nsg10ka.htm
 

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

FORM 10-K/A
Amendment No. 1


 
x   ANNUAL REPORT PURSUANT TO SECTION 13 or 15(D) OF THE SECURITIES EXCHANGE ACT OF 1934
For the Fiscal Year Ended December 31, 2009

OR

    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

Securities registered pursuant to Section 12 (b) of the Act:
 
None
 
Securities registered pursuant to Section 12 (g) of the Act:
 
Common Stock, par value $1.00 per share                                                                                                The NASDAQ Global Market (EXCHANGE)

 
Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. Yes      No  x

Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act.   Yes      No  x

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  x    No  

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).      □ Yes    □ No

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant's knowledge in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. 

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See definition of “large accelerated filler,”  “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):

Large accelerated filer      Accelerated filer     Non-accelerated filer    Smaller Reporting Company x

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

The aggregate market value of the voting stock held by non-affiliates of the Registrant as of the last business day of the registrant’s most recently completed second fiscal quarter, based upon the bid price of these shares on NASDAQ on such date, was $15,850,514

Indicate the number of shares outstanding of each of the issuer’s classes of Common Stock, as of the close of the period covered by this report.
 
 Class
 
 
 
Outstanding March 26, 2010
 
 
 
 
Common Stock, $1.00 par value
2,466,600 shares
  


 
 

 

Explanatory Note
 
This Form 10-K/A is filed to amend Item 6 and Item 8 of the Registrant's Form 10-K for the year ended December 31, 2009 (the "2009 10-K") to report that the financial statements included  in the 2009 Form 10-K for the year ended December 31, 2008 are unaudited.

The 2009 Form 10-K , as filed with the SEC on March 26, 2010, includes the audit report of the Registrant's independent auditors, Warren, Averett, Kimbrough & Marino LLC ("Warren Averett"), dated March 26, 2010, on the consolidated financial statements of the Registrant and its subsidiaries for the year ended December 31, 2009 and related financial schedules.  The report refers to the audit of the consolidated financial statements of Registrant and subsidiaries for the year ended December 31, 2008, that was performed by the Registrant's predecessor auditor, Barfield, Murphy, Shank, & Smith, P.C. ("Barfield Murphy").  By letter dated December 15, 2010, Registrant received the following comment from the staff of the Securities and Exchange Commission regarding the 2009 Form 10-K:
 
The audit report of Warren, Averett, Kimbrough & Marino, LLC references the report of another auditor for the year ended December 31, 2008.  Please file this report as reissued by the other auditor as required by Rule 2-05 of Regulation S-X.
 
Rule 2-05 of SEC Regulation S-X requires the separate report of the predecessor auditor to be filed in registrant's 2009 10-K.  Barfield Murphy has advised the Registrant that it is not able to reissue its audit report on the 2008 financial statements for inclusion in the 2009 10-K because it is no longer independent for the reasons described below.

Registrant is a party to certain litigation involving the 2007 sale of its investment in a 50% owned subsidiary, Mobile Attic, Inc.  As disclosed in Part II, Item 1 of Registrant's Quarterly Report on Form 10-Q for the quarter ended September 30, 2010, Registrant and the other then shareholders of Mobile Attic, Inc. sold 61% of its outstanding stock to Bagley Family Revocable Trust pursuant to a Stock Purchase Agreement executed in April 2007.  Under the terms of the Stock Purchase Agreement, the sellers made certain warranties regarding the financial condition of Mobile Attic, Inc. and agreed to jointly and severally indemnify purchaser for damages resulting from any breach of those warranties.  Barfield Murphy was the auditor for both the Registrant and also performed a separate audit for Mobile Attic, Inc. for the years ended December 31, 2006 and 2005.
 
On January 9, 2009, Bagley Family Revocable Trust filed a complaint against the other sellers of the stock of Mobile Attic, Inc. that included, among other claims, a claim for damages resulting from a breach of certain warranties regarding the financial statements of Mobile Attic, Inc. and regarding the financial condition of Mobile Attic, Inc.  The purchaser also included a complaint against Barfield Murphy for negligence in the preparation of the financial statements of Mobile Attic, Inc.  The purchaser did not name the Registrant in its complaint, but notified Registrant of a claim for indemnity for breach of warranty by separate letter in February 2009.  Registrant requested documentation supporting the indemnity claim in response to the letter; no documentation was provided.  In July 2009, Registrant filed a complaint in intervention in the Mobile Attic litigation requesting the Court to find that Registrant is not liable for indemnity under the Stock Purchase Agreement.  Registrant's complaint also included a third party claim against Barfield Murphy for indemnity for any liability sustained by Registrant in the litigation as a result of the negligence of Barfield Murphy in its audit of the financial statements of Mobile Attic, Inc.  In August 2010, Registrant amended its complaint to dismiss the claim against Barfield Murphy without prejudice, and Barfield Murphy has agreed to toll the statute of limitation as of the date Registrant filed its complaint.
 
Barfield Murphy has taken the position that it is not able to reissue its audit report on the 2008 consolidated financial statements for inclusion in the 2009 Form 10-K because it is no longer independent due to its adverse position with the Registrant in the Mobile Attic litigation.  Registrant believes that Barfield Murphy was independent at the time it issued its audit report, dated March 27, 2009, with respect to the consolidated financial statements for the year ended December 31, 2008.  Registrant's decision to intervene in the Mobile Attic litigation was made, and its claim against Barfield Murphy as the auditor of Mobile Attic, Inc. was first asserted, three months after the date of Barfield Murphy's audit report (March 27, 2009).
 
 
 
 
 
1

 
 
Due to the predecessor auditor’s refusal to reissue their audit report, registrant has engaged its current auditor, Warren Averett, to audit its 2008 consolidated financial statements.  Warren Averett did not audit the 2008 consolidated financial statements in connection with its audit of Registrant's 2009 consolidated financial statements; however, Warren Averett has advised Registrant that it should be able to perform an audit of the 2008 consolidated financial statements because it was able to perform such audit procedures as it deemed necessary to issue its 2009 audit report and because Warren Averett received cooperation from Barfield Murphy in making inquiries and reviewing work papers associated with Barfield Murphy's audit of the 2008 consolidated financial statements.

Registrant intends to file a subsequent amendment to the 2009 10-K to include its audited consolidated financial statements for the year ended December 31, 2008.  The Registrant usually releases its prior year earnings in February.  Although neither the Registrant nor Warren Averett expect any significant reclassifications or adjustments resulting from the audit of the 2008 consolidated financial statements, the Registrant will delay its release of earnings for the year ended December 31, 2010, to allow Warren Averett additional time to audit the 2008 consolidated financial statements and to complete its audit of the 2010 consolidated financial statements.  The earnings release will be distributed, and the 2010 Form 10-K will be filed, on or before March 31, 2011. The Registrant expects to file the 2009 Form 10-K amendment including the audited 2008 consolidated financial statements no later than March 31, 2011.
 
 
Except as otherwise expressly set forth herein, all of the information in this Form 10-K/A is as of March 26, 2010, the date the Company filed the 2009 10-K with the SEC. This Form 10-K/A continues to speak as of the date of the 2009 10-K and does not reflect any subsequent information or events other than as expressly set forth otherwise in this Form 10-K/A.  Accordingly, this Form 10-K/A should be read in conjunction with our filings made with the SEC subsequent to the filing of the 2009 10-K, including any amendments to those filings.  Among other things, forward-looking statements made in the 2009 10-K have not been revised to reflect events, results or developments that occurred or facts that became known to us after the date of the 2009 10-K, other than this amendment.

Except as amended by this Form 10-K/A, the information contained in the 2009 10-K is unchanged and may be reviewed under the filing made on March 26, 2010.  


 
 
 
 
 
 

 
2

 


 
Item 6.  Selected Financial Data

Selected financial information presented in the tables below is unaudited for the period ended December 31, 2008 and as of December 31, 2008.

Five-Year Financial Information:
(Amounts in thousands, except per share)


Operating results
 
2009
   
2008 (unaudited)
   
2007
   
2006
   
2005
 
                               
Net premiums earned
  $ 59,594     $ 56,264     $ 62,250     $ 58,874     $ 53,563  
Net investment income
    5,289       4,368       4,749       4,463       3,964  
Net realized investment (losses) gains
    357       (1,049 )     1,493       2,565       3,493  
Other income
    764       1,107       1,071       1,211       1,416  
Total revenues
  $ 66,004     $ 60,690     $ 69,563     $ 67,113     $ 62,436  
                                         
Net income (loss)
  $ 4,224     $ (5,204 )   $ 6,040     $ 4,250     $ 1,558  
Net income (loss) per share
  $ 1.71     $ (2.11 )   $ 2.45     $ 1.72     $ 0.63  


Other Selected Financial Data
 
2009
   
2008 (unaudited)
   
2007
   
2006
   
2005
 
                               
Total shareholders' equity
  $ 41,168     $ 34,648     $ 48,447     $ 45,379     $ 43,556  
Book value per share
  $ 16.69     $ 14.04     $ 19.64     $ 18.39     $ 17.66  
Dividends per share
  $ 0.600     $ 0.900     $ 0.900     $ 0.885     $ 0.865  
Net change in unrealized
                                       
  capital gains (net of tax)
  $ 3,520     $ (6,147 )   $ (664 )   $ (244 )   $ (2,544 )
Total assets
  $ 131,396     $ 124,890     $ 135,585     $ 134,911     $ 139,226  

Quarterly Information:

   
Premiums
   
Investment & Other Income
   
Realized Investment Gains (Losses)
   
Claims and Benefit Payments
   
Net Income (Loss)
   
Net Income (Loss)
 Per Share
2009
                                 
1st QTR
  $ 15,220     $ 1,378     $ 1     $ 7,792     $ 1,481     $ 0.60  
2nd QTR
    15,373       1,566       (231 )     11,314       92       0.04
3rd QTR
    14,357       1,584       79       9,131       651       0.26  
4th QTR
    14,644       1,525       508       7,602       2,000       0.81
    $ 59,594     $ 6,053     $ 357     $ 35,839     $ 4,224     $ 1.71  
                                               
2008 (unaudited)
                                               
1st QTR
  $ 16,586     $ 1,642     $ 66     $ 10,560     $ 782     $ 0.32
2nd QTR
    13,968       1,593       82       10,812       (36 )     (0.01 )
3rd QTR
    11,707       1,586       (1,452 )     15,795       (6,945 )     (2.82
4th QTR
    14,003       654       255       7,579       995       0.40  
    $ 56,264     $ 5,475     $ (1,049 )   $ 44,746     $ (5,204 )   $ (2.11

 
 
 
 
 
 
 
 

 
3

 

Item 8.  Financial Statements and Supplementary Data



Index to Financial Statements
   
     
Consolidated Financial Statements:
   
     
Report of Independent Registered Public Accounting Firm
 
5
     
Consolidated Balance Sheets –
   
  December 31, 2009 and 2008 (unaudited)
 
6
     
Consolidated Statements of Operations –
   
  Years Ended December 31, 2009 and 2008 (unaudited)
 
8
     
Consolidated Statements of Shareholders’ Equity –
   
  Years Ended December 31, 2009 and 2008 (unaudited)
 
9
     
Consolidated Statements of Cash Flows –
   
  Years Ended December 31, 2009 and 2008 (unaudited)
 
10
     
Notes to Consolidated Financial Statements –
   
  December 31, 2009
 
11
     
Financial Statement Schedules:
   
     
Schedule I.  Summary of Investments Other Than Investments in Related Parties –
  December 31, 2009 and 2008 (unaudited)
 
37
     
Schedule II.  Condensed Financial Information of Registrant –
   
  December 31, 2009 and 2008 (unaudited)
 
38
     
Schedule III.  Supplementary Insurance Information –
   
  December 31, 2009 and 2008 (unaudited)
 
42
     
Schedule IV.  Reinsurance –
   
  Years Ended December 31, 2009 and 2008 (unaudited)
 
43
     
Schedule V.  Valuation and Qualifying Accounts –
 
44
  Years Ended December 31, 2009 and 2008 (unaudited)
   
     
All other Schedules are not required under related instructions or are
 not applicable and therefore have been omitted.


 
4

 
  
 
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
 
 

 
To the Board of Directors and Shareholders
The National Security Group, Inc.
Elba, Alabama
 
We have audited the accompanying consolidated balance sheet of The National Security Group, Inc. as of December 31, 2009, and the related consolidated statements of operations, shareholders’ equity and cash flows for the year then ended.  The Company’s management is responsible for these consolidated financial statements. Our responsibility is to express an opinion on these consolidated financial statements based on our audit. 
 
We conducted our audit in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the consolidated financial statements are free of material misstatement. The Company is not required to have, nor were we engaged to perform, an audit of its internal control over financial reporting. Our audit included consideration of internal control over financial reporting as a basis for designing audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the Company’s internal control over financial reporting. Accordingly, we express no such opinion. An audit also includes examining, on a test basis, evidence supporting the amounts and disclosures in the consolidated financial statements, assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement and financial statement schedules presentation. We believe that our audit provides a reasonable basis for our opinion.
 
In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of The National Security Group, Inc. as of December 31, 2009, and the results of its operations and its cash flows for the year then ended in conformity with accounting principles generally accepted in the United States of America.  Also, in our opinion, the financial statement schedules listed in the accompanying index appearing under Item 8, when considered in relation to the basic consolidated financial statements taken as a whole, present fairly, in all material respects, the information set forth therein.
 


 
/s/ Warren, Averett, Kimbrough & Marino, LLC
   
Birmingham, Alabama
March 26, 2010
 

 
 
5

 
 
 

 
 
 
The National Security Group, Inc.
                 
CONSOLIDATED BALANCE SHEETS
                 
       
(Dollars in thousands)
       
December 31,
ASSETS
   
2009
   
2008
                  (unaudited)
Investments
           
 
Fixed maturities held-to-maturity, at amortized cost (estimated fair value: 2009 - $6,080;
           
   
 2008 - $10,995)
 
$
        5,942
 
$
      10,952
 
Fixed maturities available-for-sale, at estimated fair value (cost: 2009 - $69,796;
           
   
 2008- $61,796)
   
     70,269
   
      58,107
 
Equity securities available-for-sale, at estimated fair value (cost: 2009 - $5,851
           
   
 2008 - $5,467)
   
        9,035
   
        7,569
 
Trading securities
   
           374
   
           253
 
Receivable for securities
   
              96
   
            513
 
Mortgage loans on real estate, at cost
   
          1,041
   
           502
 
Investment real estate, at book value (accumulated depreciation: 2009 - $18; 2008 - $18)
   
         4,815
   
        4,754
 
Policy loans
   
          1,018
   
           968
 
Company owned life insurance
   
         5,197
   
         1,957
 
Other invested assets
   
        3,933
   
        4,557
                 
   
Total Investments
   
     101,720
   
      90,132
                 
Cash
   
        4,686
   
        3,027
Accrued investment income
   
           802
   
           804
Policy receivables and agents' balances, less allowance (2009 - $0; 2008 - $59)
   
        9,700
   
         9,179
Reinsurance recoverable
   
           784
   
         4,146
Deferred policy acquisition costs
   
       10,210
   
        9,825
Property and equipment, net
   
        2,537
   
        2,844
Deferred income tax asset
   
               -
   
         1,839
Accrued income tax recoverable
   
               -
   
         2,321
Other assets
   
           957
   
           773
                 
   
Total Assets
 
$
     131,396
 
$
    124,890

 

See accompanying notes to consolidated financial statements


 
6

 



The National Security Group, Inc.
 
             
CONSOLIDATED BALANCE SHEETS
 
             
 
(Dollars in thousands)
 
 
December 31,
 
LIABILITIES AND SHAREHOLDERS' EQUITY
 
2009
   
2008
 
             (unaudited)  
Property and casualty benefit and loss reserves
  $ 12,646     $ 14,436  
Accident and health benefit and loss reserves
    1,612       1,222  
Life and annuity benefit and loss reserves
    28,579       28,045  
Unearned premiums
    27,381       27,764  
Policy and contract claims
    535       503  
Other policyholder funds
    1,347       1,344  
Long-term debt
    12,372       12,372  
Accrued income taxes
    111       -  
Deferred income tax liability
    61       -  
Other liabilities
    5,584       4,556  
                 
Total Liabilities
    90,228       90,242  
                 
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 and 10,000,000 shares authorized, respectively,
               
2,466,600 shares issued and outstanding
    2,467       2,467  
Additional paid-in capital
    4,951       4,951  
Accumulated other comprehensive income (loss)
    2,265       (1,511 )
Retained earnings
    31,485       28,741  
                 
Total Shareholders' Equity
    41,168       34,648  
                 
Total Liabilities and Shareholders' Equity
  $ 131,396     $ 124,890  





See accompanying notes to consolidated financial statements
 
 
 
 
 
 

 
7

 


The National Security Group, Inc.
 
   
CONSOLIDATED STATEMENTS OF OPERATIONS
 
             
             
   
(Dollars in thousands
 
   
except per share amounts)
 
   
Year Ended December 31,
 
   
2009
   
2008
 
REVENUES
           (unaudited)  
Net premiums earned
  $ 59,594     $ 56,264  
Net investment income
    5,289       4,368  
Net realized investment gains (losses)
    357       (1,049 )
Other income
    764       1,107  
      66,004       60,690  
                 
BENEFITS AND EXPENSES
               
Policyholder benefits paid or provided
    35,839       44,746  
Amortization of deferred policy acquisition costs
    3,673       4,344  
Commissions
    7,863       8,262  
General and administrative expenses
    10,396       8,558  
Taxes, licenses and fees
    1,631       1,447  
Interest expense
    1,126       1,147  
      60,528       68,504  
                 
                 
Income (Loss) Before Income Tax Expense (Benefit)
    5,476       (7,814 )
                 
INCOME TAX EXPENSE (BENEFIT)
               
Current
    1,136       (3,495 )
Deferred
    116       885  
      1,252       (2,610 )
                 
Net Income(Loss)
  $ 4,224     $ (5,204 )
                 
                 
Net Earnings (Loss) Per Common Share
  $ 1.71     $ (2.11 )


 See accompanying notes to consolidated financial statements





 
8

 


 
THE NATIONAL SECURITY GROUP, INC.
 
                           
CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY
 
                           
(Dollars in thousands)
 
                           
               
Accumulated
         
               
Other
         
     
Comprehensive
 
Retained
 
Comprehensive
Common
 
Paid-in
 
 
Total
 
Income (Loss)
 
Earnings
 
Income (Loss)
Stock
 
Capital
 
                           
                           
Balance at December 31, 2007
 $  48,447
 $
                 -   
  $
36,165
 
 $  4,864
 $   2,467
  $
4,951
 
Comprehensive loss:
                         
Net loss for 2008
      (5,204)
 
       (5,204)
   
       (5,204)
 
               -
                -
   
               -
 
Other comprehensive loss, net of tax
                         
Unrealized loss on securities, net
                         
of reclassification adjustment of ($978)
       (6,147)
 
        (6,147)
   
                   -
 
     (6,147)
                -
   
               -
 
Unrealized loss on interest rate swap
          (228)
 
           (228)
   
                   -
 
       (228)
                -
   
               -
 
Comprehensive loss
   
       (11,579)
                   
Cash dividends ($0.90 per share)
      (2,220)
       
       (2,220)
 
               -
                -
   
               -
 
Balance at December 31, 2008   (unaudited)
      34,648
 
   
   
        28,741
 
       (1,511)
       2,467
   
       4,951
 
Comprehensive income:
                         
Net income for 2009
        4,224
 
         4,224
   
         4,224
 
               -
                -
   
               -
 
Other comprehensive income, net of tax
                         
Unrealized gain on securities, net
                         
of reclassification adjustment of $282
        3,520
 
         3,520
   
                   -
 
      3,520
                -
   
               -
 
Unrealized gain on interest rate swap
            256
 
             256
   
                   -
 
         256
                -
   
               -
 
Comprehensive income
   
         8,000
                   
Cash dividends ($0.60 per share)
       (1,480)
       
        (1,480)
 
               -
                -
   
               -
 
                           
Balance at December 31, 2009
 $    41,168
      $
31,485
 
 $  2,265
 $   2,467
  $
4,951
 





See accompanying notes to consolidated financial statements.
 
 
 
 
 
 


 
9

 

 
The National Security Group, Inc.
CONSOLIDATED STATEMENTS OF CASH FLOWS
 
   
(Dollars in thousands)
Year ended December 31,
 
 
2009
   
2008
Cash flows from operating activities:
           (unaudited)  
             
Net income (loss)
  $ 4,224     $ (5,204 )
Adjustments to reconcile net income to net cash provided by (used in) operating activities:
               
  Depreciation expense and amortization/accretion, net
    229       409  
  Increase in cash surrender of company owned life insurance
    ( 740 )     543  
  Net realized (gains) losses on investments
    ( 357 )     1,049  
  Deferred income taxes
    116       ( 885 )
  Amortization of deferred policy acquisition costs
    3,673       4,344  
  Changes in assets and liabilities:
               
    Change in receivable for securities
    417       ( 513 )
    Change in accrued investment income
    2       ( 10 )
    Change in reinsurance recoverable
    3,362       ( 3,229 )
    Policy acquisition costs deferred
    ( 4,058 )     ( 5,176 )
    Change in accrued income taxes
    2,432       ( 3,400 )
    Change in prepaid reinsurance premiums
    ( 10 )     ( 2 )
    Change in net policy liabilities and claims
    ( 1,738 )     8,105  
    Change in other liabilities
    1,284       ( 2,204 )
    Other, net
    ( 113 )     281  
                 
Net cash provided by (used in) operating activities
    8,723       ( 5,892 )
                 
Cash flows from investing activities:
               
Purchases of:
               
  Available-for-sale securities
    (30,594 )     (22,514 )
  Trading securities and short-term investments
    ( 141 )     ( 154 )
  Real estate held for investment
    ( 66 )     ( 446 )
  Company owned life insurance
    ( 2,500 )     ( 2,500 )
  Other invested assets
    ( 108 )     ( 3,714 )
  Property and equipment
    ( 116 )     ( 368 )
Proceeds from sale or maturities of:
               
  Held-to-maturity securities
    4,926       6,377  
  Available-for-sale securities
    22,830       28,938  
  Trading securities and short-term investments
    20       1,165  
  Real estate held for investment
    19       720  
  Other invested assets
    732       1,259  
Other
    ( 589 )     ( 58 )
                 
Net cash (used in) provided by investing activities
    ( 5,587 )     8,705  
Cash flows from financing activities:
               
  (Repayment of) Proceeds from short-term debt
    -       ( 900 )
  Change in other policyholder funds
    3       35  
  Dividends paid
    ( 1,480 )     ( 2,220 )
                 
                  Net cash used in financing activities
    ( 1,477 )     ( 3,085 )
                 
Net increase (decrease) in cash
    1,659       ( 272 )
                 
Cash at beginning of year
    3,027       3,299  
Cash at end of year
  $ 4,686     $ 3,027  
   
See accompanying notes to consolidated financial statements.
 
 
 
 
 
 
 
 
 
 
 
10

 


*References to 2008 balances in the following notes to consolidated financial statements are 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 significant accounting policies followed by the Company and subsidiaries that materially affect financial reporting are summarized below.

Description of Business
NSIC is licensed in the states of Alabama, Florida, Georgia, Mississippi, South Carolina and Texas and was organized in 1947 to provide life and burial insurance policies to the home service market.  Business is now produced by both company and independent agents.  Primary products include ordinary life, accident and health, supplemental hospital, and cancer insurance products.

NSFC is licensed in Alabama, Arkansas, Florida, Georgia, Kentucky, Mississippi, Oklahoma, South Carolina, Tennessee and West Virginia.  In addition, NSFC operates on a surplus lines basis in Louisiana, Missouri, and Texas.  NSFC operates in various property and casualty lines, the most significant of which are dwelling property fire and extended coverage,  homeowners, mobile homeowners, ocean marine, private passenger automobile physical damage and liability and commercial auto liability.

Omega is licensed in the states of Alabama and Louisiana.  Omega operates in property and casualty lines, the most significant of which are homeowners and private passenger automobile physical damage and liability.

The Company is incorporated under the laws of the State of Delaware.  Its Common Stock is traded on the NASDAQ Global Market under the ticker symbol NSEC.  Pursuant to the regulations of the United States Securities and Exchange Commission (SEC), the Company is considered a “Smaller Reporting Company” as defined by SEC Rule 12b-2 of the Exchange Act.  The Company has elected to comply with the new scaled disclosure requirements of Regulation S-K and only two years of financial statements are included herein. The Company previously used a non-accelerated filer status.

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.

Concentration of Risk
The Company’s property and casualty segment is licensed or operates on a surplus lines basis in 13 states.  However, over 60% of segment revenue is generated in the states of Alabama, Mississippi and Louisiana, subjecting the Company to significant geographic concentration.  Consequently, adverse weather conditions or changes in the legal, regulatory or economic environment could adversely impact the Company.

The Company’s life, accident and health insurance segment, composing nearly 12% of consolidated revenues, is licensed in six states.  However, over 75% of segment revenue is generated in the states of Alabama and Georgia.  Consequently, changes in the legal, regulatory or economic environment could adversely impact the Company.

For the year ended December 31, 2009 and 2008, there was one agency in the property and casualty segment that individually produced greater than 5% of the Company’s direct written premium.
 
 
 
 
 
 


 
11

 

NOTE 1 –  SIGNIFICANT ACCOUNTING POLICIES – CONTINUED

Investments
The Company’s securities are classified  as follows:

·  
Securities Held-to-Maturity.  Bonds, notes and redeemable preferred stock for which the Company has the positive intent and ability to hold to maturity are reported at cost, adjusted for amortization of premiums and accretion of discounts which are recognized in interest income using methods which approximate level yields over the period to maturity.

·  
Securities Available-for-Sale.  Bonds, notes, common stock and non-redeemable preferred stock not classified as either held-to-maturity, or trading are reported at fair value, and adjusted for other-than-temporary declines in fair value.

·  
Trading Securities.  Trading securities are classified as such on the balance sheet and reported at fair value.
 
 
Unrealized gains and losses on investments, net of tax, on securities available-for-sale are reflected directly in shareholders’ equity as a component of accumulated other comprehensive income, and accordingly, have no effect on net income until realized.

Changes in fair value of trading securities are recognized in net income.

Realized gains and losses on the sale of investments available-for-sale are determined using the specific-identification method and include write downs on available-for-sale investments considered to have other than temporary declines in market value.

When a fixed maturity security has a decline in value, where fair value is below amortized cost, an other-than-temporary impairment (OTTI) is triggered in circumstances where:

·  
the Company has the intent to sell the security

·  
it is more likely-than-not that the Company will be required to sell the security before recovery of its amortized cost basis

·  
the Company does not expect to recover the entire amortized cost basis of the security.

If the Company intends to sell the security or if it is more-likely-than not the Company will be required to sell the security before recovery, an OTTI is recognized as a realized loss in the income statement equal to the difference between the security’s amortized cost and its fair value.  If the Company does not intend to sell the security or it is not more-likely-than not that the Company will be required to sell the security before recovery, the OTTI is separated into an amount representing the credit loss, which is recognized as a realized loss in the income statement, and the amount related to all other factors, which is recognized in other comprehensive income.

When an equity security has a decline in value, where fair value is below cost, that is deemed to be other than temporary, the Company reduces the book value of the security to its current fair value, recognizing the decline as a realized loss in the income statement.  Any future increases in the market value of investments written down are reflected as changes in unrealized gains as part of accumulated other comprehensive income within stockholders’ equity.

Interest on fixed income securities is credited to income as it accrues on the principal amounts outstanding adjusted for amortization of premiums and accretion of discounts computed utilizing the effective interest rate method.  Premiums and discounts on mortgage backed securities are amortized or accreted using anticipated prepayments with changes in anticipated prepayments accounted for prospectively.  The model used to determine anticipated prepayment assumptions for mortgage backed securities uses separate home sale, refinancing, curtailment and pay-off assumptions derived from a variety of industry sources.  Mortgage-backed security valuations are subject to prospective adjustments in yield due to changes in prepayment assumptions.  The utilization of the prospective method will result in a recalculated effective yield that will equate the carrying amount of the investment to the present value of the projected future cash flows.  The recalculated yield is used to accrue income on investments for subsequent periods.
 
 
 
 
 

 
 
12

 
 
 
NOTE 1 – SIGNIFICANT ACCOUNTING POLICIES – CONTINUED

Mortgage loans and policy loans are stated at the unpaid principal balance of such loans.

Investment real estate is reported at cost, less allowances for depreciation computed on the straight-line basis.  Investment real estate consists primarily of timberland and undeveloped commercial real estate.  Real estate is carried at cost.

Other investments consist primarily of investments in notes and equity investments in limited liability companies and company owned life insurance.  The Company has no influence or control over the operating or financial policies of the investee limited liability companies and consequently, these investments are accounted for using the cost method.

The Company owns life insurance contracts on certain management employees.  The life insurance contracts are carried at their current cash surrender value.  Changes in cash surrender values are included in income in the current period.  Death proceeds from the contracts are recorded when the proceeds become payable under the terms of the policy.

Cash and short-term investments are carried at cost, which approximates market value.

Investments with other than temporary impairment in value are written down to estimated realizable values and losses recognized in the determination of net income.  The fair value of the investment becomes its new cost basis.

Fair Values of Financial Instruments
The Company uses the following methods and assumptions to estimate fair values:

Investments – Fixed income security fair values are based on quoted market prices when available.  If not available, fair values are based on values obtained from investment brokers and independent pricing services.

Equity security fair values are based on quoted market prices.

Multiple observable inputs are not available for certain of our investments, primarily private placements and limited partnerships.  Management values these investments either using non-binding broker quotes or pricing models that utilize market based assumptions that have limited observable inputs.

Receivables and reinsurance recoverable – The carrying amounts reported approximate fair value.

Interest rate swaps – The estimated fair value of the interest rate swaps is based on valuations received from financial institution counterparties.

Trust preferred securities obligations and line of credit obligations – The carrying amounts reported for these instruments are equal to the principal balance outstanding and approximate their fair value.


Policy Receivables
Receivable balances are reported at unpaid balances, less a provision for credit losses.

Accounts Receivable
Accounts receivable are reported at net realizable value.  Management determines the allowance for doubtful accounts based on historical losses and current economic conditions.  On a continuing basis, management analyzes delinquent receivables and, once these receivables are determined to be uncollectible, they are written off through a charge against an existing allowance account or against earnings.

Property and Equipment
Property and equipment is carried at cost less accumulated depreciation and includes expenditures that substantially increase the useful lives of existing property and equipment.   Significant costs incurred for internally developed software are capitalized and amortized over estimated useful lives of 3 years.   Maintenance, repairs, and minor renovations are charged to expense as incurred.  Upon sale or retirement of property and equipment, the costs and related accumulated depreciation are eliminated from the respective account and the resulting gain or loss is included in the results of operations.  The Company provides for depreciation of property and equipment using the straight-line method designed to amortize costs over estimated useful lives.  Estimated useful lives range up to 40 years for buildings and from 3-8 years
 
 
 
 
 
 
 
 
13

 
 
NOTE 1 – SIGNIFICANT ACCOUNTING POLICIES – CONTINUED

for electronic data processing equipment and furniture and fixtures.  Property and equipment are reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount may not be recoverable.

Statement of Cash Flows
For purposes of reporting cash flows, cash includes cash-on-hand, demand deposits with banks and overnight investments.

Premium Revenue
Life insurance premiums are recognized as revenues when due.  Property and casualty insurance premiums include direct writings plus reinsurance assumed less reinsurance ceded and are recognized on a pro rata basis over the terms of the policies.  Unearned premiums represent that portion of direct premiums written that are applicable to the unexpired terms of policies in force and is reported as a liability.  Prepaid reinsurance premiums represent the unexpired portion of premiums ceded to reinsurers and is reported as an asset.

Deferred Policy Acquisition Costs
The costs of acquiring new insurance business are deferred and amortized over the lives of the policies.  Deferred costs include commissions, premium taxes, other agency compensation and expenses, and other underwriting expenses directly related to the level of new business produced.

Acquisition costs relating to life contracts are amortized over the premium paying period of the contracts, or the first renewal period of term policies, if earlier.  Assumptions utilized in amortization are consistent with those utilized in computing policy liabilities.

The method of computing the deferred policy acquisition costs for property and casualty policies limits the amount deferred to a percentage of related unearned premiums.

Policy Liabilities
The liability for future life insurance policy benefits is computed using a net level premium method including the following assumptions:

Years of Issue                                                        Interest Rate
1947 - 1968                                                                  4%
1969 - 1978                                                       6% graded to 5%
1979 - 2003                                                       7% graded to 6%
2004 - 2009                                                                  5.25%

Mortality assumptions include various percentages of the 1955-60 and 1965-70 Select and Ultimate Basic Male Mortality Table.  Withdrawal assumptions are based on the Company’s experience.

Claim Liabilities
The liability for unpaid claims represents the estimated liability for claims reported to the Company and its subsidiaries plus claims incurred but not yet reported and the related loss adjustment expenses.  The liabilities for claims and related adjustment expenses are determined using case-basis evaluations and statistical analyses and represent estimates of the ultimate net cost of all losses incurred through December 31 of each year.  Although considerable variability is inherent in such estimates, management believes that the liabilities for unpaid claims and related loss adjustment expenses are adequate.  The estimates are continually reviewed and adjusted as necessary; such adjustments are included in the period in which they are determined.

Earnings Per Share
Earnings per share of common stock is based on the weighted average number of shares outstanding during each year.  The adjusted weighted average shares outstanding were 2,466,600 (2,466,600 in 2008).

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.  In 2009, NSFC maintained a catastrophe reinsurance agreement to cover losses from catastrophic events, primarily hurricanes.
 
 
 
 
 
 
14

 
 
 
 
 
NOTE 1 – SIGNIFICANT ACCOUNTING POLICIES – 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 1-3 cover events occurring from January1-December 31 of the contract year.  The Company placed the fourth layer in July allowing an interim review of exposure and projected storm patterns for the current contract year.  The fourth layer covers events occurring from July 1-June 30 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.

Income Taxes
The Company uses the asset and liability method of accounting for income taxes.  Deferred income taxes arise from the recognition of temporary differences between financial statement carrying amounts and the tax bases of the Company’s assets and liabilities and operating loss carry-forwards.  Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled.  A valuation allowance is provided when it is more likely than not that some portion of the deferred tax asset will not be realized.  The effect of a change in tax rates is recognized in the period the new rate is enacted.

The Company evaluates all tax positions taken on its U.S. federal income tax return.  No material uncertainties exist for any tax positions taken by the Company

Contingencies
Liabilities for loss contingencies arising from, but not limited to,  litigation, claims, assessments, fines and penalties are recorded when it is probable that a liability has been incurred and the amount of the assessment and/or remediation can be reasonably estimated.

Reclassifications
Certain 2008 amounts have been reclassified from the prior year financial statements to conform to the 2009 presentation.

Advertising
The Company expenses advertising costs as incurred.  Advertising costs charged to expense were $109,000 for the year ended December 31, 2009 ($186,000 for the year ended December 31, 2008).  Advertising cost consists primarily of agent convention expense and print media.

Concentration of Credit Risk
The Company maintains cash depository accounts which, at times, may exceed federally insured limits.  These amounts represent actual account balances held by financial institutions at the end of the period, and unlike the balance reported in the financial statements, the account balances do not reflect timing delays inherent in reconciling items such as outstanding checks and deposits in transit.  The Company has not experienced any losses in such accounts.  The Company believes it is not exposed to any significant credit risk on cash and cash equivalents.


 
15

 
 
 
 
 
NOTE 1 – SIGNIFICANT ACCOUNTING POLICIES – CONTINUED

Policy receivables are reported at unpaid balances.  Policy receivables are generally offset by associated unearned premium liabilities and are not subject to significant credit risk.  Receivables from agents, less provision for credit losses, are composed of balances due from independent agents.  At December 31, 2009 the single largest balance due from one agent totaled $525,000.

Reinsurance contracts do not relieve the Company of its obligations to policyholders.  A failure of a reinsurer to meet their obligation could result in losses to the insurance subsidiaries.  Allowances for losses are established if amounts are believed to be uncollectible.  At December 31, 2009 and 2008, no amounts were deemed uncollectible.  The Company, at least annually, evaluates the financial condition of all reinsurers and evaluates any potential concentrations of credit risk. At December 31, 2009, management does not believe the Company is exposed to any significant credit risk related to its reinsurance program.

Recently Issued Accounting Standards

In April 2009, a new accounting standard was issued which amends the recognition guidance for other-than-temporary impairments (OTTI) of debt securities and expands the financial statement disclosures for OTTI on debt and equity securities.

·  
This new accounting standard states that an OTTI write-down of debt securities, where fair value is below amortized cost, is triggered in circumstances where (1) an entity has the intent to sell a security, (2) it is more-likely-than-not that the entity will be required to sell the security before recovery of its amortized cost basis, or (3) the entity does not expect to recover the entire amortized cost basis of the security. If an entity intends to sell a security or if it is more-likely-than-not the entity will be required to sell the security before recovery, an OTTI write-down is recognized in earnings equal to the difference between the security’s amortized cost and its fair value. If an entity does not intend to sell the security or it is not more-likely-than-not that it will be required to sell the security before recovery, the OTTI write-down is separated into an amount representing the credit loss, which is recognized in earnings, and the amount related to all other factors, which is recognized in other comprehensive income.

·  
This new accounting standard requires that companies record, as of the beginning of the interim period of adoption, a cumulative-effect adjustment to reclassify the noncredit component of a previously recognized OTTI loss from retained earnings to other comprehensive income if the Company does not intend to sell the security and it is more-likely-than-not that the Company will not be required to sell the security before recovery of its amortized cost basis. The adoption had no impact on our financial position or results of operations. The Company had no cumulative-effect adjustment upon adoption at the beginning of the second quarter.

In April 2009, a new accounting standard was issued related to determining fair value when the volume and level of activity for the asset or liability have significantly decreased and identifying transactions that are not orderly. Our adoption of this new accounting standard was effective April 1, 2009. The new accounting standard reaffirms that fair value is the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date under current market conditions. The new accounting standard also reaffirms the need to use judgment in determining if a formerly active market has become inactive and in determining fair values when the market has become inactive. The implementation of the new guidance did not have a significant impact on our financial statements.

In April 2009, a new accounting standard was issued related to interim disclosures about fair value of financial instruments. The new accounting standard requires disclosing qualitative and quantitative information about the fair value of all financial instruments on a quarterly basis, including methods and significant assumptions used to estimate fair value during the period. These disclosures were previously only done annually. The disclosures required by the new accounting standard were effective for the quarter ending June 30, 2009.  The implementation of the new guidance did not have a significant impact on our financial statements.
 
 

 
16

 
 
NOTE 1 – SIGNIFICANT ACCOUNTING POLICIES – CONTINUED

In June 2009, a new accounting standard was issued related to the accounting for transfers of financial assets, which updates accounting for securitizations and special-purpose entities. The new accounting standard is a revision of previously issued accounting standards related to accounting for transfers and servicing of financial assets and extinguishments of liabilities, and will require additional information regarding financial asset transfers, including securitization transactions, and the presence of continuing exposure around the risks related to transferred financial assets. In addition, the new accounting standard removes the concept of a qualifying special-purpose entity and changes the requirements for de-recognizing financial assets. The new accounting standard was effective January 1, 2010. We do not expect the implementation of this new accounting standard to have a significant impact on our financial statements.
 
In June 2009, new consolidation guidance was issued which replaces the quantitative-based risks and rewards calculation for determining whether an enterprise is the primary beneficiary in a variable interest entity with an approach that is primarily qualitative, requires ongoing assessments whether an enterprise is the primary beneficiary of a variable interest entity, and requires additional disclosure about an enterprise’s involvement in variable interest entities. This guidance is effective for financial statements issued for fiscal years beginning after November 15, 2009. We do not expect the adoption of this guidance to have a material impact on our financial statements.

Effective July 1, 2009, the Financial Accounting Standards Board (FASB) issued the Accounting Standards Codification (ASC), which combined and superseded all existing non-SEC accounting and reporting standards under GAAP and became the single official source for authoritative GAAP guidance combined with guidance issued by the U.S. Securities and Exchange Commission (SEC).  The FASB no longer issues new standards in the previous formats.  Instead, amendments to the Codification are made by issuing “Accounting Standards Updates” (ASU).  The Codification did not change existing GAAP. Accordingly, the issuance of the codification did not impact the Company’s consolidated results of operations or financial condition.

In August 2009, the FASB issued ASU 2009-05 “Measuring Liabilities at Fair Value” (“ASU 2009-05”).  ASU 2009-05 updated ASC Section 820-10 (“Fair Value Measurements”) to provide additional guidance on how to measure liabilities at fair value for which a quoted price in an active market is not available.  In this situation a company can either use the quoted price of an identical liability when traded as an asset or the quoted price of similar liabilities when traded as assets.  As of December 31, 2009, the only liability measured at fair value was an interest rate swap discussed in Note 7.  The new guidance was effective for the company on October 1, 2009. The implementation of the new guidance did not have a significant impact on our financial statements.

NOTE 2 – VARIABLE INTEREST ENTITIES

The Company holds a passive interest in a limited partnership that is considered to be a Variable Interest Entity (VIE) under the provisions of FIN 46(R).  The Company is not the primary beneficiary of the entity and is not required to consolidate under FIN 46(R).  The entity is a private placement investment fund formed for the purpose of investing in private equity investments.  The Company owns less than 1% of the limited partnership.  The carrying value of the investment totals $325,000 and is included as a component of Other Invested Assets.

In December 2005, the Company formed National Security Capital Trust I, a statutory trust created under the Delaware Statutory Trust Act, for the sole purpose of issuing, in private placement transactions, $9,000,000 of trust preferred securities (TPS) and using the proceeds thereof, together with the equity proceeds received from the Company in the initial formation of the Trust, to purchase $9,300,000 of variable rate subordinated debentures issued by the Company.  The Company owns all voting securities of the Trust and the subordinated debentures are the sole assets of the Trust.  The Trust will meet the obligations of the TPS with the interest and principal paid on the subordinated debentures.  The Company received net proceeds from the TPS transactions, after commissions and other costs of issuance, of $9,005,000.  The Company also holds all the voting securities issued by the Trust and such trusts are considered to be VIE’s. The Trust is not consolidated because the Company is not the primary beneficiary of the trust. The Subordinated Debentures, disclosed in Note 9, are reported in the accompanying Consolidated Balance Sheets as a component of long-term debt. The Company’s equity investments in the Trust total $279,000 and are included in Other Assets.

 
 
 
 
 
17

 
 
NOTE 2 – VARIABLE INTEREST ENTITIES – CONTINUED

In June 2007, the Company formed National Security Capital Trust II for the sole purpose of issuing, in private placement transactions, $3,000,000 of trust preferred securities (TPS) and using the proceeds thereof, together with the equity proceeds received from the Company in the initial formation of the Trust, to purchase $3,093,000 unsecured junior subordinated deferrable interest debentures.  The Company owns all voting securities of the Trust and the subordinated debentures are the sole assets of the Trust.  The Trust will meet the obligations of the TPS with the interest and principal paid on the subordinated debentures.  The Company received net proceeds from the TPS transactions, after commissions and other costs of issuance, of $2,995,000.  The Company also holds all the voting securities issued by the Trust and such trusts are considered to be VIE’s. The Trust is not consolidated because the Company is not the primary beneficiary of the Trust. The Subordinated Debentures, disclosed in Note 9, are reported in the accompanying Consolidated Balance
 
Sheets as a component of long-term debt. The Company’s equity investments in the Trust total $93,000 and are included in Other Assets.

NOTE 3 – STATUTORY ACCOUNTING PRACTICES

The accompanying consolidated financial statements have been prepared in conformity with generally accepted accounting principles (GAAP) which vary in certain respects from reporting practices prescribed or permitted by insurance regulatory authorities.  The significant differences for statutory reporting include: (a) acquisition costs of acquiring new business are charged to operations as incurred, (b) life policy liabilities are established utilizing interest and mortality factors specified by regulatory authorities, (c) the Asset Valuation Reserve (AVR) and the Interest Maintenance Reserve (IMR) are recorded as liabilities, and (d) non-admitted assets (furniture and equipment, agents’ debit balances and prepaid expenses) are charged directly to surplus.

Statutory net gains (losses) from operations and capital and surplus, excluding intercompany transactions, are summarized as follows:

   
2009
   
2008
 
NSIC - including realized capital gains (losses) of $234 and $(1,509), respectively
  $ 1,314     $ (442 )
NSFC - including realized capital gains of $198 and $615, respectively
  $ 4,179     $ (5,730 )
Omega - including realized capital (losses) of $(78) and $(231), respectively
  $ 246     $ (344 )
                 
Statutory risk-based adjusted capital:
               
NSIC - including AVR of $517 and $191, respectively
  $ 9,642     $ 8,396  
NSFC
  $ 28,742     $ 26,783  
Omega
  $ 9,568     $ 9,087  


The above amounts exclude allocation of overhead from the Company.  NSIC, NSFC and Omega are in compliance with statutory restrictions with regard to minimum amounts of surplus and capital.


 
 
 
 
 

 
 
18

 


 
NOTE 4 INVESTMENT SECURITIES

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

                         
   
(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  
                                 
   
December 31, 2008
 
           
Gross
   
Gross
         
   
Amortized
   
Unrealized
   
Unrealized
   
Fair
 
   
Cost
   
Gains
   
Losses
   
Value
 
Available-for-sale securities:
                               
Corporate debt securities
  $ 21,153     $ 84     $ 2,277     $ 18,960  
Mortgage backed securities
    11,101       257       24       11,334  
Private label mortgage backed securities
    6,590       2       1,369       5,223  
Obligations of states and political subdivisions
    13,401       81       875       12,607  
U.S. Treasury securities and obligations of
                               
U.S. Government corporations and agencies
    9,551       433       1       9,983  
Total fixed maturities
    61,796       857       4,546       58,107  
Equity securities
    5,467       3,130       1,028       7,569  
                                 
Total
  $ 67,263     $ 3,987     $ 5,574     $ 65,676  
                                 
Held-to-maturity securities:
                               
Corporate debt securities
  $ 88     $ -     $ 3     $ 85  
Mortgage backed securities
    4,087       20       41       4,066  
Private label mortgage backed securities
    249       -       1       248  
Obligations of states and political subdivisions
    2,141       34       14       2,161  
U.S. Treasury securities and obligations of
                               
U.S. Government corporations and agencies
    4,387       48       -       4,435  
                                 
Total
  $ 10,952     $ 102     $ 59     $ 10,995  
                                 
   
 
 
 
 
 
 
 
 

 
19

 

NOTE 4 INVESTMENT SECURITIES – CONTINUED

The amortized cost and aggregate fair value of debt securities at December 31, 2009, 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
  $ 419     $ 425  
Due after one year through five years
    14,320       15,551  
Due after five years through ten years
    24,013       24,433  
Due after ten years
    31,044       29,860  
                 
Total
  $ 69,796     $ 70,269  
                 
Held-to-maturity securities:
               
Due in one year or less
  $ 303     $ 309  
Due after one year through five years
    802       828  
Due after five years through ten years
    1,929       1,991  
Due after ten years
    2,908       2,952  
                 
Total
  $ 5,942     $ 6,080  
 

A summary of securities available-for-sale with unrealized losses as of December 31, 2009 and 2008 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)
   
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  

 
 
 
 
 
 
 
 
20

 

NOTE 4 – INVESTMENT SECURITIES – CONTINUED

 
 
   
(Dollars in thousands)
   
December 31, 2008
 
   
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
  $ 9,904     $ 1,337     $ 4,396     $ 940     $ 14,300     $ 2,277       45  
Mortgage backed securities
    315       5       1,868       19       2,183       24       9  
Private label mortgage backed
                                                       
 securities
    412       87       4,354       1,282       4,766       1,369       11  
Obligations of state and
                                                       
 political subdivisions
    3,745       332       4,812       543       8,557       875       25  
U.S. Treasury securities and
                                                       
 obligations of U.S. government
                                                       
 corporations and agencies
    295       1       -       -       295       1       1  
Equity securities
    981       446       731       582       1,712       1,028       12  
    $ 15,652     $ 2,208     $ 16,161     $ 3,366     $ 31,813     $ 5,574       103  

For 2009, gross gains of $1,102,000 ($2,070,000 for 2008) and gross losses of $319,000 ($611,000 for 2008) were realized on sales of available-for-sale-securities.

A summary of securities held-to-maturity with unrealized losses as of December 31, 2009 and 2008 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)
   
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  

   
(Dollars in thousands)
   
December 31, 2008
 
   
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
  $ 84     $ 3     $ -     $ -     $ 84     $ 3       1  
Mortgage backed securities
    -       -       2,408       41       2,408       41       7  
Private label mortgage backed
                                                       
 securities
    249       1       -       -       249       1       1  
Obligations of state and
                                                       
 political subdivisions
    -       -       646       14       646       14       2  
U.S. Treasury securities and
                                                       
 obligations of U.S. government
                                                       
 corporations and agencies
    -       -       -       -       -       -       -  
                                                         
    $ 333     $ 4     $ 3,054     $ 55     $ 3,387     $ 59       11  

 
 
 
 
 
 
 
 
 
21

 
NOTE 4 –  INVESTMENT SECURITIES – CONTINUED

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.

Management has evaluated each security in a significant unrealized loss position.  For the year ended December 31, 2009, the Company realized $443,000 in other than temporary impairments.  The single largest accumulated loss was in the equity portfolio and totaled $337,000.  The second largest loss position was in the bond portfolio and totaled $332,000.  The third largest loss position was in the equity portfolio and totaled $163,000.  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 less than 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.

NOTE 5 NET INVESTMENT INCOME

Major categories of investment income are summarized as follows:
 


 
(Dollars in thousands)
 
 
Year ended December 31,
 
   
2009
   
2008
 
             
Fixed maturities
  $ 4,075     $ 4,357  
Equity securities
    199       364  
Mortgage loans on real estate
    62       32  
Investment real estate
    82       65  
Policy loans
    73       68  
Company owned life insurance
    740       (543 )
Other, principally short-term investments
    346       367  
      5,577       4,710  
Less: Investment expenses
    288       342  
Net investment income
  $ 5,289     $ 4,368  
                 
An analysis of investment gains (losses) follows:
Year ended December 31,
 
      2009       2008  
Net realized investment gains (losses):
               
Fixed maturities
  $ 548     $ 179  
Equity securities
    234       1,313  
Other, principally real estate
    18       432  
Other than temporary impairments
    (443 )     (2,973 )
    $ 357     $ (1,049 )
 
 
 
 
 
 
 
 
 

 
22

 

 
NOTE 5 NET INVESTMENT INCOME – CONTINUED

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


             
   
(Dollars in thousands)
 
   
Year ended December 31,
 
   
2009
   
2008
 
             
Net change in unrealized appreciation on available-
           
for-sale securities before deferred tax
  $ 5,304     $ (8,335 )
Deferred income tax
    (1,784 )     2,188  
                 
Net change in unrealized appreciation on available-
               
for-sale securities
  $ 3,520     $ (6,147 )





NOTE 6 – 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.

 
 
 
 
 
 
 
 
23

 

 
 
Level 3 - Unobservable inputs to the valuation methodology that are significant to the measurement of fair value of assets or liabilities.
 
 
NOTE 6 – FAIR VALUE OF FINANCIAL ASSETS AND FINANCIAL LIABILITIES – CONTINUED

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.

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 December 31, 2009 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
  $ 70,269     $ 9,214     $ 60,478     $ 577  
Short-term investments
    -       -       -       -  
Trading securities
    374       374       -       -  
Equity securities available-for-sale
    9,035       8,373       -       662  
                                 
                                 
Total Financial Assets
  $ 79,678     $ 17,961     $ 60,478     $ 1,239  
                                 
Financial Liabilities
                               
Interest rate swap
  $ 60     $ -     $ -     $ 60  
                                 
Total Financial Liabilities
  $ 60     $ -     $ -     $ 60  

The table below presents reconciliation for all assets measured at fair value on a recurring basis using significant unobservable inputs (Level 3) for the year ended December 31, 2009:


   
For the year ended December 31, 2009
 
   
Fixed Maturities Available for sale
   
Equity Securities Available for Sale
   
Interest
 
(In Thousands)
 
Rate Swap
 
Beginning balance
  $ 652     $ 733     $ (316 )
  Total gains or losses (realized and
                       
    unrealized):
                       
    Included in earnings
    -       -       -  
    Included in other comprehensive income
    (75 )     (71 )     256  
  Purchases, sales, issuances and settlements,
                       
    net
    -       -       -  
  Transfers in/(out) of Level 3
    -       -       -  
Ending balance
  $ 577     $ 662     $ (60 )
The amount of total gains or losses for the
                       
  period included in earnings attributable to the
                       
  change in unrealized gains or losses relating
                       
  to assets and liabilities still held as of
                       
  December 31, 2009
  $ -     $ -     $ -  

 
 
 
 
 

 
24

 
 
 
 
For the year ended December 31, 2009, there were no assets or liabilities measured at fair values on a nonrecurring basis.
 
 
 
NOTE 6 – FAIR VALUE OF FINANCIAL ASSETS AND FINANCIAL LIABILITIES – CONTINUED

 
The table below presents reconciliation for all assets measured at fair value on a recurring basis using significant unobservable inputs (Level 3) for the year ended December 31, 2008:
 

 

   
For the year ended December 31, 2008
       
   
Fixed Maturities Available for sale
   
Equity Securities Available for Sale
   
Interest
 
(In Thousands)
 
Rate Swap
 
Year ended December 31, 2008
                 
Beginning balance
  $ 702     $ 999     $ (88 )
  Total gains or losses (realized and
                       
    unrealized):
                       
    Included in earnings
    -       -       -  
    Included in other comprehensive income
    (50 )     (266 )     (228 )
  Purchases, sales, issuances and settlements,
                       
    net
    -       -       -  
  Transfers in/(out) of Level 3
    -       -       -  
Ending balance
  $ 652     $ 733     $ (316 )
The amount of total gains or losses for the
                       
  period included in earnings attributable to the
                       
  change in unrealized gains or losses relating
                       
  to assets and liabilities still held as of
                       
  December 31, 2008
  $ -     $ -     $ -  
 

For the year ended December 31, 2008, 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 9 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 December 31, are as follows:
 
 
 
 

 
 
25

 

   
In Thousands of Dollars at December 31,
 
   
2009
   
2008
 
   
Carrying
   
Estimated
   
Carrying
   
Estimated
 
   
Value
   
Fair Value
   
Value
   
Fair Value
 
Assets and related instruments
                       
Mortgage loans
  $ 1,041     $ 1,041     $ 502     $ 502  
Policy loans
    1,018       1,018       968       968  
Company owned life insurance
    5,197       5,197       1,957       1,957  
Other invested assets
    3,933       3,933       4,557       4,557  
                                 
Liabilities and related instruments
                               
Other policyholder funds
    1,347       1,347       1,344       1,344  
Long-term debt
    12,372       12,372       12,372       12,372  


NOTE 7 - PROPERTY AND EQUIPMENT

At December 31, property and equipment consisted of the following:


   
(Dollars in Thousands)
 
   
2009
   
2008
 
Building and improvements
  $ 3,196     $ 3,196  
Electronic data processing equipment
    2,472       2,549  
Furniture and fixtures
    1,005       1,085  
      6,673       6,830  
Less accumulated depreciation
    4,136       3,986  
    $ 2,537     $ 2,844  


Depreciation expense for the year ended December 31, 2009 was $424,000 ($454,000 for the year ended December 31, 2008).

NOTE 8 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 December 31, 2009 and December 31, 2008. 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.

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 a net deferred tax liability position of $61,000 in 2009 and net deferred tax asset position of $1,839,000 in 2008.
 
 
 
 

 
 
 
 
26

 
 
 
 
 
NOTE 8 INCOME TAXES
 
 
The tax effect of significant differences representing deferred tax assets and liabilities are as follows:
 
   
(Dollars in Thousands)
 
   
December 31,
   
December 31,
 
   
2009
   
2008
 
General insurance expenses
  $ 1,135     $ 769  
Unearned premiums
    1,814       1,885  
Claims liabilities
    298       337  
Unrealized losses on securities available-for-sale
    -       392  
Other than temporary impairments on securities owned
    501       734  
  Deferred tax assets
    3,748       4,117  
                 
Depreciation
    (126 )     (118 )
Deferred policy acquisition costs
    (2,291 )     (2,160 )
Unrealized gains on securities available-for-sale
    (1,392 )     -  
  Deferred tax liabilities
    (3,809 )     (2,278 )
                 
Net deferred tax (liability) asset
  $ (61 )   $ 1,839  


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)
 
   
Year ended December 31,
 
   
2009
   
2008
 
             
Federal income tax rate applied to pre-tax income
  $ 1,862     $ (2,657 )
Dividends received deduction and tax-exempt interest
    (201 )     (137 )
Company owned life insurance
    (252 )     185  
Small life deduction
    (145 )     (174 )
Other, net
    (12 )     173  
                 
Federal income tax expense (benefit)
  $ 1,252     $ (2,610 )

 

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


   
Year ended December 31,
 
   
2009
   
2008
 
             
Deferred policy acquisition costs
  $ 131     $ (261 )
Other-than-temporary impairments
    233       734  
Unearned premiums
    71       362  
General insurance expenses
    (366 )     (69 )
Depreciation
    8       40  
Claim liabilities
    39       79  
                 
    $ 116     $ 885  

 
 
 
 

 


 
27

 

 
NOTE 8 INCOME TAXES – CONTINUED

Under pre-1984 life insurance company tax laws, a portion of NSIC's gain from operations was not subject to current income taxation, but was accumulated for tax purposes in a memorandum account designated "policyholders' surplus".  The aggregate balance in this account, $2,520,000 at December 31, 2009, would be taxed at current rates only if distributed to shareholders or if the account exceeded a prescribed minimum.  The Deficit Reduction Act of 1984 eliminated additions to policyholders' surplus for 1984 and thereafter.  Deferred taxes have not been provided on amounts designated as policyholders' surplus.  The deferred income tax liability not recognized is approximately $857,000 at December 31, 2009

NOTE 9 – NOTES PAYABLE AND LONG-TERM DEBT

Long-term debt consisted of the following as of December 31, 2009 and December 31, 2008:


   
(Dollars in thousands)
 
   
2009
   
2008
 
             
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  


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 (discussed in Note 2) 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.
 
 
 
 
 
 
28

 
 
 
NOTE 9 – NOTES PAYABLE AND LONG-TERM DEBT – CONTINUED

 
The swaps entered into in 2007 and 2009 have fair values of $245,000 (liability) and $185,000 (asset), respectively, for a net liability of $60,000 at December 31, 2009 ($316,000 at December 31, 2008) which is reported as a component of other liabilities on the consolidated balance sheets. A net valuation gain of $256,000 is included in accumulated other comprehensive income related to the swap agreements for the current period.  A net valuation loss of $228,000 was included in accumulated other comprehensive income related to the swap in the prior year.

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 $469,000.  Please see Note 6 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.  No funds were drawn on this line at December 31, 2009.

NOTE 10 –  POLICY AND CLAIM RESERVES

The Company regularly updates its reserve estimates as new information becomes available and events occur that may impact the resolution of unsettled claims.  Changes in prior years’ reserve estimates are reflected in the results of operations in the year such changes are determined.  The following table is a reconciliation of beginning and ending property and casualty reserve balances for claims and claim adjustment expense for the years ended December 31:


   
(Dollars in thousands)
 
   
2009
   
   2008
 
Claims and claim adjustment expense
           
   reserves at beginning of year
  $ 14,436     $ 11,973  
Less reinsurance recoverables on
               
   unpaid losses
    2,421       555  
Net balances at beginning of year
    12,015       11,418  
Provision for claims and claim adjustment
               
   expenses for claims arising in current year
    34,239       43,284  
Estimated claims and claim adjustment
               
   expenses for claims arising in prior years
    (2,626 )     (2,374 )
Total increases
    31,613       40,910  
Claims and claim adjustment expense
               
   payments for claims arising in:
               
      Current year
    25,941       35,516  
      Prior years
    5,590       4,797  
Total payments
    31,531       40,313  
Net balance at end of year
    12,097       12,015  
Plus reinsurance recoverables on
               
   unpaid losses
    549       2,421  
Claims and claim adjustment expense
               
   reserves at end of year
  $ 12,646     $ 14,436  
                 
                 


The 2009 decline in the provision for claims and claim adjustment expenses arising from claims in the current year and the ending reinsurance recoverable on unpaid losses are attributable to the absence of hurricane losses during the year.  The decrease in provision for claims and claim adjustment expenses for prior years (net of reinsurance recoveries) for 2008 is primarily due to reductions in incurred but not reported loss reserves on dwelling property lines of business.
 
 
 
 
 

 

 
29

 

 
 

NOTE 10 –  POLICY AND CLAIM RESERVES – CONTINUED
 
The Company has a geographic exposure to catastrophe losses in certain areas of the country.  Catastrophes can be caused by various events including hurricanes, windstorms, earthquakes, hail, severe winter weather, explosions and fires, and the incidence and severity of catastrophes are inherently unpredictable.  The extent of losses from a catastrophe is a function of both the total amount of insured exposure in the area affected by the event and the severity of the event.  Most catastrophe losses are restricted to small geographic areas; however, hurricanes and earthquakes may produce significant damage in large, heavily populated areas. The Company generally seeks to reduce its exposure to catastrophes through individual risk selection and the purchase of catastrophe reinsurance.  At December 31, 2009, the Company’s estimate of unpaid losses and adjustment expenses for hurricane related claims incurred in prior years totaled $787,000 before reinsurance ($758,000 in 2008).  Because the Company has exhausted its catastrophe coverage limits available for Hurricane Katrina any additional development will not be covered by reinsurance.  The Company maintains case reserves of $519,000 for losses in excess of catastrophe reinsurance ($594,000 in 2008).

NOTE 11 – REINSURANCE

The Company’s insurance operations participate in reinsurance in order to limit losses, minimize exposure to large risks, provide additional capacity for future growth and effect business-sharing arrangements.  Life reinsurance is accomplished through yearly renewable term.  Property and casualty reinsurance is placed on both a quota-share and excess of loss basis.  Reinsurance ceded arrangements do not discharge the insurance subsidiaries as the primary insurer, except for cases involving a novation.  Failure of reinsurers to honor their obligations could result in losses to the insurance subsidiaries.  The insurance subsidiaries evaluate the financial conditions of their reinsurers and monitor concentrations of credit risk arising from similar geographic regions, activities, or economic characteristics of the reinsurers to minimize their exposure to significant losses from reinsurance insolvencies.
 
At December 31, 2009, the largest reinsurance recoverable of a single reinsurer was $95,000 ($607,000 in 2008).  The amounts of recoveries pertaining to reinsurance contracts that were deducted from losses incurred during 2009 and 2008 were approximately $-0- and $12,582,000, respectively.  The Company incurred no losses from covered events occurring in 2009.  Amounts reported as ceded incurred losses in 2009 were related to development of losses from prior year catastrophes.

The effect of reinsurance on premiums written and earned was as follows:

 
 
   
(Dollars in Thousands)
   
2009
   
Life
 
Property & Casualty
   
 Written
 
 Earned
 
 Written
 
 Earned
                         
Direct
 
$
         7,251
 
 $
   7,247
 
 $
      58,185
 
 $
      59,213
Assumed
   
                   -
   
              -
   
                   -
   
                   -
Ceded
   
             (48)
   
         (48)
   
      (6,660)
   
       (6,818)
Net
 
$
        7,203
 
 $
    7,199
 
 $
      51,525
 
 $
     52,395
                         
                         
   
2008
   
Life
 
  Property & Casualty
   
 Written
 
 Earned
 
 Written
 
 Earned
                         
Direct
 
$
        7,049
 
 $
   7,003
 
 $
       61,197
 
 $
     55,866
Assumed
   
                   -
   
              -
   
                   -
   
                   -
Ceded
   
             (47)
   
         (47)
   
      (6,487)
   
      (6,558)
Net
 
$
        7,002
 
 $
   6,956
 
 $
      54,710
 
 $
     49,308
 
 

 
 
30

 
 
 
 
NOTE 12 – EMPLOYEE BENEFIT PLANS

In 1989, the Company and its subsidiaries established a retirement savings plan (401K Plan) and transferred the assets from the defined contribution profit sharing plan into the new plan.  All full-time employees who have completed six months of service at the beginning of any calendar quarter are eligible to participate and all employee contributions are fully vested for employees who have completed 1,000 hours of service in the year of contribution.  Company matching contributions for 2009 and 2008 amounted to $219,000 and $255,000, respectively.  The Company contributes dollar-for-dollar matching contributions up to 5% of compensation subject to government limitations.
 
In 1987, the Company established a non-qualified deferred compensation plan for its Board of Directors.  The Board members had an option of deferring their fees to a cash account or to a stock account and all share deferrals are recorded at the fair market value on the date of the award.  The directors’ non-qualified deferred compensation plan was frozen on December 31, 2004, and deferrals are no longer allowed.  A new non-qualified plan became effective January 1, 2006 under which directors are allowed to defer all or a portion of directors’ fees into various investment options.  The supplemental executive retirement plan (SERP) became effective March 1, 2008  and covers named executive officers with the Company contributing 15% of executive compensation to the plan.  Contributions to the plan are fully vested upon the earlier of death, disability, change in control, or ten years of participation in the plan. Costs for amounts credited of the non-qualified deferred compensation plans for 2009 and 2008 amounted to approximately 388,000 and ($349,000), respectively.

 
 
NOTE 13 –  REGULATORY REQUIREMENTS AND DIVIDEND RESTRICTIONS

The amount of dividends paid from NSIC to the Company in any year may not exceed, without prior approval of regulatory authorities, the greater of 10% of statutory surplus as of the end of the preceding year, or the statutory net gain from operations for the preceding year.  At December 31, 2009, NSIC’s retained earnings unrestricted for the payment of dividends in 2010 amounted to $1,250,000.

NSFC is similarly restricted in the amount of dividends payable to the Company; dividends may not exceed the greater of 10% of statutory surplus as of the end of the preceding year, or net income for the preceding year.  At December 31, 2009, NSFC’s retained earnings unrestricted for the payment of dividends in 2010 amounted to $4,179,000.

 
 
 
31

 
 
NOTE 13 –  REGULATORY REQUIREMENTS AND DIVIDEND RESTRICTIONS – CONTINUED
 
At December 31, 2009, securities with market values of $3,530,000 ($3,812,000 at December 31, 2008) were deposited with various states pursuant to statutory requirements.

Under applicable Alabama insurance laws and regulations, NSFC is required to maintain a minimum total surplus (to include both paid-in and contributed and unassigned surplus) of $100,000.

Under applicable Alabama insurance laws and regulations, NSIC is required to maintain a minimum total surplus (to include both paid-in and contributed and unassigned surplus) of $200,000.

Under applicable Alabama insurance laws and regulations, Omega is required to maintain a minimum total surplus (to include both paid-in and contributed and unassigned surplus) of $500,000.

NOTE 14 –  SHAREHOLDERS’ EQUITY

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

Common Stock
The holders of the Class A Common Stock will have one-twentieth of one vote per share, and the holders of the common stock will have one vote per share.

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

An amendment changing the number of authorized shares of common stock from 10,000,000 to 3,000,000 was approved by the shareholders at the 2009 Annual Meeting on May 14, 2009.
 
 
 

 
32

 
 
NOTE 15 – INDUSTRY SEGMENTS

The Company and its subsidiaries operate primarily in the insurance industry.  Selected balance sheet information by industry segment for the years ended December 31, 2009 and 2008 is summarized below:

 
 
                         
(Dollars in thousands)
                       
   
Total
   
P&C Insurance Operations
   
Life Insurance Operations
   
Non-Insurance Operations
 
December 31, 2009
                       
                         
Selected Assets
                       
Investments
  $ 101,720     $ 60,768     $ 40,079     $ 873  
                                 
Reinsurance recoverable
  $ 784     $ 784     $ -     $ -  
                                 
Deferred policy acquisition costs
  $ 10,210     $ 3,915     $ 6,295     $ -  
                                 
Total Assets
  $ 131,396     $ 79,321     $ 49,872     $ 2,203  
                                 
Total Liabilities
  $ 90,228     $ 43,099     $ 34,348     $ 12,781  



                         
(Dollars in thousands)
                       
   
Total
   
P&C Insurance Operations
   
Life Insurance Operations
   
Non-Insurance Operations
 
December 31, 2008
                       
                         
Selected Assets
                       
Investments
  $ 90,132     $ 56,422     $ 33,200     $ 510  
                                 
Reinsurance recoverable
  $ 4,146     $ 4,146     $ -     $ -  
                                 
Deferred policy acquisition costs
  $ 9,825     $ 4,037     $ 5,788     $ -  
                                 
Total Assets
  $ 124,890     $ 78,802     $ 43,653     $ 2,435  
                                 
Total Liabilities
  $ 90,242     $ 45,476     $ 31,627     $ 13,139  
 
 
 
 
 
 
 

 
33

 

NOTE 15 – INDUSTRY SEGMENTS – CONTINUED

Premium revenues and operating income by industry segment for the years ended December 31, 2009 and 2008 are summarized below:


(Dollars in thousands)
                       
   
Total
   
P&C Insurance Operations
   
Life Insurance Operations
   
Non-Insurance Operations
 
Year ended December 31, 2009
                       
REVENUE
                       
Net premiums earned
  $ 59,594     $ 52,395     $ 7,199     $ -  
Net investment income
    5,289       3,125       2,114       50  
Net realized investment gains
    357       120       234       3  
Other income
    764       761       3       -  
      66,004       56,401       9,550       53  
                                 
BENEFITS AND EXPENSES
                               
Policyholder benefits paid or provided
    35,839       30,908       4,931       -  
Amortization of deferred policy acquisition costs
    3,673       3,397       276       -  
Commissions
    7,863       7,317       546       -  
General and administrative expenses
    10,396       6,775       2,543       1,078  
Insurance taxes, licenses and fees
    1,631       1,387       244       -  
Interest expense
    1,126       -       49       1,077  
      60,528       49,784       8,589       2,155  
                                 
Income (Loss) Before Income Taxes
    5,476       6,617       961       (2,102 )
                                 
INCOME TAX EXPENSE (BENEFIT)
                               
Current
    1,136       1,369       105       (338 )
Deferred
    116       97       392       (373 )
      1,252       1,466       497       (711 )
                                 
NET INCOME (LOSS)
  $ 4,224     $ 5,151     $ 464     $ (1,391 )









 
34

 

NOTE 15 –  INDUSTRY SEGMENTS – CONTINUED


(Dollars in thousands)
                       
   
Total
   
P&C Insurance Operations
   
Life Insurance Operations
   
Non-Insurance Operations
 
Year ended December 31, 2008
                       
REVENUE
                       
Net premiums earned
  $ 56,264     $ 49,308     $ 6,956     $ -  
Net investment income
    4,368       2,309       1,940       119  
Net realized investment (losses) gains
    (1,049 )     372       (1,423 )     2  
Other income
    1,107       1,047       60       -  
      60,690       53,036       7,533       121  
                                 
BENEFITS AND EXPENSES
                               
Policyholder benefits paid or provided
    44,746       39,719       5,027       -  
Amortization of deferred policy acquisition costs
    4,344       3,312       1,032       -  
Commissions
    8,262       7,772       490       -  
General and administrative expenses
    8,558       6,722       1,614       222  
Insurance taxes, licenses and fees
    1,447       1,159       288       -  
Interest expense
    1,147       1       61       1,085  
      68,504       58,685       8,512       1,307  
                                 
Loss Before Income Taxes
    (7,814 )     (5,649 )     (979 )     (1,186 )
                                 
INCOME TAX EXPENSE (BENEFIT)
                               
Current
    (3,495 )     (2,919 )     (281 )     (295 )
Deferred
    885       867       161       (143 )
      (2,610 )     (2,052 )     (120 )     (438 )
                                 
NET LOSS
  $ (5,204 )   $ (3,597 )   $ (859 )   $ (748 )


NOTE 16 –  CONTINGENCIES

Litigation

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. 

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.
 


 
35

 
 
 
NOTE 16 – CONTINGENCIES – CONTINUED
 
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. 
 
NOTE 17 SUPPLEMENTAL CASH FLOW INFORMATION
 

Cash paid for interest during 2009 was $1,077,000 ($1,085,000 in 2008).  Cash received from income taxes in 2009 was $796,000 compared to cash paid for income taxes in 2008 was $500,000.

NOTE 18 SUBSEQUENT EVENTS

There were no subsequent events requiring adjustment to the condensed consolidated financial statements.




 
36

 

 
 
THE NATIONAL SECURITY GROUP, INC.
 
SCHEDULE I. SUMMARY OF INVESTMENTS (CONSOLIDATED)
 
(Dollars in Thousands)
 
                                     
                                     
   
December 31, 2009
   
December 31, 2008 (unaudited)
 
                                     
               
Amount per
               
Amount per
 
         
Fair
   
          the Balance
         
Fair
   
          the Balance
 
   
Cost
   
Value
   
Sheet
   
Cost
   
Value
   
Sheet
 
Securities Held-to-Maturity:
                                   
                                     
United States government . . . . . . . . . . .
  $ 441     $ 455     $ 441     $ 4,387     $ 4,435     $ 4,387  
States, municipalities and
                                               
political subdivisions . . .
    2,139       2,182       2,139       2,141       2,161       2,141  
Mortgage backed securities . . . . . . . . . . .
    3,175       3,251       3,175       4,087       4,066       4,087  
Private label mortgage backed securities . . . . .
    187       192       187       249       248       249  
Industrial and Miscellaneous . . . . . . . . .
    -       -       -       88       85       88  
Total Securities Held-to-Maturity . . . . . . .
    5,942       6,080       5,942       10,952       10,995       10,952  
                                                 
Securities Available-for-Sale:
                                               
                                                 
          Equity Securities:
                                               
Banks and insurance companies  . . . . . .
    1,489       989       989       1,256       1,699       1,699  
Industrial and all other . . . . . . . . . . . . . .
    4,362       8,046       8,046       4,211       5,870       5,870  
Total equity securities  . . . . . . . . . . . . .
    5,851       9,035       9,035       5,467       7,569       7,569  
                                                 
          Debt Securities:
                                               
United States government . . . . . . . . . . .
    9,532       9,713       9,713       9,551       9,983       9,983  
States, municipalities and
                                               
political subdivisions . . .
    15,641       15,516       15,516       13,401       12,607       12,607  
Mortgage backed securities . . . . . . . . . . .
    8,203       8,320       8,320       11,101       11,334       11,334  
Private label mortgage backed securities . . . . .
    9,634       8,896       8,896       6,590       5,223       5,223  
Public Utilities . . . . . . . . . .  . . . . . . . . .
    -       -       -       549       554       554  
Industrial and Miscellaneous . . . . . . . . .
    26,786       27,824       27,824       20,604       18,406       18,406  
Total Debt Securities . . . . . . . . . . . . . .
    69,796       70,269       70,269       61,796       58,107       58,107  
                                                 
Total Available-for-Sale . . . . . . . . .
    75,647       79,304       79,304       67,263       65,676       65,676  
                                                 
Total Securities . . . . . . . . . . . . . . ..
    81,589       85,384     $ 85,246       78,215       76,671       76,628  
Trading securities. . . . . . . . . . . .  . . . . .. . . . . . .
    314       374       374       354       253       253  
Receivable for securities. . . . . . . . . . . . .
    96       96       96       513       513       513  
Mortgage loans on real estate . . . . . . . . . . . . .
    1,041       1,041       1,041       502       502       502  
Investment real estate . . . . . . . . . . . . . . . . . . . .
    4,815       4,815       4,815       4,754       4,754       4,754  
Policy loans . . . . . . . . . . . . . . . . . . . . . . . . . . . .
    1,018       1,018       1,018       968       968       968  
Company  owned life insurance. . . . . . . . . . . . . .
    5,000       5,197       5,197       2,500       1,957       1,957  
Other invested assets. . . . . . . . . . . . . . . . . . . .
    3,933       3,933       3,933       4,557       4,557       4,557  
Total investments . . .
  $ 97,806     $ 101,858     $ 101,720     $ 92,363     $ 90,175     $ 90,132  








 
37

 


             
THE NATIONAL SECURITY GROUP, INC. (PARENT COMPANY)
 
SCHEDULE II - CONDENSED FINANCIAL INFORMATION OF REGISTRANT
 
BALANCE SHEETS
 
(Amounts in thousands)
 
             
   
December 31,
 
   
2009
   
2008
 
Assets
         (unaudited)  
Cash
  $ 382     $ 454  
Investment in subsidiaries (equity method)
               
    eliminated upon consolidation
    51,658       45,380  
Other assets
    2,866       2,269  
                 
       Total Assets
  $ 54,906     $ 48,103  
                 
Liabilities and Shareholders' Equity
               
Accrued general expenses
  $ 1,366     $ 1,083  
Notes payable
    12,372       12,372  
                 
       Total Liabilities
    13,738       13,455  
                 
       Total Shareholders' Equity
    41,168       34,648  
                 
       Total Liabilities and Shareholders' Equity
  $ 54,906     $ 48,103  






 
38

 



 
THE NATIONAL SECURITY GROUP, INC. (PARENT COMPANY)
 
SCHEDULE II - CONDENSED FINANCIAL INFORMATION OF REGISTRANT
 
STATEMENTS OF INCOME (LOSS)
 
(Amounts in thousands)
 
   
Years Ended
 
   
December 31,
 
   
2009
   
2008
 
Income
         (unaudited)  
             
    Dividends (eliminated upon consolidation)
  $ 2,800     $ -  
    Other income
    52       119  
      2,852       119  
                 
Expenses
               
State taxes
    1       1  
Other expenses
    2,154       1,300  
      2,155       1,301  
Income before income taxes and equity in
               
undistributed earnings (loss) of subsidiaries
    697       (1,182 )
Income tax (benefit) expense
    (711 )     (437 )
                 
Income (loss) before equity in undistributed earnings (loss)
               
of subsidiaries
    1,408       (745 )
Equity in undistributed (losses) earnings of subsidiaries
    2,816       (4,459 )
                 
Net (loss) income
  $ 4,224     $ (5,204 )







 
39

 


 

THE NATIONAL SECURITY GROUP, INC. (PARENT COMPANY)
 
SCHEDULE II - CONDENSED FINANCIAL INFORMATION OF REGISTRANT
 
STATEMENTS OF CASH FLOWS
 
(Amounts in thousands)
 
   
Years Ended
 
   
December 31,
 
   
2009
   
2008
 
Cash flows from operating activities:
         (unaudited)  
Net income (loss)
  $ 4,224     $ (5,204 )
Adjustments to reconcile net income (loss) to net
               
cash provided by operating activities:
               
    Equity in undistributed loss (income) of subsidiaries
    (2,816 )     4,459  
    Change in other assets
    (539 )     3,246  
    Change in accrued general expenses
    539       (659 )
Net cash provided by
               
    operating activities
    1,408       1,842  
                 
                 
Cash flows from investing activities:
               
Net cash provided by investing activities
    -       -  
Net cash provided by
               
    investing activities
    -       -  
                 
                 
Cash flows from financing activities:
               
Cash dividends
    (1,480 )     (2,220 )
Net cash used in
               
    financing activities
    (1,480 )     (2,220 )
                 
Net (decrease) increase in cash and cash equivalents
    (72 )     (378 )
                 
Cash at beginning of year
    454       832  
                 
Cash at end of year
  $ 382     $ 454  

 
 
 
 
 
 
40

 

THE NATIONAL SECURITY GROUP, INC. (PARENT COMPANY)
Notes to Condensed Financial Information of Registrant
                 
                 
Note 1-Basis of Presentation
           
 
Pursuant to the rules and regulations of the Securities and Exchange Commission, the Condensed Financial
 
Information of the Registrant does not include all of the information and notes normally included with financial
 
statements prepared in accordance with generally accepted accounting principles.  It is, therefore, suggested
 
that this Condensed Financial Information be read in conjunction with the Consolidated Financial Statements
 
and Notes thereto included in the Registrant’s Annual Report as referenced in Form 10-K, Part II, Item 8, page 44.
                 
Note 2-Cash Dividends from Subsidiaries
           
 
In 2009, dividends of $2.8 million were paid to the Registrant by its subsidiaries.  No dividends were
 
received from subsidiaries during 2008.
           


 
 
 
 
 
 
41

 


THE NATIONAL SECURITY GROUP, INC.
 
SCHEDULE III SUPPLEMENTARY INSURANCE INFORMATION (CONSOLIDATED)
 
(Amounts in thousands)
 
                                     
                                     
                     
Deferred
   
Future
       
                     
Acquisition
   
Policy
   
Unearned
 
                     
Costs
   
Benefits
   
Premiums
 
At December 31, 2009:
                                   
Life and accident and health insurance . . . . . . . . . . . . . . .
          $ 6,295     $ 30,726     $ 16  
Property and casualty insurance . . . . . ... . . . . . . . . . . . .
          3,915       -       27,365  
Total . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
    $ 10,210     $ 30,726     $ 27,381  
                                           
At December 31, 2008 (unaudited):
                                         
Life and accident and health insurance . . . . . . . . . . . . . . .
          $ 5,788     $ 29,770     $ 44  
Property and casualty insurance . . . . . ... . . . . . . . . . . . .
          4,037       -       27,720  
Total . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
    $ 9,825     $ 29,770     $ 27,764  
                                           
                             
Commissions,
         
                     
Benefits,
   
Amortization
   
General
 
                     
Claims,
   
of Deferred
   
Expenses,
 
         
Net
         
Losses and
   
Policy
   
Taxes,
 
   
Premium
   
Investment
   
Other
   
Settlement
   
Acquisition
   
Licenses
 
   
Revenue
   
Income
   
Income
   
Expenses
   
Costs
   
and Fees
 
For the year ended December 31, 2009:
                                         
Life and accident and health insurance
  $ 7,199     $ 2,114     $ 3     $ 4,931     $ 822     $ 2,787  
Property and casualty insurance . . . . . .
    52,395       3,125       761       30,908       10,714       8,162  
Other . . . . . . . . .
    -       50       -       -       -       1,078  
    Total . . . .. . . .
  $ 59,594     $ 5,289     $ 764     $ 35,839     $ 11,536     $ 12,027  
                                                 
For the year ended December 31, 2008 (unaudited):
                                               
Life and accident and health insurance
  $ 6,956     $ 1,940     $ 60     $ 5,027     $ 1,522     $ 1,614  
Property and casualty insurance . . . . . .
    49,308       2,309       1,047       39,719       11,084       6,722  
Other . . . . . . . . .
    -       119       -       -       -       222  
    Total . . . .. . . .
  $ 56,264     $ 4,368     $ 1,107     $ 44,746     $ 12,606     $ 10,005  
                                                 
                                                 
Note: Investment income and other operating expenses are reported separately by segment and not allocated.
                 

 
 
 
 
 
 
42

 


THE NATIONAL SECURITY GROUP, INC.
 
SCHEDULE IV. REINSURANCE (CONSOLIDATED)
 
(Amounts in thousands)
 
                               
                           
Percentage
 
         
Ceded
   
Assumed
         
of Amount
 
   
Gross
   
to Other
   
from Other
   
Net
   
Assumed
 
   
Amount
   
Companies
   
Companies
   
Amount
   
to Net
 
                               
For the year ended December 31, 2009
                             
Life insurance in force  . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
  $ 215,028     $ 12,034     $ -     $ 202,994       0.00 %
                                         
Premiums:
                                       
Life insurance and accident and health insurance . . . . . . . . . . . . .
    7,247       48       -       7,199       0.00 %
Property and casualty insurance . . . . . . . . . . . . . . . . . . . . . . . . . . . .
    59,213       6,818       -       52,395       0.00 %
                                         
    Total premiums . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
  $ 66,460     $ 6,866     $ -     $ 59,594       0.00 %
                                         
For the year ended December 31, 2008 (unaudited):
                                       
Life insurance in force  . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
  $ 214,160     $ 10,115     $ -     $ 204,045       0.00 %
                                         
Premiums:
                                       
Life insurance and accident and health insurance . . . . . . . . . . . . .
    7,003       47       -       6,956       0.00 %
Property and casualty insurance . . . . . . . . . . . . . . . . . . . . . . . . . . . .
    55,866       6,558       -       49,308       0.00 %
                                         
    Total premiums . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
  $ 62,869     $ 6,605     $ -     $ 56,264       0.00 %
                                         
                                         






 
 

 


 
43

 

 
 
The National Security Group, Inc
             
Schedule V. Valuation and Qualifying Accounts
Years ended December 31, 2009 and 2008
             
             
 
2009
 
2008
 
       (Dollars in thousands)
(unaudited)
             
Balance, January 1
  $ 59     $ 110  
Additions
    0       0  
Deletions
    59       51  
                 
Balance, December 31
  $ 0     $ 59  



 
 


 
44

 

Financial Statement Schedules

(a) The following documents are filed as part of this report:

1.  
Consolidated financial statements, notes thereto and related information of The National Security Group, Inc. (the “Company”) are included in Item 8 of Part II of this report:

 
Report of Independent Registered Public Accounting Firm (2009)

 
Consolidated Statements of Operation – Years ended December 31, 2009 and 2008 (unaudited)

 
Consolidated Balance Sheets – December 31, 2009 and 2008 (unaudited)

 
Consolidated Statements of Shareholders’ Equity – Years ended December 31, 2009 and 2008 (unaudited)
 
 
Consolidated Statements of Cash Flows – Years ended December 31, 2009 and 2008 (unaudited)

 
Consolidated Notes to the Financial Statements (2009 and 2008(unaudited))

2.  
Additional financial statement schedules and report of independent registered accounting firm are furnished herewith pursuant to the requirements of Form 10-K:
 
 
     
The National Security Group, Inc.
 
     
Schedule I
Summary of Investments Other Than Investments in Related Parties
Schedule II
Condensed Financial Information of Registrant
 
Schedule III
Supplementary Insurance Information (Consolidated)
 
Schedule IV
Reinsurance (Consolidated)
 
Schedule V
Valuation and Qualifying Accounts
 

3.  
Exhibits filed as part of this Form 10-K:

**Certifications listed below will be filed with the final 10-K/A the Registrant will file to comply with SEC reporting requirements.
 
31.1  Certification of Chief Executive Officer Pursuant to 18 U. S. C. Section 1350, as Adopted
     Pursuant  to Section 302 of the Sarbanes-Oxley Act of 2002 (not attached, to be filed by amendment in a subsequent Form 10-K/A)
 
31.2      Certification of Chief Financial Officer Pursuant to 18 U. S. C. Section 1350, as Adopted
     Pursuant  to Section 302 of the Sarbanes-Oxley Act of 2002 (not attached, to be filed by amendment in a subsequent Form 10-K/A)
 
         32.      Certification Chief Executive Officer and Chief Financial Officer Pursuant to 18 U. S. C. Section
    1350, as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 (not attached, to be filed by amendment in a subsequent Form 10-K/A)
 

 
 
 
 
 

 
 
45

 
 
 
 
 
SIGNATURE

Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.

THE NATIONAL SECURITY GROUP, INC.

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

Date: March 4, 2011

 
 
 
 
 
 
 
 
 

 
 
46