Annual Report 2019
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Two Lincoln Center, 5420 Lyndon B Johnson Freeway, Suite 1100 | Dallas, Texas 75240 | P (817) 348-1600 | www.hallmarkgrp.com
NASDAQ: HALL
Headquartered in Dallas, Texas, Hallmark Financial Services, Inc. is a publicly traded
holding company with wholly-owned subsidiaries engaged in property and casualty
insurance. Hallmark Financial operates as a diversified underwriter of niche property
and casualty insurance products, executed by wholly-owned business units, each with
a separate specialty product focus.
Corporate Information
BOARD OF DIRECTORS
Mark E. Schwarz
Executive Chairman
Scott T. Berlin
President
Mason Structural Steel, LLC
James H. Graves
Partner
Ervin, Graves & Jones, LP
Mark E. Pape
Chairman
H2Options, Inc. & U.S. Rain Group, Inc.
OFFICERS
Mark E. Schwarz
Executive Chairman
Naveen Anand
Christopher Kenney
Senior Vice President &
Chief Accounting Officer
President & Chief Executive Officer
LEGAL COUNSEL
INDEPENDENT REGISTERED
PUBLIC ACCOUNTANTS
Baker Tilly Virchow Krause, LLP
Milwaukee, Wisconsin
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
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 December 22, 2020,
at Two Lincoln Center, 5420 Lyndon B. Johnson
Freeway, Suite 1110, Dallas, Texas 75240.
CORPORATE HEADQUARTERS
Hallmark Financial Services, Inc.
Two Lincoln Center
5420 Lyndon B. Johnson Freeway, Suite 1110
Dallas, Texas 75240
(817) 348-1600
www.hallmarkgrp.com
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-K
(Mark One)
(cid:95)(cid:95) ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the fiscal year ended DECEMBER 31, 2019
Or
(cid:134) 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)
5420 Lyndon B. Johnson Freeway, Suite 1100, Dallas, Texas
(Address of Principal Executive Offices)
87-0447375
(I.R.S. Employer Identification No.)
75240
(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
Trading Symbol(s)
Name of each exchange on which registered
Common Stock, $0.18 par value
HALL
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 (cid:134) No (cid:95)
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 (cid:134) No (cid:95)
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 (cid:95) No (cid:134)
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 (cid:95) No (cid:134)
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 (cid:134)
Accelerated filer (cid:95)
Non-accelerated filer (cid:134)
Smaller reporting company (cid:95)
Emerging growth company (cid:134)
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. (cid:134)
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes (cid:134) No (cid:95)
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. $184.3 million
Indicate the number of shares outstanding of each of the registrant’s classes of common stock, as of the latest practicable date. 18,141,496
shares of common stock, $.18 par value per share, outstanding as of June 15, 2020.
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.
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 business activities and availability of funds.
Statements regarding the following subjects are forward-looking by their nature:
(cid:120) our business and growth strategies;
(cid:120) our performance goals;
(cid:120) our projected financial condition and operating results;
(cid:120) our understanding of our competition;
(cid:120)
(cid:120)
(cid:120)
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
business units organized by products and distribution channel. Our business units are supported by our
insurance company subsidiaries. Our Commercial Auto business unit offers primary and excess commercial
vehicle insurance products and services; our E&S Casualty business unit offers primary and excess liability,
excess public entity liability, E&S package and garage liability insurance products and services; our E&S
Property business unit offers primary and excess commercial property insurance for both catastrophe and non-
catastrophe exposures; our Professional Liability business unit offers healthcare and financial lines professional
liability insurance products and services primarily for businesses, medical professionals, medical facilities and
senior care facilities; and our Aerospace & Programs business unit offers general aviation and satellite launch
property/casualty insurance products and services, as well as certain specialty programs. These products and
services were previously reported as the Contract Binding and Specialty Commercial business units. Our
Commercial Accounts business unit (f/k/a Standard Commercial P&C business unit) offers package and
monoline property/casualty and occupational accident insurance products. Effective June 1, 2016 we ceased
marketing new or renewal occupational accident policies. Our former Workers Compensation operating unit
specialized in small and middle market workers compensation business. Effective July 1, 2015, we no longer
market or retain any risk on new or renewal workers compensation policies. Our Specialty Personal Lines
business unit offers non-standard personal automobile and renters insurance products and services.
Each business unit has its own management team with significant experience in distributing products to its
target markets and proven success in achieving underwriting profitability. Each business 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 business units. We expect future growth
to be derived from organic growth in the premium production of our existing business units and selected
opportunistic acquisitions that meet our criteria.
3
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 expect to offer
these products profitably as a result of the expertise of our experienced underwriters. We also believe our long-
standing relationships with independent general agencies and retail agents and the service we provide
differentiate us from larger property/casualty insurers.
Our Commercial Auto business unit offers primary and excess commercial vehicle insurance products and
services in both the excess and surplus lines market and the admitted 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.
Most of the admitted risks are unique and hard to place in the standard admitted market but, for marketing and
regulatory reasons, they must remain with an admitted insurance company. Our Commercial Auto business unit
focuses on middle market commercial risks that do not meet the underwriting requirements of standard insurers
due to factors such as loss history, number of years in business, minimum premium size and types of business
operation. Our Commercial Auto business unit markets its products in 50 states plus the District of Columbia
through 96 wholesale brokers and 73 general agency offices, as well as four independent retail agents in Texas.
The Commercial Auto business unit also writes primary commercial automobile liability and physical damage
risk on an admitted basis in 16 states through a program underwriter.
Our E&S Casualty business unit offers primary and excess liability, excess public entity liability, E&S package
and garage liability insurance products and services on both an admitted and non-admitted basis. The principal
focus of the primary and excess liability products, as well as the E&S package insurance products, are coverage
for small to midsize businesses in class categories such as contracting, manufacturing, hospitality and service
(non-transportation). Public entity excess coverage is offered on an insurance and reinsurance basis for cities,
counties and other public entities with populations up to 1,000,000. Garage liability targets non-franchised car
dealers and service and repair shops. Our E&S Casualty business unit markets its primary and excess liability
and excess public entity liability products through 78 wholesale brokers in 50 states plus the District of
Columbia. Our E&S Casualty business unit markets our E&S package and garage liability products through
142 general agents, four wholesale brokers and one retail agent in 46 states.
The primary/excess commercial property coverages underwritten by our E&S Property business unit specialize
in shared and layered accounts on a non-admitted basis which target regional and national property programs.
Our E&S Property business unit markets these products through 22 wholesale brokers in 50 states.
The medical professional liability insurance underwritten on an excess and surplus lines basis by our
Professional Liability business unit 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
Professional Liability business unit also underwrites medical professional liability for standard medical
facilities, hospitals and healthcare systems. The medical facilities are generally outpatient facilities such as
surgery centers, imaging centers, laboratories, 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 other specialty hospitals and
4
healthcare systems providing medical services. Our Professional Liability business unit markets these products
through 40 wholesale and retail brokers in 49 states. The Professional Liability business 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 Professional Liability business unit focuses
on management and professional liability products that include directors and officers, employment practices
and retirement and benefit plan fiduciary services for private, public and non-profit entities, as well as
miscellaneous professional liability insurance for non-financial institution service industries. Our Professional
Liability business unit distributes its financial professional liability insurance products through 33 wholesale
brokers in 40 states.
The aircraft liability and hull insurance products underwritten by our Aerospace & Programs business unit
target standard general aviation aircraft risks. Airport liability insurance is marketed to smaller, regional
airports. Our Aerospace & Programs business unit markets these general aviation insurance products through
168 independent specialty brokers in 48 states. The satellite launch property/casualty policies produced by our
Aerospace & Programs business 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 specialty programs business marketed by our Aerospace & Programs business unit presently
consists primarily of a fronting arrangement in Texas for a third party insurance company and a program
underwriter writing primarily commercial automobile coverage for risks specializing in daily rental operations.
Our Commercial Accounts business unit primarily underwrites low-severity, short-tailed commercial
property/casualty insurance products in the standard market. These products include general liability,
commercial automobile, commercial property and umbrella coverages. Our Commercial Accounts business
unit currently markets its products through a network of 184 independent agency groups primarily serving
businesses in the non-urban areas of 14 states predominately in the southwest and northwest regions. In
addition, our Commercial Accounts business unit previously provided occupational accident coverage in Texas
through an underwriting agency that specialized in the occupational accident insurance market. Effective
June 1, 2016, we ceased marketing new or renewal occupational accident policies.
Our Specialty Personal Lines business 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 business unit also provides a renters insurance
product that complements our non-standard automobile offering and fits well in our distribution channel. Our
Specialty Personal Lines business unit markets and services these non-standard automobile and renters
insurance policies through 4,506 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 32% of the net premiums written by any of them, HIC retains 32% of the net premiums written
by any of them, HSIC retains 26% 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
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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 business units are segregated into three reportable industry segments for financial accounting purposes.
The Specialty Commercial Segment includes our Commercial Auto business unit, E&S Casualty business unit,
E&S Property business unit, Professional Liability business unit and our Aerospace & Programs business unit.
The Standard Commercial Segment consists of the Commercial Accounts business unit and the runoff from our
former Workers Compensation operating unit. The Personal Segment consists solely of our Specialty Personal
Lines business unit. The following table displays the gross premiums written and net premiums written by these
reportable segments for affiliated and unaffiliated insurers for the years ended December 31, 2019, 2018 and
2017.
Gross Premiums Written:
Specialty Commercial Segment
Standard Commercial Segment
Personal Segment
Total
Net Premiums Written:
Specialty Commercial Segment
Standard Commercial Segment
Personal Segment
Total
2019
Year Ended December 31,
2018
(dollars in thousands)
2017
651,913 $
92,645
99,273
843,831 $
501,806 $
86,121
75,088
663,015 $
464,714
78,228
61,214
604,156
350,047 $
62,892
83,613
496,552 $
251,731 $
69,222
42,845
363,798 $
265,022
69,288
31,273
365,583
$
$
$
$
6
Specialty Commercial Segment
The Specialty Commercial Segment of our business includes our Commercial Auto business unit, E&S
Casualty business unit, E&S Property business unit, Professional Liability business unit and Aerospace &
Programs business unit. The following table displays the gross premiums written and net premiums written for
affiliated and unaffiliated insurers by these business units reported in the Specialty Commercial Segment for
the years ended December 31, 2019 and 2018.
Gross Premiums Written:
Commercial Auto business unit
E&S Casualty business unit
E&S Property business unit
Professional Liability business unit
Aerospace & Programs business unit
Total Specialty Commercial Segment
Net Premiums Written:
Commercial Auto business unit
E&S Casualty business unit
E&S Property business unit
Professional Liability business unit
Aerospace & Programs business unit
Total Specialty Commercial Segment
2019
Year Ended December 31,
% of Total 2019
2018
(dollars in thousands)
% of Total 2018
$ 286,904
94,886
122,302
106,808
41,013
$ 651,913
44.0% $ 275,820
59,792
14.5%
63,225
18.8%
66,118
16.4%
36,851
6.3%
100.0% $ 501,806
$ 208,748
51,812
26,054
49,851
13,582
$ 350,047
59.6% $ 177,218
28,624
14.8%
12,622
7.5%
22,610
14.2%
10,657
3.9%
100.0% $ 251,731
55.0%
11.9%
12.6%
13.2%
7.3%
100.0%
70.4%
11.4%
5.0%
9.0%
4.2%
100.0%
Commercial Auto business unit. Our Commercial Auto business unit provides commercial auto liability and
physical damage insurance to local, intermediate and long haul truckers, as well as other classes of commercial
auto transportation.
Our Commercial Auto business unit focuses on middle market commercial risks that do not meet the
underwriting requirements of traditional standard insurers due to issues such as loss history, number of years
in business, minimum premium size and types of business operation. Target risks for commercial automobile
insurance are business automobile and trucking for hire fleets. The insurance products offered by our
Commercial Auto business unit include the following:
(cid:120) 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.
(cid:120) Commercial excess liability. Commercial excess liability insurance is designed to provide an extra
layer of protection for bodily injury losses above the underlying layers of commercial automobile
insurance. The excess insurance does not begin until the limits of liability in the underlying layer have
been exhausted.
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Our Commercial Auto business unit focuses its primary automobile policies on business automobile, local and
long-haul trucking, specialty automobile, truckers for hire and truckers not for hire. These primary automobile
policies consist of both contract binding policies distributed through 73 general agency locations in four states
and brokerage policies distributed in 25 states through 18 wholesale brokers and four independent retail agents.
Coverages for both contract binding and brokerage policies include commercial automobile liability up to
$1,000,000 and physical damage. The vast majority of primary automobile policies written by our Commercial
Auto business unit are for a term of 12 months. Primary automobile policies are paid in full up front or financed
with various premium finance companies.
During 2019, general agents produced 74%, wholesale brokers produced 25%, and retail agents produced 1%
of the total primary automobile premiums produced by our Commercial Auto business unit. During 2019, the
top ten general agents produced 56%, and no general agent produced more than 10%, of the total primary
automobile premium volume of our Commercial Auto business unit. During the same period, the top ten
wholesale brokers produced 22%, and no wholesale broker produced more than 6%, of the total primary
automobile premium volume of our Commercial Auto business unit.
Our Commercial Auto business unit focuses its excess automobile policies on transportation classes such as
truckers for hire, certain hazardous materials classes and specialty risks. These excess automobile policies are
distributed through 77 wholesale brokers in 50 states plus the District of Columbia. Limits of liability offered
are from $1,000,000 to $5,000,000 in coverage in excess of the underlying carrier’s limits of liability. The
majority of the excess automobile policies written by our Commercial Auto business unit are on an annual
basis. However, exceptions are common in an attempt to have policy effective dates coincide with those of the
primary insurance policies. Policy premiums are due in full 30 days from the inception date of the policy.
During 2019, the top ten wholesale brokers accounted for 89%, and no wholesale broker accounting for more
than 34%, of the total excess automobile premium volume of our Commercial Auto business unit.
In February, 2020, we made the strategic decision to exit the contract binding line of the primary automobile
business marketed by our Commercial Auto business unit as a result of increasing claim severity and limited
opportunity for meaningful rate increases. At that time, we began the process of non-renewing policies and
placing in-force policies in runoff in accordance with state regulatory guidelines. During 2019, this contract
binding business produced $115.0 million in gross premiums written, which represented 56% of the total
primary automobile premium volume of our Commercial Auto business unit.
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E&S Casualty business unit. Our E&S Casualty business unit offers primary and excess liability, excess
public entity liability, E&S package and garage liability insurance products and services on both an admitted
and non-admitted basis through wholesale brokers in 50 states plus the District of Columbia. Limits of liability
offered are from $1,000,000 to $10,000,000 in coverage in excess of the primary carrier’s limits of liability.
During 2019, the top ten wholesale brokers accounted for 66% of our primary and excess casualty premium
volume, with no single wholesale broker accounting for more than 15%.
The insurance products offered by our E&S Casualty business unit include the following:
(cid:120) 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 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.
(cid:120) Commercial umbrella. Commercial umbrella insurance protects businesses for bodily injury, personal
and advertising injury, general liability and employer’s liability losses, 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.
(cid:120) 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.
(cid:120) Public entity excess liability. Public entity excess liability is designed to provide an extra layer of
protection for target classes of public entities for automobile liability, general liability, public officials’
liability, wrongful acts, employment practices liability, law enforcement liability, educators’ legal
liability and related coverages.
(cid:120) E&S package. E&S package provides both commercial property and general liability in a single policy
for third-party bodily injury and property damage claims arising from accidents occurring on the
insured’s premises or from their general business operations.
(cid:120) Garage liability. Garage liability 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.
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E&S Property business unit. Our E&S Property business unit markets primary/excess commercial property
coverages, on a non-admitted basis, for both catastrophe and non-catastrophe exposures. The primary/excess
property coverages offered by our E&S Property business unit are offered in conjunction with shared and
layered accounts for multiple specialty property classes. Targeted classes primarily include institutions,
municipalities, religious organizations and education. Our E&S Property business unit also markets inland
marine property coverages included with shared and layered accounts for specialty property risks. Targeted
classes for our inland marine property coverages include contractors equipment and builders risk. Our E&S
Property business unit distributes its primary/excess commercial property and inland marine insurance products
through 22 wholesale brokers in 50 states. During 2019, the top ten wholesale brokers accounted for 62% of
our primary/excess commercial property and inland marine premium volume, with no single wholesale broker
accounting for more than 19%.
Professional Liability business unit. Our Professional Liability business unit markets medical professional
liability insurance on an excess and surplus lines basis. Medical professional liability insurance provides
coverage for third-party bodily injury claims resulting from professional services provided by physicians,
surgeons, podiatrists and medical entities, as well as outpatient medical facilities and hospitals and healthcare
systems. Our Professional Liability business unit distributes its medical professional liability insurance products
through 40 wholesale and retail brokers in 49 states. The Professional Liability business 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. During 2019, the top ten brokers
accounted for 27% of our medical professional liability premium volume, with no single broker accounting for
more than 14%. During 2019 the program manager accounted for 63% of our medical professional liability
premium volume.
Our Professional Liability business unit also 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 Professional Liability business unit distributes its financial
professional liability insurance products through 33 wholesale brokers in 40 states. During 2019, the top ten
wholesale brokers accounted for 88% of our financial professional liability premium volume, with no single
wholesale broker accounting for more than 39%.
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Aerospace & Programs business unit. Our Aerospace & Programs business unit markets, underwrites and
services general aviation property/casualty insurance in 48 states, satellite launch property/casualty insurance
products and services, as well as certain specialty programs. The marketing strategy for our general aviation
property/casualty insurance 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 Aerospace & Programs business unit offers satellite launch property/casualty policies marketed
through underwriting agencies with technical knowledge of space insurance. The general aviation and satellite
launch products offered by our Aerospace & Programs business unit include the following:
(cid:120) 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.
(cid:120) 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.
(cid:120) Satellite. We retain up to $2.0 million per risk for satellite launches and in-orbit coverage for up to
12 months.
Our Aerospace & Programs business unit distributes its general aviation insurance products through 168
aviation specialty brokers. These specialty brokers submit requests for aviation insurance quotations received
from the states in which we operate and our Aerospace & Programs business unit selectively determines the
risks fitting its target niche for which it will prepare a quote. During 2019, the top ten independent specialty
brokers produced 45%, and no broker produced more than 14%, of the total general aviation premium volume
of our Aerospace & Programs business unit. Our Aerospace & Programs business 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 87% of the aircraft written in
2019 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 2019 was approximately $153,000.
The specialty programs within our Aerospace & Programs business unit consist of fronting and agency
arrangements, as well as a program underwriter. The specialty programs business presently consists primarily
of a fronting arrangement in Texas for a third party insurance company and a program underwriter writing
primarily commercial auto coverage for risks specializing in daily rental operations.
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Standard Commercial Segment
The Standard Commercial Segment of our business includes the package and monoline property/casualty and
occupational accident insurance products and services handled by our Commercial Accounts business unit
(f/k/a Standard Commercial P&C operating unit) and the runoff of workers compensation insurance products
handled by our former Workers Compensation operating unit. Effective June 1, 2016, we ceased marketing
new or renewal occupational accident policies. Effective July 1, 2015, the former Workers Compensation
operating unit ceased retaining any risk on new or renewal policies.
Commercial Accounts business unit. Our Commercial Accounts business 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 Commercial Accounts business 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 Commercial Accounts business unit underwriting criteria exclude lines of business
and classes of risks that are considered to be high-severity or volatile, or which involve significant latent injury
potential or other long-tailed liability exposures. Products offered by our Commercial Accounts business unit
include the following:
(cid:120) 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.
(cid:120) 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.
(cid:120) 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.
(cid:120) 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.
(cid:120) 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.
(cid:120) 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, commercial automobile and umbrella coverage.
Our Commercial Accounts business unit markets its property/casualty insurance products through 184
independent agency groups operating in its target markets. Our Commercial Accounts business unit strives to
provide its independent agents with convenient access to product information and personalized service. As a
result, the Commercial Accounts business unit has historically maintained excellent relationships with its
producing agents, as evidenced by the 17 year average tenure of the 26 agency groups that each produced more
than $1.0 million in premium during the year ended December 31, 2019. During 2019, the top ten agency
12
groups produced 36%, and no individual agency group produced more than 7%, of the total premium volume
of our Commercial Accounts business unit.
Our Commercial Accounts business unit writes most risks on a package basis using a commercial multi-peril
policy or a business owner’s policy. Umbrella policies are written only when our Commercial Accounts
business unit also writes the insured’s underlying general liability and commercial automobile coverage.
All of the commercial policies written by our Commercial Accounts business unit are for a term of 12 months.
If the insured is unable or unwilling to pay for the entire premium in advance, we provide an installment
payment plan that requires the insured to pay 20% or 25% down and the remaining payments over eight months.
We charge installment fees of up to $7.50 per payment for the installment payment plan.
Former 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 former Workers
Compensation operating unit is being administered by an independent third party.
Personal Segment
The Personal Segment of our business consists solely of our Specialty Personal Lines business unit. Our
Specialty Personal Lines business 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
business unit include the following:
(cid:120) Personal automobile. Personal automobile insurance is the primary product offered by our Specialty
Personal Lines business 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.
(cid:120) 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 business unit markets its products through 4,506 independent retail agent
locations in its target geographic markets. Non-standard automobile represented 97% of the premiums
produced during 2019. Our Specialty Personal Lines business unit qualifies new agent appointments in order
to establish an efficient network of independent agents to effectively penetrate its highly competitive markets.
Our Specialty Personal Lines business unit periodically evaluates its independent agents and discontinues the
appointment of agents whose production history does not satisfy certain standards. During 2019, the top ten
independent agency locations produced 40%, and no individual agency location produced more than 6%, of the
total premium volume of our Specialty Personal Lines business unit. During 2019, personal automobile liability
coverage accounted for 69% and personal automobile physical damage coverage accounted for the remaining
31% of the total non-standard automobile premiums produced by our Specialty Personal Lines business unit.
Our most common policy term is a six month policy. We offer 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.
13
Our Competitive Strengths
We believe that we enjoy the following competitive strengths:
(cid:120) Specialized market knowledge and underwriting expertise. All of our business units possess extensive
knowledge of the specialty and niche markets in which they operate, which we believe allows them to
effectively structure and market their property/casualty insurance products.
(cid:120) Tailored market strategies. Each of our business units has developed its own customized strategy for
penetrating the specialty or niche markets in which it operates. These strategies include distinctive
product structuring, marketing, distribution, underwriting and servicing approaches by each business
unit. As a result, we are able to structure our property/casualty insurance products to serve the unique
risk and coverage needs of our insureds. We believe these market-specific strategies enable us to
provide policies tailored to the target customer that are appropriately priced and fit our risk profile.
(cid:120) Superior agent and customer service. We believe performing the underwriting, billing, customer
service and claims management functions tailored to the needs of each business unit allows us to
provide superior service to both our agents and brokers and our insured customers. The easy-to-use
interfaces and responsiveness of our business units enhance their relationships with the agents and
brokers who sell our policies. We also believe that consistently offering insurance products through
hard and soft markets helps to build and maintain the loyalty of agents and brokers. We value our
strong relationships with our agents and brokers and continue to enhance the value proposition to our
agents, brokers and insureds by delivering exceptional customer service.
(cid:120) Market diversification. We believe operating in various specialty and niche segments of the
property/casualty insurance market diversifies both our revenues and our risks. We also believe our
business units generally operate on different market cycles, producing more earnings stability than if
we focused entirely on one product. As a result of the pooling arrangement among four of our insurance
company subsidiaries, we are able to efficiently allocate our capital among these various specialty and
niche markets in response to market conditions and expansion opportunities. We believe this market
diversification reduces our risk profile and enhances our profitability.
(cid:120) Experienced management team. Our senior corporate management team has extensive insurance
experience. In addition, our business 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.
14
Our Strategy
We strive to become a “Best in Class” specialty insurance company offering products in specialty and niche
markets through the following strategies:
(cid:120) Focusing on underwriting discipline and operational efficiency. We seek to consistently generate an
underwriting profit on the business we write in hard and soft markets. Our business units have a strong
track record of underwriting discipline and operational efficiency, which we seek to continue. We
believe that in soft markets our competitors often offer policies at a low or negative underwriting profit
in order to maintain or increase their premium volume and market share. In contrast, we seek to write
business based on its profitability rather than focusing solely on premium production. To that end, we
provide financial incentives to many of our underwriters, agents and brokers based on underwriting
profitability.
(cid:120) Achieving organic growth in our existing business lines. We believe we can achieve organic growth
in our existing business lines by consistently providing our insurance products through market cycles,
expanding geographically, expanding our product offerings, expanding our agency relationships and
further penetrating our existing customer base. We believe our extensive market knowledge and strong
agency relationships position us to compete effectively in our various specialty and niche markets. We
also believe there is a significant opportunity to expand some of our existing business lines into new
geographical areas and through new agency relationships while maintaining our underwriting discipline
and operational efficiency. In addition, we believe there is an opportunity for some of our business
units to further penetrate their existing customer bases with additional products offered by other
business units.
(cid:120) 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.
(cid:120) 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 our agents and brokers is critical to our ability
to identify, attract and retain profitable business. Each of our business units has developed its own tailored
approach to establishing and maintaining its relationships with these independent distributors of our products.
These strategies focus on providing excellent service to our agents and brokers, maintaining a consistent
presence in our target niche and specialty markets through hard and soft market cycles and fairly compensating
the agents and brokers who market our products. Our business units also regularly evaluate independent general
and retail agents based on the underwriting profitability of the business they produce and their performance in
relation to our objectives.
15
Except for the products of our Specialty Commercial Segment, the distribution of property/casualty insurance
products by our business units is geographically concentrated. For the twelve months ended December 31,
2019, five states accounted for approximately 52% of the gross premiums written by our insurance company
subsidiaries. The following table reflects the geographic distribution of our insured risks, as represented by
direct and assumed premiums written by our business segments for the twelve months ended December 31,
2019.
State
Texas
California
Florida
Arizona
Oklahoma
All other states
Total gross premiums written
Percent of total
Underwriting
Specialty Standard
Commercial Commercial
Segment
Segment
Personal
Total
Percent of
Total
$ 190,252
87,755
38,916
4,668
17,177
313,145
$ 651,913
Segment
(dollars in thousands)
$ 31,926
—
—
30,848
9,723
26,776
$ 99,273
$ 23,485
—
—
2,432
—
66,728
$ 92,645
$ 245,663
87,755
38,916
37,948
26,900
406,649
$ 843,831
77.3 %
11.0 %
11.7 %
100.0 %
29.1 %
10.4 %
4.6 %
4.5 %
3.2 %
48.2 %
The underwriting process employed by our business units involves securing an adequate level of underwriting
information, identifying and evaluating risk exposures and then pricing the risks we choose to accept. Each of
our business units offering commercial, 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 business
unit. We employ a disciplined underwriting approach that seeks to provide policies appropriately tailored to the
specified risks and to adopt price structures that will be supported in the applicable market. Our experienced
commercial, healthcare professional, aviation and public entity underwriters have developed underwriting
principles and processes appropriate to the coverages offered by their respective business units.
We believe that managing the underwriting process through our business units capitalizes on the knowledge
and expertise of their personnel in specific markets and results in better underwriting decisions. All of our
underwriters have established limits of underwriting authority based on their level of experience. We also
provide financial incentives to many of our underwriters based on underwriting profitability.
To better diversify our revenue sources and manage our risk, we seek to maintain an appropriate business mix
among our business units. At the beginning of each year, we establish a target net loss ratio for each business
unit. We 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
16
calculated as the ratio of underwriting and operating expenses to net premiums written, assists in measuring the
insurer’s cost of processing and managing the business. The statutory combined ratio, which is the sum of the
statutory loss and LAE ratio and the statutory expense ratio, is indicative of the overall profitability of an
insurer’s underwriting activities, with a combined ratio of less than 100% indicating profitable underwriting
results.
The following table shows, for the periods indicated, (i) our gross premiums written (in thousands); and (ii) our
underwriting results as measured by the net statutory loss and LAE ratio, the net statutory expense ratio, and
the net statutory combined ratio of our insurance company subsidiaries.
Gross premiums written
Net statutory loss & LAE ratio
Net statutory expense ratio
Net statutory combined ratio
$
843,831
$
81.5 %
25.9 %
107.4 %
2019
Year Ended December 31, 2019
2018
663,015
$
69.8 %
25.5 %
95.3 %
2017
604,156
79.1 %
27.0 %
106.1 %
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, 2019, 2018 and 2017, our consolidated premium-to-surplus ratios were 195%, 147% and 157%,
respectively.
Claims Management and Administration
We believe that effective claims management is critical to our success and that our claims management process
is cost-effective, delivers the appropriate level of claims service and produces superior claims results. Our
claims management philosophy emphasizes the delivery of courteous, prompt and effective claims handling
and embraces responsiveness to policyholders and agents. Our claims strategy focuses on thorough
investigation, timely evaluation and fair settlement of covered claims while consistently maintaining
appropriate case reserves. We seek to compress the cycle time of claim resolution in order to control both loss
and claim handling cost. We also strive to control legal expenses by negotiating competitive rates with defense
counsel and vendors, establishing litigation budgets and monitoring invoices.
Each of our business units maintains its own dedicated staff of specialized claims personnel to manage and
administer claims arising under policies produced through their respective operations. The claims process is
managed 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 business unit and monitored by Hallmark senior management.
17
Claims personnel receive in-house training and are required to attend various continuing education courses
pertaining to topics such as best practices, fraud awareness, legal environment, legislative changes and litigation
management. Depending on the criteria of each business unit, our claims adjusters are assigned a variety of
claims to enhance their knowledge and ensure their continued development in efficiently handling claims. As
of December 31, 2019, we had a total of 104 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, 2019 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.
18
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
2019
843,831 $
(347,279)
496,552 $
752,966 $
(316,089)
436,877 $
Year Ended December 31
2018
663,015 $
(299,217)
363,798 $
641,596 $
(278,509)
363,087 $
$
$
$
$
2017
604,156
(238,573)
365,583
568,769
(207,732)
361,037
Reinsurance recoveries
$
211,768 $
199,690 $
144,948
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, 2019, we had total invested assets of
$675.7 million. If market rates were to increase by 1%, the fair value of our fixed-income securities as of
December 31, 2019 would decrease by approximately $8.4 million. The following table shows the fair values
of various categories of fixed-income securities, the percentage of the total fair value of our invested assets
represented by each category and the tax equivalent book yield of each category of invested assets as of
December 31, 2019 and 2018.
As of December 31, 2019
As of December 31, 2018
Fair
Value
Percent of
Total
(in thousands)
Yield
Fair
Value
Percent of
Total
(in thousands)
Yield
Category:
Corporate bonds
Collateralized corporate bank loans
Municipal bonds
US Treasury securities and obligations
of U.S. Government
Mortgage backed
$ 300,825
115,757
83,270
66,600
7,827
$ 574,279
Total
52.4 %
20.1 %
14.5 %
2.7 % $ 242,152
4.0 % 126,528
4.8 % 115,527
44.4 %
23.2 %
21.1 %
11.6 %
1.4 %
100.0 %
48,106
1.8 %
2.8 %
13,557
3.2 % $ 545,870
8.8 %
2.5 %
100.0 %
2.8 %
5.0 %
3.6 %
1.9 %
3.1 %
3.4 %
19
The weighted average credit rating for our fixed-income portfolio was Baa1 at December 31, 2019. The
following table shows the distribution of our fixed-income portfolio by rating as a percentage of total fair value
as of December 31, 2019 and 2018:
Rating:
"Aaa"
"Aa"
"A"
"Baa"
"Ba"
"B"
"Caa"
"Ca"
"C"
"NR"
Total
As of
December 31, 2019
As of
December 31, 2018
15.0 %
7.0 %
13.9 %
44.8 %
15.7 %
0.7 %
— %
— %
— %
2.9 %
100.0 %
13.6 %
6.7 %
11.8 %
44.3 %
19.1 %
0.3 %
0.2 %
1.0 %
— %
3.0 %
100.0 %
The following table shows the composition of our fixed-income portfolio by remaining time to maturity as of
December 31, 2019 and 2018.
Remaining time to maturity:
Less than one year
One to five years
Five to ten years
More than ten years
Mortgage-backed
Total
As of December 31, 2019
As of December 31, 2018
Percentage of
Total
Fair Value
Fair Value
Fair Value
Percentage of
Total
Fair Value
(in thousands)
(in thousands)
$
$
107,605
345,860
88,061
24,926
7,827
574,279
18.8 % $
60.2 %
15.3 %
4.3 %
1.4 %
100.0 % $
120,127
284,947
102,047
25,192
13,557
545,870
22.0 %
52.2 %
18.7 %
4.6 %
2.5 %
100.0 %
20
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, 2019, 15% of our investment
portfolio was invested in equity securities. Our investment portfolio is managed internally. We regularly review
our portfolio for declines in value. For fixed maturity investments that are considered other-than-temporarily
impaired and that we do not intend to sell and will not be required to sell, we separate the amount of the
impairment into the amount that is credit related (credit loss component) and the amount due to all other factors.
The credit loss component is recognized in earnings and is the difference between the investment’s amortized
cost basis and the present value of its expected future cash flows. The remaining difference between the
investment’s fair value and the present value of future expected cash flows is recognized in other comprehensive
income.
The following table details the net unrealized gain balance by invested asset category as of December 31, 2019.
Net Unrealized Gain Balance
(in thousands)
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
$
159
3,224
88
1,483
(173)
27,320
(1,594)
30,507
As part of our overall investment strategy, we also maintain an integrated cash management system utilizing
on-line banking services and daily overnight investment accounts to maximize investment earnings on all
available cash.
Technology
The majority of our technology systems are based on products licensed from insurance-specific technology
vendors that have been substantially customized to meet the unique needs of our various business units. Our
technology systems primarily consist of integrated central processing computers, a series of server-based
computer networks and communications systems that allow our various operations to share systems solutions
and communicate to the corporate office in a timely, secure and consistent manner. We maintain backup
facilities and systems through a contract with a leading provider of computer disaster recovery services. Each
business unit bears the information services expenses specific to its operations as well as a portion of the
corporate services expenses. Increases to vendor license and service fees are capped per annum.
We believe the implementation of our various technology systems has increased our efficiency in the processing
of our business, resulting in lower operating costs. Additionally, our systems enable us to provide a high level
of service to our agents and policyholders by processing our business in a timely and efficient manner,
communicating and sharing data with our agents and providing a variety of methods for the payment of
premiums. We believe these systems have also improved the accumulation and analysis of information for our
management.
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
21
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 to coordinated, elaborate and targeted activity. We
retain highly trained staff committed to the development and maintenance of our information technology
systems. We maintain and regularly review recovery plans which are intended to enable us to restore critical
systems with minimal disruption. We have established an information security committee to oversee and steer
risk management plans to manage these exposures on an ongoing basis. We also employ comprehensive
employee engagement and training programs to guard against the potential for malicious attempts to extort
sensitive information from our systems using social engineering techniques (also known as “phishing”) and
have increased our cyber liability insurance to seek to minimize our post-event financial impacts.
We recognize the potential for new risks arising alongside the benefits we derive from technological and digital
development. We employ technological security measures to prevent, detect and mitigate such threats,
including independent and in-house vulnerability assessments, access controls, data encryption, continuous
monitoring of our information technology networks and systems and maintenance of backup and protective
systems. Nonetheless, the infrastructure may be vulnerable to security incidents which could result in the
disruption of business operations and the corruption, unavailability, misappropriation or destruction of critical
data and confidential information (both our own and 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. On March 2, 2020, A.M. Best announced that its current ratings of our insurance company
subsidiaries were under review with negative implications. On June 9, 2020, A.M. Best announced that it was
maintaining this status pending further review.
22
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. In many instances, we have less financial or other
resources than our competition and their affiliates. 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.
The primary competition for our Commercial Auto business unit includes such carriers as American
Millennium Insurance Company, Canal Insurance Company, Clear Blue Insurance Company, Commercial
Alliance Insurance Company, Fairfax Financial, Hudson Insurance Company, National Casualty Company,
National Liability & Fire Insurance Company, Northland Insurance Company, Progressive County Mutual,
Sompo International, State National Insurance Company, Prime Insurance Company, Underwriters at Lloyds
of London, Wilshire Insurance Company and W.R. Berkley. Our E&S Casualty business unit considers its
primary competition for our excess, umbrella and general liability insurance products to include such carriers
as American International Group, Inc., Axis Insurance Company, Berkshire Hathaway Companies, Crum &
Forster Insurance Group, Endurance American Specialty Insurance Company, XL Specialty Insurance, Markel
Insurance Company, Navigators Specialty Insurance Company, and W.R. Berkley Corporation. The primary
competition for our E&S Package business unit includes such carriers as Nationwide E&S/Specialty, Markel
Insurance Company, Colony Specialty Insurance Company, Atlantic Casualty Insurance Company, Nautilus
Insurance Company, Mesa Underwriters Insurance Company, and Penn America Insurance Company. The
primary competition for our E&S Property business unit includes such carriers as Chubb Westchester, Aspen
Insurance, Everest National Insurance Company, RSUI Group, Navigators Specialty Insurance Company, Starr
Surplus Lines, Ironshore Specialty Insurance Company, Axis Insurance Company, and Markel Insurance
Company. The primary competition for the medical professional liability insurance products produced by our
Professional Liability business unit includes such carriers as Admiral Insurance Company, Aspen Specialty
Insurance Company, Beazley Insurance Company, CNA Financial Corporation, Iron Health, Kinsale Insurance
Company, Markel Insurance Company, Medical Protective Insurance Company, ProAssurance Corporation,
RSUI Group and TDC Companies. The primary competition for the financial professional liability insurance
products produced by our Professional Liability business 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 competitors for our general aviation insurance products produced by our Aerospace & Programs
business 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. Our Commercial Accounts business unit competes with a variety
of large national standard commercial lines carriers such as Liberty Mutual Group, Travelers Companies, Inc.,
Cincinnati Financial Corporation and The Hartford Financial Services Group, as well as numerous smaller
regional companies. Although our Specialty Personal Lines business unit competes with large national insurers
such as Allstate Corporation, GEICO Corporation and Progressive Insurance Company, as a participant in the
non-standard personal automobile marketplace its competition is most directly associated with numerous
regional companies and managing general agencies.
23
Insurance Regulation
AHIC, HCM and TBIC are domiciled in Texas, HIC and HNIC are domiciled in Arizona and HSIC is domiciled
in Oklahoma. Therefore, our insurance operations are regulated by the Texas Department of Insurance, the
Arizona Department of Insurance and the Oklahoma Insurance Department, as well as the applicable insurance
department of each state in which we issue policies. Our insurance company subsidiaries are required to file
quarterly and annual statements of their financial condition prepared in accordance with statutory accounting
practices with the insurance departments of their respective states of domicile and the applicable insurance
department of each state in which they write business. The financial conditions of our insurance company
subsidiaries, including the adequacy of surplus, loss reserves and investments, are subject to review by the
insurance department of their respective states of domicile.
Periodic financial and market conduct examinations. The insurance departments of the states of domicile for
our insurance company subsidiaries have broad authority to enforce insurance laws and regulations through
examinations, administrative orders, civil and criminal enforcement proceedings, and suspension or revocation
of an insurer’s certificate of authority or an agent’s license. The state insurance departments that have
jurisdiction over our insurance company subsidiaries may conduct on-site visits and examinations of the
insurance companies’ affairs, especially as to their financial condition, ability to fulfill their obligations to
policyholders, market conduct, claims practices and compliance with other laws and applicable regulations.
Typically, these examinations are conducted every three to five years. In addition, if circumstances dictate,
regulators are authorized to conduct special or target examinations of insurance companies to address particular
concerns or issues. The results of these examinations can give rise to injunctive relief, regulatory orders
requiring remedial or other corrective action on the part of the company that is the subject of the examination,
assessment of fines, or other penalties against that company. In extreme cases, including actual or pending
insolvency, the insurance department may take over, or appoint a receiver to take over, the management or
operations of an insurer or an agent’s business or assets.
Guaranty funds. All insurance companies are subject to assessments for state-administered funds that cover
the claims and expenses of insolvent or impaired insurers. The size of the assessment is determined each year
by the total claims on the fund that year. Each insurer is assessed a pro rata share based on its direct premiums
written in that state. Payments to the fund may generally be recovered by the insurer through deductions from
its premium taxes over a specified period of years.
Transactions between insurance companies and their affiliates. Hallmark is also regulated as an insurance
holding company by the Texas Department of Insurance, the Arizona Department of Insurance and the
Oklahoma Insurance Department. Financial transactions between Hallmark or any of its affiliates and our
insurance company subsidiaries are subject to regulation. Transactions between our insurance company
subsidiaries and their affiliates generally must be disclosed to state regulators, and prior regulatory approval
generally is required before any material or extraordinary transaction may be consummated or any management
agreement, services agreement, expense sharing arrangement or other contract providing for the rendering of
services on a regular, systematic basis is implemented. State regulators may refuse to approve or may delay
approval of such a transaction, which may impact our ability to innovate or operate efficiently.
Dividends. Dividends and distributions to Hallmark by our insurance company subsidiaries are restricted by
the insurance regulations of the respective state in which each insurance company subsidiary is domiciled. As
property/casualty insurance companies domiciled in the state of Texas, AHIC and TBIC may only pay
dividends from unassigned surplus funds. In addition, AHIC and TBIC must obtain the approval of the Texas
Department of Insurance before the payment of extraordinary dividends, which are defined as dividends or
distributions of cash or other property the fair market value of which combined with the fair market value of
24
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.
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, 2019, 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.
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.
25
Investment restrictions. We are subject to state laws and regulations that require diversification of our
investment portfolios and that limit the amount of investments in certain categories. Failure to comply with
these laws and regulations would cause non-conforming investments to be treated as non-admitted assets for
purposes of measuring statutory surplus and, in some instances, would require divestiture.
Trade practices. The manner in which we conduct the business of insurance is regulated by state statutes in an
effort to prohibit practices that constitute unfair methods of competition or unfair or deceptive acts or practices.
Prohibited practices include disseminating false information or advertising; defamation; boycotting, coercion
and intimidation; false statements or entries; unfair discrimination; rebating; improper tie-ins with lenders and
the extension of credit; failure to maintain proper records; failure to maintain proper complaint handling
procedures; and making false statements in connection with insurance applications for the purpose of obtaining
a fee, commission or other benefit.
Unfair claims practices. Generally, insurance companies, adjusting companies and individual claims adjusters
are prohibited by state statutes from engaging in unfair claims practices on a flagrant basis or with such
frequency to indicate a general business practice. Examples of unfair claims practices include:
(cid:120) misrepresenting pertinent facts or insurance policy provisions relating to coverages at issue;
(cid:120)
(cid:120)
(cid:120)
(cid:120)
(cid:120)
(cid:120)
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;
(cid:120)
refusing to pay claims without conducting a reasonable investigation;
(cid:120) making claim payments to an insured without indicating the coverage under which each payment is
being made;
(cid:120) 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;
(cid:120)
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
26
(cid:120) 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, 2019, we employed 486 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 Two Lincoln Centre, 5420 Lyndon B. Johnson Freeway, Suite
1100 Dallas, Texas 75240. The Company’s mailing address is Two Lincoln Centre, 5420 Lyndon B. Johnson
Freeway, Suite 1100 Dallas, Texas 75240. Its telephone number is (817) 348-1600. The Company’s website
address is www.hallmarkgrp.com. The Company files annual, quarterly and current reports, proxy statements
and other information and documents with the U.S. Securities and Exchange Commission (the “SEC”), which
are made available to read and copy at the SEC’s Public Reference Room at 100 F Street, N.E., Washington,
D.C. 20549. You may obtain information on the operation of the Public Reference Room by contacting the
SEC at 1-800-SEC-0330. Reports filed with the SEC are also made available at www.sec.gov. The Company
makes available free of charge on its website its annual report on Form 10-K, quarterly reports on Form 10-Q,
current reports on Form 8-K and amendments to those reports filed with or furnished to the SEC pursuant to
Section 13 or 15(d) of the Securities Exchange Act of 1934 (the “Exchange Act”) 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:
(cid:120)
(cid:120)
the availability of sufficient reliable data and our ability to properly analyze available data;
the uncertainties that inherently characterize estimates and assumptions;
(cid:120) our selection and application of appropriate pricing techniques; and
(cid:120)
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.
27
Our results may fluctuate as a result of cyclical changes in the property/casualty insurance industry.
Our revenue is primarily attributable to property/casualty insurance, which as an industry is cyclical in nature
and has historically been characterized by soft markets followed by hard markets. A soft market is a period of
relatively high levels of price competition, less restrictive underwriting standards and generally low premium
rates. A hard market is a period of capital shortages resulting in lack of insurance availability, relatively low
levels of competition, more selective underwriting of risks and relatively high premium rates. If we find it
necessary to reduce premiums or limit premium increases due to competitive pressures on pricing in a softening
market, we may experience a reduction in our premiums written and in our profit margins and revenues, which
could adversely affect our financial results.
Estimating reserves is inherently uncertain. If our loss reserves are not adequate, it will have an
unfavorable impact on our results.
We maintain loss reserves to cover our estimated ultimate liability for unpaid losses and LAE for reported and
unreported claims incurred as of the end of each accounting period. Reserves represent management’s estimates
of what the ultimate settlement and administration of claims will cost and are not reviewed by an independent
actuary. These estimates, which generally involve actuarial projections, are based on management’s assessment
of facts and circumstances then known, as well as estimates of future trends in claim severity and frequency,
judicial theories of liability, and other factors. These variables are affected by both internal and external events,
such as changes in claims handling procedures, inflation, judicial trends and legislative changes. Many of these
factors are not quantifiable. Additionally, there may be a significant lag between the occurrence of an event and
the time it is reported to us. The inherent uncertainties of estimating reserves are greater for certain types of
liabilities, particularly those in which the various considerations affecting the type of claim are subject to change
and in which long periods of time may elapse before a definitive determination of liability is made. Reserve
estimates are continually refined in a regular and ongoing process as experience develops and further claims
are reported and settled. Adjustments to reserves are reflected in the results of the periods in which such
estimates are changed. For example, a 1% change in December 31, 2019 unpaid losses and LAE would have
produced a $6.2 million change to pretax earnings. Our gross loss and LAE reserves totaled $620.4 million at
December 31, 2019. Our loss and LAE reserves, net of reinsurance recoverable on unpaid loss and LAE, were
$347.8 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 32% of the net premiums written by any of them, HIC retains 32% of the net premiums written
by any of them, HSIC retains 26% 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. On March 2, 2020, A.M. Best announced that its current ratings of our insurance company subsidiaries
were under review with negative implications. On June 9, 2020, A.M. Best announced that it was maintaining
this status pending further review.
28
These financial strength ratings are used by policyholders, insurers, reinsurers and insurance and reinsurance
intermediaries as an important means of assessing the financial strength and quality of insurers. These ratings
are not evaluations directed to potential purchasers of our common stock and are not recommendations to buy,
sell or hold our common stock. Our ratings are subject to change at any time and could be revised downward
or revoked at the sole discretion of the rating agencies. We believe that the ratings assigned by A.M. Best are
an important factor in marketing our products. Our ability to retain our existing business and to attract new
business in our insurance operations depends largely on these ratings. Our failure to maintain our ratings, or
any other adverse development with respect to our ratings, could cause our current and future independent
agents and insureds to choose to transact their business with more highly rated competitors. If A.M. Best
downgrades our ratings or publicly indicates that our ratings are under review, it is likely that we would not be
able to compete as effectively with our competitors, and our ability to sell insurance policies could decline. If
that happened, our sales and earnings would decrease. For example, many of our agencies and insureds have
guidelines that require us to have an A.M. Best financial strength rating of “A-” (Excellent) or higher. A
reduction of our A.M. Best rating below “A-” would prevent us from issuing policies to insureds or potential
insureds with such ratings requirements.
Lenders and reinsurers also use our A.M. Best ratings as a factor in deciding whether to transact business with
us. The failure of our insurance company subsidiaries to maintain their current ratings could dissuade a lender
or reinsurance company from conducting business with us or might increase our interest or reinsurance costs.
In addition, a ratings downgrade by A.M. Best below “A-” would require us to post collateral in support of our
obligations under certain of our reinsurance agreements pursuant to which we assume business.
The loss of key executives could disrupt our business.
Our success will depend in part upon the continued service of certain key executives. Our success will also
depend on our ability to attract and retain additional executives and personnel. The loss of key personnel, or
our inability to recruit and retain additional qualified personnel, could cause disruption in our business and
could prevent us from fully implementing our business strategies, which could materially and adversely affect
our business, growth and profitability.
Our industry is very competitive, which may unfavorably impact our results of operations.
Our competitors include entities that have access to greater financial and other resources than us . Our
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.
29
If the companies that provide our reinsurance do not pay our claims in a timely manner, we could incur
severe losses.
We purchase reinsurance by transferring, or ceding, part of the risk we have assumed to a reinsurance company
in exchange for part of the premium we receive in connection with the risk. Although reinsurance makes the
reinsurer liable to us to the extent the risk is transferred or ceded to the reinsurer, it does not relieve us of our
liability to our policyholders. Accordingly, we bear credit risk with respect to our reinsurers. We cannot assure
that our reinsurers will pay all of our reinsurance claims, or that they will pay our claims on a timely basis. At
December 31, 2019, we had a total of $479.7 million due us from reinsurers, including $315.5 million of
recoverables from losses and $164.2 million in ceded unearned premiums. The largest amount due us from a
single reinsurer as of December 31, 2019 was $130.5 million reinsurance and premium recoverable from Swiss
Reinsurance America Corporation. If any of our reinsurers are unable or unwilling to pay amounts they owe us
in a timely fashion, we could suffer a significant loss or a shortage of liquidity, which would have a material
adverse effect on our business and results of operations.
Catastrophic losses are unpredictable and may adversely affect our results of operations, liquidity and
financial condition.
Property/casualty insurance companies are subject to claims arising out of catastrophes that may have a
significant effect on their results of operations, liquidity and financial condition. Catastrophes can be caused by
various events, including hurricanes, windstorms, earthquakes, hail storms, explosions, severe winter weather
and fires, and may include man-made events, such as terrorist attacks. The incidence, frequency, and severity
of catastrophes are inherently unpredictable. The extent of losses from a catastrophe is a function of both the
total amount of insured exposure in the area affected by the event and the severity of the event.
Claims from catastrophic events could reduce our net income, cause substantial volatility in our financial results
for any fiscal quarter or year or otherwise adversely affect our financial condition, liquidity or results of
operations. Catastrophes may also negatively affect our ability to write new business. Increases in the value
and geographic concentration of insured property and the effects of inflation could increase the severity of
claims from catastrophic events in the future.
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.
30
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:
(cid:120)
(cid:120)
(cid:120)
(cid:120)
(cid:120)
(cid:120)
(cid:120)
approval of policy forms and rates;
standards of solvency, including risk-based capital measurements, which are a measure developed by
the National Association of Insurance Commissioners and used by the state insurance regulators to
identify insurance companies that potentially are inadequately capitalized;
licensing of insurers and their agents;
restrictions on the nature, quality and concentration of investments;
restrictions on the ability of insurance company subsidiaries to pay dividends;
restrictions on transactions between insurance company subsidiaries and their affiliates;
requiring certain methods of accounting;
(cid:120) periodic examinations of operations and finances;
(cid:120)
(cid:120)
(cid:120)
(cid:120)
(cid:120)
(cid:120)
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;
(cid:120) prescribing the form and content of records of financial condition to be filed;
(cid:120)
requiring reserves for unearned premium, losses and other purposes; and
(cid:120) 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.
31
State insurance departments also conduct periodic examinations of the affairs of insurance companies and
require filing of annual and other reports relating to the financial condition of insurance companies, holding
company issues and other matters. Our business depends on compliance with applicable laws and regulations
and our ability to maintain valid licenses and approvals for our operations. Regulatory authorities may deny or
revoke licenses for various reasons, including violations of regulations. Changes in the level of regulation of
the insurance industry or changes in laws or regulations themselves or interpretations by regulatory authorities
could have a material adverse affect on our operations. In addition, we could face individual, group and class-
action lawsuits by our policyholders and others for alleged violations of certain state laws and regulations. Each
of these regulatory risks could have an adverse effect on our profitability.
State statutes limit the aggregate amount of dividends that our subsidiaries may pay Hallmark, thereby
limiting its funds to pay expenses and dividends.
Hallmark is a holding company and a legal entity separate and distinct from its subsidiaries. As a holding
company without significant operations of its own, Hallmark’s principal sources of funds are dividends and
other sources of funds from its subsidiaries. State insurance laws limit the ability of Hallmark’s insurance
company subsidiaries to pay dividends and require our insurance company subsidiaries to maintain specified
minimum levels of statutory capital and surplus. The aggregate maximum amount of dividends permitted by
law to be paid by an insurance company does not necessarily define an insurance company’s actual ability to
pay dividends. The actual ability to pay dividends may be further constrained by business and regulatory
considerations, such as the impact of dividends on surplus, by our competitive position and by the amount of
premiums that we can write. Without regulatory approval, the aggregate maximum amount of dividends that
could be paid to Hallmark in 2020 by our insurance company subsidiaries is $15.8 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
32
in mandatory reinsurance funds. The effect of these assessments and mandatory reinsurance arrangements, or
changes in them, could reduce our profitability in any given period or limit our ability to grow our business.
We monitor developments with respect to various state facilities, such as the Texas FAIR Plan and the Texas
Windstorm Insurance Association. The impact of any catastrophe experience on these facilities could result in
the facilities recognizing a financial deficit or a financial deficit greater than the level currently estimated. They
may, in turn, have the ability to assess participating insurers when financial deficits occur, adversely affecting
our results of operations. While these facilities are generally designed so that the ultimate cost is borne by
policyholders, the exposure to assessments and the availability of recoupments or premium rate increases from
these facilities may not offset each other in our financial statements. Moreover, even if they do offset each
other, they may not offset each other in financial statements for the same fiscal period due to the ultimate timing
of the assessments and recoupments or premium rate increases, as well as the possibility of policies not being
renewed in subsequent years.
Adverse securities market conditions can have a significant and negative impact on our investment
portfolio.
Our results of operations depend in part on the performance of our invested assets. As of December 31, 2019,
85% of our investment portfolio was invested in fixed-income securities. Certain risks are inherent in
connection with fixed-income securities, including loss upon default and price volatility in reaction to changes
in interest rates and general market factors. In general, the fair value of a portfolio of fixed-income securities
increases or decreases inversely with changes in the market interest rates, while net investment income realized
from future investments in fixed-income securities increases or decreases along with interest rates. In addition,
34% of our fixed-income securities have call or prepayment options. This subjects us to reinvestment risk
should interest rates fall and issuers call their securities. Furthermore, actual net investment income and/or cash
flows from investments that carry prepayment risk, such as mortgage-backed and other asset-backed securities,
may differ from those anticipated at the time of investment as a result of interest rate fluctuations. An investment
has prepayment risk when there is a risk that cash flows from the repayment of principal might occur earlier
than anticipated because of declining interest rates or later than anticipated because of rising interest rates. The
fair value of our fixed-income securities as of December 31, 2019 was $574.3 million. If market interest rates
were to increase 1%, the fair value of our fixed-income securities would decrease by approximately $8.4 million
as of December 31, 2019. The calculated change in fair value was determined using duration modeling
assuming no prepayments.
In addition to the general risks described above, although 81% 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, 2019, Hallmark
had $7.8 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.
Our variable rate indebtedness subjects us to interest rate risk, which could cause our debt service
obligations to increase significantly
The interest rates under our trust preferred securities are adjusted quarterly using LIBOR. On July 27, 2017,
the Financial Conduct Authority (the authority that regulates LIBOR) announced that it intends to stop
33
compelling banks to submit rates for the calculation of LIBOR after 2021 and it is unclear whether new methods
of calculating LIBOR will be established. If LIBOR is unavailable on an interest calculation date, the trustee is
authorized to calculate the interest rate on the basis of quotations from certain major banks in London or New
York. If the trustee is unable to determine an interest rate in this manner, the immediately preceding interest
rate remains in effect. It is not possible to predict the effect of these changes. To the extent these interest rates
increase, our interest expense will increase, which could adversely affect our financial condition, operating
results and 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.
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 over financial reporting are not fail-safe.
We continually enhance our operating procedures and internal controls over financial reporting (ICFR) 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. ICFR 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
34
inherent limitations in a cost-effective control system, misstatement due to error or fraud may occur and not be
detected. Accordingly, our ICFR 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 52% of our gross written premiums for 2019: Texas (29%),
California (10%), Florida (5%) Arizona (5%) 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
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
35
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.
The COVID-19 pandemic could disrupt our business operations and materially adversely impact our
results of operations and financial condition.
On March 11, 2020, the World Health Organization declared the outbreak of novel coronavirus (COVID-19)
as a pandemic, which continues to spread throughout the United States. There have been mandates from federal,
state, and local authorities requiring forced closures of non-essential business locations, including insurance
carriers, brokers and agents. As a result, our corporate offices, and the offices of most of our agents and brokers,
have been closed for a significant period. While our management and most employees have continued to
effectively work remotely, and our agents and brokers have continued to produce and service our insurance
policies, an extended period of these restrictions could disrupt our business operations and the production of
policies by our agents and brokers. In addition, the adverse effect of COVID-19 on the national and global
economy could result in reduced demand for our insurance products and services.
We do not write coverage for pandemics or specialty risks such as event cancellation, trip cancellation, trade
credit or political risk, and our customer base is concentrated in small and medium sized enterprises with less
exposure than larger organizations. Although we expect to receive notice of property and liability losses related
to COVID-19, we believe that most such claims will not be covered due to policy terms requiring occurrence
of physical loss and/or specific exclusions contained in most applicable policies. However, certain of our
policies provide sublimits for business interruption due to communicable disease which do not require physical
loss. Further, the relevant exclusions from business interruption coverage are likely to be a target of litigation,
and legislation could be enacted mandating retroactive coverage of business interruption claims stemming from
COVID-19. Similarly, exclusions from general liability policies covering the negligence or gross negligence
of an insured could also be challenged. In addition, vacant or converted facilities (e.g., a hotel into emergency
housing or a healthcare facility) could result in potential risk exposure that was not envisioned during
underwriting. Claims could also be made under our healthcare professional liability policies related to, among
other things, negligent treatment of COVID-19 patients, failure to prevent spread of the disease within a facility
and/or inadequate protection of healthcare workers. Despite typical bodily injury exclusions, claims could also
be asserted under our financial professional liability policies relating to issues such as employment practices,
misrepresentations, incomplete disclosures, and/or other business practices in response to COVID-19.
We continue to monitor developments relating to the COVID-19 pandemic and implement measures intended
to mitigate its impact on our business. Nonetheless, our results of operations and financial condition could be
materially adversely impacted by the COVID-10 pandemic.
Item 1B. Unresolved Staff Comments.
Not applicable.
36
Item 2. Properties.
Our corporate headquarters, our Commercial Accounts business unit and certain employees of our Specialty
Commercial Segment are currently located at Two Lincoln Centre located at 5420 LBJ Freeway, Dallas, Texas.
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 commenced 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.
Certain employees of our Commercial Auto and E&S Casualty business units are 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 $35,523 per month pursuant to a lease that expires
November 30, 2020.
Our Specialty Commercial Segment also maintains branch offices in the following locations:
Location
Chicago, Illinois
Atlanta, Georgia
Jersey City, New Jersey
Monthly Rent
Lease Expiration
$
$
$
12,721
June 30, 2020
12,305 November 30, 2026
5,230 December 31, 2020
Our Specialty Personal Lines business unit is located at 6500 Pinecrest, Suite 100, Plano, Texas. The suite is
located in a one story office building and contains 23,941 square feet of space. The rent is currently $30,525
per month pursuant to a lease that expires December 31, 2020.
Our Aerospace & Programs business unit, as well as certain employees of our Commercial Auto and E&S
Casualty business units, were previously located at 13727 Noel Road, Dallas, Texas. These leased premises
consist of 15,072 square feet of office space. The rent is currently $30,458 per month pursuant to a lease that
expires November 30, 2022. We are currently seeking a sublease for this office space.
Item 3. Legal Proceedings.
On May 5, 2020, a lawsuit styled Schulze v. Hallmark Financial Services, Inc., et. al (Case No. 3:20-cv-01130)
was filed in the U.S. District Court for the Northern District of Texas, Dallas Division. The Company, its Chief
Executive Officer and its Chief Financial Officer are named defendants in the lawsuit brought on behalf of a
putative class of shareholders who acquired Hallmark securities between March 5, 2019 and March 17, 2020. In
general, the complaint alleges that the defendants violated the Securities Exchange Act of 1934 by failing to
disclose that (a) the Company lacked effective internal controls over financial reporting related to its reserves
for unpaid losses, (b) the Company improperly accounted for reserves for unpaid losses, (c) the Company would
be forced to report $63.8 million of prior year net adverse loss development, (d) the Company would exit the
contract binding line of its commercial automobile primary insurance business, and (e) the defendants’ positive
statements about the Company’s business, operations and prospects were materially misleading and/or lacked
a reasonable basis. The court has not yet appointed a lead plaintiff, and defendants’ responsive pleading is not
yet due and has not been filed. The litigation is in its initial stages and we are unable to reasonably predict its
potential outcome. The Company, however, believes that the lawsuit is without merit and intends to vigorously
37
defend the claims. The Company’s current policy is to expense legal costs as incurred. Historically, the
Company has not carried director and officer liability insurance and does not currently hold such a policy.
We are engaged in various other 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.
38
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, 2018.
Period
Year Ended December 31, 2019:
First quarter
Second quarter
Third quarter
Fourth quarter
Year Ended December 31, 2018:
First quarter
Second quarter
Third quarter
Fourth quarter
High Sale
Low Sale
$
$
10.96 $
14.99
20.30
20.13
10.70 $
10.54
11.31
11.58
9.48
9.80
13.26
15.79
8.62
8.85
9.49
9.82
Holders
As of June 17, 2020, there were 4,843 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 without significant operations of its own, Hallmark’s principal sources of funds are dividends and
management fees from its subsidiaries. State insurance laws limit the ability of our insurance company
subsidiaries to pay dividends and require our insurance company subsidiaries to maintain specified minimum
levels of statutory capital and surplus. Our ability to pay dividends may be further constrained by business and
regulatory considerations, 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
2020 by our insurance company subsidiaries is $15.8 million. Consequently, Hallmark’s ability to pay cash
dividends to our stockholders may be limited.
39
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, 2019.
Plan Category
Equity compensation plans approved
by security holders
Equity compensation plans not
approved by security holders
Total
Number of securities to be
issued upon exercise of
Weighted-average
exercise price of
outstanding options, warrants outstanding options,
warrants and rights
and rights
Number of securities
remaining available for future
issuance under equity
compensation plans
[excluding securities reflected
in column (a)](1)
(a)
(b)
(c)
14,157 $
—
14,157 $
6.99
—
6.99
1,469,764
—
1,469,764
(1) Securities remaining available for future issuance are net of a maximum of 530,236 shares of common
stock issuable pursuant to outstanding restricted stock units, subject to applicable vesting requirements and
performance criteria. See Note 14 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. We did not repurchase any
shares of our common stock during the three months ended December 31, 2019.
Item 6. Selected Financial Data
Not required for smaller reporting company.
40
Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations.
The following discussion should be read together with our consolidated financial statements and the notes
thereto. This discussion contains forward-looking statements. Please see “Risks Associated with Forward-
Looking Statements in this Form 10-K” for a discussion of some of the uncertainties, risks and assumptions
associated with these statements.
Overview
Hallmark is an insurance holding company which, through its subsidiaries, engages in the sale of
property/casualty insurance products to businesses and individuals. Our business involves marketing,
distributing, underwriting and servicing our insurance products, as well as providing other insurance related
services. We pursue our business activities primarily through subsidiaries whose operations are organized into
business units and are supported by our insurance carrier subsidiaries.
Our insurance activities are organized by business units into the following reportable segments:
(cid:120) Specialty Commercial Segment. Our Specialty Commercial Segment includes our Commercial Auto
business unit which offers primary and excess commercial vehicle insurance products and services; our
E&S Casualty business unit which offers primary and excess liability, excess public entity liability, and
E&S package and garage liability insurance products and services; our E&S Property business unit
which offers primary and excess commercial property insurance for both catastrophe and non-
catastrophe exposures; our Professional Liability business unit which offers healthcare and financial
lines professional liability insurance products and services primarily for businesses, medical
professionals, medical facilities and senior care facilities; and our Aerospace & Programs business unit
which offers general aviation and satellite launch property/casualty insurance products and services, as
well as certain specialty programs. These products were previously reported as the Contract Binding
and Specialty Commercial operating units. This realignment did not impact our reportable segments.
(cid:120) Standard Commercial Segment. Our Standard Commercial Segment includes the package and
monoline property/casualty and occupational accident insurance products and services handled by our
Commercial Accounts business unit (f/k/a Standard Commercial P&C operating unit) and the runoff
of workers compensation insurance products handled by our former Workers Compensation operating
unit. Effective June 1, 2016, we ceased marketing new or renewal occupational accident policies.
Effective July 1, 2015, the former Workers Compensation operating unit ceased retaining any risk on
new or renewal policies.
(cid:120) Personal Segment. Our Personal Segment includes the non-standard personal automobile and renters
insurance products and services handled by our Specialty Personal Lines business unit.
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.
41
AHIC, HIC, HSIC and HNIC have entered into a pooling arrangement pursuant to which AHIC retains 32% of
the net premiums written by any of them, HIC retains 32% of the net premiums written by any of them, HSIC
retains 26% 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
Certain 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 debt investment below cost is deemed other-than-temporary. All debt securities with an
unrealized loss are reviewed. We recognize an impairment loss when a debt 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.
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.
42
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:
(cid:120) Level 1: quoted prices in active markets for identical assets;
(cid:120) 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
(cid:120) Level 3: inputs to the valuation methodology that are unobservable for the asset or liability.
This hierarchy requires the use of observable market data when available.
Under ASC 820, we determine fair value based on the price that would be received for an asset or paid to
transfer a liability in an orderly transaction between market participants on the measurement date. It is our
policy to maximize the use of observable inputs and minimize the use of unobservable inputs when developing
fair value measurements, in accordance with the fair value hierarchy described above. Fair value measurements
for assets and liabilities where there exists limited or no observable market data are calculated based upon our
pricing policy, the economic and competitive environment, the characteristics of the asset or liability and other
factors as appropriate. These estimated fair values may not be realized upon actual sale or immediate settlement
of the asset or liability.
Where quoted prices are available on active exchanges for identical instruments, investment securities are
classified within Level 1 of the valuation hierarchy. Level 1 investment securities include common stock,
preferred stock and the equity warrant classified as Other Investments.
Level 2 investment securities include corporate bonds, collateralized corporate bank loans, municipal bonds,
U.S. Treasury securities, other obligations of the U.S. Government and mortgage-backed securities for which
quoted prices are not available on active exchanges for identical instruments. We use a third party pricing
service to determine fair values for each Level 2 investment security in all asset classes. Since quoted prices in
active markets for identical assets are not available, these prices are determined using observable market
information such as quotes from less active markets and/or quoted prices of securities with similar
characteristics, among other things. We have reviewed the processes used by the pricing service and have
determined that they result in fair values consistent with the requirements of ASC 820 for Level 2 investment
securities. We have not adjusted any prices received from third-party pricing sources.
In cases where there is limited activity or less transparency around inputs to the valuation, investment securities
are classified within Level 3 of the valuation hierarchy. Level 3 investments are valued based on the best
available data in order to approximate fair value. This data may be internally developed and consider risk
premiums that a market participant would require. Investment securities classified within Level 3 include other
less liquid investment securities.
Deferred policy acquisition costs. Policy acquisition costs (mainly commission, premium taxes, underwriting
and marketing expenses and ceding commissions) 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.
43
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, 2019 and 2018, there
was no premium deficiency related to deferred policy acquisition costs.
Goodwill. Goodwill is tested for impairment at the reporting unit level (business unit or one level below a
business 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 business units except for the E&S Casualty and Aerospace & Programs business units for which reporting
units are at the component level (“one level below”). Our consolidated balance sheet as of December 31, 2019
includes goodwill of acquired businesses of $44.7 million that is assigned to our business units as follows:
Commercial Accounts business unit - $2.1 million; Commercial Auto business units - $21.3 million; E&S
Casualty business unit - $6.3 million (comprised of $2.6 million for the primary/excess liability and public
entity component and $3.7 million for the E&S package component); Aerospace & Programs business unit-
$9.7 million (comprised entirely of the general aviation component); and Specialty Personal Lines business
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 2019 and determined that there was no impairment at that time.
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 2019. The income projections also include loss and LAE assumptions which
reflect recent historical claim trends and the movement towards a more favorable pricing environment. The
income projections also include assumptions for expense growth and investment yields which are based on
business plans for each of our business units. The discount rate was based on a risk free rate plus a beta adjusted
equity risk premium and specific company risk premium. The assumptions were based on historical experience
(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.
44
The fair values of each of our business units were in excess of their respective carrying values, including
goodwill, as a result of our annual test for impairment during the fourth quarter 2019. However, a 36% decline
in the fair value of our Commercial Accounts business unit, a 35% decline in the fair value of our Commercial
Auto business unit, a 73% decline in the primary/excess liability and public entity component, a 60% decline
in the E&S package and garage liability component, a 26% decline in our general aviation and satellite
component, or a 38% decline in the fair value of our Specialty Personal Lines business unit 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.
While we believe the estimates and assumptions used in determining the fair value of our business units were
reasonable, actual results could vary materially. If our actual results are not consistent with our estimates and
assumptions used to calculate fair value, we may be required to perform the second step of impairment testing
prescribed by ASC 350 in future periods and impairment of goodwill could result. We cannot predict future
events that might impact the fair value of our business units and goodwill impairment. Such events include, but
are not limited to, increased competition in insurance markets, global economic changes and significant declines
in our market capitalization.
Deferred income tax assets and liabilities. We file a consolidated federal income tax return. Deferred federal
income taxes reflect the future tax consequences of differences between the tax basis of assets and liabilities
and their financial reporting amounts at each year end. Deferred taxes are recognized using the liability method,
whereby tax rates are applied to cumulative temporary differences based on when and how they are expected
to affect the tax return. Deferred tax assets and liabilities are adjusted for tax rate changes. A valuation
allowance is provided against our deferred tax assets to the extent that we do not believe it is more likely than
not that future taxable income will be adequate to realize these future tax benefits.
Reserves for unpaid losses and LAE. Reserves for unpaid losses and LAE are established for claims that have
already been incurred by the policyholder but which we have not yet paid. Unpaid losses and LAE represent
the estimated ultimate net cost of all reported and unreported losses incurred through each balance sheet date.
The reserves for unpaid losses and LAE are estimated using individual case-basis valuations and statistical
analyses. These reserves are revised periodically and are subject to the effects of trends in loss severity and
frequency. (See “Item 1. Business – Analysis of Losses and LAE” and Note 6 to the audited consolidated
financial statements included in this report.)
Although considerable variability is inherent in such estimates, we believe that our reserves for unpaid losses
and LAE are adequate. Due to the inherent uncertainty in estimating unpaid losses and LAE, the actual ultimate
amounts may differ from the recorded amounts. A small percentage change could result in a material effect on
reported earnings. For example, a 1% change in December 31, 2019 reserves for unpaid losses and LAE would
have produced a $6.2 million change to pretax earnings. The estimates are continually reviewed and adjusted
as experience develops or new information becomes known. Such adjustments are included in current
operations.
Our actuaries estimate claim liabilities by considering a variety of reserving methods, each of which reflects a
level of uncertainty. The estimated range derived from the various methods is used to assess the reasonableness
of management’s estimates. 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
45
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, 2019 was $539.2 million to $767.0 million. Our best estimate of unpaid
losses and LAE as of December 31, 2019 is $620.4 million. Our carried reserve for unpaid losses and LAE as
of December 31, 2019 is comprised of $300.8 million in case reserves and $319.6 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 $32.7 million below the midpoint, or
80.9% of the high end, of the actuarial range at December 31, 2019 as compared to $44.6 million above the
midpoint, or 97.8% of the high end, of the actuarial range at December 31, 2018. 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.
Results of Operations
Comparison of Years ended December 31, 2019 and December 31, 2018
Management overview. During fiscal 2019, our total revenues were $486.4 million, which was $107.1 million
more than the $379.3 million in total revenues for fiscal 2018. During the year ended December 31, 2019, we
reported net loss before tax of $1.0 million as compared to a net income before tax of $12.8 million during the
same period of 2018.
This increase in revenue was largely due to a $73.8 million increase in net premiums earned during the year
ended December 31, 2019 as compared to the same period of 2018. In addition, the increase in revenue for the
year ended December 31, 2019 was impacted by investment gains of $20.6 million as compared to investment
losses of $10.2 million during the same period of 2018. Higher finance charges and investment income also
contributed to the increase in revenue, partially offset by lower commission and fees and other income during
the year ended December 31, 2019 as compared to the same period of 2018.
The increase in revenue for the year ended December 31, 2019 was partially offset by increased losses and LAE
of $106.1 million, higher operating expenses of $13.9 million and increased interest expense of $0.9 million as
compared to the same period of 2018. The increase in losses and LAE was primarily the result of unfavorable
net prior year loss reserve development of $60.9 million for the year ended December 31, 2019 as compared to
$6.0 million of unfavorable net prior year loss reserve development for the year ended December 31, 2018, as
well as higher net premiums earned. The increase in operating expenses was primarily due to increased
production related expenses primarily attributable to higher net premiums earned, as well as higher salary and
related expenses, professional service fees, occupancy and related and other operating expenses during the year
ended December 31, 2019 as compared to the same period during 2018. The increase in interest expense was
46
primarily the net result of the issuance of $50.0 million of senior unsecured notes during the third quarter of
2019 and the concurrent repayment of $30.0 million outstanding under a revolving credit facility. (See below
under, “–Liquidity and Capital Resources-Senior Unsecured Notes” and “–Liquidity and Capital Resources-
Frost Credit Facilities.”)
We reported a net loss of $0.6 million for the year ended December 31, 2019, as compared to net income of
$10.3 million for the year ended December 31, 2018. On a diluted per share basis, net loss was ($0.03) per
share for fiscal 2019 as compared to net income of $0.57 per share for fiscal 2018. Our effective tax rate was
39% for the year ended December 31, 2019 as compared to 19% for the same period in 2018. The increase in
the effective tax rate for the year ended December 31, 2019 was due in large part to the affect of tax exempt
income.
Segment information
The following is additional business segment information for the years ended December 31, 2019 and 2018 (in
thousands):
Specialty Commercial
Segment
Standard Commercial
Segment
2019
Gross premiums written
Ceded premiums written
Net premiums written
Change in unearned premiums
Net premiums earned
$ 651,913
(301,866)
350,047
(57,459)
292,588
2018
$ 501,806
(250,075)
251,731
6,455
258,186
2019
$ 92,645
(29,753)
62,892
1,078
63,970
2018
$ 86,121
(16,899)
69,222
3,099
72,321
Personal Segment
2019
2018
$ 75,088
$ 99,273
(32,243)
(15,660)
42,845
83,613
(10,265)
(3,294)
32,580
80,319
$
Corporate
Consolidated
2019
2018
2019
— $
—
—
—
—
— $ 843,831
(347,279)
—
496,552
—
(59,675)
—
436,877
—
2018
$ 663,015
(299,217)
363,798
(711)
363,087
Year Ended December 31,
Total revenues
309,619
280,283
68,179
76,548
88,225
38,623
20,348
(16,186)
486,371
379,268
Losses and loss adjustment
expenses
248,781
194,268
50,036
39,396
63,348
22,364
—
—
362,165
256,028
Pre-tax (loss) income
(1,371)
28,780
(841)
13,090
427
3,061
753
(32,128)
(1,032)
12,803
Net loss ratio (1)
Net expense ratio (1)
Net combined ratio (1)
85.0 %
21.8 %
106.8 %
75.2 %
22.6 %
97.8 %
78.2 %
30.0 %
108.2 %
54.5 %
33.5 %
88.0 %
78.9 %
22.7 %
101.6 %
68.6 %
26.3 %
94.9 %
82.9 %
25.1 %
108.0 %
70.5 %
26.6 %
97.1 %
Net Favorable (Unfavorable)
Prior Year Development
(60,138)
(16,457)
(726)
8,993
(36)
1,511
(60,900)
(5,953)
1
The net loss ratio is calculated as incurred losses and LAE divided by net premiums earned, each determined in accordance with GAAP. The net expense ratio is
calculated as total underwriting expenses offset by agency fee income divided by net premiums earned, each determined in accordance with GAAP. Net combined ratio
is calculated as the sum of the net loss ratio and the net expense ratio.
Specialty Commercial Segment
Gross premiums written for the Specialty Commercial Segment were $651.9 million for the year ended
December 31, 2019, which was $150.1 million, or 30%, more than the $501.8 million reported for the same
period in 2018. Net premiums written were $350.0 million for the year ended December 31, 2019 as compared
to $251.7 million for the same period of 2018. The increase in gross and net premiums written was the result
of increased premium production reflected in each of the business units comprising our Specialty Commercial
Segment.
The $309.6 million of total revenue for the year ended December 31, 2019 was $29.3 million higher than the
$280.3 million reported for 2018. This increase in revenue was primarily due to higher net premiums earned of
$34.4 million due to higher net earned premium in our Professional Liability, E&S Property, E&S Casualty
47
and Aerospace & Programs business units, partially offset by lower net earned premium in our Commercial
Auto business unit. This increase in net premiums earned was partially offset by lower net investment income
of $3.5 million and lower commission and fees of $1.6 million for the year ended December 31, 2019 as
compared to the same period of 2018.
Pre-tax loss for the Specialty Commercial Segment was $1.4 million for the year ended December 31, 2019 as
compared to pre tax income of $28.8 million reported for the same period in 2018. The pre-tax loss was
primarily due to higher loss and LAE of $54.5 million and higher operating expense of $5.0 million, partially
offset by the increased revenue discussed above.
Our Specialty Commercial Segment reported a $54.5 million increase in losses and LAE which consisted of (a)
a $22.5 million increase in losses and LAE in our Commercial Auto business unit due largely to $47.4 million
of unfavorable prior year net loss reserve development recognized during the year ended December 31, 2019
as compared to $18.1 million of unfavorable prior year net loss reserve development during the same period of
2018, partially offset by lower current accident year loss trends and lower net earned premiums, (b) a $22.9
million increase in losses and LAE in our E&S Casualty business unit due primarily to $13.6 million of
unfavorable prior year net loss reserve development during the year ended December 31, 2019 as compared to
$5.2 million of favorable prior year net loss reserve development during the same period of 2018, as well as
higher net earned premiums, (c) a $1.0 million decrease in losses and LAE in our E&S Property business unit
due primarily to $0.3 million of net favorable prior year loss reserve development during the year ended
December 31, 2019 as compared to $0.8 million of unfavorable prior year net loss reserve development during
the same period of 2018, (d) a $9.0 million increase in losses and LAE attributable to our Professional Liability
business unit due primarily to increased net premiums earned, partially offset by $0.7 million of net favorable
prior loss reserve development during the year ended December 31, 2019 as compared to $1.5 million of net
unfavorable prior year loss reserve development during the same period of 2018 as well as lower current
accident year loss trends, and (e) a $1.1 million increase in losses and LAE in our Aerospace & Programs
business unit due primarily to higher current accident year loss trends as well as higher net premiums earned,
partially offset by $0.1 million of net unfavorable prior year loss reserve development during the year ended
December 31, 2019 as compared to $1.3 million of net unfavorable prior year loss reserve development during
the same period of 2018.
The Specialty Commercial Segment reported a net loss ratio of 85.0% for the year ended December 31, 2019
as compared to 75.2% for the same period during 2018. The gross loss ratio before reinsurance was 75.9% for
the year ended December 31, 2019 as compared to 73.4% for the same period in 2018. The increase in the gross
and net loss ratios was primarily due to higher unfavorable prior year net loss reserve development, partially
offset by lower catastrophe losses. The Specialty Commercial Segment reported $60.1 million of unfavorable
prior year net loss reserve development for the year ended December 31, 2019 as compared to unfavorable
prior year net loss reserve development of $16.5 million for the same period of 2018. During the year ended
December 31, 2019 the Specialty Commercial Segment reported $2.3 million of net catastrophe losses as
compared to $6.0 million during the same period of 2018. The Specialty Commercial Segment reported a net
expense ratio of 21.8% for the year ended December 31, 2019 as compared to 22.6% for the same period of
2018. The decrease in the expense ratio was due predominately to increased ceding commissions in our
Commercial Auto business unit.
48
Standard Commercial Segment
Gross premiums written for the Standard Commercial Segment were $92.6 million for the year ended December
31, 2019, which was $6.5 million, or 8%, more than the $86.1 million reported for the same period in 2018.
The increase in gross premiums written was due to higher premium production in our Commercial Accounts
business unit. Net premiums written were $62.9 million for the year ended December 31, 2019 as compared
to $69.2 million for the same period in 2018. The decrease in net premiums written was due to increased ceded
premium under a quota share reinsurance agreement entered into during the fourth quarter of 2018 on the
casualty lines of business produced by the Commercial Accounts business unit.
Total revenue for the Standard Commercial Segment of $68.2 million for the year ended December 31, 2019,
was $8.4 million, or 11%, less than the $76.6 million reported for the same period in 2018. This decrease in
total revenue was due to lower net premiums earned of $8.3 million, due primarily to the quota share reinsurance
agreement entered into during the fourth quarter of 2018, and lower commission and fees of $0.2 million,
partially offset by higher net investment income of $0.1 million during the year ended December 31, 2019 as
compared to the same period during 2018.
Our Standard Commercial Segment reported a pre-tax loss of $0.8 million for the year ended December 31,
2019 as compared to pre-tax income of $13.1 million for the same period of 2018. The pre-tax loss was the
result of higher losses and LAE of $10.6 million and the lower revenue discussed above, partially offset by
lower operating expenses of $5.1 million. Reduced operating expenses were largely the result of lower
production related expenses of $5.2 million due to increased ceding commission primarily from the reinsurance
contract entered into during the fourth quarter of 2018 and lower salary and related expenses of $0.3 million,
partially offset by higher professional service fees and other general expenses of $0.4 million.
The Standard Commercial Segment reported a net loss ratio of 78.2% for the year ended December 31, 2019
as compared to 54.5% for the same period of 2018. The gross loss ratio before reinsurance for the year ended
December 31, 2019 was 74.0% as compared to the 61.9% reported for the same period of 2018. The increase
in the gross and net loss ratios was due to higher current net accident year loss trends and unfavorable prior
year reserve development. During the year ended December 31, 2019, the Standard Commercial Segment
reported unfavorable net loss reserve development of $0.7 million as compared to favorable net loss reserve
development of $9.0 million during the same period of 2018. The Standard Commercial Segment reported $1.5
million of net catastrophe losses during the year ended December 31, 2019 as compared to $3.3 million of net
catastrophe losses during the same period of 2018. The Standard Commercial Segment reported a net expense
ratio of 30.0% for the year ended December 31, 2019 as compared to 33.5% for the same period of 2018. The
decrease in the expense ratio was primarily due to the impact of increased ceding commissions in our
Commercial Accounts business unit.
Personal Segment
Gross premiums written for the Personal Segment were $99.3 million for the year ended December 31, 2019
as compared to $75.1 million for the same period in the prior year. Net premiums written for our Personal
Segment were $83.6 million for the year ended December 31, 2019, which was an increase of $40.8
million from the $42.8 million reported for the same period in 2018. The increase in gross written premiums
was primarily due to higher premium production in our current geographical footprint. The increase in net
written premiums was due to increased production as well as increased retention of business effective October
1, 2018.
49
Total revenue for the Personal Segment was $88.2 million for the year ended December 31, 2019 as compared
to $38.6 million for the same period in 2018. The increase in revenue was due to an increase in net premiums
earned of $47.7 million and increased finance charges of $1.9 million during the year ended December 31,
2019 as compared to the same period during 2018.
Pre-tax income for the Personal Segment was $0.4 million for the year ended December 31, 2019 as compared
to pre-tax income of $3.1 million for the same period of 2018. The decrease in pre-tax income was primarily
the result of the increased losses and LAE of $41.0 million and increased operating expenses of $11.3 million,
partially offset by the increased revenue discussed above for the year ended December 31, 2019 as compared
to the same period during 2018.
The Personal Segment reported a net loss ratio of 78.9% for the year ended December 31, 2019 as compared
to 68.6% for the same period of 2018. The gross loss ratio before reinsurance was 81.1% for the year ended
December 31, 2019 as compared to 66.7% for the same period in 2018. The higher gross loss ratio was primarily
the result of higher current accident year loss trends. The higher net loss ratio was primarily the result of higher
gross current accident year loss trends, including net catastrophe losses of $1.5 million as compared to $48
thousand for the prior year, and a small unfavorable prior year net loss reserve development as compared to
$1.5 million favorable prior year net loss reserve development in 2018, partially offset by a higher ceded loss
ratio. The Personal Segment reported a net expense ratio of 22.7% for the year ended December 31, 2019 as
compared to 26.3% for the same period of 2018. The decrease in the expense ratio was due predominately
to higher net premiums earned and higher finance charges, partially offset by higher production related
expenses due to increased retention of business effective October 1, 2018.
Corporate
Total revenue for Corporate increased by $36.5 million for the year ended December 31, 2019 as compared to
the same period the prior year. This increase in total revenue was due predominately to investment gains of
$20.6 million during the year ended December 31, 2019 as compared to investment losses of $10.2 million
reported for the same period of 2018, as well as higher net investment income of $5.7 million for the year ended
December 31, 2019 as compared to the same period during 2018.
Corporate pre-tax income was $0.8 million for the year ended December 31, 2019 as compared to a pre-tax loss
of $32.1 million for the same period of 2018. The pre-tax income was primarily due to the higher revenue
discussed above, partially offset by higher operating expenses of $2.7 million, primarily as a result of increased
salary and related expenses, professional services and other general expenses, and higher interest expense of
$0.9 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, 2019, we had $19.0 million in unrestricted cash and cash equivalents, including $12.5 million
held in premium and claim trust accounts, as well as $1.0 million in debt securities, at the holding company
and our non-insurance subsidiaries. As of that date, our insurance subsidiaries held $34.3 million of unrestricted
50
cash and cash equivalents as well as $573.3 million in debt securities with an average modified duration of
1.5 years. Accordingly, we do not anticipate selling long-term debt instruments to meet any liquidity needs.
AHIC and TBIC, domiciled in Texas, are limited in the payment of dividends to their stockholders in any
12-month period, without the prior written consent of the Texas Department of Insurance, to the greater of
statutory net income for the prior calendar year or 10% of statutory policyholders’ surplus as of the prior year
end. HIC and HNIC, both domiciled in Arizona, are limited in the payment of dividends to the lesser of 10%
of prior year policyholders’ surplus or prior year’s net 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 2020, the aggregate ordinary
dividend capacity of these subsidiaries is $22.6 million, of which $15.8 million is available to Hallmark. As a
county mutual, dividends from HCM are payable to policyholders. During the years ended December 31, 2019
and 2018 our insurance company subsidiaries paid $15.5 million and $5.5 million, respectively, in dividends to
Hallmark.
The state insurance departments also regulate financial transactions between our insurance subsidiaries and
their affiliated companies. Applicable regulations require approval of management fees, expense sharing
contracts and similar transactions. During 2019 and 2018 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, 2019, our insurance company subsidiaries reported statutory capital
and surplus of $254.7 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, 2019, 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, 2019 and 2018 was 195% and 147%, respectively.
Comparison of December 31, 2019 to December 31, 2018
On a consolidated basis, our cash and investments, excluding restricted cash and investments, at December 31,
2019 were $729.0 million compared to $663.5 million at December 31, 2018. The primary reasons for this
increase in unrestricted cash and investments were cash provided by operations, proceeds from our senior
unsecured note offering, increases in investment fair values and proceeds from the exercise of employee stock
options, partially offset by the repayment of the principal balance and accrued interest on our revolving credit
facility, net purchases of fixed assets, and repurchases of common stock.
Comparison of Years Ended December 31, 2019 and December 31, 2018
Net cash provided by our consolidated operating activities was $27.7 million for the year ended December 31,
2019 compared to net cash flow used in operations of $32.9 million for the year ended December 31,
2018. The cash flow provided by operations during 2019 was driven by an increase in collected net premiums,
higher collected investment income and higher collected finance charges. These increases in operating cash
flow were partially offset by increased paid operating expense, increased federal income taxes paid and higher
net paid claims during the year ended December 31, 2019 as compared to the same period the prior year.
51
Net cash used in investing activities during the year ended December 31, 2019 was $32.4 million as compared
to net cash provided by investing activities of $7.3 million for the prior year. The cash used in investing
activities during the year ended December 31, 2019 was primarily comprised of an increase of $37.1 million in
purchases of debt and equity securities, a decrease of $0.5 million in maturities, sales and redemptions of
investment securities and a $2.1 million increase in purchases of fixed assets.
Net cash provided by financing activities during the year ended December 31, 2019 was $19.2 million as a
result of net proceeds from our senior unsecured note offering of $49.0 million and proceeds from the exercise
of employee stock options of $1.5 million, partially offset by the $30.0 million repayment of the principal
balance on our revolving credit facility and $1.3 million in repurchases of our common stock. 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.
Revolving Credit Facilities
Our Second Restated Credit Agreement with Frost Bank (“Frost”) dated June 30, 2015, as amended, provided
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 bore interest at a rate equal to the prime rate or LIBOR plus 2.5%, at our
election. We paid 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. On August 19, 2019, we terminated Facility A.
The Second Restated Credit Agreement with Frost also provided a $30.0 million revolving credit facility
(“Facility B”), in addition to Facility A. We used Facility B loan proceeds solely for the purpose of making
capital contributions to AHIC and HIC. We paid a quarterly fee of 0.25% per annum of the average daily
unused balance of Facility B. Facility B bore interest at a rate equal to the prime rate or LIBOR plus 3.00%, at
our election. On August 19, 2019, we repaid the $30.0 million principal balance and accrued interest on Facility
B. Upon such repayment, we terminated Facility B.
Subordinated Debt Securities
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. Each trust pays dividends on its
preferred securities at the same rate each quarter as interest is paid on the junior subordinated debt
securities. Under the terms of the trust subordinated debt securities, we pay interest only each quarter and the
principal of each note at maturity. The subordinated debt securities of each trust are uncollateralized and do
not require maintenance of minimum financial covenants.
52
The following table summarizes the nature and terms of the junior subordinated debt and trust preferred
securities:
Issue date
Principal amount of trust preferred securities $
Principal amount of junior subordinated debt
securities
Maturity date of junior subordinated debt
securities
Trust common stock
Interest rate, per annum
Current interest rate at December 31, 2019
$
Hallmark
Statutory
Trust I
Hallmark
Statutory
Trust II
June 21, 2005
30,000
30,928
August 23, 2007
25,000
25,774
$
$
June 15, 2035
928
September 15, 2037
774
$
Three Month LIBOR + 3.25% Three Month LIBOR + 2.90%
$
5.14%
4.79%
Senior Unsecured Notes
On August 19, 2019, Hallmark issued $50.0 million of senior unsecured notes (“Notes”) due August 15,
2029. Interest on the Notes accrues at the rate of 6.25% per annum and is payable semi-annually in arrears
commencing February 15, 2020. The Notes are not obligations of or guaranteed by any of Hallmark’s
subsidiaries and are not subject to any sinking fund requirements. At Hallmark’s option, the Notes are
redeemable, in whole or in part, prior to the stated maturity subject to certain provisions intended to make the
holders of the Notes whole on scheduled interest and principal payments. The indenture governing the Notes
contains certain covenants which, among other things, restrict Hallmark’s ability to incur additional
indebtedness, make certain payments, create liens on the stock of certain subsidiaries, dispose of certain assets,
or merge or consolidate with other entities. As of December 31, 2019, Hallmark was in compliance with all of
these covenants.
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
Reports of Independent Registered Public Accounting Firms
Consolidated Balance Sheets at December 31, 2019 and 2018
Consolidated Statements of Operations for the Years Ended December 31, 2019 and 2018
Consolidated Statements of Comprehensive Income (Loss) for the Years Ended December 31,
2019 and 2018
Consolidated Statements of Stockholders’ Equity for the Years Ended December 31, 2019 and
2018
Consolidated Statements of Cash Flows for the Years Ended December 31, 2019 and 2018
Notes to Consolidated Financial Statements
Financial Statement Schedules
Page Number
F-2
F-4
F-5
F-6
F-7
F-8
F-9
F-52
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.
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 Financial 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, 2019.
Baker Tilly Virchow Krause, LLP, the independent registered public accounting firm that audited our
consolidated financial statements as of December 31, 2019 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, 2019. The Baker
Tilly Virchow Krause, LLP attestation report, which expresses an unqualified opinion on the effectiveness of
our internal control over financial reporting as of December 31, 2019, is included in this Item under the heading
“Report of Independent Registered Public Accounting Firm.”
Item 9B. Other Information.
None.
55
PART III
Item 10. Directors, Executive Officers and Corporate Governance.
Directors and Executive Officers
Name
Age
Current Position(s) with the Company
Mark E. Schwarz
Scott T. Berlin
James H. Graves
Mark E. Pape
Naveen Anand
Jeffrey R. Passmore
59
50
71
69
53
52
Director and Executive Chairman
Director
Director
Director
President and Chief Executive Officer
Senior Vice President, Chief Financial
Officer and Secretary
No director or executive officer has been selected on the basis of any special arrangement or understanding
with any other person. No director or executive officer bears any family relationship to any other executive
officer or director of the Company. Each director serves a term until the next annual meeting of shareholders.
Each executive officer serves at the will of the board of directors of the Company (the “Board”).
Mark E. Schwarz has served as a director of the Company since 2001 and was elected Executive Chairman in
August, 2006. He served as Chief Executive Officer of the Company from January, 2003 until August, 2006,
and as President from November, 2003 through March, 2006. Since 1993, Mr. Schwarz has indirectly
controlled Newcastle Partners, L.P., a private investment firm. Mr. Schwarz presently serves as Chairman of
the boards of directors of Rave Restaurant Group, Inc., an operator and franchisor of pizza restaurants; and
Wilhelmina International, Inc., a model management and talent representation company. Within the past five
years, Mr. Schwarz has served as a director of SL Industries, Inc., a developer of power systems used in a
variety of aerospace, computer, datacom, industrial, medical, telecom, transportation and utility equipment
applications. He also serves as a director of various privately held companies. The Board believes that Mr.
Schwarz should serve as a director of the Company due to his extensive business and investment expertise,
broad director experience and significant direct and indirect shareholdings in the Company. (See, “Item 12.
Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters.”)
Scott T. Berlin has served as a director of the Company since 2001. Since June, 2017, he has served as the
President of Mason Structural Steel, LLC, a fabricator of structural steel and distributor of building products.
From 2016 to 2017, he was the Director of Business Development of Ullman Oil Company, LLC, a supplier of
heating oil, commercial fuels, industrial lubricants, greases and coolants. During portions of 2015, Mr. Berlin
served in a financial restructuring role as President of JC Fodale Energy Services, LLC, an oilfield services
company. Subsequently, in February 2016, JC Fodale Energy Services, LLC filed a voluntary petition for
liquidation under Chapter 7 of the United States Bankruptcy Code. From 1997 to 2015, he was a Managing
Director and principal of Brown, Gibbons, Lang & Company, an investment banking firm serving middle
market companies, where he focused on the corporate finance and mergers/acquisitions practice. Prior to joining
Brown, Gibbons, Lang & Company, Mr. Berlin was a lending officer in the Middle Market Group at The
56
Northern Company. The Board believes that Mr. Berlin should serve as a director of the Company due to his
general background in investment banking and his particular experience in advising public and private
companies and their boards in merger, acquisition and financing transactions.
James H. Graves has served as a director of the Company since 1995. He has been a Partner of Erwin, Graves
& Jones, LP, a management consulting firm, since 2002. He has also served as Chairman and a director of
Medaxion, Inc., a healthcare technology company providing real-time anesthesia intelligence solutions, since
2010; and as a director and partner of BankCap Partners, a private equity firm focused on the U.S. financial
services sector, since 2006. From 2002 until 2006, Mr. Graves was a director, Vice Chairman and Chief
Operating Officer of Detwiler, Mitchell & Co., a securities research firm. Prior to 2002, he served as a senior
executive in Dean Witter Reynolds Investment Banking Division and as the Chief Operating Officer of J.C.
Bradford & Company. Mr. Graves also presently serves as a director of FirstCash, Inc., a leading operator of
retail-based pawn stores; and Atlantic Capital Bancshares, Inc., a bank holding company. Within the past five
years, Mr. Graves has served as a director of Cash America International, Inc., a company operating pawn shops
and jewelry stores which merged with FirstCash during 2016; and TriState Capital Holdings, Inc., a bank
holding company. The Board believes Mr. Graves should serve as a director due to his executive leadership
and management experience in several businesses, including large corporations and businesses within the
financial services industry, his over 30 years of experience analyzing financial statements, and his experience
as a director of both private and public companies, including his service as chairman of the audit committee of
another public company.
Mark E. Pape has served as a director of the Company since 2016. He has served as the Chairman of the
boards of directors of H2Options, Inc., a water conservation design/installation firm, since 2009, and U.S. Rain
Group, Inc., a private equity company investing in water conservation opportunities, since 2013. He is also
currently a director and chairman of the audit committee of Wilhelmina International, Inc., a model
management and talent representation company; and of Interface Special Holdings, Inc., a provider of bundled,
managed internet protocol physical and network security services. He served as the Chief Financial Officer of
Oryon Technologies, Inc., a lighting technology company, from 2010 to 2014, and as a director from 2012 to
January, 2014. Oryon Technologies, Inc. filed a petition under Chapter 11 of the federal Bankruptcy Code in
May 2014. Mr. Pape served as a partner at Tatum LLC, an executive services firm, from 2008 to 2009. From
2005 to 2007, he served as Executive Vice President and Chief Financial Officer at Affirmative Insurance
Holdings, Inc., a property/casualty insurance company specializing in non-standard automobile insurance, and
served on its board of directors and audit committee from 2004 to 2005. Mr. Pape served as the Chief Financial
Officer of HomeVestors of America, Inc., a franchisor of home acquisition services, during 2005; as President
and Chief Executive Officer of R.E. Technologies, Inc., a provider of software tools to the housing industry,
from 2002 to 2005; as Senior Vice President and Chief Financial Officer of LoanCity.com, a start-up e-
commerce mortgage bank, from 1999 to 2001; as Vice President-Planning for Torchmark Corporation, a
life/health insurance holding company, from 1998 to 1999; as Senior Vice President and Chief Financial Officer
of United Dental Care, Inc., a dental benefits insurance company, from 1995 to 1997; and as Executive Vice
President and Chief Financial Officer of American Income Holding, Inc., a life insurance company, from 1991
to 1994. Previously, Mr. Pape was engaged in investment banking from 1979 to 1991 with First City National
Bank of Houston, Merrill Lynch Capital Markets Group, the First Boston Corporation and then Bear, Stearns
& Co. He began his career in 1974 as an auditor with KPMG LLP. He is a certified public accountant licensed
in Texas. The Board believes that Mr. Pape should serve as a director due to his leadership and operational
skills developed as a business executive, his background in finance and financial services, and his experience
as a director of both private and public companies.
57
Naveen Anand became President and Chief Executive Officer of the Company in September, 2014. Mr. Anand
was an executive with Torus Insurance Holdings Limited from 2009 to 2013, serving first as the Global Chief
Operating Officer for Torus Group before being promoted to Chief Executive Officer of Torus Americas.
Previously, Mr. Anand was employed by CNA Financial Corporation where he served as Vice President from
2002 to 2005, as Senior Vice President and President of the Central Region from 2005 to 2006, as Senior Vice
President and President and Chief Underwriting Officer for Commercial Insurance from 2006 to 2009, and as
Chairman and President of CNA Claim Plus from 2008 to 2009. From 1988 to 2002, he was employed by
Chubb Group of Insurance Companies where he began in the commercial underwriting department, was
promoted to Regional Underwriting Manager in 1993, became Assistant Vice President for Commercial Lines
in 1995, and rose to Vice President for Commercial Lines, New York Zone, in 1998. Mr. Anand began his
insurance career in 1987 as a trainee underwriter with St. Paul Insurance Companies.
Jeffrey R. Passmore was appointed Senior Vice President and Chief Financial Officer of the Company in
April, 2019. He had previously served as Senior Vice President and Chief Accounting Officer of the Company
since June, 2003, and as Vice President of Business Development since November, 2002. Prior to joining the
Company, Mr. Passmore had since 2000 served as Vice President and Controller of Benfield Blanch, Inc. and
its predecessor E.W. Blanch Holdings, Inc., a reinsurance intermediary. From 1998 to 1999, he served E.W.
Blanch Holdings, Inc. as Assistant Vice President of Financial Reporting. From 1994 to 1998, he was a senior
financial analyst with TIG Holdings, Inc., a property/casualty insurance holding company. Mr. Passmore began
his career as an accountant for Gulf Insurance Group from 1990 to 1993. Mr. Passmore is a certified public
accountant licensed in Texas.
Compliance with Section 16(a) of the Exchange Act
The Company's executive officers, directors and beneficial owners of more than 10% of the Company's
common stock are required to file reports of ownership and changes in ownership of our common stock with
the SEC. Based solely upon information provided to the Company by individual directors, executive officers
and beneficial owners, we believe that all such reports were timely filed during and with respect to the year
ended December 31, 2019.
Code of Ethics
The Board has adopted a Code of Ethics applicable to all of the Company’s employees, officers and directors.
The Code of Ethics covers compliance with law; fair and honest dealings with the Company, its competitors
and others; full, fair and accurate disclosure to the public; and procedures for compliance with the Code of
Ethics. This Code of Ethics is posted on the Company’s website at www.hallmarkgrp.com.
Nominating Procedures
No changes to the procedures by which security holders may recommend nominees to the Board have been
implemented since the Company’s disclosures in its Proxy Statement for the 2019 Annual Meeting of
Shareholders.
58
Audit Committee
The Board has a separately-designated Audit Committee comprised of Scott T. Berlin, James H. Graves
(Chairman) and Mark E. Pape. The Board has determined that all members of the Audit Committee satisfy the
current independence and experience requirements of Nasdaq and the SEC. The Board has also determined
that Mr. Graves satisfies the requirements for an “audit committee financial expert” under applicable rules of
the SEC and has designated Mr. Graves as its “audit committee financial expert.” (For an overview of Mr.
Graves’ relevant experience, see “Directors and Executive Officers” above.)
Item 11. Executive Compensation.
Summary Compensation Table
The following table sets forth information for the fiscal years ended December 31, 2019 and 2018 concerning
the compensation of the Chief Executive Officer, Chief Financial Officer and every other person who served
as an executive officer of the Company at any time during 2019 (the “Named Executive Officers”).
Name and
Principal Position
Mark E. Schwarz
Executive Chairman;
Director
Naveen Anand
President;
Chief Executive Officer
Jeffrey R. Passmore
Senior Vice President;
Chief Financial Officer
2019
2018
2019
2018
2019
2018
195,000
195,000
518,750
500,000
255,394
250,518
Year
Salary ($)
Bonus ($)
Stock
Awards ($)1
All Other
Compensation
($)2
---
---
---
---
19,799
15,893
Total ($)
214,799
210,893
225,000
315,000
300,000
9,117
3,566
842,867
1,028,566
55,000
89,957
87,682
22,476
16,691
367,827
409,891
1 Reflects the fair value of restricted stock unit awards estimated on the date of grant based on the probable outcome
of certain performance conditions. Assumptions used in calculating the grant date fair value are included under
Note 14 , “Share-based Payment Arrangements” in the Notes to Consolidated Financial Statements. Assuming
that the highest level of performance conditions will be achieved, the grant date fair value of the awards would
be (i) $472,500 and $450,000 for Mr. Anand’s 2019 and 2018 awards, respectively; and (ii) $134,936 and
$131,523 for Mr. Passmore’s 2019 and 2018 awards, respectively.
2 Represents the employee portion of life, disability and health insurance premiums paid by the Company and the
Company’s matching contributions to employee 401(k) accounts.
59
Employment Agreements
In connection with the grant of restricted stock units during 2015, the Company entered into a Confidentiality
and Non-Solicitation Agreement with Messrs. Anand and Passmore pursuant to which severance is payable in
an amount equal to at least six months of base salary in the event such executive officer is terminated from
employment without cause. The Company does not otherwise have employment agreements with any of its
executive officers.
Outstanding Equity Awards at 2019 Fiscal Year-End
The following table sets forth information concerning all equity awards to the Named Executive Officers which
were outstanding as of December 31, 2019, consisting of unexercised stock options and unvested restricted
stock units granted under the Company’s 2005 Long Term Incentive Plan and 2015 Long Term Incentive Plan.
Option Awards
Stock Awards
Number of Securities
Underlying Unexercised
Options
Name
Exer-
cisable (#)
Unexer-
cisable (#)
Option
Exercise
Price ($)
Option
Expiration
Date
Award
Date1
Number of
Unearned
Shares
Underlying
Restricted
Stock Units
That Have
Not Vested
(#)2
Market Value
of Unearned
Shares
Underlying
Restricted
Stock Units
That Have
Not Vested
($)2
Mark E. Schwarz
14,157
Naveen Anand
Jeffrey R. Passmore
---
---
---
---
---
6.99
12/30/2021
---
---
---
---
---
---
---
09/24/2018
09/26/2019
09/24/2018
09/16/2019
13,800
8,702
4,033
2,485
242,466
152,894
70,860
43,661
1 Restricted stock units awarded in 2018 and 2019 vest March 31, 2021 and 2022, respectively.
2 Based on achieving the threshold performance criteria and the closing market price of the Company’s common
stock of $17.57 on December 31, 2019.
60
Compensation of Directors in 2019 Fiscal Year
The Company’s standard compensation arrangement for each non-employee director is currently a $30,000
annual retainer plus a fee of $1,500 for each Board meeting attended in person or telephonically and a fee of
$750 for each committee meeting attended in person or telephonically. The chairman of the Audit Committee
also receives an additional $7,500 annual retainer. No other cash compensation was paid to any non-employee
director during 2019. The Compensation Committee also periodically grants stock options to the directors of
the Company. However, no stock options were granted to any of the non-employee directors of the Company
during 2019.
The following table sets forth information concerning the compensation of the non-employee directors of the
Company for the fiscal year ended December 31, 2019.
Name
Scott T. Berlin
James H. Graves
Mark E. Pape
Fees Earned or
Paid in Cash ($)
Option Awards
($)
All Other
Compensation
($)
$49,500
$57,000
$49,500
---1
---1
---
---
---
---
Total ($)
$49,500
$57,000
$49,500
1 As of December 31, 2019, there were no exercisable options to purchase Common Stock outstanding to any non-
employee directors.
Item 12. Security Ownership of Certain Beneficial Owners and Management and Related Stockholder
Matters.
The following table and the notes thereto set forth certain information regarding the beneficial ownership of
the common stock of the Company as of June 15, 2020 by (i) each current executive officer and director of the
Company, (ii) all current executive officers and directors of the Company as a group; and (iii) each other person
known to the Company to own beneficially more than five percent of our presently outstanding common stock.
Except as otherwise indicated, (a) the persons identified in the table have sole voting and dispositive power
with respect to the shares shown as beneficially owned by them, (b) the mailing address for all persons is the
same as that of the Company, and (c) the current directors and executive officers have not pledged any of such
shares as security.
61
Shareholder
Mark E. Schwarz1, 2
Naveen Anand
Jeffrey R. Passmore
Scott T. Berlin
James H. Graves
Mark E. Pape
All current executive officers and
directors, as a group (6 persons)3
Newcastle Partners, L.P.4
NCM Services, Inc.5
Dimensional Fund Advisors LP6
* Represents less than 1%.
No. of Shares
Beneficially Owned
Percent of Class
Beneficially Owned
5,069,647
77,400
7,000
15,250
23,498
---
5,192,795
3,730,432
949,702
1,522,758
27.9
*
*
*
*
---
28.6
20.6
5.2
8.4
1 Mark E. Schwarz, is the sole trustee of the Schwarz 2012 Family Trust, which entity is the sole shareholder
of NCM Services, Inc. (“NCMS”), which entity is the sole member of Newcastle Capital Group, L.L.C.
(“NCG”), which entity is the sole general partner of Newcastle Capital Management, L.P. (“NCM”), which
entity is the sole general partner of Newcastle Partners, L.P. (“Newcastle Fund”). As a result of these
relationships, Mr. Schwarz has sole investment and voting control over the shares of common stock
beneficially owned by NCMS, NCM and the Newcastle Fund. (See, Item 13. “Certain Relationships and
Related Transactions, and Director Independence.”)
2
3
Includes 202,580 shares owned by Mr. Schwarz, 949,702 shares owned by NCMS, 172,776 shares owned
by NCM and 3,730,432 shares owned by the Newcastle Fund. (See Note 1, above.) Also includes 14,157
shares which may be acquired by Mr. Schwarz pursuant to exercisable stock options.
Includes 14,157 shares which may be acquired pursuant to exercisable stock options.
4 Does not include shares directly owned by Mark E. Schwarz, NCMS or NCM. (See Note 1, above.)
5 Does not include shares directly owned by Mark E. Schwarz, NCM or the Newcastle Fund. (See Note 1,
above.)
6 Per Schedule 13G/A filed February 12, 2020. Includes 58,146 shares over which Dimensional Fund
Advisors LP has no voting power. The address of Dimensional Fund Advisors LP is Building One, 6300
Bee Cave Road, Austin, Texas 78746.
62
Item 13. Certain Relationships and Related Transactions, and Director Independence.
The Executive Chairman of the Company, Mark E. Schwarz, is the sole trustee of the Schwarz 2012 Family
Trust, which entity is the sole shareholder of NCM Services, Inc. (“NCMS”), which entity is the sole member
of Newcastle Capital Group, L.L.C. (“NCG”), which entity is the sole general partner of Newcastle Capital
Management, L.P. (“NCM”), which entity is the sole general partner of Newcastle Partners, L.P. (“Newcastle
Fund”). As a result of these relationships, Mr. Schwarz has sole investment and voting control over the shares
of Common Stock beneficially owned by NCMS, NCM and the Newcastle Fund, which collectively are the
largest holders of the Common Stock of the Company. (See, Item 12. “Security Ownership of Certain
Beneficial Owners and Management and Related Stockholder Matters.”)
Also as a result of these relationships, the Company, Mr. Schwarz, NCG, NCM and the Newcastle Fund may
be deemed a “group” for purposes of Section 13(d)(3) of the Securities Exchange Act of 1934 with respect to
their respective investments in Rave Restaurant Group, Inc., an operator and franchisor of pizza restaurants in
which Mr. Schwarz serves as Chairman of the board of directors. The Company presently owns $346,200
principal amount of 4% Convertible Senior Notes due 2022 issued by Rave Restaurant Group, Inc. at par value
in connection with a shareholder rights offering, which notes are convertible to common stock at the rate of
$2.00 per share. The Company also presently owns an aggregate of 2,246,086 shares of the common stock of
Rave Restaurant Group, Inc. which it acquired at an average price of $1.52 per share in the open market, in
shareholder rights offerings and upon conversion of 4% Convertible Senior Notes due 2022. As a result, the
Company currently beneficially owns approximately 15.8% of the total outstanding common stock of Rave
Restaurant Group, Inc. The Company has no other financial transactions, arrangements or relationships with
Rave Restaurant Group, Inc.
The Board has determined that all of the directors of the Company other than Mr. Schwarz meet the current
independence requirements of The Nasdaq Stock Market (“Nasdaq”). The Board has further determined that
all members of the Audit Committee, Nomination and Governance Committee and Compensation Committee
of the Board satisfy all of the independence requirements of the SEC and Nasdaq applicable to such committees.
63
Item 14. Principal Accountant Fees and Services.
BDO USA, LLP (“BDO”) served as the Company’s independent registered public accounting firm for the fiscal
year ending December 31, 2018 and was initially engaged in such capacity for the fiscal year ending December
31, 2019. On March 5, 2020, the Company dismissed BDO as its independent registered public accounting
firm prior to completion of their audit of the financial statements of the Company for the fiscal year ended
December 31, 2019. On March 12, 2020, the Company engaged Baker Tilly Virchow Krause, LLP (“BT”) as
its independent registered public accounting firm to audit the Company’s financial statements for the year ended
December 31, 2019, which had not been completed by BDO. The following table presents fees for professional
services rendered by BT for the fiscal year ended December 31, 2019, and BDO for the fiscal year ended
December 31, 2018.
Audit Fees1
Audit-Related Fees
Tax Fees
All Other Fees
BT for
Fiscal 2019
$1,163,423
BDO for
Fiscal 2018
$830,000
---
---
---
---
---
---
1 Reflects fees for audit services of the firm rendering an audit opinion for the indicated fiscal year, all or a portion
of which fees were paid in the subsequent fiscal year. Does not include $1,620,875 in fees charged by BDO for
2019 audit services.
The current policy of the Audit Committee of the Company’s board of directors is to review and approve all
proposed audit and non-audit services prior to the engagement of independent registered public accountants to
perform such services. Review and approval of such services generally occur at the Audit Committee’s
regularly scheduled quarterly meetings. In situations where it is impractical to wait until the next regularly
scheduled quarterly meeting, the Audit Committee has delegated to its chairman the authority to approve audit
and non-audit services. Any audit or non-audit services approved pursuant to such delegation of authority must
be reported to the full Audit Committee at its next regularly scheduled meeting. During fiscal 2019 and 2018,
all audit and non-audit services performed by BT and BDO were in accordance with the policies and procedures
established by the Audit Committee.
64
PART IV
Item 15. Exhibits, Financial Statement Schedules.
(a)(1) Financial Statements
The following consolidated financial statements, notes thereto and related information are included
in Item 8 of this report:
Reports of Independent Registered Public Accounting Firms
Consolidated Balance Sheets at December 31, 2019 and 2018
Consolidated Statements of Operations for the Years Ended December 31, 2019 and 2018
Consolidated Statements of Comprehensive Income (Loss) for the Years Ended December 31,
2019 and 2018 Consolidated Statements of Stockholders’ Equity for the Years Ended December
31, 2019 and 2018 Consolidated Statements of Cash Flows for the Years Ended December 31,
2019 and 2018
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+
Description of registrant’s securities.
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).
65
4.4
4.5
4.6
4.7
4.8
Amended and Restated Declaration of Trust of Hallmark Statutory Trust I dated as of June 21,
2005, among Hallmark Financial Services, Inc., as sponsor, Chase Bank USA, National
Association, as Delaware trustee, and JPMorgan Chase Bank, National Association, as
institutional trustee, and Mark Schwarz and Mark Morrison, as administrators (incorporated by
reference to Exhibit 4.2 to the registrant’s Current Report on Form 8-K filed June 27, 2005).
Form of Junior Subordinated Debt Security Due 2035 (included in Exhibit 4.2 above).
Form of Capital Security Certificate (included in Exhibit 4.3 above).
Indenture dated as of August 23, 2007, between Hallmark Financial Services, Inc. and The Bank
of New York Trust Company, National Association (incorporated by reference to Exhibit 4.1 to
the registrant’s Current Report on Form 8-K filed August 24, 2007).
Amended and Restated Declaration of Trust of Hallmark Statutory Trust II dated as of August 23,
2007, among Hallmark Financial Services, Inc., as sponsor, The Bank of New York (Delaware),
as Delaware trustee, and The 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).
4.9
Form of Junior Subordinated Debt Security Due 2037 (included in Exhibit 4.7 above).
4.10
Form of Capital Security Certificate (included in Exhibit 4.8 above).
4.11
4.12
10.1
10.2
10.3
10.4
Indenture between Hallmark Financial Services, Inc. and The Bank of New York Mellon Trust
Company, N.A. dated August 19, 2019 (incorporated by reference to Exhibit 4.1 to the registrant’s
Form 8-K filed August 21, 2019).
First Supplemental Indenture between Hallmark Financial Services, Inc. and The Bank of New
York Mellon Trust Company, N.A. dated August 19, 2019 (incorporated by reference to Exhibit
4.2 to the registrant’s Form 8-K filed August 21, 2019).
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).
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).
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).
66
10.5
10.6
10.7*
10.8*
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).
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).
Form of Indemnification Agreement between Hallmark Financial Services, Inc. and its officers
and directors, adopted July 19, 2002 (incorporated by reference to Exhibit 10(c) to the registrant’s
Quarterly Report on Form 10-QSB for the quarter ended September 30, 2002).
Hallmark Financial Services, Inc. Amended and Restated 2005 Long Term Incentive Plan
(incorporated by reference to Exhibit 10.1 to the registrant’s Current Report on Form 8-K filed
June 3, 2013).
10.9*
Form of Incentive Stock Option Grant Agreement (incorporated by reference to Exhibit 10.2 to
the registrant’s Current Report on Form 8-K filed June 3, 2005).
10.10*
Form of Non-Qualified Stock Option Agreement (incorporated by reference to Exhibit 10.3 to the
registrant’s Current Report on Form 8-K filed June 3, 2005).
10.11*
Form of Restricted Stock Unit Award Agreement (incorporated by reference to Exhibit 10.13 to
the registrant’s Form 10-K for the year ended December 31, 2013).
10.12*
Hallmark Financial Services, Inc. 2015 Long Term Incentive Plan (incorporated by reference to
Exhibit 10.1 to the registrant’s Current Report on Form 8-K filed June 2, 2015).
10.13*
Form of Incentive Stock Option Grant Agreement (incorporated by reference to Exhibit 10.2 to
the registrant’s Current Report on Form 8-K filed June 2, 2015).
10.14*
Form of Non-Qualified Stock Option Agreement (incorporated by reference to Exhibit 10.3 to the
registrant’s Current Report on Form 8-K filed June 2, 2015).
10.15*
Form of Restricted Stock Unit Award Agreement (incorporated by reference to Exhibit 10.4 to
the registrant’s Form 8-K filed June 2, 2015).
10.16
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).
67
10.17
10.18*
10.19*
Guarantee Agreement dated as of August 23, 2007, by Hallmark Financial Services, Inc. for the
benefit of the holders of trust preferred securities (incorporated by reference to Exhibit 10.1 to the
registrant’s Current Report on Form 8-K filed August 24, 2007).
Letter agreement dated August 13, 2014, between Hallmark Financial Services, Inc. and Naveen
Anand (incorporated by reference to Exhibit 10.1 to the registrant’s Current Report on Form 8-K
filed August 15, 2014).
Form of Confidentiality and Non-Solicitation Agreement dated May 29, 2015, between Hallmark
Financial Services, Inc. and certain employees of the Company (incorporated by reference to
Exhibit 10.23 to the registrant’s Form 10-K for the year ended December 31, 2015).
21+
List of subsidiaries of the registrant.
23 (a)+
Consent of Independent Registered Public Accounting Firm.
23 (b)+
Consent of Independent Registered Public Accounting Firm.
31(a)+
Certification of principal executive officer required by Rule 13A-14(a) or Rule 15d-14(b).
31(b)+
Certification of principal financial officer required by Rule 13A-14(a) or Rule 15d-14(b).
32(a)+
Certification of principal executive officer pursuant to 18 U.S.C. 1350.
32(b)+
Certification of principal financial officer pursuant to 18 U.S.C. 1350.
101 INS+ XBRL Instance Document.
101 SCH+ XBRL Taxonomy Extension Schema Document.
101 CAL+ XBRL Taxonomy Extension Calculation Linkbase Document.
101 LAB+ XBRL Taxonomy Extension Label Linkbase Document.
101 PRE+ XBRL Taxonomy Extension Presentation Linkbase Document.
101 DEF+ XBRL Taxonomy Extension Definition Linkbase Document.
* Management contract or compensatory plan or arrangement.
+ Filed herewith.
Item 16. Form 10–K Summary.
Not applicable.
68
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:
June 29, 2020
HALLMARK FINANCIAL SERVICES, INC.
(Registrant)
By: /s/ Naveen Anand
Naveen Anand, Chief Executive Officer and
President
Date:
June 29, 2020
By: /s/ Jeffrey R. Passmore
Jeffrey R. Passmore, Chief Financial 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:
June 29, 2020
Date:
June 29, 2020
Date:
June 29, 2020
Date:
June 29, 2020
Date:
June 29, 2020
Date:
June 29, 2020
/s/ Naveen Anand
Naveen Anand, Chief Executive Officer and
President (principal executive officer)
/s/ Jeffrey R. Passmore
Jeffrey R. Passmore, Chief Financial 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
69
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HALLMARK FINANCIAL SERVICES, INC. AND SUBSIDIARIES
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
Description
Reports of Independent Registered Public Accounting Firms
Consolidated Balance Sheets at December 31, 2019 and 2018
Consolidated Statements of Operations for the Years Ended December 31, 2019 and 2018
Consolidated Statements of Comprehensive Income (Loss) for the Years Ended December 31,
2019 and 2018
Consolidated Statements of Stockholders’ Equity for the Years Ended December 31, 2019 and
2018
Consolidated Statements of Cash Flows for the Years Ended December 31, 2019 and 2018
Notes to Consolidated Financial Statements
Financial Statement Schedules
Page
Number
F-2
F-4
F-5
F-6
F-7
F-8
F-9
F-52
F-1
Report of Independent Registered Public Accounting Firm
To the shareholders and the board of directors of Hallmark Financial Services, Inc.:
Opinions on the Financial Statements and Internal Control over Financial Reporting
We have audited the accompanying consolidated balance sheet of Hallmark Financial Services, Inc. (the
"Company") as of December 31, 2019, the related consolidated statements of operations, comprehensive
income, stockholders’ equity and cash flows for the year ended December 31, 2019, the related notes and
financial statement schedules (collectively referred to as the "consolidated financial statements"). We also have
audited the Company’s internal control over financial reporting as of December 31, 2019, based on criteria
established in Internal Control – Integrated Framework: (2013) issued by the Committee of Sponsoring
Organizations of the Treadway Commission (COSO).
In our opinion, the consolidated financial statements present fairly, in all material respects, the financial position
of the Company as of December 31, 2019, and the results of its operations and its cash flows for the year ended
December 31, 2019, in conformity with accounting principles generally accepted in the United States of
America. Also in our opinion, the Company maintained, in all material respects, effective internal control over
financial reporting as of December 31, 2019, based on criteria established in Internal Control – Integrated
Framework: (2013) issued by COSO.
Basis for Opinions
The Company’s management is responsible for these consolidated financial statements, for maintaining
effective internal control over financial reporting, and for its assessment of the effectiveness of internal control
over financial reporting, included in the accompanying Management’s Report on Internal Control over
Financial Reporting. Our responsibility is to express an opinion on the Company's consolidated financial
statements and an opinion on the Company’s internal control over financial reporting based on our audits. We
are a public accounting firm registered with the Public Company Accounting Oversight Board (United States)
("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, and whether effective internal control over financial
reporting was maintained in all material respects.
Our audits of the financial statements 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. Our audit of internal control over financial reporting 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 audits also included performing such other procedures as we considered necessary in the
circumstances. We believe that our audits provide a reasonable basis for our opinions.
F-2
Definition and Limitations of Internal Control Over Financial Reporting
A company's internal control over financial reporting is a process designed to provide reasonable assurance
regarding the reliability of financial reporting and the preparation of financial statements for external purposes
in accordance with generally accepted accounting principles. A company's internal control over financial
reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in
reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company;
(2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial
statements in accordance with generally accepted accounting principles, and that receipts and expenditures of
the company are being made only in accordance with authorizations of management and directors of the
company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized
acquisition, use, or disposition of the company's assets that could have a material effect on the financial
statements.
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/ BAKER TILLY VIRCHOW KRAUSE, LLP
We have served as the Company's auditor since 2020.
Milwaukee, Wisconsin
June 29, 2020
F-3
Report of Independent Registered Public Accounting Firm
Stockholders and Board of Directors
Hallmark Financial Services, Inc. and subsidiaries
Dallas, Texas
Opinion on the Consolidated Financial Statements
We have audited the accompanying consolidated balance sheet of Hallmark Financial Services, Inc. and
subsidiaries (the “Company”) as of December 31, 2018, the related consolidated statements of operations,
comprehensive income (loss), stockholders’ equity, and cash flows for the year 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 the results of their operations and
their cash flows for the year then ended, in conformity with accounting principles generally accepted in the
United States of America.
Basis for Opinion
These consolidated financial statements are the responsibility of the Company’s management. Our
responsibility is to express an opinion on the Company’s consolidated financial statements based on our audit.
We are a public accounting firm registered with the PCAOB and are required to be independent with respect to
the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the
Securities and Exchange Commission and the PCAOB.
We conducted our audit in accordance with the standards of the PCAOB. Those standards require that we plan
and perform the audit to obtain reasonable assurance about whether the consolidated financial statements are
free of material misstatement, whether due to error or fraud.
Our audit included performing procedures to assess the risks of material misstatement of the consolidated
financial statements, whether due to error or fraud, and performing procedures that respond to those risks. Such
procedures included examining, on a test basis, evidence regarding the amounts and disclosures in the
consolidated financial statements. Our audit also included evaluating the accounting principles used and
significant estimates made by management, as well as evaluating the overall presentation of the consolidated
financial statements. We believe that our audit provides a reasonable basis for our opinion.
/s/ BDO USA, LLP
Dallas, Texas
March 14, 2019
F-4
HALLMARK FINANCIAL SERVICES, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
December 31, 2019 and 2018
($ in thousands)
ASSETS
Investments:
Debt securities, available-for-sale, at fair value (amortized cost; $569,498 in 2019 and
$550,268 in 2018)
Equity securities (cost; $71,895 in 2019 and $68,709 in 2018)
Other investments (cost; $3,763 in 2019 and $3,763 in 2018)
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
Federal income recoverable
Deferred federal income taxes, net
Prepaid expenses
Other assets
Total assets
December 31,
2019
December 31,
2018
$
574,279 $
99,215
2,169
675,663
53,336
1,612
164,221
148,288
4,286
12,581
315,466
22,994
44,695
5,087
8,995
2,185
2,603
33,262
$ 1,495,274 $
545,870
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
1,264,894
LIABILITIES AND STOCKHOLDERS’ EQUITY
Liabilities:
Senior unsecured notes due 2029 (less unamortized debt issuance cost of $942 in 2019)
Revolving credit facility payable
Subordinated debt securities (less unamortized debt issuance cost of $846 in 2019 and
$898 in 2018)
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 18)
Stockholders’ equity:
Common stock, $.18 par value, authorized 33,333,333 shares; issued 20,872,831 shares in
2019 and 2018
Additional paid-in capital
Retained earnings
Accumulated other comprehensive income (loss)
Treasury stock (2,749,738 shares in 2019 and 2,846,131 in 2018), at cost
Total stockholders’ equity
Total liabilities and stockholders’ equity
$
49,058 $
—
—
30,000
55,856
620,355
388,926
59,274
1,388
1,648
—
55,487
1,231,992
3,757
123,468
160,570
688
(25,201)
263,282
$ 1,495,274 $
55,804
527,247
298,061
67,328
2,018
698
4
28,202
1,009,362
3,757
123,168
161,195
(6,660)
(25,928)
255,532
1,264,894
The accompanying notes are an integral part of the consolidated financial statements
F-5
HALLMARK FINANCIAL SERVICES, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
For the years ended December 31, 2019 and 2018
($ in thousands, except per share amounts)
Gross premiums written
Ceded premiums written
Net premiums written
Change in unearned premiums
Net premiums earned
Investment income, net of expenses
Investment gains (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
(Loss) income before tax
Income tax (benefit) expense
Net (loss) income
Net (loss) income per share:
Basic
Diluted
$
2019
843,831 $
(347,279)
496,552
(59,675)
436,877
2018
663,015
(299,217)
363,798
(711)
363,087
20,604
20,618
7,026
1,190
56
486,371
362,165
117,360
5,410
2,468
18,232
(10,195)
5,115
2,928
101
379,268
256,028
103,424
4,545
2,468
487,403
366,465
(1,032)
(407)
(625) $
12,803
2,456
10,347
$
$
$
(0.03) $
(0.03) $
0.57
0.57
The accompanying notes are an integral part of the consolidated financial statements
F-6
HALLMARK FINANCIAL SERVICES, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
For the years ended December 31, 2019 and 2018
($ In thousands)
Net (loss) income
Other comprehensive income:
Change in net actuarial loss (gain)
Tax effect on change in net actuarial (loss) gain
Unrealized holding gains (losses) arising during the period
Tax effect on unrealized holding (gains) losses arising during the period
Reclassification adjustment for gains included in net income
Tax effect on reclassification adjustment for gains included in net income
Other comprehensive income (loss), net of tax
Comprehensive income
2019
2018
$
(625) $ 10,347
120
(25)
13,645
(2,865)
(4,464)
937
7,348
6,723 $
(576)
121
(3,343)
702
(1,803)
379
(4,520)
5,827
$
The accompanying notes are an integral part of the consolidated financial statements
F-7
HALLMARK FINANCIAL SERVICES, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY
For the years ended December 31, 2019 and 2018
(In thousands)
Number
of
Additional
Accumulated
Other
Paid-In Retained Comprehensive Treasury
Shares Par Value Capital Earnings Income (loss) Stock
Number
of
Shares
Total
Stockholders’
Equity
Balance at January 1, 2018
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
20,873 $
3,757 $ 123,180 $ 136,474 $
12,234 $ (24,527)
2,704 $
251,118
—
—
—
16,993
(16,993)
—
—
—
—
—
—
—
—
—
—
—
—
—
—
—
—
—
152
(2,619)
—
—
(164)
—
—
—
10,347
—
2,619
—
—
—
(1,807)
—
—
—
(4,520)
406
—
—
—
187
—
(45)
—
—
—
(1,807)
152
242
10,347
(4,520)
Balance at December 31, 2018
20,873 $
3,757 $ 123,168 $ 161,195 $
(6,660) $ (25,928)
2,846 $
255,532
Acquisition of treasury stock
Equity incentive plan activity
Shares issued under employee benefit
plans
Net loss
Other comprehensive income, net of
tax
—
—
—
—
—
—
—
—
—
—
—
887
(587)
—
—
—
—
(625)
—
—
(1,380)
—
134
—
—
—
2,107
—
(230)
—
(1,380)
887
1,520
(625)
—
—
7,348
—
—
7,348
Balance at December 31, 2019
20,873 $
3,757 $ 123,468 $ 160,570 $
688 $ (25,201)
2,750 $
263,282
The accompanying notes are an integral part of the consolidated financial statements
F-8
HALLMARK FINANCIAL SERVICES, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
For the years ended December 31, 2019 and 2018
($ in thousands)
Cash flows from operating activities:
Net (loss) income
2019
2018
$
(625) $
10,347
Adjustments to reconcile net (loss) income to cash provided by (used in)
operating activities:
Depreciation and amortization expense
Deferred federal income taxes
Investment (gains) 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) payable
Change in all other liabilities
Change in all other assets
Net cash provided by (used in) 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 (used in) provided by investing activities
Cash flows from financing activities:
Proceeds from exercise of employee stock options
Payment of revolving credit facility
Payment of debt issuance costs
Proceeds from senior unsecured note offering
Purchase of treasury shares
Net cash provided by (used in) financing activities
Increase (decrease) in cash and cash equivalents and restricted cash
Cash and cash equivalents and restricted cash at beginning of period
Cash and cash equivalents and restricted cash at end of period
$
5,365
817
(20,618)
887
(31,190)
(28,510)
(2,667)
(8,703)
93,108
90,865
(63,437)
(8,054)
(8,999)
5,158
4,273
27,670
(4,188)
(259,769)
231,603
(32,354)
1,520
(30,000)
(979)
50,000
(1,380)
19,161
14,477
40,471
54,948 $
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)
(2,101)
(222,642)
232,081
7,338
242
—
—
—
(1,807)
(1,565)
(27,162)
67,633
40,471
The accompanying notes are an integral part of the consolidated financial statements
F-9
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
business units organized by products and distribution channel. Our business units are supported by our
insurance company subsidiaries. Our Commercial Auto business unit offers primary and excess
commercial vehicle insurance products and services; our E&S Casualty business unit offers primary and
excess liability, excess public entity liability, E&S package and garage liability insurance products and
services; our E&S Property business unit offers primary and excess commercial property insurance for both
catastrophe and non-catastrophe exposures; our Professional Liability business unit offers healthcare and
financial lines professional liability insurance products and services primarily for businesses, medical
professionals, medical facilities and senior care facilities; and our Aerospace & Programs business unit
offers general aviation and satellite launch property/casualty insurance products and services, as well as
certain specialty programs. These products and services were previously reported as the Contract Binding
and Specialty Commercial business units. Our Commercial Accounts business unit (f/k/a Standard
Commercial P&C business unit) offers package and monoline property/casualty and occupational accident
insurance products. Effective June 1, 2016 we ceased marketing new or renewal occupational accident
policies. Our former Workers Compensation operating unit specialized in small and middle market workers
compensation business. Effective July 1, 2015, we no longer market or retain any risk on new or renewal
workers compensation policies. Our Specialty Personal Lines business unit offers non-standard personal
automobile and renters insurance products and services. Our insurance company subsidiaries supporting
these business units are American Hallmark Insurance Company of Texas (“AHIC”), Hallmark Insurance
Company (“HIC”), Hallmark Specialty Insurance Company (“HSIC”), Hallmark County Mutual Insurance
Company (“HCM”), Hallmark National Insurance Company (“HNIC”) and Texas Builders Insurance
Company (“TBIC”).
These business units are segregated into three reportable industry segments for financial accounting
purposes. The Specialty Commercial Segment includes our Commercial Auto business unit, E&S Casualty
business unit, E&S Property business unit, Professional Liability business unit and Aerospace & Programs
business unit. The Standard Commercial Segment consists of the Commercial Accounts business unit and
the runoff from our former Workers Compensation operating unit. The Personal Segment consists solely of
our Specialty Personal Lines business unit.
Basis of Presentation
The accompanying consolidated financial statements include the accounts and operations of Hallmark and
its subsidiaries. Intercompany accounts and transactions have been eliminated. The accompanying
consolidated financial statements have been prepared in conformity with U.S. generally accepted
accounting principles (“GAAP”) which, as to our insurance company subsidiaries, differ from statutory
accounting practices prescribed or permitted for insurance companies by insurance regulatory authorities.
F-10
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.
The liability for unpaid claims and claims adjustment expenses and related amounts recoverable from
reinsurers represents the most significant estimate in the accompanying financial statements, and any
difference between such estimate and actual results could be material. Significant estimates in the
accompanying financial statements also include the fair values of investments, deferred policy acquisition
cost recoverability, deferred tax asset valuation, and fair value of goodwill and intangible assets.
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.
Subordinated debt securities: Our trust preferred securities are reported at carry value of $55.9 million and
$55.8 million, and had a fair value of $41.7 million and $45.6 million, as of December 31, 2019 and 2018,
respectively, and would be included in Level 3 of the fair value hierarchy if they were reported at fair value.
Senior unsecured notes due 2029: Our senior unsecured notes payable due in 2029 had a carry value of
$49.1 million and a fair value of $49.8 million as of December 31, 2019. Our senior unsecured notes
payable 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 recoverable/payable, other assets and
other liabilities, the carrying amounts approximate fair value because of the short maturity of such financial
instruments.
F-11
Investments
Debt securities available for sale are reported at fair value. Unrealized gains and losses are recorded as a
component of accumulated other comprehensive income (“AOCI”), 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 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 AOCI, net of related tax effects.
Other investments consist 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
Cash and cash equivalents include cash and highly liquid investments with an original maturity of
three months or less.
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.)
F-12
Deferred Policy Acquisition Costs
Policy acquisition costs (mainly direct commission, premium taxes, underwriting, marketing expenses and
ceding commission) that are directly related to the successful acquisition of new and renewal insurance
contracts are deferred and recognized 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 2019 and 2018, we
deferred ($156.8) million and ($124.5) million of direct policy acquisition costs and amortized $141.0
million and $120.3 million of deferred direct policy acquisition costs, respectively. During 2019 and 2018,
we deferred $160.8 million and $88.8 million of ceding commission acquisition costs and amortized
($153.7) million and ($82.9) million of deferred ceding commission acquisition costs, respectively.
Therefore, the net amortization (deferrals) of policy acquisition costs were ($8.7) million and $1.7 million
for 2019 and 2018, respectively.
Business Combinations
We account for business combinations using the acquisition method of accounting pursuant to Accounting
Standards Codification (“ASC”) 805, “Business Combinations.” The base cash purchase price plus the
estimated fair value of any non-cash or contingent consideration given for an acquired business is allocated
to the assets acquired (including identified intangible assets) and liabilities assumed based on the estimated
fair values of such assets and liabilities. The excess of the fair value of the total consideration given for an
acquired business over the aggregate net fair values assigned to the assets acquired and liabilities assumed
is recorded as goodwill. Contingent consideration is recognized as a liability at fair value as of the
acquisition date with subsequent fair value adjustments recorded in the consolidated statements of
operations. The valuation of contingent consideration requires assumptions regarding anticipated cash
flows, probabilities of cash flows, discount rates and other factors. Significant judgment is employed in
determining the propriety of these assumptions as of the acquisition date and for each subsequent period.
Accordingly, future business and economic conditions, as well as changes in any of the assumptions, can
materially impact the amount of contingent consideration expense we record in any given period. Indirect
and general expenses related to business combinations are expensed as incurred.
Goodwill and Intangible Assets, net
We account for our goodwill and intangible assets according to ASC 350, “Intangibles – Goodwill and
Other.” Under ASC 350, intangible assets with a finite life are amortized over the estimated useful life of
the asset. Goodwill and intangible assets with an indefinite useful life are not amortized. Goodwill and
intangible assets are tested for impairment on an annual basis or more frequently if events or changes in
circumstances indicate that the carrying amount may not be recoverable. For goodwill, we may perform a
qualitative test to determine whether it is more likely than not that the fair value of a reporting unit is less
than its carrying amount as a basis for determining whether it is necessary to perform the quantitative
goodwill impairment test. The first step of the quantitative test is to identify if a potential impairment exists
by comparing the fair value of a reporting unit with its carrying amount, including goodwill (“Step 1”). If
the fair value of a reporting unit exceeds its carrying value amount, goodwill of the reporting unit is not
considered to have a potential impairment and the second step is not necessary. However, if the carrying
amount of the reporting unit exceeds its fair value, the second step (“Step 2”) is performed to determine if
goodwill is impaired and to measure the amount of impairment loss to recognize, if any. Step 2 compares
F-13
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 a right of use asset and a lease obligation. Right of use assets and lease obligations are classified
in other assets and in accounts payable and other accrued expenses, respectively, on our consolidated
balance sheets.
Property and Equipment
Property and equipment (including leasehold improvements), aggregating $34.6 million and $27.0 million,
at December 31, 2019 and 2018, 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. Property and equipment includes $3.4 million of leasehold
incentives at December 31, 2019 from the adoption of ASU 2016-02, “Leases (Topic 842)” effective
January 1, 2019. Depreciation expense for 2019 and 2018 was $3.0 million and $2.7 million, respectively.
Accumulated depreciation was $23.8 million and $20.8 million at December 31, 2019 and 2018,
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
F-14
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, 2019 and 2018. 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 $8.7 million and $6.5 million for the years ended
December 31, 2019 and 2018, respectively.
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.
F-15
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 12 and 14.)
Adoption of New Accounting Pronouncements
In February 2018, the Financial Accounting Standards Board (“FASB”) issued updated guidance that
allows a reclassification of the stranded tax effects in AOCI resulting from the Tax Cuts and Jobs Act of
2017 (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 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 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 to be 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 and elected to reclassify the income tax
effects of the TCJA from AOCI to retained earnings as of January 1, 2018. This reclassification resulted in
a decrease in retained earnings of $2.6 million as of January 1, 2018 and an increase in AOCI by the same
amount.
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. The adoption of ASU 2017-08 had no impact
on our financial results and disclosures.
In January 2017, the FASB issued ASU 2017-01, “Clarifying the Definition of a Business (Topic 715)”.
ASU 2017-01 is intended to assist entities 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
F-16
elected to report changes in the fair value of equity investments in investment gains (losses) in the
Consolidated Statement of Operations.
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 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 adopted the standard on its effective date
of January 1, 2019. We also elected certain practical expedients that allow us not to reassess existing leases
under the new guidance. As of December 31, 2019, $16.0 million of right-of-use assets and $17.3 million
of lease liabilities for operating leases were included in the other assets and other liabilities line items of
the balance sheet, respectively, as a result of the adoption of this update.
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. The adoption of this new guidance
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 revenue is recognized as the entity satisfies the performance obligations and transfers control of a good
or service to the customer. Incremental costs of obtaining a contract may be capitalized to the extent the
entity expects to recover those costs. The guidance is effective for reporting periods beginning after
December 15, 2017 and is to be applied retrospectively. Revenue from insurance contracts is excluded from
the scope of this new guidance. While insurance contracts are excluded from this guidance, policy fee
income, billing and other fees and fee income related to property business written as a cover-holder through
a Lloyds Syndicate is subject to this updated guidance. The Company adopted this guidance in the first
quarter of 2018 with no material impact on the consolidated financial statements.
F-17
Recently Issued Accounting Pronouncements
In December 2019, the FASB issued updated guidance for the accounting for income taxes. The updated
guidance is intended to simplify the accounting for income taxes by removing several exceptions contained
in the existing guidance and amending other existing guidance to simplify several other income tax
accounting matters. The updated guidance is effective for the quarter ending March 31, 2021. Early
adoption is permitted. The adoption of this guidance is not expected to have a material effect on the
Company’s results of operations, financials position or liquidity.
On August 28, 2018, the FASB issued ASU 2018-13, “Fair Value Measurement: Disclosure Framework-
Changes to the Disclosure Requirements for Fair Value Measurement” (Topic 820), which amends ASC
820 to add, remove, and modify fair value measurement disclosure requirements. The requirements to
disclose the amount of and reasons for transfers between Level 1 and Level 2 of the fair value hierarchy,
the policy for timing of transfers between levels and the valuation processes for Level 3 fair value
measurements have all been removed. However, the changes in unrealized gains and losses included in
other comprehensive income for recurring Level 3 fair value measurements held at the end of the reporting
period must be disclosed along with the range and weighted average of significant unobservable inputs used
to develop Level 3 fair value measurements (or other quantitative information if it is more reasonable).
Finally, for investments measured at net asset value, the requirements have been modified so that the timing
of liquidation and the date when restrictions from redemption might lapse are only disclosed if the investee
has communicated the timing to the entity or announced the timing publicly. This ASU is effective for
annual and interim reporting periods beginning after December 15, 2019. As the amendments are only
disclosure related, our financial statements will not be materially impacted by this update.
In January 2017, the FASB issued ASU 2017-04, “Simplifying the Test for Goodwill Impairment” (Topic
350). ASU 2017-04 requires only a one-step quantitative impairment test, whereby a goodwill impairment
loss will be measured as the excess of a reporting unit’s carrying amount over its fair value (not to exceed
the total goodwill allocated to that reporting unit). It eliminates Step 2 of the current two-step goodwill
impairment test, under which a goodwill impairment loss is measured by comparing the implied fair value
of a reporting unit’s goodwill. The ASU is effective for annual or any interim goodwill impairment tests in
fiscal years beginning after December 15, 2019. The adoption of ASU 2017-04 is not expected to have a
material impact on the Company’s results of operations, financial position or liquidity.
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. As a smaller reporting
company, ASU 2016-13 is effective for fiscal years of the Company beginning after December 15, 2022,
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.
F-18
2. Investments:
The cost or amortized cost and the estimated fair value of investments in debt and equity securities by
category is as follows (in thousands):
Cost/Amortized
Cost
Gross
Unrealized
Gains
Gross
Unrealized
Losses
Fair Value
As of December 31, 2019
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, 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
$
$
$
$
66,441
297,601
115,669
81,787
8,000
569,498
71,895
3,763
645,156
48,609
243,314
131,779
112,574
13,992
550,268
68,709
3,763
622,740
$
162
3,387
556
1,531
46
5,682
35,028
—
$ 40,710
$
5
440
19
3,791
11
4,266
20,693
—
$ 24,959
$
(3) $ 66,600
(163) 300,825
(468) 115,757
83,270
(48)
(219)
7,827
(901) 574,279
99,215
(7,708)
(1,594)
2,169
$ (10,203) $ 675,663
$
(508) $ 48,106
(1,602) 242,152
(5,270) 126,528
(838) 115,527
13,557
(446)
(8,664) 545,870
80,896
(8,506)
(2,615)
1,148
$ (19,785) $ 627,914
Major categories of net investment income are summarized as follows (in thousands):
U.S. Treasury securities and obligations of U.S. Government
Corporate bonds
Collateralized corporate bank loans
Municipal bonds
Mortgage-backed
Equity securities
Cash and cash equivalents
Investment expenses
Investment income, net of expenses
Twelve Months Ended December 31,
2019
$
916 $
7,317
6,028
3,907
311
2,364
766
21,609
(1,005)
20,604 $
$
2018
902
6,696
5,658
3,757
521
1,151
518
19,203
(971)
18,232
No investments in any entity or its affiliates exceeded 10% of stockholders’ equity at December 31, 2019
or 2018.
F-19
Major categories of net investment gains (losses) on investments are summarized as follows (in thousands):
U.S. Treasury securities and obligations of U.S. Government
Corporate bonds
Collateralized corporate bank loans
Municipal bonds
Mortgage-backed
Equity securities
Gain on investments
Unrealized gains (losses) on equity securities
Unrealized gains (losses) on other investments
Investment gains (losses), net
Year Ended December 31,
$
2019
— $
235
(34)
4,270
—
(7)
4,464
15,133
1,021
$
20,618 $
2018
—
(83)
90
1,435
2
359
1,803
(9,322)
(2,676)
(10,195)
We realized gross gains on investments of $5.0 million and $2.5 million during the years ended
December 31, 2019 and 2018, respectively, of which $4.1 million and $1.5 million were from the sales of
securities during the years ended December 31, 2019 and 2018, respectively. We realized gross losses on
investments of $0.5 million and $0.7 million during the years ended December 31, 2019 and 2018,
respectively, of which $0.1 million was from the sale of securities during the year ended December 31,
2019. Our realized losses during the year ended December 31, 2018 did not include sales from securities.
We recorded proceeds from the sale of investment securities of $13.0 million, and $17.7 million during
the years ended December 31, 2019 and 2018, respectively. Realized investment gains and losses are
recognized in operations on the first in-first out method.
F-20
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, 2019 and December 31, 2018 (in
thousands):
12 months or less
As of December 31, 2019
Longer than 12 months
Unrealized
Unrealized
Total
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
— $ 5,513 $
(144)
1,150
(41) 10,228
1,618
(29)
(101)
562
(315) 19,071
$
— $
27,268
9,000
4,808
1,712
42,788
10,905 (2,363)
—
(3)
(163)
(468)
(48)
(219)
(901)
(7,708)
(1,594)
$ 53,693 $ (2,678) $ 27,333 $ (7,525) $ 81,026 $ (10,203)
(3) $ 5,513 $
(19) 28,418
(427) 19,228
6,426
(19)
(118)
2,274
(586) 61,859
6,093 (5,345) 16,998
2,169
2,169 (1,594)
—
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
$ 18,902 $
117,450
Corporate bonds
Collateralized corporate bank loans 120,410
14,281
Municipal bonds
6,592
Mortgage-backed
277,635
30,981
1,148
Total debt securities
Total equity securities
Total other investments
(4,938)
(96)
(60)
(181) $ 28,201 $
(907) 100,060
4,931
25,891
5,986
(508)
(1,602)
(5,270)
(838)
(446)
(8,664)
(8,506)
(2,615)
—
$ 309,764 $ (12,496) $ 169,544 $ (7,289) $ 479,308 $ (19,785)
(327) $ 47,103 $
(695) 217,510
(332) 125,341
40,172
(742)
12,578
(386)
(6,182) 165,069 (2,482) 442,704
35,456
(3,699)
1,148
(2,615)
4,475 (4,807)
—
Total investments
We held a total of 61 debt securities with an unrealized loss, of which 41 were in an unrealized loss position
for less than one year and 20 were in an unrealized loss position for a period of one year or greater, as of
December 31, 2019. 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 9 equity securities with an unrealized loss,
of which 7 were in an unrealized loss position for less than one year and 2 were in an unrealized loss position
for a period of one year or greater, as of December 31, 2019. 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 consider these
losses as a temporary decline in value as they are predominately on securities that we do not intend to sell
and do not believe we will be required to sell prior to recovery of our amortized cost basis. The gross
unrealized losses on the debt security positions at December 31, 2019 were due predominately to normal
market and interest rate fluctuations and we see no other indications that the decline in values of these
securities is other-than-temporary.
F-21
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 2019 and 2018.
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.
During 2019 we disposed of six previously impaired securities and recognized a realized gain of $4.1
million. During 2018 we sold one previously impaired security with a realized loss of $0.1 million and
recognized a change in unrealized gain of $1.8 million on the remaining securities.
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.
Details regarding the carrying value of the other invested assets portfolio as of December 31, 2019 and
2018 were as follows:
Investment Type
Equity warrant
Total other investments
December 31, December 31,
2019
2018
$
$
2,169 $
2,169 $
1,148
1,148
We acquired this equity warrant in an active market and it entitles us to buy the underlying common stock
of a publicly traded company at a fixed exercise price until the expiration date of January 19, 2021.
F-22
The amortized cost and estimated fair value of debt securities at December 31, 2019 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)
$ 107,108 $ 107,605
342,962 345,860
88,061
87,669
24,926
23,760
7,999
7,827
$ 569,498 $ 574,279
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 $28.9 million at December 31, 2019 and a carrying value of $29.5 million at December 31,
2018.
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:
(cid:120) Level 1: quoted prices in active markets for identical assets;
(cid:120) 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
(cid:120) 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
F-23
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-24
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, 2019 and December 31, 2018 (in thousands).
Quoted Prices in
Active Markets for
As of December 31, 2019
Identical Assets Other Observable Unobservable
Inputs (Level 2)
Inputs (Level 3)
(Level 1)
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
$
$
— $
—
—
—
—
—
99,215
2,169
101,384 $
66,600 $
300,486
115,757
83,270
7,827
573,940
—
—
573,940 $
- $ 66,600
339 300,825
- 115,757
83,270
-
7,827
-
339 574,279
99,215
—
2,169
—
339 $ 675,663
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
Quoted Prices in
Active Markets for
As of December 31, 2018
Identical Assets Other Observable Unobservable
(Level 1)
Inputs (Level 2) Inputs (Level 3)
Total
$
$
— $
—
—
—
—
—
80,896
1,148
82,044 $
48,106 $
241,861
126,528
115,527
13,557
545,579
—
—
545,579 $
— $ 48,106
291 242,152
— 126,528
— 115,527
13,557
—
291 545,870
80,896
—
—
1,148
291 $ 627,914
Due to significant unobservable inputs into the valuation model for one corporate bond as of December 31,
2019 and 2018, we classified this investment as Level 3 in the fair value hierarchy. The corporate bond
classified as level 3 in 2019 and 2018 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.
F-25
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, 2019
and 2018 (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
2019
291 $
—
—
—
—
48
—
—
—
339 $
2018
3,757
—
(2,925)
—
—
80
—
—
(621)
291
$
$
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. We account for transfers as they occur.
4. Acquisitions, Goodwill and Intangible Assets:
Goodwill is tested for impairment at the reporting unit level (business unit or one level below a business
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 business units except for the E&S Casualty and Aerospace & Programs business units for which
reporting units are at the component level (“one level below”). Our consolidated balance sheet as of
December 31, 2019 includes goodwill of acquired businesses of $44.7 million that is assigned to our
business units as follows: Commercial Accounts business unit - $2.1 million; Commercial Auto business
units - $21.3 million; E&S Casualty business unit - $6.3 million (comprised of $2.6 million for the
primary/excess liability and public entity component and $3.7 million for the E&S package component);
Aerospace & Programs business unit- $9.7 million (comprised entirely of the general aviation component);
and Specialty Personal Lines business 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 2019 and determined that there was no
impairment at that time.
The income approach to determining fair value computed the projections of the cash flows that the reporting
unit was expected to generate converted into a present value equivalent through discounting. Significant
assumptions in the income approach model included income projections, discount rates and terminal growth
values. The income projections reflected an improved premium rate environment across most of our lines
of business that continued throughout 2019. The income projections also included loss and LAE
assumptions which reflected recent historical claim trends and the movement towards a more favorable
pricing environment. The income projections also included assumptions for expense growth and investment
yields which were based on business plans for each of our business units. The discount rate was based on a
risk free rate plus a beta adjusted equity risk premium and specific company risk premium. The assumptions
were based on historical experience (including factors such as prior year loss reserve development),
F-26
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 2019 and 2018, 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
2019
2018
$ 32,177 $ 32,177
3,440
3,232
4,235
1,300
44,384
3,440
3,232
4,235
1,300
44,384
(28,752)
(3,078)
(3,232)
(4,235)
(39,297)
$
(26,515)
(2,847)
(3,232)
(4,235)
(36,829)
7,555
5,087 $
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):
2020
2021
2022
2023
2024
$ 2,467
503
$
501
$
316
$
—
$
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.
F-27
5. Other Assets:
The following table details our other assets as of December 31, 2019 and 2018 (in thousands):
2019
2018
Profit sharing commission receivable
Credit Facility B issuance costs
Accrued investment income
Investment in unconsolidated trust subsidiaries
Fixed assets
Right of use asset
Other assets
$
26 $
—
4,483
1,702
10,843
16,044
164
246
106
4,175
1,702
6,154
—
188
$ 33,262 $ 12,571
6. Reserves for Losses and Loss Adjustment Expenses:
Activity in the consolidated reserves for unpaid losses and LAE is summarized as follows (in thousands):
Balance at January 1
Less reinsurance recoverable
Net balance at January 1
Incurred related to:
Current year
Prior years
Total incurred
Paid related to:
Current year
Prior years
Total paid
Net balance at December 31
Plus reinsurance recoverable
Balance at December 31
$
2019
527,247 $
221,716
305,531
2018
527,100
154,612
372,488
301,265
60,900
362,165
250,075
5,953
256,028
127,610
192,335
319,945
90,640
232,345
322,985
347,751
272,604
620,355 $
305,531
221,716
527,247
$
The $60.9 million unfavorable net development and $6.0 million unfavorable net development in prior
accident years recognized in 2019 and 2018, respectively, represent changes in our loss reserve estimates.
In 2019 and 2018, 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, 2019 was primarily driven by the continued emergence of increased
frequency and severity trends in our primary commercial auto lines of business within our Commercial
Auto business unit, which was representative of industry trends and unfavorable development in our general
liability lines with our E&S Casualty business unit. The unfavorable prior year reserve development during
F-28
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 Commercial
Auto business unit, which was representative of industry trends, partially offset by net favorable
development in our general liability lines within our E&S Casualty and Commercial Accounts business
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,
2019
2018
$ 60,138 $ 16,457
(8,993)
(1,511)
—
$ 60,900 $ 5,953
726
36
—
The following describes the primary factors behind each segment’s prior accident year loss reserve
development for the years ended December 31, 2019 and 2018:
Year ended December 31, 2019:
(cid:120) Specialty Commercial Segment. Our Commercial Auto business unit experienced net unfavorable
development in the 2017 and prior accident years primarily in the commercial automobile liability
line of business, partially offset by favorable development primarily in the commercial automobile
line of business in the 2018 accident year. Our E&S Casualty business unit experienced net
unfavorable development primarily in our E&S package insurance products in the 2018 and prior
accident years. We experienced net favorable development in our E&S Property and Professional
Liability business units, partially offset by net unfavorable development in our Aerospace &
Programs business unit.
(cid:120) Standard Commercial Segment. Our Commercial Accounts business operating unit experienced
net unfavorable development in the 2017, 2016, 2015 and 2013 and prior accident years primarily
in the general liability line of business, partially offset by net favorable development primarily in
the commercial property line of business in the 2018 and 2014 accident years and net favorable
development primarily in the 2015 accident year in the occupational accident line of business. Our
former Workers Compensation operating unit experienced net favorable development primarily in
the 2015 accident year.
(cid:120) Personal Segment. Net unfavorable development in our Specialty Personal Lines business unit
was mostly attributable to the 2018, 2016, 2014 and 2012 and prior accidents years, partially offset
by favorable development in the 2017, 2015 and 2013 accident years.
F-29
Year ended December 31, 2018:
(cid:120) Specialty Commercial Segment. Our Commercial Auto business unit experienced net unfavorable
development in the 2016 and prior accident years, partially offset by favorable development in the
2017 accident year. Our E&S Casualty business unit experienced net favorable development
primarily in our E&S package insurance products. We experienced net unfavorable development
in our E&S Property, Professional Liability and Aerospace & Programs business units.
(cid:120) Standard Commercial Segment. Our Commercial Accounts business 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 former Workers Compensation
operating unit experienced net favorable development in the 2016 and prior accident years.
(cid:120) Personal Segment. Net favorable development in our Specialty Personal Lines business unit
was mostly attributable to the 2013 through 2017 accident years, partially offset by unfavorable
development in the 2012 and prior 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 the similar
claim duration period of our primary lines of business (certain lines of business have short settlement
periods versus long settlement periods).
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
F-30
coverage, the general approach for calculating IBNR remains the same: ultimate losses are forecasted first,
and that amount is reduced by the amount of cumulative paid claims and case reserves. Reserves established
in prior years are adjusted as loss experience develops and new information becomes available.
Adjustments to previously estimated reserves are reflected in the results of operations in the year in which
they are made.
As described above, various actuarial methods are utilized to determine the reserves for losses and LAE
recorded in our consolidated balance sheets. Weightings of methods at a detailed level may change from
evaluation to evaluation based on a number of observations, measures, and time elements.
Methodology for Determining Cumulative Number of Reported Claims
A claim file is created when the Company is notified of an actual demand for payment, notified of an event
that may lead to a demand for payment or 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 the claim level for our Commercial Accounts,
Aviation, Personal, Primary Commercial Auto Liability, and certain Programs lines of business and at a
coverage level by occurrence for our other lines of business. 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 primary lines of business with similar claims
duration periods. The incurred and paid losses by accident year information presented for all lines of
business with similar claim duration periods in the below tables for calendar years prior to 2017 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,
2019 ($ in thousands):
F-31
2010
2011
2012
2013
2014
2015
2016
2017
2018
2019
Accident
Year
2010
2011
2012
2013
2014
2015
2016
2017
2018
2019
Commercial Auto Liability
Incurred Claims and Allocated Claim Adjustment Expenses, Net of Reinsurance
As of December 31,
Accident
Year
2010
2011
2012
Unaudited
2013
2014
2015
2016
2017
For the Years Ended December 31,
$ 38,276 $ 44,052 $ 44,597 $ 46,338 $ 46,097 $ 46,557 $ 46,637 $ 46,805 $ 46,944 $
49,933
52,099
60,844
55,934
69,628
93,692
55,853
68,225
86,902
102,053
55,259
71,515
90,726
93,187
106,133
53,587
73,153
96,974
99,280
106,608
111,913
53,691
75,464
102,031
106,138
125,161
115,044
125,315
Cumulative
Number of
Reported
IBNR
2019
2018
55,775
75,657
103,379
113,357
133,574
121,714
119,583
119,070
2019
44,402 $
57,499
76,333
103,571
116,373
135,774
137,690
148,563
118,334
118,351
Total $ 1,056,890
—
46
45
(417)
(1,289)
1,093
2,352
12,280
34,175
48,275
Claims
2019
2,656
3,328
4,932
6,564
7,308
8,167
8,771
8,586
7,605
6,293
Cumulative Paid Claims and Allocated Claim Adjustment Expenses, Net of Reinsurance
For the Years Ended December 31,
2010
$
7,476
$
2011
23,464
8,288
$
2012
32,807
27,773
12,859
$
Unaudited
2013
41,298
44,227
30,046
13,333
$
$
$
$
$
$
2014
44,818
49,793
46,510
40,670
17,145
2015
45,544
52,261
59,883
63,255
43,078
18,108
2016
46,487
52,928
69,026
83,184
67,410
48,239
19,788
2019
47,125
53,275
75,039
106,894
112,617
141,678
129,761
133,880
49,912
16,812
$ 866,994
—
Liabilities for claims and claim adjustment expenses, net of reinsurance $ 189,896
2018
46,604
53,276
75,190
101,146
107,912
123,668
106,707
77,884
26,101
Total
All outstanding liabilities before 2010, net of reinsurance
2017
46,607
53,203
72,907
93,554
88,823
95,056
53,398
22,578
F-32
Casualty
Incurred Claims and Allocated Claim Adjustment Expenses, Net of Reinsurance
As of December 31,
Accident
Year
2010
2011
2012
Unaudited
2013
2014
2015
2016
2017
2018
For the Years Ended December 31,
$ 14,928 $ 13,241 $ 11,848 $ 12,413 $ 12,921 $ 12,329 $ 11,830 $ 11,928 $ 11,368 $
2019
9,600 $
2010
2011
2012
2013
2014
2015
2016
2017
2018
2019
Accident
Year
2010
2011
2012
2013
2014
2015
2016
2017
2018
2019
14,331
11,675
13,020
12,942
11,301
13,379
12,529
13,098
12,002
15,590
11,855
12,230
12,384
14,007
17,362
11,510
13,330
12,792
12,034
16,746
16,039
11,407
12,390
12,874
11,663
15,046
16,513
17,845
11,265
11,852
12,205
11,676
15,266
16,927
15,751
23,056
11,660
12,944
13,330
13,167
15,945
18,625
20,360
24,590
34,610
Total $ 174,831
Cumulative Paid Claims and Allocated Claim Adjustment Expenses, Net of Reinsurance
For the Years Ended December 31,
Unaudited
2010
2011
2012
2013
2014
2015
2016
2017
$
3,035
$
5,096 $
7,175
$
8,817 $
10,023 $
10,407
$
10,557 $
10,991
$
2,340
4,292
1,337
6,007
2,666
1,331
8,334
6,096
3,190
1,829
9,292
8,037
5,461
4,196
1,420
9,642
9,868
10,255
10,938
9,212
5,499
4,133
1,753
11,134
8,075
8,258
5,672
2,900
Cumulative
Number of
Reported
IBNR
2019
Claims
2019
88
144
(318)
(190)
(49)
247
240
2,900
2,930
26,946
836
714
637
618
704
726
738
1,123
1,739
2,277
2018
11,357
11,149
13,553
11,138 $
11,866
11,327
2019
9,345
11,204
12,572
12,255
12,365
16,158
16,442
11,268
8,027
2,526
Total $ 112,163
860
63,528
5,884
2,708
11,269
All outstanding liabilities before 2010, net of reinsurance
Liabilities for claims and claim adjustment expenses, net of reinsurance $
F-33
Commercial Accounts
Incurred Claims and Allocated Claim Adjustment Expenses, Net of Reinsurance
As of December 31,
Accident
Year
2010
2011
2012
Unaudited
2013
2014
2015
2016
2017
2018
2019
For the Years Ended December 31,
Cumulative
Number of
Reported
IBNR
2019
Claims
2019
$ 45,263 $ 45,235 $ 44,847 $ 43,164 $ 43,459 $ 42,426 $ 42,175 $ 42,880 $ 42,427 $ 40,337 $
49,375
46,540
47,194
45,723
48,085
46,413
41,721
44,625
47,385
46,280
41,081
42,632
46,990
46,470
40,966
40,745
41,451
43,917
43,806
42,580
43,327
40,100
40,350
42,822
43,806
41,429
43,449
40,943
38,585
38,669
39,567
43,673
38,385
41,983
42,704
42,898
38,585
38,669
40,211
42,463
39,287
43,111
43,579
41,290
37,984
Total $ 405,517
106
199
198
423
562
1,440
1,518
2,793
5,929
13,663
3,143
2,911
2,703
2,800
2,737
2,568
2,526
2,709
2,550
2,459
2010
2011
2012
2013
2014
2015
2016
2017
2018
2019
Cumulative Paid Claims and Allocated Claim Adjustment Expenses, Net of Reinsurance
For the Years Ended December 31,
2010
21,304
$
$
2011
28,342 $
22,002
2012
30,957
30,811
22,264
$
Unaudited
2013
33,428 $
33,701
30,096
19,386
2014
37,166 $
35,333
32,378
29,586
21,322
2015
39,115
36,302
34,597
33,927
31,150
16,557
$
$
2016
39,706 $
37,214
35,943
36,225
33,544
28,501
19,776
2017
40,937
38,253
37,808
37,947
36,775
30,974
29,456
16,644
Accident
Year
2010
2011
2012
2013
2014
2015
2016
2017
2018
2019
All outstanding liabilities before 2010, net of reinsurance
Liabilities for claims and claim adjustment expenses, net of reinsurance $
2018
42,063 $
38,311
38,044
38,892
39,185
35,238
35,035
28,813
19,233
2019
40,040
38,228
38,211
39,329
41,162
35,611
39,417
36,650
29,381
17,490
Total $ 355,519
1,202
51,200
F-34
Aviation
Incurred Claims and Allocated Claim Adjustment Expenses, Net of Reinsurance
As of December 31,
Accident
Year
2010
2011
2012
Unaudited
2013
2014
2015
2016
2017
2018
2019
For the Years Ended December 31,
2010
2011
2012
2013
2014
2015
2016
2017
2018
2019
$ 11,331 $ 10,960 $ 9,570 $ 9,186 $ 9,316 $ 9,432 $ 9,489 $ 9,820 $ 9,839 $ 9,839 $
12,330
11,299
10,988
9,759
10,738
10,236
9,729
10,353
11,304
3,179
9,829
10,336
10,295
3,654
1,870
9,884
10,024
9,563
3,627
1,709
2,330
10,045
10,021
10,057
3,558
1,643
2,241
2,325
10,028
9,941
10,649
3,566
1,631
2,119
2,082
2,382
10,028
9,941
10,252
3,567
1,630
2,219
2,079
1,990
5,246
Total $ 56,791
Cumulative
Number of
Reported
IBNR
2019
Claims
2019
—
—
—
—
—
—
33
26
143
836
269
305
229
231
201
197
292
319
332
265
Accident
Year
2010
2011
2012
2013
2014
2015
2016
2017
2018
2019
Cumulative Paid Claims and Allocated Claim Adjustment Expenses, Net of Reinsurance
For the Years Ended December 31,
Unaudited
2010
2011
2012
2013
2014
2015
2016
2017
2018
$
5,613
$
7,041 $
8,635
$
9,031 $
9,083 $
9,083
$
9,245 $
9,811
$
9,836 $
6,313
8,894
5,641
8,924
8,486
6,537
9,311
9,672
9,493
2,779
9,546
9,628
10,049
10,041
9,584
3,105
958
9,356
3,259
1,405
1,469
10,028
10,041
9,944
3,327
1,520
1,907
1,260
10,028
10,041
10,456
3,565
1,601
1,918
1,837
1,716
Total $
All outstanding liabilities before 2010, net of reinsurance
Liabilities for claims and claim adjustment expenses, net of reinsurance $
2019
9,618
10,028
9,941
10,242
3,567
1,630
2,082
2,021
2,237
2,911
54,277
—
2,514
F-35
Runoff
Incurred Claims and Allocated Claim Adjustment Expenses, Net of Reinsurance
As of December 31,
Accident
Year
2010
2011
2012
Unaudited
2013
2014
2015
2016
2017
2018
2019
For the Years Ended December 31,
2010
2011
2012
2013
2014
2015
2016
2017
2018
2019
$
— $
— $
— $
— $
— $
— $
— $
— $
— $
— $
10,861
9,949
4,804
9,433
4,469
9,069
7,547
3,597
10,143
9,208
6,185
3,358
9,713
9,338
8,605
6,678
2,821
9,257
9,762
7,277
3,553
6,741
2,636
9,257
10,076
8,624
4,733
450
6,659
2,752
9,472
10,452
8,892
4,365
465
—
6,637
2,752
9,486
10,463
8,420
4,416
415
—
—
Total $ 42,590
Cumulative
Number of
Reported
IBNR
2019
Claims
2019
—
287
70
165
460
182
29
72
—
—
—
965
661
711
1,130
822
599
439
66
—
Cumulative Paid Claims and Allocated Claim Adjustment Expenses, Net of Reinsurance
For the Years Ended December 31,
Accident
Year
2010
2011
2012
Unaudited
2013
2014
2015
2016
2017
2018
2019
2010
2011
2012
2013
2014
2015
2016
2017
2018
2019
$
—
$
—
2,897
$
$
—
4,308
1,181
$
—
5,208
2,107
3,737
$
—
4,968
2,411
6,825
2,933
$
—
4,838
2,594
7,882
5,972
2,528
$
—
5,227
2,583
8,350
7,970
5,744
1,732
$
—
5,427
2,600
8,809
9,004
7,328
2,550
111
—
5,483
2,602
8,961
9,210
8,049
3,743
171
—
$
—
5,357
2,675
9,010
9,323
8,495
4,418
203
Total
All outstanding liabilities before 2010, net of reinsurance
Liabilities for claims and claim adjustment expenses, net of reinsurance $
$ 39,481
—
3,109
F-36
Programs
Incurred Claims and Allocated Claim Adjustment Expenses, Net of Reinsurance
As of December 31,
Accident
Year
2010
2011
2012
Unaudited
2013
2014
2015
2016
2017
2018
2019
For the Years Ended December 31,
2010
2011
2012
2013
2014
2015
2016
2017
2018
2019
$
— $
— $
— $
— $
— $
— $
— $
— $
— $
- $
317
196
3,001
196
2,045
1,595
196
2,045
2,543
1,623
196
3,885
1,561
666
1,683
196
2,045
2,076
2,039
1,629
478
196
2,045
2,302
1,575
752
1,200
955
196
2,045
2,302
1,575
752
1,178
1,775
3,598
196
2,045
2,302
1,575
752
1,178
1,801
4,368
5,407
Total $ 19,624
Cumulative
Number of
Reported
IBNR
2019
Claims
2019
—
—
—
—
—
—
—
55
440
1,481
—
—
3
2
5
2
1
23
88
56
Accident
Year
2010
2011
2012
2013
2014
2015
2016
2017
2018
2019
Cumulative Paid Claims and Allocated Claim Adjustment Expenses, Net of Reinsurance
For the Years Ended December 31,
Unaudited
2010
2011
2012
2013
2014
2015
2016
2017
2018
$
—
$
— $
—
$
— $
— $
—
$
— $
—
$
— $
196
196
2,045
196
2,045
1,489
196
2,045
1,561
758
196
2,045
1,561
1,502
1,515
196
2,045
2,076
1,575
1,629
1,139
196
2,045
2,302
1,575
752
1,139
36
196
2,045
2,302
1,575
752
1,178
1,556
911
Total $
All outstanding liabilities before 2010, net of reinsurance
Liabilities for claims and claim adjustment expenses, net of reinsurance $
2019
—
196
2,045
2,302
1,575
752
1,178
1,551
1,290
4,501
15,390
—
4,234
F-37
Personal Segment
Incurred Claims and Allocated Claim Adjustment Expenses, Net of Reinsurance
As of December 31,
Accident
Year
2010
2011
2012
Unaudited
2013
2014
2015
2016
2017
2018
2019
For the Years Ended December 31,
2010
2011
2012
2013
2014
2015
2016
2017
2018
2019
$ 63,862 $ 78,294 $ 80,765 $ 84,724 $ 83,903 $ 84,252 $ 84,591 $ 84,808 $ 84,867 $ 84,867 $
75,746
77,652
58,604
87,810
73,795
55,706
86,757
70,552
59,132
5,452
86,804
71,513
60,100
5,340
23,104
86,948
72,042
60,211
6,243
25,682
32,260
86,853
72,037
60,379
6,699
25,307
32,893
23,342
87,199
72,076
60,328
6,504
25,136
32,728
21,968
18,334
87,198
72,100
60,310
6,518
25,102
32,803
21,926
18,353
56,009
Total $ 465,186
Cumulative
Number of
Reported
IBNR
2019
32
—
—
—
—
—
27
13
(191)
619
Claims
2019
30,180
31,615
23,940
23,472
19,293
23,376
23,752
16,796
15,268
24,221
Cumulative Paid Claims and Allocated Claim Adjustment Expenses, Net of Reinsurance
For the Years Ended December 31,
2010
38,643
$
$
2011
67,755 $
46,416
2012
75,199
67,939
37,860
$
Unaudited
2013
82,624 $
83,497
64,278
45,901
2014
83,511 $
85,533
68,849
54,514
2,515
2015
84,111
86,217
70,807
58,047
4,418
11,570
$
$
2016
84,556 $
86,593
71,995
59,775
5,631
22,281
21,669
2017
84,717
86,660
72,055
60,277
6,428
24,262
30,646
15,776
Accident
Year
2010
2011
2012
2013
2014
2015
2016
2017
2018
2019
All outstanding liabilities before 2010, net of reinsurance
Liabilities for claims and claim adjustment expenses, net of reinsurance $
2018
84,768 $
86,989
72,094
60,297
6,566
25,243
32,260
21,061
11,137
2019
84,782
87,045
72,124
60,279
6,580
25,098
32,777
21,972
18,009
41,524
Total $ 450,190
31
15,027
F-38
Property
Incurred Claims and Allocated Claim Adjustment Expenses, Net of Reinsurance
As of December 31,
For the Years Ended December 31,
Accident
Year
Unaudited
2013
2012
2010
2011
2014
$ 9,652 $ 9,836 $ 9,680 $ 9,656 $ 9,668 $ 9,654 $ 9,675 $ 9,700 $ 9,496 $
12,406
18,119
22,363
22,551
12,228
17,541
21,644
12,289
18,518
11,768
2018
2017
2016
2015
2019
9,501 $
12,598
17,743
22,264
21,950
20,256
12,616
17,768
22,578
21,862
19,919
20,734
12,494
18,005
22,914
21,793
20,014
22,838
24,182
12,551
17,974
22,936
21,852
20,091
22,632
23,003
22,822
12,549
17,963
22,935
21,876
20,202
22,789
24,490
18,694
20,214
Total $ 191,214
2010
2011
2012
2013
2014
2015
2016
2017
2018
2019
Cumulative
Number of
Reported
IBNR
2019
Claims
2019
—
—
—
—
(20)
5
(0)
10
(649)
4,640
1,316
1,512
1,629
1,893
2,037
1,993
2,029
2,006
1,052
997
Cumulative Paid Claims and Allocated Claim Adjustment Expenses, Net of Reinsurance
For the Years Ended December 31,
Unaudited
2010
2011
2012
2013
2014
2015
2016
2017
$
8,692
$
9,632 $
9,522
$
9,479 $
9,474 $
9,479
$
9,498 $
9,496
$
10,317
12,354
15,773
12,343
17,679
17,785
12,370
17,743
21,452
19,586
12,492
17,666
21,864
21,749
17,513
12,541
17,693
22,197
21,778
19,500
17,248
12,550
17,978
22,826
21,849
19,928
22,500
18,703
Accident
Year
2010
2011
2012
2013
2014
2015
2016
2017
2018
2019
2018
20,134
21,911
22,936
12,551
17,974
9,496 $
2019
9,501
12,549
17,963
22,935
21,955
19,953
22,789
23,821
16,914
11,344
Total $ 179,725
—
11,489
22,613
22,059
10,923
All outstanding liabilities before 2010, net of reinsurance
Liabilities for claims and claim adjustment expenses, net of reinsurance $
F-39
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
Commercial Auto Liability
Casualty
Commercial Accounts
Aviation
Runoff
Programs
Personal Segment
Property
2019
2018
$ 189,896 $ 150,288
61,014
56,865
2,185
5,070
2,164
8,743
12,739
63,528
51,200
2,514
3,109
4,234
15,027
11,489
Liabilities for unpaid losses and allocated loss adjustment
expenses, net of reinsurance
340,997
299,068
Reinsurance recoverable on unpaid losses and LAE
Commercial Auto Liability
Casualty
Commercial Accounts
Aviation
Runoff
Programs
Personal Segment
Property
Total reinsurance recoverable on unpaid losses and LAE
Unallocated loss adjustment expenses
Commercial Auto Liability
Casualty
Commercial Accounts
Aviation
Runoff
Programs
Personal Segment
Property
Total unallocated loss adjustment expenses
Total reserves for unpaid losses and loss adjustment
expenses
112,931
91,900
13,671
9,469
1,326
3,618
11,752
27,937
272,604
23,262
139,928
8,255
9,114
1,528
421
13,131
26,077
221,716
1,383
760
2,732
85
170
63
1,250
311
6,754
1,264
707
2,788
383
170
31
955
165
6,463
$ 620,355 $ 527,247
F-40
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, 2019:
Commercial Auto Liability
Casualty
Commercial Accounts
Aviation
Runoff
Programs
Personal Segment
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
14.5 % 25.6 % 26.3 % 16.3 % 10.0 %
12.4 % 15.8 % 19.9 % 21.3 % 14.3 %
5.8 %
5.8 %
36.8 % 16.8 %
2.8 %
63.5 % 22.7 %
6.2 %
4.2 %
31.9 % 37.8 % 17.6 %
— %
6.5 %
73.2 % 20.3 %
0.9 %
8.9 %
56.0 % 28.8 %
6.3 %
3.3 %
6.9 %
— %
4.7 %
3.6 %
4.7 %
7.0 %
1.5 %
1.4 %
— %
0.3 %
0.1 %
2.6 %
7.6 %
2.2 %
2.8 %
5.7 %
0.5 %
1.6 %
1.5 % (1.3)%
— %
— %
0.2 %
0.1 %
— %
0.8 %
6.9 %
0.1 %
— %
— %
0.1 %
1.0 %
1.0 %
6.1 %
(2.2) %
— %
— %
— %
Property
77.2 % 15.8 %
1.7 %
0.5 %
3.6 %
1.2 %
— %
— %
— %
— %
(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.
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, 2019 was with
reinsurers that had an A.M. Best rating of “A-” or better. We also mitigate our credit risk for the remaining
reinsurance recoverable by obtaining letters of credit.
F-41
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
$
$
$
$
$
836,797
7,034
(347,279)
496,552
748,203
4,763
(316,089)
436,877
211,768
$
$
$
$
$
660,298
2,717
(299,217)
363,798
639,437
2,159
(278,509)
363,087
199,690
Included in reinsurance recoverable on the consolidated balance sheets are paid loss recoverables of $36.6
million and $29.7 million as of December 31, 2019 and 2018, respectively.
8. Revolving Credit Facilities:
Our Second Restated Credit Agreement with Frost Bank (“Frost”) dated June 30, 2015, as amended,
provided 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 bore interest at a rate equal to the prime rate or LIBOR
plus 2.5%, at our election. We paid 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. On August 19, 2019, we terminated Facility A.
The Second Restated Credit Agreement with Frost also provided a $30.0 million revolving credit facility
(“Facility B”), in addition to Facility A. We used Facility B loan proceeds solely for the purpose of making
capital contributions to AHIC and HIC. We paid a quarterly fee of 0.25% per annum of the average daily
unused balance of Facility B. Facility B bore interest at a rate equal to the prime rate or LIBOR plus
3.00%, at our election. On August 19, 2019, we repaid the $30 million principal balance and accrued
interest on Facility B. Upon such repayment, we terminated Facility B.
F-42
9. Subordinated Debt Securities:
We issued trust preferred securities through Trust I and Trust II. These Delaware statutory trusts are
sponsored and wholly-owned by Hallmark and each was created solely for the purpose of issuing the trust
preferred securities. Each trust pays dividends on its preferred securities at the same rate each quarter as
interest is paid on the junior subordinated debt securities. Under the terms of the trust subordinated debt
securities, we pay interest only each quarter and the principal of each note at maturity. The subordinated
debt securities of each trust are uncollateralized and do not require maintenance of minimum financial
covenants.
The following table summarizes the nature and terms of the junior subordinated debt and trust preferred
securities:
Issue date
Principal amount of trust preferred
securities
Principal amount of junior subordinated
debt securities
Maturity date of junior subordinated debt
securities
Trust common stock
Interest rate, per annum
Current interest rate at December 31,
2019
$
$
Hallmark
Statutory
Trust I
Hallmark
Statutory
Trust II
June 21, 2005
August 23, 2007
30,000
30,928
$
$
25,000
25,774
June 15, 2035
928
September 15, 2037
774
$
Three Month LIBOR + 3.25% Three Month LIBOR + 2.90%
$
5.14%
4.79%
10. Senior Unsecured Notes:
On August 19, 2019, Hallmark issued $50.0 million of senior unsecured notes (“Notes”) due August 15,
2029. Interest on the Notes accrues at the rate of 6.25% per annum and is payable semi-annually in arrears
commencing February 15, 2020. The Notes are not obligations of or guaranteed by any of Hallmark’s
subsidiaries and are not subject to any sinking fund requirements. At Hallmark’s option, the Notes are
redeemable, in whole or in part, prior to the stated maturity subject to certain provisions intended to make
the holders of the Notes whole on scheduled interest and principal payments. The indenture governing the
Notes contains covenants which restrict Hallmark’s ability to incur additional indebtedness, pay dividends
on or acquire its common stock, or make payments on its other securities or indebtedness if any such action
would cause the Company’s debt to capital ratio (calculated in accordance with the indenture) to exceed
35%. Among other things, the indenture also limits Hallmark’s ability to create liens on the stock of,
dispose of all or substantially all of the assets of, or permit the merger or consolidation with another entity
of any direct or indirect insurance company subsidiary with statutory surplus of at least $50.0 million. As
of December 31, 2019, Hallmark was in compliance with all of these covenants.
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11. Segment Information:
We pursue our business activities primarily through subsidiaries whose operations are organized into
business units and are supported by our insurance carrier subsidiaries. Our non-carrier insurance activities
are organized by business units into the following reportable segments:
(cid:120) Specialty Commercial Segment. Our Specialty Commercial Segment includes our Commercial
Auto business unit which offers primary and excess commercial vehicle insurance products and
services; our E&S Casualty business unit which offers primary and excess liability, excess public
entity liability, E&S package and garage liability insurance products and services; our E&S
Property business unit which offers primary and excess commercial property insurance for both
catastrophe and non-catastrophe exposures; our Professional Liability business unit which offers
healthcare and financial lines professional liability insurance products and services primarily for
businesses, medical professionals, medical facilities and senior care facilities; and our Aerospace
& Programs business unit which offers general aviation and satellite launch property/casualty
insurance products and services, as well as certain specialty programs. These products were
previously reported as the Contract Binding and Specialty Commercial operating units. This
realignment did not impact our reportable segments.
(cid:120) Standard Commercial Segment. Our Standard Commercial Segment includes the package and
monoline property/casualty and occupational accident insurance products and services handled by
our Commercial Accounts business unit (f/k/a Standard Commercial P&C operating unit) and the
runoff of workers compensation insurance products handled by our former Workers Compensation
operating unit. Effective June 1, 2016, we ceased marketing new or renewal occupational accident
policies. Effective July 1, 2015, the former Workers Compensation operating unit ceased retaining
any risk on new or renewal policies.
(cid:120) Personal Segment. Our Personal Segment includes the non-standard personal automobile and
renters insurance products and services handled by our Specialty Personal Lines business unit.
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
32% of the net premiums written by any of them, HIC retains 32% of the net premiums written by any of
them, HSIC retains 26% 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-44
The following is additional business segment information for the twelve months ended December 31, 2019
and 2018 (in thousands):
2019
2018
$ 309,619 $ 280,283
76,548
38,623
(16,186)
$ 486,371 $ 379,268
68,179
88,225
20,348
$
$
$
$
$
$
$
$
3,158 $
598
1,227
382
5,365 $
2,986
390
1,312
453
5,141
— $
—
—
5,410
5,410 $
—
—
—
4,545
4,545
(540) $
(331)
168
296
(407) $
5,521
2,511
587
(6,163)
2,456
(1,371) $
(841)
427
753
(1,032) $
28,780
13,090
3,061
(32,128)
12,803
Revenues
Specialty Commercial Segment
Standard Commercial Segment
Personal Segment
Corporate
Consolidated
Depreciation and Amortization Expense
Specialty Commercial Segment
Standard Commercial Segment
Personal Segment
Corporate
Consolidated
Interest Expense
Specialty Commercial Segment
Standard Commercial Segment
Personal Segment
Corporate
Consolidated
Tax (Benefit) Expense
Specialty Commercial Segment
Standard Commercial Segment
Personal Segment
Corporate
Consolidated
Pre-tax (loss) income
Specialty Commercial Segment
Standard Commercial Segment
Personal Segment
Corporate
Consolidated
F-45
The following is additional business segment information as of the following dates (in thousands):
Assets:
Specialty Commercial Segment
Standard Commercial Segment
Personal Segment
Corporate
Consolidated
12. Earnings Per Share:
December 31, December 31,
2019
2018
$ 1,082,804 $ 858,262
158,881
226,431
21,320
$ 1,495,274 $ 1,264,894
193,710
164,685
54,075
We have adopted the provisions of ASC 260, “Earnings Per Share,” requiring presentation of both basic
and diluted earnings per share. A reconciliation of the numerators and denominators of the basic and diluted
per share calculations is presented below (in thousands, except per share amounts):
Numerator for both basic and diluted earnings per share:
Net (loss) income
Denominator, basic shares
Effect of dilutive securities:
Stock-based compensation awards
Denominator, diluted shares
Basic (loss) earnings per share:
Diluted (loss) earnings per share:
2019
2018
$
(625) $ 10,347
18,107
18,086
—
18,107
115
18,201
$
(0.03) $
0.57
$
(0.03) $
0.57
We had 14,157 and 32,164 shares of common stock potentially issuable upon exercise of employee stock
options for years ended December 31, 2019 and 2018, 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, to the extent not previously cancelled or exercised, expire in 2021.
13. 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.
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 $35.5 million as of December 31, 2019.
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
F-46
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 2020, the aggregate ordinary dividend capacity of these subsidiaries is $22.6 million, of which $15.8
million is available to Hallmark. As a county mutual, dividends from HCM are payable to policyholders.
During the years ended December 31, 2019 and 2018 our insurance company subsidiaries paid $15.5
million and $5.5 million, respectively, in dividends to Hallmark. The total restricted net assets of our
insurance company subsidiaries as of December 31, 2019, was $227.8 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 2019 and 2018.
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, 2019 and 2018, our insurance company subsidiaries
reported statutory capital and surplus of $254.7 million and $247.0 million, respectively, substantially
greater than the minimum requirements for each state. For the years ended December 31, 2019, and 2018,
respectively, our insurance company subsidiaries reported a statutory net loss of $10.2 million and statutory
net income of $35.9 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, 2019, the adjusted capital under the
risk-based capital calculation of each of our insurance company subsidiaries substantially exceeded the
minimum requirements.
14. 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, 2019, there were no outstanding incentive stock options and
outstanding non-qualified stock options to purchase 14,157 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, 2019, restricted
stock units representing the right to receive up to 530,236 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,
2019.
F-47
Stock Options:
Non-qualified stock options outstanding under the 2005 LTIP vest 100% six months after the date of
grant and terminate ten years from the date of grant. The grant of 200,000 non-qualified stock options in
2009 vested in equal annual increments on each of the first seven anniversary dates and was fully exercised
prior to termination in 2019.
A summary of the status of our stock options as of December 31, 2019 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, 2019
Granted
Exercised
Forfeited or expired
Outstanding at December 31, 2019
Exercisable at December 31, 2019
244,157 $
—
(230,000) $
— $
14,157 $
14,157 $
6.63
—
6.61
—
6.99
6.99
2.0 $
2.0 $
150
150
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
2019
2018
$
$
$
845 $
— $
— $
122
—
—
As of December 31, 2019, 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 2019 or 2018.
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 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
F-48
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,” and are not included in the calculation of basic or diluted earnings
per share.
Compensation cost is measured as an amount equal to the fair value of the restricted stock units on the date
of grant and is expensed over the vesting period if achievement of the performance criteria is deemed
probable, with the amount of the expense recognized based on our best estimate of the ultimate achievement
level. The grant date fair value of restricted stock units granted in 2015, 2016, 2017, 2018 and 2019 was
$11.10, $11.41, $10.20, $10.87 and $18.10 per unit, respectively. We incurred compensation expense of
$887 thousand and $152 thousand related to restricted stock units during the years ended December 31,
2019 and 2018. We recorded income tax benefit of $186 thousand and $32 thousand related to restricted
stock units during the years ended December 31, 2019 and 2018.
The following table details the status of our restricted stock units as of and for the years ended December 31,
2019 and 2018:
Nonvested at January 1
Granted
Vested
Forfeited
Nonvested at December 31
Number of Restricted Stock Units
2019
338,897
97,804
—
(83,210)
353,491
2018
385,779
144,059
(8,198)
(182,743)
338,897
As of December 31, 2019, there was $2.4 million of unrecognized grant date compensation cost related to
unvested restricted stock units assuming compensation cost accrual at target achievement level. Based on
the current performance estimate, we expect to recognize $2.4 million of compensation cost related to
unvested restricted stock units, of which $1.4 million is expected to be recognized in 2020, $0.8 million is
expected to be recognized in 2021 and $0.2 million is expected to be recognized in 2022.
15. 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-49
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, 2019 and 2018 (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 loss (gain)
Benefits paid
Benefit obligation as of end of period
Change in plan assets:
Fair value of plan assets as of beginning of period
Actual return on plan assets (net of expenses)
Employer contributions
Benefits paid
Fair value of plan assets as of end of period
Net periodic pension cost:
Service cost - benefits earned during the period
Interest cost on projected benefit obligation
Expected return on plan assets
Recognized actuarial loss
Net periodic pension cost
Discount rate
Expected return on plan assets
Rate of compensation increase
F-50
2019
2018
2.98 %
N/A
4.05 %
N/A
$ (12,376)
$ (11,687)
$ (12,376)
10,988
$ (1,388)
$ (11,687)
9,669
$ (2,018)
(4,010)
(4,010)
2,622
$ (1,388)
(4,130)
(4,130)
2,112
$ (2,018)
$ 11,687
454
1,083
(848)
$ 12,376
$ 12,758
424
(628)
(867)
$ 11,687
$ 9,669
1,667
500
(848)
$ 10,988
$ 11,153
(617)
—
(867)
9,669
$
$
$
—
454
(607)
143
(10)
$
$
—
424
(694)
106
(164)
4.05 %
6.50 %
N/A
3.45 %
6.50 %
N/A
Estimated future benefit payments by fiscal year (in thousands):
2020
2021
2022
2023
2024
2025-2029
866
$
874
$
859
$
839
$
828
$
$ 3,807
As of December 31, 2019, the fair value of the plan assets was composed of cash and cash equivalents of
$0.6 million, debt securities of $3.4 million and equity securities of $7.0 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, 2019. 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 2020. We expect our 2020 net periodic pension cost to be ($190) thousand, the components of which
are interest cost of $355 thousand, expected return on plan assets of ($684) thousand and amortization of
actuarial loss of $139 thousand.
F-51
The following table shows the weighted-average asset allocation for the defined benefit cash balance plan
held as of December 31, 2019 and 2018.
Asset Category:
Debt securities
Equity securities
Other
Total
December 31
2019 2018
31 %
64 %
5 %
100 %
36 %
61 %
3 %
100 %
We determine the fair value of our financial instruments based on the fair value hierarchy established in
ASC 820. (See Note 3.)
The following table presents, for each of the fair value hierarchy levels, our plan assets that are measured
at fair value on a recurring basis at December 31, 2019 and December 31, 2018 (in thousands).
As of December 31, 2019
Quoted Prices in Active Other Observable
Markets for Identical
Assets (Level 1)
Inputs
(Level 2)
Unobservable Inputs
(Level 3)
Total
Debt securities
Equity securities
Total
$
$
— $
6,977
6,977 $
3,410 $
—
3,410 $
— $ 3,410
—
6,977
— $ 10,387
Debt securities
Equity securities
Total
Quoted Prices in Active
Markets for Identical Other Observable Unobservable Inputs
As of December 31, 2018
Assets (Level 1)
Inputs (Level 2)
(Level 3)
$
$
— $
5,913
5,913 $
3,468 $
—
3,468 $
Total
— $ 3,468
—
5,913
— $ 9,381
Our plan assets also include cash and cash equivalents of $0.6 million and $0.3 million at December 31,
2019 and 2018, respectively, that are carried at cost which approximates fair value.
We also 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 $0.7 million and $0.2 million for the years ended December 31, 2019 and 2018.
F-52
16. Income Taxes:
The composition of deferred tax assets and liabilities and the related tax effects as of December 31, 2019
and 2018, 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
2019
2018
$ (4,829) $ (3,001)
(1,087)
(22)
(2,179)
(357)
(72)
(992)
(279)
(7,989)
(6,408)
(17)
(1,882)
(357)
(77)
(1,529)
(315)
(15,414)
9,438
36
842
2,154
3,284
18
722
489
616
17,599
6,931
71
867
93
2,505
54
632
1,446
373
12,972
Deferred federal income taxes, net
$
2,185 $ 4,983
We concluded that no valuation allowance was necessary against our deferred tax assets as of December 31,
2019 and 2018.
F-53
A reconciliation of the income tax provisions based on the applicable statutory tax rate of 21% to the
provisions reflected in the consolidated financial statements for the years ended December 31, 2019 and
2018, respectively, is as follows (in thousands):
Computed expected income tax (benefit) expense at statutory tax rate
Meals and entertainment
Tax exempt interest
Dividends received deduction
State taxes (net of federal benefit)
Other
Income tax (benefit) expense
Current income tax (benefit) expense
Deferred tax expense (benefit)
Income tax (benefit) expense
2019
2018
(217) $ 2,689
102
75
(435)
(421)
(191)
(94)
266
414
(94)
(45)
(407) $ 2,456
(1,224) $ 4,300
817
(1,844)
(407) $ 2,456
$
$
$
$
We have available, for federal income tax purposes, unused net operating loss of $10.3 million at
December 31, 2019. The TCJA generally repealed the previous two year carry-back and 20 year carry-
forward provision for net operating losses and adopted an indefinite carry-forward of net operating losses
arising in tax years ending after December 31, 2017. However, the TCJA preserved present law for net
operating losses of property/casualty insurance companies. Thus, our net operating losses may be carried-
back two years and carried-forward 20 years. On March 27, 2020, the Coronavirus Aid Relief and Economic
Security Act (“CARES Act”) was signed into law. The CARES Act grants taxpayers a five-year carry-
back period for net operating losses arising in tax years beginning after December 31, 2017 and before
January 1, 2021 (i.e. calendar years 2018, 2019 and 2020).
The net operating losses will expire if unused, as follows (in thousands):
Year
2022
2028
2029
2031
2032
2033
2034
2035
2036
2037
2038
2039
Indefinite
2
25
45
77
73
59
33
50
29
40
67
9,758
$ 10,258
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 2016. The Company recognizes interest and penalties related to uncertain tax positions in
income tax expense. There were no uncertain tax positions at December 31, 2019.
F-54
17. 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
2019 2018
$ 53,336 $ 35,594
Cash and cash equivalents
Restricted cash
4,877
1,612
Total cash, cash equivalents and restricted cash shown in the statement of cash flows $ 54,948 $ 40,471
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, 2019
and 2018:
Interest paid
Income taxes paid (recovered)
Supplemental schedule of non-cash investing activities:
December 31,
2019
2018
$
4,289
$
4,842
$
7,775
$
(3,236)
Receivable for securities related to investment disposals
$
12,581
Payable for securities related to investment purchases
$
1,648
$
$
3,369
698
18. Commitments and Contingencies:
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
2019 and 2018.
As of December 31, 2019 we were 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 were a party are routine in nature and incidental to our business.
F-55
19. Changes in Accumulated Other Comprehensive Income Balances:
The changes in accumulated other comprehensive income balances as of December 31, 2019 and 2018 were
as follows (in thousands):
Balance at January 1, 2018
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
Pension Unrealized
Liability Gains (Loss)
$ (2,310) $ 14,544 $
Accumulated Other
Comprehensive
Income (Loss)
(576)
121
—
—
—
—
(455)
—
—
(3,343)
702
(1,803)
379
(4,065)
12,234
(576)
121
(3,343)
702
(1,803)
379
(4,520)
(569)
3,188
2,619
—
(16,993)
(16,993)
Balance at December 31, 2018
Other comprehensive income:
Change in net actuarial loss
Tax effect on change in net actuarial loss
Unrealized holding gains arising during the period
Tax effect on unrealized gains arising during the period
Reclassification adjustment for gains included in net realized gains
Tax effect on reclassification adjustment for gains included in
income tax expense
Other comprehensive income, net of tax
Balance at December 31, 2019
$ (3,334) $ (3,326) $
120
(25)
—
—
—
—
95
—
—
13,645
(2,865)
(4,464)
937
7,253
3,927 $
$ (3,239) $
(6,660)
120
(25)
13,645
(2,865)
(4,464)
937
7,348
688
20. 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, 2019.
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, 2019 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-56
21. Leases:
We adopted ASU 2016-02, “Leases, (Topic 842)” on January 1, 2019, which resulted in the recognition of
operating leases on the balance sheet in 2019 and going forward. See Note 1 for more information on the
adoption of ASU 2016-02. Right-of-use assets are included in the other assets line item and lease liabilities
are included in the other liabilities line item of the consolidated balance sheet. We also elected certain
practical expedients that allow us not to reassess existing leases under the new guidance. We determine if
a contract contains a lease at inception and recognize operating lease right-of-use assets and operating lease
liabilities based on the present value of the future minimum lease payments at the commencement date.
Since our leases do not provide an implicit rate, we use our incremental borrowing rate based on the
information available at the commencement date in determining the present value of future payments. Lease
agreements which have lease and non-lease components are accounted for as a single lease component.
Lease expense is recognized on a straight-line basis over the lease term.
The Company’s operating lease obligations predominately pertain to office leases utilized in the operation
of our business. Our leases have remaining terms of one to 13 years, some of which include options to
extend the leases. The components of lease expense and other lease information as of and during the period
ended December 31, 2019 are as follows (in thousands):
Operating lease cost
Cash paid for amounts included in the measurement of lease liabilities
Operating cash flows from operating leases
Right-of-use assets obtained in exchange for new operating lease liabilities
Twelve Months Ended
December 31,
2019
$
$
$
2,936
1,889
—
We incurred $26 thousand in short-term lease payments not included in our lease liability during the year
ended December 31, 2019.
The components of lease expense and other lease information as of and during the twelve month period
ended December 31, 2019 are as follows (in thousands):
Operating lease right-of-use assets
Operating lease liabilities
Weighted-average remaining lease term - operating leases
Weighted-average discount rate - operating leases
$
$
December 31,
2019
16,044
17,347
10.6
5.88%
F-57
Future minimum lease payments under non-cancellable leases as of December 31, 2019 and December 31,
2018 are as follows (in thousands):
2019
2020
2021
2022
2023
Thereafter
Total future minimum lease payments
Less imputed interest
Total operating lease liability
22. Subsequent Events:
December 31,
2019
December 31,
2018
$
$
$
$
—
2,473
2,172
2,171
1,885
15,266
23,967
(6,620)
17,347
$
$
$
$
1,889
2,473
2,172
2,171
1,885
15,266
25,856
N/A
N/A
In February, 2020, we made the strategic decision to exit the contract binding line of the primary
automobile business marketed by our Commercial Auto business unit as a result of increasing claim severity
and limited opportunity for meaningful rate increases. At that time, we began the process of non-renewing
policies and placing in-force policies in runoff in accordance with state regulatory guidelines. During 2019,
this contract binding business produced $115.0 million in gross premiums written, which represented 56%
of the total primary automobile premium volume of our Commercial Auto business unit.
On May 5, 2020, a lawsuit styled Schulze v. Hallmark Financial Services, Inc., et. al (Case No. 3:20-cv-
01130) was filed in the U.S. District Court for the Northern District of Texas, Dallas Division. The
Company, its Chief Executive Officer and its Chief Financial Officer are named defendants in the lawsuit
brought on behalf of a putative class of shareholders who acquired Hallmark securities between March 5,
2019 and March 17, 2020. In general, the complaint alleges that the defendants violated the Securities
Exchange Act of 1934 by failing to disclose that (a) the Company lacked effective internal controls over
financial reporting related to its reserves for unpaid losses, (b) the Company improperly accounted for
reserves for unpaid losses, (c) the Company would be forced to report $63.8 million of prior year net adverse
loss development, (d) the Company would exit the contract binding line of its commercial automobile
primary insurance business, and (e) the defendants’ positive statements about the Company’s business,
operations and prospects were materially misleading and/or lacked a reasonable basis. The court has not
yet appointed a lead plaintiff, and defendants’ responsive pleading is not yet due and has not been filed. The
litigation is in its initial stages and we are unable to reasonably predict its potential outcome. The Company,
however, believes that the lawsuit is without merit and intends to vigorously defend the claims. The
Company’s current policy is to expense legal costs as incurred. Historically, the Company has not carried
director and officer liability insurance and does not currently hold such a policy.
In connection with its normal process for evaluating triggering events, the Company determined that a
significant decline in its market capitalization below its stockholders’ equity during the first quarter of 2020
was an event that indicated the impairment of the goodwill and indefinite-lived intangible assets included
in its balance sheet. As a result, the Company has taken a $44.7 million charge to goodwill and a $1.3
million charge to indefinite-lived intangible assets as of March 31, 2020.
F-58
Schedule II – Condensed Financial Information of Registrant (Parent Company Only)
HALLMARK FINANCIAL SERVICES, INC.
BALANCE SHEETS
December 31, 2019 and 2018
(In thousands)
2019
2018
ASSETS
Debt securities, available-for-sale, at fair value (amortized cost; $150 in 2019
and $150 in 2018)
Cash and cash equivalents
Investment in subsidiaries
Deferred federal income taxes
Federal income tax recoverable
Other assets
Total assets
LIABILITIES AND STOCKHOLDERS’ EQUITY
Liabilities:
Senior unsecured notes due 2029 (less unamortized debt issuance cost of $942
in 2019)
Revolving credit facility payable
Subordinated debt securities (less unamortized debt issuance cost of $846 in
2019 and $898 in 2018)
Accounts payable and other accrued expenses
Total liabilities
Stockholders’ equity:
Common stock, $.18 par value, authorized 33,333,333 shares; issued
20,872,831 shares in 2019 and in 2018
Additional paid-in capital
Retained earnings
Accumulated other comprehensive income (loss)
Treasury stock (2,749,738 shares in 2019 and 2,846,131 in 2018), at cost
Total stockholders’ equity
Total liabilities and stockholders’ equity
$
1,024 $
786
10,159
344,904
442
6,133
3,784
$ 407,332 $ 366,208
19,637
358,436
1,053
5,904
21,278
$ 49,058 $
—
—
30,000
55,856
39,136
144,050
55,804
24,872
110,676
3,757
123,468
160,570
688
(25,201)
3,757
123,168
161,195
(6,660)
(25,928)
263,282
255,532
$ 407,332 $ 366,208
See accompanying report of independent registered public accounting firm.
F-59
Schedule II (Continued) – Condensed Financial Information of Registrant (Parent Company Only)
HALLMARK FINANCIAL SERVICES, INC.
STATEMENTS OF OPERATIONS
For the years ended December 31, 2019 and 2018
(In thousands)
2019
2018
Investment income, net of expenses
Dividend income from subsidiaries
Net realized gains
Management fee income
Total revenues
Operating expenses
Interest expense
Total expenses
47 $
$
15,500
830
16,044
32,421
290
5,525
—
14,736
20,551
14,185
5,410
11,395
4,545
19,595
15,940
Income before equity in undistributed earnings of subsidiaries and income tax
benefit
12,826
4,611
Income tax benefit
Income before equity in undistributed earnings of subsidiaries
Equity in undistributed share of (loss) earnings in subsidiaries
Net (loss) income
Comprehensive income
(732)
(306)
13,558
(14,183)
4,917
5,430
$
(625) $ 10,347
$
6,723 $ 5,827
See accompanying report of independent registered public accounting firm.
F-60
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, 2019 and 2018
(In thousands)
Cash flows from operating activities:
Net (loss) income
2019
2018
$
(625) $ 10,347
Adjustments to reconcile net (loss) income to cash provided by (used in)
operating activities:
Depreciation and amortization expense
Deferred income tax (benefit) expense
Net realized gains
Undistributed share of loss (earnings) of subsidiaries
Change in current federal income tax payable (recoverable)
Change in all other liabilities
Change in all other assets
Net cash provided by (used in) operating activities
Cash flows from investing activities:
Purchases of property and equipment
Purchase of investment securities
Maturities, sales and redemptions of investment securities
Capital contribution to subsidiaries
Net cash used in investing activities
Cash flows from financing activities:
Proceeds from exercise of employee stock options
Payment of revolving credit facility
Payment of debt issuance costs
Proceeds from senior unsecured note offering
Purchase of treasury shares
Net cash used provided by (used in) financing activities
Increase (decrease) in cash and cash equivalents
Cash and cash equivalents at beginning of year
Cash and cash equivalents at end of year
Supplemental cash flow information:
Interest paid
Income taxes (recovered) paid
381
(611)
(830)
14,183
229
994
(2,339)
11,382
377
51
—
(5,430)
(2,219)
(3,075)
(466)
(415)
(1,211)
(1,259)
1,405
(20,000)
(21,065)
(55)
—
—
—
(55)
1,520
(30,000)
(979)
50,000
(1,380)
19,161
242
—
—
—
(1,807)
(1,565)
(2,035)
9,478
10,159
12,194
19,637 $ 10,159
$
$
4,289 $ 4,842
$
(448) $ 1,996
See accompanying report of independent registered public accounting firm.
F-61
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
2019
Specialty Commercial Segment
Standard Commercial Segment
Personal Segment
Corporate
Consolidated
2018
Specialty Commercial Segment
Standard Commercial Segment
Personal Segment
Corporate
Consolidated
Acquisition Adjustment Unearned Benefits Premium Investment Settlement Acquisition Operating Premiums
Expenses Written
Expenses Premiums Payable Revenue
Expenses
Income
Costs
Costs
$
$
$
$
14,108 $
4,530
4,356
—
22,994 $
520,117 $ 321,047 $
44,032
72,208
23,847
28,030
—
—
620,355 $ 388,926 $
— $ 292,588 $
— 63,970
— 80,319
—
—
— $ 436,877 $
15,856 $ 248,781 $
50,036
3,879
63,348
1,139
—
(270)
20,604 $ 362,165 $
(38,274) $ 68,545 $ 350,047
62,892
83,613
—
(12,686) $ 126,063 $ 496,552
18,275
25,058
14,185
9,730
15,858
—
5,637 $
5,212
3,442
—
14,291 $
429,741 $ 234,563 $
40,813
74,677
22,685
22,829
—
—
527,247 $ 298,061 $
— $ 258,186 $
— 72,321
— 32,580
—
—
— $ 363,087 $
19,302 $ 194,268 $
39,396
3,736
22,364
1,185
(5,991)
—
18,232 $ 256,028 $
21,133 $ 52,071 $ 251,731
69,222
13,415
42,845
2,888
—
—
37,436 $ 101,712 $ 363,798
22,825
15,420
11,396
See accompanying report of independent registered public accounting firm.
F-62
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
$
— $
— $
— $
—
$
— $
— $
— $
—
—
—
—
—
748,203
—
748,203 $
(316,089)
—
(316,089) $
4,763
—
436,877
—
4,763 $ 436,877
$
1.00 %
1.00 %
$
— $
— $
— $
—
$
— $
— $
— $
—
—
—
—
—
639,437
—
639,437 $
(278,509)
—
(278,509) $
2,159
—
363,087
—
2,159 $ 363,087
$
0.59 %
0.59 %
Year Ended
December 31, 2019
Life insurance in
force
Premiums
Life insurance
Accident and health
insurance
Property and
liability insurance
Title Insurance
Total premiums
Year Ended
December 31, 2018
Life insurance in
force
Premiums
Life insurance
Accident and health
insurance
Property and
liability insurance
Title Insurance
Total premiums
See accompanying report of independent registered public accounting firm.
F-63
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
Claims and Claim
Deferred Claims and Discount if
Claim
Policy
any,
Adjustment Expenses Amortization of Paid Claims
Incurred Related to Deferred Policy and Claims
Net
Net
Affiliation With Acquisition Adjustment Deducted In Unearned Earned Investment (1) Current (2) Prior Acquisitions
Adjustment Premiums
Registrant
Costs
Expenses Column C Premiums Premiums Income
Year
Years
Costs
Expenses Written
(a) Consolidated
property-
casualty Entities
2019
2018
$
22,994 $
620,355 $
— $ 388,926 $ 436,877 $
20,604 $ 301,265 $ 60,900 $
(12,686) $ 319,945 $ 496,522
$
14,291 $
527,247 $
— $ 298,061 $ 363,087 $
18,232 $ 250,075 $
5,953 $
37,436 $ 322,985 $ 363,798
See accompanying report of independent registered public accounting firm.
F-64
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NASDAQ: HALL
Headquartered in Dallas, Texas, Hallmark Financial Services, Inc. is a publicly traded
holding company with wholly-owned subsidiaries engaged in property and casualty
insurance. Hallmark Financial operates as a diversified underwriter of niche property
and casualty insurance products, executed by wholly-owned business units, each with
a separate specialty product focus.
Corporate Information
BOARD OF DIRECTORS
Mark E. Schwarz
Executive Chairman
Scott T. Berlin
President
Mason Structural Steel, LLC
James H. Graves
Partner
Ervin, Graves & Jones, LP
Mark E. Pape
Chairman
H2Options, Inc. & U.S. Rain Group, Inc.
OFFICERS
Mark E. Schwarz
Executive Chairman
Naveen Anand
President & Chief Executive Officer
Christopher Kenney
Senior Vice President &
Chief Accounting Officer
INDEPENDENT REGISTERED
PUBLIC ACCOUNTANTS
Baker Tilly Virchow Krause, LLP
Milwaukee, Wisconsin
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 December 22, 2020,
at Two Lincoln Center, 5420 Lyndon B. Johnson
Freeway, Suite 1110, Dallas, Texas 75240.
CORPORATE HEADQUARTERS
Hallmark Financial Services, Inc.
Two Lincoln Center
5420 Lyndon B. Johnson Freeway, Suite 1110
Dallas, Texas 75240
(817) 348-1600
www.hallmarkgrp.com
Annual Report 2019
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Two Lincoln Center, 5420 Lyndon B Johnson Freeway, Suite 1100 | Dallas, Texas 75240 | P (817) 348-1600 | www.hallmarkgrp.com