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Table of Contents

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

FORM 10-Q

Quarterly report pursuant to Section 13 or 15(d) of the

(Mark One) Securities Exchange Act of 1934

Quarterly Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934

For the quarterly period ended March 31, 2021

Transition Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934

Commission file number 001-11252

Hallmark Financial Services, Inc.

(Exact name of registrant as specified in its charter)

Nevada

87-0447375

(State or other jurisdiction of

(I.R.S. Employer

Incorporation or organization)

Identification No.)

5420 Lyndon B. Johnson Freeway, Suite 1100, Dallas, Texas

75240

(Address of principal executive offices)

(Zip Code)

Registrant’s telephone number, including area code: (817) 348-1600

Securities registered pursuant to Section 12(b) of the Act:

Title of each class

Trading Symbol(s)

Name of each exchange on which registered

Common Stock, $0.18 par value

HALL

Nasdaq Global Market

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.   Yes        No

Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit such files).  Yes  No

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer,  a smaller reporting company or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer,”  “smaller reporting company” and “emerging growth company” in Rule 12b-2 of the Exchange Act.

Large accelerated filer

Accelerated filer

Non-accelerated filer

Smaller reporting company

Emerging growth company  

If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 15(a) of the Exchange Act.

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

Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date: Common Stock, par value $0.18 per share – 18,171,032 shares outstanding as of  May 13, 2021.

Table of Contents

PART I

FINANCIAL INFORMATION

Item 1.   Financial Statements

INDEX TO FINANCIAL STATEMENTS

Page
Number

Consolidated Balance Sheets at March 31, 2021 (unaudited) and December 31, 2020

3

Consolidated Statements of Operations (unaudited) for the three months ended March 31, 2021 and March 31, 2020

4

Consolidated Statements of Comprehensive Income (Loss) (unaudited) for the three months ended March 31, 2021 and March 31, 2020

5

Consolidated Statements of Stockholders’ Equity (unaudited) for the three months ended March 31, 2021 and March 31, 2020

6

Consolidated Statements of Cash Flows (unaudited) for the three months ended March 31, 2021 and March 31, 2020

7

Notes to Consolidated Financial Statements (unaudited)

8

2

Table of Contents

Hallmark Financial Services, Inc. and Subsidiaries

Consolidated Balance Sheets

($ in thousands, except par value)

March 31,

December 31,

2021

2020

(unaudited)

ASSETS

  

 

  

Investments:

  

 

  

Debt securities, available-for-sale, at fair value (amortized cost; $344,232 in 2021 and $502,167 in 2020)

$

348,525

$

507,279

Equity securities (cost; $46,847 in 2021 and $26,988 in 2020)

 

53,621

 

29,388

Total investments

 

402,146

 

536,667

Cash and cash equivalents

 

281,849

 

102,580

Restricted cash

 

5,434

 

5,728

Ceded unearned premiums

 

134,206

 

138,926

Premiums receivable

 

109,799

 

120,332

Accounts receivable

 

4,625

 

5,967

Receivable for securities

 

1,382

 

913

Reinsurance recoverable

 

494,815

 

490,231

Deferred policy acquisition costs

 

16,386

 

17,840

Intangible assets, net

 

1,196

 

1,322

Federal income tax recoverable

23,855

25,642

Deferred federal income taxes, net

 

8,319

 

8,724

Prepaid expenses

 

6,679

 

2,648

Other assets

 

26,852

 

28,013

Total assets

$

1,517,543

$

1,485,533

LIABILITIES AND STOCKHOLDERS’ EQUITY

 

  

 

  

Liabilities:

 

  

 

  

Senior unsecured notes due 2029 (less unamortized debt issuance cost of $820 in 2021 and $844 in 2020)

$

49,180

$

49,156

Subordinated debt securities (less unamortized debt issuance cost of $782 in 2021 and $795 in 2020)

 

55,920

 

55,907

Reserves for unpaid losses and loss adjustment expenses

 

812,272

 

789,768

Unearned premiums

 

305,015

 

320,806

Reinsurance payable

 

51,673

 

46,700

Pension liability

 

1,749

 

1,859

Payable for securities

 

10,979

 

Accounts payable and other accrued expenses

 

51,003

 

50,415

Total liabilities

 

1,337,791

 

1,314,611

Commitments and contingencies (Note 18)

 

 

  

Stockholders’ equity:

 

 

  

Common stock, $.18 par value, authorized 33,333,333 shares; issued 20,872,831 shares in 2021 and 2020

 

3,757

 

3,757

Additional paid-in capital

 

122,725

 

122,893

Retained earnings

 

78,260

 

68,915

Accumulated other comprehensive (loss) income

 

(229)

 

383

Treasury stock (2,701,799 shares in 2021 and 2,730,673 in 2020), at cost

 

(24,761)

 

(25,026)

Total stockholders’ equity

 

179,752

 

170,922

Total liabilities and stockholders’ equity

$

1,517,543

$

1,485,533

The accompanying notes are an integral part of the consolidated financial statements

3

Table of Contents

Hallmark Financial Services, Inc. and Subsidiaries

Consolidated Statements of Operations

(Unaudited)

($ in thousands, except per share amounts)

Three Months Ended March 31, 

    

2021

    

2020

Gross premiums written

$

163,018

$

201,589

Ceded premiums written

 

(69,871)

 

(75,084)

Net premiums written

 

93,147

 

126,505

Change in unearned premiums

 

11,071

 

(2,572)

Net premiums earned

 

104,218

 

123,933

Investment income, net of expenses

 

3,010

 

4,458

Investment gains (losses), net

 

5,779

 

(29,330)

Finance charges

 

1,133

 

1,644

Commission and fees

 

260

 

324

Other income

 

19

 

19

Total revenues

 

114,419

 

101,048

Losses and loss adjustment expenses

 

70,903

 

93,405

Operating expenses

 

30,441

 

29,148

Interest expense

 

1,249

 

1,468

Impairment of goodwill and other intangible assets

45,996

Amortization of intangible assets

 

126

 

617

Total expenses

 

102,719

 

170,634

Income (loss) before tax

 

11,700

 

(69,586)

Income tax expense (benefit)

 

2,355

 

(5,276)

Net income (loss)

9,345

(64,310)

Net income (loss) per share:

 

  

 

  

Basic

$

0.52

$

(3.55)

Diluted

$

0.52

$

(3.55)

The accompanying notes are an integral part of the consolidated financial statements

4

Table of Contents

Hallmark Financial Services, Inc. and Subsidiaries

Consolidated Statements of Comprehensive Income (Loss)

(Unaudited)

($ in thousands)

Three Months Ended

March 31,

    

2021

    

2020

Net income (loss)

$

9,345

$

(64,310)

Other comprehensive (loss) income:

 

  

 

  

Change in net actuarial gain

 

43

 

34

Tax effect on change in net actuarial gain

 

(9)

 

(7)

Unrealized holding gains (losses) arising during the period

 

585

 

(6,987)

Tax effect on unrealized holding (gains) losses arising during the period

 

(123)

 

1,467

Reclassification adjustment for gains included in net income (loss)

 

(1,403)

 

(5,636)

Tax effect on reclassification adjustment for gains included in net income (loss)

 

295

 

1,184

Other comprehensive loss, net of tax

 

(612)

 

(9,945)

Comprehensive income (loss)

$

8,733

$

(74,255)

The accompanying notes are an integral part of the consolidated financial statements

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Hallmark Financial Services, Inc. and Subsidiaries

Consolidated Statements of Stockholders’ Equity

(Unaudited)

($ in thousands)

Three Months Ended

March 31, 

    

2021

    

2020

Common Stock

    

  

    

  

Balance, beginning of period

$

3,757

$

3,757

Balance, end of period

 

3,757

 

3,757

Additional Paid-In Capital

 

 

  

Balance, beginning of period

 

122,893

 

123,468

Equity based compensation

 

97

 

(581)

Shares issued under employee benefit plans

 

(265)

 

(169)

Balance, end of period

 

122,725

 

122,718

Retained Earnings

 

  

 

  

Balance, beginning of period

 

68,915

 

160,570

Net income (loss)

 

9,345

 

(64,310)

Balance, end of period

 

78,260

 

96,260

Accumulated Other Comprehensive Income

 

  

 

  

Balance, beginning of period

 

383

 

688

Additional minimum pension liability, net of tax

 

34

 

27

Unrealized holding gains (losses) arising during period, net of tax

 

462

 

(5,520)

Reclassification adjustment for gains included in net income (loss), net of tax

 

(1,108)

 

(4,452)

Balance, end of period

 

(229)

 

(9,257)

Treasury Stock

 

  

 

  

Balance, beginning of period

 

(25,026)

 

(25,201)

Shares issued under employee benefit plans

 

265

 

169

Balance, end of period

 

(24,761)

 

(25,032)

Total Stockholders' Equity

$

179,752

$

188,446

The accompanying notes are an integral part of the consolidated financial statements

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Hallmark Financial Services, Inc. and Subsidiaries

Consolidated Statements of Cash Flows

(Unaudited)

($ in thousands)

Three Months Ended March 31,

2021

2020

Cash flows from operating activities:

  

 

  

 

Net income (loss)

$

9,345

$

(64,310)

Adjustments to reconcile net income (loss) to cash used in operating activities:

 

  

 

  

Depreciation and amortization expense

 

830

 

1,377

Deferred federal income taxes expense (benefit)

 

568

 

(4,804)

Investment (gains) losses , net

 

(5,779)

 

29,330

Share-based payments expense (benefit)

 

97

 

(581)

Impairment of goodwill and other intangibles

45,996

Change in ceded unearned premiums

 

4,720

 

12,925

Change in premiums receivable

 

10,533

 

8,068

Change in accounts receivable

 

1,342

 

474

Change in deferred policy acquisition costs

 

1,454

 

(2,593)

Change in reserves for losses and loss adjustment expenses

 

22,504

 

33,135

Change in unearned premiums

 

(15,791)

 

(10,353)

Change in reinsurance recoverable

 

(4,584)

 

(49,004)

Change in reinsurance balances

 

4,973

 

(1,321)

Change in federal income tax payable (recoverable)

 

1,787

 

(472)

Change in all other liabilities

 

515

 

(7,185)

Change in all other assets

 

(3,038)

 

(524)

Net cash provided by (used in) operating activities

 

29,476

 

(9,842)

Cash flows from investing activities:

 

  

 

  

Purchases of property and equipment

 

(64)

 

(433)

Purchases of investment securities

 

(27,829)

 

(144,398)

Maturities, sales and redemptions of investment securities

 

177,392

 

168,622

Net cash provided by investing activities

 

149,499

 

23,791

Increase in cash and cash equivalents and restricted cash

 

178,975

 

13,949

Cash and cash equivalents and restricted cash at beginning of period

 

108,308

 

54,948

Cash and cash equivalents and restricted cash at end of period

$

287,283

$

68,897

The accompanying notes are an integral part of the consolidated financial statements

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Hallmark Financial Services, Inc. and Subsidiaries

Notes to Consolidated Financial Statements (Unaudited)

1. General

Hallmark Financial Services, Inc. (“Hallmark” and, together with subsidiaries, the “Company”, “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 our insurance products, as well as providing other insurance related services.

We market, distribute, underwrite and service our property/casualty insurance products primarily through business units organized by products and distribution channels. Our business units are supported by our insurance company subsidiaries.  Our Commercial Auto business unit offers primary and excess commercial vehicle insurance products and services; our E&S Casualty business unit offers primary and excess liability, excess public entity liability, E&S package and garage liability insurance products and services; our E&S Property business unit offers primary and excess commercial property insurance for both catastrophe and non-catastrophe exposures; our Professional Liability business unit offers healthcare and financial lines professional liability insurance products and services primarily for businesses, medical professionals, medical facilities and , through 2020, senior care facilities; and our Aerospace & Programs business unit offers general aviation and, until exited during 2020, satellite launch property/casualty insurance products and services, as well as certain specialty programs.  Our Commercial Accounts business unit offers package and monoline property/casualty and, until exited in 2016, occupational accident insurance products. Our Specialty Personal Lines business unit offers non-standard personal automobile and renters insurance products and services.   Our former Workers Compensation operating unit specialized in small and middle market workers compensation business until discontinued during 2015. Our insurance company subsidiaries supporting these business units are American Hallmark Insurance Company of Texas (“AHIC”), Hallmark Insurance Company (“HIC”), Hallmark Specialty Insurance Company (“HSIC”), Hallmark County Mutual Insurance Company (“HCM”), Hallmark National Insurance Company (“HNIC”) and Texas Builders Insurance Company (“TBIC”).

These business units are segregated into three reportable industry segments for financial accounting purposes. The Specialty Commercial Segment includes our Commercial Auto business unit, E&S Casualty business unit, E&S Property business unit, Professional Liability business unit and Aerospace & Programs business unit. The Standard Commercial Segment consists of the Commercial Accounts business unit and the runoff from our former Workers Compensation operating unit. The Personal Segment consists solely of our Specialty Personal Lines business unit.

 

2. Basis of Presentation

Our unaudited consolidated financial statements included herein have been prepared in accordance with accounting principles generally accepted in the United States of America  (“GAAP”) and include our accounts and the accounts of our subsidiaries. All intercompany accounts and transactions have been eliminated in consolidation. Certain footnote disclosures normally included in financial statements prepared in accordance with GAAP have been condensed or omitted pursuant to rules and regulations of the Securities and Exchange Commission (“SEC”) for interim financial reporting. These unaudited consolidated financial statements should be read in conjunction with our audited consolidated financial statements for the year ended December 31, 2020 included in our Annual Report on Form 10-K filed with the SEC.

The interim financial data as of March 31, 2021 and 2020 is unaudited. However, in the opinion of management, the interim financial data includes all adjustments, consisting of normal recurring adjustments, necessary for a fair statement of the results for the interim periods. The results of operations for the period ended March 31, 2021 are not necessarily indicative of the operating results to be expected for the full year.

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Use of Estimates in the Preparation of the Financial Statements

Our preparation of financial statements in conformity with GAAP requires us to make estimates and assumptions that affect our reported amounts of assets and liabilities and our disclosure of contingent assets and liabilities at the date of our consolidated financial statements, as well as our reported amounts of revenues and expenses during the reporting period. Refer to “Critical Accounting Estimates and Judgments” under Item 7 of our Annual Report on Form 10-K for the year ended December 31, 2020 for information on accounting policies that we consider critical in preparing our consolidated financial statements. Actual results could differ materially from those estimates.

Fair Value of Financial Instruments

Fair value estimates are made at a point in time based on relevant market data as well as the best information available about the financial instruments. Fair value estimates for financial instruments for which no or limited observable market data is available are based on judgments regarding current economic conditions, credit and interest rate risk. These estimates involve significant uncertainties and judgments and cannot be determined with precision. As a result, such calculated fair value estimates may not be realizable in a current sale or immediate settlement of the instrument. In addition, changes in the underlying assumptions used in the fair value measurement technique, including discount rate and estimates of future cash flows, could significantly affect these fair value estimates.

Cash and Cash Equivalents:  The carrying amounts reported in the balance sheet for these instruments approximate their fair values.

Restricted Cash:  The carrying amount for restricted cash reported in the balance sheet approximates the fair value.

Senior Unsecured Notes Due 2029:  Our senior unsecured notes payable due in 2029 had a carrying value of $49.2 million and a fair value of $52.2 million as of March 31, 2021.   Our senior unsecured notes payable would be included in Level 3 of the fair value hierarchy if they were reported at fair value

Subordinated Debt Securities:  Our trust preferred securities had a carrying value of $55.9 million and a fair value of $30.3 million as of March 31, 2021. Our trust preferred securities would be included in Level 3 of the fair value hierarchy if they were reported at fair value.

For reinsurance balances, premiums receivable, federal income tax recoverable, other assets and other liabilities, the carrying amounts approximate fair value because of the short maturity of such financial instruments.

Variable Interest Entities

On June 21, 2005, we formed Hallmark Statutory Trust I (“Trust I”), an unconsolidated trust subsidiary, for the sole purpose of issuing $30.0 million in trust preferred securities. Trust I used the proceeds from the sale of these securities and our initial capital contribution to purchase $30.9 million of subordinated debt securities from Hallmark. The debt securities are the sole assets of Trust I, and the payments under the debt securities are the sole revenues of Trust I.

On August 23, 2007, we formed Hallmark Statutory Trust II (“Trust II”), an unconsolidated trust subsidiary, for the sole purpose of issuing $25.0 million in trust preferred securities. Trust II used the proceeds from the sale of these securities and our initial capital contribution to purchase $25.8 million of subordinated debt securities from Hallmark. The debt securities are the sole assets of Trust II, and the payments under the debt securities are the sole revenues of Trust II.

We evaluate on an ongoing basis our investments in Trust I and Trust II (collectively the “Trusts”) and have determined that we do not have a variable interest in the Trusts. Therefore, the Trusts are not included in our consolidated financial statements.

We are also involved in the normal course of business with variable interest entities primarily as a passive investor in mortgage-backed securities and certain collateralized corporate bank loans issued by third-party variable interest

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entities. The maximum exposure to loss with respect to these investments is limited to the investment carrying values included in the consolidated balance sheets.

Income Taxes

We file a consolidated federal income tax return. Deferred federal income taxes reflect the future tax consequences of differences between the tax basis of assets and liabilities and their financial reporting amounts at each year end. Deferred taxes are recognized using the liability method, whereby tax rates are applied to cumulative temporary differences based on when and how they are expected to affect the tax return. Deferred tax assets and liabilities are adjusted for tax rate changes in effect for the year in which these temporary differences are expected to be recovered or settled.

Recently Adopted Accounting Pronouncements

In December 2019, the FASB issued updated guidance for the accounting for income taxes.  The updated guidance is intended to simplify the accounting for income taxes by removing several exceptions contained in the existing guidance and amending other existing guidance to simplify several other income tax accounting matters.  The updated guidance is effective for the quarter ending March 31, 2021.  The adoption of this guidance did not have a material effect on the Company’s results of operations, financials position or liquidity.

Recently Issued Accounting Pronouncements

In March 2020, the FASB issued ASU 2020-04, Reference Rate Reform ("ASU 2020-04"). ASU 2020-04 provides optional guidance for a limited period of time to ease potential accounting impact associated with transitioning away from reference rates that are expected to be discontinued, such as the London Interbank Offered Rate ("LIBOR"). The amendments in this ASU apply only to contracts, hedging relationships, and other transactions that reference LIBOR or another reference rate expected to be discontinued. The amendments in ASU 2020-04 can be adopted as of March 12, 2020 and are effective through December 31, 2022. We do not currently have any contracts that have been changed to a new reference rate, but we will continue to evaluate our contracts and the effects of this standard on our condensed consolidated financial statements prior to adoption.

In June 2016, the FASB issued ASU 2016-13, “Measurement of Credit Losses on Financial Instruments” (Topic 326). ASU 2016-13 requires organizations to estimate credit losses on certain types of financial instruments, including receivables and available-for-sale debt securities, by introducing an approach based on expected losses. The expected loss approach will require entities to incorporate considerations of historical information, current information and reasonable and supportable forecasts. As a smaller reporting company, ASU 2016-13 is effective for fiscal years of the Company beginning after December 15, 2022, including interim periods within those fiscal years.  ASU 2016-13 requires a modified retrospective transition method and early adoption is permitted. We are currently evaluating the impact that the adoption of this standard will have on our financial results and disclosures, but do not anticipate that any potential impact will be material.  

3. Acquisitions, Goodwill and Intangible Assets

In connection with its normal process for evaluating impairment triggering events, the Company determined that a significant decline in its market capitalization below its stockholders’ equity during the first quarter of 2020  indicated the impairment of the goodwill and indefinite-lived intangible assets included in its balance sheet.  As a result, the Company took a $44.7 million charge to goodwill and a $1.3 million charge to indefinite-lived intangible assets during the first quarter of 2020. As of March 31, 2021 there was no goodwill or indefinite-lived intangibles reported on our  consolidated balance sheet.

4. Fair Value

ASC 820 defines fair value, establishes a consistent framework for measuring fair value and expands disclosure requirements about fair value measurements. ASC 820, among other things, requires us to maximize the use of observable

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inputs and minimize the use of unobservable inputs when measuring fair value. In addition, ASC 820 precludes the use of block discounts when measuring the fair value of instruments traded in an active market, which were previously applied to large holdings of publicly traded equity securities.

We determine the fair value of our financial instruments based on the fair value hierarchy established in ASC 820. In accordance with ASC 820, we utilize the following fair value hierarchy:

Level 1: quoted prices in active markets for identical assets;
Level 2: inputs to the valuation methodology include quoted prices for similar assets and liabilities in active markets, inputs of identical assets for less active markets, and inputs that are observable for the asset or liability, either directly or indirectly, for substantially the full term of the instrument; and
Level 3: inputs to the valuation methodology that are unobservable for the asset or liability.

This hierarchy requires the use of observable market data when available.

Under ASC 820, we determine fair value based on the price that would be received for an asset or paid to transfer a liability in an orderly transaction between market participants on the measurement date. It is our policy to maximize the use of observable inputs and minimize the use of unobservable inputs when developing fair value measurements, in accordance with the fair value hierarchy described above. Fair value measurements for assets and liabilities where there exists limited or no observable market data are calculated based upon our pricing policy, the economic and competitive environment, the characteristics of the asset or liability and other factors as appropriate. These estimated fair values may not be realized upon actual sale or immediate settlement of the asset or liability.

Where quoted prices are available on active exchanges for identical instruments, investment securities are classified within Level 1 of the valuation hierarchy. Level 1 investment securities include equity securities.

Level 2 investment securities include corporate bonds, collateralized corporate bank loans, municipal bonds, U.S. Treasury securities, other obligations of the U.S. Government and mortgage-backed securities for which quoted prices are not available on active exchanges for identical instruments. We use third-party pricing services to determine fair values for each Level 2 investment security in all asset classes. Since quoted prices in active markets for identical assets are not available, these prices are determined using observable market information such as quotes from less active markets and/or quoted prices of securities with similar characteristics, among other things. We have reviewed the processes used by the pricing services and have determined that they result in fair values consistent with the requirements of ASC 820 for Level 2 investment securities. We have not adjusted any prices received from third-party pricing sources. There were no transfers between Level 1 and Level 2 securities.

In cases where there is limited activity or less transparency around inputs to the valuation, investment securities are classified within Level 3 of the valuation hierarchy. Level 3 investments are valued based on the best available data in order to approximate fair value. This data may be internally developed and consider risk premiums that a market participant would require. Investment securities classified within Level 3 include other less liquid investment securities.

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The following table presents, for each of the fair value hierarchy levels, assets that are measured at fair value on a recurring basis at March 31, 2021 and December 31, 2020 (in thousands):

As of March 31, 2021

    

Quoted Prices in

    

    

    

Active Markets for

Identical Assets

Other Observable

Unobservable

    

(Level 1)

    

Inputs (Level 2)

    

Inputs (Level 3)

    

Total

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

$

$

45,407

$

$

45,407

Corporate bonds

 

 

191,186

 

354

 

191,540

Corporate bank loans

 

 

59,600

 

 

59,600

Municipal bonds

 

 

48,588

 

 

48,588

Mortgage-backed

 

 

3,390

 

 

3,390

Total debt securities

 

 

348,171

 

354

 

348,525

Total equity securities

 

53,621

 

 

 

53,621

Total investments

$

53,621

$

348,171

$

354

$

402,146

As of December 31, 2020

    

Quoted Prices in

    

    

    

Active Markets for

Identical Assets

Other Observable

Unobservable

    

(Level 1)

    

Inputs (Level 2)

    

Inputs (Level 3)

    

Total

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

$

$

179,746

$

$

179,746

Corporate bonds

 

 

219,020

 

348

 

219,368

Corporate bank loans

 

 

52,782

 

 

52,782

Municipal bonds

 

 

50,539

 

 

50,539

Mortgage-backed

 

 

4,844

 

 

4,844

Total debt securities

 

 

506,931

 

348

 

507,279

Total equity securities

 

29,388

 

 

 

29,388

Total investments

$

29,388

$

506,931

$

348

$

536,667

Due to significant unobservable inputs into the valuation model for one corporate bond as of March 31, 2021 and December 31, 2020, we classified this investment as Level 3 in the fair value hierarchy. The corporate bond is a convertible senior note and its fair value was estimated by the sum of the bond value using an income approach discounting the scheduled interest and principal payments and the conversion feature utilizing a binomial lattice model.

The following table summarizes the changes in fair value for all financial assets measured at fair value on a recurring basis using significant unobservable inputs (Level 3) during the three months ended March 31, 2021 and 2020 (in thousands):

Beginning balance as of January 1, 2021

    

$

348

Sales

 

Settlements

 

Purchases

 

Issuances

 

Total realized/unrealized losses included in net income

 

6

Net gain included in other comprehensive income

 

Transfers into Level 3

 

Transfers out of Level 3

 

Ending balance as of March 31, 2021

$

354

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Beginning balance as of January 1, 2020

    

$

339

Sales

 

Settlements

 

Purchases

 

Issuances

 

Total realized/unrealized gains included in net loss

 

(61)

Net gains included in other comprehensive loss

 

Transfers into Level 3

 

Transfers out of Level 3

 

Ending balance as of March 31, 2020

$

278

5. Investments

The amortized cost and estimated fair value of investments in debt and equity securities by category is as follows (in thousands):

    

    

Gross

    

Gross

    

Amortized Cost/

Unrealized

Unrealized

    

Carrying Value

    

Gains

    

Losses

    

Fair Value

As of March 31, 2021

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

$

45,088

$

320

$

(1)

$

45,407

Corporate bonds

 

187,405

 

4,258

 

(123)

 

191,540

Corporate bank loans

 

60,330

 

7

 

(737)

 

59,600

Municipal bonds

 

48,027

 

607

 

(46)

 

48,588

Mortgage-backed

 

3,382

 

70

 

(62)

 

3,390

Total debt securities

 

344,232

 

5,262

 

(969)

 

348,525

Total equity securities

 

46,847

 

8,974

 

(2,200)

 

53,621

Total investments

$

391,079

$

14,236

$

(3,169)

$

402,146

    

Gross

    

Gross

    

Amortized Cost/

Unrealized

Unrealized

As of December 31, 2020

 

Carrying Value

    

Gains

    

Losses

    

Fair Value

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

$

179,259

$

487

$

$

179,746

Corporate bonds

 

214,666

 

5,086

 

(384)

 

219,368

Corporate bank loans

 

53,650

 

3

 

(871)

 

52,782

Municipal bonds

 

49,833

 

756

 

(50)

 

50,539

Mortgage-backed

 

4,759

 

114

 

(29)

 

4,844

Total debt securities

 

502,167

 

6,446

 

(1,334)

 

507,279

Total equity securities

 

26,988

 

5,648

 

(3,248)

 

29,388

Total investments

$

529,155

$

12,094

$

(4,582)

$

536,667

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Major categories of net investment gains (losses) on investments are summarized as follows (in thousands):

Three Months Ended March 31, 

    

2021

    

2020

    

Corporate bonds

$

197

$

55

Corporate bank loans

 

51

 

(148)

Municipal bonds

 

(9)

 

1,420

Equity securities

 

1,164

 

4,309

Gain on investments

 

1,403

 

5,636

Unrealized (losses) gains on other investments

 

 

(2,001)

Unrealized gain (losses) on equity investments

4,376

(32,965)

Investment gains (losses), net

$

5,779

$

(29,330)

We realized gross gains on investments of $1.5 million and $20.4 million during the three months ended March 31, 2021 and 2020, respectively. We realized gross losses on investments of $0.1 million and $14.8 million for the three months ended March 31, 2021 and 2020, respectively. We recorded proceeds from the sale of investment securities of $1.2 million and $100.8 million during the three months ended March 31, 2021 and 2020 respectively. Realized investment gains and losses are recognized in operations on the first in-first out method.

The following schedules summarize the gross unrealized losses showing the length of time that investments have been continuously in an unrealized loss position as of March 31, 2021 and December 31, 2020 (in thousands):

As of March 31, 2021

12 months or less

Longer than 12 months

Total

    

    

Unrealized

    

    

Unrealized

    

    

Unrealized

    

Fair Value

    

Losses

    

Fair Value

    

Losses

    

Fair Value

    

Losses

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

$

2,950

$

(1)

$

$

$

2,950

$

(1)

Corporate bonds

 

1,819

 

(5)

 

3,244

 

(118)

 

5,063

 

(123)

Corporate bank loans

 

22,011

 

(104)

 

25,118

 

(633)

 

47,129

 

(737)

Municipal bonds

 

2,720

 

(27)

 

1,464

 

(19)

 

4,184

 

(46)

Mortgage-backed

 

368

 

(57)

 

13

 

(5)

 

381

 

(62)

Total debt securities

 

29,868

 

(194)

 

29,839

 

(775)

 

59,707

 

(969)

Total equity securities

 

8,118

 

(635)

6,538

(1,565)

14,656

 

(2,200)

Total investments

$

37,986

$

(829)

$

36,377

$

(2,340)

$

74,363

$

(3,169)

As of December 31, 2020

12 months or less

Longer than 12 months

Total

    

    

Unrealized

    

    

Unrealized

    

    

Unrealized

    

Fair Value

    

Losses

    

Fair Value

    

Losses

    

Fair Value

    

Losses

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

$

$

$

$

$

$

Corporate bonds

 

7,801

 

(186)

 

3,556

 

(198)

 

11,357

 

(384)

Corporate bank loans

 

45,233

 

(559)

 

4,144

 

(312)

 

49,377

 

(871)

Municipal bonds

 

2,859

 

(33)

 

1,154

 

(17)

 

4,013

 

(50)

Mortgage-backed

 

635

 

(25)

 

14

 

(4)

 

649

 

(29)

Total debt securities

 

56,528

 

(803)

 

8,868

 

(531)

 

65,396

 

(1,334)

Total equity securities

 

9,572

 

(1,610)

 

1,848

 

(1,638)

 

11,420

 

(3,248)

Total investments

$

66,100

$

(2,413)

$

10,716

$

(2,169)

$

76,816

$

(4,582)

We had a total of 90 debt securities with an unrealized loss, of which 49 were in an unrealized loss position for less than one year and 41 were in an unrealized loss position for a period of one year or greater, as of March 31, 2021.  We held a total of 81 debt securities with an unrealized loss, of which 64 were in an unrealized loss position for less than one year and 17 were in an unrealized loss position for a period of one year or greater, as of December 31, 2020. We consider these losses as a temporary decline in value as they are predominately on securities that we do not intend to sell and do not

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believe we will be required to sell prior to recovery of our amortized cost basis. The gross unrealized losses on the debt security positions at March 31, 2021 and December 31, 2020 were due predominately to market and interest rate fluctuations and we see no other indications that the decline in values of these securities is other-than-temporary.

Based on evidence gathered through our normal credit evaluation process, we presently expect that all debt securities held in our investment portfolio will be paid in accordance with their contractual terms. Nonetheless, it is at least reasonably possible that the performance of certain issuers of these debt securities will be worse than currently expected resulting in future write-downs within our portfolio of debt securities.

We complete a detailed analysis each quarter to assess whether any decline in the fair value of any debt security below cost is deemed other-than-temporary. All debt securities with an unrealized loss are reviewed. We recognize an impairment loss when a debt security’s value declines below cost, adjusted for accretion, amortization and previous other-than-temporary impairments and it is determined that the decline is other-than-temporary.  We did not recognize any impairment loss on debt securities during the three months ended March 31, 2021 or 2020.

Debt Investments: We assess whether we intend to sell, or it is more likely than not that we will be required to sell, a fixed maturity investment before recovery of its amortized cost basis less any current period credit losses. For fixed maturity investments that are considered other-than-temporarily impaired and that we do not intend to sell and will not be required to sell, we separate the amount of the impairment into the amount that is credit related (credit loss component) and the amount due to all other factors. The credit loss component is recognized in earnings and is the difference between the investment’s amortized cost basis and the present value of its expected future cash flows. The remaining difference between the investment’s fair value and the present value of future expected cash flows is recognized in other comprehensive income. During the three months ended March 31, 2021 or 2020 we did not dispose of any previously impaired securities.

Equity Investments: Equity investments that are not consolidated or accounted for under the equity method of accounting with readily determinable fair values are not required to be evaluated for other-than-temporary-impairment.

The amortized cost and estimated fair value of debt securities at March 31, 2021 by contractual maturity are as follows. Expected maturities may differ from contractual maturities because certain borrowers may have the right to call or prepay obligations with or without penalties.

    

Amortized Cost

    

Fair Value

(in thousands)

Due in one year or less

$

150,383

$

151,762

Due after one year through five years

 

140,739

 

143,504

Due after five years through ten years

 

32,369

 

32,165

Due after ten years

 

17,359

 

17,704

Mortgage-backed

 

3,382

 

3,390

$

344,232

$

348,525

6. Pledged Investments

We have pledged certain of our securities for the benefit of various state insurance departments and reinsurers. These securities are included with our available-for-sale debt securities because we have the ability to trade these securities. We retain the interest earned on these securities. These securities had a carrying value of $20.9 million and $29.7 million at March 31, 2021 and December 31, 2020, respectively.

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7. Reserves for Unpaid Losses and Loss Adjustment Expenses

Year to-date activity in the consolidated reserves for unpaid losses and LAE is summarized as follows (in thousands):