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HALL > SEC Filings for HALL > Form 10-Q on 7-Nov-2013All Recent SEC Filings

Show all filings for HALLMARK FINANCIAL SERVICES INC

Form 10-Q for HALLMARK FINANCIAL SERVICES INC


7-Nov-2013

Quarterly Report


Item 2. 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-Q" for a discussion of some of the uncertainties, risks and assumptions associated with these statements.

Introduction

Hallmark Financial Services, Inc. ("Hallmark" and, together with subsidiaries, "we," "us" or "our") is an insurance holding company that, through its subsidiaries, engages in the sale of property/casualty insurance products to businesses and individuals. Our business involves marketing, distributing, underwriting and servicing commercial insurance, personal insurance and general aviation insurance, as well as providing other insurance related services. Our business is geographically concentrated in the south central and northwest regions of the United States, except for our Hallmark Select business which is written on a national basis. We pursue our business activities through subsidiaries whose operations are organized into five business units, which are supported by our insurance company subsidiaries.

Our non-carrier insurance activities are segregated by business units into the following reportable segments:

Standard Commercial Segment.Our Standard Commercial Segment includes the standard lines commercial property/casualty insurance products and services handled by our Standard Commercial P&C business unit and the workers compensation insurance products handled by our Workers Compensation business unit.

Specialty Commercial Segment.Our Specialty Commercial Segment includes the excess and surplus lines commercial property/casualty insurance products and services handled by our E&S Commercial business unit and the general aviation, commercial umbrella and excess liability and medical professional liability insurance products and services handled by our Hallmark Select business unit, as well as certain Specialty Programs which are managed at the parent level.

Personal Segment. Our Personal Segment includes the non-standard personal automobile, low value dwelling/homeowners, renters, manufactured homes, motorcycle and business auto insurance products and services handled by our Personal Lines business unit.

The retained premium produced by these reportable segments is supported by the following insurance company subsidiaries:

American Hallmark Insurance Company of Texas ("AHIC")presently retains a portion of the risks on the commercial property/casualty and workers compensation policies marketed within the Standard Commercial Segment, retains a portion of the risks on personal policies marketed within the Personal Segment and retains a portion of the risks on the commercial, medical professional liability, aviation and satellite launch property/casualty policies marketed within the Specialty Commercial Segment.

Hallmark Specialty Insurance Company ("HSIC") presently retains a portion of the risks on the commercial property/casualty and medical professional liability policies marketed within the Specialty Commercial Segment and a portion of the commercial property/casualty policies marketed within the Standard Commercial Segment.

Hallmark Insurance Company ("HIC") presently retains a portion of the risks on both the personal policies marketed within the Personal Segment and the commercial and aviation property/casualty products marketed within the Specialty Commercial Segment.

Hallmark National Insurance Company ("HNIC") presently retains a portion of the risks on the personal policies marketed within the Personal Segment.

Hallmark County Mutual Insurance Company ("HCM") control and management 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.

Texas Builders Insurance Company ("TBIC")retains a portion of the risks on the workers compensation policies marketed within our Standard Commercial Segment.

AHIC, HIC, HSIC and HNIC have entered into a pooling arrangement pursuant to which AHIC retains 30% of the total net premiums written by any of them, HIC retains 27% of our total net premiums written by any of them, HSIC retains 30% of our total net premiums written by any of them and HNIC retains 13% of our total premiums written by any of them. Neither HCM nor TBIC is a party to the intercompany pooling arrangement. This pooling arrangement has no impact on our consolidated financial statements reported in accordance with U.S. generally accepted accounting principles ("GAAP").

Results of Operations

Management Overview During the three and nine months ended September 30, 2013, our total revenues were $108.6 million and $301.1 million, representing a 27% and 19% increase, respectively, from the $85.6 million and $253.2 million in total revenues for the same period of 2012. The growth in revenue was primarily attributable to increased premium production and resulting earned premium driven largely from our Specialty Commercial Segment and our Standard Commercial Segment. Further contributing to the increase in revenue were higher net realized gains on our investment portfolio and a lower adverse profit share commission revenue adjustment in our Standard Commercial Segment. These increases in revenue were partially offset by lower net investment income and lower year to date earned premium in our Personal Segment due mostly to the impact of discontinued products and a reduction of premium written in underperforming states.

The increase in revenue for the three and nine months ended September 30, 2013 was accompanied by increased loss and loss adjustment expenses ("LAE") of $15.3 million and $36.1 million, respectively, as compared to the same periods in 2012. During the three months ended September 30, 2013 we recorded $0.5 million of unfavorable prior year loss development. During the three months ended September 30, 2012 we recorded $2.2 million of favorable prior year loss development. During the nine months ended September 30, 2013 we recorded $8.0 million of unfavorable prior year loss development. During the nine months ended September 30, 2012 we recorded to $3.6 million of favorable development. The increase in loss and LAE occurred despite a $3.1 million decrease in catastrophe losses to $8.5 million during the nine months ended September 30, 2013 from $11.6 million reported during the same period of 2012. Other operating expenses also increased due mostly to increased production related expenses in our E&S Commercial business unit.

We reported $6.3 million net income for the three months ended September 30, 2013, as compared to $3.4 million net income for the same period during 2012. We reported net income of $4.8 million for the nine months ended September 30, 2013, which was $3.1 million higher than the $1.7 million net income reported for the nine months ended September 30, 2012. On a diluted basis per share, we reported net income of $0.32 per share for the three months ended September 30, 2013, as compared to net income of $0.18 per share for the same period in 2012. On a diluted basis per share, net income per share was $0.25 for the nine months ended September 30, 2013, as compared to net income per share of $0.09 for the same period during 2012.

Third Quarter 2013 as Compared to Third Quarter 2012

The following is additional business segment information for the three months ended September 30, 2013 and 2012 (in thousands):

                                                                         Three Months Ended September 30
                              Standard                   Specialty
                             Commercial                 Commercial                   Personal
                               Segment                    Segment                    Segment                  Corporate                Consolidated
                          2013         2012         2013          2012          2013          2012        2013         2012         2013          2012
Gross premiums
written                 $ 21,444       18,706     $  83,453        62,349     $  18,767       18,393     $     -            -     $ 123,664        99,448
Ceded premiums
written                   (1,837 )     (1,876 )     (17,932 )     (12,385 )      (1,006 )       (182 )         -            -       (20,775 )     (14,443 )
Net premiums written      19,607       16,830        65,521        49,964        17,761       18,211           -            -       102,889        85,005
Change in unearned
premiums                     332          736        (7,512 )      (6,396 )       1,743        1,136           -            -        (5,437 )      (4,524 )
Net premiums earned       19,939       17,566        58,009        43,568        19,504       19,347           -            -        97,452        80,481

Total revenues            21,163       17,761        60,787        46,373        21,256       21,172       5,407          314       108,613        85,620

Losses and loss
adjustment expenses       13,537       12,476        37,914        25,532        16,707       14,831           -            -        68,158        52,839

Pre-tax income
(loss), net of
non-controlling
interest                   1,163         (529 )       7,564         8,287        (1,613 )       (345 )     2,358       (2,650 )       9,472         4,763

Net loss ratio (1)          67.9 %       71.0 %        65.4 %        58.6 %        85.7 %       76.7 %                                 69.9 %        65.7 %
Net expense ratio (1)       32.5 %       33.4 %        26.8 %        27.3 %        25.4 %       29.3 %                                 28.9 %        30.1 %
Net combined ratio
(1)                        100.4 %      104.4 %        92.2 %        85.9 %       111.1 %      106.0 %                                 98.8 %        95.8 %

Favorable
(Unfavorable) Prior
Year Development           1,408           71        (1,405 )       2,757          (534 )       (651 )         -            -          (531 )       2,177

(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 for our business units that retain 100% of produced premium as total operating expenses for the unit offset by agency fee income divided by net premiums earned, each determined in accordance with GAAP. For the business units that do not retain 100% of the produced premium, the net expense ratio is calculated as underwriting expenses of the insurance company subsidiaries for the unit 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.

Standard Commercial Segment

Gross premiums written for the Standard Commercial Segment were $21.4 million for the three months ended September 30, 2013, which was $2.7 million, or 15%, more than the $18.7 million reported for the same period in 2012. Net premiums written were $19.6 million for the three months ended September 30, 2013 as compared to $16.8 million reported for the same period in 2012. The increase in premium volume was primarily due to increased premium production in our Standard Commercial P&C business unit.

Total revenue for the Standard Commercial Segment of $21.2 million for the three months ended September 30, 2013 was $3.4 million more than the $17.8 million reported during the same period in 2012. This 19% increase in total revenue was mostly due to increased net premiums earned of $2.4 million and a $1.0 million lower adverse profit share commission revenue adjustment during the three months ended September 30, 2013 as compared to the same period in 2012.

Our Standard Commercial Segment reported pre-tax income of $1.2 million for the three months ended September 30, 2013 as compared to a pre-tax loss of $0.5 million for the same period of 2012. The increased revenue discussed above was the primary driver of the increased pre-tax income for the three months ended September 30, 2013, partially offset by higher loss and LAE of $1.1 million and higher operating expenses of $0.6 million consisting primarily of increased production related expenses.

The Standard Commercial Segment reported a net loss ratio of 67.9% for the three months ended September 30, 2013 as compared to 71.0% for the same period of 2012. The gross loss ratio before reinsurance for the three months ended September 30, 2013 was 62.7% as compared to the 68.1% reported for the same period of 2012. The lower gross and net loss ratios for the three months ended September 30, 2013 were the result of lower current accident year loss trends and increased favorable loss reserve development of $1.4 million as compared to favorable loss reserve development of $0.1 million during the same period of 2012, partially offset by higher catastrophe losses during the third quarter of 2013 as compared to the same period in 2012. The gross and net loss results for the three months ended September 30, 2013 and 2012 include $2.2 million and $0.6 million, respectively, of catastrophe losses.

Specialty Commercial Segment

The $60.8 million of total revenue for the three months ended September 30, 2013 was $14.4 million higher than the $46.4 million reported by the Specialty Commercial Segment for the same period in 2012. This 31% increase in revenue was primarily due to higher net premiums earned of $14.4 million largely from increased production in both our E&S Commercial and Hallmark Select business units. Higher net investment income of $0.3 million was offset by lower commission revenue of $0.3 million due primarily to unfavorable profit share commission adjustments for the three months ended September 30, 2013 as compared to the third quarter of 2012.

Pre-tax income for the Specialty Commercial Segment of $7.6 million for the third quarter of 2013 was $0.7 million lower than the $8.3 million reported for the same period in 2012. The decrease in pre-tax income was primarily due to higher loss and LAE expenses of $12.4 million and higher operating expenses of $3.2 million, partially offset by lower amortization of intangible assets of $0.2 million, lower non-controlling interest of $0.3 million and the increased revenue discussed above. Our E&S Commercial business unit reported a $14.0 million increase in loss and LAE due primarily to increased premium production as well as unfavorable prior year loss development, partially offset by lower current accident year loss trends. Our Hallmark Select business unit reported a $0.8 million decrease in loss and LAE which consisted of (a) a $1.3 million decrease in loss and LAE due primarily to favorable prior year loss development in our aircraft and airport liability lines of business during the third quarter of 2013 as compared to unfavorable prior year loss reserve development during the third quarter of 2012, (b) a $0.1 million decrease in loss and LAE attributable to our medical professional liability insurance products, partially offset by (c) a $0.6 million increase in loss and LAE due to increased premium production in our commercial umbrella and excess liability line of business. Our Specialty Programs reported a $0.8 million decrease in loss and LAE due primarily to decreased current accident year loss trends. The increase in operating expenses for the three months ended September 30, 2013 was primarily the result of increased production related expenses of $2.7 million, increased salary and related expenses of $0.4 million and increased professional service fees of $0.1 million.

The Specialty Commercial Segment reported a net loss ratio of 65.4% for the three months ended September 30, 2013 as compared to 58.6% for the same period during 2012. The gross loss ratio before reinsurance was 65.1% for the three months ended September 30, 2013 as compared to 60.3% for the same period in 2012. The higher gross and net loss ratios include $1.4 million unfavorable prior years' loss development for the three months ended September 30, 2013 as compared to $2.8 million favorable prior years' loss development for the same period of 2012.

Personal Segment

Gross premiums written for the Personal Segment were $18.8 million for the three months ended September 30, 2013, which was $0.4 million more than the $18.4 million reported for the same period in 2012. Net premiums written for our Personal Segment were $17.8 million in the third quarter of 2013, which was a decrease of $0.4 million from the $18.2 million reported for the same period of 2012. The decrease in net premium written was due mostly to a quota share reinsurance contract entered into during the first quarter of 2013 on our low value dwelling/homeowners, renters, and manufactured homes lines of business.

Total revenue for the Personal Segment were $21.3 million for the third quarter of 2013, which was $0.1 million more than the $21.2 million reported for the same period of 2012. Higher earned premium of $0.2 million and higher finance charges of $0.1 million, partially offset by decreased net investment income of $0.2 million, were the primary reasons for the increase in revenue for the period.

Pre-tax loss for the Personal Segment was $1.6 million for the three months ended September 30, 2013 as compared to pre-tax loss of $0.3 million for the same period of 2012. The higher pre-tax loss was primarily the result of increased losses and LAE of $1.9 million, partially offset by (a) lower operating expenses of $0.5 million due to lower production related expenses of $0.2 million and lower salary and related expenses of $0.3 million, and (b) the higher revenue discussed above.

The Personal Segment reported a net loss ratio of 85.7% for the three months ended September 30, 2013 as compared to 76.7% for the same period during 2012. The gross loss ratio before reinsurance was 85.3% for the three months ended September 30, 2013 as compared to 77.7% for the same period in 2012. The higher gross and net loss ratio are primarily the result of higher current accident year loss trends for the three months ended September 30, 2013 as compared to the same period of 2012. The loss and LAE during the three months ended September 30, 2013 and 2012 included unfavorable prior years' loss reserve development of $0.5 million and $0.7 million, respectively. The Personal Segment reported a net expense ratio of 25.4% for the third quarter of 2013 as compared to 29.3% for the same period of 2012. The decrease in the expense ratio was due predominately to lower operating expenses.

Corporate

Total revenue for Corporate increased by $5.1 million for the three months ended September 30, 2013 as compared to the same period the prior year. This increase in total revenue was due to higher net realized gains on our investment portfolio of $6.0 million as compared to the same period of the prior year, partially offset by lower net investment income of $0.9 million for the three months ended September 30, 2013 as compared to the same period of the prior year.

Corporate pre-tax income was $2.4 million for the three months ended September 30, 2013 as compared to a pre-tax loss of $2.7 million for the same period during 2012. The increase in pre-tax income was primarily due to the increased revenue discussed above.

Nine Months Ended September 30, 2013 as Compared to Nine Months Ended September 30, 2012

The following is additional business segment information for the nine months ended September 30, 2013 and 2012 (in thousands):

                                                                            Nine Months Ended September 30
                               Standard                   Specialty
                              Commercial                  Commercial                   Personal
                                Segment                    Segment                     Segment                   Corporate                 Consolidated
                           2013         2012          2013          2012          2013          2012         2013         2012          2013          2012
Gross premiums written   $ 66,773       58,292     $  225,120       178,690     $  59,385       60,676     $      -            -     $  351,278       297,658
Ceded premiums written     (5,934 )     (5,063 )      (45,232 )     (36,948 )      (3,782 )       (543 )          -            -        (54,948 )     (42,554 )
Net premiums written       60,839       53,229        179,888       141,742        55,603       60,133            -            -        296,330       255,104
Change in unearned
premiums                   (2,763 )     (2,194 )      (20,302 )     (19,449 )       3,519        2,477            -            -        (19,546 )     (19,166 )
Net premiums earned        58,076       51,035        159,586       122,293        59,122       62,610            -            -        276,784       235,938

Total revenues             62,160       53,791        168,127       129,812        64,621       68,508        6,145        1,066        301,053       253,177

Losses and loss
adjustment expenses        42,567       39,253        113,303        76,827        49,085       52,779            -            -        204,955       168,859

Pre-tax income (loss),
net of non-controlling
interest                      641       (2,601 )       11,828        17,193        (3,331 )     (5,747 )     (2,820 )     (8,082 )        6,318           763

Net loss ratio (1)           73.3 %       76.9 %         71.0 %        62.8 %        83.0 %       84.3 %                                   74.0 %        71.6 %
Net expense ratio (1)        32.6 %       33.8 %         27.0 %        28.2 %        25.7 %       28.5 %                                   29.2 %        30.4 %
Net combined ratio (1)      105.9 %      110.7 %         98.0 %        91.0 %       108.7 %      112.8 %                                  103.2 %       102.0 %

Favorable
(Unfavorable) Prior
Year Development            3,630        2,827        (10,062 )       3,679        (1,531 )     (2,937 )          -            -         (7,963 )       3,569

(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 for our business units that retain 100% of produced premium as total operating expenses for the unit offset by agency fee income divided by net premiums earned, each determined in accordance with GAAP. For the business units that do not retain 100% of the produced premium, the net expense ratio is calculated as underwriting expenses of the insurance company subsidiaries for the unit 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.

Standard Commercial Segment

Gross premiums written for the Standard Commercial Segment were $66.8 million for the nine months ended September 30, 2013, which was $8.5 million, or 15%, more than the $58.3 million reported for the same period in 2012. Net premiums written were $60.8 million for the nine months ended September 30, 2013 as compared to $53.2 million reported for the same period in 2012. The increase in premium volume was primarily due to increased premium production in both our Standard Commercial P&C and Workers Compensation business units.

Total revenue for the Standard Commercial Segment of $62.2 million for the nine months ended September 30, 2013 was $8.4 million more than the $53.8 million reported during the same period in 2012. This 16% increase in total revenue was mostly due to increased net premiums earned of $7.0 million, higher net investment income of $0.1 million and a $1.3 million lower adverse profit share commission revenue adjustment during the nine months ended September 30, 2013 as compared to the same period the prior year.

Our Standard Commercial Segment reported pre-tax income of $0.6 million for the nine months ended September 30, 2013 as compared to a pre-tax loss of $2.6 million for the same period of 2012. The increased revenue discussed above was the primary driver of the increased pre-tax income for the nine months ended September 30, 2013, partially offset by higher loss and LAE of $3.3 million and higher operating expenses of $1.9 million consisting primarily of higher production related expenses due to increased premium production.

The Standard Commercial Segment reported a net loss ratio of 73.3% for the nine months ended September 30, 2013 as compared to 76.9% for the same period in 2012. The gross loss ratio before reinsurance for the nine months ended September 30, 2013 was 68.7% as compared to the 75.4% reported for the same period of 2012. The lower gross and net loss ratios for the nine months ended September 30, 2013 were primarily the result of lower catastrophe losses coupled with increased favorable prior year loss reserve development. The gross and net loss results for the nine months ended September 30, 2013 and 2012 include catastrophe losses of $5.7 million and $9.4 million, respectively. During the nine months ended September 30, 2013 and 2012, the Standard Commercial Segment reported favorable loss reserve development of $3.6 million and $2.8 million, respectively.

Specialty Commercial Segment

Gross premiums written for the Specialty Commercial Segment were $225.1 million for the nine months ended September 30, 2013, which was $46.4 million, or 26%, more than the $178.7 million reported for the same period in 2012. Net premiums written were $179.9 million for the nine months ended September 30, 2013 as compared to $141.7 million reported for the same period in 2012. The increase in premium volume was primarily due to increased premium production in our E&S Commercial and Hallmark Select business units.

The $168.1 million of total revenue for the Specialty Commercial Segment for the nine months ended September 30, 2013 was $38.3 million higher than the $129.8 million reported for 2012. This 30% increase in revenue was due to higher net premiums earned of $37.3 million due predominately to increased production discussed above. Further contributing to this increased revenue was higher net investment income of $1.1 million partially offset by lower profit share commission revenue adjustment of $0.1 million for the nine months ended September 30, 2013 as compared to the same period of 2012.

Pre-tax income for the Specialty Commercial Segment of $11.8 million for the nine months ended September 30, 2013 was $5.4 million lower than the $17.2 million reported for the same period in 2012. The decrease in pre-tax income was primarily due to higher loss and LAE expenses of $36.5 million and higher operating expenses of $7.8 million, partially offset by lower amortization of intangible assets of $0.3 million, lower non-controlling interest of $0.3 million and the increased revenue discussed above. Our E&S Commercial business unit reported a $33.6 million increase in loss and LAE due primarily to increased premium volume and $11.7 million of unfavorable prior year loss reserve development as compared to $1.1 million of favorable development during the same period of 2012. In addition, our Hallmark Select business unit reported a $3.5 million increase in loss and LAE which consisted of (a) a $1.3 million increase in loss and LAE due to increased premium production in our commercial umbrella and excess liability line of business, (b) a $2.1 million increase in loss and LAE primarily due to large loss volatility in our aircraft hull coverage during the first nine months of 2013, (c) a $0.1 million increase in loss and LAE attributable to our medical professional liability insurance products. Partially offsetting the increase in Specialty Commercial Segment loss and LAE was a $0.6 million decrease in loss and LAE in our Specialty Programs due primarily to lower current accident year loss trends. The increase in operating expense was the combined result of increased production related expenses of $7.0 million, higher salary and related expenses of $0.4 million, . . .

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