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EX-31.1 - EXHIBIT 31.1 - NATIONAL SECURITY GROUP INCexhibit3113-31x2015.htm
EX-32.1 - EXHIBIT 32.1 - NATIONAL SECURITY GROUP INCexhibit3213-31x2015.htm
EX-31.2 - EXHIBIT 31.2 - NATIONAL SECURITY GROUP INCexhibit3123-31x2015.htm
EXCEL - IDEA: XBRL DOCUMENT - NATIONAL SECURITY GROUP INCFinancial_Report.xls

UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549

 FORM 10-Q

  (Mark One)
þ
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For Quarterly Period Ended March 31, 2015

or      
o
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 0-18649

The National Security Group, Inc.
(Exact name of registrant as specified in its charter)

Delaware
 
63-1020300
(State or Other Jurisdiction of
Incorporation or Organization)
 
(IRS Employer
Identification No.)
 
 
 
661 East Davis Street
Elba, Alabama
 
36323
(Address of principal executive offices)
 
(Zip-Code)
 
Registrant’s Telephone Number including Area Code (334) 897-2273

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  þ    No  o

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).    þ Yes    o No

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer (as defined in rule 12b-2 of the Act).  (Check One) :    Large accelerated filer o Accelerated filer  o Non-accelerated filer  o Smaller reporting company  þ

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).  Yes o No  þ

As of May 14, 2015, there were 2,507,452 shares, $1.00 par value, of the registrant’s common stock outstanding.

1


THE NATIONAL SECURITY GROUP, INC.

TABLE OF CONTENTS

PART I. FINANCIAL INFORMATION
 
 
 
 
Page No.
 
Item 1.  Financial Statements
 
 
 
 
 
 
 
Condensed Consolidated Balance Sheets
 
 
Condensed Consolidated Statements of Income
 
 
Condensed Consolidated Statements of Comprehensive Income
 
 
Condensed Consolidated Statements of Changes in Shareholders’ Equity
 
 
Condensed Consolidated Statements of Cash Flows
 
 
Notes to Condensed Consolidated Financial Statements
 
 
Review Report of Independent Registered Public Accounting Firm
 
 
 
 
 
Item 2.  Management’s Discussion and Analysis of Financial Condition and Results of Operations
 
 
 
 
 
Item 3.  Quantitative and Qualitative Disclosures about Market Risk
 
 
 
 
 
Item 4.  Controls and Procedures
 
 
 
 
 
 
 
 
PART II. OTHER INFORMATION
 
 
 
 
 
 
Item 1.    Legal Proceedings
 
Item 1A. Risk Factors
 
Item 2.    Unregistered Sales of Equity Securities and Use of Proceeds
 
Item 3.    Defaults Upon Senior Securities
 
Item 4. Mine Safety Disclosures
 
Item 5.    Other Information
 
Item 6.    Exhibits
 
 
 
 
 
 
 
SIGNATURE
 
 
 
 
 
 
 
 
 





2


Cautionary Statement Regarding Forward-Looking Statements

Any statement contained in this report which is not a historical fact, or which might otherwise be considered an opinion or projection concerning the Company or its business, whether expressed or implied, is meant as and should be considered a forward-looking statement as that term is defined in the Private Securities Litigation Reform Act of 1995. The following report contains forward-looking statements that are not strictly historical and that involve risks and uncertainties. Such statements include any statements containing the words “expect,” “plan,” “estimate,” “anticipate” or other words of a similar nature. Management cautions investors about forward-looking statements. Forward-looking statements involve certain evaluation criteria, such as risks, uncertainties, estimates, and/or assumptions made by individuals informed of the Company and industries in which we operate. Any variation in the preceding evaluation criteria could cause actual results to differ materially from those expressed or implied by such forward-looking statements. These risks and uncertainties include, without limitation, the following:

The insurance industry is highly competitive and the Company encounters significant competition in all lines of business from other insurance companies. Many of the competing companies have more abundant financial resources than the Company.

Insurance is a highly regulated industry. It is possible that legislation may be enacted which would have an adverse effect on the Company's business.

The Company is subject to regulation by state governments for each of the states in which it conducts business. The Company cannot predict the subject of any future regulatory initiative(s) or its (their) impact on the Company's business.

The Company is rated by various insurance rating agencies. If a rating is downgraded from its current level by one of these agencies, sales of the Company's products and stock price could be adversely impacted.

The Company's financial results are adversely affected by increases in policy claims received by the Company. While a manageable risk, this fluctuation is often unpredictable.
  
The Company's investments are subject to a variety of risks. Investments are subject to defaults and changes in market value. Market value can be affected by changes in interest rates, market performance and the economy.

The Company mitigates risk associated with life policies through implementing effective underwriting and reinsurance strategies. These factors mitigate, not eliminate, risk related to mortality and morbidity exposure. The Company has established reserves for claims and future policy benefits based on amounts determined by independent actuaries. There is no assurance that these estimated reserves will prove to be sufficient or that the Company will not incur claims exceeding reserves, which could result in operating losses and loss of capital.

The Company mitigates risk associated with property and casualty policies through implementing effective underwriting and reinsurance strategies. The Company obtains reinsurance which increases underwriting capacity and limits the risk associated with policy claims. The Company is subject to credit risk with regard to reinsurers as reinsurance does not alleviate the Company's liability to its insured's for the ceded risks. The Company utilizes a third-party to develop a reinsurance treaty with reinsurers who are reliable and financially stable. However, there is no guarantee that booked reinsurance recoverable will actually be recovered. A reinsurer's insolvency or inability to make payments due could have a material adverse impact on the financial condition of the Company.

The Company's ability to continue to pay dividends to shareholders is contingent upon profitability and capital adequacy of the insurance subsidiaries. The insurance subsidiaries operate under regulatory restrictions that could limit the ability to fund future dividend payments of the Company. An adverse event or series of events could materially impact the ability of the insurance subsidiaries to fund future dividends, and consequently, the Board of Directors would have to suspend the declaration of dividends to shareholders.

The Company is subject to the risk of adverse settlements or judgments resulting from litigation of contested claims. It is difficult to predict or quantify the expected results of litigation because the outcome depends on decisions of the court and jury that are based on facts and legal arguments presented at the trial.

3


PART I. Financial Information

Item 1. Financial Statements

THE NATIONAL SECURITY GROUP, INC.

CONDENSED CONSOLIDATED BALANCE SHEETS (In thousands)
 
 
March 31, 2015
 
December 31, 2014
 
 
(UNAUDITED)
 
 
ASSETS
 
 
 
 
Investments
 
 
 
 
Fixed maturities held-to-maturity, at amortized cost (estimated fair value: 2015 -
      $2,905; 2014 - $3,182)
 
$
2,767

 
$
3,108

Fixed maturities available-for-sale, at estimated fair value (cost: 2015 - $86,454;
2014 - $84,024)
 
89,901

 
86,886

Equity securities available-for-sale, at estimated fair value (cost: 2015 - $2,420;
2014 - $2,420)
 
4,964

 
4,995

Trading securities
 
19

 
19

Mortgage loans on real estate, at cost
 
208

 
210

Investment real estate, at book value
 
3,735

 
3,735

Policy loans
 
1,556

 
1,530

Company owned life insurance
 
5,161

 
5,513

Other invested assets
 
3,484

 
3,553

Total Investments
 
111,795

 
109,549

Cash
 
7,108

 
6,426

Accrued investment income
 
842

 
797

Policy receivables and agents' balances, net
 
11,285

 
10,948

Reinsurance recoverable
 
1,510

 
939

Deferred policy acquisition costs
 
8,586

 
8,592

Property and equipment, net
 
2,035

 
2,013

Deferred income tax asset, net
 
3,055

 
3,189

Other assets
 
800

 
2,412

Total Assets
 
$
147,016

 
$
144,865

LIABILITIES AND SHAREHOLDERS' EQUITY
 
 

 
 

Property and casualty benefit and loss reserves
 
$
8,876

 
$
8,321

Accident and health benefit and loss reserves
 
2,991

 
3,017

Life and annuity benefit and loss reserves
 
31,482

 
31,418

Unearned premiums
 
29,564

 
28,853

Policy and contract claims
 
1,113

 
996

Other policyholder funds
 
1,525

 
1,510

Short-term notes payable and current portion of long-term debt
 
1,557

 
857

Long-term debt
 
17,515

 
18,715

Accrued income taxes
 
492

 
487

Other liabilities
 
7,688

 
7,934

Total Liabilities
 
102,803

 
102,108

Contingencies
 


 


Shareholders' equity
 
 

 
 

Common stock
 
2,508

 
2,508

Additional paid-in capital
 
5,267

 
5,267

Accumulated other comprehensive income
 
3,020

 
2,772

Retained earnings
 
33,418

 
32,210

Total Shareholders' Equity
 
44,213

 
42,757

Total Liabilities and Shareholders' Equity
 
$
147,016

 
$
144,865


The Notes to Condensed Consolidated Financial Statements are an integral part of these statements.

4


THE NATIONAL SECURITY GROUP, INC.

CONDENSED CONSOLIDATED STATEMENTS OF INCOME (UNAUDITED)
(In thousands, except per share amounts)

 
Three Months Ended
March 31,
 
2015
 
2014
REVENUES
 
 
 
Net premiums earned
$
14,706

 
$
13,824

Net investment income
974

 
948

Net realized investment gains
142

 
88

Other income
158

 
154

Total Revenues
15,980

 
15,014

BENEFITS, LOSSES AND EXPENSES
 

 
 

Policyholder benefits and settlement expenses
8,262

 
7,864

Amortization of deferred policy acquisition costs
899

 
898

Commissions
2,055

 
2,027

General and administrative expenses
2,006

 
2,026

Taxes, licenses and fees
655

 
530

Interest expense
317

 
386

Total Benefits, Losses and Expenses
14,194

 
13,731

 
 
 
 
Income Before Income Taxes
1,786

 
1,283

 
 
 
 
INCOME TAX EXPENSE
 

 
 

Current
471

 
88

Deferred
7

 
196

 
478

 
284

 
 
 
 
Net Income
$
1,308

 
$
999

 
 
 
 
INCOME PER COMMON SHARE BASIC AND DILUTED
$
0.52

 
$
0.40

 
 
 
 
DIVIDENDS DECLARED PER SHARE
$
0.04

 
$
0.03



The Notes to Condensed Financial Statements are an integral part of these statements.


5


THE NATIONAL SECURITY GROUP, INC.

CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (UNAUDITED)
(In thousands)

 
Three Months Ended
March 31,
 
2015
 
2014
 
 
 
 
Net income
$
1,308

 
$
999

 

 
 
Other comprehensive income (loss), net of tax
 
 
 
Changes in:
 
 
 
Unrealized gains on securities, net of reclassification adjustment of $94 and $59 for 2015 and 2014, respectively
365

 
1,073

Unrealized loss on interest rate swap
(117
)
 
(76
)
 
 
 
 
Other comprehensive income, net of tax
248

 
997

 
 
 
 
Comprehensive income
$
1,556

 
$
1,996


The Notes to Condensed Consolidated Financial Statements are an integral part of these statements.



6


THE NATIONAL SECURITY GROUP, INC.

CONDENSED CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS’ EQUITY (UNAUDITED)
(In thousands)

 
Total
 
Retained
Earnings
 
Accumulated
Other
Comprehensive
Income
 
Common
Stock
 
Additional
Paid-in
Capital
Balance at December 31, 2014 (AUDITED)
$
42,757

 
$
32,210

 
$
2,772

 
$
2,508

 
$
5,267

 
 
 
 
 
 
 
 
 
 
Net income for the three months ended March 31, 2015
1,308

 
1,308

 
 

 
 

 
 

 
 
 
 
 
 
 
 
 
 
Other comprehensive income (net of tax)
248

 
 

 
248

 
 

 
 

 
 
 
 
 
 
 
 
 
 
Cash dividends
(100
)
 
(100
)
 
 

 
 

 
 

 
 
 
 
 
 
 
 
 
 
Balance at March 31, 2015
$
44,213

 
$
33,418

 
$
3,020

 
$
2,508

 
$
5,267


The Notes to Condensed Consolidated Financial Statements are an integral part of these statements.






7


THE NATIONAL SECURITY GROUP, INC.

CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED) (In thousands)
 
Three months ended
March 31,
 
2015
 
2014
Cash Flows from Operating Activities
 
 
 
Net income
$
1,308

 
$
999

Adjustments to reconcile net income to net cash provided by operating activities:
 
 
 

Depreciation expense and amortization/accretion, net
79

 
134

Increase in cash surrender value of company owned life insurance
(44
)
 
(30
)
Net realized gains on investments
(142
)
 
(88
)
Deferred income taxes
7

 
196

Amortization of deferred policy acquisition costs
899

 
898

Changes in assets and liabilities:
 
 
 
Change in accrued investment income
(45
)
 
(19
)
Change in reinsurance recoverable
(571
)
 
223

Policy acquisition costs deferred
(893
)
 
(856
)
Change in accrued income taxes
5

 
38

Change in net policy liabilities and claims
1,075

 
1,066

Change in other assets/liabilities, net
1,247

 
(71
)
Other, net
8

 
8

Net cash provided by operating activities
2,933

 
2,498

Cash Flows from Investing Activities
 
 
 

Purchase of:
 
 
 
Available-for-sale securities
(7,582
)
 
(2,707
)
Property and equipment
(69
)
 
(4
)
Proceeds from sale or maturities of:
 
 
 
Held-to-maturity securities
346

 
39

Available-for-sale securities
5,256

 
2,370

Property and equipment

 
3

Other invested assets, net
383

 
34

Net cash used in investing activities
(1,666
)
 
(265
)
Cash Flows from Financing Activities
 

 
 

Change in other policyholder funds
15

 
19

Proceeds from long-term debt

 
275

Repayments of long-term debt
(500
)
 

Change in short-term notes payable

 
(700
)
Dividends paid
(100
)
 
(75
)
Net cash used in financing activities
(585
)
 
(481
)
Net change in cash and cash equivalents
682

 
1,752

Cash and cash equivalents, beginning of year
6,426

 
4,987

Cash and cash equivalents, end of year
$
7,108

 
$
6,739


The Notes to Condensed Consolidated Financial Statements are an integral part of these statements.

8


THE NATIONAL SECURITY GROUP, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED EXCEPT FOR DECEMBER 31, 2014 AMOUNTS)



NOTE 1 – SIGNIFICANT ACCOUNTING POLICIES

Principles of Consolidation and Basis of Presentation
The accompanying condensed consolidated financial statements include the accounts of The National Security Group, Inc. (the Company) and its wholly-owned subsidiaries:  National Security Insurance Company (NSIC), National Security Fire and Casualty Company (NSFC) and NATSCO, Inc. (NATSCO).  NSFC includes a wholly-owned subsidiary, Omega One Insurance Company (Omega).  The accompanying condensed consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America (GAAP).  In the opinion of management, all adjustments, consisting of normal and recurring items, necessary for the fair presentation of the condensed consolidated financial statements have been included. All significant intercompany transactions and accounts have been eliminated. The financial information presented herein should be read in conjunction with the Company’s Annual
Report on Form 10-K for the year ended December 31, 2014, which includes information and disclosures not presented
herein.

Use of Estimates
The preparation of financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the condensed consolidated financial statements and the reported amounts of revenues and expenses during the reporting period. Among the more significant estimates included in these condensed consolidated financial statements are reserves for future life insurance policy benefits, liabilities for losses and loss adjustment expenses, reinsurance recoverable associated with loss and loss adjustment expense liabilities, deferred policy acquisition costs, deferred income tax assets and liabilities, assessments of other-than-temporary impairments on investments and accruals for contingencies.  Actual results could differ from these estimates.

Earnings Per Share
Earnings per share of common stock is based on the weighted average number of shares outstanding during each year. The adjusted weighted average shares outstanding were 2,507,452 in 2015 and 2,494,480 in 2014.

Reclassifications
Certain 2014 amounts have been reclassified from the prior year consolidated financial statements to conform to the 2015 presentation.

Concentration of Credit Risk
The Company maintains cash balances which are generally held in non-interest bearing demand deposit accounts subject to FDIC insured limits of $250,000 per entity. At March 31, 2015, the net amount exceeding FDIC insured limits was $3,924,000 at one financial institution. The Company has not experienced any losses in such accounts. Management of the Company reviews financial information of financial institutions on a quarterly basis and believes the Company is not exposed to any significant credit risk on cash and cash equivalents.

Policy receivables are reported at unpaid balances. Policy receivables are generally offset by associated unearned premium liabilities and are not subject to significant credit risk. Receivables from agents, less provision for credit losses, are composed of balances due from independent agents. At March 31, 2015, the single largest balance due from one agent totaled $937,000.

Reinsurance contracts do not relieve the Company of its obligations to policyholders. A failure of a reinsurer to meet their obligation could result in losses to the insurance subsidiaries. Allowances for losses are established if amounts are believed to be uncollectible. At March 31, 2015 and December 31, 2014, no amounts were deemed uncollectible. The Company, at least annually, evaluates the financial condition of all reinsurers and evaluates any potential concentrations of credit risk. At March 31, 2015, management does not believe the Company is exposed to any significant credit risk related to its reinsurance program.


9


THE NATIONAL SECURITY GROUP, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED EXCEPT FOR DECEMBER 31, 2014 AMOUNTS)


Accounting Changes Not Yet Adopted

Revenue from Contracts with Customers
In May 2014, the Financial Accounting Standards Board (FASB) issued guidance on a comprehensive new revenue recognition standard. This standard will not impact accounting for insurance contracts, leases, financial instruments and guarantees. For those contracts that are impacted by the new guidance, the guidance will require an entity to recognize revenue upon the transfer of promised goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled to, in exchange for those goods or services. The guidance requires additional disclosure about the nature, amount, timing and uncertainty of revenue and cash flows arising from customer contracts, including significant judgments and changes in judgments and assets recognized from costs incurred to obtain or fulfill a contract. This guidance is effective retrospectively for fiscal years beginning after December 15, 2016 and interim periods within those years. Early adoption of this standard is not permitted. Although insurance contracts are specifically scoped out of this new guidance, the Company has minor services that may be subject to the new revenue recognition guidance and are still in the process of evaluating the impact, if any, the guidance may have on its consolidated financial statements.

Presentation of Financial Statements - Going Concern
In August 2014, the FASB issued guidance on determining when and how to disclose going concern uncertainties in the financial statements, and requires management to perform interim and annual assessments of an entity’s ability to continue as a going concern within one year of the date the financial statements are issued. The updated guidance is effective for annual periods ending after December 15, 2016 and interim periods thereafter. Early adoption is permitted. The Company does not expect the adoption to have a material impact on its financial position or results of operations.

Simplifying Income Statement Presentation by Eliminating the Concept of Extraordinary Items
In January 2015, the FASB issued guidance that eliminates from GAAP the concept of extraordinary items. The guidance is effective for fiscal periods ending after December 15, 2015 and interim periods thereafter. Early adoption is permitted. The Company does not expect the adoption to have a material impact on its financial position or results of operations.

Amendments to the Consolidation Analysis
In February 2015, the FASB issued additional guidance regarding the consolidation of certain legal entities. The guidance modifies the evaluation of whether or not limited partnerships and similar legal entities are variable interest entities (VIEs) and the consolidation analysis of entities involved with VIEs, particularly those that have fee arrangements and related party relationships. This guidance is effective for fiscal years beginning after December 15, 2015. The Company does not expect the adoption to have a material impact on its financial position or results of operations.

Recently Adopted Accounting Standards

Repurchase-to-Maturity Transactions, Repurchase Financings, and Disclosures
In June 2014, the FASB issued guidance requiring secured borrowing accounting treatment for repurchase-to-maturity transactions and provides guidance on accounting for repurchase financing arrangements. This ASU is effective for interim and annual reporting periods beginning after December 15, 2014. The Company adopted this standard on January 1, 2015. The Company is the counter party to repurchase agreements and as such, the adoption did not have a material impact on its financial position or results of operations.

Reporting Discontinued Operations and Disclosure of Disposals of components of an Entity
In April 2014, the FASB issued guidance which modifies the definition of discontinued operations by limiting discontinued operations reporting to disposals of components of an entity that represent strategic shifts that have (or will have) a major effect on an entity’s operations and financial results. Also, this update requires additional financial statement disclosures about discontinued operations, as well as disposals of an individually significant component of an entity that do not qualify for discontinued operations presentation. This ASC update is effective for all disposals (or classifications as held for sale) of components of an entity that occur within annual and interim periods beginning on or after December 15, 2014 and for all businesses that, on acquisition, are classified as held for sale that also occur within interim and annual periods beginning on or after December 15, 2014. The Company adopted this standard on

10


THE NATIONAL SECURITY GROUP, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED EXCEPT FOR DECEMBER 31, 2014 AMOUNTS)


January 1, 2015. The Company has no discontinued operations, and the adoption of this standard did not have a material impact on its financial position or results of operations.

NOTE 2 – VARIABLE INTEREST ENTITIES

The Company holds a passive interest in a limited partnership that is considered to be a Variable Interest Entity (VIE) under the provisions of ASC 810 Consolidation. The Company is not the primary beneficiary of the entity and is not required to consolidate under ASC 810. The entity is a private placement investment fund formed for the purpose of investing in private equity investments. The Company owns less than 1% of the limited partnership. The carrying value of the investment totals $294,000 and is included as a component of Other Invested Assets in the accompanying condensed consolidated balance sheets.

In December 2005, the Company formed National Security Capital Trust I, a statutory trust created under the Delaware Statutory Trust Act, for the sole purpose of issuing, in private placement transactions, $9,000,000 of trust preferred securities (TPS) and using the proceeds thereof, together with the equity proceeds received from the Company in the initial formation of the Trust, to purchase $9,279,000 of variable rate subordinated debentures issued by the Company. The Company owns all voting securities of the Trust and the subordinated debentures are the sole assets of the Trust. The Trust will meet the obligations of the TPS with the interest and principal paid on the subordinated debentures. The Company received net proceeds from the TPS transactions, after commissions and other costs of issuance, of $9,005,000. The Company also holds all the voting securities issued by the Trust and such trusts are considered to be VIE's. The Trust is not consolidated because the Company is not the primary beneficiary of the trust. The Subordinated Debentures, disclosed in Note 8, are reported in the accompanying condensed consolidated balance sheets as a component of long-term debt. The Company's equity investments in the Trust total $279,000 and are included in Other Assets in the accompanying condensed consolidated balance sheets.

In June 2007, the Company formed National Security Capital Trust II for the sole purpose of issuing, in private placement transactions, $3,000,000 of trust preferred securities (TPS) and using the proceeds thereof, together with the equity proceeds received from the Company in the initial formation of the Trust, to purchase $3,093,000 unsecured junior subordinated deferrable interest debentures. The Company owns all voting securities of the Trust and the subordinated debentures are the sole assets of the Trust. The Trust will meet the obligations of the TPS with the interest and principal paid on the subordinated debentures. The Company received net proceeds from the TPS transactions, after commissions and other costs of issuance, of $2,995,000. The Company also holds all the voting securities issued by the Trust and such trusts are considered to be VIE's. The Trust is not consolidated because the Company is not the primary beneficiary of the Trust. The Subordinated Debentures, disclosed in Note 7, are reported in the accompanying condensed consolidated balance sheets as a component of long-term debt. The Company's equity investments in the Trust total $93,000 and are included in Other Assets in the accompanying condensed consolidated balance sheets.

NOTE 3 – INVESTMENTS

The amortized cost and aggregate fair values of investments in available-for-sale securities as of March 31, 2015 are as follows (dollars in thousands):
Available-for-sale securities:
 
Amortized
Cost
 
Gross
Unrealized
Gains
 
Gross
Unrealized
Losses
 
Fair
Value
Corporate debt securities
 
$
36,570

 
$
1,904

 
$
311

 
$
38,163

Mortgage backed securities
 
11,998

 
297

 
132

 
12,163

Private label mortgage backed securities
 
5,111

 
42

 
73

 
5,080

Obligations of states and political subdivisions
 
14,885

 
1,043

 
4

 
15,924

U.S. Treasury securities and obligations of U.S. Government corporations and agencies
 
17,890

 
727

 
46

 
18,571

Total fixed maturities
 
86,454

 
4,013

 
566

 
89,901

Equity securities
 
2,420

 
2,690

 
146

 
4,964

Total
 
$
88,874

 
$
6,703

 
$
712

 
$
94,865



11


THE NATIONAL SECURITY GROUP, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED EXCEPT FOR DECEMBER 31, 2014 AMOUNTS)


The amortized cost and aggregate fair values of investments in held-to-maturity securities as of March 31, 2015 are as follows (dollars in thousands):
Held-to-maturity securities:
 
Amortized
Cost
 
Gross
Unrealized
Gains
 
Gross
Unrealized
Losses
 
Fair
Value
Mortgage backed securities
 
$
2,708

 
$
134

 
$

 
$
2,842

U.S. Treasury securities and obligations of U.S. Government corporations and agencies
 
59

 
4

 

 
63

Total
 
$
2,767

 
$
138

 
$

 
$
2,905


The amortized cost and aggregate fair values of investments in available-for-sale securities as of December 31, 2014 are as follows (dollars in thousands):
Available-for-sale securities:
 
Amortized
Cost
 
Gross
Unrealized
Gains
 
Gross
Unrealized
Losses
 
Fair
Value
Corporate debt securities
 
$
37,299

 
$
1,773

 
$
405

 
$
38,667

Mortgage backed securities
 
12,691

 
214

 
153

 
12,752

Private label mortgage backed securities
 
1,261

 
38

 
3

 
1,296

Obligations of states and political subdivisions
 
14,919

 
993

 
13

 
15,899

U.S. Treasury securities and obligations of U.S. Government corporations and agencies
 
17,854

 
525

 
107

 
18,272

Total fixed maturities
 
84,024

 
3,543

 
681

 
86,886

Equity securities
 
2,420

 
2,745

 
170

 
4,995

Total
 
$
86,444

 
$
6,288

 
$
851

 
$
91,881


The amortized cost and aggregate fair values of investments in held-to-maturity securities as of December 31, 2014 are as follows (dollars in thousands):

Held-to-maturity securities:
 
Amortized
Cost
 
Gross
Unrealized
Gains
 
Gross
Unrealized
Losses
 
Fair
Value
Mortgage backed securities
 
$
2,818

 
$
69

 
$

 
$
2,887

U.S. Treasury securities and obligations of U.S. Government corporations and agencies
 
290

 
5

 

 
295

Total
 
$
3,108

 
$
74

 
$

 
$
3,182


The amortized cost and aggregate fair value of debt securities at March 31, 2015, by contractual maturity, are presented in the following table (dollars in thousands).  Expected maturities will differ from contractual maturities because borrowers may have the right to call or prepay obligations with or without call or prepayment penalties.
(Dollars in Thousands)
 
Amortized
Cost
 
Fair
Value
Available-for-sale securities:
 
 
 
 
Due in one year or less
 
$
1,209

 
$
1,220

Due after one year through five years
 
17,042

 
18,112

Due after five years through ten years
 
29,435

 
30,121

Due after ten years
 
38,768

 
40,448

Total
 
$
86,454

 
$
89,901

 
 
 
 
 
Held-to-maturity securities:
 
 

 
 

Due in one year or less
 
$

 
$

Due after one year through five years
 
134

 
141

Due after five years through ten years
 
129

 
141

Due after ten years
 
2,504

 
2,623

Total
 
$
2,767

 
$
2,905


12


THE NATIONAL SECURITY GROUP, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED EXCEPT FOR DECEMBER 31, 2014 AMOUNTS)



A summary of securities available-for-sale with unrealized losses as of March 31, 2015, along with the related fair value, aggregated by the length of time that investments have been in a continuous unrealized loss position, is as follows (dollars in thousands):
 
 
Less than 12 months
 
12 months or longer
 
Total
March 31, 2015
 
Fair
Value
 
Gross
Unrealized
Losses
 
Fair
Value
 
Gross
Unrealized
Losses
 
Fair
Value
 
Gross
Unrealized
Losses
 
Total
Securities in a Loss Position
Fixed maturities
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Corporate debt securities
 
$
4,612

 
$
304

 
$
865

 
$
7

 
$
5,477

 
$
311

 
11

Mortgage backed securities
 
153

 
2

 
1,225

 
130

 
1,378

 
132

 
6

Private label mortgage backed securities
 
3,924

 
70

 
91

 
3

 
4,015

 
73

 
7

Obligations of state and political subdivisions
 

 

 
338

 
4

 
338

 
4

 
1

U.S. Treasury securities and obligations of U.S. Government corporations and agencies
 

 

 
2,492

 
46

 
2,492

 
46

 
4

Equity securities
 

 

 
1,140

 
146

 
1,140

 
146

 
1

 
 
$
8,689

 
$
376

 
$
6,151

 
$
336

 
$
14,840

 
$
712

 
30


There were no securities held-to-maturity with unrealized losses as of March 31, 2015.

A summary of securities available-for-sale with unrealized losses as of December 31, 2014, along with the related fair value, aggregated by the length of time that investments have been in a continuous unrealized loss position, is as follows (dollars in thousands):
 
 
Less than 12 months
 
12 months or longer
 
Total
December 31, 2014
 
Fair
Value
 
Gross
Unrealized
Losses
 
Fair
Value
 
Gross
Unrealized
Losses
 
Fair
Value
 
Gross
Unrealized
Losses
 
Total
Securities in a Loss Position
Fixed maturities
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Corporate debt securities
 
$
6,306

 
$
364

 
$
1,843

 
$
41

 
$
8,149

 
$
405

 
18
Mortgage backed securities
 
1,386

 
4

 
1,855

 
149

 
3,241

 
153

 
12
Private label mortgage backed securities
 

 

 
97

 
3

 
97

 
3

 
1
Obligations of state and political subdivisions
 

 

 
651

 
13

 
651

 
13

 
2
U.S. Treasury securities and obligations of U.S. Government corporations and agencies
 
1,475

 
6

 
3,499

 
101

 
4,974

 
107

 
10
Equity securities
 

 

 
1,116

 
170

 
1,116

 
170

 
1
 
 
$
9,167

 
$
374

 
$
9,061

 
$
477

 
$
18,228

 
$
851

 
44

There were no securities held-to-maturity with unrealized losses as of December 31, 2014.

The Company conducts periodic reviews to identify and evaluate securities in an unrealized loss position in order to identify other-than-temporary impairments. For securities in an unrealized loss position, the Company assesses

13


THE NATIONAL SECURITY GROUP, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED EXCEPT FOR DECEMBER 31, 2014 AMOUNTS)


whether the Company has the intent to sell the security or more-likely-than-not will be required to sell the security before the anticipated recovery.  If either of these conditions is met, the Company is required to recognize an other-than-temporary impairment with the entire unrealized loss reported in earnings.  For securities in an unrealized loss position that do not meet these conditions, the Company assesses whether the impairment of a security is other-than-temporary.  If the impairment is determined to be other-than-temporary, the Company is required to separate the other-than-temporary impairments into two components:  the amount representing the credit loss and the amount related to all other factors.  The credit loss is the portion of the amortized book value in excess of the net present value of the projected future cash flows discounted at the effective interest rate implicit in the debt security prior to impairment.  The credit loss component of other-than-temporary impairments is reported in earnings, whereas the amount relating to factors other than credit losses are recorded in other comprehensive income, net of taxes.

Management has evaluated each security in a significant unrealized loss position.  The Company has no material exposure to sub-prime mortgage loans and less than 3.69% of the fixed income investment portfolio is rated below investment grade.  In evaluating whether or not the equity loss positions were other-than-temporary impairments, Management evaluated financial information on each company and where available, reviewed analyst reports from at least two independent sources.  Based on a review of the available financial information, the prospect for future earnings of each company and consideration of the Company’s intent and ability to hold the securities until market values recovered, it was determined that the securities in an accumulated loss position in the portfolio were temporary impairments.

For the three months ended March 31, 2015 and year ended December 31, 2014, the Company realized no other-than-temporary impairments.

Major categories of investment income are summarized as follows (dollars in thousands):
 
 
Three months ended March 31,
 
 
2015

2014
Fixed maturities
 
$
894

 
$
859

Equity securities
 
30

 
29

Mortgage loans on real estate
 
4

 
4

Investment real estate
 
2

 
2

Policy loans
 
29

 
27

Company owned life insurance change in surrender value
 
44

 
30

Other
 
42

 
54

 
 
1,045

 
1,005

Less: Investment expenses
 
71

 
57

Net investment income
 
$
974

 
$
948

Major categories of investment gains and losses are summarized as follows (dollars in thousands):
 
 
Three months ended March 31,
 
 
2015
 
2014
Fixed maturities
 
$
142

 
$
90

Other, principally real estate
 

 
(2
)
Net realized investment gains
 
$
142

 
$
88



14


THE NATIONAL SECURITY GROUP, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED EXCEPT FOR DECEMBER 31, 2014 AMOUNTS)


An analysis of the net change in unrealized appreciation on available-for-sale securities follows (dollars in thousands):

 
March 31, 2015
 
December 31, 2014
Net change in unrealized appreciation on available-for-sale securities before deferred tax
$
553

 
$
3,123

Deferred income tax
(188
)
 
(1,062
)
Net change in unrealized appreciation on available-for-sale securities
$
365

 
$
2,061


NOTE 4 – FAIR VALUE OF FINANCIAL ASSETS AND FINANCIAL LIABILITIES

Our available-for-sale securities consists of fixed maturity and equity securities which are recorded at fair value in the accompanying condensed consolidated balance sheets.  The change in the fair value of these investments, unless deemed to be other-than-temporarily impaired, is recorded as a component of other comprehensive income.

We are permitted to elect to measure financial instruments and certain other items at fair value, with the change in fair value recorded in earnings.  We elected not to measure any eligible items using the fair value option.

Accounting standards define fair value as the price that would be received to sell an asset or would be paid to transfer a liability in an orderly transaction between market participants at the measurement date, and establishes a framework to make the measurement of fair value more consistent and comparable.  In determining fair value, we primarily use prices and other relevant information generated by market transactions involving identical or comparable assets.

The Company categorizes assets and liabilities carried at their fair value based upon a fair value hierarchy:

Level 1 – Quoted prices in active markets for identical assets or liabilities that the Company has the ability to access at the measurement date.

Level 1 assets and liabilities consist of money market fund deposits and certain of our marketable debt and equity instruments, including equity instruments offsetting deferred compensation, that are traded in an active market with sufficient volume and frequency of transactions.

Level 2 - Observable inputs other than Level 1 prices such as quoted prices for similar assets or liabilities; quoted prices in markets with insufficient volume or infrequent transactions (less active markets); or model-derived valuations in which all significant inputs are observable or can be derived principally from or corroborated by observable market data for substantially the full term of the assets or liabilities.

Level 2 assets include certain of our marketable debt and equity instruments with quoted market prices that are traded in less active markets or priced using a quoted market price for similar instruments. Level 2 assets also include marketable equity instruments with security-specific restrictions that would transfer to the buyer, marketable debt instruments priced using indicator prices which represent non-binding market consensus prices that can be corroborated by observable market quotes, as well as derivative contracts and debt instruments priced using inputs that are observable in the market or can be derived principally from or corroborated by observable market data.  Marketable debt instruments in this category generally include commercial paper, bank time deposits, repurchase agreements for fixed-income instruments, and a majority of floating-rate notes, corporate bonds, and municipal bonds.

Level 3 - Unobservable inputs to the valuation methodology that are significant to the measurement of fair value of assets or liabilities.

Level 3 assets and liabilities include marketable debt instruments, non-marketable equity investments, derivative contracts, and company issued debt whose values are determined using inputs that are both unobservable and significant to the values of the instruments being measured. Level 3 assets also include marketable debt instruments that are priced using indicator prices that we were unable to corroborate with observable market quotes.


15


THE NATIONAL SECURITY GROUP, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED EXCEPT FOR DECEMBER 31, 2014 AMOUNTS)


Marketable debt instruments in this category generally include asset-backed securities and certain floating-rate notes, corporate bonds, and municipal bonds.

Assets/Liabilities Measured at Fair Value on a Recurring Basis
 
Financial assets and liabilities measured at fair value on a recurring basis as of March 31, 2015 are summarized in the following table by the type of inputs applicable to the fair value measurements (in thousands):
 
 
 
Fair Value Measurements at Reporting Date Using
Description
 
Total
 
Level 1
 
Level 2
 
Level 3
Financial Assets
 
 
 
 
 
 
 
 
Fixed maturities available-for-sale
 
 
 
 
 
 
 
 
Corporate debt securities
 
$
38,163

 
$

 
$
38,163

 
$

Mortgage backed securities
 
12,163

 

 
12,163

 

Private label mortgage backed securities
 
5,080

 

 
5,080

 

Obligations of states and political subdivisions
 
15,924

 

 
15,924

 

U.S. Treasury securities and obligations of U.S.
   Government corporations and agencies
 
18,571

 
18,571

 

 

Trading securities
 
19

 
19

 

 

Equity securities available-for-sale
 
4,964

 
3,823

 

 
1,141

Total Financial Assets
 
$
94,884

 
$
22,413

 
$
71,330

 
$
1,141

Financial Liabilities
 

 
 

 
 

 
 

Interest rate swap
 
$
(1,415
)
 
$

 
$

 
$
(1,415
)
Total Financial Liabilities
 
$
(1,415
)
 
$

 
$

 
$
(1,415
)

The methods and assumptions the Company uses to estimate the fair value of assets and liabilities measured at fair value on a recurring basis are summarized below.

Fixed maturities available-for-sale — The fair values of the Company’s public fixed maturity securities are generally based on prices obtained from independent pricing services. Consistent with the fair value hierarchy described above, securities with validated quotes from pricing services are generally reflected within Level 2, as they are primarily based on observable pricing for similar assets and/or other market observable inputs.

Trading securities — Trading securities consist primarily of mutual funds whose fair values are determined consistent with similar instruments described above under “Fixed Maturities” and below under “Equity Securities.”

Equity securities — Equity securities consist principally of investments in common and preferred stock of publicly traded companies and privately traded securities. The fair values of our publicly traded equity securities are based on quoted market prices in active markets for identical assets and are classified within Level 1 in the fair value hierarchy.

Estimated fair values for our privately traded equity securities require a substantial level of judgment. Privately traded equity securities are classified within Level 3.

Interest rate swaps — Interest rate swaps are recorded at fair value either as assets, within other assets or as liabilities, within other liabilities. The fair values of our interest rate swaps are provided by a third-party broker and are classified within Level 3.

As of March 31, 2015, Level 3 fair value measurements of assets include $1,141,000 of equity securities in a local community bank whose value is based on an evaluation of the financial statements of the entity. The Company does not develop the unobservable inputs used in measuring fair value.


16


THE NATIONAL SECURITY GROUP, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED EXCEPT FOR DECEMBER 31, 2014 AMOUNTS)


As of March 31, 2015, Level 3 fair value measurements of liabilities include $1,415,000 net fair value of various interest rate swap agreements whose value is based on analysis provided by a third party broker who utilizes financial modeling tools and assumptions on interest and other factors. The Company does not develop the unobservable inputs used in measuring fair value. Additional information regarding the interest rate swap agreements is provided in Note 7.

The table below presents a reconciliation for all assets measured at fair value on a recurring basis using significant unobservable inputs (Level 3) for the three months ended March 31, 2015 (in thousands):
For the three months ended March 31, 2015
 
Equity Securities Available-for-Sale
 
Interest Rate Swap
Beginning balance
 
$
1,116

 
$
(1,238
)
Total gains or losses (realized and unrealized):
 
 

 
 

Included in earnings
 

 

Included in other comprehensive income
 
25

 
(177
)
Purchases:
 

 

Sales:
 

 

Issuances:
 

 

Settlements:
 

 

Transfers in/(out) of Level 3
 

 

Ending balance
 
$
1,141

 
$
(1,415
)
The amount of total gains or losses for the period included in earnings attributable to the change in unrealized gains or losses relating to assets and liabilities still held as of March 31, 2015:
 
$

 
$


For the three months ended March 31, 2015, there were no assets or liabilities measured at fair values on a nonrecurring basis.

Financial assets and liabilities measured at fair value on a recurring basis as of December 31, 2014 are summarized in the following table by the type of inputs applicable to the fair value measurements (in thousands):
 
 
Fair Value Measurements at Reporting Date Using
Description
 
Total
 
Level 1
 
Level 2
 
Level 3
Financial Assets
 
 
 
 
 
 
 
 
Fixed maturities available-for-sale
 
 
 
 
 
 
 
 
Corporate debt securities
 
$
38,667

 
$

 
$
38,667

 
$

Mortgage backed securities
 
12,752

 

 
12,752

 

Private label mortgage backed securities
 
1,296

 

 
1,296

 

Obligations of states and political subdivisions
 
15,899

 

 
15,899

 

U.S. Treasury securities and obligations of U.S.
   Government corporations and agencies
 
18,272

 
18,272

 

 

Trading securities
 
19

 
19

 

 

Equity securities available-for-sale
 
4,995

 
3,879

 

 
1,116

Total Financial Assets
 
$
91,900

 
$
22,170

 
$
68,614

 
$
1,116

Financial Liabilities
 
 

 
 

 
 

 
 

Interest rate swap
 
$
(1,238
)
 
$

 
$

 
$
(1,238
)
Total Financial Liabilities
 
$
(1,238
)
 
$

 
$

 
$
(1,238
)



17


THE NATIONAL SECURITY GROUP, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED EXCEPT FOR DECEMBER 31, 2014 AMOUNTS)


The table below presents a reconciliation for all assets measured at fair value on a recurring basis using significant unobservable inputs (Level 3) for the year ended December 31, 2014 (in thousands):
For the year ended December 31, 2014
 
Equity Securities Available-for-Sale
 
Interest Rate Swap
Beginning balance
 
$
875

 
$
(897
)
Total gains or losses (realized and unrealized):
 
 

 
 

Included in earnings
 

 

Included in other comprehensive income
 
241

 
(341
)
Purchases:
 

 

Sales:
 

 

Issuances:
 

 

Settlements:
 

 

Transfers in/(out) of Level 3
 

 

Ending balance
 
$
1,116

 
$
(1,238
)
The amount of total gains or losses for the period included in earnings attributable to the change in unrealized gains or losses relating to assets and liabilities still held as of December 31, 2014:
 
$

 
$


For the year ended December 31, 2014, there were no assets or liabilities measured at fair values on a nonrecurring basis.

The Company is exposed to certain risks in the normal course of its business operations.  The primary risk that is managed through the use of derivatives is interest rate risk on floating rate borrowings.  This risk is managed through the use of interest rate swap agreements which are designated as cash flow hedges.  For cash flow hedges, the effective portion of the gain or loss on the interest rate swap is included as a component of other comprehensive income and reclassified into earnings in the same period during which the hedged transaction is recognized in earnings.  The Company does not hold or issue derivatives that are not designated as hedging instruments.  See Note 7 for additional information about the interest rate swap agreements.

The following methods and assumptions were used to estimate fair value of each class of financial instrument for which it is practical to estimate that value:

Cash and cash equivalents — the carrying amount is a reasonable estimate of fair value.

Fixed maturities held-to-maturity — the carrying amount is amortized cost; the fair values of the Company’s public fixed maturity securities that are classified as held-to-maturity are generally based on prices obtained from independent pricing services.

Mortgage loans — the carrying amount is a reasonable estimate of fair value due to the restrictive nature and limited marketability of the mortgage notes.

Policy loans — the carrying amount is a reasonable estimate of fair value.

Company owned life insurance — the carrying amount is a reasonable estimate of fair value.

Other invested assets — the carrying amount is a reasonable estimate of fair value.

Other policyholder funds — the carrying amount is a reasonable estimate of fair value.

Debt — the carrying amount is a reasonable estimate of fair value.


18


THE NATIONAL SECURITY GROUP, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED EXCEPT FOR DECEMBER 31, 2014 AMOUNTS)


The carrying amount and estimated fair value of the Company’s financial instruments as of March 31, 2015 and December 31, 2014 are as follows (in thousands):
 
 
March 31, 2015
 
December 31, 2014
 
 
Carrying
Value
 
Estimated
Fair Value
 
Carrying
Value
 
Estimated
Fair Value
Assets and related instruments
 
 
 
 
 
 
 
 
Held-to-maturity securities
 
$
2,767

 
$
2,905

 
$
3,108

 
$
3,182

Mortgage loans
 
208

 
208

 
210

 
210

Policy loans
 
1,556

 
1,556

 
1,530

 
1,530

Company owned life insurance
 
5,161

 
5,161

 
5,513

 
5,513

Other invested assets
 
3,484

 
3,484

 
3,553

 
3,553

 
 
 
 
 
 
 
 
 
Liabilities and related instruments
 
 

 
 

 
 

 
 

Other policyholder funds
 
1,525

 
1,525

 
1,510

 
1,510

Short-term notes payable and current portion of long-term debt
 
1,557

 
1,557

 
857

 
857

Long-term debt
 
17,515

 
17,515

 
18,715

 
18,715


NOTE 5 – PROPERTY AND EQUIPMENT

Major categories of property and equipment are summarized as follows (dollars in thousands):

 
March 31, 2015
 
December 31, 2014
 
 
 
 
Building and improvements
$
3,348

 
$
3,367

Electronic data processing equipment
1,606

 
1,570

Furniture and fixtures
658

 
606

 
5,612

 
5,543

Less accumulated depreciation
3,577

 
3,530

Property and equipment, net
$
2,035

 
$
2,013


Depreciation expense for the three months ended March 31, 2015 was $47,000 ($306,000 for the year ended December 31, 2014).

NOTE 6 – INCOME TAXES

The Company recognizes tax-related interest and penalties as a component of tax expense.  The Company files income tax returns in the U.S. federal jurisdiction and various states.  The Company is not subject to examinations by authorities related to its U.S. federal or state income tax filings for years prior to 2009. Tax returns have been filed through the year 2013.

Net deferred tax liabilities are determined based on the estimated future tax effects of differences between the financial statement and tax basis of assets and liabilities given the provisions of the enacted tax laws.  Management believes that, based on its historical pattern of taxable income, the Company will produce sufficient income in the future to realize its deferred tax assets.  The Company recognized net deferred tax asset positions of $3,055,000 at March 31, 2015 and $3,189,000 at December 31, 2014.


19


THE NATIONAL SECURITY GROUP, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED EXCEPT FOR DECEMBER 31, 2014 AMOUNTS)


The tax effect of significant differences representing deferred tax assets and liabilities are as follows (dollars in thousands):
 
 
As of
March 31, 2015
 
As of
December 31, 2014
General expenses
 
$
1,415

 
$
1,371

Unearned premiums
 
2,009

 
1,961

Claims liabilities
 
863

 
849

Litigation settlement
 
2,040

 
2,040

AMT credit
 
1,121

 
1,240

Impairment on real estate owned
 
187

 
187

Unrealized loss on interest rate swaps
 
482

 
421

Deferred tax assets
 
8,117

 
8,069

 
 
 
 
 
Depreciation
 
(107
)
 
(111
)
Deferred policy acquisition costs
 
(2,919
)
 
(2,921
)
Unrealized gains on securities available-for-sale
 
(2,036
)
 
(1,848
)
Deferred tax liabilities
 
(5,062
)
 
(4,880
)
Net deferred tax asset
 
$
3,055

 
$
3,189


The appropriate income tax effects of changes in temporary differences are as follows (dollars in thousands):
 
 
Three months ended March 31,
 
 
2015
 
2014
Deferred policy acquisition costs
 
$
(2
)
 
$
(14
)
Unearned premiums
 
(48
)
 
(76
)
General expenses
 
(44
)
 
(5
)
Depreciation
 
(4
)
 
(42
)
Claims liabilities
 
(14
)
 
(42
)
AMT credit
 
119

 

NOL carryforward
 

 
375

 
 
 
 
 
Deferred income tax expense
 
$
7

 
$
196


Total income tax expense (benefit) varies from amounts computed by applying current federal income tax rates to income or loss before income taxes.  The reasons for these differences and the approximate tax effects are as follows:
 
 
Three months ended March 31,
 
 
2015
 
2014
Federal income tax rate applied to pre-tax income/loss
 
34.0
 %
 
34.0
 %
Dividends received deduction and tax-exempt interest
 
(1.5
)%
 
(2.4
)%
Company owned life insurance
 
(0.8
)%
 
(0.8
)%
Small life deduction
 
(3.2
)%
 
(11.4
)%
AMT
 
 %
 
1.9
 %
Other, net
 
(1.8
)%
 
0.8
 %
Effective federal income tax rate
 
26.7
 %
 
22.1
 %


20


THE NATIONAL SECURITY GROUP, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED EXCEPT FOR DECEMBER 31, 2014 AMOUNTS)


NOTE 7 – NOTES PAYABLE AND LONG-TERM DEBT

Short-term debt and current portion of long-term debt consisted of the following as of March 31, 2015 and December 31, 2014 (dollars in thousands):

 
 
2015
 
2014
Line of credit with variable interest rate equal to the Wall Street Journal (WSJ) prime rate, subject to a 5.0% floor; maturity February 2016.  Interest payments due quarterly.  Unsecured.
 
$
700

 
$

Current portion of installment note payable due November 2015 with variable interest rate equal to the WSJ prime rate plus 1%; Unsecured
 
857

 
857

 
 
$
1,557

 
$
857


Long-term debt consisted of the following as of March 31, 2015 and December 31, 2014 (dollars in thousands):

 
 
2015
 
2014
Line of credit with variable interest rate equal to the WSJ prime rate, subject to a 5.0% floor; maturity February 2016.  Interest payments due quarterly.  Unsecured.
 
$

 
$
700

 
 
 
 
 
Line of credit with variable interest rate equal to the WSJ prime rate, subject to a 4.5% floor; maturity September 2017.  Interest payments due monthly.  Secured.
 

 
500

 
 
 
 
 
Long term portion of installment note with variable interest rate equal to the WSJ prime rate plus 1% and adjustable each November; maturity November 2021. Interest payable annually with principal payable in equal annual installments. Next principal installment on long term portion due November 2015. Unsecured.
 
5,143

 
5,143

 
 
 
 
 
Subordinated debentures issued on December 15, 2005 with fixed interest rate of 8.83% each distribution period thereafter until December 15, 2015 when the coupon rate shall equal the 3-Month LIBOR plus 3.75% applied to the outstanding principal; maturity December 2035.  Interest payments due quarterly.  All may be redeemed at any time following the tenth anniversary of issuance.  Unsecured.
 
9,279

 
9,279

 
 
 
 
 
Subordinated debentures issued on June 21, 2007 with a floating interest rate equal to the 3-Month LIBOR plus 3.40% applied to the outstanding principal; maturity June 15, 2037. Interest payments due quarterly.  All may be redeemed at any time following the fifth anniversary of issuance.  Unsecured.
 
3,093

 
3,093

 
 
$
17,515

 
$
18,715



The Company has entered into various swap agreements related to the trust preferred securities. On March 19, 2009, the Company entered into a forward swap effective September 17, 2012, with a notional amount of $3,000,000 and designated the swap as a hedge against changes in cash flows attributable to changes in the benchmark interest rate (LIBOR) associated with the subordinated debentures issued June 21, 2007. Quarterly, commencing September 17, 2012, under the terms of the forward swap, the Company will pay interest at a fixed rate of 7.02% until March 15, 2019. On May 26, 2010, the Company entered into a forward swap with a notional amount of $9,000,000 effective December 15, 2015, which will hedge against changes in cash flows following the termination of the fixed rate period. Quarterly, commencing March 16, 2016 under the terms of the forward swap, the Company will pay interest at a fixed rate of 8.49% until March 15, 2020.

The swaps entered into in 2009 and 2010 have fair values of $274,000 (liability) and $1,141,000 (liability), respectively, for a total liability of $1,415,000 at March 31, 2015 ($1,238,000 at December 31, 2014).  The swap liability is reported as a component of other liabilities on the condensed consolidated balance sheets.  A net valuation loss of $117,000 (net of tax) is included in accumulated other comprehensive income related to the swap agreements at March 31, 2015.  A net valuation loss of $412,000 (net of tax) was included in accumulated other comprehensive income related to the swap at December 31, 2014.

21


THE NATIONAL SECURITY GROUP, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED EXCEPT FOR DECEMBER 31, 2014 AMOUNTS)



We use dollar offset at the hedge's inception and for each reporting period thereafter to assess whether the derivative used in a hedging transaction is expected to be, and has been, effective in offsetting changes in the fair value of the hedged item. Since inception, no portion of the hedged item has been deemed ineffective. For all hedges, we discontinue hedge accounting if it is determined that a derivative is not expected to be, or has ceased to be, effective as a hedge.

The Company’s interest rate swaps include provisions requiring the Company to post collateral when the derivative is in a net liability position.  At March 31, 2015, the Company has securities on deposit with fair market values of $1,518,000 (all of which is posted as collateral). At December 31, 2014, the Company had securities on deposit with fair market values of $1,494,000 (all of which is posted as collateral). See Note 4 for additional information about the interest rate swaps.

NOTE 8 – REINSURANCE

The Company's insurance operations utilize reinsurance in order to limit losses, minimize exposure to large risks, provide additional capacity for future growth and effect business-sharing arrangements. Life reinsurance is accomplished through yearly renewable term coverage. Property and casualty reinsurance is placed on an excess of loss basis to cover losses from catastrophe events. Reinsurance ceded arrangements do not discharge the insurance subsidiaries as the primary insurer, except for cases involving a novation. Failure of re-insurers to honor their obligations could result in losses to the insurance subsidiaries. The insurance subsidiaries evaluate the financial conditions of their reinsurance companies and monitor concentrations of credit risk arising from similar geographic regions, activities, or economic characteristics of the companies to minimize their exposure to significant losses from reinsurance insolvencies.

In the normal course of business, NSFC seeks to reduce the loss that may arise from catastrophes or other individually significant large loss events that cause unfavorable underwriting results by re-insuring certain levels of risk in various areas of exposure with reinsurance companies.  NSFC maintains a catastrophe reinsurance agreement to cover losses from catastrophic events, primarily hurricanes.
 
Under the catastrophe reinsurance program, the Company retains the first $4,000,000 in losses from each catastrophe event.  Catastrophe reinsurance coverage is maintained in three layers as follows:
Layer
Reinsurers' Limits of Liability
First Layer
100% of $13,500,000 in excess of $4,000,000
Second Layer
100% of $25,000,000 in excess of $17,500,000
Third Layer
100% of $30,000,000 in excess of $42,500,000

Each reinsurance layer covers events occurring from January 1 through December 31 of the contract year.  All significant reinsurance companies under the program carry A.M. Best ratings of A- (Excellent) or higher, or equivalent ratings.

The Company's catastrophe reinsurance contract allows for one reinstatement. The Company maintains reinstatement premium protection (RPP) to cover reinstatement premiums incurred. The RPP further reduces risk from a major catastrophe and serves to strengthen the Company's capital position by reducing the modeled 100 year event net cost.

Amounts recoverable from re-insurers are estimated in a manner consistent with the claim liability associated with the underlying insurance policies.  Amounts paid for prospective reinsurance contracts are reported as prepaid reinsurance premiums and amortized over the remaining contract period.

In the normal course of business, NSIC seeks to limit its exposure to loss on any single insured and to recover a portion of benefits paid by ceding reinsurance to reinsurance companies under excess coverage contracts.  NSIC retains a maximum of $50,000 of coverage per individual life.  The cost of reinsurance is amortized over the contract period of the reinsurance.

22


THE NATIONAL SECURITY GROUP, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED EXCEPT FOR DECEMBER 31, 2014 AMOUNTS)


At March 31, 2015, the largest reinsurance recoverable of a single reinsurer was $24,000 ($37,000 at December 31, 2014). Amounts reported as ceded incurred losses in both 2015 and 2014 were related to the development of losses from prior year catastrophes.

NOTE 9 – EMPLOYEE BENEFIT PLANS

The Company and its subsidiaries have an established retirement savings plan (401K Plan). All full-time employees are eligible to participate, and all employer contributions are fully vested for employees who have completed 1,000 hours of service in the year of contribution. Company matching contributions for the three months ended March 31, 2015 and 2014 amounted to $43,000 and $46,000, respectively. The Company contributes dollar-for-dollar matching contributions up to 5% of compensation subject to government limitations.

In January 2006, the Company established a non-qualified plan under which directors are allowed to defer all or a portion of directors' fees into various investment options.

The supplemental executive retirement plan (SERP) became effective March 1, 2008 and covers named executive officers with the Company contributing 15% of executive compensation to the plan. Contributions to the plan are fully vested upon the earlier of death, disability, change in control, or ten years of participation in the plan. Costs for amounts credited to the non-qualified deferred compensation plans for the three months ended March 31, 2015 and 2014 amounted to approximately $45,000 and $30,000, respectively.

The Company and its subsidiaries established an Employee Stock Ownership Plan (ESOP) in January 2010, to enable its eligible employees to acquire a proprietary interest in the Company's common stock and to provide retirement and other benefits to such employees. There were no costs incurred during the first three months of 2015 and $50,000 in costs incurred during the first three months of 2014 related to ESOP plan contributions. All contributions were made in cash for purchase of Company shares in the open market. The Company has not allocated shares directly to the plan and the plan has no debt.

NOTE 10 – SHAREHOLDERS' EQUITY

During the three months ended March 31, 2015, and year ended December 31, 2014, changes in shareholders' equity consisted of net income of $1,308,000 and $7,616,000, respectively; dividends paid of $100,000 in 2015 and $300,000 in 2014; changes in accumulated other comprehensive income, net of applicable taxes, of $248,000 in 2015 and other comprehensive income, net of applicable taxes, of $1,836,000 in 2014.  Other comprehensive gains and loss consisted of accumulated unrealized gains and losses on securities available for sale and unrealized loss on interest rate swaps.

Preferred Stock
Preferred Stock may be issued in one or more series as shall from time to time be determined and authorized by the Board of Directors. The directors may make specific provisions regarding (a) the voting rights, if any (b) whether such dividends are to be cumulative or noncumulative (c) the redemption provisions, if any (d) participating rights, if any (e) any sinking fund or other retirement provisions (f) dividend rates (g) the number of shares of such series and (h) liquidation preference.

Common Stock
The holders of the Class A Common Stock will have one-twentieth of one vote per share, and the holders of the common stock will have one vote per share. There is currently no Class A Common Stock issued or outstanding.

In the event of any liquidation, dissolution or distribution of the assets of the Company remaining after the payments to the holders of the Preferred Stock of the full preferential amounts to which they may be entitled as provided in the resolution or resolutions creating any series thereof, the remaining assets of the Company shall be divided and distributed among the holders of both classes of common stock, except as may otherwise be provided in any such resolution or resolutions.


23


THE NATIONAL SECURITY GROUP, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED EXCEPT FOR DECEMBER 31, 2014 AMOUNTS)


The table below provides information regarding the Company's preferred and common stock as of March 31, 2015 and December 31, 2014:

 
Authorized
 
Issued
 
Outstanding
Preferred Stock, $1 par value
500,000

 

 

Class A Common Stock, $1 par value
2,000,000

 

 

Common Stock, $1 par value
3,000,000

 
2,507,452

 
2,507,452


NOTE 11 – ACCUMULATED OTHER COMPREHENSIVE INCOME

Accumulated other comprehensive income (loss) ("AOCI") includes certain items that are reported directly within a separate component of shareholders' equity. The following table presents changes in AOCI balances (dollars in thousands):
 
 
Three months ended
March 31,
 
 
2015
 
2014
Gains and Losses on Cash Flow Hedges
 
 
 
 
Balance at beginning of period
 
$
(816
)
 
$
(591
)
Other comprehensive income (loss) for period:
 
 
 
 
Other comprehensive income (loss) before reclassifications
 
(117
)
 
(76
)
Amounts reclassified from accumulated other comprehensive income
 

 

Net current period other comprehensive income (loss)
 
(117
)
 
(76
)
Balance at end of period
 
$
(933
)
 
$
(667
)
Unrealized Gains and Losses on Available-for-Sale Securities
 
 
 
 
Balance at beginning of period
 
$
3,588

 
$
1,527

Other comprehensive income (loss) for period:
 
 
 
 
Other comprehensive income before reclassifications
 
459

 
1,132

Amounts reclassified from accumulated other comprehensive income
 
(94
)
 
(59
)
Net current period other comprehensive income
 
365

 
1,073

Balance at end of period
 
$
3,953

 
$
2,600

Total Accumulated Other Comprehensive Income at end of period
 
$
3,020

 
$
1,933

The following table presents the amounts reclassified out of AOCI for the three months ended March 31, 2015 (dollars in thousands):
Details about Accumulated Other Comprehensive Income Components
 
Amounts Reclassified from Accumulated Other Comprehensive Income
 
Affected Line Item in the Statement Where Net Income is Presented
Unrealized Gains and Losses on
Available-for-Sale Securities
 
$
142

 
Net realized investment gains
 
 
142

 
Total before tax
 
 
(48
)
 
Tax (expense) or benefit
 
 
$
94

 
Net of Tax

24


THE NATIONAL SECURITY GROUP, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED EXCEPT FOR DECEMBER 31, 2014 AMOUNTS)


The following table presents the amounts reclassified out of AOCI for the three months ended March 31, 2014 (dollars in thousands):
Details about Accumulated Other Comprehensive Income Components
 
Amounts Reclassified from Accumulated Other Comprehensive Income
 
Affected Line Item in the Statement Where Net Income is Presented
Unrealized Gains and Losses on
Available-for-Sale Securities
 
$
88

 
Net realized investment gains
 
 
88

 
Total before tax
 
 
(29
)
 
Tax (expense) or benefit
 
 
$
59

 
Net of Tax

NOTE 12 – SEGMENTS

The Company’s property and casualty insurance operations comprise one business segment. The property and casualty insurance segment primarily underwrites home insurance coverage with primary lines of business consisting of:  dwelling fire and extended coverage, homeowners (including mobile homeowners) and other liability. The Company has ceased writing ocean marine coverages and no policies were in-force in this line of business during 2015.  

Management organizes the business utilizing a niche strategy focusing on lower valued dwellings.  Our chief decision makers (Chief Executive Officer, Chief Financial Officer and President) review results and operating plans making decisions on resource allocations on a company-wide basis.  The Company’s products are primarily produced through agents within the states in which we operate.  

The Company’s life and accident and health operations comprise the second business segment.  The life and accident and health insurance segment consists of two lines of business: traditional life insurance and accident and health insurance.

Total assets by industry segment at March 31, 2015 and at December 31, 2014 are summarized below (dollars in thousands):

 
 
Total
 
P&C Insurance Operations
 
Life Insurance Operations
 
Non-Insurance Operations
March 31, 2015
 
 
 
 
 
 
 
 
 
 
$
147,016

 
$
82,573

 
$
56,827

 
$
7,616

December 31, 2014
 


 
 
 
 
 
 
 
 
$
144,865

 
$
81,648

 
$
56,541

 
$
6,676



25


THE NATIONAL SECURITY GROUP, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED EXCEPT FOR DECEMBER 31, 2014 AMOUNTS)


Premium revenues and operating income by business segment for the three months ended March 31, 2015 and 2014 are summarized below (dollars in thousands):

Three months ended March 31, 2015
Total
 
P&C Insurance Operations
 
Life Insurance Operations
 
Non-Insurance Operations
REVENUE
 
 
 
 
 
 
 
Net premiums earned
$
14,706

 
$
13,122

 
$
1,584

 
$

Net investment income
974

 
490

 
465

 
19

Net realized investment gains (losses)
142

 
31

 
111

 

Other income
158

 
157

 
1

 

 
15,980

 
13,800

 
2,161

 
19

BENEFITS AND EXPENSES
 

 
 

 
 

 
 

Policyholder benefits paid
8,262

 
6,777

 
1,485

 

Amortization of deferred policy acquisition costs
899

 
675

 
224

 

Commissions
2,055

 
1,968

 
87

 

General and administrative expenses
2,006

 
1,540

 
309

 
157

Taxes, licenses and fees
655

 
544

 
111

 

Interest expense
317

 

 
10

 
307

 
14,194

 
11,504

 
2,226

 
464

Income (Loss) Before Income Taxes
$
1,786

 
$
2,296

 
$
(65
)
 
$
(445
)




Three months ended March 31, 2014
Total
 
P&C Insurance Operations
 
Life Insurance Operations
 
Non-Insurance Operations
REVENUE
 
 
 
 
 
 
 
Net premiums earned
$
13,824

 
$
12,173

 
$
1,651

 
$

Net investment income
948

 
455

 
474

 
19

Net realized investment gains
88

 
48

 
40

 

Other income
154

 
153

 
1

 

 
15,014

 
12,829

 
2,166

 
19

BENEFITS AND EXPENSES