nsg10q.htm

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, 2010
      or      
o
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from           to          .

Commission File Number 0-18649
 

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





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






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

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

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

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

As of August 13, 2010, there were 2,466,600 shares, $1.00 par value, of the registrant’s common stock outstanding.
 

 
1

 

THE NATIONAL SECURITY GROUP, INC

INDEX



PART I. FINANCIAL INFORMATION
   
       
Page No.
 
Item 1.  Financial Statements (unaudited)
   
         
     
3
     
5
   
6
     
7
   
8
   
24
       
 
25
         
       
 
32
       
   
32
         
         
PART II. OTHER INFORMATION
   
         
   
33
   
33
 
33
   
33
   
33
   
33
         
         
   
34
         
 
   
 




 
2

 


 
Part I.  FINANCIAL INFORMATION

Item 1.  Financial Statements
THE NATIONAL SECURITY GROUP, INC.

CONDENSED CONSOLIDATED BALANCE SHEETS (UNAUDITED)
(In thousands, except per share amounts)

                 
                 
         
June 30,
   
December 31,
ASSETS
   
2010
   
2009
         
(unaudited)
     
Investments
           
 
Fixed maturities held-to-maturity, at amortized cost (estimated fair value: 2010 - $5,902;
           
   
  2009 - $6,080)
 
$
 5,674
 
$
 5,942
 
Fixed maturities available-for-sale, at estimated fair value (cost: 2010 - $73,853;
           
   
 2009 - $69,796)
   
 75,414
   
 70,269
 
Equity securities available-for-sale, at estimated fair value (cost: 2010 - $5,371
           
   
 2009 - $5,851)
   
 8,102
   
 9,035
 
Trading securities
   
 574
   
 374
 
Receivable for securities
   
 -
   
 96
 
Mortgage loans on real estate, at cost
   
 1,033
   
 1,041
 
Investment real estate, at book value (accumulated depreciation: 2010 - $18; 2009 - $18)
   
 4,955
   
 4,815
 
Policy loans
   
 1,056
   
 1,018
 
Company owned life insurance
   
 5,302
   
 5,197
 
Other invested assets
   
 3,868
   
 3,933
                 
   
Total Investments
   
 105,978
   
 101,720
                 
Cash
   
 2,698
   
 4,686
Accrued investment income
   
 854
   
 802
Policy receivables and agents' balances
   
 11,751
   
 9,700
Reinsurance recoverable
   
 753
   
 784
Deferred policy acquisition costs
   
 10,724
   
 10,210
Property and equipment, net
   
 2,444
   
 2,537
Other assets
   
 1,210
   
 957
                 
   
Total Assets
 
$
 136,412
 
$
 131,396





 
3

 


The National Security Group, Inc.
 
             
CONDENSED CONSOLIDATED BALANCE SHEETS (UNAUDITED)
 
             
 
(Dollars in thousands)
 
   
June 30,
   
December 31,
 
LIABILITIES AND SHAREHOLDERS' EQUITY
 
2010
   
2009
 
              (unaudited)        
Property and casualty benefit and loss reserves
  $ 12,849     $ 12,646  
Accident and health benefit and loss reserves
    1,706       1,612  
Life and annuity benefit and loss reserves
    28,784       28,579  
Unearned premiums
    28,842       27,381  
Policy and contract claims
    535       535  
Other policyholder funds
    1,331       1,347  
Notes payable
    400       -  
Long-term debt
    12,372       12,372  
Accrued income taxes
    49       111  
Deferred income tax liability
    658       61  
Other liabilities
    5,559       5,584  
                 
Total Liabilities
    93,085       90,228  
                 
Contingencies
               
                 
Shareholders' Equity
               
Preferred stock, $1 par value, 500,000 shares authorized, none issued or outstanding
    -       -  
Class A common stock, $1 par value, 2,000,000 shares authorized, none issued or outstanding
    -       -  
Common stock, $1 par value, 3,000,000 authorized, 2,466,600 shares issued and outstanding
    2,467       2,467  
Additional paid-in capital
    4,951       4,951  
Accumulated other comprehensive income
    2,456       2,265  
Retained earnings
    33,453       31,485  
                 
Total Shareholders' Equity
    43,327       41,168  
                 
Total Liabilities and Shareholders' Equity
  $ 136,412     $ 131,396  






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

 
4

 


THE NATIONAL SECURITY GROUP, INC.

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


   
Three Months
   
Six Months
 
   
Ended June 30
   
Ended June 30
 
   
2010
   
2009
   
2010
   
2009
 
                         
REVENUES
                       
Net premiums earned
  $ 15,903     $ 15,373     $ 30,941     $ 30,593  
Net investment income
    1,195       1,374       2,521       2,611  
Net realized investment gains (losses)
    689       (231 )     1,358       (230 )
Other Income
    256       192       555       333  
                                 
  Total Revenues
    18,043       16,708       35,375       33,307  
                                 
BENEFITS AND EXPENSES
                               
Policyholder benefits paid or provided
    11,061       11,314       19,534       19,106  
Policy acquisition costs
    2,970       3,175       5,718       6,267  
General expenses
    2,155       1,792       4,740       4,496  
Taxes, licenses and fees
    480       523       967       980  
Interest expense
    307       288       565       565  
Total Expenses
                               
    16,973       17,092       31,524       31,414  
                                 
  Income (Loss) Before Income Taxes
    1,070       (384 )     3,851       1,893  
                                 
INCOME TAX (BENEFIT) EXPENSE
                               
      Current
    (14 )     (287 )     588       425  
      Deferred
    270       (189 )     555       (105 )
      256       (476 )     1,143       320  
                                 
   Net Income
  $ 814     $ 92     $ 2,708     $ 1,573  
                                 
                                 
EARNINGS PER COMMON SHARE
  $ 0.33     $ 0.04     $ 1.10     $ 0.64  
                                 
DIVIDENDS DECLARED PER SHARE
  $ 0.15     $ 0.15     $ 0.30     $ 0.30  
                                 



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

 
5

 

THE NATIONAL SECURITY GROUP, INC.

CONDENSED CONSOLIDATED STATEMENTS OF SHAREHOLDERS’ EQUITY (UNAUDITED)
(In thousands, except per share amounts)

               
Accumulated
             
               
Other
         
Additional
 
         
Retained
   
Comprehensive
   
Common
   
Paid-in
 
   
Total
   
Earnings
   
Income
   
Stock
   
Capital
 
                               
Balance at December 31, 2009
  $ 41,168     $ 31,485     $ 2,265     $ 2,467     $ 4,951  
                                         
Comprehensive Income
                                       
Net income six months ended 6/30/2010
    2,708       2,708                          
Other comprehensive income (net of tax)
                                       
    Unrealized gain on securities, net of
                                       
      reclassification adjustment of $896
    416               416                  
    Unrealized loss on interest rate swap
    (225 )             (225 )                
                                         
Total Comprehensive Income
    2,899                                  
                                         
Cash dividends
    (740 )     (740 )                        
                                         
Balance at June 30, 2010 (Unaudited)
  $ 43,327     $ 33,453     $ 2,456     $ 2,467     $ 4,951  










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


 
6

 

THE NATIONAL SECURITY GROUP, INC.

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)
(In thousands)



   
Six Months
 
   
Ended June 30,
 
   
2010
   
2009
 
             
Cash Flows from Operating Activities
           
  Net income
  $ 2,708     $ 1,573  
  Adjustments to reconcile net income to net cash  
               
    provided by (used in) operating activities:
               
    Change in receivable for securities sold
    96       -  
    Change in accrued investment income
    (52 )     (95 )
    Change in reinsurance recoverables
    31       221  
    Change in deferred policy acquisition costs
    (514 )     (372 )
    Change in accrued income taxes
    (62 )     27  
    Change in deferred income taxes
    (555 )     105  
    Depreciation expense
    194       292  
    Change in policy liabilities and claims
    (88 )     (1,410 )
    Other, net
    (562 )     1,347  
      Net cash provided by operating activities
    1,196       1,688  
                 
Cash Flows from Investing Activities
               
    Cost of investments acquired
    (22,379 )     (17,171 )
    Sale and maturity of investments
    19,652       13,527  
    Purchase of property and equipment
    (101 )     (47 )
                 
    Net cash used in investing activities
    (2,828 )     (3,691 )
                 
Cash Flows from Financing Activities
               
    Change in other policyholder funds
    (16 )     (1 )
    Change in notes payable
    400       -  
    Dividends paid
    (740 )     (740 )
      Net cash used in financing activities
    (356 )     (741 )
                 
Net change in cash and cash equivalents
    (1,988 )     (2,744 )
                 
Cash and cash equivalents, beginning of period
    4,686       3,027  
                 
Cash and cash equivalents, end of period
  $ 2,698     $ 283  








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


 
7

 





THE NATIONAL SECURITY GROUP, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

NOTE 1 – SIGNIFICANT ACCOUNTING POLICIES

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 of America (GAAP).  All significant intercompany transactions and accounts have been eliminated.  The financial information presented herein should be read in conjunction with the Company’s Annual Report on Form 10-K for the year ended December 31, 2009, which includes information and disclosures not presented herein.

Use of Estimates
The preparation of financial statements in conformity with generally accepted accounting principles 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 financial statements and the reported amounts of revenues and expenses during the reporting period. Among the more significant estimates included in these financial statements are reserves for future policy benefits, liabilities for losses and loss adjustment expenses, reinsurance recoverable asset on associated loss and loss adjustment expense liabilities, deferred policy acquisition costs, deferred income tax assets and liabilities, and assessments of other than temporary impairments on investments.   Actual results could differ from those estimates.

Reclassifications
Certain 2009 amounts have been reclassified from the prior year financial statements to conform to the 2010 presentation.

Recently Issued Accounting Standards
Fair Value Measurements
Effective for interim and annual reporting periods beginning after December 15, 2009 or December 15, 2010, as specified, the FASB revised GAAP guidance related to fair value measurement to require additional disclosures and to clarify certain existing disclosure requirements. The guidance is intended to improve the disclosures and increase transparency in financial reporting. We adopted the revised guidance on January 1, 2010 except for disclosures about purchases, sales, issuances, and settlements in the roll forward of activity in Level 3 fair value measurements which are effective for interim and annual reporting periods beginning on or after December 15, 2010; adoption had no effect on our results of operations or financial position.

Own-Share Lending Arrangements in Contemplation of Convertible Debt Issuance
Effective for interim and annual reporting periods beginning on or after December 15, 2009 for outstanding arrangements and effective otherwise for reporting periods beginning on or after June 15, 2009, the FASB issued guidance related to share-lending arrangements for an entity’s own shares executed in contemplation of a convertible debt offering or other financing. We adopted the guidance on January 1, 2010; adoption had no effect on our results of operations or financial position.

Consolidation of Variable Interest Entities
Effective at the start of a reporting entity’s first fiscal year beginning after November 15, 2009, the FASB revised guidance which changes how a reporting entity determines whether or not to consolidate its interest in an entity that is insufficiently capitalized or is not controlled through voting (or similar) rights. The determination of whether a reporting entity is required to consolidate another entity will now be based on, among other things, the other entity’s purpose and design and the reporting entity’s ability to direct the activities of the other entity that most significantly impact the other entity’s economic performance. The revised guidance also requires the reporting

 
 
 
 
 
8

 
 
THE NATIONAL SECURITY GROUP, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
 (Continued)

entity to provide additional disclosures about its involvement with variable interest entities and any significant changes in risk exposure due to that involvement. A reporting entity will be required to disclose how its involvement with a variable interest entity affects the reporting entity’s financial statements. We adopted the revised guidance on January 1, 2010; adoption had no effect on our results of operations or financial position.

Transfers and Servicing-Accounting for Transfers of Financial Assets
Effective at the start of a reporting entity’s first fiscal year beginning after November 15, 2009, the FASB revised guidance that requires additional disclosure regarding transfers of financial assets, including securitization transactions, where entities have continuing exposure to risks related to the transferred financial assets. We adopted the revised guidance on January 1, 2010; adoption had no effect on our results of operations or financial
position.

Investments—Disclosure Requirements; Other-than-temporary Impairments
Effective for interim and annual reporting periods ending on or after June 15, 2009, the FASB revised GAAP to require expanded disclosures related to investments in debt and equity securities. Guidance regarding other-than-temporary impairments was also revised. Previous investment guidance required that an impairment of a debt security be considered as other-than-temporary unless management could assert both the intent and the ability to hold the impaired security until recovery of value. The revised impairment guidance specifies that an impairment be considered as other-than-temporary unless an entity can assert that it has no intent to sell the security and that it is not more likely than not that the entity will be required to sell the security before recovery of its anticipated amortized cost basis.

The new guidance also establishes the concept of credit loss. Credit loss is defined as the difference between the present value of the cash flows expected to be collected from a debt security and the amortized cost basis of the security. The new guidance states that “in instances in which a determination is made that a credit loss exists but the entity does not intend to sell the debt security and it is not more likely than not that the entity will be required to sell the debt security before the anticipated recovery of its remaining amortized cost basis” an impairment is to be separated into (a) the amount of the total impairment related to the credit loss and (b) the amount of total impairment related to all other factors. The credit loss component of the impairment is to be recognized in income of the current period. The non-credit component is to be recognized as a part of other comprehensive income. Transition provisions require a cumulative effect adjustment to reclassify the noncredit component of a previously recognized other-than-temporary impairment from retained earnings to accumulated other comprehensive income “if an entity does not intend to sell and it is not more likely than not that the entity will be required to sell the security before recovery of its amortized cost basis”. We adopted the revised guidance as of the beginning of the quarter ended June 30, 2009. We have no non-credit losses.

NOTE 2 – REINSURANCE

In the normal course of business, NSFC seeks to reduce the loss that may arise from catastrophes or other events that cause unfavorable underwriting results by reinsuring certain levels of risk in various areas of exposure with other insurance enterprises or reinsurers.  NSFC maintains a catastrophe reinsurance agreement to cover losses from catastrophic events, primarily hurricanes.
 
 
 

 

 
9

 


THE NATIONAL SECURITY GROUP, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
 (Continued)
 
 
Under the catastrophe reinsurance program, the Company retains the first $3.5 million in losses from each event.  Reinsurance is maintained in four layers as follows:



Layer
Reinsurers' Limits of Liability
 
First Layer
  95% of  $6,500,000 in excess of $3,500,000
Second Layer
  95% of  $7,500,000 in excess of $10,000,000
Third Layer
 100% of  $25,000,000 in excess of $17,500,000
Fourth Layer
 100% of  $30,000,000 in excess of $42,500,000



Layers 1-4 cover events occurring from January1-December 31 of the contract year.  All significant reinsurers under the program carry A.M. Best ratings of A- (Excellent) or higher.

Amounts recoverable from reinsurers are estimated in a manner consistent with the claim liability associated with the reinsured policy.  Amounts paid for prospective reinsurance contracts are reported as prepaid reinsurance premiums and amortized over the remaining contract period.

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

NOTE 3 – CALCULATION OF EARNINGS PER SHARE

Earnings per share were based on net income divided by the weighted average common shares outstanding.  The weighted average number of shares outstanding for the three month and six month periods ending June 30, 2010 and 2009 were 2,466,600.

NOTE 4 – CHANGES IN SHAREHOLDERS’ EQUITY

During the six months ended June 30, 2010 and 2009, there were no changes in shareholders' equity except for net income of $2,708,000 and $1,573,000, respectively; dividends paid of $740,000 in 2010 and 2009; changes in accumulated other comprehensive income, net of applicable taxes of $191,000 and $1,796,000, respectively.  Other comprehensive income consists of accumulated unrealized gains and losses on securities and unrealized gains and losses on interest rate swaps.








 
10

 

 

THE NATIONAL SECURITY GROUP, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
 (Continued)

NOTE 5 – INVESTMENTS

The amortized cost and aggregate fair values of investments in securities are as follows:


                         
   
(Dollars in thousands)
 
   
June 30, 2010
 
         
Gross
   
Gross
       
   
Amortized
   
Unrealized
   
Unrealized
   
Fair
 
   
Cost
   
Gains
   
Losses
   
Value
 
Available-for-sale securities:
                       
Corporate debt securities
  $ 22,360     $ 1,621     $ 283     $ 23,698  
Mortgage backed securities
    7,092       350       14       7,428  
Private label mortgage backed securities
    15,060       182       1,002       14,240  
Obligations of states and political subdivisions
    16,064       440       246       16,258  
U.S. Treasury securities and obligations of
                               
U.S. Government corporations and agencies
    13,277       513       -       13,790  
Total fixed maturities
    73,853       3,106       1,545       75,414  
Equity securities
    5,371       3,521       790       8,102  
                                 
Total
  $ 79,224     $ 6,627     $ 2,335     $ 83,516  
                                 
Held-to-maturity securities:
                               
Corporate debt securities
  $ -     $ -     $ -     $ -  
Mortgage backed securities
    2,972       150       -       3,122  
Private label mortgage backed securities
    161       6       -       167  
Obligations of states and political subdivisions
    2,138       55       7       2,186  
U.S. Treasury securities and obligations of
                               
U.S. Government corporations and agencies
    403       24       -       427  
                                 
Total
  $ 5,674     $ 235     $ 7     $ 5,902  

 
 
 
 

 
 
11

 


THE NATIONAL SECURITY GROUP, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
 (Continued)


                         
                         
   
(Dollars in thousands)
 
   
December 31, 2009
 
         
Gross
   
Gross
       
   
Amortized
   
Unrealized
   
Unrealized
   
Fair
 
   
Cost
   
Gains
   
Losses
   
Value
 
Available-for-sale securities:
                       
Corporate debt securities
  $ 26,786     $ 1,557     $ 519     $ 27,824  
Mortgage backed securities
    8,203       282       165       8,320  
Private label mortgage backed securities
    9,634       72       810       8,896  
Obligations of states and political subdivisions
    15,641       211       336       15,516  
U.S. Treasury securities and obligations of
                               
U.S. Government corporations and agencies
    9,532       261       80       9,713  
Total fixed maturities
    69,796       2,383       1,910       70,269  
Equity securities
    5,851       3,990       806       9,035  
                                 
Total
  $ 75,647     $ 6,373     $ 2,716     $ 79,304  
                                 
Held-to-maturity securities:
                               
Mortgage backed securities
  $ 3,175     $ 101     $ 25     $ 3,251  
Private label mortgage backed securities
    187       5       -       192  
Obligations of states and political subdivisions
    2,139       51       8       2,182  
U.S. Treasury securities and obligations of
                               
U.S. Government corporations and agencies
    441       14       -       455  
                                 
Total
  $ 5,942     $ 171     $ 33     $ 6,080  


The amortized cost and aggregate fair value of debt securities at June 30, 2010, by contractual maturity, are as follows.  Expected maturities will differ from contractual maturities because borrowers may have the right to call or prepay obligations with or without call or prepayment penalties.


   
(Dollars in Thousands)
 
   
Amortized
   
Fair
 
Available-for-sale securities:
 
Cost
   
Value
 
Due in one year or less
  $ 1,635     $ 1,642  
Due after one year through five years
    10,613       11,600  
Due after five years through ten years
    29,723       31,051  
Due after ten years
    31,882       31,121  
                 
Total
  $ 73,853     $ 75,414  
                 
Held-to-maturity securities:
               
Due in one year or less
  $ 803     $ 816  
Due after one year through five years
    300       310  
Due after five years through ten years
    1,833       1,928  
Due after ten years
    2,738       2,848  
                 
Total
  $ 5,674     $ 5,902  



 
12

 

THE NATIONAL SECURITY GROUP, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
 (Continued)

A summary of securities available-for-sale with unrealized losses as of June 30, 2010 and December 31, 2009 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)
   
June 30, 2010
 
   
Less than 12 months
   
12 months or longer
   
Total
 
         
Gross
         
Gross
         
Gross
   
Total
 
   
Fair
   
Unrealized
   
Fair
   
Unrealized
   
Fair
   
Unrealized
   
Securities in a
 
   
Value
   
Losses
   
Value
   
Losses
   
Value
   
Losses
   
Loss Position
 
Fixed maturities
                                         
Corporate
  $ 1,858     $ 115     $ 2,341     $ 168     $ 4,199     $ 283       10  
Mortgage backed securities
    406       3       302       11       708       14       4  
Private label mortgage backed
                                                       
 securities
    1,943       227       4,195       775       6,138       1,002       12  
Obligations of state and
                                                       
 political subdivisions
    3,493       137       2,559       109       6,052       246       18  
U.S. Treasury securities and
                                                       
 obligations of U.S. government
                                                       
 corporations and agencies
    -       -       -       -       -       -       -  
Equity securities
    1,446       662       808       128       2,254       790       13  
    $ 9,146     $ 1,144     $ 10,205     $ 1,191     $ 19,351     $ 2,335       57  
 
 


   
(Dollars in thousands)
   
December 31, 2009
 
   
Less than 12 months
   
12 months or longer
   
Total
 
         
Gross
         
Gross
         
Gross
   
Total
 
   
Fair
   
Unrealized
   
Fair
   
Unrealized
   
Fair
   
Unrealized
   
Securities in a
 
   
Value
   
Losses
   
Value
   
Losses
   
Value
   
Losses
   
Loss Position
 
Fixed maturities:
                                         
Corporate debt securities
  $ 1,856     $ 21     $ 6,772     $ 498     $ 8,628     $ 519       23  
Mortgage backed securities
    1,443       156       71       9       1,514       165       6  
Private label mortgage backed
                                                       
 securities
    2,660       72       4,651       738       7,311       810       15  
Obligations of state and
                                                       
 political subdivisions
    5,889       199       991       137       6,880       336       21  
U.S. Treasury securities and
                                                       
 obligations of U.S. government
                                                       
 corporations and agencies
    3,708       80       -       -       3,708       80       11  
Equity securities
    78       13       2,283       793       2,361       806       13  
    $ 15,634     $ 541     $ 14,768     $ 2,175     $ 30,402     $ 2,716       89  

 
 
 
 
 
 
 
 

 
 
13

 
 
 
 
THE NATIONAL SECURITY GROUP, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
 (Continued)

A summary of securities held-to-maturity with unrealized losses as of June 30, 2010 and December 31, 2009 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)
   
June 30, 2010
 
   
Less than 12 months
   
12 months or longer
   
Total
 
         
Gross
         
Gross
         
Gross
   
Total
 
   
Fair
   
Unrealized
   
Fair
   
Unrealized
   
Fair
   
Unrealized
   
Securities in a
 
   
Value
   
Losses
   
Value
   
Losses
   
Value
   
Losses
   
Loss Position
 
Fixed maturities
                                         
Corporate
  $ -     $ -     $ -     $ -     $ -     $ -       -  
Mortgage backed securities
    -       -       -       -       -       -       -  
Private label mortgage backed
                                                       
 securities
    -       -       -       -       -       -       -  
Obligations of state and
                                                       
 political subdivisions
    161       7       -       -       161       7       1  
U.S. Treasury securities and
                                                       
 obligations of U.S. government
                                                       
 corporations and agencies
    -       -       -       -       -       -       -  
Equity securities
    -       -       -       -       -       -       -  
    $ 161     $ 7     $ -     $ -     $ 161     $ 7       1  



   
(Dollars in thousands)
   
December 31, 2009
 
   
Less than 12 months
   
12 months or longer
   
Total
 
         
Gross
         
Gross
         
Gross
   
Total
 
   
Fair
   
Unrealized
   
Fair
   
Unrealized
   
Fair
   
Unrealized
   
Securities in a
 
   
Value
   
Losses
   
Value
   
Losses
   
Value
   
Losses
   
Loss Position
 
Fixed maturities:
                                         
Corporate debt securities
  $ -     $ -     $ -     $ -     $ -     $ -       -  
Mortgage backed securities
    -       -       333       25       333       25       2  
Private label mortgage backed
                                                       
 securities
    -       -       -       -       -       -       -  
Obligations of state and
                                                       
 political subdivisions
    160       4       351       4       511       8       2  
U.S. Treasury securities and
                                                       
 obligations of U.S. government
                                                       
 corporations and agencies
    -       -       -       -       -       -       -  
                                                         
    $ 160     $ 4     $ 684     $ 29     $ 844     $ 33       4  


According to the most recent accounting guidance, for securities in an unrealized loss position, the Company is required to assess 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.
 
 
 
 
 
14

 
 
 
THE NATIONAL SECURITY GROUP, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
 (Continued)

Management has evaluated each security in a significant unrealized loss position.  For the quarter ended June 30, 2010, the Company realized no additional other-than-temporary impairments.  For year ended December 31, 2009, the Company realized $443,000 in other-than-temporary impairments.  The single largest accumulated loss at June 30, 2010 was in the bond portfolio and totaled $359,000.  The second largest loss position was in the bond portfolio and totaled $189,000.  The third largest loss position was in the bond portfolio and totaled $157,000.  Most unrealized losses in the fixed income portfolio are interest rate driven as opposed to credit quality driven and management believes no ultimate loss will be realized.  The Company has no material exposure to sub-prime mortgage loans and just over 2% of the fixed income investment portfolio is rated below investment grade.  In evaluating whether or not the equity loss positions were other-than-temporary impairments, Management evaluated financial information on each company and reviewed analyst reports from at least two independent sources.  Based on a review of the available financial information, the prospect for future earnings of each company and consideration of the Company’s intent and ability to hold the securities until market values recovered, it was determined that the remaining securities in an accumulated loss position in the portfolio were temporary impairments.

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

             
   
(Dollars in thousands)
 
       
   
June 30 ,2010
   
December 31, 2009
 
   
(unaudited)
       
Net change in unrealized appreciation on available-
           
for-sale securities before deferred tax
  $ 543     $ 5,304  
Deferred income tax
    (127 )     (1,784 )
                 
Net change in unrealized appreciation on available-
               
for-sale securities
  $ 416     $ 3,520  


The increase in unrealized appreciation is directly attributable to recoveries in the market values of available-for-sale debt securities.

NOTE 6 – INCOME TAXES

The Company recognizes tax-related interest and penalties as a component of tax expense.  The Company incurred $-0- in interest and penalties as of both June 30, 2010 and December 31, 2009. The Company files income tax returns in the U.S. federal jurisdiction and various states.  The Company is not subject to examinations by authorities related to its U.S. federal or state income tax filings for years prior to 2006. The Internal Revenue Service completed an examination during 2008 of the Company’s 2005 Federal Income Tax Return.  No material adjustments were made as a result of this examination.  No income tax returns are currently under examination by the Internal Revenue Service or any state or local taxing authority.  Tax returns have been filed through the year 2008 with extensions filed for 2009.

Net deferred tax liabilities are determined based on the estimated future tax effects of differences between the financial statement and tax basis of assets and liabilities given the provisions of the enacted tax laws.  Management believes that, based on its historical pattern of taxable income, the Company will produce sufficient income in the future to realize its deferred tax assets.   The Company recognized net deferred tax liability positions of $658,000 at June 30, 2010 and $61,000 at December 31, 2009.

 
 
 
15

 
 
 
 
THE NATIONAL SECURITY GROUP, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
 (Continued)

The tax effect of significant differences representing deferred tax assets and liabilities are as follows:

   
June 30,
   
December 31,
 
   
2010
   
2009
 
General expenses
  $ 978     $ 1,135  
Unearned premiums
    1,958       1,814  
Claims liabilities
    301       298  
Other than temporary impairments on securities owned
    417       501  
  Deferred tax assets
  $ 3,654     $ 3,748  
                 
Depreciation
  $ (118 )   $ (126 )
Deferred policy acquisition costs
    (2,760 )     (2,291 )
Unrealized gains on securities available-for-sale
    (1,434 )     (1,392 )
  Deferred tax liabilities
  $ (4,312 )   $ (3,809 )
                 
Net deferred tax liability
  $ (658 )   $ (61 )
 (in thousands)

The appropriate income tax effects of changes in temporary differences are as follows:
(in thousands)

   
Six months ended June 30,
 
   
2010
   
2009
 
             
Deferred policy acquisition costs
  $ 157     $ 88  
Other-than-temporary-impairments
    (144 )     (75 )
Unearned premiums
    (3 )     (73 )
General insurance expenses
    84       (18 )
Depreciation
    (8 )     29  
Claim liabilities
    469       (56 )
                 
    $ 555     $ (105 )



 
 
 
16

 
 
 
 
THE NATIONAL SECURITY GROUP, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
 (Continued)

Total income tax expense varies from amounts computed by applying current federal income tax rates to income before income taxes.  The reason for these differences and the approximate tax effects are as follows:


   
(Dollars in thousands)
 
   
Six months ended June 30,
 
   
2010
   
2009
 
             
Federal income tax rate applied to pre-tax income
  $ 1,309     $ 644  
Dividends received deduction and tax-exempt interest
    (89 )     (107 )
Company owned life insurance
    (36 )     (77 )
Small life deduction
    3       (164 )
Other, net
    (44     24  
                 
Federal income tax expense
  $ 1,143     $ 320  



NOTE 7 –NOTES PAYABLE AND LONG-TERM DEBT

Notes payable consisted of the following as of June 30, 2010 and December 31, 2009:
( in thousands)

             
   
2010
   
2009
 
Line of credit with fixed interest rate of  5.0%.  Interest payments due quarterly. Unsecured.
  $ 400     $ -  


Long-term debt consisted of the following as of June 30, 2010 and December 31, 2009:
( in thousands)

             
   
2010
   
2009
 
Subordinated debentures issued on December 15, 2005 with fixed interest rate of 8.83% each distribution period thereafter until December 15, 2015 when the coupon rate shall equal the 3-month LIBOR plus 3.75% applied to the outstanding principal; maturity December, 2035.  Interest payments due quarterly.  All may be redeemed at any time following the tenth anniversary of issuance.  Unsecured.
  $ 9,279     $ 9,279  
                 
Subordinated debentures issued on June 21, 2007 with a floating interest rate equal to the 3 Month LIBOR plus 3.40% applied to the outstanding principal; maturity June 15, 2037. Interest payments due quarterly.  All may be redeemed at any time following the fifth anniversary of issuance.  Unsecured.
    3,093       3,093  
    $ 12,372     $ 12,372  

 
 
 
 
17

 
 
 
 
THE NATIONAL SECURITY GROUP, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
 (Continued)

The $9,279,000 of subordinated debentures is due in 2035 and $3,093,000 of subordinated debentures is due in 2037.

The subordinated debentures (debentures) have the same maturities and other applicable terms and features as the associated trust preferred securities (TPS).  Payment of interest may be deferred for up to 20 consecutive quarters; however, stockholder dividends cannot be paid during any extended interest payment period or any time the debentures are in default.  All have stated maturities of thirty years.  None of the securities require the Company to maintain minimum financial covenants. The Company has guaranteed that amounts paid to the Trusts will be remitted to the holders of the associated TPS.  This guarantee, when taken together with the obligations of the Company under the debentures, the Indentures pursuant to which the debentures were issued, and the related trust agreement (including obligations to pay related trust fees, expenses, debt and other obligations with respect to the TPS), provides a full and unconditional guarantee of amounts due the Trusts.  The amount guaranteed is not expected to at any time exceed the obligations of the TPS, and no additional liability has been recorded related to the guarantee.

On September 13, 2007, the Company entered into a 5 year swap effective September 17, 2007 with a notional amount of $3,000,000 and designated the swap as a hedge against changes in cash flows attributable to changes in the benchmark interest rate (LIBOR) associated with the subordinated debentures issued on June 21, 2007.  Commencing December 17, 2007, under the terms of the swap, the Company will pay interest at the three-month LIBOR rate plus 3.4% and receive interest at the fixed rate of 8.34%.

On March 19, 2009, the Company entered into a forward swap effective September 17, 2012, which will also hedge against changes in cash flows following the termination of the 5 year swap agreement discussed previously.  Commencing September 17, 2012, under the terms of the forward swap, the Company will pay interest at the three-month LIBOR rate plus 3.4% and receive interest at the fixed rate of 7.02%.  This forward swap will effectively fix the interest rate on $3,000,000 in debt until September of 2019.

On May 26, 2010, the Company entered into a forward swap with a notional amount of $9,000,000 effective December 15, 2015, which will hedge against changes in cash flows following the termination of the fixed rate period.  Quarterly, commencing March 16, 2016 under the terms of the forward swap, the Company will pay interest at a fixed rate of 8.49% until March 15, 2020.

The swaps entered into in 2007, 2009 and 2010 have fair values of $242,000 (liability) and $47,000 (liability) and $141,000 (liability), respectively, for a net liability of $430,000 at June 30, 2010 ($60,000 at December 31, 2009).  The net swap liability is reported as a component of other liabilities on the consolidated balance sheets. A net valuation loss of $225,000 is included in accumulated other comprehensive income related to the swap agreements for the current period.  A net valuation gain of $256,000 was included in accumulated other comprehensive income related to the swap at December 31, 2009.

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

The Company’s interest rate swaps include provisions requiring the Company to post collateral when the derivative is in a net liability position.  The Company has posted collateral of $762,000.  See Note 9 for additional information about the interest rate swaps.

In December of 2009, the Company obtained an unsecured line of credit for $700,000, with an interest rate of 5%, to be made available for general corporate purposes.  The line of credit matures December 25, 2010.  The Company had drawn $400,000 on this line at June 30, 2010 while no funds were drawn at December 31, 2009.

 
 
 
 
 
18

 
 
THE NATIONAL SECURITY GROUP, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
 (Continued)


 
NOTE 8 – CONTINGENCIES

The Company and its subsidiaries continue to be named as parties to litigation related to the conduct of their insurance operations.  These suits involve alleged breaches of contracts, torts, including bad faith and fraud claims based on alleged wrongful or fraudulent acts of agents of the Company’s subsidiaries, and miscellaneous other causes of action.  Most of these lawsuits include claims for punitive damages in addition to other specified relief.

The Company’s property & casualty subsidiaries are defending a number of matters filed in the aftermath of Hurricanes Katrina and Rita in Mississippi, Louisiana and Alabama.  These actions include individual lawsuits and purported statewide class action lawsuits, although to date no class has been certified in any action.  These actions make a number of allegations of underpayment of hurricane-related claims,  including allegations that the flood exclusion found in the Company’s subsidiaries’ policies, and in certain actions other insurance companies’ policies, is either ambiguous, unenforceable as unconscionable or contrary to public policy, or inapplicable to the damage sustained.  The various suits seek a variety of remedies, including actual and/or punitive damages in unspecified amounts and/or declaratory relief.  All of these matters are in various stages of development and the Company’s subsidiaries intend to vigorously defend them.  The outcome of these disputes is currently uncertain. 

The Company has been sued in a putative class action in the State of Alabama. The Plaintiff alleges entitlement to, but did not receive, payment for general contractor overhead and profit (“GCOP”) in the proceeds received from the Company concerning the repair of the Plaintiff’s home. Plaintiff alleges that said failure to include GCOP is a material breach by the Company of the terms of its contract of insurance with Plaintiff and seeks monetary damages in the form of contractual damages. A class certification hearing was held on March 1, 2010 with the trial court taking the Plaintiff’s motion for class certification under advisement. On May 10, 2010, the trial court issued its ruling granting Plaintiff’s motion to certify the class. The Company plans to immediately appeal the trial court’s ruling in this matter. The Company denies Plaintiff’s allegations and intends to vigorously defend this lawsuit.

In 2007, the Company sold substantially all of its interest in a consolidated subsidiary, Mobile Attic, Inc.  On July 9, 2009, the Company moved to intervene in a complaint filed by the purchaser of Mobile Attic against the founder
and former president/CEO of Mobile Attic and others, regarding the plaintiff’s purchase of shares of Mobile Attic.  The Company filed a proposed complaint in intervention requesting the Court to find that the Company is not liable for indemnity under the Stock Purchase Agreement, or in the alternative, to award damages to the Company for any loss suffered as a result of the fraudulent actions of the former president/CEO of Mobile Attic and as a result of the negligence of Mobile Attic and its auditors in the preparation of Mobile Attic’s financial statements. The Court has subsequently granted the Company’s motion to intervene and the action is in the initial stages of discovery.  No amount has been accrued in these financial statements since the outcome of this matter is uncertain and the amount of liability, if any, cannot be determined.

The company establishes and maintains reserves on contingent liabilities.  In many instances, however, it is not feasible to predict the ultimate outcome with any degree of accuracy.  While a resolution of these matters may significantly impact consolidated earnings and the Company’s consolidated financial position, it remains management’s opinion, based on information presently available, that the ultimate resolution of these matters will not have a material impact on the Company’s consolidated financial position. 

 
 
 
 
19

 
 
 
THE NATIONAL SECURITY GROUP, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
 (Continued)

NOTE 9 – FAIR VALUE OF FINANCIAL ASSETS AND FINANCIAL LIABILITIES

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

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

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

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

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

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

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

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

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

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


 
 
20

 
 
 
 
THE NATIONAL SECURITY GROUP, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
 (Continued)

Marketable debt instruments in this category generally include asset-backed securities and certain of our floating-
rate notes, corporate bonds, and municipal bonds.
 
Assets/Liabilities Measured at Fair Value on a Recurring Basis
 
Financial assets and liabilities measured at fair value on a recurring basis as of June 30, 2010 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
  $ 75,414     $ 13,000     $ 61,826     $ 630  
Short-term investments
    -       -       -       -  
Trading securities
    574       574       -       -  
Equity securities available-for-sale
    8,102       7,478       -       624  
                                 
                                 
Total Financial Assets
  $ 84,090     $ 21,052     $ 61,826     $ 1,254  
                                 
Financial Liabilities
                               
Interest rate swap agreements
  $ 430     $ -     $ -     $ 430  
                                 
Total Financial Liabilities
  $ 430     $ -     $ -     $ 430  

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, 2010:
 

 

   
For the six-months ended June 30, 2010
 
   
Fixed Maturities Available-for-Sale
   
Equity Securities Available-for-Sale
   
Interest Rate Swaps
 
(In Thousands)
                   
Beginning balance
  $ 577     $ 662     $ (60 )
  Total gains or losses (realized and
                       
    unrealized):
                       
    Included in earnings
    -       -       -  
    Included in other comprehensive income
    53       (38 )     (370 )
  Purchases, sales, issuances and settlements,
                       
    net
    -       -          
  Transfers in/(out) of Level 3
    -       -       -  
Ending balance
  $ 630     $ 624     $ (430 )
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, 2010
  $ -     $ -     $ -  
 
 
 
 
 
21

 

THE NATIONAL SECURITY GROUP, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
 (Continued)

For the quarter ended June 30, 2010, 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 swaps 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.  Please see Note 7 for additional information about the interest rate swaps.

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.

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

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.

The carrying amount and estimate fair value of the Company’s financial instruments as of June 30, 2010 and December 31, 2009 are as follows:



   
In Thousands of Dollars
 
   
June 30, 2010
   
December 31, 2009
 
   
Carrying
   
Estimated
   
Carrying
   
Estimated
 
   
Value
   
Fair Value
   
Value
   
Fair Value
 
Assets and related instruments
                       
Mortgage loans
  $ 1,033     $ 1,033     $ 1,041     $ 1,041  
Policy loans
    1,056       1,056       1,018       1,018  
Company owned life insurance
    5,302       5,302       5,197       5,197  
Other invested assets
    3,868       3,868       3,933       3,933  
                                 
Liabilities and related instruments
                               
Other policyholder funds
    1,331       1,331       1,347       1,347  
Notes payable
    400       400       -       -  
Long-term debt
    12,372       12,372       12,372       12,372  



 
22

 

THE NATIONAL SECURITY GROUP, INC.
 
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
 (Continued)

NOTE 10 – SEGMENTS

The Company’s property and casualty insurance operations comprise one business segment.  The property and casualty insurance segment consists of seven lines of business:  dwelling fire and extended coverage, homeowners (including mobile homeowners), ocean marine, other liability, private passenger auto liability, commercial auto liability and auto physical damage.  Management organizes the business utilizing a niche strategy focusing on lower valued dwellings as well as non-standard automobile products.  Our chief operating decision makers (President, Chief Financial Officer and Chief Executive Officer) review results and operating plans making decisions on resource allocations on a company-wide basis.  The Company’s products are primarily produced through agents within the states in which we operate.

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

The following table presents the Company’s gross premiums written and earned for the property and casualty segment and the life and accident and health segment for the six months ended June 30, 2010 and 2009, respectively:
 
 
 
   
Three Months Ended
   
Six Months Ended
 
   
June 30,
   
June 30,
 
   
2010
   
2009
   
2010
   
2009
 
Gross premiums written:
                       
Life, accident and health operations:
                       
Traditional life insurance
  $ 1,295     $ 1,305     $ 2,610     $ 2,653  
Accident and health insurance
    486       466       977       897  
     Total life, accident and health
    1,781       1,771       3,587       3,550  
                                 
Property and Casuatly operations:
                               
Dwelling fire & extended coverage
    7,453       7,060       14,044       14,088  
Homeowners (Including mobile homeowners)
    7,735       7,553       14,136       14,394  
Ocean Marine
    456       328       556       622  
Other liability
    355       312       681       667  
Private passenger auto liability
    826       307       2,013       451  
Commercial auto liability
    120       115       253       274  
Auto physical damage
    331       181       801       272  
Reinsurance premium ceded
    (1,554 )     (1,205 )     (3,082 )     (2,733 )
     Total property and casualty
    15,722       14,651       29,402       28,035  
                                 
Total premiums written
  $ 17,503     $ 16,422     $ 32,989     $ 31,585  
                                 
Gross premiums earned:
                               
Life, accident and health operations:
                               
Traditional life insurance
  $ 1,315     $ 1,345     $ 2,679     $ 2,742  
Accident and health insurance
    474       467       972       911  
     Total life, accident and health
    1,789       1,812       3,651       3,653  
                                 
Property and Casuatly operations:
                               
Dwelling fire & extended coverage
    6,239       7,002       12,621       14,030  
Homeowners (Including mobile homeowners)
    7,270       6,557       13,864       13,398  
Ocean Marine
    312       323       632       617  
Other liability
    333       350       643       705  
Private passenger auto liability
    960       219       1,635       363  
Commercial auto liability
    121       176       253       334  
Auto physical damage
    405       111       707       202  
Reinsurance premium ceded
    (1,526 )     (1,177 )     (3,065 )     (2,709 )
     Total property and casualty
    14,114       13,561       27,290       26,940  
                                 
Total premiums earned
  $ 15,903     $ 15,373     $ 30,941     $ 30,593  
 
 


 
23

 

REVIEW OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM


To the Board of Directors and Shareholders
The National Security Group, Inc.

We have reviewed the condensed consolidated balance sheet of The National Security Group, Inc. as of June 30, 2010, and the related condensed consolidated statements of income for the three-month and six-month periods ended June 30, 2010 and 2009, shareholders equity for the six-month period ended June 30, 2010, and cash flows for the six-month period ended June 30, 2010 and 2009.  These condensed consolidated financial statements are the responsibility of the company’s management.

We conducted our reviews in accordance with the standards of the Public Company Accounting Oversight Board (United States). A review of interim financial information consists principally of applying analytical procedures and making inquiries of persons responsible for financial and accounting matters. It is substantially less in scope than an audit conducted in accordance with standards of the Public Company Accounting Oversight Board (United States), the objective of which is the expression of an opinion regarding the condensed consolidated financial statements taken as a whole. Accordingly, we do not express such an opinion.

Based on our reviews, we are not aware of any material modifications that should be made to the accompanying condensed consolidated financial statements referred to above for them to be in conformity with accounting principles generally accepted in the United States of America.

We have previously audited, in accordance with auditing standards of the Public Company Accounting Oversight Board (United States), the consolidated balance sheet of The National Security Group, Inc. as of December 31, 2009, and the related consolidated statements of income, shareholders’ equity, and cash flows for the year then ended (not presented herein); and in our report dated March 26, 2010, we expressed an unqualified opinion on those consolidated financial statements.  In our opinion, the information set forth in the accompanying condensed consolidated balance sheet as of December 31, 2009, is fairly stated, in all material respects, in relation to the consolidated balance sheet from which it has been derived.


/s/ Warren Averett Kimbrough & Marino, LLC

Birmingham, Alabama
August 13, 2010














 
24

 





Item 2.
MANAGEMENTS’ DISCUSSION AND ANALYSIS OF
 FINANCIAL CONDITION AND RESULTS OF OPERATIONS

 
The following discussion addresses the financial condition of The National Security Group, Inc. (referred to in this document as we, our, us, the Company or NSEC) as of June 30, 2010, compared with December 31, 2009 and its results of operations and cash flows for the three-month and six-month period ending June 30, 2010, compared with the same period last year. This discussion and analysis should be read in conjunction with the unaudited condensed consolidated financial statements and related notes thereto included in Part I, Item 1 of this report and with our audited consolidated financial statements and related notes thereto contained in our Annual Report on Form 10-K for the year ended December 31, 2009.
 
This discussion will primarily consist of an analysis of the two segments of our operations.  The life segment consists of the operations of our life insurance subsidiary, National Security Insurance Company (NSIC).  The property and casualty (P&C) segment consists of the operations of our two property and casualty insurance subsidiaries, National Security Fire & Casualty Company (NSFC) and Omega One Insurance Company (Omega).

 
This discussion contains forward-looking statements that are not historical facts, including statements about our beliefs and expectations. These statements are based upon current plans, estimates and projections. Our actual results may differ materially from those projected in these forward-looking statements as a result of various factors. See “Cautionary Statement Regarding Forward-Looking Statements” contained on Page 4 included in our Annual Report on Form 10-K for the fiscal year ended December 31, 2009 filed with the Securities and Exchange Commission.

The reader is assumed to have access to the Company’s 2009 Annual Report.  This discussion should be read in conjunction with the Annual Report and with the consolidated financial statements on pages 3 through 24 of this form 10-Q.

Information in this discussion is presented in whole dollars rounded to the nearest thousand.

The National Security Group operates in the property and casualty and life, accident and supplemental health insurance businesses and markets products primarily through independent agents.  The company operates in eleven states with over 46% of total premium revenue generated in the states of Alabama and Mississippi.  Property and casualty insurance is the most significant segment accounting for 88.2% of total insurance premium revenue during the first six months of 2010.  Revenue generated from the life segment accounted for 11.8% of total insurance premium revenue.

National Security Insurance Company (NSIC) is a life, accident and health insurance company founded in 1947 and is the oldest subsidiary of the Company.  The premium revenue produced in NSIC from the traditional life products and the accident and health products accounted for 8.7% and 3.1%, respectively, of total consolidated premium revenue.  All references to NSIC in the remainder of this management discussion and analysis will refer to the combined life, accident and health insurance operations and will compose the life segment of the Company.  NSIC is licensed to underwrite life and accident and health insurance in Alabama, Florida, Georgia, Mississippi, South Carolina and Texas.

Omega One Insurance Company (Omega) is a property and casualty insurance company incorporated in 1992.  Omega is a wholly owned subsidiary of National Security Fire and Casualty Company (NSFC) and is the smallest of the insurance subsidiaries accounting for approximately 8.6% of consolidated premium revenue.  Omega is licensed and underwrites property and casualty insurance in the states of Alabama and Louisiana.  There is no material product differentiation between those products underwritten by NSFC and Omega as both primarily underwrite personal lines of insurance.

National Security Fire and Casualty Company (NSFC) is a property and casualty insurance company and is the largest of the insurance subsidiaries accounting for slightly less than 79.6% total consolidated premium revenue of the Company.  NSFC operates primarily in the personal lines segment of the property and casualty insurance market.  NSFC has been in operation since 1959.  NSFC is licensed and underwrites property and casualty insurance in the states of Alabama, Arkansas, Florida, Georgia, Mississippi, Oklahoma, South Carolina and Tennessee.  NSFC is licensed, but does not currently underwrite any business, in the states of Kentucky and West Virginia.  NSFC also underwrites insurance on a non-admitted or surplus lines basis in the states of Louisiana, Missouri and Texas.

 
25

 
All of the insurance subsidiaries are Alabama domiciled insurance companies and therefore the Alabama Department of Insurance is the primary insurance regulator.  However, each subsidiary is subject to regulation by the respective insurance regulators of each state in which it is licensed to transact business.  Insurance rates charged by each of the insurance subsidiaries are typically reviewed and approved by each insurance department for the respective state to which the rates will apply.

All of our insurance companies have been assigned ratings by A.M. Best.  The property and casualty group has been assigned a group rating of “B++” (Good) with a negative outlook.  In addition, A.M. Best has assigned an issuer credit rating of “bbb” with a negative outlook.  NSFC, the largest of the insurance subsidiaries, carries the same A.M. Best ratings as the group.  Omega carries an A.M. Best rating of “B+” (Good) with a stable outlook and an issuer credit rating of “bbb-” with a stable outlook.  The life insurance subsidiary, NSIC, has been assigned a rating of “B” (Fair) with a stable outlook and an issuer credit ration of “bb+” with a stable outlook.  All ratings are reviewed at least annually by A.M. Best with the latest ratings effective date of April 16, 2010.

The two primary segments in which we report insurance operations are the personal lines property and casualty segment (NSFC) and the life, accident and health insurance segment (NSIC).  Please note that due to the small amount of premium revenue produced by Omega and the fact that Omega is a wholly owned subsidiary of NSFC underwriting similar lines of business, all references to NSFC in the remainder of this management discussion and analysis will include the insurance operations of both NSFC and Omega.  Our income in principally derived from net underwriting profits and investment income.  Net underwriting profit  is principally derived from earned premiums received less claims paid, sales commissions to agents, costs of underwriting and insurance taxes and fees.  Investment income includes interest and dividend income and gains and losses on investment holdings.


CONSOLIDATED RESULTS OF OPERATIONS

Summary:

For the quarter ended June 30, 2010, the Company had net income of $814,000 compared to net income of $92,000 for the same period last year.  The most significant factor contributing to the improvement in the second quarter of 2010 was a $920,000 increase in realized investment gains.  In addition, net income was positively impacted by reductions in policyholder benefits paid or provided and policy acquisition costs totaling $253,000 and $205,000, respectively.

For the six-months ended June 30, 2010, the Company had net income of $2,708,000 compared to net income of $1,573,000 for the same period last year.  The year-to-date increase of $1,588,000 in net realized investment gains was the primary reason for the improvement in net income in 2010 compared to the same period in 2009.  The increase in year-to-date net income was partially offset by a $428,000 increase in policyholder benefits paid or provided.  Year-to-date incurred losses were up in the first half of 2010 in the life segment as well as in the automobile program in the P&C segment compared to the same period last year.

Three-months ended June 30, 2010 compared to three-months ended June 30, 2009:

Premium revenue:

Premium revenue increased $530,000 to $15,903,000 in the second quarter of 2010 compared to $15,373,000 for the same period last year.  The life segment experienced an overall decline of 1.3% for the second quarter of 2010 compared to the second quarter of 2009.  The primary contributing factor to the decline was a 2.2% decrease in premium revenue from traditional life insurance products.  The second quarter decrease was partially offset by a 1.5% increase in accident and health premium revenue compared to the same period last year.


 
26

 
The increase in P&C segment revenue for the quarter was primarily the result of increases in the homeowners and automobile lines of business  The homeowners program experienced a 10.9% increase in premium revenue compared to second quarter of 2009 while the automobile program showed over a 313.6% increase compared to the same time period.  During 2009 we began expanding our automobile program into Louisiana.  The program grew quickly in Louisiana and now contributes over 92% of total automobile premium revenue compared to 37% of total automobile premium revenue for the same period in 2009.

Investment income:

Investment income in the second quarter of 2010 was $1,195,000, a decline of $179,000 compared to the same period last year.  The decline in investment income was the result of reduced interest income generated in the P&C segment in the current quarter compared to the same period in the prior year with a decline in average yields on corporate bonds being the primary factor contributing to the reduction.

Realized investment gains and losses:

Net realized investment gains totaled $689,000 for the second quarter compared to net realized investment losses of $231,000 for the three months ended June 30, 2009.  Capital gains have been primarily generated from the sale of corporate bonds in the portfolio.  A combination of declining interest rates and tightening yield spreads on corporate bonds have contributed to significant price appreciation over the past year in the corporate bond portfolio and selective reductions in holdings have generated the increase in capital gains.

Other income:

For the three-months ended June 30, 2010, other income was $256,000 compared to $192,000 for the same period last year; an increase of $64,000.  The primary reason for the growth in other income was the increase in policy and payment fees related to the automobile program in the P&C segment.

Policyholder benefits and settlement expenses:

For the three-months ended June 30, 2010, the Company incurred policyholder benefits and settlement expenses totaling $11,061,000 compared to $11,314,000 for the same period last year; a decrease of 2.24%.  The primary reason for the decline for the three-month period was a reduction in incurred losses related to death benefits in the life segment and P&C segment decreases in the dwelling fire programs compared to the same period last year.  The P&C segment decreases were partially offset by incurred loss increases in the automobile program.

Policy acquisition cost:

For the three-month period ended June 30, 2010, policy acquisition cost was 18.7% of premium revenue compared to 20.6% for the same period last year.  The primary factor contributing to the reduction in policy acquisition cost was a reduction in the accrual for contingent commission payments to property and casualty segment agents in the current year compared to the same period last year.  The accrual reduction was due to a revision in estimates due to a modification in the contingent commission formula made in 2009.

General expenses:

General expenses for the three-months ended June 30, 2010, totaled $2,155,000 or 13.5% of premium revenue compared to $1,792,000 or 11.6% of premium revenue for the same period last year.  Litigation expense increased $116,000 at the holding company level compared to the same period last year and accounted for one-third of the overall increase for the second quarter.

Taxes, licenses and fees:

Taxes, licenses and fees totaled $480,000 for the quarter-ended June 30, 2010, compared to $523,000 for the quarter-ended June 30, 2009; a $43,000 decline.  As a percent of premiums earned, taxes, licenses and fees remained relatively unchanged at 3.0% for the second quarter of 2010 compared to 3.4% for the same period last year.
 
 
 
27

 

 
Interest expense:

Interest expense was $307,000 for the quarter ended June 30, 2010, compared to $288,000 for the same period last year.  An increase in the debt outstanding at the holding company level was the primary reason for the growth in interest expense for the three-months ended June 30, 2010, compared to the same period last year.

Income taxes:

For the three-month period ended June 30, 2010, income tax expense totaled $256,000 compared to an income tax benefit of $476,000 for the same period last year.  Income tax expense in the current year resulted in an effective tax rate of 23.93% compared to the statutory rate of 34%.  Significant items reducing taxable income in 2010 were tax free investment income of $126,000 (3.9%) and the change in value of company owned life insurance of $16,000 (0.52%).  An income tax benefit was recognized for the same period last year and was increased by the change in value of company owned life insurance of $419,000 (37.1%) and tax free investment income of $316,000 (11.6%).

Six-months ended June 30, 2010 compared to six-months ended June 30, 2009

Premium revenues:

For the six-months ended June 30, 2010, premiums earned were $30,941,000 compared to $30,593,000 for the same period last year; an increase of 1.1%.  The Life segment ended the first six months of 2010 with premium revenue of $3,651,000 compared to $3,653,000 for the same period last year.  Year-to-date premiums earned for NSIC were down due to a $63,000 decline in production of traditional life insurance products.  NSIC continued to see growth in its accident and health lines of business which increased $61,000 or 6.7%, year-to-date.

NSIC produces business selling its insurance products primarily using two methods of distribution: independent agents and employee agents.  Independent agents account for approximately 85% of all new business production in NSIC and income from business serviced by independent agents now accounts for 62.8% of total NSIC premium revenue.  Employee agents primarily consist of home service agents that sell policies and collect premium principally in the insured’s home.  The home service distribution method has been a primary method of product distribution for NSIC since its founding in 1947.  Revenue from business serviced by home service agents accounted for 31.9% of total NSIC premium revenue during the first half of 2010.  The remaining premium revenue was generated from the servicing of discontinued books of business and inactive programs which contributed approximately 5.3% to NSIC income. 

The P&C segment ended the first six months of 2010 with year-to-date earned premiums of $27,290,000 compared to $26,940,000 for the same period last year; an increase of 1.3%.  Increases in earned premiums in the homeowners and automobile lines of business were the primary reasons for the overall increase in P&C premium revenue in the current year compared to the same period last year.  The homeowners programs experienced a 3.5% increase in premium revenue compared to first half of 2009 while the automobile program showed over a 314.5% increase compared to the same time period.  During early 2009 we expanded our automobile program into Louisiana.  The program grew quickly in Louisiana and now contributes over 92% of total automobile premium revenue compared to 37% of total automobile premium revenue for the same period in 2009. The increase in P&C premium revenue was partially offset by the 13.1% increase in ceded premium in 2010 compared to 2009.  Ceded premium increased as a result of higher premiums due to reinsurers under our P&C catastrophe reinsurance agreement.  The increase for the first six months compared to the same period last year was over $356,000.

Investment income:

Investment income for the six months ended June 30, 2010 was $2,521,000 compared to $2,611,000 for the same period last year.  The decline in investment income was the result of reduced interest income generated in the P&C segment in the current year compared to the same period in the prior year with a decline in average yields on corporate bonds being the primary factor contributing to the reduction.
 
 
 
28

 

 
Capital gains:

The company ended the first half of 2010 with realized capital gains of $1,358,000 compared to a realized capital loss totaling $230,000 for the same period last year.  During the current year, the life and P&C segments realized investment gains totaling $388,000 and $970,000, respectively, compared to realized losses totaling $160,000 and $70,000, respectively during 2009.  Capital gains during the first half of 2010 have been primarily generated from the sale of corporate bonds in the portfolio.  A combination of declining interest rates and tightening yield spreads on corporate bonds have contributed to significant price appreciation over the past year in the corporate bond portfolio and selective reductions in holdings have generated the increase in capital gains.  The primary reason for the realized investment loss in 2009 relates to the other-than-temporary impairments recognized in both the life and P&C segments during the second quarter of 2009.  The life segment recognized losses on other-than-temporary impairments totaling $195,000 due to the write-down in value of a CIT Group bond while the property and casualty segment recognized losses on other-than-temporary impairments totaling $88,000 due to the write-down of a General Motors asset backed security.

Other income:

Other income increased $222,000 in the first six months of 2010 compared to the same period last year.  Other income is primarily composed of insurance related fees tied to the non-standard automobile line of business as well as billing fees generated from our property lines of business.  The increase in premium revenue in the automobile program in the current year was the primary reason for the increase in payment and policy fees in the P&C segment.

Policyholder benefits and settlement expenses:

Year-to-date policyholder benefits and settlement expenses for 2010 were $19,534,000 compared to $19,106,000 for the same period last year; an increase of 2.2%.  While claims in the life segment were down for the first half of 2010, P&C segment losses were up.  Through the second quarter of 2010, the P&C segment was impacted by seven non-hurricane catastrophe related weather events leading to incurred losses totaling $1,584,000.  In comparison, during the first half of 2009, the P&C segment incurred losses from ten non-hurricane catastrophes totaling $2,029,000.  Although non-hurricane catastrophe losses were down for the first half of 2010, non-catastrophe incurred losses were up compared to the same period last year.  The P&C segment homeowners programs experienced an increase in the loss ratio of 5.3 percentage points compared to the first six months of 2009 while the automobile program loss ratio increased 12.3 percentage points.

The increase in incurred losses was primarily the result of increases in fire related total losses.  During 2010, fire related incurred losses totaled $8,041,000 compared to $7,245,000 for the same period last year; an 11% increase.  Incurred losses related to hail damage were also up ending June 2010 at $907,000 compared to $441,000 as of June 2009.  In contrast, incurred losses related to wind damage were down significantly ending June 2010 at $2,569,000 compared to $3,868,000 for the same period last year.  As mentioned previously, due to the expansion of the automobile program into Louisiana, the incurred losses increased over 600% compared to the same period last year and the loss ratio increased 12.3 percentage points compared to June 2009.

Policy acquisition costs:

For the six-month period ended June 30, 2010, policy acquisition cost was $5,718,000 or 18.5% of premium revenue compared $6,267,000 or 20.4% or premium revenue for the same period last year.  The primary reason for the decline in policy acquisition costs was the reduction in the agent contingent commission profit sharing accrual in the current year compared to the prior year.  The accrual reduction accounted for 83% of the overall decline for the six-month period.  The contingent commission calculation and standards for agent qualification were implemented as of January 1, 2010 which allowed the reduction of this accrual during the current year.
 
 
 
 
29

 

 
General expenses:

General expenses for the six-months ended June 30, 2010 totaled $4,740,000 compared to $4,496,000 for the same period last year.  General expenses as a percent of earned premium were virtually unchanged at 15.3% and 14.7% for the year-to-date periods ended June 30, 2010 and 2009 respectively.  The increase in general expenses related to increases in legal fees and deferred compensation expense of the holding company.

Taxes, licenses, and fees:

Taxes, licenses and fees were $967,000 for the six-month period ended June 30, 2010 compared to $980,000 for the same period last year.  As a percent of earned premium, taxes, licenses and fees were virtually unchanged at 3.12% and 3.2% for the year-to-date periods ended June 30, 2010 and 2009, respectively.

Interest expense:

Interest expense totaled $565,000 for the six-months ended June 30, 2010 and 2009.  For the current year, interest expense was 1.8% of premium revenue, relatively unchanged from the same period last year.

Income taxes:

For the six-month period ended June 30, 2010, income tax expense totaled $1,143,000 compared to $320,000 for the same period last year.  Income tax expense in the current year resulted in an effective tax rate of 29.7% compared to the statutory rate of 34%.  Significant items reducing taxable income in 2010 were tax free investment income of $263,000 (2.3%) and the change in value of company owned life insurance of $105,000 (0.93%).  Income tax expense for the same period last year resulted in an effective tax rate of 16.9%.  Significant items reducing taxable income in 2009 were the small life deduction of $483,000 (8.7%), tax free investment income of $316,000 (5.7%) and the change in value of company owned life insurance of $227,000 (4.1%).

Investments:

Invested assets at June 30, 2010 increased $4,258,000 compared to December 31, 2009.  Contributing to this increase were the purchase of investments of $2,830,000 as well as increases in market value of fixed maturity available-for-sale securities of $544,000.  The value of the Company’s investment in company owned life insurance increased in value by $105,000.

The Company considers any fixed income investment with a Standard & Poor’s rating of BB+ or lower to be below investment grade (Commonly referred to as “Junk Bonds”).  At June 30, 2010 the Company has no material exposure to sub-prime mortgage loans and approximately 2% of the Company’s investment portfolio was invested in fixed income investments rated below investment grade. The Company monitors its level of investments in debt and equity securities held in issuers of below investment grade debt securities.  Management believes the level of such investments is not material to the Company’s financial condition.

Liquidity and capital resources:

At June 30, 2010, the Company had aggregate equity capital, unrealized investment gains (net of income taxes) and retained earnings of $43,327,000, up $2,159,000 compared to December 31, 2009.  Factors contributing to the change in equity were year-to-date net income of $2,708,000, recoveries in market values of fixed maturities and equity securities of $416,000, a net loss on interest rate swaps of $225,000 and dividends paid of $740,000.

The Company has $12,372,000 in debt outstanding consisting of long-term debt from the proceeds of two separate trust preferred securities issuances, the latest of which totaled $3,000,000 and was completed in June 2007.   The Company had $400,000 outstanding on a revolving line of credit at June 30, 2010.  The Company currently does not anticipate any new borrowings.
 
 
 
 
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The Company had $2,698,000 in cash and short-term investments at June 30, 2010.  Net cash provided by operating activities totaled $1,196,000 for the six-months ended June 30, 2010 primarily due to year-to-date net income of $2,708,000 and reinsurance recoveries of $31,000 and a decrease in depreciation expenses.
 
 
The liquidity requirements of the Company are primarily met by funds provided from operations of the life insurance and property/casualty subsidiaries.  The Company receives funds from its subsidiaries consisting of dividends, payments for federal income taxes, and reimbursement of expenses incurred at the corporate level for the subsidiaries.  These funds are used to pay stockholder dividends, corporate interest, corporate administrative expenses, federal income taxes, and for funding investments in subsidiaries.

The Company’s subsidiaries require cash in order to fund policy acquisition costs, claims, other policy benefits, interest expense, general expenses, and dividends to the Company.  Premium and investment income, as well as maturities, calls, and sales of invested assets, provide the primary sources of cash for both subsidiaries.  A significant portion of the Company’s investment portfolio consists of readily marketable securities, which can be sold for cash.

The Company’s business is concentrated primarily in the Southeastern United States.  Accordingly, unusually severe storms or other disasters in the Southeastern United States might have a more significant effect on the Company than on a more geographically diversified insurance company.  However, the Company maintains a catastrophe reinsurance program to limit the effect of such catastrophic events on the Company’s financial condition.  The Company deductible under the terms of the reinsurance contract totals $3.5 million however; the Company maintains cash and short-term investments in sufficient amounts to cover the deductible payment in the event of a catastrophic event.


















 
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Item 3.  Quantitative and Qualitative Disclosures about Market Risk

The Company’s primary objectives in managing its investment portfolio are to maximize investment income and total investment returns while minimizing overall credit risk.  Investment strategies are developed based on many factors including changes in interest rates, overall market conditions, underwriting results, regulatory requirements, and tax position.  Investment decisions are made by management and reviewed by the Board of Directors.  Market risk represents the potential for loss due to adverse changes in fair value of securities.  The three potential risks related to the Company’s fixed maturity portfolio are interest rate risk, prepayment risk, and default risk.  The primary risk related to the Company’s equity portfolio is equity price risk.  The Company has not incurred material losses in its investment portfolio in the first three months of 2010 related to interest rate changes, defaults on certain securities and changes in value of equity investments.  These changes are discussed in detail under Item 2 of this Form 10-Q.  For further information reference is made to the Company’s Form 10-K for the year ended December 31, 2009.

For further information regarding market risk, reference is made to the Company’s Form 10-K for the year ended December 31, 2009.

Item 4.  Controls and Procedures

Our management carried out an evaluation, with the participation of our chief executive officer and chief financial officer, of the effectiveness of our disclosure controls and procedures as of June 30, 2010. Based upon that evaluation, our chief executive officer and chief financial officer concluded that our disclosure controls and procedures were effective to ensure that information required to be disclosed by us in reports that we file or submit under the Securities Exchange Act of 1934 is recorded, processed, summarized and reported within the time periods specified in the rules and forms of the Securities and Exchange Commission.

There has not been any change in our internal control over financial reporting in connection with the evaluation required by Rule 13A-15(d) under the Exchange Act that occurred during the six month period ended June 30, 2010, that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.
 
 

 
 
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Part II. OTHER INFORMATION
 
Please refer to Note 8 to the financial statements.
 
There has been no material change in risk factors previously disclosed under Item 1A. of the
Company’s annual report for 2009 on Form 10-K.
 
None
 
None
 
None
 

a.  Exhibits
 
31.1 Certification Pursuant to 18 U. S. C. Section 1350, as Adopted Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
 
31.2 Certification Pursuant to 18 U. S. C. Section 1350, as Adopted Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
 
32.1 Certification Pursuant to 18 U. S. C. Section 1350, as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
 
b.  Reports on Form 8-K during the quarter ended June  30, 2010


Date of Report
 
Date Filed
 
Description
                   
April 16, 2010
 
April 16, 2010
 
Press release, dated April 16, 2010, issued by The National Security Group, Inc.
                   
April 15, 2010
 
April 19, 2010
 
Press release, dated April 19, 2010, issued by The National Security Group, Inc.
                   
May 14, 2010
 
May 14, 2010
 
Press release, dated May 14, 2010, issued by The National Security Group, Inc.
                   
May 14, 2010
 
June 17, 2010
 
Item 5.07 Submission of Matters to a Vote notification issued by The National Security Group, Inc.
 
 
 
 
 
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SIGNATURE

Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed by the undersigned duly authorized officer, on its behalf and in the capacity indicated.

The National Security Group, Inc.


/s/ William L. Brunson, Jr.
 
/s/ Brian R. McLeod
William L. Brunson, Jr.
 
Brian R. McLeod
President and Chief Executive Officer
 
Vice President  and Chief Financial Officer

Dated: August 13, 2010




 
 
 
 
 
 
 
 
 
 

 









 
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