Annual Report 2018
2018
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777 Main Street, Suite 1000 I Fort Worth, Texas 76102 I P (817) 348-1600 I www.hallmarkgrp.com
Corporate Information
BOARD OF DIRECTORS
INDEPENDENT REGISTERED
PUBLIC ACCOUNTANTS
NASDAQ: HALL
Headquartered in Fort Worth, Texas, Hallmark Financial Services, Inc. is a publicly
traded holding company with wholly-owned subsidiaries engaged in property and
casualty insurance.
Hallmark Financial's
Business Plan
is to operate as a diversified underwriter of niche property and casualty
insurance products. This plan is executed by wholly-owned business
units, each with a separate specialty product focus.
Our Corporate Strategy
is to create a “Best-in-Class” specialty insurance company focused on
under writing profitability and long-term growth of stockholders’ book
value per share. Our specialty product focus and niche market strategy
enable us to develop and retain in-house underwriting expertise and
specialized market knowledge, which helps differentiate Hallmark
Financial from our competitors. Each business unit tailors its products
and product distribution to the unique nature of the risks and coverages
it provides.
Our Financial Goal
is to earn a consistent underwriting profit and build long-term share-
holder value by focusing on profitability and operating efficiency versus
topline premium growth and market share.
Mark E. Schwarz
Executive Chairman
Scott T. Berlin
President
Mason Structural Steel, LLC
James H. Graves
Partner
Erwin, Graves & Jones, LP
Mark E. Pape
Chairman
H2Options, Inc. & U.S. Rain Group, Inc.
MANAGEMENT TEAM
Mark E. Schwarz
Executive Chairman
Naveen Anand
President & Chief Executive Officer
Jeffrey R. Passmore
Senior Vice President &
Chief Financial Officer
Ken Krissinger
Senior Vice President &
Chief Actuary
BDO USA, LLP
600 North Pearl
Suite 1700
Dallas, Texas 75201
STOCK SYMBOL
Hallmark Financial Services, Inc.
common stock is listed on the
NASDAQ Global Market under
the symbol “HALL.”
TRANSFER AGENT
Securities Transfer Corporation
2901 North Dallas Parkway
Suite 380
Plano, Texas 75093-5990
(469) 633-0101
LEGAL COUNSEL
McGuire, Craddock & Strother, P.C.
2501 N. Harwood
Suite 1800
Dallas, Texas 75201
STOCKHOLDER MEETING
The annual meeting of stockholders will be held
at 10:00 a.m. CDT on May 30, 2019 in the Train-
ing Center on the Concourse level at 777 Main
Street, Ft. Worth, Texas 76102.
CORPORATE HEADQUARTERS
Hallmark Financial Services, Inc.
777 Main Street
Suite 1000
Ft. Worth, Texas 76102
(817) 348-1600
www.hallmarkgrp.com
“HALL”: Book Value Per Share vs. Stock Price
STOCK PRICE
$14.50
$14.28
$13.72
$13.50
$13.11
$12.50
$11.50
$10.50
$9.50
$13.82
$14.17
B
O
O
K
V
A
L
U
E
P
E
R
S
H
A
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E
$10.69
2014
2015
2016
2017
2018
Highlights
For the Years Ended December 31, ($ in thousands, except per share amounts)
For the Years Ended December 31, ($ in thousands, except per share amounts)
Operating Results
Gross premiums written
Net premiums earned
Net income (loss)
Operating earnings (loss)1
Per Share
Net income (loss)—diluted
Operating earnings (loss)1
Book value
Weighted average shares
outstanding—diluted
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
2018
2017
2016 2015
2014
$ 663,015
363,087
10,347
18,401
$ 604,156
361,037
(11,553)
(11,420)
$ 549,077
353,370
6,526
6,766
$ 514,223
349,081
21,863
20,236
$ 473,218
321,217
13,429
13,342
$ 0.57
$ 1.01
$ 14.17
$ (0.63)
$ (0.62)
$ 13.82
$ 0.34
$ 0.36
$ 14.28
$ 1.13
$ 1.04
$ 13.72
$ 0.69
$ 0.69
$ 13.11
18,201
18,343
18,941
19,405
19,366
$ 668,385
$1,264,894
$ 728,966
$1,231,126
$ 741,078
$ 701,797
$1,162,460 $1,075,547
$ 650,128
$ 979,765
$ 527,247
$ 298,061
$1,009,362
$ 255,532
$ 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
70.5%
26.6%
97.1%
79.9%
28.0%
107.9%
71.8%
28.0%
99.8%
65.9%
28.0%
93.9%
65.4%
30.5%
95.9%
1
See “Non-GAAP Financial Measures” disclosure
Letter from Our Chairman
Mark E. Schwarz
Hallmark’s book value per share increased 3% in 2018 to
$14.17 per share. On its face 3% growth does not appear
notable, but it actually is because few property and ca-
sualty insurance companies posted any increase in book
value in 2018. The explanation for this industry result
is twofold: catastrophe losses and negligible investment
returns. Hallmark fared better than most, delivering both
an underwriting profit – largely averting the catastrophe
losses negatively impacting others – and a modest posi-
tive investment return for the year.
Natural catastrophes, storms and weather-related losses
again played a big role in 2018, in what was the second
costliest year ever for the insurance industry following
on the catastrophe losses that exceeded $100 billion last
year. Apart from the sizable catastrophe losses, overall
conditions in insurance markets generally trended fa-
vorable. Economic growth led to an increase in insured
exposures while rate increases were experienced across
most lines of business. A notable exception was com-
mercial transportation lines, which continued to produce
poor results for many in the industry.
Financial markets in 2018 proved to be tumultuous with
the unusual occurrence of negative returns produced by
both stock and bond market indicies for the year. Stocks
trended upward most of the year amid a generally healthy
U.S. economy and reported increases in corporate prof-
its. But in the fourth quarter, concerns over a trade war
with China, rising interest rates and general geopolitical
uncertainty caused stock prices to tumble. The S&P 500
ended down over 4% for the year, including a 14% loss
in the fourth quarter. For smaller capitalization compa-
nies the results were worse, with the Russell 2000 Index
down 12% for the year and 21% in the fourth quarter.
As 2018 proved, owning stocks can be much riskier than
owning bonds in the short-term, but over the longer-term,
common stock investments are the far better choice. In-
clusive of the challenging year in 2018, the S&P 500 has
returned about 13% annually during the past 10 years,
whereas high-grade bonds have returned about 4%.
Amidst the volatility of 2018, Hallmark increased the
size of its stock portfolio with purchases of $44 million
of marketable equities – over half made during the fourth
quarter market decline – while only selling $6 million.
The importance stock investments can make to the long-
ASSET ALLOCATION
63%
Fixed Income
Bank Loans
Equities
Cash & Cash
Equivalents
63%
19%
12%
6%
term gain in value of Hallmark cannot be over empha-
sized. Accordingly, each day begins with a review of
every stock in our portfolio with the goal of maximizing
after-tax future returns. There are many approaches tak-
en by investors attempting to beat the returns of the S&P
500, an objective that has been depressingly difficult to
accomplish in recent years. 2018 saw the retirements of
a number of formerly celebrated investment managers
that quit trying. We continue to believe the odds for
success are highest through owning a portfolio that is
meaningfully different than the S&P 500 and compound-
ing investment gains for as long as possible. Identify-
ing stocks with cheap valuation metrics is easy. Buy-
ing them with a disciplined methodology is intelligent.
But far more difficult is to judge the sustainability and
growth in future earnings that can support compounded
investment gains over long periods. Time and experi-
ence have taught us how a company performs over time
is more important than current valuation. Increasingly,
this has become the area of our greatest focus.
The rise and fall of equity prices cited above produced
large swings in the reported GAAP (Generally Accepted
Accounting Principles) earnings for insurance companies
in 2018, due to the adoption of a new accounting rule that
includes changes in unrealized gains and losses of equi-
ty securities in reported income. This new accounting
approach treats reductions in existing unrealized gains
on equities as a loss in reported income. The transition
to this partial mark-to-market accounting methodology
(changes in unrealized gains and losses of fixed income
securities are excluded) has given increased relevance to
operating earnings as a measure of periodic changes in
corporate profitability. Hallmark produced $18.4 mil-
lion in operating earnings in 2018. The operating return
on beginning tangible equity was 8.9%.
ued to reflect a deep and persistent discount to book val-
ue. Despite this opportunity, Hallmark only repurchased
$2 million of its common stock this year, a consequence
also related to the accelerated cash outflows experienced
this year. Cumulative repurchases since 2008 total over
three million shares at approximately $29 million or an
average price of $8.96 per share, equivalent to 63% of
our year end book value per share.
The mid-teens percentage growth achieved in net invest-
ment income in each of the past three years was inter-
rupted in 2018 due to a reduction in cash available for in-
vestment associated with an acceleration of paid losses.
This led to a reduction in the amount of fixed maturity
securities held in our portfolio, which was partially off-
set by an increase in the book yield on these investments.
This cash flow impact is expected to be transitory as we
work off the increases in loss reserves posted in prior
years.
INVESTMENTS + CASH PER SHARE
$39.82
$40.12
$36.75
$37.08
$33.83
2014
2015
2016
2017
2018
Similarly, more than ten years of steady growth in total
investments and cash was also interrupted in 2018 by the
same cash flow effect described above. This measure
was further impacted in the fourth quarter by the reduc-
tion in the amount of net unrealized capital gains exist-
ing in our equity investments. For the year, investments
and cash ended at $668 million or $37.08 per share.
The market price for Hallmark’s stock increased 2% in
2018. This increase is again notable not in the absolute
but because of its outperformance compared to market
averages. The trading prices for Hallmark shares contin-
The major reset in leadership undertaken four years ago
began to show signs of success in 2018. Positive operat-
ing earnings were achieved in all four calendar quarters,
each an improvement over the prior year. The 97.1%
combined ratio for the year was also a much-improved
result compared to last year.
As we enter 2019, the pricing environment continues
to improve and our company-specific dynamics remain
positive. Continued execution of management’s strategy
to balance and diversify our mix of business is expect-
ed to drive further improvements in results. Ultimately,
the increased retention and earned premium growth as-
sociated with our developing casualty lines will signify
a true milestone in the development of the company and
should represent a big gain in value creation.
As stated last year, Hallmark is undeniably a much better
company today than it was a few short years ago. Finan-
cial results are just beginning to reflect the magnitude of
positive change that has been achieved during this time.
Our objective remains the same as prior – clear and un-
wavering – to improve profitability and create a more
balanced, diversified and valuable portfolio of specialty
business. We have made significant progress in these re-
spects and remain committed to deliver strong financial
performance in the future.
Mark E. Schwarz
Executive Chairman of the Board
April 10, 2019
Letter from Our President & CEO
Naveen Anand
Our vision:
To be a market-leading provider of specialty
property and casualty insurance solutions by
focusing on operational excellence, commitment
to stakeholders, and being recognized for our
employee’s specialist knowledge and expertise.
Hallmark Financial’s 2018 results are an improvement
over the prior year and begin to reveal the impact of the
consistent execution of our strategy. Our focus on un-
derwriting performance and the further actions taken to
address legacy claims are having the expected impact.
Over the past 4 years, we have transformed from a pri-
marily regional auto writer into a national specialty in-
surance company. Today, as a result of the significant
investments made in talent and technology, Hallmark
Financial is well positioned to take advantage of current
market opportunities. This investment has also allowed
us to diversify our specialty product portfolio and ex-
pand geographically while maintaining our focus on
underwriting profitability and disciplined expense man-
agement.
2018 Results
Our combined ratio for the year was 97.1%. This is
an improvement of nearly 11 points from 2017, a year
which was impacted by significant prior year adverse de-
velopment. While some prior year adverse development
occurred in 2018 (1.6 points), primarily associated with
the legacy commercial auto book, the overall results are
trending closer to expectations. But there is still room
for improvement.
2018 marked another year with significant industry ca-
tastrophe losses, including the devastation of Hurricane
Michael and the tragic wildfire losses on the west coast.
In fact, the industry has incurred over $200 billion of
insured losses in the last two years, making it the largest
two-year period for catastrophes in history.
While these catastrophe losses impacted our results, we
fared relatively well as our underwriting actions and risk
management efforts have protected the portfolio. Our ca-
tastrophe losses contributed 2.6 points to our combined
ratio in 2018 and have generally been between 2 and 3
points each year since 2015.
CALENDAR YEAR COMBINED RATIO
95.9%
93.9%
99.8%
107.9%
97.1%
2014
2015
2016
2017
2018
ACCIDENT YEAR LOSS RATIO
EXPENSE RATIO
CATASTROPHE LOSSES
PRIOR YEAR DEVELOPMENT
Gross premiums increased by 10%, ending at $663 mil-
lion and have been growing at a steady and balanced
pace of 8.8% CAGR since 2014. This growth is the re-
sult of both acquiring new customers and increases in the
underlying rates.
GROSS WRITTEN PREMIUMS ($000,000)
$514
$549
$473
$663
$604
2014
2015
2016
2017
2018
Focus on underwriting and operational execution
The team has made significant strides in repositioning
the company. The following are some of the key opera-
tional initiatives that we have focused on:
1. Specialty focused product diversification
in underserved markets
A cornerstone of our strategy has been to develop new
specialty products in niche segments where we can dif-
ferentiate Hallmark Financial by our underwriting ex-
pertise, our use of data and analytics, our technology and
our claims expertise.
We target these specialty product niches because they
are underserved markets with limited competition and
have long track records of profitability. We can also dif-
ferentiate ourselves in these niches by our underwriting
and functional expertise. Each of these product lines are
scalable and we are still only addressing a portion of the
available business in these markets. These new specialty
product lines now account for nearly 36% of our gross
written premium.
As these portfolios gain scale and mature, we expect to
retain more of the risk produced by these profitable niche
products, providing a further increase to our income. We
initiated this process with the development of a consol-
idated casualty reinsurance program in the fourth quar-
ter of 2018. This treaty increases our retained premiums
and optimizes the profitability of the premium that is
retained.
2. Improve legacy product lines and position them
for sustained profitability
While it is a strategic imperative to develop and diversify
Hallmark Financial’s position in the specialty portfolio,
my greatest focus has been fixing the established product
lines. The results in these lines have been disappointing
and have masked the progress the organization has made
in its transformation. I’m pleased to report that we are
making positive strides here as well.
In my note last year, I addressed the significant challeng-
es the industry is facing regarding commercial auto. The
industry continues to experience rising claims severity
impacted by higher medical costs, higher repair costs,
BUSINESS UNITS
Aviation
Commercial
Auto
E&S
Casualty
Aircraft
Hull &
Liability;
Airport
Liability
Aircraft
&
General
Liability
Primary
& Excess
Commercial
Auto
Liability
& Physical
Damage
Primary,
Excess &
Excess
Public
Entity
General
Liability
&
Product
Liability
WHOLESALE
E&S
Contract
Binding
E&S
Property
Monoline
General
Liability
& Package
Shared &
Layered;
Builders’
Risk
Pro -
Financial
Lines
D&O &
E&O
General
Liability
&
Property
Property
Mgmt
Professional
Liability
GENERAL
AGENTS
Pro -
Healthcare
Programs
Business
produced
by
Specialty
MGAs
Property
&
Casualty
Lines
Hospitals,
Medical
Facilities
&
Physicians
Medical
Malpractice
General
Liability &
Professional
Liability
RETAIL
Specialty
Personal
Lines
Commercial
Accounts
(CIS)
Personal
Auto &
Renters
Package
& BOP
Commercial
Multi-
Peril
Auto
Liability,
Physical
Damage,
General
Liability &
Property
11%
17%
36%
36%
rising litigation, distracted driving and overall social in-
flation, resulting in 2018 being another poor year for this
industry segment.
In our commercial auto portfolio, we achieved a cumu-
lative double-digit rate increase over the past two years.
Additionally, through our segmentation efforts we have
identified the best and worst performing classes and ex-
ited poor performing states (LA and MS). We also devel-
oped our next generation proprietary predictive pricing
model to give underwriters better insight on risk quality.
Our actions resulted in a reduction of our primary gross
premium by over $40 million in 2018. However, we ex-
pect that the loss ratios will continue to improve because
of these initiatives. While better risk selection and pric-
ing are paramount in addressing the new realities of the
line, it’s not the only area to address.
The claims initiatives, put in place starting in late 2016,
are having the expected impact as well. In 2017 we con-
ducted a review of open claims, and subsequently adjust-
ed case reserves to reflect our current outlook. This re-
sulted in the significant prior year adverse development
we experienced in 2017. While we still witnessed some
adverse development in this line in 2018, it was greatly
reduced from the prior year.
We are focused on closing legacy claims as well as ad-
dressing new claims faster with our revamped claims
structure. We implemented this claims structure in late
2016 starting with our specialty personal lines auto port-
folio and expanded this structure to our commercial auto
portfolio throughout 2017 and early 2018. This has sig-
nificantly shortened the time it takes to close a claim, re-
ducing the ultimate cost of the claim, even in an external
environment of rising loss costs.
These actions diminish the likelihood of litigation, which
can otherwise result in an even higher claim costs. While
this has had an impact on near term cash flow as we used
reserves to close out legacy claims and accelerate the
payment of new claims, we expect cash flows to begin to
normalize in 2019.
THE HALLMARK FINANCIAL APPROACH:
COMMERCIAL AUTO
CLAIMS:
• Hired experts in auto and auto litigation
• Organized teams to promptly address new and legacy
claims, with the goal of closing claims quickly to min-
imize severity (Fast track for the first 30 days)
• Greatly improved the adequacy of case reserves
CLAIMS
PRICING
UNDERWRITING
UNDERWRITING:
• Hired experts in commercial auto underwriting
• Consolidated primary and excess groups to form a
single cohesive team
• Developed a next-gen predictive model to increase
segmentation and better assess risk quality
Identified the best and worst performing classes
•
• Exited worst performing states (LA and MS)
PRICING:
• Achieved a cumulative double digit rate increase
over the past two years
In Specialty Personal lines, we achieved a combined
ratio of 94.9%, our best result since 2009. Over the last
four years we have completely re-tooled the business.
We developed and launched a new technology platform
in 2016, providing the foundation for improvement.
Together with multiple rate increases, ongoing pricing
insight driven by data modeling and analytics, and a
focused approach in the limited states in which we do
business (reduced from 33 to 10), we are well positioned
for this business to produce sustained profitable results.
The Standard Commercial segment posted a combined
ratio of 88%, with the portfolio growing by 10%. Here
we have successfully re-positioned the business to focus
on targeted segments that provide the ability to differen-
tiate our products and offer the best opportunity for long
term profitability. In 2018, we expanded into Arizona
and 2 additional states, increasing our total footprint in
this segment to 14 states. I expect to add 1 to 2 states per
year going forward.
3. Develop and embed a culture of data and
analytics that informs decision making
Insurance companies by their nature produce a lot of
data. However very few companies can harness the
power of this data and effectively embed analytics into
their organization and culture. We started this journey a
few years ago and continue to make progress. Our ini-
tiatives have been focused on using data to improve risk
selection and pricing in each of our product lines. By
combining the use of internal and external data, we are
continuously refining pricing and risk selection criteria
for our products. Furthermore, we’ve developed greater
focus on achieving a target return on capital in each of
our lines of business. This allows us to allocate capital
to the lines of business where we feel we have the best
opportunity to profitably grow. Two years ago, we devel-
oped a platform for premium and claims reporting. To-
day our business intelligence platform allows our leaders
and underwriters to see production and loss data daily
for their business, which enables them to take note of
trends and drive appropriate action.
4. Disciplined expense management
We’ve made many strategic investments in the organiza-
tion in both expertise (people) and technology. However,
we haven’t lost sight of our expenses. Hallmark Finan-
cial achieved an expense ratio of 26.6% in 2018, which
was an improvement of 3.9% points since 2014. The
advantage created by our expense ratio is evident when
compared to our peer group, which highlights the bene-
ficial gap between us and our peers, and further accentu-
ates the recent improvements in our expense ratio. With
a relentless focus on managing expenses while making
the organization more productive, and by using modern
technology capabilities like robotic process automation
and machine learning, we have earned this advantage in
the market.
EXPENSE RATIO RELATIVE TO OUR PEERS
HALLMARK FINANCIAL
PEER GROUP
35.2%
35.6%
36.1%
34.9%
34.6%
EXPENSE ADVANTAGE
30.5%
28.0%
28.0%
28.0%
26.6%
2014
2015
2016
2017
2018
Peer Group: ACGL, ARGO, AHL, AXS, CNFR, DGICA, EMCI, RE, GBLI,
THG, JRVR, NAVG, RNR, RLI, SIGI, WRB
5. Invest, develop and retain expertise
Going through a transformation at the scale and magni-
tude that we have puts a lot of strain on an organization.
Particularly for a specialty insurance company, attracting
and retaining expertise is key to our current and future
success. Hallmark Financial continues to make progress
in this area. Today each of our specialty product lines has
leaders that have deep experience in their areas of spe-
cialty. Our claims, actuarial, finance, HR and technology
teams are equally adept and focused on supporting our
specialty portfolios.
Market outlook
As we put 2018 in the rearview mirror, I’m excited for the
future of Hallmark Financial. Having addressed many of
the issues that have impacted our results in the past, we
are well positioned to take advantage of the current mar-
ket opportunities. The growing economy and strong pos-
itive rate environment will add to our momentum. Thank
you for your support and we look forward to 2019.
Naveen Anand
President and Chief Executive Officer
April 10, 2019
1 Non-GAAP Financial Measures
The Company’s financial statements are prepared in accordance with United States generally accepted accounting
principles (“GAAP”). However, the Company also presents and discusses certain non-GAAP financial measures that
it believes are useful to investors as measures of operating performance. Management may also use such non-GAAP
financial measures in evaluating the effectiveness of business strategies and for planning and budgeting purposes.
However, these non-GAAP financial measures should not be viewed as an alternative or substitute for the results re-
flected in the Company’s GAAP financial statements. In addition, the Company’s definitions of these items may not
be comparable to the definitions used by other companies.
Operating earnings and operating earnings per share are calculated by excluding net investment gains and losses from
GAAP net income. Management believes that operating earnings and operating earnings per share provide useful
information to investors about the performance of and underlying trends in the Company’s core insurance operations.
Net income and net income per share are the GAAP measures that are most directly comparable to operating earnings
and operating earnings per share. A reconciliation of operating earnings and operating earnings per share to the most
comparable GAAP financial measures is presented below.
For the Years Ended December 31, ($ in thousands, except per share amounts)
Non-GAAP Reconciliation
Net income (loss)
Excluded investment (gains)/losses
Tax rate
Tax impact
Excluded investment (gains)/losses,
net of tax
Operating earnings
2018
2017
2016
2015
2014
$ 10,347
$ (11,553)
$ 6,526
$ 21,863
$ 13,429
$ 10,195
21%
$ 2,141
$ 205
35%
$ 72
$ 369
35%
$ 129
$ (2,503) $ (134)
35%
35%
$ (876) $ (47)
$ 8,054
$ 18,401
$ 133
$ (11,420)
$ 240
$ 6,766
$ (1,627) $ (87)
$ 20,236 $ 13,342
Weighted average shares outstanding
18,201
- diluted
$ 0.57
Net income (loss) per share - diluted
Excluded investment (gains)/losses
$ 0.44
Operating earnings (loss) per share - diluted $ 1.01
18,343
$ (0.63)
$ 0.01
$ (0.62)
18,941
$ 0.34
$ 0.02
$ 0.36
19,405
19,366
$ 1.13 $ 0.69
$ (0.09) $ (0.00)
$ 1.04 $ 0.69
Operating return on beginning tangible equity is calculated as operating earnings divided by GAAP equity at the begin-
ning of the period excluding goodwill. Management believes that operating return on beginning tangible equity provides
useful information to investors about the performance of the Company’s core insurance operations relative to its core
shareholder equity exclusive of non-depreciable goodwill from prior acquisitions. Return on beginning equity is the
GAAP measure that is most directly comparable to operating return on beginning tangible equity. A reconciliation of
operating return on beginning tangible equity to return on beginning equity is presented below.
Fiscal 2018 net income
Excluded investment losses, net of tax
Fiscal 2018 operating earnings
Beginning GAAP equity
Reverse goodwill
Beginning tangible equity
Return on beginning GAAP equity
Operating return on beginning tangible equity
10,347
8,054
18,401
251,118
(44,695)
206,423
a
b
c
d
4.1%
8.9%
(a / c)
(b / d)
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, 2018
Or
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the transition period from _________________________ to _________________________________
Commission file number 001-11252
Hallmark Financial Services, Inc.
(Exact name of registrant as specified in its charter)
Nevada
(State or Other Jurisdiction of Incorporation or
Organization)
777 Main Street, Suite 1000, Fort Worth, Texas
(Address of Principal Executive Offices)
87-0447375
(I.R.S. Employer
Identification No.)
76102
(Zip Code)
Registrant’s Telephone Number, Including Area Code: (817) 348-1600
Securities registered pursuant to Section 12(b) of the Act:
Title of Each Class
Common Stock $.00 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 every Interactive Data File
required to be submitted 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 such files).
Yes No
1
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, a smaller reporting company or an emerging growth company. See definition of “accelerated
filer”, “large accelerated filer”, “smaller reporting company” and “emerging growth company” in Rule 12b-2
of the Exchange Act.:
Large
accelerated
filer
Accelerated
filer
Non-
accelerated
filer
Smaller reporting
company
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
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. $129.5million
Indicate the number of shares outstanding of each of the registrant’s classes of common stock, as of the latest
practicable date. 18,123,093 shares of common stock, $.18 par value per share, outstanding as of March 14,
2019.
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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.
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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.
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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 37 states through 11 wholesale brokers and 114 general agency offices, as well as 27
independent retail agents in Texas.
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 1000 power units and up to $150 million in receipts (non-construction)
or $200 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 124 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 186 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 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 is underwritten on an excess and surplus lines basis by our
Specialty Commercial operating unit and focuses on physicians, mid-level providers, miscellaneous medical
facilities, hospitals and healthcare organizations and senior care/nursing homes. The physicians and mid-level
providers are generally hard to place or non-standard risks. These are individuals 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 standard medical facilities,
hospitals and healthcare systems and senior care/nursing homes. The medical facilities are generally outpatient
facilities such as surgery centers, imaging centers, labs, home health agencies and other non-hospital facilities
providing medical services. The hospitals and healthcare systems are generally stand-alone acute care facilities,
multi-hospital systems, integrated delivery systems, critical access hospitals and others specialty hospitals and
healthcare systems providing medical services. Our Specialty Commercial operating unit markets these
products through 34 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
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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 30 wholesale brokers in
49 states. The primary/excess commercial property coverages underwritten by our Specialty Commercial
operating unit specialize 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 166
independent agency groups primarily serving businesses in the non-urban areas of 14 states predominately in
the southwest and northwest regions. 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 offering and fits well in our distribution channel. Our Specialty
Personal Lines operating unit markets and services these non-standard auto and renters insurance policies
through 4,305 independent retail agent locations in 10 and 12 states, respectively.
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.
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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, 2018, 2017 and 2016.
Gross Premiums Written:
Specialty Commercial Segment
Standard Commercial Segment
Personal Segment
Total
Net Premiums Written:
Specialty Commercial Segment
Standard Commercial Segment
Personal Segment
Total
2018
Year Ended December 31,
2017
(dollars in thousands)
2016
$
501,806 $
86,121
75,088
$
663,015 $
464,714 $
78,228
61,214
604,156 $
388,914
76,891
83,272
549,077
$
251,731 $
69,222
42,845
$
363,798 $
265,022 $
69,288
31,273
365,583 $
249,072
68,490
44,267
361,829
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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, 2018.
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Specialty Commercial Segment
The Specialty Commercial Segment of our business includes our Contract Binding operating unit and our
Specialty Commercial operating unit. During 2018, our Contract Binding operating unit accounted for 34% and
our Specialty Commercial operating unit accounted for 66% 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 37 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. During the second quarter of 2018 we discontinued offering premium
financing through PAAC for both the Contract Binding operating unit as well as unaffiliated general and retail
agents. During 2018 our Contract Binding operating unit accounts for 77% 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 2018, commercial automobile,
general liability and all other property/casualty accounted for 86%, 11% 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.
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• 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 37 states through 11 wholesale brokers and 114
general agency offices, as well as 27 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 instantaneous quoting and signature-ready applications which can be emailed
or faxed to its independent retail agents. During 2018, general agents produced 84%, retail agents produced 2%
and wholesale brokers produced 14% of total premiums produced by our Contract Binding operating unit.
During 2018, the top ten general agents produced 41%, the eleven wholesale brokers produced 14% 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 and general liability insurance on both an admitted and non-
admitted basis focused 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 $6,000,000 (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 2018, the top ten wholesale brokers accounted for 42%
of our primary and excess casualty premium volume, with no single wholesale broker accounting for more than
9%. During 2018, commercial transportation excess liability risks accounted for 68% of the premiums, with
the remaining 32% coming from non-transportation commercial excess, public entity and general liability risks.
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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.
• 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 practices liability, law enforcement liability, educators’ legal
liability and related coverages.
Our Specialty Commercial operating unit markets, underwrites and services general aviation property/casualty
insurance in 48 states. The marketing strategy of our Specialty Commercial operating unit is similar to only a
few competitors in the U.S. and focuses 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 retain up to $2.0 million per risk for satellite launches and in-orbit coverage for up to
12 months.
Our Specialty Commercial operating unit distributes its general aviation insurance products through 186
aviation specialty brokers. These specialty brokers submit 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 2018, the top ten independent specialty
brokers produced 39%, and no broker produced more than 9%, of the total general aviation premium volume
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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
2018 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 2018 was approximately $169,000. 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 and hospitals and healthcare systems. Our Specialty Commercial
operating unit distributes its medical professional liability insurance products through 34 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.
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 liability on a claims-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 30 wholesale brokers in 49 states. Our Specialty Commercial
operating unit markets primary/excess commercial property coverages, on a non-admitted basis, for both
catastrophe and non-catastrophe exposures. Our Specialty Commercial operating unit distributes its
primary/excess commercial property insurance products through 22 wholesale brokers in 50 states. 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, a program underwriter writing
primarily commercial auto liability and physical damage risk in 16 states and a program underwriter writing
primarily commercial auto coverage for risks specializing in daily rental operations in 45 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 2018, our Standard Commercial
P&C operating unit accounted for 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 14 states
predominately in the southwest and northwest regions. Our Standard Commercial P&C operating unit 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. In addition,
our Standard Commercial P&C operating unit previously provided occupational accident coverage in Texas
through an underwriting agency that is a specialist in the occupational accident insurance market. Effective
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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.
• 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.
Our Standard Commercial P&C operating unit markets its property/casualty insurance products through 166
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 21 year average tenure of the 25 agency groups that each produced more than $1.0
million in premium during the year ended December 31, 2018. During 2018, the top ten agency groups
produced 37%, and no individual agency group produced more than 7%, 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.
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Workers Compensation operating unit. Effective July 1, 2015, this operating unit ceased marketing or
retaining any risk on new or renewal policies. The run-off of existing policies issued by our Workers
Compensation operating unit 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 and 12 states, respectively. Our non-standard personal automobile insurance generally
provides for the minimum limits of liability coverage mandated by state laws to drivers who find it difficult to
purchase automobile insurance from standard carriers as a result of various factors, including driving record,
vehicle, age, claims history, or limited financial resources. Products offered by our Specialty Personal Lines
operating unit include the following:
• Personal automobile. Personal automobile insurance is the primary product offered by our
Specialty Personal Lines operating unit. Our policies typically provide third-party coverage to
individuals for bodily injury and property damage at the minimum limits required by law, and for
physical damage to an insured’s own vehicle from collision and various other perils. In addition,
many states require policies to provide for first party personal injury protection, frequently referred
to as no-fault coverage.
• Renters. Renters insurance provides coverage for the contents of a renter’s home or apartment and
for liability. Renter’s policies are similar to homeowners insurance, except they do not cover the
structure.
Our Specialty Personal Lines operating unit markets its products through 4,305 independent retail agent
locations operating in its target geographic markets. Non-standard automobile represented 96% of the
premiums produced during 2018. 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
2018, the top ten independent agency locations produced 36%, and no individual agency location produced
more than 6%, of the total premium volume of our Specialty Personal Lines operating unit.
During 2018, personal automobile liability coverage accounted for 72% and personal automobile physical
damage coverage accounted for the remaining 28% 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-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 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
14
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 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 team has extensive insurance
experience. In addition, our operating units have strong management and underwriting teams, that
also have extensive insurance industry experience. 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
15
underwriting profit in order to maintain or increase their premium volume and market share. In
contrast, we seek to write business based on its profitability rather than focusing solely on premium
production. To that end, we provide financial incentives to many of our underwriters and
independent agents based on underwriting profitability.
• Achieving organic growth in our existing business lines. We believe we can achieve organic
growth in our existing business lines by consistently providing our insurance products through
market cycles, expanding geographically, expanding our product offerings, expanding our agency
relationships and further penetrating our existing customer base. We believe our extensive market
knowledge and strong agency relationships position us to compete effectively in our various
specialty and niche markets. We also believe there is a significant opportunity to expand some of
our existing business lines into new geographical areas and through new agency relationships while
maintaining our underwriting discipline and operational efficiency. In addition, we believe there is
an opportunity for some of our operating units to further penetrate their existing customer bases
with additional products offered by other operating units.
• Pursuing selected, opportunistic acquisitions. We seek to opportunistically acquire insurance
organizations that operate in specialty or niche property/casualty insurance markets that are
complementary to our existing operations. We seek to acquire companies with experienced
management teams, stable loss results and strong track records of underwriting profitability and
operational efficiency. Where appropriate, we intend to ultimately retain profitable business
produced by the acquired companies that would otherwise be retained by unaffiliated insurers. Our
management has significant experience in evaluating potential acquisition targets, structuring
transactions to ensure continued success and integrating acquired companies into our operational
structure.
• Maintaining a strong balance sheet. We seek to maintain a strong balance sheet by employing
conservative investment, reinsurance and reserving practices and to measure our performance
based on long-term growth in book value per share.
Distribution
We market our property/casualty insurance products predominately through independent general agents, retail
agents and specialty brokers. Therefore, our relationships with independent agents and brokers are critical to
our ability to identify, attract and retain profitable business. Each of our operating units has developed its own
tailored approach to establishing and maintaining its relationships with these independent distributors of our
products. These strategies focus on providing excellent service to our agents and brokers, maintaining a
consistent presence in our target niche and specialty markets through hard and soft market cycles and fairly
compensating the agents and brokers who market our products. Our operating units also regularly evaluate
independent general and retail agents based on the underwriting profitability of the business they produce and
their performance in relation to our objectives.
Except for the products of our Specialty Commercial Segment, the distribution of property/casualty insurance
products by our operating units is geographically concentrated. For the twelve months ended December 31,
2018, five states accounted for approximately 54% of the gross premiums written by our insurance company
subsidiaries.
16
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, 2018.
State
Texas
California
Arizona
Florida
Oklahoma
All other states
Total gross premiums written
Percent of total
Underwriting
Specialty Standard
Commercial Commercial Personal
Segment
Segment
Segment Total
Percent of
Total
$
$
$
177,410
56,591
3,319
26,057
15,023
223,406
501,806
$
75.7 %
(dollars in thousands)
21,558
—
1,136
—
—
63,427
86,121
$ 18,163
—
28,249
—
7,836
20,840
$ 75,088
$ 217,131
56,591
32,704
26,057
22,859
307,673
$ 663,015
13.0 %
11.3 %
100.0 %
32.8 %
8.5 %
4.9 %
3.9 %
3.5 %
46.4 %
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, aviation and public entity underwriters have developed
underwriting principles and processes appropriate to the coverages offered by their respective operating units.
We believe that managing the underwriting process through our operating units capitalizes on the knowledge
and expertise of their personnel in specific markets and results in better underwriting decisions. All of our
underwriters have established limits of underwriting authority based on their level of experience. We also
provide financial incentives to many of our underwriters based on underwriting profitability.
To better diversify our revenue sources and manage our risk, we seek to maintain an appropriate business mix
among our operating units. At the beginning of each year, we establish a target net loss ratio for each operating
unit. We continually monitor actual net loss ratios against targets. 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
17
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.
Gross premiums written
Net statutory loss & LAE ratio
Net statutory expense ratio
Net statutory combined ratio
$
Year Ended December 31,
2017
604,156
2018
663,015
$
69.8 %
25.5 %
95.3 %
$
79.1 %
27.0 %
106.1 %
2016
549,077
71.2 %
29.4 %
100.6 %
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, 2018, 2017 and 2016, our consolidated premium-to-surplus ratios were 147%, 157% and 146%,
respectively.
Claims Management and Administration
We believe that effective claims management is critical to our success and that our claims management process
is cost-effective, delivers the appropriate level of claims service and produces superior claims results. Our
claims management philosophy emphasizes the delivery of courteous, prompt and effective claims handling
and embraces responsiveness to policyholders and agents. Our claims strategy focuses on thorough
investigation, timely evaluation and fair settlement of covered claims while consistently maintaining
appropriate case reserves. We seek to compress the cycle time of claim resolution in order to control both loss
and claim handling cost. We also strive to control legal expenses by negotiating competitive rates with defense
counsel and vendors, establishing litigation budgets and monitoring invoices.
Each of our operating units maintains its own dedicated staff of specialized claims personnel to manage and
administer claims arising under policies produced through their respective operations. The claims process is
managed 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.
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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, 2018, we had a total of 92 claims managers, supervisors and adjusters with an average
experience of approximately 16 years.
Analysis of Losses and LAE
Our consolidated financial statements include an estimated reserve for unpaid losses and LAE. We estimate our
reserve for unpaid losses and LAE by using case-basis evaluations and statistical projections, which include
inferences from both losses paid and losses incurred. We also use recent historical cost data and periodic
reviews of underwriting standards and claims management practices to modify the statistical projections. We
give consideration to the impact of inflation in determining our loss reserves, but do not discount reserve
balances.
The amount of reserves represents our estimate of the ultimate cost of all unpaid losses and LAE incurred.
These estimates are subject to the effect of trends in claim severity and frequency. We regularly review the
estimates and adjust them as claims experience develops and new information becomes known. Such
adjustments are included in current operations, including increases and decreases, net of reinsurance, in the
estimate of ultimate liabilities for insured events of prior years.
Changes in loss development patterns and claim payments can significantly affect the ability of insurers to
estimate reserves for unpaid losses and related expenses. We seek to continually improve our loss estimation
process by refining our ability to analyze loss development patterns, claim payments and other information
within a legal and regulatory environment that affects development of ultimate liabilities. Future changes in
estimates of claim costs may adversely affect future period operating results. However, such effects cannot be
reasonably estimated currently.
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, 2018 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.
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The following table presents our gross and net premiums written and earned and reinsurance recoveries for
each of the last three years (in thousands).
Gross premiums written
Ceded premiums written
Net premiums written
Gross premiums earned
Ceded premiums earned
Net premiums earned
$
$
$
$
2016
Year Ended December 31,
2017
604,156 $ 549,077
(238,573 ) (187,248)
365,583 $ 361,829
568,769 $ 524,229
(207,732 ) (170,859)
361,037 $ 353,370
2018
663,015 $
(299,217 )
363,798 $
641,596 $
(278,509 )
363,087 $
Reinsurance recoveries
$
199,690 $
144,948 $ 116,057
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, 2018, we had total invested assets of
$627.9 million. If market rates were to increase by 1%, the fair value of our fixed-income securities as of
December 31, 2018 would decrease by approximately $7.6 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, 2018 and 2017.
As of December 31, 2018
Percent of
Fair
As of December 31, 2017
Percent of
Fair
Yield Value Total
Yield
Value Total
(in thousands)
(in thousands)
Category:
Corporate bonds
Collateralized corporate bank loans
Municipal bonds
US Treasury securities and obligations
of U.S. Government
Mortgage backed
Total
$ 242,152
126,528
115,527
48,106
13,557
$ 545,870
44.4 %
23.2 %
21.1 %
2.8 % $ 279,073
5.0 % 125,937
3.6 % 134,256
46.1 %
20.8 %
22.2 %
2.5 %
3.9 %
2.9 %
8.8 %
2.5 %
100.0 %
1.9 % 49,947
3.1 % 16,533
3.4 % $ 605,746
8.2 %
2.7 %
100.0 %
1.8 %
2.6 %
2.9 %
20
The weighted average credit rating for our fixed-income portfolio was BBB+ at December 31, 2018. The
following table shows the distribution of our fixed-income portfolio by rating as a percentage of total fair value
as of December 31, 2018 and 2017:
Rating:
"AAA"
"AA"
"A"
"BBB"
"BB"
"B"
"CCC"
"CC"
"D"
"NR"
Total
As of
As of
December 31, 2018 December 31, 2017
13.6 %
6.7 %
11.8 %
44.3 %
19.1 %
0.3 %
0.2 %
1.0 %
— %
3.0 %
100.0 %
4.3 %
20.3 %
8.4 %
46.3 %
15.0 %
1.3 %
0.1 %
— %
0.7 %
3.6 %
100.0 %
The following table shows the composition of our fixed-income portfolio by remaining time to maturity as of
December 31, 2018 and 2017.
As of December 31, 2018
Percentage of
Total
As of December 31, 2017
Percentage of
Total
Fair Value
Fair Value
Fair Value Fair Value
Remaining time to maturity:
Less than one year
One to five years
Five to ten years
More than ten years
Mortgage-backed
Total
(in thousands)
(in thousands)
$ 120,127
284,947
102,047
25,192
13,557
$ 545,870
22.0 % $ 116,060
308,829
52.2 %
124,168
18.7 %
40,156
4.6 %
16,533
2.5 %
100.0 % $ 605,746
19.2 %
51.0 %
20.5 %
6.6 %
2.7 %
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, 2018, 13% 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.
21
The following table details the net unrealized gain balance by invested asset category as of December 31, 2018.
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)
$ (503)
(1,162)
(5,251)
2,953
(435)
12,187
(2,615)
$ 5,174
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
22
“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 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 2,994
property/casualty insurance companies and 2,060 property/casualty insurance groups operating in North
America as of July 2, 2018. The primary competition for our Contract Binding operating unit includes such
carriers as American Millennium Insurance Company, Canal Insurance Company, Clear Blue 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, Underwriters at Lloyds of London, and Wilshire Insurance Company.
Our Specialty Commercial operating unit considers its primary competition for our excess, umbrella and
23
general liability insurance products to include such carriers as American International Group, Inc., First
Mercury Insurance Company, Axis Insurance Company, Berkshire Hathaway Companies, Endurance
American Specialty 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, Aspen, Beazley, CNA Financial Corporation, Iron Health,
Kinsale Insurance Company, Markel, Medical Protective Insurance Company, 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, Chubb Group of Insurance Companies, Euclid
Executive Liability Managers, Berkley Insurance Company, CNA Financial Corporation, Evanston Insurance
Company, Kinsale Insurance Company, RSUI Group, Hiscox USA, and XL Catlin Insurance Company. The
primary competition for our primary/excess commercial property insurance products includes such carriers as
Chubb Westchester, Aspen Insurance, Everst National Insurance Company, RSUI Group, Navigators Specialty
Insurance Company, Starr Surplus Lines, Ironshore Specialty Insurance Company, Axis Insurance Company,
and Markel Insurance Company. Our Standard Commercial P&C operating unit competes with a variety of
large national standard commercial lines carriers such as Liberty Mutual Group, Travelers Companies, Inc.,
Cincinnati Financial Corporation and The Hartford Financial Services Group, as well as numerous smaller
regional companies. 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
24
policyholders, market conduct, claims practices and compliance with other laws and applicable regulations.
Typically, these examinations are conducted every three to five years. In addition, if circumstances dictate,
regulators are authorized to conduct special or target examinations of insurance companies to address particular
concerns or issues. The results of these examinations can give rise to injunctive relief, regulatory orders
requiring remedial or other corrective action on the part of the company that is the subject of the examination,
assessment of fines, or other penalties against that company. In extreme cases, including actual or pending
insolvency, the insurance department may take over, or appoint a receiver to take over, the management or
operations of an insurer or an agent’s business or assets.
Guaranty funds. All insurance companies are subject to assessments for state-administered funds that cover
the claims and expenses of insolvent or impaired insurers. The size of the assessment is determined each year
by the total claims on the fund that year. Each insurer is assessed a pro rata share based on its direct premiums
written in that state. Payments to the fund may generally be recovered by the insurer through deductions from
its premium taxes over a specified period of years.
Transactions between insurance companies and their affiliates. Hallmark is also regulated as an insurance
holding company by the Texas Department of Insurance, the Arizona Department of Insurance and the
Oklahoma Insurance Department. Financial transactions between Hallmark or any of its affiliates and our
insurance company subsidiaries are subject to regulation. Transactions between our insurance company
subsidiaries and their affiliates generally must be disclosed to state regulators, and prior regulatory approval
generally is required before any material or extraordinary transaction may be consummated or any management
agreement, services agreement, expense sharing arrangement or other contract providing for the rendering of
services on a regular, systematic basis is implemented. State regulators may refuse to approve or may delay
approval of such a transaction, which may impact our ability to innovate or operate efficiently.
Dividends. Dividends and distributions to Hallmark by our insurance company subsidiaries are restricted by
the insurance regulations of the respective state in which each insurance company subsidiary is domiciled. As
property/casualty insurance companies domiciled in the state of Texas, AHIC and TBIC may only pay
dividends from unassigned surplus funds. In addition, AHIC and TBIC must obtain the approval of the Texas
Department of Insurance before the payment of extraordinary dividends, which are defined as dividends or
distributions of cash or other property the fair market value of which combined with the fair market value of
each other dividend or distribution made in the preceding 12 months exceeds the greater of: (1) statutory net
income as of the prior December 31 or (2) 10% of statutory policyholders’ surplus as of the prior December 31.
HIC and HNIC, both domiciled in Arizona, may pay dividends out of that part of their available surplus funds
that is derived from realized net profits on their business. Without prior written approval from the Arizona
Department of Insurance, HIC and HNIC may not pay extraordinary dividends, which are defined as dividends
or distributions of cash or other property the fair market value of which combined with the fair market value of
each other dividend or distribution made in the preceding 12 months exceeds the lesser of: (1) 10% of statutory
policyholders’ surplus as of the prior December 31 or (2) net 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.
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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, 2018, the adjusted
capital under the risk-based capital calculation of each of our insurance company subsidiaries substantially
exceeded the minimum requirements.
Required licensing. Our non-insurance company subsidiaries are subject to and in compliance with the
licensing requirements of the department of insurance in each state in which they produce business. These
licenses govern, among other things, the types of insurance coverages, agency and claims services and products
that we may offer consumers in these states. Such licenses typically are issued only after we file an appropriate
application and satisfy prescribed criteria. Generally, each state requires one officer to maintain an agent
license. Claims adjusters employed by us are also subject to the licensing requirements of each state in which
they conduct business. Each employed claim adjuster either holds or has applied for the required licenses. Our
premium finance subsidiaries are subject to licensing, financial reporting and certain financial requirements
imposed by the Texas Department of Insurance, as well as regulations promulgated by the Texas Office of
Consumer Credit Commissioner.
Regulation of insurance rates and approval of policy forms. The insurance laws of most states in which our
subsidiaries operate require insurance companies to file insurance rate schedules and insurance policy forms
for review and approval. State insurance regulators have broad discretion in judging whether our rates are
adequate, not excessive and not unfairly discriminatory and whether our policy forms comply with law. The
speed at which we can change our rates depends, in part, on the method by which the applicable state’s rating
laws are administered. Generally, state insurance regulators have the authority to disapprove our rates or request
changes in our rates.
Restrictions on cancellation, non-renewal or withdrawal. Many states have laws and regulations that limit an
insurance company’s ability to exit a market. For example, certain states limit an automobile insurance
company’s ability to cancel or not renew policies. Some states prohibit an insurance company from withdrawing
from one or more lines of business in the state, except pursuant to a plan approved by the state insurance
department. In some states, this applies to significant reductions in the amount of insurance written, not just to
a complete withdrawal. State insurance departments may disapprove a plan that may lead to market disruption.
Investment restrictions. We are subject to state laws and regulations that require diversification of our
investment portfolios and that limit the amount of investments in certain categories. Failure to comply with
these laws and regulations would cause non-conforming investments to be treated as non-admitted assets for
purposes of measuring statutory surplus and, in some instances, would require divestiture.
Trade practices. The manner in which we conduct the business of insurance is regulated by state statutes in an
effort to prohibit practices that constitute unfair methods of competition or unfair or deceptive acts or practices.
Prohibited practices include disseminating false information or advertising; defamation; boycotting, coercion
and intimidation; false statements or entries; unfair discrimination; rebating; improper tie-ins with lenders and
the extension of credit; failure to maintain proper records; failure to maintain proper complaint handling
procedures; and making false statements in connection with insurance applications for the purpose of obtaining
a fee, commission or other benefit.
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Unfair claims practices. Generally, insurance companies, adjusting companies and individual claims adjusters
are prohibited by state statutes from engaging in unfair claims practices on a flagrant basis or with such
frequency to indicate a general business practice. Examples of unfair claims practices include:
• misrepresenting pertinent facts or insurance policy provisions relating to coverages at issue;
•
•
•
•
•
•
failing to acknowledge and act reasonably promptly upon communications with respect to claims
arising under insurance policies;
failing to adopt and implement reasonable standards for the prompt investigation and settlement of
claims arising under insurance policies;
failing to affirm or deny coverage of claims within a reasonable time after proof of loss statements
have been completed;
attempting to settle a claim for less than the amount to which a reasonable person would have
believed such person was entitled;
attempting to settle claims on the basis of an application that was altered without notice to, or
knowledge and consent of, the insured;
compelling insureds to institute suits to recover amounts due under policies by offering
substantially less than the amounts ultimately recovered in suits brought by them;
•
refusing to pay claims without conducting a reasonable investigation;
• making claim payments to an insured without indicating the coverage under which each payment
is being made;
• delaying the investigation or payment of claims by requiring an insured, claimant or the physician
of either to submit a preliminary claim report and then requiring the subsequent submission of
formal proof of loss forms, both of which submissions contain substantially the same information;
•
failing, in the case of claim denials or offers of compromise or settlement, to promptly provide a
reasonable and accurate explanation of the basis for such actions; and
• not attempting in good faith to effectuate prompt, fair and equitable settlements of claims in which
liability has become reasonably clear.
Employees
As of December 31, 2018, we employed 439 people on a full-time basis. None of our employees are represented
by labor unions. We consider our employee relations to be good.
Available Information
The Company’s executive offices are located at 777 Main Street, Suite 1000 Fort Worth, Texas 76102. The
Company’s mailing address is 777 Main Street, Suite 1000 Fort Worth, Texas 76102. Its telephone number is
(817) 348-1600. The Company’s website address is www.hallmarkgrp.com. The Company files annual,
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quarterly and current reports, proxy statements and other information and documents with the U.S. Securities
and Exchange Commission (the “SEC”), which are made available to read and copy at the SEC’s Public
Reference Room at 100 F Street, N.E., Washington, D.C. 20549. You may obtain information on the operation
of the Public Reference Room by contacting the SEC at 1-800-SEC-0330. Reports filed with the SEC are also
made available at www.sec.gov. The Company makes available free of charge on its website its annual report
on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K and amendments to those reports
filed with or furnished to the SEC pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 as
soon as reasonably practical after it electronically files them with or furnishes them to the SEC.
Item 1A. Risk Factors.
Our success depends on our ability to price accurately the risks we underwrite.
Our results of operations and financial condition depend on our ability to underwrite and set premium rates
accurately for a wide variety of risks. Adequate rates are necessary to generate premiums sufficient to pay
losses, loss settlement expenses and underwriting expenses and to earn a profit. To price our products
accurately, we must collect and properly analyze a substantial amount of data; develop, test and apply
appropriate pricing techniques; closely monitor and timely recognize changes in trends; and project both
severity and frequency of losses with reasonable accuracy. Our ability to undertake these efforts successfully,
and as a result price our products accurately, is subject to a number of risks and uncertainties, some of which
are outside our control, including:
•
•
the availability of sufficient reliable data and our ability to properly analyze available data;
the uncertainties that inherently characterize estimates and assumptions;
• our selection and application of appropriate pricing techniques; and
•
changes in applicable legal liability standards and in the civil litigation system generally.
Consequently, we could underprice risks, which would adversely affect our profit margins, or we could
overprice risks, which could reduce our sales volume and competitiveness. In either case, our profitability could
be materially and adversely affected.
Our results may fluctuate as a result of cyclical changes in the property/casualty insurance industry.
Our revenue is primarily attributable to property/casualty insurance, which as an industry is cyclical in nature
and has historically been characterized by soft markets followed by hard markets. A soft market is a period of
relatively high levels of price competition, less restrictive underwriting standards and generally low premium
rates. A hard market is a period of capital shortages resulting in lack of insurance availability, relatively low
levels of competition, more selective underwriting of risks and relatively high premium rates. If we find it
necessary to reduce premiums or limit premium 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.
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Estimating reserves is inherently uncertain. If our loss reserves are not adequate, it will have an
unfavorable impact on our results.
We maintain loss reserves to cover our estimated ultimate liability for unpaid losses and LAE for reported and
unreported claims incurred as of the end of each accounting period. Reserves represent management’s estimates
of what the ultimate settlement and administration of claims will cost and are not reviewed by an independent
actuary. These estimates, which generally involve actuarial projections, are based on management’s assessment
of facts and circumstances then known, as well as estimates of future trends in claim severity and frequency,
judicial theories of liability, and other factors. These variables are affected by both internal and external events,
such as changes in claims handling procedures, inflation, judicial trends and legislative changes. Many of these
factors are not quantifiable. Additionally, there may be a significant lag between the occurrence of an event and
the time it is reported to us. The inherent uncertainties of estimating reserves are greater for certain types of
liabilities, particularly those in which the various considerations affecting the type of claim are subject to change
and in which long periods of time may elapse before a definitive determination of liability is made. Reserve
estimates are continually refined in a regular and ongoing process as experience develops and further claims
are reported and settled. Adjustments to reserves are reflected in the results of the periods in which such
estimates are changed. For example, a 1% change in December 31, 2018 unpaid losses and LAE would have
produced a $5.3 million change to pretax earnings. Our gross loss and LAE reserves totaled $527.2 million at
December 31, 2018. Our loss and LAE reserves, net of reinsurance recoverable on unpaid loss and LAE, were
$305.5 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
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reduction of our A.M. Best rating below “A-” would prevent us from issuing policies to insureds or potential
insureds with such ratings requirements.
Lenders and reinsurers also use our A.M. Best ratings as a factor in deciding whether to transact business with
us. The failure of our insurance company subsidiaries to maintain their current ratings could dissuade a lender
or reinsurance company from conducting business with us or might increase our interest or reinsurance costs.
In addition, a ratings downgrade by A.M. Best below “A-” would require us to post collateral in support of our
obligations under certain of our reinsurance agreements pursuant to which we assume business.
The loss of key executives could disrupt our business.
Our success will depend in part upon the continued service of certain key executives. Our success will also
depend on our ability to attract and retain additional executives and personnel. The loss of key personnel, or
our inability to recruit and retain additional qualified personnel, could cause disruption in our business and
could prevent us from fully implementing our business strategies, which could materially and adversely affect
our business, growth and profitability.
Our industry is very competitive, which may unfavorably impact our results of operations.
The property/casualty insurance market, our primary source of revenue, is highly competitive and, except for
regulatory considerations, has very few barriers to entry. According to A.M. Best, there were 2,994
property/casualty insurance companies and 2,060 property/casualty insurance groups operating in North
America as of July 2, 2018. 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
30
December 31, 2018, we had a total of $385.0 million due us from reinsurers, including $252.0 million of
recoverables from losses and $133.0 million in ceded unearned premiums. The largest amount due us from a
single reinsurer as of December 31, 2018 was $71.8 million reinsurance and premium recoverable from Swiss
Reinsurance America Corporation. If any of our reinsurers are unable or unwilling to pay amounts they owe us
in a timely fashion, we could suffer a significant loss or a shortage of liquidity, which would have a material
adverse effect on our business and results of operations.
Catastrophic losses are unpredictable and may adversely affect our results of operations, liquidity and
financial condition.
Property/casualty insurance companies are subject to claims arising out of catastrophes that may have a
significant effect on their results of operations, liquidity and financial condition. Catastrophes can be caused by
various events, including hurricanes, windstorms, earthquakes, hail storms, explosions, severe winter weather
and fires, and may include man-made events, such as terrorist attacks. The incidence, frequency, and severity
of catastrophes are inherently unpredictable. The extent of losses from a catastrophe is a function of both the
total amount of insured exposure in the area affected by the event and the severity of the event.
Claims from catastrophic events could reduce our net income, cause substantial volatility in our financial results
for any fiscal quarter or year or otherwise adversely affect our financial condition, liquidity or results of
operations. Catastrophes may also negatively affect our ability to write new business. Increases in the value
and geographic concentration of insured property and the effects of inflation could increase the severity of
claims from catastrophic events in the future.
Catastrophe models may not accurately predict future losses.
Along with other insurers in the industry, we use models developed by third-party vendors in assessing our
exposure to catastrophe losses that assume various conditions and probability scenarios. However, these models
do not necessarily accurately predict future losses or accurately measure losses currently incurred. Catastrophe
models, which have been evolving since the early 1990s, use historical information about various catastrophes
and detailed information about our in-force business. While we use this information in connection with our
pricing and risk management activities, there are limitations with respect to their usefulness in predicting losses
in any reporting period. Examples of these limitations are significant variations in estimates between models
and modelers and material increases and decreases in model results due to changes and refinements of the
underlying data elements and assumptions. Such limitations lead to questionable predictive capability and post-
event measurements that have not been well understood or proven to be sufficiently reliable. In addition, the
models are not necessarily reflective of company or state-specific policy language, demand surge for labor and
materials or loss settlement expenses, all of which are subject to wide variation by catastrophe. Because the
occurrence and severity of catastrophes are inherently unpredictable and may vary significantly from year
to year, historical results of operations may not be indicative of future results of operations.
We are subject to comprehensive regulation, and our results may be unfavorably impacted by these
regulations.
We are subject to comprehensive governmental regulation and supervision. Most insurance regulations are
designed to protect the interests of policyholders rather than of the stockholders and other investors of the
insurance companies. These regulations, generally administered by the department of insurance in each state in
which we do business, relate to, among other things:
•
approval of policy forms and rates;
31
•
•
•
•
•
•
standards of solvency, including risk-based capital measurements, which are a measure developed
by the National Association of Insurance Commissioners and used by the state insurance regulators
to identify insurance companies that potentially are inadequately capitalized;
licensing of insurers and their agents;
restrictions on the nature, quality and concentration of investments;
restrictions on the ability of insurance company subsidiaries to pay dividends;
restrictions on transactions between insurance company subsidiaries and their affiliates;
requiring certain methods of accounting;
• periodic examinations of operations and finances;
•
•
•
•
•
•
the use of non-public consumer information and related privacy issues;
the use of credit history in underwriting and rating;
limitations on the ability to charge policy fees;
the acquisition or disposition of an insurance company or of any company controlling an insurance
company;
involuntary assignments of high-risk policies, participation in reinsurance facilities and
underwriting associations, assessments and other governmental charges;
restrictions on the cancellation or non-renewal of policies and, in certain jurisdictions, withdrawal
from writing certain lines of business;
• prescribing the form and content of records of financial condition to be filed;
•
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.
32
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 2019 by our insurance company subsidiaries is $22.9 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.
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
33
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, 2018,
87% 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,
29% 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, 2018 was $545.9 million. If market interest rates
were to increase 1%, the fair value of our fixed-income securities would decrease by approximately $7.6 million
as of December 31, 2018. The calculated change in fair value was determined using duration modeling
assuming no prepayments.
In addition to the general risks described above, although 76% 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, 2018, Hallmark
had $50 thousand in its investment portfolio exposed to sub-prime mortgages and $13.6 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.
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 products 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.
34
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 54% of our gross written premiums for 2018: Texas (33%),
California (9%), Arizona (5%), Florida (4%) and Oklahoma (3%). Our revenues and profitability are subject to
the prevailing regulatory, legal, economic, political, demographic, competitive, weather and other conditions
in the principal states in which we do business. Changes in any of these conditions could make it less attractive
for us to do business in such states and would have a more pronounced effect on us compared to companies
that are more geographically diversified. In addition, our exposure to severe losses from localized natural perils,
such as windstorms or hailstorms, is increased in those areas where we have written significant numbers of
property/casualty insurance policies.
The exclusions and limitations in our policies may not be enforceable.
Many of the policies we issue include exclusions or other conditions that define and limit coverage, which
exclusions and conditions are designed to manage our exposure to certain types of risks and expanding theories
of legal liability. In addition, many of our policies limit the period during which a policyholder may bring a
claim under the policy, which period in many cases is shorter than the statutory period under which these claims
35
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 currently 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 $53,299 per month pursuant to a lease which terminates June 30, 2019
pursuant to our exercise of an early termination option.
36
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 currently located at 13727 Noel Road, Dallas, Texas. These leased
premises consist of 15,072 square feet of office space. The rent is currently $29,830 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
Chicago, Illinois
Atlanta, Georgia
Jersey City, New Jersey
Glendale, California
Monthly Rent Lease Expiration
$
$
$
$
12,471
June 30, 2020
12,305 November 30, 2026
5,136 December 31, 2020
July 31, 2020
2,627
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 $30,525
per month pursuant to a lease that expires December 31, 2020.
We have entered into a lease for new office space in a high-rise office building commonly known as Two
Lincoln Centre located at 5420 LBJ Freeway, Dallas, Texas. We intend to relocate our corporate headquarters,
our Standard Commercial P&C and our Specialty Commercial operating units. The leased premises consist of
47,172 square feet of office space (“Suite 1100”) and approximately 3,000 square feet of storage space (“Suite
380”). The initial term of the lease commences June 1, 2019 and expires May 31, 2032, and we have the right
to renew the lease for up to ten years at market rental rates prevailing at the time of renewal. The initial base
rent for Suite 1100 of $121,861 per month is waived for the first 12 months of the lease and the initial base rent
for Suite 380 of $4,250 per month is waived for the first 48 months of the lease. We estimate that additional
rent based on a share of certain expenses of the building will initially be approximately $5,000 per month.
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.
37
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, 2017.
Period
Year Ended December 31, 2018:
First quarter
Second quarter
Third quarter
Fourth quarter
Year Ended December 31, 2017:
First quarter
Second quarter
Third quarter
Fourth quarter
High Sale
Low Sale
$
$
10.70 $
10.54
11.31
11.58
11.98 $
11.62
11.83
11.76
8.62
8.85
9.49
9.82
10.14
9.94
9.91
9.95
Holders
As of March 1, 2019, there were 1,649 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 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.
38
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, 2018.
Number of securities to be
issued upon exercise of
Weighted-average
exercise price of
Number of securities
remaining available for future
issuance under equity
compensation plans
Plan Category
Equity compensation plans
approved by security holders
Equity compensation plans not
approved by security holders
Total
outstanding options, warrants outstanding options, [excluding securities reflected
warrants and rights
(b)
in column (a)](1)
(c)
and rights
(a)
244,157 $
—
244,157 $
6.63
—
6.63
1,491,655
—
1,491,655
(1) Securities remaining available for future issuance are net of a maximum of 508,345 shares of common
stock issuable pursuant to outstanding restricted stock units, subject to applicable vesting requirements and
performance criteria. See Note 13 to the audited consolidated financial statements included in this report.
Issuer Repurchases
Our stock buyback program initially announced on April 18, 2008, authorized the repurchase of up to 1,000,000
shares of our common stock in the open market or in privately negotiated transactions (the “Stock Repurchase
Plan”). On January 24, 2011, we announced an increased authorization to repurchase up to an additional
3,000,000 shares. The Stock Repurchase Plan does not have an expiration date.
The following table furnishes information for purchases made pursuant to the Stock Repurchase Plan during
the quarter ended December 31, 2018:
Period
Average
Total Number of Price Paid
Shares Purchased Per Share
Cumulative Number
of Shares Purchased
as Part of Publicly
Announced Plan
Maximum Number of
Shares that May Yet
Be Purchased Under
the Plan
October 1st- October 31st
November 1st - November 30th
December 1st - December 31st
- $
- $
31,976 $
-
-
10.71
3,229,135
3,229,135
3,261,111
770,865
770,865
738,889
Item 6. Selected Financial Data
Not required for smaller reporting company.
39
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 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.
40
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: On January 1, 2018, we adopted ASU 2016-01, “Recognition and Measurement of
Financial Assets and Financial Liabilities”. ASU 2016-01 requires equity investments that are not consolidated
or accounted for under the equity method of accounting to be measured at fair value with changes in fair value
recognized in net income each reporting period. As a result of the new standard, equity securities with readily
determinable fair values are no longer required to be evaluated for other-than-temporary-impairment.
Prior to the adoption of ASU 2016-01, 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 was determined that an equity investment
was other-than-temporarily impaired, the security was written down to fair value, and the amount of the
impairment was included in earnings as a realized investment loss. The fair value then became the new cost
basis of the investment, and any subsequent recoveries in fair value were recognized at disposition. We
recognized a realized loss when impairment was deemed to be other-than-temporary even if a decision to sell
an equity investment had not been made. If we decided to sell a temporarily impaired available-for-sale equity
investment and we did not expect the fair value of the equity investment to fully recover prior to the expected
41
time of sale, the investment was deemed to be other-than-temporarily impaired in the period in which the
decision to sell was 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
42
available data in order to approximate fair value. This data may be internally developed and consider risk
premiums that a market participant would require. Investment securities classified within Level 3 include other
less liquid investment securities.
Deferred policy acquisition costs. Policy acquisition costs (mainly commission, underwriting and marketing
expenses) that vary with and are primarily related to the successful acquisition of new and renewal insurance
contracts are deferred and charged to operations over periods in which the related premiums are earned. Ceding
commissions from reinsurers, which include expense allowances, are deferred and recognized over the period
premiums are earned for the underlying policies reinsured.
The method followed in computing deferred policy acquisition costs limits the amount of such deferred costs
to their estimated realizable value. A premium deficiency exists if the sum of expected claim costs and claim
adjustment expenses, unamortized acquisition costs, and maintenance costs exceeds related unearned premiums
and expected investment income on those unearned premiums, as computed on a product line basis. We
routinely evaluate the realizability of deferred policy acquisition costs. At December 31, 2018 and 2017, 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, 2018 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 2018 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 2018. The income projections also include loss and LAE assumptions which
43
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 2018. However, a 13% 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 20% decline in the fair value of our Specialty Personal Lines operating unit, a 61%
decline in the fair value of our excess and umbrella component or a 29% 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 2018. 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,
2018. Through December 31, 2018, 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.)
44
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, 2018 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.
The range of unpaid losses and LAE estimated by our actuary as of December 31, 2018 was $426.5 million to
$538.8 million. Our best estimate of unpaid losses and LAE as of December 31, 2018 is $527.2 million. Our
carried reserve for unpaid losses and LAE as of December 31, 2018 is comprised of $242.3 million in case
reserves and $284.9 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 $44.6 million higher than the midpoint, or 97.8% of the high end, of the actuarial range at
December 31, 2018 as compared to $39.9 million above the midpoint, or 96.3% of the high end, of the actuarial
range at December 31, 2017. 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.
45
Results of Operations
Comparison of Years ended December 31, 2018 and December 31, 2017
Management overview. During fiscal 2018, our total revenues were $379.3 million, which was $6.2 million
less than the $385.5 million in total revenues for fiscal 2017. During the year ended December 31, 2018, we
reported net income before tax of $12.8 million as compared to a net loss before tax of $16.6 million during the
same period of 2017.
This decrease in revenue was largely due to investment losses of $10.2 million during the year ended December
31, 2018 as compared to investment losses of $0.2 million during the same period of 2017, as well as lower net
investment income and lower other income, partially offset by higher net earned premiums, higher commissions
and fees and higher finance charges. The investment losses for the year ended December 31, 2018 included
$9.3 million in loss attributable to the adoption effective January 1, 2018 of Accounting Standards Update No.
2016-01, “Recognition and Measurement of Financial Assets and Financial Liabilities” (“ASU 2016-01”)
which requires equity investments that are not consolidated or accounted for under the equity method of
accounting to be measured at fair value with changes in fair value recognized in net income. We adopted ASU
2016-01 using the modified-retrospective approach pursuant to which we recorded a cumulative effect
adjustment to retained earnings of $17.0 million as of January 1, 2018 and decreased accumulated other
comprehensive income by the same amount and did not restate prior periods.
The increase in income before tax for the year ended December 31, 2018 was due primarily to decreased losses
and loss adjustment expenses (“LAE”) of $32.3 million and lower operating expenses of $3.4 million as
compared to the same periods in 2017, partially offset by the decrease in revenue discussed. The decrease in
losses and LAE was primarily the result of unfavorable net prior year loss reserve development of $40.1 million
for the year ended December 31, 2017 as compared to $6.0 million of unfavorable net prior year loss reserve
development for the year ended December 31, 2018. The decrease in operating expenses was primarily due to
lower production related expenses due primarily to increased ceding commission in our Specialty Commercial
Segment, partially offset by increased salary and related expenses, professional service fees and other operating
expenses during the year ended December 31, 2018 as compared to the same period during 2017.
We reported net income of $10.3 million for the year ended December 31, 2018, as compared to a net loss of
$11.6 million for the year ended December 31, 2017. On a diluted per share basis, net income was $0.57 per
share for fiscal 2018 as compared to a net loss of $0.63 per share for fiscal 2017. Our effective tax rate was
19.2% for the year ended December 31, 2018 as compared to 30.3% for the same period in 2017. The effective
tax rate for 2018 was favorably impacted by the lower statutory rate from the enactment of the Tax Cuts and
Jobs Act (“TCJA”) on December 22, 2017. The rate for 2017 varied from the statutory tax rate primarily due
to a $1.3 million charge from the revaluation of deferred tax balances from a 35% statutory rate to the new 21%
statutory tax rate under the TCJA as well as a correction of an immaterial error in prior years’ deferred tax on
bond premium amortization, partially offset by the amount of tax exempt income in relation to total pre-tax
income.
46
Segment information
The following is additional business segment information for the years ended December 31, 2018 and 2017 (in
thousands):
Year Ended December 31,
Specialty Commercial
Segment
Standard Commercial
Segment
2018
$ 501,806
(250,075 )
251,731
2017
$ 464,714
(199,692 )
265,022
2018
$
86,121
(16,899 )
69,222
$
2017
78,228
(8,940 )
69,288
Personal Segment
2017
2018
$
$
61,214
75,088
(29,941 )
(32,243 )
31,273
42,845
$
6,455
258,186
(5,936 )
259,086
3,099
72,321
(3,070 )
66,218
(10,265 )
32,580
4,460
35,733
Gross premiums written
Ceded premiums written
Net premiums written
Change in unearned
premiums
Net premiums earned
Corporate
Consolidated
2018
2017
— $
—
—
—
—
2018
— $ 663,015
(299,217 )
—
363,798
—
2017
$ 604,156
(238,573 )
365,583
—
—
(711 )
363,087
(4,546 )
361,037
Total revenues
280,283
277,946
76,548
70,302
38,623
40,462
(16,186 )
(3,189 ) 379,268
385,521
Losses and loss adjustment
expenses
194,268
213,050
39,396
45,227
22,364
30,031
—
—
256,028
288,308
Pre-tax income (loss)
28,780
2,012
13,090
2,440
3,061
(3,058 )
(32,128 ) (17,966 )
12,803
(16,572 )
Net loss ratio (1)
Net expense ratio (1)
Net combined ratio (1)
Favorable (Unfavorable)
Prior Year Development
75.2 %
22.6 %
97.8 %
82.2 %
23.7 %
105.9 %
54.5 %
33.5 %
88.0 %
68.3 %
34.5 %
102.8 %
68.6 %
26.3 %
94.9 %
84.0 %
29.3 %
113.3 %
70.5 %
26.6 %
97.1 %
79.9 %
28.0 %
107.9 %
(16,457 )
(40,477 )
8,993
970
1,511
(598 )
(5,953 )
(40,105 )
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 $501.8 million for the year ended
December 31, 2018, which was $37.1 million, or 8%, more than the $464.7 million reported for the same period
in 2017. The increase in gross premiums written were primarily the result of increased premium production in
our Specialty Commercial operating unit, partially offset by lower premium production in our Contract Binding
operating unit. Net premiums written were $251.7 million for the year ended December 31, 2018 as compared
to $265.0 million reported for the same period in 2017. The decrease in net premiums written was due to a
change in mix towards business with higher ceded premium as a percentage of the gross premium.
The $280.3 million of total revenue for the year ended December 31, 2018 was $2.4 million higher than the
$277.9 million reported for 2017. This increase in revenue was primarily due to higher net investment income
of $2.5 million and higher commission and fees of $1.0 million, partially offset by lower other income of $0.2
million and lower net premiums earned of $0.9 million due to decreased premium production in our Contract
Binding operating unit, partially offset by increased premium production in our Specialty Commercial
operating unit.
Pre-tax income for the Specialty Commercial Segment of $28.8 million for the year ended December 31, 2018
was $26.8 million higher than the $2.0 million reported for the same period in 2017. This increase in pre-tax
47
income was primarily due to lower loss and LAE expenses of $18.8 million, lower operating expense of $5.6
million and the increased revenue discussed above.
Our Contract Binding operating unit reported a $44.9 million decrease in loss and LAE due primarily to $11.2
million of unfavorable prior year net loss reserve development recognized during the year ended December 31,
2018 as compared to $38.6 million of unfavorable prior year net loss reserve development recognized for the
prior year. Our Specialty Commercial operating unit reported a $26.1 million increase in loss and LAE which
consisted of (a) a $9.3 million increase in losses and LAE attributable to our professional liability insurance
products due primarily to increased net earned premiums as well as net unfavorable prior year loss reserve
development as compared to favorable prior year loss development during the same period of 2017, (b) a $7.7
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 $3.9 million increase in losses and
LAE in our commercial umbrella and primary/excess liability line of business due primarily to increased net
earned premiums as well as increased net unfavorable prior year loss reserve development as compared to the
same period during 2017, (d) a $3.8 million increase in losses and LAE in our specialty programs due primarily
to increased net earned premiums, (e) a $1.1 million increase in losses and LAE in our satellite launch insurance
line of business due to higher current accident year loss trends as well as net unfavorable prior year loss reserve
development during 2018, and (f) a $0.3 million increase in losses and LAE in our general aviation line of
business due primarily to higher current accident year loss trends, partially offset by lower unfavorable prior
year loss development as compared to the same period during 2017. The $5.6 million decrease in operating
expense was primarily the result of lower production related expenses of $9.2 million due primarily to increased
ceding commissions in our Specialty Commercial operating unit, partially offset by increased salary and related
expenses of $2.0 million, increased professional services of $0.8 million, increased occupancy and other
operating expenses of $0.7 million and increased travel and related expenses of $0.1 million.
The Specialty Commercial Segment reported a net loss ratio of 75.2% for the year ended December 31, 2018
as compared to 82.2% for the same period during 2017. The gross loss ratio before reinsurance was 73.4% for
the year ended December 31, 2018 as compared to 76.5% for the same period in 2017. The lower gross and net
loss ratios were largely the result of $16.5 million of unfavorable prior year net loss reserve development for
the year ended December 31, 2018 as compared to unfavorable prior year net loss reserve development of $40.5
million for the same period of 2017, as well as lower gross current accident year loss trends during the year
ended December 31, 2018 as compared to the same period during 2017. The Specialty Commercial Segment
reported $6.0 million of net catastrophe losses during the year ended December 31, 2018 as compared to $3.8
million of net catastrophe losses during the same period of 2017. The Specialty Commercial Segment reported
a net expense ratio of 22.6% for the year ended December 31, 2018 as compared to 23.7% for the same period
of 2017. The decrease in the expense ratio was due predominately to increased ceding commissions in our
Specialty Commercial operating unit.
Standard Commercial Segment.
Gross premiums written for the Standard Commercial Segment were $86.1 million for the year ended December
31, 2018, which was $7.9 million, or 10%, more than the $78.2 million reported for the same period in 2017.
The gross premiums written for the Standard Commercial P&C operating unit increased $8.2 million, offset by
a decrease of $0.3 million due to the discontinued marketing of new and renewal occupational accident policies.
Net premiums written were $69.2 million for the year ended December 31, 2018 as compared to $69.3 million
reported for the same period in 2017. The net premiums written include a $0.2 million increase in our Standard
Commercial P&C operating unit for the year ended December 31, 2018 as compared to the same period during
2017, offset by a decrease in premium volume of $0.2 million due to the discontinued marketing of new and
48
renewal occupational accident policies and a $0.1 million decrease due to the discontinued marketing of
workers compensation policies.
Total revenue for the Standard Commercial Segment of $76.5 million for the year ended December 31, 2018
was $6.2 million more than the $70.3 million reported during the year ended December 31, 2017. This 9%
increase was primarily due to higher net premiums earned of $6.1 million primarily as a result of increased net
premiums earned of $6.6 million in our Standard Commercial P&C operating unit and higher commissions and
fees of $0.3 million, partially offset by lower net investment income and finance charges of $0.2 million for the
year ended December 31, 2018 as compared to the same period in 2017.
Our Standard Commercial Segment reported pre-tax income of $13.1 million for the year ended December 31,
2018, which was $10.7 million higher than the $2.4 million reported for the same period of 2017. The increase
in pre-tax income was the result of the increased revenue discussed above and lower losses and LAE of $5.8
million, partially offset by higher operating expenses of $1.3 million primarily as the result of higher production
related expenses.
The net loss ratio for the year ended December 31, 2018 was 54.5% as compared to the 68.3% reported for the
year ended December 31, 2017. The gross loss ratio before reinsurance was 61.9% for the year ended December
31, 2018 as compared to 63.3% for the prior year. The decreases in the gross and net loss ratios were due
predominantly to favorable prior year net loss reserve development of $9.0 million during the year ended
December 31, 2018 as compared to $1.0 million of favorable prior year net loss reserve development for the
same period of 2017. Further contributing to the lower gross and net loss ratios were lower catastrophe losses
during the year ended December 31, 2018 as compared to the same period of 2017. The Standard Commercial
Segment reported $3.3 million of net catastrophe losses during the year ended December 31, 2018 as compared
to $3.6 million of net catastrophe losses during the same period of 2017. The Standard Commercial Segment
reported a net expense ratio of 33.5% during the year ended December 31, 2018 as compared to 34.5% for the
same period of 2017. The decrease in the expense ratio was primarily due to the increased earned premium.
Personal Segment.
Gross premiums written for the Personal Segment were $75.1 million for the year ended December 31, 2018,
which was $13.9 million more than the $61.2 million reported for the same period in 2017. Net premiums
written for our Personal Segment were $42.8 million for the year ended December 31, 2018, which was an
increase of $11.5 million from the $31.3 million reported for the same period of 2017. The increase in gross
written premiums was due primarily to increased production in our current geographical footprint. The increase
in net written premiums was also due to increased production as well as increased retention of business effective
October 1, 2018.
Total revenue for the Personal Segment decreased 5% to $38.6 million for the year ended December 31, 2018
from $40.4 million for the same period during 2017. The $1.8 million decrease in revenue was primarily the
result of lower net premiums earned of $3.1 million due to the earning impact of intentionally reducing certain
underperforming portions of this business to address loss ratio performance early in 2018 and the deferred
earning impact of the subsequent growth later in 2018, partially offset by higher finance charges of $1.3 million
reported during the year ended December 31, 2018 as compared to the same period during 2017.
Our Personal Segment reported pre-tax income of $3.1 million for the year ended December 31, 2018 as
compared to a pre-tax loss of $3.1 million for the same period of 2017. The pre-tax income was primarily the
result of decreased losses and LAE of $7.7 million and lower operating expenses of $0.3 million for the year
49
ended December 31, 2018 as compared to the same period during 2017, partially offset by the decreased revenue
discussed above.
The Personal Segment reported a net loss ratio of 68.6% for the year ended December 31, 2018 as compared to
84.0% for the same period of 2017. The gross loss ratio before reinsurance was 66.7% for the year ended
December 31, 2018 as compared to 80.1% for the same period in 2017. The lower gross and net loss ratios were
primarily the result of favorable prior year net loss reserve development of $1.5 million during the year ended
December 31, 2018 as compared to unfavorable net loss reserve development of $0.6 million reported during
the same period of 2017, as well as lower current accident year loss trends. The Personal Segment reported a
net expense ratio of 26.3% for the year ended December 31, 2018 as compared to 29.3% for the same period
of 2017. The decrease in the expense ratio was due predominately to higher finance charges, partially offset by
lower net premiums earned.
Corporate.
Total revenue for Corporate decreased by $13.0 million for the year ended December 31, 2018 as compared to
the same period the prior year. This decrease in total revenue was due predominately to investment losses of
$10.2 million during the year ended December 31, 2018 as compared to investment losses of $0.2 million
reported for the same period of 2017 and lower net investment income of $3.0 million for the year ended
December 31, 2018 as compared to the same period during 2017. The investment losses during 2018 include
$9.3 million in loss attributable to the adoption of ASU 2016-01 effective January 1, 2018.
Corporate pre-tax loss was $32.1 million for the year ended December 31, 2018 as compared to a pre-tax loss
of $18.0 million for the same period of 2017. The increase in pre-tax loss was primarily due to the lower
revenue discussed above and higher operating expenses of $1.1 million.
Operating expenses increased $1.1 million primarily as a result of higher salary and related expenses of $0.9
million due primarily to higher incentive compensation accruals during the year ending December 31, 2018 as
compared to the same period during 2017. Further contributing to the higher operating expenses were increased
occupancy and related expenses of $0.4 million primarily related to the early termination of our Ft. Worth office
lease. These increases to operating expenses were partially offset by lower professional service fees and other
expenses of $0.2 million.
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, 2018, we had $15.6 million in unrestricted cash and cash equivalents, as well as $0.8 million in
debt securities, at the holding company and our non-insurance subsidiaries. As of that date, our insurance
subsidiaries held $20.0 million of unrestricted cash and cash equivalents as well as $545.1 million in debt
securities with an average modified duration of 1.4 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
50
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 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 2019, the aggregate ordinary
dividend capacity of these subsidiaries is $33.9 million, of which $22.9 million is available to Hallmark. As a
county mutual, dividends from HCM are payable to policyholders. During the years ended December 31, 2018
and 2017 our insurance company subsidiaries paid $5.5 million and $11.4 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 2018 and 2017 our insurance subsidiaries did not pay management
fees to Hallmark or our non-insurance company subsidiaries.
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, 2018, our insurance company subsidiaries reported statutory capital
and surplus of $247.0 million, substantially greater than the minimum requirements for each state. Each of our
insurance company subsidiaries is also required to satisfy certain risk-based capital requirements. (See, “Item 1.
Business – Insurance Regulation – Risk-based Capital Requirements.”) As of December 31, 2018, the adjusted
capital under the risk-based capital calculation of each of our insurance company subsidiaries substantially
exceeded the minimum requirements. Our total statutory net premium-to-surplus percentage for the years ended
December 31, 2018 and 2017 was 147% and 157%, respectively.
Comparison of December 31, 2018 to December 31, 2017
On a consolidated basis, our cash and investments, excluding restricted cash and investments, at December 31,
2018 were $663.5 million compared to $726.3 million at December 31, 2017. The primary reasons for this
decrease in unrestricted cash and investments were cash used by operations, a decrease in investment fair
values, purchases of property and equipment and repurchases of our common stock.
Comparison of Years Ended December 31, 2018 and December 31, 2017
Net cash used by our consolidated operating activities was $32.9 million for the year ended December 31, 2018
compared to net cash flow provided by operations of $7.2 million for the year ended December 31, 2017. The
decrease in operating cash flow was driven by a temporary acceleration of paid claims as we improved our
claims practices to address the increase in frequency and severity in our commercial auto portfolio as well as
increased paid operating expenses. These decreases in operating cash flow were partially offset by higher
collected net premiums, higher collected finance charges and collected income tax recoverable during the year
ended December 31, 2018 as compared to the same period the prior year.
Net cash provided by investing activities during the year ended December 31, 2018 was $7.3 million as
compared to net cash used in investing activities of $21.4 million for the prior year. The cash provided by
investing activities during the year ended December 31, 2018 was comprised of a decrease in purchases of debt
and equity securities of $83.2 million and a decrease of $0.6 million in purchases of property and equipment,
partially offset by a decrease of $55.1 million in maturities, sales and redemptions of investment securities.
51
Net cash used in financing activities during the year ended December 31, 2018 was $1.6 million as a result of
$1.8 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, 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.
Credit Facilities
Our Second Restated Credit Agreement with Frost Bank (“Frost”) dated June 30, 2015, as amended to date,
provides a $15.0 million revolving credit facility (“Facility A”), with a $5.0 million letter of credit sub-facility.
The outstanding balance of the Facility A bears interest at a rate equal to the prime rate or LIBOR plus 2.5%, at
our election. We pay an annual fee of 0.25% of the average daily unused balance of Facility A and letter of
credit fees at the rate of 1.00% per annum. All principal and accrued interest on Facility A becomes due and
payable on June 30, 2020. As of December 31, 2018, we had no outstanding borrowings under Facility A.
The Second Restated Credit Agreement with Frost also provides a $30.0 million revolving credit facility
(“Facility B”), in addition to Facility A. We may use Facility B loan proceeds solely for the purpose of making
capital contributions to AHIC and HIC. We may borrow, repay and reborrow under 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, 2018, 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 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, 2018, the principal balance of our Trust I subordinated debt was $30.9
million and the interest rate was 6.04% 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
52
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, 2018, the principal balance of our Trust II subordinated
debt was $25.8 million and the interest rate was 5.69% per annum.
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.
Not required for smaller reporting company.
53
Item 8. Financial Statements and Supplementary Data.
The following consolidated financial statements of Hallmark and its subsidiaries are filed as part of this report.
Description
Report of Independent Registered Public Accounting Firm
Consolidated Balance Sheets at December 31, 2018 and 2017
Consolidated Statements of Operations for the Years Ended December 31, 2018 and 2017
Consolidated Statements of Comprehensive Income (Loss) for the Years Ended
December 31, 2018 and 2017
Consolidated Statements of Stockholders’ Equity for the Years Ended December 31, 2018
and 2017
Consolidated Statements of Cash Flows for the Years Ended December 31, 2018 and 2017
Notes to Consolidated Financial Statements
Financial Statement Schedules
Page Number
F-2
F-3
F-4
F-5
F-6
F-7
F-8
F-48
54
Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure.
None.
Item 9A. Controls and Procedures.
Evaluation of Disclosure Controls and Procedures
The principal executive officer and principal financial officer of Hallmark have evaluated our disclosure
controls and procedures and have concluded that, as of the end of the period covered by this report, such
disclosure controls and procedures were effective in ensuring that information required to be disclosed by us in
the reports that we file or submit under the Securities Exchange Act of 1934 is timely recorded, processed,
summarized and reported. The principal executive officer and principal financial officer also concluded that
such disclosure controls and procedures were effective in ensuring that information required to be disclosed by
us in the reports that we file or submit under such Act is accumulated and communicated to our management,
including our principal executive officer and principal financial officer, as appropriate, to allow timely decisions
regarding required disclosure.
During the three month period ended December 31, 2018, 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, 2018.
BDO USA, LLP, the independent registered public accounting firm that audited our consolidated financial
statements as of December 31, 2018 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, 2018. 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, 2018, is included in this Item under the heading “Report of Independent
Registered Public Accounting Firm.”
55
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, 2018, 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, 2018, 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 sheets of the Company as of December 31, 2018 and
2017, the related consolidated statements of operations, comprehensive income (loss), stockholders’ equity,
and cash flows for the years then ended and the related notes and financial statement schedules listed in the
accompanying index and our report dated March 14, 2019 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
56
company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized
acquisition, use, or disposition of the company’s assets that could have a material effect on the financial
statements.
Because of its inherent limitations, internal control over financial reporting may not prevent or detect
misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that
controls may become inadequate because of changes in conditions, or that the degree of compliance with the
policies or procedures may deteriorate.
/s/ BDO USA, LLP
Dallas, Texas
March 14, 2019
57
Item 9B. Other Information.
None.
Item 10. Directors, Executive Officers and Corporate Governance.
PART III
The information required by Item 10 is incorporated by reference from the Registrant’s definitive proxy
statement to be filed with the Securities and Exchange Commission pursuant to Regulation 14A not later than
120 days after the end of the fiscal year covered by this report.
Item 11. Executive Compensation.
The information required by Item 11 is incorporated by reference from the Registrant’s definitive proxy
statement to be filed with the Securities and Exchange Commission pursuant to Regulation 14A not later than
120 days after the end of the fiscal year covered by this report.
Item 12. Security Ownership of Certain Beneficial Owners and Management and Related Stockholder
Matters.
The information required by Item 12 is incorporated by reference from the Registrant’s definitive proxy
statement to be filed with the Securities and Exchange Commission pursuant to Regulation 14A not later than
120 days after the end of the fiscal year covered by this report.
Item 13. Certain Relationships and Related Transactions, and Director Independence.
The information required by Item 13 is incorporated by reference from the Registrant’s definitive proxy
statement to be filed with the Securities and Exchange Commission pursuant to Regulation 14A not later than
120 days after the end of the fiscal year covered by this report.
Item 14. Principal Accounting Fees and Services.
The information required by Item 14 is incorporated by reference from the Registrant’s definitive proxy
statement to be filed with the Securities and Exchange Commission pursuant to Regulation 14A not later than
120 days after the end of the fiscal year covered by this report.
58
Item 15. Exhibits, Financial Statement Schedules.
PART IV
(a)(1) Financial Statements
The following consolidated financial statements, notes thereto and related information are included in Item 8
of this report:
Report of Independent Registered Public Accounting Firm
Consolidated Balance Sheets at December 31, 2018 and 2017
Consolidated Statements of Operations for the Years Ended December 31, 2018 and 2017 Consolidated
Statements of Comprehensive Income (Loss) for the Years Ended December 31, 2018 and 2017 Consolidated
Statements of Stockholders’ Equity for the Years Ended December 31, 2018 and 2017 Consolidated Statements
of Cash Flows for the Years Ended December 31, 2018 and 2017
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
Description
3.1
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).
3.2
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).
4.1
4.2
4.3
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).
59
4.4
4.5
4.6
4.7
4.8
4.9
4.10
4.11
4.12
4.13
4.14
4.15
4.16
Form of Junior Subordinated Debt Security Due 2035 (included in Exhibit 4.2 above).
Form of Capital Security Certificate (included in Exhibit 4.3 above).
Indenture dated as of August 23, 2007, between Hallmark Financial Services, Inc. and The Bank
of New York Trust Company, National Association (incorporated by reference to Exhibit 4.1 to
the registrant’s Current Report on Form 8-K filed August 24, 2007).
Amended and Restated Declaration of Trust of Hallmark Statutory Trust II dated as of August 23,
2007, among Hallmark Financial Services, Inc., as sponsor, The Bank of New York (Delaware),
as Delaware trustee, and The 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).
Third Amendment to Second Restated Credit Agreement between Hallmark Financial Services,
Inc. and Frost Bank dated March 15, 2018 (incorporated by reference to Exhibit 10.1 to the
registrant’s Current Report on Form 8-K filed March 15, 2018).
60
4.17
10.1
10.2
10.3
10.4
10.5
10.6
10.7
Fourth Amendment to Second Restated Credit Agreement between Hallmark Financial Services,
Inc. and Frost Bank dated June 19, 2018 (incorporated by reference to Exhibit 10.1 to the
registrant’s Current Report on Form 8-K filed June 20, 2018).
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
Exhibit 10(a) to the registrant’s Quarterly Report on Form 10-QSB for the quarter ended June 30,
2003).
Office Lease by and between SAOP Northwest Center, L.P. and Hallmark Specialty Underwriters,
Inc. dated January 29, 2010 (incorporated by reference to Exhibit 10.1 to the registrant’s Current
Report on Form 8-K filed February 2, 2010).
First Amendment to Office Lease between MS Crescent One SPV, LLC and Hallmark Financial
Services, Inc., dated February 28, 2011 (incorporated by reference to Exhibit 10.1 to the
registrant’s Current Report on Form 8-K filed March 1, 2011).
Assignment and Assumption of Lease Agreement and Bill of Sale between Equitymetrix, LLC
and Hallmark Financial Services, Inc. dated March 1, 2016 (incorporated by reference to Exhibit
10.1 to the registrant’s Current Report on Form 8-K filed March 2, 2016).
Lease between Musref 13727 Noel, L.P. and Equitymetrix, LLC dated March 25, 2009, as
amended by First Amendment to Lease between Musref 13727 Noel, L.P. and Equitymetrix, LLC
dated February 3, 2010, Second Amendment to Lease between Musref 13727 Noel, L.P. and
Equitymetrix, LLC dated July 2, 2013, and Third Amendment to Lease between Musref 13727
Noel, L.P. and Equitymetrix, LLC dated February 25, 2014 (incorporated by reference to Exhibit
10.2 to the registrant’s Current Report on Form 8-K filed March 2, 2016).
10.8
Office Lease between Hallmark Financial Services, Inc. and Teachers Insurance and Annuity
Association of America dated August 6, 2018 (incorporated by reference to Exhibit 10.1 to the
registrant’s Current Report on Form 8-K filed August 8, 2018).
10.9*
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).
61
10.10*
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).
10.11*
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).
10.12*
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).
10.13*
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).
10.14*
Hallmark Financial Services, Inc. 2015 Long Term Incentive Plan (incorporated by reference to
Exhibit 10.1 to the registrant’s Current Report on Form 8-K filed June 2, 2015).
10.15*
Form of Incentive Stock Option Grant Agreement (incorporated by reference to Exhibit 10.2 to
the registrant’s Current Report on Form 8-K filed June 2, 2015).
10.16*
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).
10.17*
Form of Restricted Stock Unit Award Agreement (incorporated by reference to Exhibit 10.4 to
the registrant’s Form 8-K filed June 2, 2015).
10.18
10.19
10.20*
10.21*
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.
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).
62
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.
63
Item 16. Form 10–K Summary.
Not applicable.
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, 2019, 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, 2019
64
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has
duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
SIGNATURES
Date: March 14, 2019
HALLMARK FINANCIAL SERVICES, INC.
(Registrant)
By: /s/ Naveen Anand
Naveen Anand, Chief Executive Officer and
President
Date: March 14, 2019
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, 2019
Date: March 14, 2019
Date: March 14, 2019
Date: March 14, 2019
Date: March 14, 2019
Date: March 14, 2019
/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
65
HALLMARK FINANCIAL SERVICES, INC. AND SUBSIDIARIES
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
Description
Report of Independent Registered Public Accounting Firm
Consolidated Balance Sheets at December 31, 2018 and 2017
Consolidated Statements of Operations for the Years Ended December 31, 2018 and 2017
Consolidated Statements of Comprehensive Income (Loss) for the Years Ended December 31,
2018 and 2017
Consolidated Statements of Stockholders’ Equity for the Years Ended December 31, 2018 and
2017
Consolidated Statements of Cash Flows for the Years Ended December 31, 2018 and 2017
Notes to Consolidated Financial Statements
Financial Statement Schedules
Page
Number
F-2
F-3
F-4
F-5
F-6
F-7
F-8
F-48
F-1
Report of Independent Registered Public Accounting Firm
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 sheets of Hallmark Financial Services, Inc. and
subsidiaries (the “Company”) as of December 31, 2018 and 2017, the related consolidated statements of
operations, comprehensive income (loss), stockholders’ equity, and cash flows for the years then ended 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 at December 31, 2018 and 2017, and the results of
their operations and their cash flows for the years then ended, 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, 2018,
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, 2019
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 audits.
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 audits in accordance with the standards of the PCAOB. Those standards require that we plan
and perform the audits to obtain reasonable assurance about whether the consolidated financial statements are
free of material misstatement, whether due to error or fraud.
Our audits 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 audits 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 audits 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, 2019
F-2
HALLMARK FINANCIAL SERVICES, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
December 31, 2018 and 2017
($ in thousands)
ASSETS
Investments:
Debt securities, available-for-sale, at fair value (amortized cost; $550,268 in 2018
and $604,999 in 2017)
Equity securities (cost; $68,709 in 2018 and $30,253 in 2017)
Other investments (cost; $3,763 in 2018 and $3,763 in 2017)
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 $898 in 2018
and $949 in 2017)
Reserves for unpaid losses and loss adjustment expenses
Unearned premiums
Reinsurance balances payable
Pension liability
Payable for securities
Federal income tax payable
Accounts payable and other accrued expenses
Total liabilities
Commitments and contingencies (Note 17)
Stockholders’ equity:
Common stock, $.18 par value, authorized 33,333,333 shares; issued 20,872,831
shares in 2018 and 2017
Additional paid-in capital
Retained earnings
Accumulated other comprehensive (loss) income
Treasury stock (2,846,131 shares in 2018 and 2,703,803 in 2017), at cost
Total stockholders’ equity
Total liabilities and stockholders’ equity
2018
2017
$
$
545,870 $ 605,746
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
1,264,894 $ 1,231,126
80,896
1,148
627,914
35,594
4,877
133,031
119,778
1,619
3,369
252,029
14,291
44,695
7,555
4,983
—
2,588
12,571
$
30,000 $ 30,000
55,804
527,247
298,061
67,328
2,018
698
4
28,202
1,009,362
55,753
527,100
276,642
52,487
1,605
7,488
—
28,933
980,008
3,757
123,168
161,195
3,757
123,180
136,474
(6,660 ) 12,234
(25,928 ) (24,527)
251,118
255,532
1,264,894 $ 1,231,126
$
The accompanying notes are an integral part of the consolidated financial statements
F-3
HALLMARK FINANCIAL SERVICES, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
For the years ended December 31, 2018 and 2017
($ in thousands, except per share amounts)
2018
2017
Gross premiums written
Ceded premiums written
Net premiums written
Change in unearned premiums
Net premiums earned
Investment income, net of expenses
Investment losses, net
Finance charges
Commission and fees
Other income
Total revenues
Losses and loss adjustment expenses
Operating expenses
Interest expense
Amortization of intangible assets
Total expenses
Income (loss) before tax
Income tax expense (benefit)
Net income (loss)
Net income (loss) per share:
Basic
Diluted
$ 663,015 $ 604,156
(299,217 ) (238,573 )
365,583
(4,546 )
361,037
363,798
363,087
(711 )
18,232
(10,195 )
5,115
2,928
101
18,874
(205 )
3,867
1,679
269
379,268
385,521
256,028
103,424
4,545
2,468
288,308
106,805
4,512
2,468
366,465
402,093
12,803
2,456
10,347 $
(16,572 )
(5,019 )
(11,553 )
$
$
$
0.57 $
0.57 $
(0.63 )
(0.63 )
The accompanying notes are an integral part of the consolidated financial statements
F-4
HALLMARK FINANCIAL SERVICES, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (LOSS)
For the years ended December 31, 2018 and 2017
($ In thousands)
Net income (loss)
Other comprehensive income (loss):
Change in net actuarial (loss) gain
Tax effect on change in net actuarial (loss) gain
Unrealized holding (losses) gains arising during the period
Tax effect on unrealized holding (losses) gains arising during the period
Reclassification adjustment for gains included in net income
Tax effect on reclassification adjustment for gains included in net income
Other comprehensive (loss) income, net of tax
Comprehensive income (loss)
2018
2017
$ 10,347 $ (11,553 )
548
(576 )
(192 )
121
9,117
(3,343 )
(3,191 )
702
(6,799 )
(1,803 )
2,380
379
(4,520 )
1,863
5,827 $ (9,690 )
$
The accompanying notes are an integral part of the consolidated financial statements
F-5
HALLMARK FINANCIAL SERVICES, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY
For the years ended December 31, 2018 and 2017
(In thousands)
Number
of
Additional
Paid-In
Shares Par Value Capital
Retained Comprehensive Treasury
Earnings Income (loss) Stock
Number
of
Total
Stockholders’
Shares Equity
Accumulated
Other
20,873 $ 3,757 $ 123,166 $ 148,027 $
10,371 $ (19,585 ) 2,261 $ 265,736
—
—
—
—
—
—
—
—
—
—
—
149
—
—
—
(135 )
—
(11,553 )
—
(5,308 )
484
(5,308)
—
—
—
—
—
149
366
—
(41)
—
231
(11,553)
—
—
1,863
—
—
1,863
20,873 $ 3,757 $ 123,180 $ 136,474 $
12,234 $ (24,527 ) 2,704 $ 251,118
—
—
—
16,993
(16,993 )
—
—
—
—
—
—
—
—
—
—
—
—
—
—
—
(2,619)
2,619
—
—
—
152
—
—
(164 )
—
—
10,347
—
(1,807 )
187
(1,807)
—
—
—
—
—
152
406
—
(45 ) 242
10,347
—
—
—
(4,520 )
—
—
(4,520)
20,873 $ 3,757 $ 123,168 $ 161,195 $
(6,660 ) $ (25,928 )
2,846 $ 255,532
Balance at
January 1, 2017
Acquisition of treasury
stock
Equity incentive plan
activity
Shares issued under
employee benefit plans
Net loss
Other comprehensive
income, net of tax
Balance at
December 31, 2017
Cumulative effect of
adoption of updated
accounting guidance for
equity financial
instruments at
January 1,2018
Reclassification of certain
tax effects from
accumulated other
comprehensive income at
January 1,2018
Acquisition of treasury
stock
Equity incentive plan
activity
Shares issued under
employee benefit plans
Net income
Other comprehensive loss,
net of tax
Balance at
December 31, 2018
The accompanying notes are an integral part of the consolidated financial statements
F-6
HALLMARK FINANCIAL SERVICES, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
For the years ended December 31, 2018 and 2017
($ in thousands)
Cash flows from operating activities:
Net income (loss)
Adjustments to reconcile net income (loss) to cash (used in) provided by
operating activities:
Depreciation and amortization expense
Deferred federal income taxes
Investment losses, net
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 (used in) provided by operating activities
Cash flows from investing activities:
Purchases of property and equipment
Purchases of investment securities
Maturities, sales and redemptions of investment securities
Net cash provided by (used in) investing activities
Cash flows from financing activities:
Proceeds from exercise of employee stock options
Purchase of treasury shares
Net cash used in financing activities
Decrease in cash and cash equivalents and restricted cash
Cash and cash equivalents and restricted cash at beginning of year
Cash and cash equivalents and restricted cash at end of year
2018
2017
$
10,347 $ (11,553)
5,141
(1,844 )
10,195
152
(20,708 )
(15,405 )
(106 )
1,711
147
21,419
(69,101 )
14,841
7,536
(267 )
3,007
(32,935 )
4,715
(1,575 )
205
149
(30,841 )
(14,658 )
756
3,191
45,533
35,388
(35,107 )
5,999
(3,581 )
3,091
5,487
7,199
(2,101 )
(2,705 )
(222,642 ) (305,930 )
287,187
(21,448 )
232,081
7,338
242
(1,807 )
(1,565 )
(27,162 )
67,633
40,471 $
231
(5,308 )
(5,077 )
(19,326 )
86,959
67,633
$
The accompanying notes are an integral part of the consolidated financial statements
F-7
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-8
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, 2018 and December 31, 2017. 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
$55.8 million, and had a fair value of $45.6 million and $43.7 million, as of December 31, 2018 and 2017,
respectively, and would be included in Level 3 of the fair value hierarchy if they were reported at fair value.
For reinsurance balances, premiums receivable, federal income tax payable, other assets and other liabilities,
the carrying amounts approximate fair value because of the short maturity of such financial instruments.
Investments
Debt 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. 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
F-9
securities until the cash is settled. Purchases of debt and equity securities are recorded in payable for securities
until the cash is settled.
Equity securities are reported at fair value. On January 1, 2018, we adopted ASU 2016-01, “Recognition and
Measurement of Financial Assets and Financial Liabilities”. ASU 2016-01 requires equity securities to be
measured at fair value with changes in fair value recognized in net income. As a result of the new standard,
equity securities with readily determinable fair values are no longer required to be evaluated for other-than-
temporary impairment. Prior to the adoption of ASU 2016-01, unrealized gains and losses on equity securities
were recorded as a component of stockholders’ equity, net of related tax effects.
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 represents amounts required to be set aside by a contractual agreement with a third-party insurer
and amounts pledged for the benefit of various state insurance departments.
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 2018 and 2017, we deferred $35.7 million and $31.1 million of policy acquisition
costs and amortized $37.4 million and $34.3 million of deferred policy acquisition costs, respectively.
Therefore, the net (amortization) deferrals of policy acquisition costs were ($1.7) million and ($3.2) million for
2018 and 2017, respectively.
F-10
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 2032. 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-11
Property and Equipment
Property and equipment (including leasehold improvements), aggregating $27.0 million and $24.9 million, at
December 31, 2018 and 2017, 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 2018 and 2017 was $2.7 million and $2.2
million, respectively. Accumulated depreciation was $20.0 million and $17.3 million at December 31, 2018
and 2017, 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, 2018 and 2017. 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 $6.5 million and $7.6 million for the years ended December 31,
2018 and 2017, 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-12
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.
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
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. Prior guidance required the effect
of a change in tax laws or rates on deferred tax balances to be reported in income from continuing operations
F-13
in the accounting period that included 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 have included the
effect of the change in the U.S. federal corporate income tax rate on the gross deferred tax amounts and related
valuation allowances, if any, at the date of the enactment of TCJA related to items in AOCI. The updated
guidance was effective for reporting periods beginning after December 15, 2018 and is applied retrospectively
to each period in which the effect of the TCJA related to items remaining in AOCI is recognized or at the
beginning of the period of adoption. The Company adopted the updated guidance effective January 1, 2018.
The reclassification of the stranded tax effects out of AOCI and into retained earnings was $2.6 million. The
adoption did not affect the Company’s results of operations, financial position, or liquidity.
In January 2017, the FASB issued ASU 2017-01, “Clarifying the Definition of a Business (Topic 715)”. ASU
2017-01 is intended to assist entities in evaluating whether transactions should be accounted for as acquisitions
(or disposals) of assets or businesses. ASU 2017-01 is effective for annual periods beginning after
December 15, 2017, including interim periods within those annual periods. The adoption of this standard did
not have a material impact on our financial condition or results of operations.
In January 2016, the FASB issued ASU 2016-01, “Recognition and Measurement of Financial Assets and
Financial Liabilities (Subtopic 825-10)”. ASU 2016-01 requires equity investments that are not consolidated or
accounted for under the equity method of accounting to be measured at fair value with changes in fair value
recognized in net income. ASU 2016-01 also requires us to assess the ability to realize our deferred tax assets
(“DTAs”) related to an available-for-sale debt security in combination with our other DTAs. ASU 2016-01 was
effective for fiscal years beginning after December 15, 2017, including interim periods within those fiscal years.
The adoption of this guidance resulted in the recognition of $17.0 million of net after-tax unrealized gains on
equity investments as a cumulative effect adjustment that increased retained earnings as of January 1, 2018 and
decreased AOCI by the same amount. The Company reports changes in the fair value of equity investments in
investment gains and (losses) in the Consolidated Statement of Operations. At December 31, 2017, equity
investments were classified as available-for-sale on the Company's balance sheet. However, upon adoption, the
updated guidance eliminated the available-for-sale balance sheet classification for equity investments.
In August 2016, the FASB issued ASU 2016-15, “Classification of Certain Cash Receipts and Cash Payments
(Topic 230)”. ASU 2016-15 will reduce diversity in practice on how eight specific cash receipts and payments
are classified on the statement of cash flows. The ASU is effective for fiscal years beginning after December
15, 2017, including interim periods within those years. Effective January 1, 2018, we adopted this new
guidance, which did not have a material impact on our financial results or disclosures.
In November 2016, the FASB issued ASU 2016-18, “Statement of Cash Flows (Topic 230): Restricted Cash.”
The purpose of ASU 2016-18 is to eliminate the diversity in classifying and presenting changes in restricted
cash in the statement of cash flows. The new guidance requires restricted cash to be combined with cash and
cash equivalents when reconciling the beginning and ending balances of cash on the statement of cash flows,
thereby no longer requiring transactions such as transfers between restricted and unrestricted cash to be treated
as a cash flow activity. Further, the new guidance requires the nature of the restrictions to be disclosed, as well
as a reconciliation between the balance sheet and the statement of cash flows on how restricted and unrestricted
cash are segregated. The new guidance is effective for fiscal years beginning after December 15, 2017, and
interim periods within that fiscal year, with early adoption permitted. Effective January 1, 2018, we
retrospectively adopted this new guidance which did not have a material impact on our financial results or
disclosures.
In May 2014, the FASB issued ASU 2014-09, guidance which revises the criteria for revenue recognition.
Under the guidance, the transaction price is attributed to underlying performance obligations in the contract and
F-14
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. 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 business written as a cover-holder through a Lloyds Syndicate is subject to this
updated guidance. Effective January 1, 2018, we adopted this new guidance which did not have a material
impact on our financial results or disclosures.
Recently Issued Accounting Pronouncements
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 have evaluated the impact of adopting ASU 2017-08 and have
determined that it will be immaterial to our financial results and disclosures.
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. We are currently evaluating the impact that the adoption of ASU 2017-04 will have
on 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. During 2018, the FASB issued several amendments and targeted improvements to ease with the
application of the standard, including the addition of a transition approach that gives the Company the option
of applying the standard at either the beginning of the earliest comparative period presented or the beginning
of the period of adoption. We plan to adopt the standard on its effective date of January 1, 2019. We will also
elect certain practical expedients that allow us not to reassess existing leases under the new guidance. Based on
F-15
our analysis, the majority of the Company’s lease obligation pertain to office leases utilized in the operation of
our businesses. We expect the primary impact of adoption to be the recognition of a right of use asset and a
lease liability for operating leases representing approximately two percent of the Company’s total assets and
total liabilities, respectively. We do not expect the standard to have a material effect on our reported
consolidated results of operations, cash flows or required disclosures.
2. Investments:
The amortized cost and estimated fair value of investments in debt and equity securities by category is as
follows (in thousands):
Gross
Unrealized Unrealized
Gross
Amortized Cost Gains
Losses
Fair Value
48,609 $
243,314
131,779
112,574
13,992
550,268
68,709
3,763
622,740 $
5 $
(508) $
440
19
3,791
11
4,266
20,693
—
48,106
242,152
(1,602)
126,528
(5,270)
115,527
(838)
13,557
(446)
545,870
(8,664)
80,896
(8,506)
1,148
(2,615)
24,959 $ (19,785) $ 627,914
50,088 $
278,611
125,536
134,052
16,712
604,999
30,253
3,763
639,015 $
7 $
1,204
702
709
37
2,659
23,014
61
25,734 $
(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
(3,416) $ 661,333
As of December 31, 2018
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
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
$
$
$
$
F-16
Major categories of net investment income are summarized as follows (in thousands):
U.S. Treasury securities and obligations of U.S. Government
Corporate bonds
Collateralized corporate bank loans
Municipal bonds
Mortgage-backed
Equity securities
Other investments
Cash and cash equivalents
Investment expenses
Investment income, net of expenses
Twelve Months Ended December 31,
2018
2017
$
$
902
6,696
5,658
3,757
521
1,151
—
518
19,203
(971 )
18,232
$
$
566
7,839
4,302
4,633
1,049
871
—
706
19,966
(1,092 )
18,874
No investments in any entity or its affiliates exceeded 10% of stockholders’ equity at December 31, 2018 or
2017.
Major categories of net investment gains (losses) on investments are summarized as follows (in thousands):
Twelve Months Ended December 31,
2018
2017
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 on other investments
Other-than-temporary impairments
Unrealized losses on equity investments
Investment losses, net
$
$
—
(83 )
90
1,435
2
359
1,803
(2,676 )
—
(9,322 )
(10,195 )
$
$
—
(468 )
79
195
(9 )
7,002
6,799
(1,127 )
(5,877 )
—
(205 )
We realized gross gains on investments of $2.5 million and $8.0 million during the years ended December 31,
2018 and 2017, respectively, of which $1.5 million and $7.2 million were from the sales of securities during
the years ended December 31, 2018 and 2017, respectively. We realized gross losses on investments of $0.7
million and $1.2 million during the years ended December 31, 2018 and 2017, respectively, of which none were
from the sales of securities during the years ended December 31, 2018 and 2017, respectively. We recorded
proceeds from the sale of investment securities of $17.7 million, and $29.1 million during the years ended
December 31, 2018 and 2017, respectively. Realized investment gains and losses are recognized in operations
on the first in-first out method.
F-17
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, 2018 and December 31, 2017 (in
thousands):
12 months or less
As of December 31, 2018
Longer than 12 months
Total
Unrealized
Unrealized
Unrealized
Fair Value Losses
Fair Value Losses
Fair Value Losses
U.S. Treasury securities
and obligations of U.S.
Government
Corporate bonds
Collateralized corporate
bank loans
Municipal bonds
Mortgage-backed
Total debt securities
Total equity securities
Total other investments
Total investments
$
18,902 $
117,450
(181) $
(907)
28,201 $
100,060
(327) $
(695)
47,103 $
217,510
(508)
(1,602)
120,410
14,281
6,592
277,635
30,981
1,148
(4,938)
(96)
(60)
(6,182)
(3,699)
(2,615)
$ 309,764 $ (12,496) $
4,931
25,891
5,986
165,069
4,475
—
169,544 $
(332)
(742)
(386)
(2,482)
(4,807)
—
(5,270)
125,341
(838)
40,172
(446)
12,578
(8,664)
442,704
(8,506)
35,456
(2,615)
1,148
(7,289) $ 479,308 $ (19,785)
12 months or less
As of December 31, 2017
Longer than 12 months
Total
Unrealized
Unrealized
Unrealized
Fair Value Losses
Fair Value Losses
Fair Value Losses
$
28,825 $
176,061
(145) $
(736)
1,997 $
2,378
(3) $
(6)
30,822 $
178,439
(148)
(742)
30,008
35,200
6,419
276,513
8,375
—
$ 284,888 $
(280)
(370)
(127)
(1,658)
(1,504)
—
(3,162) $
2,517
8,917
1,415
17,224
—
—
17,224 $
(21)
(135)
(89)
(254)
—
—
32,525
44,117
7,834
293,737
8,375
—
(254) $ 302,112 $
(301)
(505)
(216)
(1,912)
(1,504)
—
(3,416)
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
We held a total of 328 debt securities with an unrealized loss, of which 221 were in an unrealized loss position
for less than one year and 107 were in an unrealized loss position for a period of one year or greater, as of
December 31, 2018. We held a total of 224 debt securities with an unrealized loss, of which 199 were in an
unrealized loss position for less than one year and 25 were in an unrealized loss position for a period of one
year or greater, as of December 31, 2017. We held a total of 20 equity securities with an unrealized loss, of
which 17 were in an unrealized loss position for less than one year and 3 were in an unrealized loss position for
a period of one year or greater, as of December 31, 2018. We held a total of 4 equity securities with an unrealized
loss, of which all were in an unrealized loss position for less than one year as of December 31, 2017. We
consider these losses as a temporary decline in value as they are predominately on securities that we do not
F-18
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, 2018 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.
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 debt security
below cost is deemed other-than-temporary. All debt securities with an unrealized loss are reviewed. We
recognize an impairment loss when a debt security’s value declines below cost, adjusted for accretion,
amortization and previous other-than-temporary impairments and it is determined that the decline is other-than-
temporary. We did not recognize an impairment loss during 2018. We recognized other-than-temporary losses
on our debt securities portfolio of $5.9 million during 2017, all related to credit losses on certain senior and
subordinated municipal bonds concentrated in Puerto Rico. The fair value of the impaired securities was $6.1
million and $4.4 million at December 31, 2018 and 2017, respectively. During 2018 we sold one security with
a realized loss of $0.1 million and recognized a change in unrealized gain of $1.8 million on the remaining
securities.
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: On January 1, 2018, we adopted ASU 2016-01, “Recognition and Measurement of
Financial Assets and Financial Liabilities”. ASU 2016-01 requires equity investments that are not consolidated
or accounted for under the equity method of accounting to be measured at fair value with changes in fair value
recognized in net income each reporting period. As a result of the new standard, equity securities with readily
determinable fair values are no longer required to be evaluated for other-than-temporary-impairment.
Prior to the adoption of ASU 2016-01,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 was determined that an equity investment
was other-than-temporarily impaired, the security was written down to fair value, and the amount of the
impairment was included in earnings as a realized investment loss. The fair value then became the new cost
basis of the investment, and any subsequent recoveries in fair value were recognized at disposition. We
F-19
recognized a realized loss when impairment was deemed to be other-than-temporary even if a decision to sell
an equity investment had not been made. If we decided to sell a temporarily impaired available-for-sale equity
investment and we did not expect the fair value of the equity investment to fully recover prior to the expected
time of sale, the investment was deemed to be other-than-temporarily impaired in the period in which the
decision to sell was made.
Details regarding the carrying value of the other invested assets portfolio as of December 31, 2018 and 2017
were as follows:
Investment Type
Equity warrant
Total other investments
2018
2017
$ 1,148 $
$ 1,148 $
3,824
3,824
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, 2018 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)
119,771 $ 120,127
284,947
284,992
102,047
105,656
25,192
25,857
13,557
13,992
550,268 $ 545,870
$
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 $29.5
million at December 31, 2018 and a carrying value of $26.2 million at December 31, 2017.
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;
F-20
• Level 2: inputs to the valuation methodology include quoted prices for similar assets and liabilities
in active markets, inputs of identical assets for less active markets, and inputs that are observable
for the asset or liability, either directly or indirectly, for substantially the full term of the instrument;
and
• Level 3: inputs to the valuation methodology that are unobservable for the asset or liability.
This hierarchy requires the use of observable market data when available.
Under ASC 820, we determine fair value based on the price that would be received for an asset or paid to
transfer a liability in an orderly transaction between market participants on the measurement date. It is our
policy to maximize the use of observable inputs and minimize the use of unobservable inputs when developing
fair value measurements, in accordance with the fair value hierarchy described above. Fair value measurements
for assets and liabilities where there exists limited or no observable market data are calculated based upon our
pricing policy, the economic and competitive environment, the characteristics of the asset or liability and other
factors as appropriate. These estimated fair values may not be realized upon actual sale or immediate settlement
of the asset or liability.
Where quoted prices are available on active exchanges for identical instruments, investment securities are
classified within Level 1 of the valuation hierarchy. Level 1 investment securities include common and
preferred stock and the equity warrant classified as Other Investments.
Level 2 investment securities include corporate bonds, collateralized corporate bank loans, municipal bonds,
U.S. Treasury securities, other obligations of the U.S. Government and mortgage-backed securities for which
quoted prices are not available on active exchanges for identical instruments. We use third party pricing services
to determine fair values for each Level 2 investment security in all asset classes. Since quoted prices in active
markets for identical assets are not available, these prices are determined using observable market information
such as quotes from less active markets and/or quoted prices of securities with similar characteristics, among
other things. We have reviewed the processes used by the pricing services and have determined that they result
in fair values consistent with the requirements of ASC 820 for Level 2 investment securities. We have not
adjusted any prices received from third party pricing services. There were no transfers between Level 1 and
Level 2 securities.
In cases where there is limited activity or less transparency around inputs to the valuation, investment securities
are classified within Level 3 of the valuation hierarchy. Level 3 investments are valued based on the best
available data in order to approximate fair value. This data may be internally developed and consider risk
premiums that a market participant would require. Investment securities classified within Level 3 include other
less liquid investment securities.
F-21
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, 2018 and December 31, 2017 (in thousands).
As of December 31, 2018
Quoted Prices in
Active Markets for
Identical Assets Other Observable Unobservable
(Level 1)
Inputs (Level 2) Inputs (Level 3) Total
U.S. Treasury securities
and obligations of U.S.
Government
Corporate bonds
Collateralized corporate
bank loans
Municipal bonds
Mortgage-backed
Total debt securities
Total equity securities
Total other investments
Total investments
$
$
— $
—
—
—
—
—
80,896
1,148
82,044 $
48,106 $
241,861
126,528
115,527
13,557
545,579
—
—
545,579 $
— $ 48,106
242,152
291
—
126,528
—
115,527
—
13,557
291
545,870
—
80,896
1,148
—
291 $ 627,914
As of December 31, 2017
Quoted Prices in
Active Markets for
Identical Assets Other Observable Unobservable
(Level 1)
Inputs (Level 2) Inputs (Level 3) Total
U.S. Treasury securities and
obligations of U.S. Government $
Corporate bonds
Collateralized corporate bank
loans
Municipal bonds
Mortgage-backed
Total debt securities
Total equity securities
Total other investments
Total investments
$
— $
—
—
—
—
—
51,142
3,824
54,966 $
49,947 $
278,760
125,937
131,433
16,533
602,610
—
—
602,610 $
— $ 49,947
279,073
313
—
2,823
—
3,136
621
—
125,937
134,256
16,533
605,746
51,763
3,824
3,757 $ 661,333
Due to significant unobservable inputs into the valuation model for one corporate bond as of December 31,
2018 and certain municipal bonds, one corporate bond and one equity security as of December 31, 2017, we
classified these as level 3 in the fair value hierarchy. The corporate bond classified as level 3 in 2018 and 2017
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. In 2017, we used an income approach in order to derive an estimated fair value
F-22
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 equity security classified
as Level 3 in the fair value hierarchy in 2017 was 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.
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, 2018 and
2017 (in thousands).
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
Ending balance as of December 31
—
2018 2017
$ 3,757 $ 5,945
—
(2,925 ) (579)
775
—
616
—
—
(621 ) (3,000)
291 $ 3,757
—
—
80
—
—
$
The transfer out of Level 3 into Level 1 during 2018 was due to the conversion of a private equity holding to a
preferred stock traded on a public exchange. The transfer out of Level 3 into Level 2 during 2017 was due to
the successful auction of one auction rate municipal bond that previously had not had a successful auction. We
account for transfers as they occur.
4. Acquisitions, Goodwill and Intangible Assets:
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, 2018 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 2018 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
F-23
values. The income projections reflected an improved premium rate environment across most of our lines of
business that continued throughout 2018. The income projections also included loss and LAE assumptions
which reflected recent historical claim trends and the movement towards a more favorable pricing environment.
The income projections also included assumptions for expense growth and investment yields which were based
on business plans for each of our operating units. The discount rate was based on a risk free rate plus a beta
adjusted equity risk premium and specific company risk premium. The assumptions were based on historical
experience (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 2018 and 2017, 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
2018
2017
$ 32,177 $ 32,177
3,440
3,232
4,235
1,300
44,384
3,440
3,232
4,235
1,300
44,384
(26,515 ) (24,276)
(2,847 ) (2,618)
(3,232 ) (3,232)
(4,235 ) (4,235)
(36,829 ) (34,361)
7,555 $ 10,023
$
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):
2019
2020
2021
2022
2023
$
$
$
$
$
2,467
2,467
503
501
317
F-24
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, 2018 and 2017 (in thousands):
Profit sharing commission receivable
Credit Facility B issuance costs
Accrued investment income
Investment in unconsolidated trust subsidiaries
Fixed assets
Other assets
2018
$
2017
246 $
106
4,175
1,702
6,154
188
252
122
4,859
1,702
6,726
195
6. Reserves for Losses and Loss Adjustment Expenses:
Activity in the consolidated reserves for unpaid losses and LAE is summarized as follows (in thousands):
$ 12,571 $ 13,856
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
F-25
2018
2017
$ 527,100 $ 481,567
123,237
358,330
154,612
372,488
250,075
5,953
256,028
248,203
40,105
288,308
90,640
232,345
322,985
92,873
181,277
274,150
305,531
221,716
372,488
154,612
$ 527,247 $ 527,100
The $6.0 million unfavorable net development and $40.1 million unfavorable net development in prior
accident years recognized in 2018 and 2017, respectively, represent changes in our loss reserve estimates. In
2018 and 2017, 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, 2018 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, partially offset by net favorable development in our general
liability lines within our Contract Binding and Standard Commercial P&C operating units. Generally, changes
in reserves are caused by variations between actual experience and previous expectations and by reduced
emphasis on the Bornhuetter-Ferguson method due to the aging of the accident years.
The impact from the unfavorable (favorable) net prior years’ loss development on each reporting segment is
presented below:
Specialty Commercial Segment
Standard Commercial Segment
Personal Segment
Corporate
Total unfavorable net prior year development
December 31,
2017
2018
$ 16,457 $ 40,477
(8,993 ) (970)
(1,511 ) 598
—
$ 5,953 $ 40,105
—
The following describes the primary factors behind each segment’s prior accident year loss reserve
development for the years ended December 31, 2018 and 2017:
Year ended December 31, 2018:
• Specialty Commercial Segment. Our Contract Binding operating unit experienced net unfavorable
development in the 2016 and prior accident years primarily in the commercial auto liability line of
business, partially offset by favorable development primarily in the commercial auto and general
liability lines of business in the 2017 accident year. Our Specialty Commercial operating unit
experienced net unfavorable development in general aviation, commercial excess liability, satellite
launch
liability
insurance products, primary/excess commercial property, professional
and specialty risk programs lines of business.
• Standard Commercial Segment. Our Standard Commercial P&C operating unit experienced net
favorable development in the 2016 and prior accident years primarily in the general liability line
of business, partially offset by net unfavorable development primarily in the commercial property
line of business in the 2017 accident year and net unfavorable development in the 2017 and prior
accident years in the occupational accident line of business. Our Workers Compensation operating
unit experienced net favorable development in the 2016 and prior accident years.
• Personal Segment. Net favorable development in our Specialty Personal Lines operating unit
was mostly attributable to the 2013 through 2017 accident years, partially offset by unfavorable
development in the 2012 and prior accident years.
F-26
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.
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
F-27
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 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,
2018 ($ in thousands):
Specialty Commercial Segment
Incurred Claims and Allocated Claim Adjustment Expenses, Net of Reinsurance
Accident
Year
2009
2010 2011 2012
For the Years Ended December 31,
Unaudited
2013
2015
2014
2016
2017
2009
2010
2011
2012
2013
2014
2015
2016
2017
2018
$ 60,950 $ 62,679 $ 61,196 $ 59,471 $ 59,831 $ 59,635 $ 59,988 $ 61,361 $ 61,761 $
74,187 78,089 75,695 77,593 78,003 77,972 77,631 78,253
88,679 87,558 91,059 90,713 89,737 87,793 87,833
106,371 111,253 111,841 115,709 116,320 117,925
140,546 135,114 137,230 143,983 150,177
144,996 133,464 138,842 144,728
147,304 146,610 162,616
151,494 157,836
170,622
As of December 31,
Cumulative
Number of
Reported
IBNR Claims
2018
2018
2018
—
62,509 $
231
77,647
98
89,815
(172)
117,469
336
151,471
(800)
152,025
854
171,315
164,570 5,527
162,193 17,247
170,926 87,288
5,389
5,071
5,852
7,424
9,294
10,242
11,057
11,750
11,806
9,702
Total $ 1,319,942
F-28
Cumulative Paid Claims and Allocated Claim Adjustment Expenses, Net of Reinsurance
2009
2010
2011
2012
2013
2014
2015
2016
For the Years Ended December 31,
Unaudited
$ 21,259 $ 34,411 $ 45,757 $ 53,135 $ 56,791 $ 57,641 $ 59,149 $ 60,785 $ 61,202 $
24,818
45,234
27,454
58,139
53,509
37,655
68,625
71,697
60,923
40,475
73,398
80,004
82,066
76,366
42,097
74,513
83,787
97,680
101,725
73,631
39,515
75,787
84,936
109,060
126,025
99,521
74,906
41,397
Accident
Year
2009
2010
2011
2012
2013
2014
2015
2016
2017
2018
2017
76,906
85,845
113,909
139,759
123,649
125,514
84,616
45,477
2018
61,397
77,075
87,200
116,607
148,706
146,290
159,707
143,685
109,220
42,359
Total $ 1,092,246
693
228,389
All outstanding liabilities before 2009, net of reinsurance
Liabilities for claims and claim adjustment expenses, net of reinsurance $
Standard Commercial Segment
2012
2013
2011
2010
Unaudited
For the Years Ended December 31,
Incurred Claims and Allocated Claim Adjustment Expenses, Net of Reinsurance
As of December 31,
Cumulative
Number of
Reported
IBNR Claims
2018
2018
2009
139
$ 44,719 $ 45,674 $ 46,772 $ 46,778 $ 45,970 $ 44,159 $ 43,851 $ 43,107 $ 42,168 $ 41,513 $
146
42,427
478
45,244
736
41,421
49,039
596
54,125 1,990
47,277 1,873
46,348 1,900
43,169 8,000
42,898 16,384
45,263 45,235 44,847 43,164 43,459 42,426 42,175 42,880
60,236 56,489 55,156 49,268 47,266 47,423 46,841
51,998 52,554 48,222 45,990 44,272 42,986
55,482 57,528 56,703 53,174 52,076
55,488 55,808 53,568 53,882
49,571 49,857 50,053
46,880 48,182
41,393
2,644
2,920
3,583
3,228
3,924
3,571
3,181
2,822
2,556
2,165
2018
2015
2016
2017
2014
Accident
Year
2009
2010
2011
2012
2013
2014
2015
2016
2017
2018
Total $ 453,461
Cumulative Paid Claims and Allocated Claim Adjustment Expenses, Net of Reinsurance
For the Years Ended December 31,
Unaudited
2009
2010
2011
2012
2013
2014
2015
2016
2017
2018
21,302
28,342
24,899
30,957
35,119
23,445
33,428
38,909
32,203
23,123
$ 15,242 $ 28,313 $ 32,075 $ 35,818 $ 38,316 $ 40,389 $ 40,575 $ 40,629 $ 40,835 $ 40,991
42,063
43,794
40,646
47,853
48,395
43,287
38,778
28,984
19,233
Total $ 394,024
2,499
Liabilities for claims and claim adjustment expenses, net of reinsurance $ 61,936
40,937
43,680
40,408
46,756
45,779
38,302
32,006
16,755
39,706
42,441
38,526
44,575
41,514
34,245
21,508
39,115
41,140
37,191
41,809
37,122
19,085
All outstanding liabilities before 2009, net of reinsurance
37,166
40,301
34,789
36,411
24,255
Accident
Year
2009
2010
2011
2012
2013
2014
2015
2016
2017
2018
F-29
Personal Segment
Unaudited
2012 2013 2014
For the Years Ended December 31,
Incurred Claims and Allocated Claim Adjustment Expenses, Net of Reinsurance
As of December 31,
Cumulative
Number of
Reported
IBNR Claims
2018
2018
2009 2010 2011
—
$ 40,436 $ 42,092 $ 46,244 $ 47,977 $ 48,930 $ 49,694 $ 49,772 $ 49,891 $ 49,971 $ 50,005 $
—
84,867
—
87,199
—
72,076
—
60,328
—
6,504
120
25,136
129
32,728
21,968
208
18,334 2,613
63,862 78,294 80,765 84,724 83,903 84,252 84,591 84,808
75,746 77,652 87,810 86,757 86,804 86,948 86,853
58,604 73,795 70,552 71,513 72,042 72,037
55,706 59,132 60,100 60,211 60,379
5,452 5,340 6,243 6,699
23,104 25,682 25,307
32,260 32,893
23,342
21,056
30,180
31,615
23,939
23,471
19,293
23,370
23,745
16,748
14,248
2016 2017
2018
2015
Accident
Year
2009
2010
2011
2012
2013
2014
2015
2016
2017
2018
Total $ 459,145
Cumulative Paid Claims and Allocated Claim Adjustment Expenses, Net of Reinsurance
For the Years Ended December 31,
Unaudited
2009
2010
2011
2012
2013
2014
2015
2016
2017
2018
38,643
67,755
46,416
75,199
67,939
37,860
82,624
83,497
64,278
45,901
$ 23,306 $ 37,621 $ 44,689 $ 47,967 $ 49,287 $ 49,539 $ 49,704 $ 49,853 $ 49,957 $ 49,992
84,768
86,989
72,094
60,297
6,566
25,243
32,260
21,061
11,137
Total $ 450,406
5
8,743
84,717
86,660
72,055
60,277
6,428
24,262
30,646
15,776
Liabilities for claims and claim adjustment expenses, net of reinsurance $
84,556
86,593
71,995
59,775
5,631
22,281
21,669
84,111
86,217
70,807
58,047
4,418
11,570
All outstanding liabilities before 2009, net of reinsurance
83,511
85,533
68,849
54,514
2,515
Accident
Year
2009
2010
2011
2012
2013
2014
2015
2016
2017
2018
F-30
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
2018
2017
Specialty Commercial Segment
Standard Commercial Segment
Personal Segment
Liabilities for unpaid losses and allocated loss adjustment
expenses, net of reinsurance
$ 228,389 $ 275,436
78,119
11,505
61,936
8,743
299,068
365,060
Reinsurance recoverable on unpaid losses and LAE
Specialty Commercial Segment
Standard Commercial Segment
Personal Segment
Total reinsurance recoverable on unpaid losses and LAE
198,802
9,783
13,131
221,716
137,975
6,051
10,586
154,612
Unallocated loss adjustment expenses
3,377
Specialty Commercial Segment
3,153
Standard Commercial Segment
898
Personal Segment
Total unallocated loss adjustment expenses
7,428
Total reserves for unpaid losses and loss adjustment expenses $ 527,247 $ 527,100
2,550
2,958
955
6,463
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, 2018:
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
Standard
Commercial
Segment
Personal
Segment
27.1 %
24.0 %
20.5 %
13.6 %
7.9 %
2.7 %
1.7 %
1.8 %
0.4 %
0.3 %
45.3 %
25.2 %
9.2 %
6.9 %
4.8 %
3.7 %
1.3 %
1.0 %
1.4 %
1.2 %
53.7 %
28.0 %
10.2 %
5.4 %
1.5 %
0.3 %
0.3 %
0.3 %
0.1 %
0.2 %
(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-31
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, 2018 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 the
last two years (in thousands):
Premium Written :
Direct
Assumed
Ceded
Premium Earned:
Direct
Assumed
Ceded
Reinsurance recoveries
2018
2017
2,717
$ 660,298 $ 601,780
2,376
(299,217 ) (238,573 )
$ 363,798 $ 365,583
2,159
$ 639,437 $ 567,089
1,680
(278,509 ) (207,732 )
$ 363,087 $ 361,037
$ 199,690 $ 144,948
Included in reinsurance recoverable on the consolidated balance sheets are paid loss recoverables of $29.7
million and $28.2 million as of December 31, 2018 and 2017, respectively.
8. Revolving Credit Facility and Notes Payable:
Our Second Restated Credit Agreement with Frost Bank (“Frost”) dated June 30, 2015, as amended to date,
provides a $15.0 million revolving credit facility (“Facility A”), with a $5.0 million letter of credit sub-facility.
The outstanding balance of the Facility A bears interest at a rate equal to the prime rate or LIBOR plus 2.5%, at
our election. We pay an annual fee of 0.25% of the average daily unused balance of Facility A and letter of
credit fees at the rate of 1.00% per annum. All principal and accrued interest on Facility A becomes due and
payable on June 30, 2020. As of December 31, 2018, we had no outstanding borrowings under Facility A.
The Second Restated Credit Agreement with Frost also provides a $30.0 million revolving credit facility
(“Facility B”), in addition to Facility A. We may use Facility B loan proceeds solely for the purpose of making
capital contributions to AHIC and HIC. We may borrow, repay and reborrow under Facility B until December
F-32
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, 2018, 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 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, 2018, the principal balance of our Trust I subordinated debt was $30.9
million and the interest rate was 6.04% 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, 2018, the principal balance of our Trust II subordinated
debt was $25.8 million and the interest rate was 5.69% 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
F-33
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-34
The following is additional business segment information for the twelve months ended December 31, 2018 and
2017 (in thousands):
2018
2017
$ 280,283 $ 277,946
70,302
40,462
(3,189 )
$ 379,268 $ 385,521
76,548
38,623
(16,186 )
$
$
$
$
$
$
$
$
2,986 $
390
1,312
453
5,141 $
— $
—
—
4,545
4,545 $
2,796
294
1,258
367
4,715
—
—
—
4,512
4,512
5,521 $
2,511
587
(6,163 )
2,456 $
(4,382 )
3,849
(676 )
(3,810 )
(5,019 )
28,780 $
13,090
3,061
(32,128 )
12,803 $
2,012
2,440
(3,058 )
(17,966 )
(16,572 )
Revenues
Specialty Commercial Segment
Standard Commercial Segment
Personal Segment
Corporate
Consolidated
Depreciation and Amortization Expense
Specialty Commercial Segment
Standard Commercial Segment
Personal Segment
Corporate
Consolidated
Interest Expense
Specialty Commercial Segment
Standard Commercial Segment
Personal Segment
Corporate
Consolidated
Tax Expense (Benefit)
Specialty Commercial Segment
Standard Commercial Segment
Personal Segment
Corporate
Consolidated
Pre-tax income (loss)
Specialty Commercial Segment
Standard Commercial Segment
Personal Segment
Corporate
Consolidated
F-35
The following is additional business segment information as of the following dates (in thousands):
December 31
2018
2017
Assets:
Specialty Commercial Segment
Standard Commercial Segment
Personal Segment
Corporate
Consolidated
11. Earnings Per Share:
$
858,262 $
158,881
226,431
21,320
810,133
162,152
232,441
26,400
$ 1,264,894 $ 1,231,126
We have adopted the provisions of ASC 260, “Earnings Per Share,” requiring presentation of both basic and
diluted earnings per share. A reconciliation of the numerators and denominators of the basic and diluted per
share calculations is presented below (in thousands, except per share amounts):
Numerator for both basic and diluted earnings per share:
Net income (loss)
Denominator, basic shares
Effect of dilutive securities:
Stock-based compensation awards
Denominator, diluted shares
Basic earnings per share:
Diluted earnings per share:
2018
2017
$ 10,347 $ (11,553 )
18,086
18,343
115
18,201
—
18,343
$
0.57 $
(0.63 )
$
0.57 $
(0.63 )
We had 32,164 and 406,731 shares of common stock potentially issuable upon exercise of employee stock
options for years ended December 31, 2018 and 2017, 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 2019 to 2021.
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 $59.7 million as of December 31, 2018.
F-36
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 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 2019, the aggregate ordinary
dividend capacity of these subsidiaries is $33.9 million, of which $22.9 million is available to Hallmark. As a
county mutual, dividends from HCM are payable to policyholders. During the years ended December 31, 2018
and 2017 our insurance company subsidiaries paid $5.5 million and $11.4 million, respectively, in dividends to
Hallmark. The total restricted net assets of our insurance company subsidiaries as of December 31, 2018, was
$195.9 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 2018 and 2017.
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, 2018 and 2017, our insurance company subsidiaries reported statutory
capital and surplus of $247.0 million and $233.3 million, respectively, substantially greater than the minimum
requirements for each state. For the years ended December 31, 2018, and 2017, respectively, our insurance
company subsidiaries reported statutory net income of $35.9 million and $1.9 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, 2018, the adjusted capital under the risk-based capital calculation
of each of our insurance company subsidiaries substantially exceeded the minimum requirements.
13. Share-based Payment Arrangements:
Our 2005 Long Term Incentive Plan (“2005 LTIP”) is a stock compensation plan for key employees and non-
employee directors that was initially approved by the shareholders on May 26, 2005 and expired by its terms
on May 27, 2015. As of December 31, 2018, there were no outstanding incentive stock options and outstanding
non-qualified stock options to purchase 244,157 shares of our common stock. The exercise price of all such
outstanding stock options is equal to the fair market value of our common stock on the date of grant.
Our 2015 Long Term Incentive Plan (“2015 LTIP”) was approved by shareholders on May 29, 2015. There
are 2,000,000 shares authorized for issuance under the 2015 LTIP. As of December 31, 2018, restricted stock
units representing the right to receive up to 508,345 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, 2018.
F-37
Stock Options:
Incentive stock options granted under the 2005 LTIP prior to 2009 vested 10%, 20%, 30% and 40% on the first,
second, third and fourth anniversary dates of the grant, respectively, and terminated 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. 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, 2018 and changes during the year then ended
is presented below:
Average
Remaining
Aggregate
Number of Weighted Average Contractual Intrinsic Value
Shares
Exercise Price
Term (Years)
($000)
Outstanding at January 1, 2018
Granted
Exercised
Forfeited or expired
Outstanding at December 31, 2018
Exercisable at December 31, 2018
406,731 $
—
(36,500 ) $
(126,074 ) $
244,157 $
244,157 $
7.85
—
6.61
10.57
6.63
6.63
0.4 $
0.4 $
991
991
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
2018
2017
$
$
$
122 $
— $
— $
163
—
—
As of December 31, 2018, 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 2018 or 2017.
Restricted Stock Units:
Restricted stock units awarded under the 2015 LTIP represent the right to receive shares of common stock upon
the satisfaction of vesting requirements, performance criteria and other terms and conditions. Restricted stock
F-38
units vest and, if performance criteria have been satisfied, shares of common stock become issuable on March
31 of the third calendar year following the year of grant.
The performance criteria for all restricted stock units require that we achieve certain compound average annual
growth rates in book value per share as well as certain average combined ratio percentages over the vesting
period in order to receive shares of common stock in amounts ranging from 50% to 150% of the number of
restricted stock units granted. Grantees of restricted stock units do not have any rights of a stockholder, and do
not participate in any distributions to our common stockholders, until the award fully vests upon satisfaction of
the vesting schedule, performance criteria and other conditions set forth in their award agreement. Therefore,
unvested restricted stock units are not considered participating securities under ASC 260, “Earnings Per Share”.
Compensation cost is measured as an amount equal to the fair value of the restricted stock units on the date of
grant and is expensed over the vesting period if achievement of the performance criteria is deemed probable,
with the amount of the expense recognized based on our best estimate of the ultimate achievement level. The
grant date fair value of restricted stock units granted in 2015, 2016, 2017 and 2018 was $11.10, $11.41, $10.20
and $10.87 per unit, respectively. We incurred compensation expense of $152 thousand and $149 thousand
related to restricted stock units during the years ended December 31, 2018 and 2017. We recorded income tax
benefit of $32 thousand and $52 thousand related to restricted stock units during the years ended December 31,
2018 and 2017.
The following table details the status of our restricted stock units as of and for the years ended December 31,
2018 and 2017:
Nonvested at January 1
Granted
Vested
Forfeited
Nonvested at December 31
Number of Restricted Stock Units
2018
385,779
144,059
(8,198 )
(182,743 )
338,897
2017
296,574
138,712
(5,998 )
(43,509 )
385,779
As of December 31, 2018, there was $2.0 million of unrecognized grant date compensation cost related to
unvested restricted stock units. Based on the current performance estimate, we expect to recognize $1.6 million
of compensation cost related to unvested restricted stock units, of which $0.7 million is expected to be
recognized in 2019, $0.7 million is expected to be recognized in 2020 and $0.2 million is expected to be
recognized in 2021.
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.
F-39
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, 2018 and 2017 (in thousands) using a measurement date of December 31.
Assumptions (end of period):
Discount rate used in determining benefit obligation
Rate of compensation increase
Reconciliation of funded status (end of period):
Accumulated benefit obligation
Projected benefit obligation
Fair value of plan assets
Funded status
Net actuarial loss
Accumulated other comprehensive loss
Prepaid pension cost
Net amount recognized as of December 31
Changes in projected benefit obligation:
Benefit obligation as of beginning of period
Interest cost
Actuarial liability (gain)/loss
Benefits paid
Benefit obligation as of end of period
Change in plan assets:
Fair value of plan assets as of beginning of period
Actual return on plan assets (net of expenses)
Employer contributions
Benefits paid
Fair value of plan assets as of end of period
Net periodic pension cost:
Service cost - benefits earned during the period
Interest cost on projected benefit obligation
Expected return on plan assets
Recognized actuarial loss
Net periodic pension cost
Discount rate
Expected return on plan assets
Rate of compensation increase
F-40
2018
2017
4.05 %
N/A
3.45 %
N/A
$ (11,687 )
$ (12,758 )
$ (11,687 )
9,669
(2,018 )
$
$ (12,758 )
11,153
(1,605 )
$
$
$
$
$
$
$
$
(4,130 )
(4,130 )
2,112
(2,018 )
(3,554 )
(3,554 )
1,949
(1,605 )
$
12,758
424
(628 )
(867 )
11,687
$ 12,618
471
554
(885 )
$ 12,758
11,153
(617 )
—
(867 )
9,669
$ 10,415
1,623
—
(885 )
$ 11,153
—
424
(694 )
106
(164 )
$
$
—
471
(646 )
126
(49 )
3.45 %
6.50 %
N/A
3.88 %
6.50 %
N/A
Estimated future benefit payments by fiscal year (in thousands):
2019
2020
2021
2022
2023
2024-2028
$
$
$
$
$
$
881
870
875
861
843
3,941
As of December 31, 2018, the fair value of the plan assets was composed of cash and cash equivalents of $0.3
million, debt securities of $3.5 million and equity securities of $5.9 million.
Our investment objectives are to preserve capital and to achieve long-term growth through a favorable rate of
return equal to or greater than 5% over the long-term (60 year) average inflation rate as measured by the
consumer price index. The objective of the equity portion of the portfolio is to achieve a return in excess of the
Standard & Poor’s 500 index. The objective of the fixed income portion of the portfolio is to add stability,
consistency, safety and total return to the total fund portfolio.
We prohibit investments in options, futures, precious metals, short sales and purchase on margin. We also
restrict the investment in fixed income securities to “A” rated or better by Moody’s or Standard & Poor’s rating
services and restrict investments in common stocks to only those that are listed and actively traded on one or
more of the major United States stock exchanges, including NASDAQ. We manage to an asset allocation of
45% to 75% in equity securities. An investment in any single stock issue is restricted to 5% of the total portfolio
value and 90% of the securities held in mutual or commingled funds must meet the criteria for common stocks.
To develop the expected long-term rate of return on assets assumption, we consider the historical returns and
the future expectations for returns for each asset class, as well as the target asset allocation of the pension
portfolio. This resulted in the selection of the 6.5% long-term rate of return on assets assumption. The expected
return on plan assets uses the fair market value as of December 31, 2018. To develop the discount rate used in
determining the benefit obligation we used the Findley 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
2019. We expect our 2019 net periodic pension cost to be zero, the components of which are interest cost of
$454 thousand, expected return on plan assets of ($597) thousand and amortization of actuarial loss of $143
thousand.
F-41
The following table shows the weighted-average asset allocation for the defined benefit cash balance plan held
as of December 31, 2018 and 2017.
Asset Category:
Debt securities
Equity securities
Other
Total
December 31
2018 2017
36 %
61 %
3 %
100 %
32 %
64 %
4 %
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, 2018 and December 31, 2017 (in thousands).
As of December 31, 2018
Quoted Prices in Active Other Observable
Markets for Identical
Assets (Level 1)
Inputs
(Level 2)
Unobservable Inputs
(Level 3)
Debt securities
Equity securities
Total
$
$
— $
5,913
5,913 $
3,468 $
—
3,468 $
Total
— $ 3,468
—
5,913
— $ 9,381
As of December 31, 2017
Quoted Prices in Active
Markets for Identical Other Observable Unobservable Inputs
Assets (Level 1)
Inputs (Level 2)
(Level 3)
Total
Debt securities
Equity securities
Total
$
$
— $
7,156
7,156 $
3,586 $
—
3,586 $
— $ 3,586
7,156
—
— $ 10,742
Our plan assets also include cash and cash equivalents of $0.3 million and $0.4 million at December 31, 2018
and 2017, respectively, that 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 for each of the years ended December 31, 2018 and 2017.
F-42
15. Income Taxes:
The composition of deferred tax assets and liabilities and the related tax effects as of December 31, 2018 and
2017, 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
Bonus accrual
Investment impairments
Other
Total deferred tax assets
2018
2017
$ (3,001 ) $ (3,361)
(1,087 ) (4,688)
(22 ) (28)
(2,179 ) (2,476)
(357 ) (357)
(72 ) (111)
(992 ) (860)
(279 ) (303)
(7,989 ) (12,184)
6,931
71
867
93
2,505
54
632
1,446
373
12,972
6,901
107
746
200
3,422
158
302
1,956
329
14,121
Deferred federal income taxes, net
$ 4,983 $ 1,937
We concluded that no valuation allowance was necessary to provide against our deferred tax assets as of
December 31, 2018.
F-43
A reconciliation of the income tax provisions based on the applicable statutory tax rates of 21% and 35% to the
provisions reflected in the consolidated financial statements for the years ended December 31, 2018 and 2017,
respectively, is as follows (in thousands):
Computed expected income tax expense (benefit) 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 expense (benefit)
2018
$
2017
2,689 $
75
(435 )
(94 )
266
—
—
(45 )
2,456 $
(5,800 )
81
(987 )
(196 )
165
1,276
464
(22 )
(5,019 )
$
Current income tax expense (benefit)
Deferred tax benefit
Income tax expense (benefit)
$
$
4,300 $
(1,844 )
2,456 $
(3,444 )
(1,575 )
(5,019 )
We have available, for federal income tax purposes, unused net operating loss of $0.4 million at December 31,
2018. 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
2038
$
$
—
2
25
45
77
73
59
33
50
29
49
442
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 2015. The Company recognizes interest and penalties related to uncertain tax positions in
income tax expense. There were no uncertain tax positions at December 31, 2018.
F-44
16. Supplemental Cash Flow Information
The following table provides a reconciliation of cash, cash equivalents and restricted cash reported in the
consolidated balance sheet to the total of the same such amounts shown in the statement of cash flows:
As of December 31,
2017
2018
Cash and cash equivalents
Restricted cash
Total cash, cash equivalents and restricted cash shown in the statement of cash flows $
$
35,594 $ 64,982
4,877
2,651
40,471 $ 67,633
Restricted cash represents amounts required to be set aside by a contractual agreement with a third-party insurer
and amounts pledged for the benefit of various state insurance departments.
The following table provides supplemental cash flow information for the years ended December 31, 2018 and
2017:
Interest paid
Income taxes (recovered) paid
Supplemental schedule of non-cash investing activities:
Receivable for securities related to investment disposals
Payable for securities related to investment purchases
17. Commitments and Contingencies:
December 31,
2017
2018
$ 4,842 $ 4,506
$ (3,236) $
137
$ 3,369 $ 5,235
$ 698 $ 7,488
We have several leases, primarily for office facilities and computer equipment, which expire in various years
through 2032. Certain of these leases contain renewal options. Rental expense amounted to $3.1 million and
$2.8 million for the years ended December 31, 2018 and 2017.
Future minimum lease payments under non-cancelable operating leases as of December 31, 2018 are as follows
(in thousands):
Year
2019
2020
2021
2022
2023
2024 and thereafter
Total minimum lease payments
$
$
2,269
2,491
2,172
2,171
1,885
15,266
26,254
F-45
From time to time, assessments are levied on us by the guaranty association of the states where we offer our
insurance products. Such assessments are made primarily to cover the losses of policyholders of insolvent or
rehabilitated insurers. Since these assessments can generally be recovered through a reduction in future
premium taxes paid, we capitalize the assessments that can be recovered as they are paid and amortize the
capitalized balance against our premium tax expense. We did not pay an assessment during 2018. During 2017
we paid $36 thousand in assessments.
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.
18. Changes in Accumulated Other Comprehensive Income Balances:
The changes in accumulated other comprehensive income balances as of December 31, 2018 and 2017 were as
follows (in thousands):
Pension Unrealized
Liability Gains (Loss)
$
(2,666 ) $
Accumulated Other
Comprehensive
Income (Loss)
13,037 $ 10,371
548
(192 )
—
—
—
548
—
(192)
—
9,117
9,117
(3,191 ) (3,191)
(6,799 ) (6,799)
—
356
2,380
1,507
2,380
1,863
(2,310 ) $
14,544 $ 12,234
(576 )
121
—
—
—
—
—
(576)
121
(3,343 ) (3,343)
702
(1,803 ) (1,803)
702
—
(455 )
379
379
(4,065 ) (4,520)
(569 )
3,188
2,619
—
(3,334 ) $
(16,993 )
(16,993)
(3,326 ) $ (6,660)
Balance at January 1, 2017
Other comprehensive income:
Change in net actuarial gain
Tax effect on change in net actuarial gain
Unrealized holding gains arising during the period
Tax effect on unrealized gains arising during the period
Reclassification adjustment for gains included in net realized gains
Tax effect on reclassification adjustment for gains included in
income tax expense
Other comprehensive income, net of tax
$
Balance at December 31, 2017
Other comprehensive income:
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
Reclassification of certain tax effects from accumulated other
comprehensive income at January 1, 2018
Cumulative effect of adoption of updated accounting guidance for
equity financial instruments at January 1, 2018
Balance at December 31, 2018
$
F-46
19. 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,
2018.
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, 2018 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.
F-47
Schedule II – Condensed Financial Information of Registrant (Parent Company Only)
HALLMARK FINANCIAL SERVICES, INC.
BALANCE SHEETS
December 31, 2018 and 2017
(In thousands)
2018
2017
ASSETS
Debt securities, available-for-sale, at fair value (amortized cost; $150 in 2018 and
$150 in 2017)
Cash and cash equivalents
Investment in subsidiaries
Deferred federal income taxes
Federal income tax recoverable
Other assets
Total assets
$
10,159
344,904
442
6,133
3,784
786 $ 150
12,194
344,496
493
3,914
3,571
$ 366,208 $ 364,818
LIABILITIES AND STOCKHOLDERS’ EQUITY
Liabilities:
Revolving credit facility payable
Subordinated debt securities (less unamortized debt issuance cost of $898 in 2018
and $949 in 2017)
Accounts payable and other accrued expenses
Total liabilities
$ 30,000 $ 30,000
55,804
24,872
110,676
55,753
27,947
113,700
Stockholders’ equity:
Common stock, $.18 par value, authorized 33,333,333 shares; issued 20,872,831
shares in 2018 and in 2017
Additional paid-in capital
Retained earnings
Accumulated other comprehensive income
3,757
123,168
161,195
(6,660 )
3,757
123,180
136,474
12,234
Treasury stock (2,846,131 shares in 2018 and 2,703,803 in 2017), at cost
(25,928 )
(24,527)
Total stockholders’ equity
Total liabilities and stockholders’ equity
251,118
255,532
$ 366,208 $ 364,818
See accompanying report of independent registered public accounting firm.
F-48
Schedule II (Continued) – Condensed Financial Information of Registrant (Parent Company Only)
HALLMARK FINANCIAL SERVICES, INC.
STATEMENTS OF OPERATIONS
For the years ended December 31, 2018 and 2017
(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 earnings (loss) in subsidiaries
Net income (loss)
Comprehensive income (loss)
2018
$
290 $
2017
5,525
—
14,736
20,551
210
11,375
(759 )
11,896
22,722
11,395
4,545
10,265
4,512
15,940
14,777
4,611
7,945
(306 )
(947 )
4,917
5,430
8,892
(20,445 )
$ 10,347 $ (11,553 )
$
5,827 $
(9,690 )
See accompanying report of independent registered public accounting firm.
F-49
Schedule II (Continued) – Condensed Financial Information of Registrant (Parent Company Only)
HALLMARK FINANCIAL SERVICES, INC.
STATEMENTS OF CASH FLOWS
For the years ended December 31, 2018 and 2017
(In thousands)
Cash flows from operating activities:
Net income (loss)
Adjustments to reconcile net income (loss) to cash (used in) provided by
operating activities:
Depreciation and amortization expense
Deferred income tax expense (benefit)
Net realized losses
Undistributed share of (earnings) loss of subsidiaries
Change in current federal income tax recoverable
Change in all other liabilities
Change in all other assets
Net cash (used in) provided by operating activities
Cash flows from investing activities:
Purchases of property and equipment
Purchase of investment securities
Net cash used in investing activities
Cash flows from financing activities:
Proceeds from exercise of employee stock options
Purchase of treasury shares
Net cash used in financing activities
(Decrease) increase in cash and cash equivalents
Cash and cash equivalents at beginning of year
Cash and cash equivalents at end of year
Supplemental cash flow information:
Interest paid
Income taxes paid
2018
2017
$ 10,347 $ (11,553 )
377
51
—
(5,430 )
(2,219 )
(3,075 )
(466 )
(415 )
367
(160 )
759
20,445
(1,158 )
306
632
9,638
(55 )
—
(55 )
(97 )
(1,304 )
(1,401 )
242
(1,807 )
(1,565 )
231
(5,308 )
(5,077 )
(2,035 )
12,194
3,160
9,034
$ 10,159 $ 12,194
$
4,842 $
4,506
$
1,996 $
372
See accompanying report of independent registered public accounting firm.
F-50
FINANCIAL STATEMENT SCHEDULES
Schedule III - Supplementary Insurance Information
(In thousands)
Column A
Column B Column C Column D Column E Column F Column G Column H Column I
Column J Column K
Future
Policy
Benefits,
Losses,
Deferred Claims, and
Policy
Loss
Other
Policy
Claims and
Net
Benefits, Amortization
Claims, of Deferred
Losses and
Policy
Other
Net
Segment
2018
Specialty Commercial
Segment
Standard Commercial
Segment
Personal Segment
Corporate
Acquisition Adjustment Unearned Benefits Premium Investment Settlement Acquisition Operating Premiums
Expenses Written
Expenses Premiums Payable Revenue
Expenses
Income
Costs
Costs
$
5,637 $ 429,741 $
234,563 $
— $
258,186 $ 19,302 $
194,268 $
21,133 $ 52,071 $
251,731
5,212
3,442
—
74,677
22,829
—
40,813
22,685
—
— 72,321
— 32,580
—
—
3,736
1,185
(5,991 )
39,396
22,364
—
13,415 22,825
2,888 15,420
— 11,396
69,222
42,845
—
Consolidated
$
14,291 $ 527,247 $
298,061 $
— $
363,087 $ 18,232 $
256,028 $
37,436 $
101,712 $
363,798
2017
Specialty Commercial
Segment
Standard Commercial
Segment
Personal Segment
Corporate
$
8,668 $ 416,788 $
224,903 $
— $
259,086 $ 16,809 $
213,050 $
21,600 $ 57,458 $
265,022
6,421
913
—
87,323
22,989
—
37,574
14,165
—
— 66,218
— 35,733
—
—
3,855
1,194
(2,984 )
45,227
30,031
—
10,890 23,180
1,775 12,712
— 10,265
69,288
31,273
—
Consolidated
$
16,002 $ 527,100 $
276,642 $
— $
361,037 $ 18,874 $
288,308 $
34,265 $
103,615 $
365,583
See accompanying report of independent registered public accounting firm.
F-51
FINANCIAL STATEMENT SCHEDULES
Schedule IV – Reinsurance
(In thousands)
Column B
Gross Amount
Column C
Ceded to
Column D
Column E
Column F
Assumed from Net Amount Percentage of Amount
Other Companies Other Companies
Assumed to Net
Year Ended
December 31, 2018
Life insurance in
force
$
— $
— $
— $
—
Premiums
Life insurance
Accident and health
insurance
Property and liability
insurance
Title Insurance
Total premiums
$
$
Year Ended
December 31, 2017
Life insurance in
force
$
Premiums
Life insurance
Accident and health
insurance
Property and liability
insurance
Title Insurance
Total premiums
$
$
— $
— $
— $
—
—
—
—
—
639,437
—
639,437 $
(278,509 )
—
(278,509 ) $
2,159
—
363,087
—
2,159 $ 363,087
0.59 %
0.59 %
— $
— $
— $
—
— $
— $
— $
—
—
—
—
—
567,089
—
567,089 $
(207,732 )
—
(207,732 ) $
1,680
—
361,037
—
1,680 $ 361,037
0.47 %
0.47 %
See accompanying report of independent registered public accounting firm.
F-52
FINANCIAL STATEMENT SCHEDULES
Schedule VI - Supplemental Information Concerning Property-Casualty Insurance Operations
(In thousands)
Column A
Column B Column C Column D Column E Column F Column G
Column H
Column I
Column J Column K
Reserves for
Unpaid
Deferred Claims and Discount if
Claim
Policy
any,
Claims and Claim
Adjustment Expenses Amortization of Paid Claims
Deferred Policy and Claims
Incurred Related to
Net
Net
Affiliation With Acquisition Adjustment Deducted In Unearned Earned Investment (1) Current
(2) Prior Acquisitions
Costs
Expenses Column C Premiums Premiums Income
Year
Years
Costs
Adjustment Premiums
Written
Expenses
Registrant
(a) Consolidated
property-casualty
Entities
2018
2017
$
$
14,291 $
16,002 $
527,247 $
527,100 $
— $ 298,061 $ 363,087 $
— $ 276,642 $ 361,037 $
18,232 $
18,874 $
250,075 $
248,203 $
5,953 $
40,105 $
37,436 $
34,265 $
322,985 $ 363,798
274,150 $ 365,583
See accompanying report of independent registered public accounting firm.
F-53
Corporate Information
BOARD OF DIRECTORS
INDEPENDENT REGISTERED
PUBLIC ACCOUNTANTS
NASDAQ: HALL
Headquartered in Fort Worth, Texas, Hallmark Financial Services, Inc. is a publicly
traded holding company with wholly-owned subsidiaries engaged in property and
casualty insurance.
Hallmark Financial's
Business Plan
is to operate as a diversified underwriter of niche property and casualty
insurance products. This plan is executed by wholly-owned business
units, each with a separate specialty product focus.
Our Corporate Strategy
is to create a “Best-in-Class” specialty insurance company focused on
under writing profitability and long-term growth of stockholders’ book
value per share. Our specialty product focus and niche market strategy
enable us to develop and retain in-house underwriting expertise and
specialized market knowledge, which helps differentiate Hallmark
Financial from our competitors. Each business unit tailors its products
and product distribution to the unique nature of the risks and coverages
it provides.
Our Financial Goal
is to earn a consistent underwriting profit and build long-term share-
holder value by focusing on profitability and operating efficiency versus
topline premium growth and market share.
Mark E. Schwarz
Executive Chairman
Scott T. Berlin
President
Mason Structural Steel, LLC
James H. Graves
Partner
Erwin, Graves & Jones, LP
Mark E. Pape
Chairman
H2Options, Inc. & U.S. Rain Group, Inc.
MANAGEMENT TEAM
Mark E. Schwarz
Executive Chairman
Naveen Anand
President & Chief Executive Officer
Jeffrey R. Passmore
Senior Vice President &
Chief Financial Officer
Ken Krissinger
Senior Vice President &
Chief Actuary
BDO USA, LLP
600 North Pearl
Suite 1700
Dallas, Texas 75201
STOCK SYMBOL
Hallmark Financial Services, Inc.
common stock is listed on the
NASDAQ Global Market under
the symbol “HALL.”
TRANSFER AGENT
Securities Transfer Corporation
2901 North Dallas Parkway
Suite 380
Plano, Texas 75093-5990
(469) 633-0101
LEGAL COUNSEL
McGuire, Craddock & Strother, P.C.
2501 N. Harwood
Suite 1800
Dallas, Texas 75201
STOCKHOLDER MEETING
The annual meeting of stockholders will be held
at 10:00 a.m. CDT on May 30, 2019 in the Train-
ing Center on the Concourse level at 777 Main
Street, Ft. Worth, Texas 76102.
CORPORATE HEADQUARTERS
Hallmark Financial Services, Inc.
777 Main Street
Suite 1000
Ft. Worth, Texas 76102
(817) 348-1600
www.hallmarkgrp.com
Annual Report 2018
2018
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777 Main Street, Suite 1000 I Fort Worth, Texas 76102 I P (817) 348-1600 I www.hallmarkgrp.com