restricted stock units representing the right to receive up to 77,640 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, 2017, restricted stock units
representing the right to receive up to 501,029 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, 2017.
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, 2017 and changes during the year then ended is
presented below:
Outstanding at January 1, 2017
Granted
Exercised
Forfeited or expired
Outstanding at December 31, 2017
Exercisable at December 31, 2017
Weighted
Average
Exercise Price
9.14
Number of
Shares
624,231 $
-
Average
Remaining
Contractual
Term (Years)
Aggregate
Instrinsic
Value ($000)
(35,000) $
(182,500) $
406,731 $
406,731 $
6.61
12.49
7.85
7.85
1.2 $
1.2 $
1,142
1,142
F-42
HALLMARK FINANCIAL SERVICES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Years ended December 31, 2017, 2016, and 2015
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
$
$
$
163 $
- $
- $
250 $
38 $
8 $
393
157
30
2017
2016
2015
As of December 31, 2017, there was no unrecognized compensation cost related to non-vested stock options granted
under our plans which is expected to be recognized in the future.
The fair value of each stock option granted is estimated on the date of grant using the Black-Scholes option pricing
model. Expected volatilities are based on the historical volatility of Hallmark’s and similar companies’ common
stock for a period equal to the expected term. The risk-free interest rates for periods within the contractual term of
the options are based on rates for U.S. Treasury Notes with maturity dates corresponding to the options expected
lives on the dates of grant. Expected term is determined based on the simplified method as we do not have sufficient
historical exercise data to provide a basis for estimating the expected term. There were no stock options granted
during 2017, 2016 or 2015.
Restricted Stock Units:
Restricted stock units awarded under the 2005 LTIP and 2015 LTIP represent the right to receive shares of common
stock upon the satisfaction of vesting requirements, performance criteria and other terms and conditions. Restricted
stock units generally vest and, if performance criteria have been satisfied, shares of common stock become issuable
on March 31 of the third calendar year following the year of grant. If and to the extent specified performance
criteria have been achieved, one grant of restricted stock units granted on September 8, 2014 will vest on March 31,
2018.
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.
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
F-43
HALLMARK FINANCIAL SERVICES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Years ended December 31, 2017, 2016, and 2015
value of restricted stock units granted in 2015, 2016 and 2017 was $11.10, $11.41 and $10.20 per unit, respectively.
We incurred compensation expense (benefit) of $149 thousand, ($156) thousand and $226 thousand related to
restricted stock units during the year ended December 31, 2017, 2016 and 2015, respectively. We recorded income
tax benefit (expense) of $52 thousand, ($55) thousand and $79 thousand related to restricted stock units during the
year ended December 31, 2017,2016 and 2015, respectively.
The following table details the status of our restricted stock units as of and for the years ended December 31, 2017,
2016 and 2015:
Nonvested at January 1
Granted
Vested
Forfeited
Nonvested at December 31
Number of Restricted Stock Units
2016
2017
2015
296,574
138,712
(5,998)
(43,509)
385,779
296,571
122,770
(7,144)
(115,623)
296,574
285,216
103,351
(8,616)
(83,380)
296,571
As of December 31, 2017, there was $1.9 million of unrecognized grant date compensation cost related to unvested
restricted stock units. Based on the current performance estimate, we expect to recognize $0.6 million of
compensation cost related to unvested restricted stock units, of which $0.3 million is expected to be recognized in
2018, $0.2 million is expected to be recognized in 2019 and $0.1 million is expected to be recognized in 2020.
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,
2017, 2016 and 2015 (in thousands) using a measurement date of December 31.
F-44
HALLMARK FINANCIAL SERVICES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Years ended December 31, 2017, 2016, and 2015
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
2017
2016
2015
3.45%
N/A
3.88%
N/A
4.12%
N/A
$
$
$
$
$
(12,758) $
(12,618) $
(12,915)
(12,758) $
11,153
(1,605) $
(12,618) $
10,415
(2,203) $
(12,915)
10,419
(2,496)
(3,554)
(3,554)
1,949
(4,102)
(4,102)
1,899
(3,957)
(3,957)
1,461
(1,605) $
(2,203) $
(2,496)
12,618 $
471
554
(885)
12,915 $
512
19
(828)
13,909
518
(646)
(866)
Benefit obligation as of end of period
$
12,758 $
12,618 $
12,915
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
$
10,415 $
1,623
-
(885)
10,419 $
415
409
(828)
11,290
(5)
-
(866)
Fair value of plan assets as of end of period
$
11,153 $
10,415 $
10,419
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
$
- $
- $
471
(646)
126
512
(653)
112
$
(49) $
(29) $
3.88%
6.50%
N/A
4.12%
6.50%
N/A
-
518
(701)
103
(80)
3.86%
6.50%
N/A
F-45
HALLMARK FINANCIAL SERVICES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Years ended December 31, 2017, 2016, and 2015
Estimated future benefit payments by fiscal year (in thousands):
2018
2019
2020
2021
2022
2023-2027
$
$
$
$
$
$
882
876
864
866
851
4,001
As of December 31, 2017, the fair value of the plan assets was composed of cash and cash equivalents of $0.4
million, debt securities of $3.6 million and equity securities of $7.2 million.
Our investment objectives are to preserve capital and to achieve long-term growth through a favorable rate of return
equal to or greater than 5% over the long-term (60 year) average inflation rate as measured by the consumer price
index. The objective of the equity portion of the portfolio is to achieve a return in excess of the Standard & Poor’s
500 index. The objective of the fixed income portion of the portfolio is to add stability, consistency, safety and total
return to the total fund portfolio.
We prohibit investments in options, futures, precious metals, short sales and purchase on margin. We also restrict
the investment in fixed income securities to “A” rated or better 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, 2017. 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 2018.
We expect our 2018 periodic pension cost to be $(164) thousand, the components of which are interest cost of $424
thousand, expected return on plan assets of ($694) thousand and amortization of actuarial loss of $106 thousand.
F-46
HALLMARK FINANCIAL SERVICES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Years ended December 31, 2017, 2016, and 2015
The following table shows the weighted-average asset allocation for the defined benefit cash balance plan held as
of December 31, 2017 and 2016.
Asset Category:
Debt securities
Equity securities
Other
Total
December 31
2017
2016
32%
64%
4%
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, 2017 and December 31, 2016 (in thousands).
As of December 31, 2017
Quoted Prices in
Active Markets for
Identical Assets
(Level 1)
Other
Observable
Inputs
(Level 2)
Unobservable Inputs
(Level 3)
$
$
- $
7,156
7,156 $
3,586 $
-
3,586 $
- $
-
- $
Total
3,586
7,156
10,742
Debt securities
Equity securities
Total
As of December 31, 2016
Quoted Prices in
Active Markets for
Identical Assets
(Level 1)
Other
Observable
Inputs
(Level 2)
Unobservable Inputs
(Level 3)
Debt securities
Equity securities
Total
$
$
- $
6,653
6,653 $
3,438 $
-
3,438 $
- $
-
- $
Total
3,438
6,653
10,091
Our plan assets also include cash and cash equivalents of $0.4 million and $0.3 million at December 31, 2017 and
2016, 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 $0.2 million, $0.4
million and $0.3 million for the years ended December 31, 2017, 2016 and 2015, respectively.
F-47
HALLMARK FINANCIAL SERVICES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Years ended December 31, 2017, 2016, and 2015
15.
Income Taxes:
The composition of deferred tax assets and liabilities and the related tax effects as of December 31, 2017 and
2016, are as follows (in thousands):
Deferred tax liabilities:
Deferred policy acquisition costs
Net unrealized holding gain on investments
Agency relationship
Intangible assets
Goodwill
Bond amortization
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
$
2017
2016
(3,361) $
(4,688)
(28)
(2,476)
(357)
(111)
(860)
(303)
(12,184)
6,901
107
746
200
3,422
158
-
302
1,956
329
14,121
(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
Deferred federal income taxes, net
$
1,937 $
1,365
We concluded that no valuation allowance was necessary to provide against our deferred tax assets as of
December 31, 2017.
F-48
HALLMARK FINANCIAL SERVICES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Years ended December 31, 2017, 2016, and 2015
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, 2017, 2016 and 2015, is as follows (in
thousands):
Computed expected income tax (benefit) expense at statutory tax rate
Meals and entertainment
Tax exempt interest
Dividends received deduction
State taxes (net of federal benefit)
Tax law change
True up bond amortization
Other
Income tax (benefit) expense
Current income tax (benefit) expense
Deferred tax (benefit) expense
Income tax (benefit) expense
2017
2016
2015
$
$
$
$
(5,800) $
81
(987)
(196)
165
1,276
464
(22)
2,967 $
81
(1,164)
(133)
203
-
-
(2)
11,160
32
(1,259)
(141)
176
-
-
55
(5,019) $
1,952 $
10,023
(3,444) $
(1,575)
1,547 $
405
11,053
(1,030)
(5,019) $
1,952 $
10,023
We have available, for federal income tax purposes, unused net operating loss of $1.0 million at December 31,
2017. 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
2037
$
553
2
25
45
77
73
59
33
50
37
954
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 2014. The Company recognizes interest and penalties related to uncertain tax positions in income tax
expense. There were no uncertain tax positions at December 31, 2017.
F-49
HALLMARK FINANCIAL SERVICES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Years ended December 31, 2017, 2016, and 2015
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 $2.8 million, $2.5
million and $2.2 million for the years ended December 31, 2017, 2016, and 2015, respectively.
Future minimum lease payments under non-cancelable operating leases as of December 31, 2017 are as follows (in
thousands):
Year
2018
2019
2020
2021
2022
2023 and thereafter
Total minimum lease payments (a)
$
$
2,398
2,251
2,151
1,155
507
-
8,462
(a) Minimum lease payments have not been reduced by minimum sublease rentals of $35 thousand due in the future under non-cancelable
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 assessments of $36 thousand and $0.1 million in 2017 and 2016,
respectively.
We are engaged in various legal proceedings in the ordinary course of business, none of which, either individually
or in the aggregate, are believed likely to have a material adverse effect on our consolidated financial position or
results of operations, in the opinion of management. The various legal proceedings to which we are a party are
routine in nature and incidental to our business.
F-50
HALLMARK FINANCIAL SERVICES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Years ended December 31, 2017, 2016, and 2015
17.
Changes in Accumulated Other Comprehensive Income Balances:
The changes in accumulated other comprehensive income balances as of December 31, 2017, 2016, and 2015 were
as follows (in thousands):
Pension
Liability
Unrealized
Gains (Loss)
Accumulated Other
Comprehensive
Income (Loss)
$
(2,600) $
20,401 $
17,801
Balance at January 1, 2015
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
Balance at December 31, 2016
Other comprehensive income:
Change in net actuarial gain
Tax effect on change in net actuarial gain
Unrealized holding gains arising during the period
Tax effect on unrealized gains arising during the period
Reclassification adjustment for gains included in net realized gains
Tax effect on reclassification adjustment for gains included in income
tax expense
Other comprehensive income, net of tax
43
(15)
-
-
-
-
(10,191)
3,567
-
(5,826)
-
28
$
(2,572) $
(145)
51
-
-
2,039
(10,411)
9,990 $
-
-
6,019
(2,107)
-
(1,331)
-
(94)
466
3,047
$
(2,666) $
13,037 $
548
(192)
-
-
-
-
9,117
(3,191)
-
(6,799)
-
356
2,380
1,507
Balance at December 31, 2017
$
(2,310) $
14,544 $
F-51
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
10,371
548
(192)
9,117
(3,191)
(6,799)
2,380
1,863
12,234
HALLMARK FINANCIAL SERVICES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Years ended December 31, 2017, 2016, and 2015
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, 2017.
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, 2017 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, 2017 and
2016 (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.
2017
2016
Q1
Q2
Q3
Q4
Q1
Q2
Q3
Q4
Total revenue
Total expense
Income (loss) before tax
Income tax expense (benefit)
Net income (loss)
$ 96,948 $ 93,475 $ 97,723 $ 97,375 $ 90,028 $ 91,052 $ 97,618 $ 97,254
91,110 98,393 99,248 113,342 84,039 89,565 90,442 103,428
7,176 (6,174)
2,128 (2,512)
5,048 $
(1,525) (15,967)
35 (5,338)
(1,560) $ (10,629) $
5,838 (4,918)
1,852 (1,568)
3,986 $
5,989
1,915
4,074 $
1,487
421
(3,350) $
1,066 $
(3,662)
$
Basic earnings (loss) per share:
$
0.21 $
(0.18) $
(0.09) $
(0.59) $
0.21 $
0.06 $
0.27 $
(0.20)
Diluted earnings (loss) per share: $
0.21 $
(0.18) $
(0.09) $
(0.59) $
0.21 $
0.06 $
0.27 $
(0.20)
F-52
FINANCIAL STATEMENT SCHEDULES
Schedule II – Condensed Financial Information of Registrant (Parent Company Only)
HALLMARK FINANCIAL SERVICES, INC.
BALANCE SHEETS
December 31, 2017 and 2016
(In thousands)
ASSETS
Debt securities, available-for-sale, at fair value (amortized cost: $150 in 2017)
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 $949 in 2017 and $1,001
in 2016)
Accounts payable and other accrued expenses
Total liabilities
Stockholders’ equity:
Common stock, $.18 par value, authorized 33,333,333 shares; issued 20,872,831 shares in 2017
and in 2016
Additional paid-in capital
Retained earnings
Accumulated other comprehensive income
Treasury stock (2,703,803 shares in 2017 and 2,260,849 in 2016), at cost
Total stockholders’ equity
Total liabilities and stockholders’ equity
2017
2016
$
150 $
12,194
344,496
493
3,914
3,571
-
9,034
363,078
333
2,756
3,878
$
364,818 $
379,079
$
30,000 $
30,000
55,753
27,947
113,700
55,701
27,642
113,343
3,757
123,180
136,474
12,234
3,757
123,166
148,027
10,371
(24,527)
(19,585)
251,118
265,736
$
364,818 $
379,079
See accompanying report of independent registered public accounting firm.
F-53
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, 2017, 2016 and 2015
(In thousands)
Investment income, net of expenses
Dividend income from subsidiaries
Net realized losses
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
Income before equity in undistributed earnings (loss) of subsidiaries
Equity in undistributed share of (loss) earnings in subsidiaries
Net (loss) income
Comprehensive (loss) income
2017
2016
2015
$
$
$
210 $
11,375
(759)
11,896
22,722
10,265
4,512
14,777
7,945
(947)
8,892
(20,445)
(11,553) $
(9,690) $
70 $
10,500
-
10,711
21,281
9,878
4,549
14,427
6,854
(1,315)
8,169
(1,643)
6,526 $
9,479 $
120
8,000
-
10,053
18,173
10,222
3,906
14,128
4,045
(1,273)
5,318
16,545
21,863
11,480
See accompanying report of independent registered public accounting firm.
F-54
Schedule II (Continued) – Condensed Financial Information of Registrant (Parent Company Only)
FINANCIAL STATEMENT SCHEDULES
HALLMARK FINANCIAL SERVICES, INC.
STATEMENTS OF CASH FLOWS
For the years ended December 31, 2017, 2016 and 2015
(In thousands)
Cash flows from operating activities:
Net (loss) income
Adjustments to reconcile net (loss) income to cash provided by (used in)
operating activities:
Depreciation and amortization expense
Deferred income tax (benefit) expense
Net realized losses
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
2017
2016
2015
$
(11,553) $
6,526 $
21,863
367
(160)
759
20,445
(1,158)
306
632
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
9,638
8,140
(1,696)
Cash flows from investing activities:
Purchases of property and equipment
Purchase of investment securities
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
(97)
(1,304)
-
(1,401)
231
(5,308)
-
-
(5,077)
3,160
9,034
(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
Cash and cash equivalents at end of year
$
12,194 $
9,034 $
8,014
Supplemental cash flow information:
Interest paid
Income taxes paid (recovered)
$
$
4,506 $
4,287 $
3,906
372 $
904 $
(1,086)
See accompanying report of independent registered public accounting firm.
F-55
FINANCIAL STATEMENT SCHEDULES
Schedule III - Supplementary Insurance Information
(In thousands)
Column A
Segment
Column B Column C Column D Column E Column F Column G Column H Column I
Column J Column K
Future
Policy
Benefits,
Losses,
Claims,
and Loss
Adjustment
Expenses
Deferred
Policy
Acquisition
Costs
Other
Policy
Claims and
Benefits
Payable
Unearned
Premiums
Premium
Revenue
Net
Investment
Income
Benefits,
Claims,
Losses and
Settlement
Expenses
Amortization
of Deferred
Policy
Acquisition
Costs
Other
Operating
Expenses
Net
Premiums
Written
2017
Specialty Commercial
Segment
Standard Commercial
Segment
$
8,668 $ 416,788 $
224,903 $
6,421
87,323
37,574
Personal Segment
913
22,989
14,165
Corporate
-
-
-
Consolidated
$
16,002 $ 527,100 $
276,642 $
2016
Specialty Commercial
Segment
Standard Commercial
Segment
$
11,961 $ 358,961 $
185,634 $
5,849
93,793
34,334
Personal Segment
1,383
28,813
21,286
Corporate
-
-
-
-
-
-
-
-
-
-
-
-
$ 259,086 $ 16,809 $
213,050 $
21,600 $ 57,458 $
265,022
66,218
3,855
45,227
10,890
23,180
69,288
35,733
1,194
30,031
1,775
12,712
31,273
-
(2,984)
-
-
10,265
-
$ 361,037 $ 18,874 $
288,308 $
34,265 $
103,615 $
365,583
$ 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
-
Consolidated
$
19,193 $ 481,567 $
241,254 $
- $ 353,370 $ 16,342 $
253,688 $
39,076 $
105,596 $
361,829
2015
Specialty Commercial
Segment
Standard Commercial
Segment
$
13,501 $ 314,975 $
161,730 $
- $ 237,640 $ 11,524 $
148,664 $
23,371 $ 58,212 $
241,775
5,633
105,971
33,701
-
72,613
3,623
47,071
4,237
22,820
71,097
Personal Segment
1,232
29,932
20,976
Corporate
-
-
-
-
-
38,828
1,235
34,414
5,066
12,205
44,072
-
(2,413)
-
-
10,377
-
Consolidated
$
20,366 $ 450,878 $
216,407 $
- $ 349,081 $ 13,969 $
230,149 $
32,674 $
103,614 $
356,944
See accompanying report of independent registered public accounting firm.
F-56
FINANCIAL STATEMENT SCHEDULES
Schedule IV – Reinsurance
(In thousands)
Year Ended December 31, 2017
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
$
$
- $
- $
- $
-
- $
-
567,089
-
- $
-
207,732
-
- $
-
1,680
-
-
-
361,037
-
0.47%
Total premiums
$
567,089 $
207,732 $
1,680 $
361,037
0.47%
Year Ended December 31, 2016
Life insurance in force
Premiums
Life insurance
Accident and health insurance
Property and liability insurance
Title Insurance
$
$
- $
- $
- $
-
- $
-
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%
See accompanying report of independent registered public accounting firm.
F-57
Schedule VI - Supplemental Information Concerning Property-Casualty Insurance Operations
(In thousands)
FINANCIAL STATEMENT SCHEDULES
Column A
Column B Column C Column D Column E Column F Column G
Column H
Column I
Column J
Column K
Affiliation With
Registrant
(a) Consolidated
property-casualty
Entities
2017
2016
2015
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
Amortization of
Deferred Policy
Acquisitions
Costs
Paid Claims
and Claims
Adjustment
Expenses
Net
Premiums
Written
(1) Current
Year
(2) Prior
Years
$
$
$
16,002 $
19,193 $
20,366 $
527,100 $
481,567 $
450,878 $
- $
- $
- $
276,642 $
241,254 $
216,407 $
361,037 $
353,370 $
349,081 $
18,874 $
16,342 $
13,969 $
248,203 $
246,080 $
237,102 $
40,105 $
7,608 $
(6,953) $
34,275 $
39,076 $
32,674 $
274,150 $
243,445 $
205,254 $
365,583
361,829
356,944
See accompanying report of independent registered public accounting firm.
F-58
$14
$12
$10
$8
$6
$4
$2
$0