Quarterly Report (10-q)

Date : 08/13/2019 @ 9:07PM
Source : Edgar (US Regulatory)
Stock : National Security Group Inc (NSEC)
Quote : 12.1  -0.77 (-5.98%) @ 8:52PM
National Security share price Chart

Quarterly Report (10-q)


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 June 30, 2019

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

IMAGE1A01A19.JPG
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, 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      o                          Accelerated filer           o  
Non-accelerated filer       þ                          Smaller reporting company       þ
Emerging growth company      o

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 12(a) of the Exchange Act.      o

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 August 13, 2019, there were 2,531,552 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 Operations
 
 
Condensed Consolidated Statements of Comprehensive Income (Loss)
 
 
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. Company insurance rates are also subject to approval by state insurance departments in each of these states. We are often limited in the level of rate increases we can obtain.

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)
 
 
June 30,
2019
 
December 31, 2018
 
 
(UNAUDITED)
 
 
ASSETS
 
 
 
 
Investments
 
 
 
 
Fixed maturities held-to-maturity, at amortized cost (estimated fair value: 2019 -
      $1,442; 2018 - $1,443)
 
$
1,388

 
$
1,449

Fixed maturities available-for-sale, at estimated fair value (cost: 2019 -
      $100,084; 2018 - $96,877)
 
102,744

 
95,125

Equity securities, at estimated fair value (cost: 2019 - $1,849; 2018 - $1,842)
 
4,465

 
4,306

Trading securities
 
141

 
107

Mortgage loans on real estate, at cost
 
151

 
156

Investment real estate, at book value
 
2,934

 
2,945

Policy loans
 
1,876

 
1,854

Company owned life insurance
 
4,631

 
4,600

Other invested assets
 
2,217

 
2,148

Total Investments
 
120,547

 
112,690

Cash and cash equivalents
 
5,627

 
5,676

Accrued investment income
 
757

 
774

Policy receivables and agents' balances, net
 
13,145

 
11,185

Reinsurance recoverable
 
326

 
1,772

Deferred policy acquisition costs
 
7,895

 
7,834

Property and equipment, net
 
1,590

 
1,649

Income tax recoverable
 
993

 
1,463

Deferred income tax asset, net
 

 
716

Other assets
 
978

 
472

Total Assets
 
$
151,858

 
$
144,231

LIABILITIES AND SHAREHOLDERS' EQUITY
 
 

 
 

Property and casualty benefit and loss reserves
 
$
7,020

 
$
8,208

Accident and health benefit and loss reserves
 
3,772

 
3,803

Life and annuity benefit and loss reserves
 
33,990

 
33,671

Unearned premiums
 
32,283

 
29,999

Policy and contract claims
 
887

 
792

Other policyholder funds
 
1,480

 
1,515

Short-term notes payable and current portion of long-term debt
 
2,200

 
2,200

Long-term debt
 
12,158

 
12,152

Deferred income tax liability
 
53

 

Other liabilities
 
6,962

 
6,025

Total Liabilities
 
100,805

 
98,365

Contingencies
 


 


Shareholders' equity
 
 

 
 

Common stock
 
2,532

 
2,527

Additional paid-in capital
 
5,602

 
5,554

Accumulated other comprehensive income (loss)
 
1,961

 
(1,570
)
Retained earnings
 
40,958

 
39,355

Total Shareholders' Equity
 
51,053

 
45,866

Total Liabilities and Shareholders' Equity
 
$
151,858

 
$
144,231

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

4


THE NATIONAL SECURITY GROUP, INC.
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS (UNAUDITED)
(In thousands, except per share amounts)

 
Three months ended
June 30,
 
Six months ended
June 30,
 
2019
 
2018
 
2019
 
2018
REVENUES
 
 
 
 
 
 
 
Net premiums earned
$
14,990

 
$
15,260

 
$
29,708

 
$
30,319

Net investment income
957

 
995

 
1,919

 
1,915

Investment gains (losses)
117

 
(200
)
 
2,237

 
(464
)
Other income
146

 
148

 
292

 
309

Total Revenues
16,210

 
16,203

 
34,156

 
32,079

BENEFITS, LOSSES AND EXPENSES
 

 
 

 
 

 
 

Policyholder benefits and settlement expenses
10,900

 
9,772

 
19,923

 
19,199

Amortization of deferred policy acquisition costs
839

 
787

 
1,819

 
1,590

Commissions
1,978

 
1,732

 
4,011

 
3,792

General and administrative expenses
2,416

 
2,668

 
4,748

 
4,671

Taxes, licenses and fees
599

 
349

 
1,286

 
998

Interest expense
291

 
309

 
586

 
611

Total Benefits, Losses and Expenses
17,023

 
15,617

 
32,373

 
30,861

 
 
 
 
 
 
 
 
Income (Loss) Before Income Taxes
(813
)
 
586

 
1,783

 
1,218

 
 
 
 
 
 
 
 
INCOME TAX EXPENSE (BENEFIT)
 

 
 

 
 

 
 

Current
(148
)
 
216

 
97

 
(318
)
Deferred
(78
)
 
(87
)
 
(170
)
 
608

 
(226
)
 
129

 
(73
)
 
290

 
 
 
 
 
 
 
 
Net Income (Loss)
$
(587
)
 
$
457

 
$
1,856

 
$
928

 
 
 
 
 
 
 
 
INCOME (LOSS) PER COMMON SHARE BASIC AND DILUTED
$
(0.23
)
 
$
0.18

 
$
0.73

 
$
0.37

 
 
 
 
 
 
 
 
DIVIDENDS DECLARED PER SHARE
$
0.05

 
$
0.05

 
$
0.10

 
$
0.10


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


5


THE NATIONAL SECURITY GROUP, INC.
CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (LOSS) (UNAUDITED)
(In thousands)

 
Three months ended
June 30,
 
Six months ended
June 30,
 
2019
 
2018
 
2019

2018
 
 
 
 
 
 
 
 
Net income (loss)
$
(587
)
 
$
457

 
$
1,856

 
$
928

 
 
 
 
 

 
 
Other comprehensive income (loss), net of tax
 
 
 
 
 
 
 
Changes in:
 
 
 
 
 
 
 
Unrealized gains (losses) on securities, net of reclassification adjustment of $12 and $102 for 2019 and 2018, respectively
1,752

 
(811
)
 
3,486

 
(2,187
)
Unrealized gain on interest rate swap
20

 
75

 
45

 
207

 
 
 
 
 
 
 
 
Other comprehensive income (loss), net of tax
1,772

 
(736
)
 
3,531

 
(1,980
)
 
 
 
 
 
 
 
 
Comprehensive income (loss)
$
1,185

 
$
(279
)
 
$
5,387

 
$
(1,052
)

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 (Loss)
 
Common
Stock
 
Additional
Paid-in
Capital
Balance at December 31, 2018
$
45,866

 
$
39,355

 
$
(1,570
)
 
$
2,527

 
$
5,554

 
 
 
 
 
 
 
 
 
 
Comprehensive income:
 

 
 

 
 

 
 

 
 

 
 
 
 
 
 
 
 
 
 
Net income for June 30, 2019
1,856

 
1,856

 

 

 

 
 
 
 
 
 
 
 
 
 
Other comprehensive income (net of tax)
3,531

 

 
3,531

 

 

 
 
 
 
 
 
 
 
 
 
Common stock issued
53

 

 

 
5

 
48

 
 
 
 
 
 
 
 
 
 
Cash dividends
(253
)
 
(253
)
 

 

 

 
 
 
 
 
 
 
 
 
 
Balance at June 30, 2019
$
51,053

 
$
40,958

 
$
1,961

 
$
2,532

 
$
5,602


 
Total
 
Retained
Earnings
 
Accumulated
Other
Comprehensive
Income (Loss)
 
Common
Stock
 
Additional
Paid-in
Capital
Balance at December 31, 2017
$
47,625

 
$
36,974

 
$
2,646

 
$
2,522

 
$
5,483

 
 
 
 
 
 
 
 
 
 
Cumulative effect of change in accounting principle

 
2,107

 
(2,107
)
 

 

 
 
 
 
 
 
 
 
 
 
Comprehensive income:
 

 
 

 
 

 
 

 
 

 
 
 
 
 
 
 
 
 
 
Net income for June 30, 2018
928

 
928

 

 

 

 
 
 
 
 
 
 
 
 
 
Other comprehensive loss (net of tax)
(1,980
)
 

 
(1,980
)
 

 

 
 
 
 
 
 
 
 
 
 
Common stock issued
76

 

 

 
5

 
71

 
 
 
 
 
 
 
 
 
 
Cash dividends
(252
)
 
(252
)
 

 

 

 
 
 
 
 
 
 
 
 
 
Balance at June 30, 2018
$
46,397

 
$
39,757

 
$
(1,441
)
 
$
2,527

 
$
5,554



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






7


THE NATIONAL SECURITY GROUP, INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)
(In thousands)
 
Six months ended
June 30,
 
2019
 
2018
Cash Flows from Operating Activities
 
 
 
Net income
$
1,856

 
$
928

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

Depreciation expense and amortization/accretion, net
143

 
169

Net (gains) losses on investments
(2,237
)
 
464

Deferred income taxes
(170
)
 
608

Amortization of deferred policy acquisition costs
1,819

 
1,590

Changes in assets and liabilities:
 
 
 
Change in accrued investment income
17

 
(40
)
Change in reinsurance recoverable
1,446

 
88

Policy acquisition costs deferred
(1,880
)
 
(1,606
)
Change in accrued income taxes
470

 
(318
)
Change in net policy liabilities and claims
(485
)
 
800

Change in other assets/liabilities, net
472

 
(270
)
Other, net
5

 
5

Net cash provided by operating activities
1,456

 
2,418

Cash Flows from Investing Activities
 
 
 

Purchase of:
 
 
 
Available-for-sale securities
(9,925
)
 
(10,579
)
Trading securities and short-term investments
(26
)
 

Property and equipment
(3
)
 
(8
)
Proceeds from sale or maturities of:
 
 
 
Held-to-maturity securities
62

 
99

Available-for-sale securities
6,650

 
6,570

Real estate held for investment
11

 
188

Other invested assets, net
2,014

 
(39
)
Net cash used in investing activities
(1,217
)
 
(3,769
)
Cash Flows from Financing Activities
 

 
 

Change in other policyholder funds
(35
)
 
2

Change in short-term notes payable

 
(500
)
Dividends paid
(253
)
 
(252
)
Net cash used in financing activities
(288
)
 
(750
)
Net change in cash and cash equivalents
(49
)
 
(2,101
)
Cash and cash equivalents, beginning of year
5,676

 
6,644

Cash and cash equivalents, end of period
$
5,627

 
$
4,543

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 AMOUNTS EXCEPT FOR DECEMBER 31, 2018 AMOUNTS)



NOTE 1 – SIGNIFICANT ACCOUNTING POLICIES AND PRACTICES

Principles of Consolidation and Basis of Presentation
The accompanying 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 consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States (GAAP).  In the opinion of management, all adjustments, consisting of normal and recurring items, necessary for the fair presentation of the consolidated financial statements have been included. All significant intercompany transactions and accounts have been eliminated in the consolidated financial statements. 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, 2018, 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 consolidated financial statements and the reported amounts of revenues and expenses during the reporting period. Among the more significant estimates included in these 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 the estimates used in preparing these consolidated financial statements.

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 2,528,233 at June 30, 2019 and 2,523,484 at June 30, 2018 . The Company did no t have any dilutive securities as of June 30, 2019 and 2018.

Reclassifications
Certain 2018 amounts have been reclassified from the prior year consolidated financial statements to conform to the 2019 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 June 30, 2019 , the net amount exceeding FDIC insured limits was $ 4,362,000 at three financial institutions. 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 June 30, 2019 , the single largest balance due from one agent totaled $805,000 .

Reinsurance contracts do not relieve the Company of its obligations to policyholders. A failure of a reinsurer to meet its obligation could result in losses to the insurance subsidiaries. Allowances for losses on reinsurance recoverables are established if amounts are believed to be uncollectible. At June 30, 2019 and December 31, 2018, 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 June 30, 2019 , 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 AMOUNTS EXCEPT FOR DECEMBER 31, 2018 AMOUNTS)


Accounting Changes Not Yet Adopted
Changes to the Disclosure Requirements for Fair Value Measurement
In August 2018, the FASB issued guidance to that removes, modifies and adds to the disclosure requirements related to fair value measurements. The guidance removes the requirements to disclose the amount and reasons for transfers between Level 1 and Level 2 assets, the policy for timing and transfers between levels and the valuation process for Level 3 fair value measurements. The guidance modifies disclosure requirements for investments in certain entities that calculate net asset value and clarifies the purpose of the measurement uncertainty disclosure. The guidance adds requirements to disclose changes in unrealized gains or losses included in other comprehensive income for recurring Level 3 fair value measurements and to disclose the range and weighted average used to develop significant unobservable inputs for Level 3 fair value measurements. The guidance is effective for fiscal years beginning after December 15, 2019 and interim periods within those fiscal years. The Company does not expect the adoption to have a material impact on its financial position or results of operations.

Targeted Improvements to the Accounting for Long-Duration Contracts
In August 2018, the FASB issued guidance to improve the existing recognition, measurement, presentation and disclosure requirements for long-duration contracts issued by an insurance entity. The guidance improves timeliness of recognizing changes in the liability for future policy benefits and modifies the rate used to discount future cash flows. The guidance will simplify and improve accounting for certain market-based options or guarantees associated with deposit type contracts and simplify the amortization of deferred policy acquisition costs. The guidance also introduces certain financial statement presentation requirements, as well as significant additional quantitative and qualitative disclosures. The guidance is effective for fiscal years beginning after December 15, 2020 and interim periods within those fiscal years. Early adoption is permitted. The Company is currently evaluating the impact of this new guidance. Due to the nature and extent of the changes required to the Company’s life insurance operations, the adoption of this standard is expected to have a material impact on the consolidated financial statements.

Contingent Put and Call Options in Debt Instruments
In March 2016, the FASB issued guidance that clarifies the requirements for assessing whether contingent call (put) options that can accelerate the payment of principal on debt instruments are clearly and closely related to their debt hosts. This guidance is effective for fiscal years beginning after December 15, 2019, including interim periods within those years. The Company does not expect the adoption to have a material impact on its financial position or results of operations.

Financial Instruments - Credit Losses
In June 2016, the FASB issued guidance that replaces the incurred loss impairment methodology in current GAAP with a methodology that reflects expected credit losses and requires consideration of a broader range of reasonable and supportable information to inform credit loss estimates. The FASB released additional guidance in November 2018 that provides scope clarification. This guidance is effective for fiscal years beginning after December 15, 2019, including interim periods within those years. The Company does not expect the adoption to have a material impact on its financial position or results of operations.

Recently Adopted Accounting Standards
Improvements to Nonemployee Share-Based Payment Accounting
In June 2018, the FASB issued guidance to simplify the accounting for nonemployee share-based payment awards. The guidance is effective for fiscal years beginning after December 15, 2018, including interim periods within that fiscal year. The Company does not make any material share-based payments. The Company adopted this guidance on January 1, 2019. The adoption of this guidance did not have a material impact on its financial position or results of operations.
             
Derivatives and Hedging
In August 2017, the FASB issued guidance that amends and simplifies hedge accounting guidance in order to enable entities to better portray the economic results of their risk management activities. The guidance is effective for fiscal years beginning after December 15, 2018, including interim periods within those periods. Early adoption is permitted. The Company adopted this guidance on January 1, 2019 and had two swaps designated as cash flow hedges. One expired March 15, 2019 and one expires March 15, 2020. The adoption of this guidance did not have a significant impact on our financial position, results of operations, cash flows or related disclosures.

10


THE NATIONAL SECURITY GROUP, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED AMOUNTS EXCEPT FOR DECEMBER 31, 2018 AMOUNTS)


Leases
In February 2016, the FASB issued guidance that requires lessees (for capital and operating leases) to recognize the lease liability and right-of-use (ROU) asset at the commencement date of the lease. Additional transition guidance was issued in 2018 and 2019. This guidance is effective for fiscal years beginning after December 15, 2018, including interim periods within those years.

The Company adopted this guidance on January 1, 2019 and recorded a ROU asset of $299,000 and corresponding lease liability of $306,000 . The ROU asset and operating lease liability are included in other assets and other liabilities, respectively, on our Condensed Consolidated Balance Sheets as of January 1, 2019. The Company elected the package of practical expedients permitted under the guidance, which allowed the Company to account for existing leases under their current classification, as well as omit any new costs classified as initial direct costs, under the new guidance. Based on this election, the Company kept existing agreements as operating leases. The Company also elected the practical expedient allowing an accounting policy election by class of underlying asset, to account for separate lease and nonlease components as a single lease component.

The Company leases automobiles and some office equipment. These leases are not considered material. Adoption of this guidance had no material impact on the Company's financial position, results of operations, cash flows or related disclosures.

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 $116,000 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 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 $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.


11


THE NATIONAL SECURITY GROUP, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED AMOUNTS EXCEPT FOR DECEMBER 31, 2018 AMOUNTS)


NOTE 3 – INVESTMENTS

Our investment in available-for-sale securities, which are reported at fair value, includes fixed maturity securities and equity securities. Net unrealized gains or losses on equity securities prior to January 1, 2018, and on fixed maturities are reported after-tax as a component of other comprehensive income. As of January 1, 2018, changes in fair value of equity securities are reported in investment gains/losses as a component of net income.

The amortized cost and aggregate fair values of investments in available-for-sale securities as of June 30, 2019 are as follows ( dollars in thousands ):
Available-for-sale securities:
 
Amortized
Cost
 
Gross
Unrealized
Gains
 
Gross
Unrealized
Losses
 
Fair
Value
U.S. Government corporations and agencies
 
$
4,164

 
$
128

 
$
19

 
$
4,273

Agency mortgage backed securities
 
31,662

 
1,101

 
119

 
32,644

Asset backed securities
 
11,176

 
37

 
170

 
11,043

Private label mortgage backed securities
 
7,164

 
456

 

 
7,620

Corporate bonds
 
37,035

 
1,321

 
248

 
38,108

States, municipalities and political subdivisions
 
8,071

 
133

 
2

 
8,202

Foreign governments
 
812

 
42

 

 
854

Total fixed maturities
 
100,084

 
3,218

 
558

 
102,744

Equity securities
 
1,849

 
2,616

 

 
4,465

Total
 
$
101,933

 
$
5,834

 
$
558

 
$
107,209


The amortized cost and aggregate fair values of investments in held-to-maturity securities as of June 30, 2019 are as follows ( dollars in thousands ):
Held-to-maturity securities:
 
Amortized
Cost
 
Gross
Unrealized
Gains
 
Gross
Unrealized
Losses
 
Fair
Value
Agency mortgage backed securities
 
$
1,388

 
$
54

 
$

 
$
1,442

Total
 
$
1,388

 
$
54

 
$

 
$
1,442


The amortized cost and aggregate fair values of investments in available-for-sale securities as of December 31, 2018 are as follows ( dollars in thousands ):

Available-for-sale securities:
 
Amortized
Cost
 
Gross
Unrealized
Gains
 
Gross
Unrealized
Losses
 
Fair
Value
U.S. Government corporations and agencies
 
$
4,820

 
$
31

 
$
107

 
$
4,744

Agency mortgage backed securities
 
27,492

 
159

 
545

 
27,106

Asset backed securities
 
10,901

 
7

 
248

 
10,660

Private label mortgage backed securities
 
5,869

 
105

 
27

 
5,947

Corporate bonds
 
36,935

 
407

 
1,551

 
35,791

States, municipalities and political subdivisions
 
10,059

 
105

 
91

 
10,073

Foreign governments
 
801

 
3

 

 
804

Total fixed maturities
 
96,877

 
817

 
2,569

 
95,125

Equity securities
 
1,842

 
2,464

 

 
4,306

Total
 
$
98,719

 
$
3,281

 
$
2,569

 
$
99,431



12


THE NATIONAL SECURITY GROUP, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED AMOUNTS EXCEPT FOR DECEMBER 31, 2018 AMOUNTS)


The amortized cost and aggregate fair values of investments in held-to-maturity securities as of December 31, 2018 are as follows ( dollars in thousands ):

Held-to-maturity securities:
 
Amortized
Cost
 
Gross
Unrealized
Gains
 
Gross
Unrealized
Losses
 
Fair
Value
Agency mortgage backed securities
 
$
1,449

 
$
16

 
$
22

 
$
1,443

Total
 
$
1,449

 
$
16

 
$
22

 
$
1,443


The amortized cost and aggregate fair value of debt securities at June 30, 2019 , by contractual maturity, are presented in the following table ( dollars in thousands ).  Expected maturities will differ from contractual maturities because issuers 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
 
$
1,878

 
$
1,890

Due after one year through five years
 
17,029

 
17,432

Due after five years through ten years
 
27,236

 
27,764

Due after ten years
 
53,941

 
55,658

Total
 
$
100,084

 
$
102,744

 
 
 
 
 
Held-to-maturity securities:
 
 

 
 

Due in one year or less
 
$

 
$

Due after one year through five years
 
36

 
38

Due after five years through ten years
 
4

 
5

Due after ten years
 
1,348

 
1,399

Total
 
$
1,388

 
$
1,442


A summary of securities available-for-sale with unrealized losses as of June 30, 2019 , 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
June 30, 2019
 
Fair
Value
 
Gross
Unrealized
Losses
 
Fair
Value
 
Gross
Unrealized
Losses
 
Fair
Value
 
Gross
Unrealized
Losses
 
Total
Securities in a Loss Position
U.S. Government corporations and agencies
 
$

 
$

 
$
500

 
$
19

 
$
500

 
$
19

 
1
Agency mortgage backed securities
 
1,032

 
11

 
4,895

 
108

 
5,927

 
119

 
15
Asset backed securities
 
3,282

 
65

 
4,908

 
105

 
8,190

 
170

 
12
Corporate bonds
 
2,188

 
61

 
6,297

 
187

 
8,485

 
248

 
15
States, municipalities and political subdivisions
 

 

 
520

 
2

 
520

 
2

 
1
 
 
$
6,502

 
$
137

 
$
17,120

 
$
421

 
$
23,622

 
$
558

 
44

There were no securities held-to-maturity with unrealized losses as of June 30, 2019 .


13


THE NATIONAL SECURITY GROUP, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED AMOUNTS EXCEPT FOR DECEMBER 31, 2018 AMOUNTS)


A summary of securities available-for-sale with unrealized losses as of December 31, 2018 , 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, 2018
 
Fair
Value
 
Gross
Unrealized
Losses
 
Fair
Value
 
Gross
Unrealized
Losses
 
Fair
Value
 
Gross
Unrealized
Losses
 
Total
Securities in a Loss Position
U.S. Government corporations and agencies
 
$

 
$

 
$
3,209

 
$
107

 
$
3,209

 
$
107

 
6
Agency mortgage backed securities
 
5,504

 
45

 
10,969

 
500

 
16,473

 
545

 
38
Asset backed securities
 
5,824

 
146

 
2,741

 
102

 
8,565

 
248

 
12
Private label mortgage backed securities
 
1,348

 
27

 

 

 
1,348

 
27

 
2
Corporate bonds
 
16,583

 
709

 
9,823

 
842

 
26,406

 
1,551

 
51
States, municipalities and political subdivisions
 
1,242

 
10

 
4,420

 
81

 
5,662

 
91

 
11
 
 
$
30,501

 
$
937

 
$
31,162

 
$
1,632

 
$
61,663

 
$
2,569

 
120

A summary of securities held-to-maturity with unrealized losses as of December 31, 2018 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:

 
 
Less than 12 months
 
12 months or longer
 
Total
December 31, 2018
 
Fair
Value
 
Gross
Unrealized
Losses
 
Fair
Value
 
Gross
Unrealized
Losses
 
Fair
Value
 
Gross
Unrealized
Losses
 
Total
Securities in a Loss Position
Agency mortgage backed securities
 
$
1,026

 
$
22

 
$

 
$

 
$
1,026

 
$
22

 
2
 
 
$
1,026

 
$
22

 
$

 
$

 
$
1,026

 
$
22

 
2

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 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 in the fixed maturity investment portfolio. The Company has no material exposure to sub-prime mortgage loans and approximately 4% of the fixed income investment portfolio is rated below investment grade.  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

14


THE NATIONAL SECURITY GROUP, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED AMOUNTS EXCEPT FOR DECEMBER 31, 2018 AMOUNTS)


securities until market values recovered, it was determined that, other than the impairment described below, the securities in an accumulated loss position in the portfolio were temporary impairments.

For the six months ended June 30, 2019, the Company realized no other-than-temporary impairments. For the year ended December 31, 2018, the Company realized $16,000 other-than-temporary impairments. At June 30, 2019, the three largest losses not realized as an impairment in the fixed maturity portfolio totaled $45,000 , $39,000 and $33,000 . Each of these losses were driven by changes in market interest rates. At December 31, 2018, the three largest losses not realized as an impairment was in the fixed maturity portfolio totaled $145,000 , $99,000 and $94,000 .

Major categories of investment income are summarized as follows (dollars in thousands):
 
Three months ended
June 30,
 
Six months ended
June 30,
 
2019
 
2018
 
2019
 
2018
Fixed maturities
$
934

 
$
963

 
$
1,871

 
$
1,854

Equity securities
20

 
20

 
47

 
40

Mortgage loans on real estate
2

 
2

 
4

 
4

Investment real estate
1

 

 
3

 
1

Policy loans
35

 
35

 
69

 
70

Other
4

 
7

 
7

 
15

 
996

 
1,027

 
2,001

 
1,984

Less: Investment expenses
39

 
32

 
82

 
69

Net investment income
$
957

 
$
995

 
$
1,919

 
$
1,915


Major categories of investment gains and losses are summarized as follows (dollars in thousands):
 
Three months ended
June 30,
 
Six months ended
June 30,
 
2019
 
2018
 
2019
 
2018
Realized gains on fixed maturities
$
5

 
$
48

 
$
15

 
$
129

Gains (losses) on trading securities
5

 

 
8

 

Change in fair value of equity securities
26

 
(163
)
 
152

 
(369
)
Change in surrender value of company owned life insurance
81

 
3

 
270

 
(136
)
Realized gain on company owned life insurance

 

 
1,792

 

Other, principally real estate

 
(88
)
 

 
(88
)
Net investment gains (losses)
$
117

 
$
(200
)
 
$
2,237

 
$
(464
)

An analysis of the net change in unrealized gains (losses) on available-for-sale securities follows (dollars in thousands):
 
June 30,
2019
 
December 31, 2018
Fixed maturities
$
4,412

 
$
(3,042
)
Deferred income tax
(926
)
 
638

Change in net unrealized gains (losses) on available-for-sale securities
$
3,486

 
$
(2,404
)


15


THE NATIONAL SECURITY GROUP, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED AMOUNTS EXCEPT FOR DECEMBER 31, 2018 AMOUNTS)


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 consolidated balance sheets.  

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 with 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.

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


16


THE NATIONAL SECURITY GROUP, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED AMOUNTS EXCEPT FOR DECEMBER 31, 2018 AMOUNTS)


Assets/Liabilities Measured at Fair Value on a Recurring Basis
Financial assets and liabilities measured at fair value on a recurring basis as of June 30, 2019 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
 
 
 
 
 
 
 
 
U.S. Government corporations and agencies
 
$
4,273

 
$
4,273

 
$

 
$

Agency mortgage backed securities
 
32,644

 
18,788

 
13,856

 

Asset backed securities
 
11,043

 
2,823

 
8,220

 

Corporate bonds
 
38,108

 

 
38,108

 

Private label asset backed securities
 
7,620

 
1,367

 
6,253

 

States, municipalities and political subdivisions
 
8,202

 

 
8,202

 

Foreign governments
 
854

 
854

 

 

Trading securities
 
141

 
141

 

 

Equity securities
 
4,465

 
3,275

 

 
1,190

Total Financial Assets
 
$
107,350

 
$
31,521

 
$
74,639

 
$
1,190

Financial Liabilities
 

 
 

 
 

 
 

Interest rate swap
 
$
(177
)
 
$

 
$

 
$
(177
)
Total Financial Liabilities
 
$
(177
)
 
$

 
$

 
$
(177
)

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 quoted market prices in active markets for identical assets are reflected within Level 1 while 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 June 30, 2019 , Level 3 fair value measurements of assets include $1,190,000 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.

As of June 30, 2019 , Level 3 fair value measurements of liabilities include $177,000 net fair value of various interest rate swap agreements whose value is based on analysis provided by a third party that utilizes financial modeling tools

17


THE NATIONAL SECURITY GROUP, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED AMOUNTS EXCEPT FOR DECEMBER 31, 2018 AMOUNTS)


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 six months ended June 30, 2019 (in thousands):

For the six months June 30, 2019
 
Equity Securities
 
Interest Rate Swap
Beginning balance
 
$
1,125

 
$
(234
)
Total gains or losses (realized and unrealized):
 
 

 
 

Included in earnings
 
65

 

Included in other comprehensive income
 

 
57

Purchases:
 

 

Sales:
 

 

Issuances:
 

 

Settlements:
 

 

Transfers in/(out) of Level 3
 

 

Ending balance
 
$
1,190

 
$
(177
)
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 June 30, 2019:
 
$

 
$


For the six months ended June 30, 2019 , 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, 2018 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
 
 
 
 
 
 
 
 
U.S. Government corporations and agencies
 
$
4,744

 
$
4,147

 
$
597

 
$

Agency mortgage backed securities
 
27,106

 
11,756

 
15,350

 

Asset backed securities
 
10,560

 
2,839

 
7,721

 

Corporate bonds
 
35,791

 

 
35,791

 

Private label asset backed securities
 
5,947

 

 
5,947

 

States, municipalities and political subdivisions
 
10,073

 

 
10,073

 

Foreign governments
 
804

 
804

 

 

Trading securities
 
107

 
107

 

 

Equity securities available-for-sale
 
4,306

 
3,181

 

 
1,125

Total Financial Assets
 
$
99,438

 
$
22,834

 
$
75,479

 
$
1,125

Financial Liabilities
 
 

 
 

 
 

 
 

Interest rate swap
 
$
(234
)
 
$

 
$

 
$
(234
)
Total Financial Liabilities
 
$
(234
)
 
$

 
$

 
$
(234
)

18


THE NATIONAL SECURITY GROUP, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED AMOUNTS EXCEPT FOR DECEMBER 31, 2018 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, 2018 (in thousands):
For the year ended December 31, 2018
 
Equity Securities Available-for-Sale
 
Interest Rate Swap
Beginning balance
 
$
1,073

 
$
(608
)
Total gains or losses (realized and unrealized):
 
 

 
 

Included in earnings
 
52

 

Included in other comprehensive income
 

 
374

Purchases:
 

 

Sales:
 

 

Issuances:
 

 

Settlements:
 

 

Transfers in/(out) of Level 3
 

 

Ending balance
 
$
1,125

 
$
(234
)
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, 2018:
 
$

 
$

For the year ended December 31, 2018, 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.


19


THE NATIONAL SECURITY GROUP, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED AMOUNTS EXCEPT FOR DECEMBER 31, 2018 AMOUNTS)


The carrying amount and estimated fair value of the Company’s financial instruments as of June 30, 2019 and December 31, 2018 are as follows (in thousands):
 
 
June 30, 2019
 
December 31, 2018
Assets and related instruments
 
Carrying
Value
 
Estimated
Fair Value
 
Carrying
Value
 
Estimated
Fair Value
Held-to-maturity securities
 
$
1,388

 
$
1,442

 
$
1,449

 
$
1,443

Mortgage loans
 
151

 
151

 
156

 
156

Policy loans
 
1,876

 
1,876

 
1,854

 
1,854

Company owned life insurance
 
4,631

 
4,631

 
4,600

 
4,600

Other invested assets
 
2,217

 
2,217

 
2,148

 
2,148

Liabilities and related instruments
 
 

 
 

 
 

 
 

Other policyholder funds
 
1,480

 
1,480

 
1,515

 
1,515

Short-term notes payable and current portion of long-term debt
 
2,200

 
2,200

 
2,200

 
2,200

Long-term debt
 
12,158

 
12,158

 
12,152

 
12,152


NOTE 5 – PROPERTY AND EQUIPMENT
Major categories of property and equipment are summarized as follows (dollars in thousands):
 
June 30, 2019
 
December 31, 2018
Building and improvements
$
3,378

 
$
3,378

Electronic data processing equipment
1,508

 
1,504

Furniture and fixtures
477

 
477

 
5,363

 
5,359

Less accumulated depreciation
3,773

 
3,710

Property and equipment, net
$
1,590

 
$
1,649

Depreciation expense for the six months ended June 30, 2019 was $62,000 ( $161,000 for the year ended December 31, 2018).

NOTE 6 – INCOME TAXES
On December 22, 2017, the President signed the Tax Cuts and Jobs Act (TCJA), a comprehensive tax legislation which, among other things, reduced the Company's statutory federal income tax rate from 34% to 21% effective January 1, 2018. In addition to the reduction in tax rates, the TCJA made broad and complex changes to the Internal Revenue Code that introduced changes to many tax related exclusions, deductions and credits. At December 31, 2017, $1,575,000 in AMT credit was booked as a deferred tax asset. Effective December 31, 2018, the Company recognized the AMT credit in federal income tax recoverable as Management anticipates $1,077,000 will be recovered with the 2018 return and the remainder recovered by 2021 pursuant to allowable amounts under the TCJA. 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 a net deferred tax liability position of $53,000 at June 30, 2019 and a net deferred tax asset position of $716,000 at December 31, 2018 .


20


THE NATIONAL SECURITY GROUP, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED AMOUNTS EXCEPT FOR DECEMBER 31, 2018 AMOUNTS)


The tax effect of significant differences representing deferred tax assets and liabilities are as follows (dollars in thousands):
 
 
As of June 30,
2019
 
As of December 31,
2018
General expenses
 
$
1,142

 
$
1,067

Unearned premiums
 
1,356

 
1,265

Claims liabilities
 
565

 
552

Impairment on real estate owned
 
119

 
119

Unrealized losses on securities available-for-sale
 

 
368

Unrealized loss on interest rate swaps
 
37

 
49

Deferred tax assets
 
3,219

 
3,420

 
 
 
 
 
Trading securities
 
(1
)
 

Depreciation
 
(75
)
 
(79
)
Deferred policy acquisition costs
 
(1,658
)
 
(1,645
)
Pre-1984 policyholder surplus account
 
(430
)
 
(463
)
Unrealized gains on securities available-for-sale
 
(559
)
 

Unrealized gains on equity securities
 
(549
)
 
(517
)
Deferred tax liabilities
 
(3,272
)
 
(2,704
)
Net deferred tax asset (liability)
 
$
(53
)
 
$
716

The appropriate income tax effects of changes in temporary differences are as follows (dollars in thousands):
 
 
Six months ended
June 30,
 
 
2019
 
2018
Deferred policy acquisition costs
 
$
13

 
$
4

Trading securities
 
1

 

Unearned premiums
 
(91
)
 
(79
)
General expenses
 
(75
)
 
(2
)
Depreciation
 
(4
)
 
(6
)
Claims liabilities
 
(13
)
 
14

AMT credit