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Section 1: 10-K (10-K)

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Table of Contents

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

 
FORM 10-K

 
 (Mark One)
þ
ANNUAL REPORT PURSUANT TO SECTION 13 or 15(D) OF THE SECURITIES EXCHANGE ACT OF 1934
For the fiscal period ended December 31, 2018

or      
o
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from           to          .

Commission File Number 0-18649


397136155_nsglogo.jpg
The National Security Group, Inc.
(Exact name of registrant as specified in its charter)

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

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  o    No  þ

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  o    No  þ

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

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

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. o

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    o                     Accelerated filer          o  

Non-accelerated filer  o                 Smaller Reporting Company þ
Emerging Growth Company    o

If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised fi nancial accounting standards provided pursuant to Section 13(a) of the Exchange Act. o

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

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 $19,777,251.

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 15, 2019
 
 
 
Common Stock $1.00 par value
 
2,527,136 shares




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Table of Contents

THE NATIONAL SECURITY GROUP, INC.

TABLE OF CONTENTS
 
Page No.
PART I
 
PART II
 
               Disclosure
PART III
 
PART IV
 
 
 
 
 
Certifications
 


DOCUMENTS INCORPORATED BY REFERENCE

1.
Definitive proxy statement for the 2019 Annual Meeting of Stockholders to be held May 17, 2019 is incorporated by reference into Part III of this report. The proxy statement will be filed no later than 120 days from December 31, 2018.

2.
Current Report on Form 8-K for event occurring on February 28, 2019 is incorporated into Part IV of this report.


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Table of Contents

PART I. Financial Information
Item 1. Business
Summary Description of The National Security Group, Inc.

The National Security Group, Inc. (the Company, NSG, we, us, our), an insurance holding company, was incorporated in Delaware on March 20, 1990. Our common stock is traded on the NASDAQ Global Market under the symbol NSEC.

Pursuant to regulations of the United States Securities and Exchange Commission (SEC), we are considered a “Smaller Reporting Company” as defined by SEC rules. We have elected to utilize an “a la carte” scaled disclosure which permits smaller reporting companies to elect to comply with scaled financial and non-financial disclosure requirements on an item by item basis. The most significant reporting difference permitted under the scaled disclosures, which we have utilized, is to include two years of audited financial statements.

The Company, through its three wholly owned subsidiaries, operates in two industry segments: property and casualty (P&C) insurance and life insurance.

The property and casualty subsidiaries of the Company, National Security Fire and Casualty (NSFC), and Omega One Insurance Company (Omega), primarily write personal lines dwelling coverage including dwelling fire and windstorm, homeowners and mobile homeowners lines of insurance in ten states. Property and casualty insurance is the most significant industry segment, accounting for 90.9% of total premium revenues.

The Company's life insurance subsidiary, National Security Insurance Company (NSIC), offers a basic line of life and health and accident insurance products in seven states.

The majority of our assets and investments are held in the insurance company subsidiaries.

The Company's website address is: www.nationalsecuritygroup.com. The “Investors” section of our website (http://investors.nationalsecuritygroup.com/) provides numerous resources for investors seeking additional information about us. Our annual reports on Form 10-K, our quarterly reports on Form 10-Q and our current reports on Form 8-K are made available on our website soon after filing with the SEC. Additionally, stock trades by insiders as filed on Forms 3, 4, and 5 are posted to the website after filing with the SEC. The website also provides information regarding corporate governance, stock quotes and press releases. Investors are encouraged to visit our website for additional information about the Company.

Cautionary Statement Regarding Forward-Looking Statements

Any statement contained in this report which is not a historical fact, or which might otherwise be considered an opinion or projection concerning the Company or its business, whether expressed or implied, is meant as and should be considered a forward-looking statement as that term is defined in the Private Securities Litigation Reform Act of 1995. The following report contains forward-looking statements that are not strictly historical and that involve risks and uncertainties. Such statements include any statements containing the words “expect,” “plan,” “estimate,” “anticipate” or other words of a similar nature. Management cautions investors about forward-looking statements. Forward-looking statements involve certain evaluation criteria, such as risks, uncertainties, estimates, and/or assumptions made by individuals informed of the Company and industries in which we operate. Any variation in the preceding evaluation criteria could cause actual results to differ materially from those expressed or implied by such forward-looking statements. These risks and uncertainties include, without limitation, the following:

The insurance industry is highly competitive and the Company encounters significant competition in all lines of business from other insurance companies. Many of the competing companies have more abundant financial resources than the Company.

Insurance is a highly regulated industry. It is possible that legislation may be enacted which would have an adverse effect on the Company's business.

The Company is subject to regulation by state governments for each of the states in which it conducts business. The Company cannot predict the subject of any future regulatory initiative(s) or its (their) impact on the Company's business. Company insurance rates are also subject to approval by state insurance departments in each of these states. We are often limited in the level of rate increases we can obtain.

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The Company is rated by various insurance rating agencies. If a rating is downgraded from its current level by one of these agencies, sales of the Company's products and stock price could be adversely impacted.

The Company's financial results are adversely affected by increases in policy claims received by the Company. While a manageable risk, this variance is often unpredictable.
  
The Company's investments are subject to a variety of risks. Investments are subject to defaults and changes in market value. Market value can be affected by changes in interest rates, market performance and the economy.

The Company mitigates risk associated with life policies through implementing effective underwriting and reinsurance strategies. These factors mitigate, not eliminate, risk related to mortality and morbidity exposure. The Company has established reserves for claims and future policy benefits based on amounts determined by independent actuaries. There is no assurance that these estimated reserves will prove to be sufficient or that the Company will not incur claims exceeding reserves, which could result in operating losses and loss of capital.

The Company mitigates risk associated with property and casualty policies through implementing effective underwriting and reinsurance strategies. The Company obtains reinsurance which increases underwriting capacity and limits the risk associated with policy claims. The Company is subject to credit risk with regard to reinsurers as reinsurance does not alleviate the Company's liability to its insured's for the ceded risks. The Company utilizes a third-party to develop a reinsurance treaty with reinsurers who are reliable and financially stable. However, there is no guarantee that booked reinsurance recoverable will actually be recovered. A reinsurer's insolvency or inability to make payments due could have a material adverse impact on the financial condition of the Company.

The Company's ability to continue to pay dividends to shareholders is contingent upon profitability and capital adequacy of the insurance subsidiaries. The insurance subsidiaries operate under regulatory restrictions that could limit the ability to fund future dividend payments of the Company. An adverse event or series of events could materially impact the ability of the insurance subsidiaries to fund future dividends, and consequently, the Board of Directors would have to suspend the declaration of dividends to shareholders.

The Company is subject to the risk of adverse settlements or judgments resulting from litigation of contested claims. It is difficult to predict or quantify the expected results of litigation because the outcome depends on decisions of the court and jury that are based on facts and legal arguments presented at the trial.


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Industry Segment and Geographical Area Information

Property and Casualty Insurance Segment
The Company's property and casualty insurance business is conducted through National Security Fire & Casualty Company (NSFC), a wholly owned subsidiary of the Company organized in 1959, and Omega One Insurance Company (Omega), a wholly owned subsidiary of National Security Fire & Casualty Company organized in 1992. This segment will be referred to throughout this report as NSFC, property-casualty segment or P&C segment. NSFC is licensed to write property and casualty insurance in Alabama, Arkansas, Florida, Georgia, Kentucky, Mississippi, Oklahoma, South Carolina, Tennessee and West Virginia, and operates on a surplus lines basis in the state of Louisiana. Omega is licensed to write insurance in Alabama and Louisiana.

The following table indicates allocation of direct premium written by state for the years ended December 31, 2018 and
2017:
State
 
Percent of Direct Written Premium
 
 
2018
 
2017
Alabama
 
$
16,261,000

 
26.65
%
 
$
16,966,000

 
27.59
%
Arkansas
 
1,941,000

 
3.18
%
 
2,086,000

 
3.39
%
Georgia
 
9,786,000

 
16.04
%
 
9,172,000

 
14.91
%
Louisiana
 
5,178,000

 
8.49
%
 
6,068,000

 
9.87
%
Mississippi
 
10,816,000

 
17.73
%
 
10,808,000

 
17.58
%
Oklahoma
 
6,828,000

 
11.19
%
 
6,580,000

 
10.70
%
South Carolina
 
6,793,000

 
11.14
%
 
6,477,000

 
10.53
%
Tennessee
 
3,404,000

 
5.58
%
 
3,341,000

 
5.43
%
 
 
$
61,007,000

 
100.00
%
 
$
61,498,000

 
100.00
%

In general, the property-casualty insurance business involves the transfer by the insured, to an insurance company of all or a portion of certain risks for the payment, by the insured, of a premium to the insurance company. A portion of such risks is often retained by the insured in the form of deductibles, which vary from policy to policy, but are typically in the range of $500 to $1,000 on dwelling property and homeowners lines of business.

The premiums or payments to be made by the insured for insurance policies of the property and casualty subsidiaries are based upon expected costs of providing benefits, underwriting and administering the policies. In determining the premium to be charged, the property and casualty subsidiaries utilize data from past claims experience, modeled catastrophe losses and anticipated claims estimates along with catastrophe reinsurance cost, commissions, taxes and general expenses.

The operating results of the property-casualty insurance industry are subject to significant fluctuations from quarter-to-quarter and from year-to-year. These fluctuations are often due to the effect of competition on pricing, unpredictable losses incurred in connection with weather-related and other catastrophic events, general economic conditions and other factors, such as changes in tax laws and the regulatory environment.

The following table sets forth the premiums earned (net of reinsurance) during the periods reported for the property and casualty insurance segment:
 
Year Ended December 31,
 
2018
 
2017
Net premiums earned:

 

Fire, allied lines and homeowners
$
54,837,000

 
$
55,044,000

Other

 

Total net earned premium
$
54,837,000

 
$
55,044,000






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Property and Casualty Loss Reserves

Our property and casualty insurance subsidiaries are required to maintain reserves to cover their ultimate liability for losses and adjustment expenses. Our staff periodically conducts reviews throughout the year of projected loss development information in order to adjust estimates. The liability for loss and adjustment expense reserves consists of an estimated liability for the ultimate settlement of claims that have been reported as well as an estimate of loss and adjustment expenses for incurred claims that have not yet been reported (IBNR). IBNR estimates are based primarily on historical development patterns using quantitative data generated from statistical information and qualitative analysis of legal developments, economic conditions and development caused by events deemed to be infrequent in occurrence. The reserves are based on an estimate made by management. Management estimates are based on an analysis of historical paid and incurred loss development patterns for the ten prior loss years. Prior year period-to-period loss development factors are applied to latest reported loss reserve estimates in order to estimate the ultimate incurred losses for each given loss year. The amount of loss reserves estimated in excess of current reported case losses are recorded as IBNR reserves.

In addition to loss and loss adjustment expense reserves for specific claims, both reported and unreported, we establish reserves for loss adjustment expenses that are not attributable to specific claims. These reserves consist of estimates for Defense and Cost Containment (DCC) and Adjusting and Other Expenses (AO). These reserves are established for the estimated expenses of internal claims staff and the cost of outside experts, such as attorneys representing our interest, in the final settlement of incurred claims that are still in process of settlement. We conduct annual and interim reviews over the course of each year in order to insure that no significant changes have occurred in our loss development that might adversely impact our loss reserving methodology.

The following loss reserve re-estimates table illustrates the change over time of the net reserves established for property-liability insurance claims and claims expense at the end of the last 10 calendar years. The first section shows the reserves as originally reported at the end of the stated year. The second section, reading down, shows retroactive re-estimates of the original recorded reserve as of the end of each successive year. These re-estimates are the result of the Company's expanded awareness of additional facts and circumstances that pertain to the unsettled claims. The third section, reading down, shows the cumulative amounts paid as of the end of successive years with respect to that year's reserve liability. The last section compares the latest re-estimated reserve to the reserve originally established and indicates whether the original reserve was adequate to cover the estimated costs of unsettled claims. The Loss Reserve Re-estimates table is cumulative, and therefore, ending balances should not be added since the amount at the end of each calendar year includes activity for both the current and prior years.

While the information in the table provides a historical perspective on the adequacy of unpaid losses and loss adjustment expenses established in previous years, it should not be assumed to be predictive of redundancies or deficiencies on current year unpaid losses in future periods. Company management believes that the reserves established at the end of 2018 are adequate. However, due to inherent uncertainties in the loss reserve estimation process, management cannot guarantee that current year reserve balances will prove to be adequate. Due to the relatively short tail nature of the property and casualty subsidiaries' claim liabilities, the Company does not discount loss reserves for the time value of money. Dollar amounts in the following table are in thousands.


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Table of Contents

Gross unpaid losses per
2008
 
2009
 
2010
 
2011
 
2012
 
2013
 
2014
 
2015
 
2016
 
2017
 
2018
     Consolidated Balance Sheet
$
14,436

 
$
12,646

 
$
13,184

 
$
14,386

 
$
11,214

 
$
8,734

 
$
8,321

 
$
9,645

 
$
7,530

 
$
7,075

 
$
8,208

Ceded reserves
 
(2,421
)
 
(549
)
 
(1,329
)
 
(2,381
)
 
(1,229
)
 
(782
)
 
(839
)
 
(1,381
)
 
(1,184
)
 
(327
)
 
(1,384
)
Net unpaid losses
 
$
12,015

 
$
12,097

 
$
11,855

 
$
12,005

 
$
9,985

 
$
7,952

 
$
7,482

 
$
8,264

 
$
6,346

 
$
6,748

 
$
6,824

Cumulative net payments:
1 year later
$
5,636

 
$
5,349

 
$
5,738

 
$
4,035

 
$
4,827

 
$
2,900

 
$
2,990

 
$
4,482

 
$
2,950

 
$
3,069

 
 
 
2 years later
6,350

 
6,305

 
7,239

 
5,346

 
6,670

 
3,539

 
3,503

 
4,839

 
3,364

 
 
 
 
 
3 years later
6,725

 
6,764

 
7,841

 
6,483

 
7,426

 
3,782

 
3,863

 
5,007

 
 
 
 
 
 
 
4 years later
6,980

 
7,244

 
8,382

 
7,001

 
7,496

 
3,910

 
4,113

 
 
 
 
 
 
 
 
 
5 years later
7,295

 
7,701

 
8,419

 
7,001

 
7,536

 
4,085

 
 
 
 
 
 
 
 
 
 
 
6 years later
7,390

 
7,725

 
8,433

 
7,060

 
7,572

 
 
 
 
 
 
 
 
 
 
 
 
 
7 years later
7,406

 
7,743

 
8,453

 
7,108

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
8 years later
7,509

 
7,746

 
8,452

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
9 years later
7,512

 
7,746

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
10 years later
7,512

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Net Liability re-estimated:
1 year later
9,438

 
8,621

 
11,443

 
9,606

 
9,354

 
6,698

 
5,597

 
6,333

 
4,495

 
5,060

 
 
 
2 years later
7,916

 
8,869

 
11,064

 
8,439

 
9,360

 
5,185

 
4,559

 
5,756

 
4,642

 
 
 
 
 
3 years later
8,179

 
9,033

 
9,725

 
8,500

 
8,483

 
4,348

 
4,605

 
5,916

 
 
 
 
 
 
 
4 years later
8,514

 
8,418

 
9,178

 
7,661

 
7,700

 
4,460

 
4,428

 
 
 
 
 
 
 
 
 
5 years later
7,855

 
8,064

 
8,854

 
7,091

 
7,683

 
4,365

 
 
 
 
 
 
 
 
 
 
 
6 years later
7,641

 
8,092

 
8,453

 
7,157

 
7,592

 
 
 
 
 
 
 
 
 
 
 
 
 
7 years later
7,707

 
7,762

 
8,457

 
7,124

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
8 years later
7,528

 
7,750

 
8,452

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
9 years later
7,516

 
7,746

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
10 years later
7,512

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Net cumulative redundancy (deficiency)
$
4,503

 
$
4,351

 
$
3,403

 
$
4,881

 
$
2,393

 
$
3,587

 
$
3,054

 
$
2,348

 
$
1,704

 
$
1,688

 
 
Our reported results, financial position and liquidity could be affected by changes in key assumptions that determine our loss reserves. The table below illustrates the change to equity that would occur as a result of a change in loss reserves and reserves for loss adjustment expense:
 
For The Years Ended December 31,
 
2018
 
2017
Change in Loss and LAE Reserves
Adjusted Loss and LAE Reserves
% Change in Equity
 
Adjusted Loss and LAE Reserves
% Change in Equity
*Loss and LAE reserves are in thousands
(10.0)%
$
7,387

1.79%
 
$
6,368

1.48%
(7.5)%
7,592

1.34%
 
6,544

1.11%
(5.0)%
7,798

0.89%
 
6,721

0.74%
(2.5)%
8,003

0.45%
 
6,898

0.37%
Reported
8,208

—%
 
7,075

—%
2.5%
8,413

(0.45)%
 
7,252

(0.37)%
5.0%
8,618

(0.89)%
 
7,429

(0.74)%
7.5%
8,824

(1.34)%
 
7,606

(1.11)%
10.0%
9,029

(1.79)%
 
7,782

(1.48)%

While our reserve estimates have had more significant variability in the past, we believe that the scenarios presented above are most reasonable as our methodology has become more seasoned, and we have maintained continuity of staff involved in the reserving process.

Life Insurance Segment
National Security Insurance Company (NSIC), a wholly owned subsidiary organized in 1947, conducts the Company's life insurance business. This segment will be referred to throughout this report as NSIC, Life Company, or Life segment. NSIC is licensed to write insurance in seven states: Alabama, Florida, Georgia, Mississippi, South Carolina, Tennessee and Texas.


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Table of Contents

The following table indicates NSIC's percentage of direct premiums collected by state for the two years ended December 31, 2018 and 2017:

State
 
Percentage of Total Direct Premiums
 
 
2018
 
2017
Alabama
 
$
3,538,000

 
57.37
%
 
$
3,616,000


57.96
%
Florida
 
62,000

 
1.01
%
 
60,000


0.96
%
Georgia
 
1,316,000

 
21.34
%
 
1,319,000


21.14
%
Mississippi
 
590,000

 
9.57
%
 
615,000


9.86
%
South Carolina
 
419,000

 
6.79
%
 
415,000


6.65
%
Tennessee
 
50,000

 
0.81
%
 
37,000


0.59
%
Texas
 
192,000

 
3.11
%
 
177,000


2.84
%
 
 
$
6,167,000

 
100.00
%
 
$
6,239,000


100.00
%

NSIC has two primary methods of distribution of insurance products: independent agents and home service (career) agents.  The independent agent distribution method accounts for 66.9% of total premium revenue in the life insurance segment. Approximately 200 of the Company's independent agents produced new business during 2018. The home service distribution method of life insurance products accounts for 28.2% of total premium revenue in the life insurance segment. Home service life products consist of products marketed directly at the home or other premises of the insured by an employee agent.  The Company employed three career agents and one regional manager as of December 31, 2018. The remaining 4.9% of premium revenue consists of the following:  a book of business acquired from a state guaranty association in 2000 (0.1%), premium generated through direct sales of school accident insurance (4.4%), and other miscellaneous business serviced directly through the home office (0.4%).

NSIC's primary products are life insurance, primarily whole life, and health and accident insurance. NSIC does not sell annuities, interest sensitive whole life or universal life insurance products.  Term life insurance policies provide death benefits if the insured's death occurs during the specific premium paying term of the policy.  The policies generally do not provide a savings or investment element included as part of the policy premium.  Whole-life insurance policies demand a higher premium than term life, but provide death benefits which are payable under effective policies regardless of the time of the insured's death and have a savings and investment element which may result in the accumulation of a cash surrender value.  Our accident and health insurance policies provide coverage for losses sustained through sickness or accident and include individual hospitalization and accident policies, group supplementary health policies, and specialty products, such as cancer policies.  Our line of health and accident products feature specified fixed benefits, so rapidly rising health care costs do not have as great an impact on our health and accident line as they do on comparable products offered by other companies. 

The following table displays a schedule of 2018 life segment premium produced by product and distribution method:
Line of Business
 
Home Service Agent
 
Independent Agent
 
Other
Industrial
 
$
43,000

 
$

 
$
32,000

Ordinary
 
1,437,000

 
2,588,000

 
21,000

Group Life
 

 
9,000

 
63,000

A&H Group
 

 
105,000

 
158,000

A&H Other
 
215,000

 
1,329,000

 
19,000

Total Premium by Distribution Method
 
$
1,695,000

 
$
4,031,000

 
$
293,000


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The following table sets forth certain information with respect to the development of Life segment business:
 
Year ended December 31,
 
2018
 
2017
Life insurance in force at end of period:
 
 
 
Ordinary-whole life
$
164,231,000

 
$
166,112,000

Term life
23,243,000

 
24,483,000

Industrial life
15,735,000

 
16,231,000

 
$
203,209,000

 
$
206,826,000

Life insurance issued:
 
 
 
Ordinary-whole life
$
16,742,000

 
$
20,957,000

 
$
16,742,000

 
$
20,957,000

Net premiums earned:
 
 
 
Life insurance
$
4,193,000

 
$
4,291,000

Accident and health insurance
1,826,000

 
1,828,000

 
$
6,019,000

 
$
6,119,000

Life Insurance Segment Reserves
We engage Wakely Actuarial Services of Palm Harbor, Florida as consulting actuary to calculate our reserves for traditional life insurance products. The methodology used requires that the present value of future benefits to be paid under life insurance policies less the present value of future net premiums be calculated. The calculation uses assumptions including estimates of any adverse deviation, investment yields and changes in investment yields, mortality, maintenance expenses and any non-forfeiture options or termination benefits. The assumptions determine the level and sufficiency of reserves which are calculated and reviewed by our consulting actuary at the end of each quarter. The independent consulting actuary also reviews our estimates for other insurance products including claims reserves under accident and health contracts. Management believes that the reserve amounts reflected in the accompanying Consolidated Financial Statements are adequate.

Investments
A significant percentage of the total income for the Company is tied to the performance of our investments. Assets that will eventually be used to pay reserve liabilities and other policyholder obligations, along with our capital, are invested to generate investment income while held by the Company. Our investment income is comprised primarily of interest and dividend income on fixed maturity securities and equity securities along with capital gains/losses generated by these investment securities. At December 31, 2018, cash and investments comprise 82% of total assets, and investment income (including realized losses) comprises 5.5% of total revenue evidencing the significant impact investments can have on financial results. Because our insurance subsidiaries are regulated as to the types of investments they may make and the amount of funds they may maintain in any one type of investment, the Company has developed a conservative value oriented investment philosophy, in order to meet regulatory requirements. The Company's investment goals are to conserve capital resources and assets, obtain the necessary investment income threshold to meet reserves, and provide a reasonable return. Current yield from invested assets and capital appreciation of investments create this return.

Marketing and Distribution
As mentioned earlier in this report, NSIC products are marketed through a field force of agents who are employees of the Life Company and through a network of independent agents. The Company's use of independent agents is expected to be more cost effective in the long term and has become our primary method of distribution. In an effort to boost productivity and better educate agents on the products and services of NSIC, we have field marketing representatives that travel throughout our service areas holding training sessions for agents.

P&C products are marketed through a network of independent agents and brokers, who are independent contractors and generally maintain relationships with one or more competing insurance companies. NSFC employs field marketing representatives who visit in the offices of our independent agents regularly to give the agents opportunities for feedback. Our NSFC marketing representatives also host training seminars throughout our service areas. The goal of these seminars is to educate the independent agent sales force about our products and services.


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Agents receive compensation for their sales efforts. In the case of life insurance agents, compensation is paid in the form of sales commissions plus a servicing commission. Commissions paid by the Life segment in 2018 averaged approximately 10.4% of premiums and are generally higher for new business production and decline each year at subsequent renewals. Commission rates paid by the P&C segment in 2018 averaged approximately 15% of premiums on both new and renewal business. During 2018, no independent agent, accounted for more than 10% of total net earned premium of the property-casualty insurance subsidiaries. The net earned premium from the largest general agent totaled $4,818,000 or 8.8% of total P&C segment net earned premium. NSFC also offers a “profit sharing bonus plan” to independent agents in order to promote better field underwriting and encourage retention of profitable business. This plan not only rewards our agents but also enhances profitability by giving the agent a vested interest in our success and also aids in maintaining price stability for all our customers as agents have a financial incentive to use good field underwriting practices when completing an application for insurance.

At December 31, 2018, NSIC employed three career agents and one regional manager. NSIC also had approximately 200 independent agents actively producing new business in seven states. At December 31, 2018, NSFC had contracts with approximately 1,700 independent agencies in eight states.

Competition
In both of our insurance segments, we operate in a very competitive environment. There are numerous insurance companies competing in the various states in which we offer our products. Many of the companies with which we compete are much larger, have significantly larger volumes of business, offer much broader ranges of products and have more significant financial resources than we do. We compete directly with many of these companies, not only in the sale of products to consumers, but also in the recruitment and retention of qualified agents. We believe the main areas in which a smaller company, like us, can compete is in the areas of providing niche products in under-served areas of the insurance market at competitive prices while providing excellent service to our agents and policyholders during the entire insurance product life cycle from policy issuance to final payment of a claim. We pride ourselves on being accessible to our independent agent force and maintain a presence through the efforts of a field marketing staff and easy access to home office staff. We believe we have made significant advancements in developing a competitive advantage for our niche products. We also have longstanding relationships with many of our agents. We believe we compete effectively within the markets we serve and continue to evolve our processes and procedures in order to garner further competitive advantages.

NSFC's primary insurance products are dwelling fire and homeowners, including mobile homeowners. Dwelling fire and homeowners are collectively referred to as the dwelling property line of business. We focus on providing niche insurance products within the markets we serve. We are in the top twenty-five dwelling property insurance carriers in our two largest states, Alabama and Mississippi. However, due to the large concentration of business among the top five carriers, our total market share in the dwelling fire line of business is approximately 2.6% in Alabama and 1.6% in Mississippi. In the homeowners line of business, our market share in both Alabama and Mississippi is less than 1%. The homeowners markets are even more concentrated with the top three homeowners carriers in both Alabama and Mississippi controlling nearly 50% of the market.

We have actively sought competitive advantages over the last decade in the area of technological advancement. The property and casualty administration system is an internally developed end-to-end system that we believe enhances our ability to compete with larger carriers in the markets we serve. The system features a web based portal that allows our independent agents to rate, quote and issue policies directly in their office. The system streamlines the underwriting process with automation of many previous manual processes and enhances our agents' ability to provide excellent service to their clients. The system also enhances the efficiency of our underwriting process allowing for a more thorough evaluation of risks.

Our property and casualty claims administration system automates processes and workflows throughout the claims process and provides a single view of the activity that has occurred on a claim.  The system also has an adjuster web portal, which allows adjusters to view policy limits, see reserve history and policy information, and view prior claims and loss history.  Communications between adjusters and examiners are centralized on the web portal allowing for any messages to be viewed securely as part of the claims history.  Computerized issuance of field checks by staff adjusters was also implemented enforcing reserve and policy limits while reducing the error rates of the previously used hand written checks issued in the field.

Regulation
Our insurance subsidiaries are directly regulated by the insurance department in our state of domicile, Alabama. We are subject to the Alabama Insurance Holding Company System Regulatory Act and report to the Alabama Department

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of Insurance. Consequently, we are subject to periodic examination and regulation under Alabama Insurance Laws. We underwent our latest periodic regulatory examination which concluded in 2015 with no material issues noted and no financial adjustments made as a result of the examination. The Alabama Department of Insurance is expected to commence a periodic examination of our insurance subsidiaries in 2019.

Our insurance subsidiaries are also subject to licensing and supervision by the various governmental agencies in the jurisdictions in which we do business. The nature and extent of such regulation varies, but generally has its source in state statutes which bestow regulatory, supervisory and administrative authority to State Insurance Commissioners and their respective insurance departments. The regulations may require the Company to meet and maintain standards of solvency, comply with licensing requirements, periodically examine market conditions and financial activities and report on the condition of operations and finances. In addition, most of our insurance rates are subject to regulation and approval by regulatory authorities within the respective states in which we offer our products.

Our insurance subsidiaries are subject to various statutory restrictions and limitations relating to the payment of dividends or distributions to stockholders. The restrictions are generally based on certain levels of surplus, net income or operating income as determined by statutory accounting practices. Alabama law permits dividends in any year which, together with other dividends made within the preceding 12 months, do not exceed the greater of (1) 10% of statutory surplus as of the end of the preceding year or (2) for property and casualty insurers, statutory net income for the preceding year or for life companies, statutory net gain from operations for the preceding year. Dividends in excess of the restricted amounts are payable only after obtaining expressed regulatory approval. Future dividends from the insurance subsidiaries may be limited by business or regulatory considerations. The Company relies insurance subsidiary dividends to fund stockholder dividends and for payment of most operating expenses of the holding company, including interest and principal payments on debt. Further discussion of dividend payment capacity of subsidiaries can be found in Note 12 of the Consolidated Financial Statements included herein.

Our insurance subsidiaries are subject to risk based capital requirements adopted by the National Association of Insurance Commissioners (NAIC). These requirements direct our insurance companies to calculate and report information according to a risk based formula which attempts to measure statutory capital and surplus needs based on the risk in our product mix and investment portfolio. The formula is designed to allow state insurance regulators to identify companies that are potentially inadequately capitalized. Under the formula, the Company calculates Risk Based Capital (RBC) by taking into account certain risks inherent in an insurer's assets, including investments and an insurer's liabilities. Risk based capital rules provide for different levels of action depending on the ratio of a company's total adjusted capital to its “authorized control level” RBC. Based on calculations made by each of our insurance subsidiaries at December 31, 2018, each subsidiary exceeds any levels that would require regulatory actions.

A.M. Best Rating
A.M. Best Company is a leading provider of insurance company financial strength ratings and insurance company issuer credit ratings. Best's financial strength ratings and issuer credit ratings provide an independent opinion based on comprehensive quantitative and qualitative evaluation of a company's balance sheet strength, operating performance and business profile. All of our insurance companies have been assigned ratings by A.M. Best Company (Best).  On April 12, 2018, A. M. Best affirmed the financial strength rating (FSR) of B++ (Good) and the issuer credit rating (ICR) of "bbb" of NSFC. In addition, Best affirmed the FSR of B+(Good) and ICR of "bbb-" of Omega and NSIC. The A.M. Best outlook for all of the ratings is "stable" for NSFC and Omega. Best upgraded the outlook from "stable" to "positive" for NSIC. Best also affirmed the ICR of "bb" of the parent holding company, NSEC, with a "stable" outlook. For the latest ratings, you can access www.ambest.com.

Demotech Rating
The property and casualty subsidiaries have been assigned ratings by Demotech, Inc. On September 30, 2018, Demotech affirmed a Financial Stability Rating of A (Exceptional) for both NSFC and Omega

Employees
The Company itself has no management or operational employees. Instead, all human resource activities are within the subsidiary National Security Insurance Company. NSIC employed 81 staff members as of December 31, 2018, none of which were represented by a labor union. The Company and its property and casualty subsidiary have a Management Service Agreement (“Agreement”) with National Security Insurance Company whereby the property and casualty subsidiaries reimburse NSIC for salaries and expenses of employees provided under the Agreement. Involved are employees in the areas of Underwriting, Customer Service, Policy Services, Accounting, Marketing, Administration, Document Management, Data Processing, Programming, Personnel, Claims, and Management. We consider our employee relations to be good.

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Additional information with respect to The National Security Group's Business
We maintain a website (www.nationalsecuritygroup.com). The National Security Group, Inc.'s annual reports on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K and any amendments to such reports that we file or furnish pursuant to Section 13(a) of the Securities Exchange Act of 1934 are available through our website, free of charge, as soon as reasonably practical upon having been electronically filed or furnished to the Securities and Exchange Commission. Our code of ethical conduct is also available on our website and in print to any stockholder who requests copies by contacting The National Security Group, Attn: Investor Relations, P. O. Box 703, Elba, AL 36323. Any of the materials we file with the SEC may also be read and copied at the SEC's Public Reference Room at 100 F Street, NE, Washington, D.C. 20549. Information on the operation of the SEC's Public Reference Room may be obtained by calling the SEC at 1.800.SEC.0330. Our periodic reports filed with the SEC, which include Forms 3, 4 and 5, Form 10-K, Form 10-Q, Form 8-K and any amendments thereto may also be accessed free of charge from the SEC's website at www.sec.gov.

Item 1A. Risk Factors
As a “Smaller Reporting Company,” we are not required to provide any disclosure under Item 1A. In providing these risk factors, we do not represent, and no inference should be drawn, that the disclosures so provided comply with all requirements of Item 1A if we were subject to them. Risk factors are events and uncertainties over which the Company has limited or no control and which can have a material adverse impact on our financial condition or results of operations. We are subject to a variety of risk factors. The following information sets forth our evaluation of the risk factors we deem to be most material. We work to actively manage these risks, but the reader should be cautioned that we are only able to mitigate the impact of most risk factors, not eliminate the risk. Also, there may be other risks which we do not presently deem material that may become material in the future.

Underwriting and Product Pricing
The insurance subsidiaries maintain underwriting departments that seek to evaluate the risks associated with the issuance of an insurance policy. NSIC accepts standard risks and, to an extent, substandard risks. In the case of the property and casualty subsidiaries, the underwriting staff attempts to assess, in light of the type of insurance sought by an applicant, the risks associated with a prospective insured or insurance situation. The underwriting assessment may involve various components in the risk evaluation process including, but not limited to, potential liability or fire hazards, age of dwelling, loss history, credit history of insured, employment status, location of fire department, home value, home heat source, and general maintenance of the property. In general, the property and casualty subsidiaries specialize in writing nonstandard risks.

The nonstandard market in which the property and casualty subsidiaries operate reacts to general economic conditions in much the same way as the standard market. When insurers' profits and equity are strong, companies sometimes cut rates or do not seek increases. Also, underwriting rules are less restrictive. As profit and/or capital fall, companies may tighten underwriting rules and seek rate increases. Premiums in the nonstandard market are higher than the standard market because of the increased risk, which generally comprises more frequent claims. Lower valued dwellings and mobile homes often warrant higher premiums because of the nature of the risk. The costs of placing such nonstandard policies and making risk determinations are similar to those of the standard market. The added costs due to more frequent claims servicing are reflected in the generally higher premiums that are charged.

Our ability to maintain profitability is contingent upon our ability to actively manage our rates and our underwriting procedures. Premium rate inadequacy may not become apparent quickly, and we will incur lag-time to correct. If our rates or underwriting processes become inadequate, our results of operations and financial condition could be adversely impacted.

Approval of Rates
Most lines of business written by our property and casualty insurers are subject to prior approval of premium rates in the majority of the states in which we operate. The process of obtaining regulatory approval can be expensive and time consuming and can impair our ability to make necessary rate adjustments due to changes in loss experience, cost of reinsurance or other factors. If our requests to regulatory bodies for rate increases are not approved in an adequate or timely manner, our results of operations and financial condition may be adversely impacted.


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Maintenance of Profit Margins and Potential for Margin Compression
Our maximum long-term average pretax profit margin on most of our insurance products is approximately five to six percent. In most states, we have limited ability to increase our margins beyond this level for higher risk, and we can incur significant delays in our ability to pass along higher cost that we may incur. Examples of this risk include:

Our catastrophe reinsurance cost is negotiated annually and effective January 1 of each year. The reinsurance market in which we operate is unregulated, and our reinsurance cost is based on negotiated rates that adjust annually. Due to increased frequency of storms over the past fifteen years and cycles of limited reinsurance market capacity, we often experience rate increases in which we have limited ability to negotiate and often cannot include these increases in our rates until the new reinsurance agreement is negotiated. Due to increased cat loads in more storm prone areas, significant year over year increases in cat cost can often temporarily eliminate our profit margins in some areas and significantly compress our overall profit margins priced into our insurance coverages.
We have a geographic concentration in the Southeastern U.S. which is exposed to significant hurricane risk. We believe that we are often not adequately compensated for certain heavily exposed risk through a combination of limits on allowable margin and regulatory delays in obtaining rate increases. We often have to manage these exposures using alternatives to pricing, such as limits on new business production, to help us manage exposure concentrations and protect our capital position.
Due to increasing catastrophe reinsurance cost, we have incurred increases in our reinsurance retentions/deductibles. Again, due to limits to profit margins, we are often not adequately compensated for the increased risk associated with these higher reinsurance retentions due to overall limits on underwriting margins in some of the states in which we operate.

Reinsurance, Risk of Loss from Catastrophic Event and Geographic Concentration
Both insurance subsidiaries customarily reinsure with other insurers certain portions of the insurance risk. The primary purpose of such reinsurance arrangements is to enable the Company to limit its risk on individual policies, and in the case of property insurance, limit its risk in the event of a catastrophe in various geographic areas. A reinsurance arrangement does not discharge the issuing company from primary liability to the insured, and the issuing company is required to discharge its liability to the insured even if the reinsurer is unable to meet its obligations under the reinsurance arrangements. Reinsurance, however, does make the reinsurer liable to the issuing company to the extent of any reinsurance in force at the time of the loss. Reinsurance arrangements also decrease premiums retained by the issuing company since that company pays the reinsuring company a portion of total premiums based upon the amount of liability reinsured. NSIC generally reinsures all risks in excess of $50,000 with respect to any one insured. The property and casualty subsidiaries have catastrophe excess reinsurance, which provide protection in part with respect to aggregate property losses arising out of a single catastrophe, such as a hurricane.

During 2018, the property and casualty segment maintained a catastrophe contract, which covered losses related to a catastrophic event with multiple policyholders affected. In the event a catastrophe exceeded the $4 million company retention stated in the contract, reinsurers would reimburse the company 100% of gross losses up to the upper limits of the reinsurance agreement, which was $72.5 million in 2018 and 2017. Any losses above the $72.5 million upper limit are the responsibility of our Company. The contract in place during 2018 also allowed one reinstatement for coverage under the contract for a second catastrophic event if needed.

The property and casualty subsidiaries utilize our actual in force policy data modeled applying two different industry accepted catastrophe models to structure catastrophe reinsurance and determine upper limits of catastrophe reinsurance agreements. Based on modeling results utilized in 2018 and 2017, the Company was reinsured at approximately a 250 year event level. While this estimate is subject to some uncertainty and model risk, the models indicate that we maintain catastrophe reinsurance upper limits to cover an event that has less than a 0.5% probability of occurring in a given year.

Our inability to procure reinsurance, primarily catastrophe reinsurance, could adversely impact our ability to maintain our level of premium revenue. The increased frequency of catastrophic events also increases our cost of reinsurance pressuring the profit margins of our insurance products. It is generally cost prohibitive to maintain deductibles below levels currently in place. Our current $4 million catastrophe deductible will adversely impact underwriting results in years in which we incur losses from a major hurricane or tornado outbreak.

As described above, we maintain catastrophe reinsurance in amounts that provides protection to the Company's financial condition in all but the most remote likelihood of occurrences. Our most critical catastrophe risk is from hurricanes due to our proximity to the Atlantic Ocean and the Gulf of Mexico. Our results of operations are very likely

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to be materially impacted in the event of the landfall of a hurricane or tropical storm striking the Northern Gulf Coast or Southern Atlantic Coast in Georgia or South Carolina where we maintain significant concentrations of business. We are also exposed to the risk of significant tornado activity in many of the states in which we operate. Our most significant catastrophic event risk is the risk of a loss in excess of the Company's upper catastrophe limit which could adversely impact the Company's financial condition if such an event occurs. We are also subject to assessments from windstorm underwriting pools in various states. These risks are often difficult to measure and in the event of a major catastrophe, could exceed the upper limits of our available reinsurance protection. We also face risk from a high frequency of catastrophe events. While these events may not exceed the upper limits of our catastrophe reinsurance retention, a large number of smaller events within our retention can materially impact our results of operations.

Catastrophe modeling results play a major role in our decision making process regarding the upper limits of our catastrophe reinsurance protection. While the level of sophistication has increased significantly in recent years in the design of computer generated catastrophe modeling, there are risks inherent in the modeling process, and the process continues to evolve. We believe the chance of a catastrophe event exceeding the upper limits of our reinsurance protection is remote; however, with the unpredictability of natural disasters, we are unable to eliminate all risk of exceeding the upper limits of our reinsurance protection. Hurricane Katrina exceeded the upper limits of our coverage in 2005. We have since increased the upper limits of our coverage and catastrophe models have improved significantly, but should a future event exceed the upper limits of our reinsurance coverage by a material amount, our financial condition could be adversely impacted.

Climate Change
Some scientific evidence supports that there have been and continue to be significant changes in climate including temperature, precipitation and wind resulting from various natural factors, processes, and human activities. Rising temperatures and changes in weather patterns could impact storm frequency and severity in our coverage areas. Increases in storm frequency and severity could negatively impact reinsurance costs impacting product pricing and the areas in which we offer our products. With respect to our property and casualty segment, climate change may impact the types of storms in our coverage areas as well as the frequency and severity of storms, thereby adversely impacting underwriting results, reinsurance placement and rates. With respect to our life insurance segment, climate change may impact life expectancies, thereby influencing mortality assumptions used in pricing assumptions and reserve calculations. Climate change could impact future product offerings, exclusions and/or policy limitations.

The Company may be impacted by domestic legislation and regulation related to climate change. Governmental mandates could impede our ability to make a profit with our current product offerings, limit the products we can offer and/or impact the geographic locations in which we offer our products. The impact of climate change cannot be quantified at this time.

Reserve Liabilities
NSIC maintains life insurance reserves for future policy benefits to meet future obligations under outstanding policies. These reserves are calculated to be sufficient to meet policy and contract obligations as they arise. Liabilities for future policy benefits are calculated using assumptions for interest, mortality, morbidity, expense and withdrawals determined at the time the policies were issued. As of December 31, 2018, the total reserves of NSIC (consisting of reserves for accident and health insurance) were approximately $37,474,000. We believe, based on current available information, reserves for future policy benefits are adequate. However, we are currently in a period of persistent and historically low interest rates. Should this period of low rates be sustained over the long term, it can impair our ability to make sufficient returns to cover future policy liabilities. Also, should actual mortality, morbidity, expense or withdrawal assumption differ materially from assumptions, our operating results could be negatively impacted.

The property and casualty subsidiaries are also required to maintain loss reserves (claim liabilities) for all lines of insurance. Such reserves are intended to cover the probable ultimate cost of settling all claims, including those incurred but not yet reported. The reserves of the property and casualty subsidiaries reflect estimates of the liability with respect to incurred claims and are determined by evaluating reported claims on an ongoing basis and by estimating liabilities for incurred but not reported claims. Such reserves include adjustment expenses to cover the cost of investigating losses and defending lawsuits. The establishment of accurate reserves is complicated by the fact that claims in some lines of insurance are settled many years after the policies have been issued, thus raising the possibility that inflation may have a significant effect on the amount of ultimate loss payment, especially when compared to initial loss estimates. The subsidiaries, however, attempt to restrict their writing to risks that settle within one to four years of issuance of the policy. As of December 31, 2018, the property and casualty subsidiaries had reserves for unpaid claims of approximately $8,208,000, before subtracting unpaid claims due from reinsurers of $1,384,000, leaving net unpaid claims of $6,824,000. The reserves are not discounted for the time value of money. No changes were made in the assumptions

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used in estimating the reserves during the years ending December 31, 2018 or 2017. The Company believes, based on current available information, such reserves are adequate to provide for settlement of claims.

We incur the risk that we may experience excessive losses due to unanticipated claims frequency, severity or both that may not be factored into our loss reserve liabilities. Unexpected frequency and severity can be adversely impacted by outcomes of claims litigation; adverse jury verdicts related to claims settlements and adverse interpretations of insurance policy provisions which result in increased liabilities. We are also subject to the risk of unanticipated assessments from state underwriting associations or windstorm pools related to losses in excess of the associations or pool's ability to pay. Such costs are often allocated to companies operating in the jurisdiction of the association or windstorm pool, and the likelihood and amount of such assessments are difficult to predict. These events could adversely impact our historical loss reserving methodology and cause financial adjustments that could materially impact our financial condition and results of operations.

Financial Ratings
The insurance subsidiaries are rated by the independent insurance rating agencies A.M. Best and Demotech. A downgrade in our ratings from either of these rating agencies could adversely impact our ability to maintain existing business or generate new business. See page 12 of this Form 10-K for additional information on our current financial ratings.

Regulation
The insurance subsidiaries are each subject to regulation by the insurance departments of those states in which they are licensed to conduct business. Although the extent of regulation varies from state to state, the insurance laws of the various states generally establish supervisory departments having broad administrative powers with respect to, among other matters: the granting and revocation of licenses to transact business, the licensing of agents, the establishment of standards of financial solvency (including reserves to be maintained), the nature of investments and in most cases premium rates, the approval of forms and policies, and the form and content of financial statements. The primary purpose of these regulations is the protection of policyholders. Compliance with regulations does not necessarily confer a benefit upon shareholders.

Many states in which the insurance subsidiaries operate, including Alabama, have laws requiring that insurers become members of guaranty associations. These associations guarantee that benefits due policyholders of insurance companies will continue to be provided even if the insurance company which wrote the business is financially unable to fulfill its obligations. To provide these benefits, the associations assess the insurance companies licensed in a state that write the line of insurance for which coverage is guaranteed. The amount of an insurer's assessment is generally based on the relationship between that company's premium volume in the state and the premium volume of all companies writing the particular line of insurance in the state. The Company has paid no material amounts to guaranty associations over the past two years. These payments, when made, are principally related to association costs incurred due to the insolvency of various insurance companies. Future assessments depend on the number and magnitude of insurance company insolvencies, and such assessments are therefore difficult to predict.

Most states have enacted legislation or adopted administrative rules and regulations covering such matters as the acquisition of control of insurance companies, transactions between insurance companies and the persons controlling them. The National Association of Insurance Commissioners has recommended model legislation on these subjects, and all states where the Company's subsidiaries transact business have adopted, with some modifications, that model legislation. Among the matters regulated by such statutes are the payments of dividends. These regulations have a direct impact on the Company since its cash flow is substantially derived from dividends from its subsidiaries, and adverse operating results in the insurance subsidiaries or the development of significant additional obligations in the holding company could adversely impact liquidity at the holding company level. Statutory limitations of dividend payments by subsidiaries are disclosed in Note 12 of the accompanying Consolidated Financial Statements.

While most regulation is at the state level, the federal government has increasingly expressed an interest in regulating aspects of the insurance industry. All of these regulations at various levels of government increase the cost of conducting business through increased compliance expenses. Also, existing regulations are constantly evolving through administrative and court interpretations, and new regulations are often adopted. It is difficult to predict what impact changes in regulation may have on the Company in the future. Changes in regulations could occur that might adversely impact our ability to achieve acceptable levels of profitability and limit our growth.


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Competition
The insurance subsidiaries are engaged in a highly competitive business and compete with many insurance companies of substantially greater financial resources, including stock and mutual insurance companies. Mutual insurance companies return profits, if any, to policyholders rather than shareholders; therefore, mutual insurance companies may be able to charge lower net premiums than those charged by stock insurers. Accordingly, stock insurers must attempt to achieve competitive premium rates through greater volume, efficiency of operations and control of expenses.

NSIC primarily markets its life and health insurance products through the home service system and independent producers. Direct competition comes from home service companies and other insurance companies that utilize independent producers to sell insurance products, of which there are many. NSIC's life and health products also compete with products sold by ordinary life companies. NSIC writes policies primarily in Alabama, Georgia and Mississippi. The market share of the total life and health premiums written is small because of the number of insurers in this highly competitive field. The primary methods of competition in the field are service and price.

Because of the increased costs associated with a home service company, premium rates are generally higher than ordinary products; as a result, competition from these ordinary insurers must be met through service. Initial costs of distribution through independent agents are generally more than through home service distribution methods, but lower commissions are paid in years subsequent to the first year of the policy so costs decline rapidly as policies renew after the first year. The primary factor in controlling cost under the independent agent distribution method is maintaining a high persistency rate. The persistency rate is the rate at which new business is maintained in renewal periods subsequent to the first year. If a high persistency rate can be maintained, the overall costs of distribution are lowered due to lower commission rate payments on policies in force subsequent to the first year.

The property and casualty subsidiaries market their products through independent agents and brokers, concentrating primarily on dwelling fire and homeowners coverage. NSFC, though one of the larger writers of lower value dwelling fire insurance in Alabama, nevertheless faces a number of competitors in this niche market. Moreover, larger general line insurers also compete with NSFC. The market share in states other than Alabama is small. Price is the primary method of competition. Because the Company utilizes independent agents, commission rates and service to the agent are also important factors in whether the independent agent agrees to offer NSFC products over those of its competitors. The Company primarily relies on an established independent agency force to market our insurance products. The loss of independent agents could adversely impact both the retention of existing business and production of new business.

Significant changes in the competitive environment in which we operate could materially impact our financial condition or results of operations.

Inflation
The Company shares the same risks from inflation as other companies. Inflation causes operating expenses to increase and erodes the purchasing power of the Company's assets. A large portion of the Company's assets is invested in fixed maturity investments. The purchasing power of these investments will be less at maturity because of inflation. This is generally offset by the reserves that are a fixed liability and will be paid with cheaper dollars. Also, inflation tends to increase investment yields, which may reduce the impact of the increased operating expenses caused by inflation.

Investment Risk and Liquidity
Our invested assets are managed by company personnel. The majority of these investments consist of fixed maturity securities. These securities are subject to price fluctuations due to changes in interest rates, and unfavorable changes could materially reduce the market value of the Company's investment portfolio and adversely impact our financial condition and results of operations. Fixed maturity investments are managed in light of anticipated liquidity needs and duration of liabilities. Should we experience a significant change in liquidity needs for any reason, we may be forced to sell fixed maturity securities at a loss to cover these liquidity needs. Changes in general economic conditions, the stock market and various other external factors could also adversely impact the value of our investments and consequently our results of operations and financial condition.

Impact of Economic and Credit Market Conditions on Our Investments
Our investment portfolio is exposed to economic and financial market risks, including changes in interest rates, credit markets and prices of marketable equity and fixed-income securities. Events that unfolded in the latest recession had a material impact on the valuations of our investments. Economic and credit market conditions during the recession adversely affected the ability of some issuers of investment securities to repay their obligations and may further affect

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the values of investment securities. If the carrying value of our investments exceeds the fair value, and the decline in fair value is deemed to be other-than-temporary, we will be required to write down the value of our investments, which could adversely impact our results of operations and financial condition.

Litigation
We are routinely involved in litigation related to our insurance products. Litigation can involve claims for damages in excess of stated policy limits and include damages for bad faith. Defense of these claims can often be expensive adding to our loss adjustment expenses, and adverse jury verdicts could materially impact our results of operations and financial position.
Dependence of the Company on Dividends from Insurance Subsidiaries
The Company is an insurance holding company with no significant operations and limited outside sources of income. The primary asset of the Company is its stock in the insurance subsidiaries. The Company relies on dividends from the insurance subsidiaries in order to pay operating expenses, to service debt obligations and to provide liquidity for the payment of dividends to shareholders. The ability of the insurance subsidiaries to pay dividends is subject to regulatory restrictions discussed in detail in Note 12 of the Consolidated Financial Statements included herein. Should the insurance subsidiaries become subject to restrictions imposed by insurance regulations regarding the payment of dividends, the ability of the Company to pay expenses, meet debt service requirements and pay cash dividends to shareholders could be adversely impacted. Additionally, should business conditions deteriorate, we could be forced to further limit or suspend dividend payments in order to protect our capital position.

Low Common Stock Trading Volume and Liquidity Limitations
We are a small public company with a large percentage of common stock outstanding owned by founding family members, employees, officers and directors. Consequently, our average daily trading volume is very low with no shares traded on some days and only a few thousand shares trading in a typical day. This low trading volume can lead to significant volatility in our share price and limit a shareholders ability to dispose of large quantities of stock in a short period of time.

Debt Covenants
Should we become unable to remain current on interest payments on our long-term debt, under our debt covenants, we would be forced to suspend the payment of dividends to stockholders until interest payments are current.

Technology and Cyber Security
Our insurance subsidiaries are dependent on computer technology and internet based platforms in the delivery of insurance products. Our ability to innovate and manage technological change is key to remaining competitive in the insurance industry. A breakdown of major systems, critical infrastructure or failure to maintain up-to-date technology could impact our ability to write new business and service existing policyholders, which would adversely impact our results of operations and financial condition. Due to the nature of our business, we maintain confidential customer information. The occurrence of computer viruses, information security breaches or unanticipated events could affect the data processing systems of the Company, our service providers or information maintained on our customers. The occurrence of any of these events could impact the Company's business and adversely affect our financial condition and results of operations.

Access to Capital
We rely on debt and equity capital to operate. Our debt levels are higher than our long term historical norm. Adverse operating results, general market and economic conditions could impair our ability to raise new capital needed to support our operations.

Key Personnel
As a small company within the insurance industry, we could be adversely impacted by the loss of key personnel. Our ability to remain competitive is contingent upon our ability to attract and retain qualified personnel in all aspects of our operations.

Accounting Standards
Our financial statements are prepared based upon generally accepted accounting standards issued by the Financial Accounting Standards Board along with standards set by other regulatory organizations. We are required to adopt newly issued or revised accounting standards that are issued periodically. Future changes could impact accounting treatment applied to financial statements and could have a material adverse impact on the Company's results of

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operations and financial conditions. Potential changes in accounting standards that are currently expected to impact the Company are disclosed in the Consolidated Notes to Financial Statements included herein.

Item 1B. Unresolved Staff Comments
As a smaller reporting company, the Company is not required to furnish the information required in Item 1B.

Item 2. Properties
Our principal executive offices, owned by NSIC, are located at 661 East Davis Street, Elba, Alabama. The executive offices are shared by the insurance subsidiaries. The building was constructed in 1977 with an addition added in 2008. The executive offices total approximately 30,700 square feet. The Company believes this space to be adequate for our immediate needs.

The Company and its subsidiaries own certain real estate investment properties. The Company owns approximately 211 acres of real estate in Coffee County in Alabama. We also own, through our subsidiary NSFC, approximately 85 acres of undeveloped commercial real estate in Greenville, Alabama. We sell undeveloped lots from this development, and the development has no depreciable improvements.

Capitalized along with the Greenville property are site preparation costs, including clearing, filling and leveling of land. There are no material improvements such as paving, parking lots or fencing that would be recorded as land improvements and depreciated over the appropriate useful life.

Item 3. Legal Proceedings
The Company and its subsidiaries are named parties to litigation related to the conduct of their insurance operations. Further information regarding details of pending suits can be found in Note 16 to the Consolidated Financial Statements.

Item 4. Mine Safety Disclosures
This section is not applicable.

Part II

Item 5. Market for Registrant's Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities

The capital stock of the Company is traded in the NASDAQ Global Market. Quotations are furnished by the National Association of Security Dealers Automated Quotations System (NASDAQ). The trade symbol is NSEC.

The following table sets forth the high and low sales prices per share, as reported by NASDAQ, during the period indicated:

 
Stock Closing Prices
 
2018
 
2017
 
High
 
Low
 
High
 
Low
  First Quarter
$
17.17

 
$
15.20

 
$
17.57

 
$
14.35

  Second Quarter
$
16.75

 
$
15.45

 
$
16.59

 
$
13.81

  Third Quarter
$
17.24

 
$
13.52

 
$
14.74

 
$
11.81

  Fourth Quarter
$
14.75

 
$
12.00

 
$
16.40

 
$
12.18


Shareholders
The number of shareholders of the Company's common stock was approximately 1,200 and the Company had 2,527,136 shares of common stock outstanding on March 15, 2019.


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Dividends
The following table sets forth quarterly dividend payment information for the Company for the periods indicated:

 
Dividends Per Share
 
2018
 
2017
  First Quarter
$
0.05

 
$
0.05

  Second Quarter
$
0.05

 
$
0.05

  Third Quarter
$
0.05

 
$
0.05

  Fourth Quarter
$
0.05

 
$
0.05


Discussion regarding dividend restrictions may be found on page 40 of the Managements' Discussion and Analysis as well as in Note 12 of the Consolidated Financial Statements.
 
The payment of shareholder dividends is subject to the discretion of our Board of Directors and is dependent upon many factors including our operating results, financial condition, capital requirements and general economic conditions. Total shareholder dividends paid in 2018 totaled $505,000.

Future dividends are dependent on future earnings, the Company's financial condition and other factors evaluated periodically by management and the Board of Directors. The Company is an insurance holding company and depends upon the dividends from the insurance subsidiaries to pay operating expenses and to provide liquidity for the payment of shareholder dividends. The payment of shareholder dividends is subject to the profitability of the insurance subsidiaries and the ability of the insurance subsidiaries to pay dividends to the holding company. Dividends from the insurance subsidiaries are subject to approval of the regulator in the state of domicile, the Alabama Department of Insurance.

Securities authorized for issuance under equity compensation plans
The Company currently only has one equity compensation plan which was approved by security holders at the 2009 Annual Shareholders Meeting. The following table sets forth securities authorized for issuance under the Company's
equity compensations plans:
Plan category
Number of securities to be issued upon exercise of outstanding options, warrants and rights
(a)
 
Weighted-average exercise price of outstanding options, warrants and rights
(b)
 
Number of securities remaining available for future issuance under equity compensation plans (excluding securities reflected in column (a))
(c)
Equity compensation plans approved by security holders

 

 
139,464

Equity compensation plans not approved by security holders

 

 

Total

 

 
139,464



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Item 6. Selected Financial Data
Under smaller reporting company rules we are not required to disclose information required under Item 6. However, in order to provide information to our investors, we have elected to provide certain selected financial data.

Five-Year Financial Information (dollars in thousands, except per share)
Selected Financial Data:
2018
 
2017
 
2016
 
2015
 
2014
Net premiums written
$
60,717

 
$
61,388

 
$
61,525

 
$
60,389

 
$
58,204

Net premiums earned
$
60,856

 
$
61,163

 
$
61,398

 
$
59,462

 
$
56,653

Net investment income
3,567

 
3,647

 
3,892

 
3,462

 
3,823

Net investment gains (losses)
(178
)
 
234

 
998

 
503

 
100

Other income
612

 
596

 
605

 
623

 
3,816

Total revenues
$
64,857

 
$
65,640

 
$
66,893

 
$
64,050

 
$
64,392

 
 
 
 
 
 
 
 
 
 
Net income (loss)
$
779

 
$
(1,203
)
 
$
3,063

 
$
4,697

 
$
7,616

Comprehensive income (loss)
$
(1,330
)
 
$
1

 
$
3,545

 
$
2,450

 
$
9,452

Total assets
$
144,231

 
$
146,438

 
$
148,579

 
$
147,841

 
$
144,865

Total debt outstanding
$
14,352

 
$
15,639

 
$
17,126

 
$
17,957

 
$
19,572

Total shareholders' equity
$
45,866

 
$
47,625

 
$
48,052

 
$
44,883

 
$
42,757

Shares outstanding (at year end, in thousands)
2,527

 
2,522

 
2,517

 
2,512

 
2,507

 
 
 
 
 
 
 
 
 
 
Key measures:
 
 
 
 
 
 
 
 
 
Return on average equity
1.67
%
 
(2.51
)%
 
6.59
%
 
10.72
%
 
19.98
%
Yield on investments, before tax
3.1
%
 
3.2
 %
 
3.4
%
 
3.1
%
 
3.6
%
Debt to equity
31.3
%
 
32.8
 %
 
35.6
%
 
40.0
%
 
45.8
%
US GAAP combined ratio (P&C Segment)
102.4
%
 
102.3
 %
 
94.6
%
 
91.0
%
 
87.4
%
P&C Catastrophe losses, net
$
18,516

 
$
14,280

 
$
9,742

 
$
5,373

 
$
2,628

Catastrophe loss impact on combined ratio (percentage points)
16.66

 
25.67

 
17.47

 
10.11

 
5.23

 
 
 
 
 
 
 
 
 
 
Per share data:
 
 
 
 
 
 
 
 
 
Book value
$
18.15

 
$
18.88

 
$
19.09

 
$
17.87

 
$
17.05

Net income (loss)
$
0.31

 
$
(0.48
)
 
$
1.22

 
$
1.87

 
$
3.04

Dividends paid
$
0.20

 
$
0.20

 
$
0.18

 
$
0.16

 
$
0.12

Quarterly Information:
 Premiums
 
 Investment & Other Income
 
Investment Gains (Losses)
 
 Claims and Benefit Payments
 
 Net Income (Loss)
 
 Net Income (Loss) Per Share
2018
 
 
 
 
 
 
 
 
 
 
 
  First Quarter
$
15,059

 
$
942

 
$
(125
)
 
$
9,427

 
$
471

 
$
0.19

  Second Quarter
15,260

 
1,146

 
(203
)
 
9,772

 
457

 
0.18

  Third Quarter
15,445

 
1,168

 
453

 
9,825

 
907

 
0.36

  Fourth Quarter
15,092

 
923

 
(303
)
 
11,385

 
(1,056
)
 
(0.42
)
 
$
60,856

 
$
4,179

 
$
(178
)
 
$
40,409

 
$
779

 
$
0.31

2017
 
 
 
 
 
 
 
 
 
 
 
  First Quarter
$
15,040

 
$
1,078

 
$
160

 
$
11,146

 
$
(316
)
 
$
(0.13
)
  Second Quarter
15,331

 
1,075

 
77

 
12,581

 
(999
)
 
(0.39
)
  Third Quarter
15,467

 
1,089

 
75

 
11,184

 
(557
)
 
(0.22
)
  Fourth Quarter
15,325

 
1,001

 
(78
)
 
7,958

 
669

 
0.26

 
$
61,163

 
$
4,243

 
$
234

 
$
42,869

 
$
(1,203
)
 
$
(0.48
)

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Table of Contents

Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations

The following discussion highlights significant factors influencing the consolidated financial position and results of operations of The National Security Group, Inc. (referred to in this document as we, our, us, the Company or NSEC) and its subsidiaries. We are a “smaller reporting company” under Securities and Exchange Commission (SEC) regulations and therefore qualify for the scaled disclosure of smaller reporting companies. In general, the same information is required to be disclosed in the management discussion and analysis by smaller reporting companies except that the discussion need only cover the latest two year period and disclosures relating to contractual obligations are not required. In accordance with the scaled disclosure requirements, this discussion covers the two year period ended December 31, 2018.

The National Security Group, Inc. operates in ten states with 46.7% of total premium revenue generated in the states of Alabama and Mississippi.  The Company is made up of the following two segments:

The Property and Casualty (P&C) segment is the most significant segment, accounting for 90.9% of gross earned premium in 2018.  The P&C segment has insurance in-force in the states of Alabama, Arkansas, Georgia, Louisiana, Mississippi, Oklahoma, South Carolina, and Tennessee.  

The Life segment accounted for 9.1% of gross premium revenue in 2018. The Life segment is licensed to underwrite life and accident and health insurance in Alabama, Florida, Georgia, Mississippi, South Carolina, Tennessee and Texas.
 
The Company's P&C segment is conducted through National Security Fire & Casualty Company (NSFC), a wholly owned subsidiary of the Company organized in 1959, and Omega One Insurance Company (Omega), a wholly owned subsidiary of National Security Fire & Casualty Company organized in 1992. Due to Omega producing no direct written premium and the fact that Omega is a wholly owned subsidiary of NSFC authorized to underwrite similar lines of business, all references to NSFC or P&C segment in the remainder of this management discussion and analysis will include the insurance operations of both NSFC and Omega.

Life segment business is conducted through National Security Insurance Company (NSIC), a wholly owned subsidiary of the Company organized in 1947. All references to NSIC or life segment in the remainder of this management discussion and analysis will refer to the combined life, accident and health insurance operations.

Our income is principally derived from net underwriting profits and investment income.  Net underwriting profit is principally derived from earned premiums received less claims paid, sales commissions to agents, costs of underwriting and insurance taxes and fees.  Investment income includes interest and dividend income and gains and losses on investment holdings.

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

All of our insurance companies have been assigned ratings by A.M. Best Co (Best).  On April 12, 2018, A. M. Best affirmed the financial strength rating (FSR) of B++ (Good) and the issuer credit rating (ICR) of "bbb" of NSFC. In addition, Best affirmed the FSR of B+(Good) and ICR of "bbb-" of Omega and NSIC. The A.M. Best outlook for all of the ratings is "stable" for NSFC and Omega. Best upgraded the outlook from "stable" to "positive" for NSIC. Best also affirmed the ICR of "bb" of the parent holding company, NSEC, with a "stable" outlook.

The property and casualty subsidiaries have been assigned ratings by Demotech, Inc. On September 30, 2018, Demotech affirmed a Financial Stability Rating of A (Exceptional) for both NSFC and Omega.

The property and casualty segment can be impacted by severe storm activity resulting in incurred losses and loss adjustment expenses primarily from hurricane, tornado, wind and hail related damage. These storm systems or other natural disasters are classified as catastrophes (referred to as "cat events" or "catastrophe events" throughout the remainder of this document) by Property Claim Service (PCS) when these events cause $25 million or more in industry wide direct insured losses and affect a significant number of policyholders and insurers.


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A primary process management utilizes to review financial information of the Company is evaluating the operating performance of each segment before intercompany eliminations. By performing the evaluation in this manner, management can assess the profitability of each segment on a standalone basis. We have altered the presentation of our Management Discussion and Analysis related to industry segment data to provide pretax income income by segment before eliminations. We have restated prior year to follow the same format. Note 15 to the consolidated financial statements in this Form 10-K contains a reconciliation of net income by segment before eliminations to consolidated net income.

This discussion and analysis of the consolidated results of operations and financial condition of the Company should be read in conjunction with the Selected Financial Data and Consolidated Financial Statements and related notes included in this Form 10-K. Please refer to our note regarding forward-looking statements on pages 4-5 of this report.

In order to present information as analyzed by Company management, industry segment data in this Management Discussion and Analysis is presented before certain intercompany eliminations. These intercompany eliminations, which are presented in Note 15 to the Consolidated Financial Statements, primarily include management and service fees paid by each subsidiary to NSEC, along with fees and expenses of the Company's employee claims adjusters. Claims adjusters are employees of NSIC but provide claim adjustment services to NSFC at rates comparable to those paid to independent (non-employee) adjusters utilized by NSFC. Management believes that the analysis of segment information prior to elimination of the intercompany transactions provides a more realistic view of performance relative to subsidiary capital allocation and product pricing strategies. While segment data is presented prior to intercompany eliminations, all intercompany transactions are eliminated in all Consolidated Financial Statements and other consolidated financial information presented in accordance with accounting principles generally accepted in the United States (GAAP).

Information in this discussion is presented in whole dollars rounded to the nearest thousand. Tabular amounts are presented in thousands.

Summary:
For the year ended December 31, 2018, net income for the Company totaled $779,000, $0.31 income per share, compared to a net loss of $1,203,000, $0.48 loss per share, for the year ended December 31, 2017; a year over year increase of $1,982,000. While the Company ended 2018 with net income from operations, results for 2018 were negatively impacted by Hurricane Michael. On October 10, 2018, Hurricane Michael made landfall in the panhandle of Florida, as a Category 4 storm. Hurricane Michael primarily impacted our policyholders in Georgia; but also affected policyholders in Alabama and South Carolina. The losses incurred from Hurricane Michael reduced fourth quarter net income by $3,160,000.

Results for 2017 were negatively impacted by Hurricane Irma coupled with an active spring storm season. During September 2017, Hurricane Irma made landfall in the Florida Keys as a Category 4 storm. After moving through the Florida peninsula, Hurricane Irma impacted our policyholders in Alabama, Georgia, South Carolina and Tennessee. Georgia was the primary state in our coverage area impacted by Hurricane Irma. Also adversely impacting 2017 earnings was a fourth quarter charge to income tax expense of $803,000 from the net impact of recognition and revaluation of deferred tax assets and liabilities due to enactment of the Tax Cuts and Jobs Act (TCJA).


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Table of Contents

Financial results for the year ended December 31, 2018 and 2017 were as follows:
Consolidated Financial Summary
 
Year ended December 31,
     (dollars in thousands, except per share)
 
2018
 
2017
Gross premiums written
 
$
67,174

 
$
67,737

Net premiums written
 
$
60,717

 
$
61,388

 
 
 
 
 
Net premiums earned
 
$
60,856

 
$
61,163

Net investment income
 
3,567

 
3,647

Investment gains (losses)
 
(178
)
 
234

Other income
 
612

 
596

Total Revenues
 
64,857

 
65,640

Policyholder benefits and settlement expenses
 
40,409

 
42,869

Amortization of deferred policy acquisition costs
 
3,597

 
3,589

Commissions
 
7,555

 
7,723

General and administrative expenses
 
8,839

 
8,821

Taxes, licenses and fees
 
2,157

 
2,445

Interest expense
 
1,235

 
1,307

Total Benefits, Losses and Expenses
 
63,792

 
66,754

Income (Loss) Before Income Taxes
 
1,065

 
(1,114
)
Income tax expense
 
286

 
89

Net Income (Loss)
 
$
779

 
$
(1,203
)
Income (Loss) Per Common Share
 
$
0.31

 
$
(0.48
)
Reconciliation of Net Income (Loss) to non-GAAP Measurement
 
 
 
 
Net income (loss)
 
$
779

 
$
(1,203
)
Income tax expense
 
286

 
89

Investment (gains) losses, net
 
178

 
(234
)
Pretax Income (Loss) From Operations
 
$
1,243

 
$
(1,348
)

Premium Revenue:
For the year ended December 31, 2018, net premiums earned were down $307,000 at $60,856,000 compared to $61,163,000 in 2017. The decrease in premium revenue was primarily driven by a decline in net earned premium in the P&C segment of $207,000. This decline was primarily attributable to a decrease in our surplus lines business in coastal Louisiana.

Investment Gains (Losses):
In 2018, due to a change in GAAP, unrealized gains and losses on equity investments are required to be reported as a component of investment gains/losses on the statement of operations. These amounts were previously reported as a component of Other Comprehensive Income. For the year ended December 31, 2018, investment losses include a $203,000 decrease in accumulated gains on equity securities held for investment. This decrease in accumulated gains was driven by an overall decline in stock market values experienced late in the fourth quarter of 2018.

Net Income (Loss):
For the year ended December 31, 2018, the Company had net income of $779,000, $0.31 income per share, compared to a net loss of $1,203,000, $0.48 loss per share, for the same period in 2017. The primary reason for the increase in 2018 year to date earnings compared to 2017 was the reduction in retained catastrophe losses over the twelve month period in 2018. Also, results in 2017 were adversely impacted by an increase in income tax expense due to revaluation of deferred tax assets under the Tax Cuts and Jobs Act (TCJA). Retained catastrophe losses were down $5,142,000 in 2018 compared to 2017. In addition, we had a fourth quarter 2017 charge to income tax expense of $803,000 from the net impact of recognition and revaluation of deferred tax assets and liabilities due to enactment of the TCJA.


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Table of Contents

Pretax Income (Loss) from Operations:
For the year ended December 31, 2018, our pretax income from operations was $1,243,000 compared to a pretax loss from operations of $1,348,000 for the year ended December 31, 2017; an improvement of $2,591,000. The primary reason for the pretax income from operations in 2018 compared to the pretax loss from operations in the prior year was a decrease in the frequency and severity of catastrophe related claims in the P&C segment. While our P&C segment was impacted by Hurricane Michael in the fourth quarter of 2018 and Hurricane Irma in the third quarter of 2017, our property and casualty subsidiary was also impacted by numerous tornado and severe thunderstorm related catastrophe events in the first half of 2017. The reduction in non-hurricane cat events in 2018 compared to the prior year was the primary reason for the decrease in claims and improvement in pretax income from operations.

P&C Segment Combined Ratio:
For the year ended December 31, 2018, the P&C segment had a GAAP combined ratio of 102.4%. Reported claims from Hurricane Michael coupled with reported claims from Hurricane Florence and 17 additional severe weather events in 2018 totaled $9,138,000 (net of reinsurance recoveries) and increased the P&C segment combined ratio by 16.7 percentage points. In comparison, for the year ended December 31, 2017, the P&C segment had a GAAP combined ratio of 102.3%. Reported claims from Hurricane Irma and 25 additional severe weather events in 2017 totaled $14,280,000 and increased the P&C segment combined ratio by 25.7 percentage points. Partially offsetting the 2018 decrease in catastrophe losses was an increase in fire related losses compared to the prior year.

Overview - Balance Sheet highlights at December 31, 2018 compared to December 31, 2017
Selected Balance Sheet Highlights
 
December 31, 2018
 
December 31, 2017
     (dollars in thousands)
 
 
 
 
Invested Assets
 
$
112,690

 
$
114,731

Cash
 
$
5,676

 
$
6,644

Total Assets
 
$
144,231

 
$
146,438

Policy Liabilities
 
$
77,988

 
$
76,674

Total Debt
 
$
14,352

 
$
15,639

Accumulated Other Comprehensive (Loss) Income
 
$
(1,570
)
 
$
2,646

Shareholders' Equity
 
$
45,866

 
$
47,625

Book Value Per Share
 
$
18.15

 
$
18.88


Invested Assets:
Invested assets as of December 31, 2018 were $112,690,000 compared to $114,731,000 as of December 31, 2017. The primary reason for the decline in invested assets was the increase in market interest rates which reduced the market value of our bond portfolio held for sale by $3,043,000.

Cash:
The Company, primarily through its insurance subsidiaries, had $5,676,000 in cash and cash equivalents at December 31, 2018, compared to $6,644,000 at December 31, 2017. The moderate decline in cash for 2018 was primarily due to payment of claims from Hurricane Michael which occurred in the fourth quarter of 2018.

Total Assets:
Total assets as of December 31, 2018 were $144,231,000 compared to $146,438,000 at December 31, 2017. Asset growth in 2018 was hindered by losses from Hurricane Michael along with a decrease in value of our bond portfolio investments due to increases in market interest rates.

Policy Liabilities:
Policy liabilities were $77,988,000 at December 31, 2018, compared to $76,674,000 at December 31, 2017; an increase of $1,314,000 or 1.7%. The primary reason for the increase in policy liabilities in 2018 compared to the same period last year was a $1,133,000 increase in P&C segment loss reserves.

Debt Outstanding:
Total debt at December 31, 2018 was $14,352,000 compared to $15,639,000 at December 31, 2017. Debt was reduced $1,287,000 during 2018 primarily from the reduction of long-term debt in our holding company. The improvement of

24

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balance sheet strength through both capital growth and reduction of debt continues to be a primary focus of management.

Shareholders' Equity:
Shareholders' equity as of December 31, 2018 was $45,866,000, down $1,759,000 compared to December 31, 2017 Shareholders' equity of $47,625,000. Book value per share was $18.15 at December 31, 2018, compared to $18.88 per share at December 31, 2017, a decrease of $0.73 per share. The primary factors contributing to the decrease in both book value per share and Shareholders' equity were an accumulated other comprehensive loss of $2,109,000, shareholder dividends of $505,000 and new shares issued under our director compensation plan which totaled $76,000. Partially offsetting these factors was net income of $779,000. The accumulated other comprehensive loss was largely driven by a $2,404,000 net of tax decline in market values in our bond portfolio due to an increase in market interest rates.

Industry Segment Data
Net earned premium revenues for The National Security Group's two operating segments (Life segment, Property and Casualty segment) are summarized as follows (amounts in thousands):
(dollars in thousands)
2018
 
%
 
2017
 
%
Life, accident and health insurance
$
6,019

 
9.9
%
 
$
6,119

 
10.0
%
Property and casualty insurance
54,837

 
90.1
%
 
55,044

 
90.0
%
 
$
60,856

 
100.0
%
 
$
61,163

 
100.0
%

The property and casualty segment composed 90.1% of total net earned premium revenue in 2018 compared to 90.0% in 2017. Through the P&C segment, we offer primarily dwelling fire and homeowners insurance coverage to our customers. The life segment composed 9.9% of net earned premium revenue in 2018 compared to 10.0% in 2017 with revenue produced from life, accident and supplemental health insurance products. While reading this discussion regarding segment information, reference is made to Note 15 to the Consolidated Financial Statements which provides additional segment related information.

The following discussion outlines more specific information with regard to the individual operating segments of the Company along with non-insurance related information (primarily administration expenses and interest expense) associated with the insurance holding company.

Life and Accident and Health Insurance Operations:
Premium revenues and operating income for the life segment for the year ended December 31, 2018 and 2017 are summarized below (amounts in thousands):

(dollars in thousands)
2018
 
2017
REVENUE
 
 
 
      Net premiums earned
$
6,019

 
$
6,119

      Net investment income
2,722

 
2,551

      Net investment gains (losses)
(78
)
 
71

      Other income
1,078

 
1,045

Total Revenues
$
9,741

 
$
9,786

BENEFITS AND EXPENSES
 
 
 
      Policyholder benefits paid or provided
$
5,242

 
$
5,045

      Amortization of deferred policy acquisition costs
838

 
812

      Commissions
288

 
343

      General and administrative expenses
2,111

 
1,929

      Insurance taxes, licenses and fees
220

 
208

      Interest expense
48

 
73

Total Expenses
$
8,747

 
$
8,410

INCOME BEFORE INCOME TAXES
$
994

 
$
1,376


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Table of Contents

Year Ended December 31, 2018 Compared to Year Ended December 31, 2017:
Net earned premium revenue in the life segment was $6,019,000 at December 31, 2018 compared to $6,119,000 at December 31, 2017; a decrease of 1.6%.  The $100,000 decrease in net earned premium revenue was primarily due to a decline in new business production in both the traditional life and supplemental accident and health insurance products offered in NSIC.

The table below provides the major categories of investment income for the year ended December 31, 2018 and 2017:
 
 
Year ended
December 31,
 
 
2018
 
2017
Fixed maturities
 
$
2,108

 
$
1,942

Equity securities
 
37

 
32

Mortgage loans on real estate
 
8

 
9

Investment real estate
 
543

 
544

Policy loans
 
141

 
130

Other
 
1

 
18

 
 
2,838

 
2,675

Less: Investment expenses
 
116

 
124

Net investment income
 
$
2,722

 
$
2,551


While NSIC composes only 9.9% of premium revenue, the segment makes up 41.2% of consolidated assets. The majority of these assets consist of fixed maturity investments. Net investment income was up $171,000 or 6.7% at $2,722,000 for the year ended December 31, 2018 compared to $2,551,000 for the same period last year. A combination of increased investment in fixed income securities due to positive cash flow from operations and the recent rise in interest rates was the primary factor contributing to the increase in investment income.

The table below provides investment gains and losses for the year ended December 31, 2018 and 2017:

 
Year ended
December 31,
 
2018
 
2017
Fixed maturities
$
96

 
$
(105
)
Equity securities

 
174

Change in fair value of equity securities
(87
)
 

Other, principally real estate
(71
)
 
2

Other-than-temporary impairments
(16
)
 

Net investment gains (losses)
$
(78
)
 
$
71


NSIC ended 2018 with net investment losses of $78,000 compared to net investment gains of $71,000 for the same period in 2017. Investment gains and losses are highly dependent on several factors including market conditions, tax position and liquidity needs of the Company and can vary significantly from period to period. In 2018, due to a change in GAAP, increases and decreases in accumulated gains/losses on equity investments held for investment are required to be reported as a component of investment gains/losses on the income statement. These amounts were previously reported as a component of Other Comprehensive Income. For the year ended December 31, 2018, life segment investment losses include a $71,000 decrease in accumulated gains on equity securities held for investment. This decrease in accumulated gains was driven by an overall decline in stock market values experienced late in the fourth quarter of 2018. The net investment gains in 2017, were primarily from the disposition of available-for-sale investments.

Other income was $1,078,000 in 2018 compared to $1,045,000 for the same period in 2017; an increase of $33,000. Other income consists primarily of adjuster fees paid to NSIC from the P&C segment and rent from affiliates which is eliminated upon consolidation. As a percent of net earned premium, other income was 17.9% in 2018 and 17.1% in 2017.

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Claims were $5,242,000 through December 31, 2018 compared to $5,045,000 through December 31, 2017; an increase of $197,000 or 3.9%. NSIC experienced a moderate increase in life insurance claims in 2018 compared to the same period last year due to an increase in both ordinary life and industrial life related claims.

Deferred policy acquisition cost amortization and commission expenses decreased $29,000 for the year ended December 31, 2018 at $1,126,000 compared to $1,155,000 for the same period in 2017; a decline of 2.5%. As a percent of net premiums earned, policy acquisition cost amortization and commission expense was 18.7% in 2018 compared to 18.9% in 2017. A decline in the rate of new business production was the primary reason for the decline in commission expenses.

General and administrative expenses were $2,111,000 in 2018 compared to $1,929,000 in 2017. As a percent of earned premium, general and administrative expenses were 35.1% and 31.5% at December 31, 2018 and 2017, respectively. The most significant factor contributing to the change in general and administrative was expenses was the reversal of a bonus accrual which reduced general and administrative expenses in 2017.

For the year ended December 31, 2018 and 2017, insurance taxes, licenses and fees were $220,000 and $208,000, respectively. As a percent of earned premium, insurance taxes, licenses and fees were comparable at 3.7% in 2018 and 3.4% in 2017.

Interest expense was $48,000 for the year ended December 31, 2018 compared to $73,000 for the year ended December 31, 2017. Interest expense is related to our life insurance policies which contain a savings account component. The primary reason for the $25,000 decrease in interest expense, in 2018 compared to 2017, was a reduction in the minimum interest rate required to be paid to policyholders from 5% to 3%.

For the year ended December 31, 2018, the life segment had pretax income of $994,000 compared to a pretax income of $1,376,000 for the same period in 2017. The increase in claims and general and administrative expenses were the primary factors contributing to the decline in pretax income.

Property & Casualty Operations:
Premium revenues and operating income for the P&C segment for the year ended December 31, 2018 and 2017 are summarized below:
(dollars in thousands)
2018
 
2017
REVENUE
 
 
 
     Net premiums earned
$
54,837

 
$
55,044

     Net investment income
1,330

 
1,571

     Net investment gains (losses)
(100
)
 
163

     Other income
609

 
592

Total Revenues
$
56,676

 
$
57,370

BENEFITS AND EXPENSES
 
 
 
     Policyholder benefits paid or provided
$
35,735

 
$
38,391

     Amortization of deferred policy acquisition costs
2,759

 
2,777

     Commissions
7,267

 
7,380

     General and administrative expenses
8,472

 
8,087

     Insurance taxes, licenses and fees
1,937

 
2,237

Total Expenses
$
56,170

 
$
58,872

INCOME (LOSS) BEFORE INCOME TAXES
$
506

 
$
(1,502
)


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Year Ended December 31, 2018 Compared to Year Ended December 31, 2017:
Premium revenue in the P&C segment is primarily driven by our dwelling fire and homeowner lines of business. The following table provides premiums earned by line of business:
(dollars in thousands)
2018
 
2017
 
 
Line of Business
Premium Earned
 
%
of NPE
 
Premium Earned
 
%
of NPE
 
2018
Increase (Decrease) over 2017
Dwelling Fire/Allied Lines
$
39,412

 
71.9
 %
 
$
38,485

 
69.9
 %
 
2.4
 %
Homeowners
21,801

 
39.7
 %
 
22,831

 
41.5
 %
 
(4.5
)%
Catastrophe Reinsurance Premium Ceded
(6,376
)
 
(11.6
)%
 
(6,272
)
 
(11.4
)%
 
1.7
 %
Net Premium Earned
$
54,837

 
100.0
 %
 
$
55,044

 
100.0
 %
 
(0.4
)%

Property and casualty segment net premium earned for 2018 was $54,837,000 compared to 55,044,000 for the same period in 2017. The primary reason for the moderate decline in 2018 compared to 2017 was a 4.5% decrease in gross premium revenue in our homeowners program primarily driven by a reduction in premium revenue in coastal Louisiana. An increase in catastrophe reinsurance cost (ceded premium) of 1.7% also contributed to our 0.4% decrease in net premium earned.

The primary source of premium revenue growth in the P&C segment was in our non-coastal states; primarily the states of Georgia and Oklahoma. Premium revenue in Georgia increased 8.0% in 2018 with policy counts up 3.7% compared to December 31, 2017. Increased rates were implemented in Georgia, along with growth in policy count, which lead to the year over year increase in premium revenue in the state. In addition, Oklahoma premium revenue increased 4.1% in 2018, with policy counts up 3.7%. An increase in new business production coupled with the implementation of increased rates were the primary reasons for the increase in premium revenue in Oklahoma in 2018 compared to the same period last year. We expect to continue to look for opportunities to increase premium revenue in non-coastal and less hurricane prone regions of the states in which we operate in order to create more geographic diversification and seek appropriate risk adjusted rates in coastal areas.

The Company maintains catastrophe reinsurance coverage to mitigate loss exposure from catastrophic events. Our per event catastrophe retention remained unchanged at $4 million in 2018 and we maintain catastrophe reinsurance coverage with an upper limit of $72.5 million. Our catastrophe reinsurance also covers the cost of a second event up to the same $72.5 million upper limit, again with a $4 million retention.

Under the catastrophe reinsurance program in 2018, the Company retained the first $4,000,000 in losses from each event.  Reinsurance coverage for 2018 was maintained in three layers as follows:
Layer
Reinsurers' Limits of Liability
First Layer
100% of $13,500,000 in excess of $4,000,000 retention
Second Layer
100% of $25,000,000 in excess of $17,500,000
Third Layer
100% of $30,000,000 in excess of $42,500,000
In our reinsurance structure, management attempts to limit the impact on pretax earnings of a single modeled 100 year cat event to no more than $4 million and the primary models utilized indicate that the Company's upper limit of reinsurance is adequate to cover up to approximately a 250 year event (a single event with an estimated probability of exceedance of 0.4% in a given year). It is noted, however, that hurricane models are subject to significant risks and uncertainties and are continuously evolving. Catastrophe models are only a tool to estimate the impact of catastrophe events and actual results can differ materially from model estimates.
We use the results of the Risk Management Solutions (RMS) and AIR Worldwide (AIR) models in our review of exposure to hurricane risk. Each of these third party vendors provides two views of the modeled results as follows: (i) a long-term view that closely relates modeled event frequency to historical hurricane activity; and (ii) a shorter-term view that adjusts historical frequencies to reflect expectations of elevated hurricane activity in the near future. We believe that modeled estimates provide a range of potential outcomes and we review multiple estimates for purposes of understanding our catastrophic risk and variability. However, due to regulatory and competitive limitations, we generally utilize long-term model output in the development of our product pricing.

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The following table provides severe thunderstorm and hurricane single event model estimates for a range of return periods based on a blended view of the RMS and AIR long-term models utilizing our actual in-force P&C segment policy data as of August 31, 2018:
 
 
Gross Losses
Net Losses 1
Net Losses as
a Percent Equity 2
Loss Return Period
Yearly Probability of Exceeding
Severe Thunderstorm
Hurricane
Severe Thunderstorm
Hurricane
Severe Thunderstorm
Hurricane
20 Years
5
%
$
3,143

$
16,833

$
2,483

$
3,160

5.41
%
6.89
%
50 Years
2
%
$
4,708

$
30,128

$
3,160

$
3,160

6.89
%
6.89
%
100 Years
1
%
$
6,096

$
42,765

$
3,160

$
3,160

6.89
%
6.89
%
250 Years
0.4
%
$
8,448

$
63,604

$
3,160

$
3,160

6.89
%
6.89
%
500 Years
0.2
%
$
10,811

$
79,525

$
3,160

$
8,710

6.89
%
18.99
%
1 - Net losses are net of reinsurance and after a 21% Federal income tax benefit.
2 - Equity as of December 31, 2017

In 2018, the P&C segment was impacted by Hurricane Michael which exceeded our $4 million catastrophe reinsurance retention. The P&C segment was also impacted, in 2018, by 18 smaller catastrophe events that individually did not exceed our catastrophe reinsurance retention; but contributed incurred losses totaling $5,138,000. In 2017, we incurred losses from 26 catastrophe events totaling $14,280,000 with none exceeding our reinsurance retention. This lead to a record year for retained catastrophe losses for the Company and adversely impacted our 2017 underwriting results. While we have sought reinsurance coverage to reduce the impact of smaller serial events, it has been challenging to obtain cost effective coverage and structure. However, through improvement in our rate structure and implementation of more adequate risk adjusted rates over the past five years, we are able to limit the adverse impact of catastrophe losses on our capital position.

Additional details regarding the structure of our 2018 catastrophe reinsurance program can be found in Note 10 to the Consolidated Financial Statements.

The table below provides the major categories of investment income for the year ended December 31, 2018 and 2017:
 
 
Year ended
December 31,
 
 
2018
 
2017
Fixed maturities
 
$
1,663

 
$
1,389

Equity securities
 
47

 
45

Company owned life insurance change in surrender value
 
(374
)
 
110

Other
 
23

 
56

 
 
1,359

 
1,600

Less: Investment expenses
 
29

 
29

Net investment income
 
$
1,330

 
$
1,571


Net investment income totaled $1,330,000 in 2018 compared to $1,571,000 in 2017; a decrease of $241,000. The primary reason for the decrease in net investment income was a $374,000 decline in the value of investments in the cash value of our company owned life insurance in the current year compared to the same period last year.


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The table below provides investment gains and losses for the year ended December 31, 2018 and 2017:

 
Year ended
December 31,
 
2018
 
2017
Fixed maturities
$
32

 
$
163

Change in fair value of equity securities
(132
)
 

Net investment gains (losses)
$
(100
)
 
$
163


The P&C segment ended 2018 with capital losses of $100,000, compared to capital gains totaling $163,000 for the same period in 2017; a decrease of $263,000. Investment gains and losses are highly dependent on several factors including market conditions, tax position and liquidity needs of the Company and can vary significantly from period to period. In 2018, due to a change in GAAP, unrealized gains and losses on equity investments are required to be reported as a component of investment gains/losses on the income statement. These amounts were previously reported as a component of Other Comprehensive Income. For the year ended December 31, 2018, P&C segment investment losses include a $132,000 decrease in accumulated gains on equity securities held for investment. This decrease in accumulated gains was driven by an overall decline in stock market values experienced late in the fourth quarter of 2018. There were no net investment gains in 2017.

Other income was $609,000 in 2018 compared to $592,000 for the same period in 2017; an increase of $17,000. Other income consists primarily of fees related to the issuance of our property insurance policies as well as other miscellaneous income. As a percent of net earned premium, other income was 1.1% in both 2018 and 2017.

Policyholder benefits and settlement expenses in the property and casualty segment were $35,735,000 in 2018 compared to $38,391,000 for the same period in 2017; a decrease of $2,656,000 or 6.9%. The P&C segment ended 2018 with a loss ratio of 65.2% compared to 68.0% for the same period in 2017. The primary reason for the decrease in claims and the loss ratio in 2018 compared to 2017 was fewer losses and loss adjustment expenses (LAE) reported from cat events in the current year compared to the same period in the prior year.

Weather related losses consistently create the most significant variability in our loss and loss adjustment expense payments from year to year in our P&C segment. The following table provides a recap of P&C segment gross reported losses and LAE by catastrophe event and non-catastrophe wind and hail losses and LAE for the year ended December, 2018 and 2017 (dollars in thousands):

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For the year ended December 31, 2018
 
For the year ended December 31, 2017
Catastrophe event
 
Reported
Losses & LAE
 
Claim Count
 
Catastrophe event
 
Reported
Losses & LAE
 
Claim Count
Cat 1814 (Feb 24-26)
 
$
160

 
52

 
Cat 1711 (Jan 1-3)
 
$
800

 
181

Cat 1817 (Mar 18-20)
 
1,151

 
215

 
Cat 1713 (Jan 18-22)
 
2,162

 
371

Cat 1821 (Apr 13-16)
 
631

 
147

 
Cat 1719 (Feb 28-Mar 2)
 
562

 
146

Cat 1824 (May 12-16)
 
149

 
36

 
Cat 1720 (Mar 6-9)
 
127

 
44

Cat 1827 (May 29-June 1)
 
255

 
50

 
Cat 1721 (Mar 21-22)
 
304

 
76

Cat 1835 (June 24-26)
 
290

 
48

 
Cat 1722 (Mar 26-28)
 
440

 
80

Cat 1836 (June 28)
 
419

 
69

 
Cat 1724 (Apr 2-3)
 
775

 
154

Cat 1840 (July 19-22)
 
338

 
64

 
Cat 1725 (Apr 4-6)
 
673

 
167

Cat 1852 (Sept 13-16)
 
1,292

 
371

 
Cat 1728 (Apr 21-25)
 
433

 
68

Cat 1857 (Oct 10-14)
 
13,378

 
2,312

 
Cat 1730 (Apr 28-May 1)
 
799

 
182

 
 
 
 
 
 
Cat 1731 (May 3-5)
 
498

 
104

 
 
 
 
 
 
Cat 1732 (May 8-11)
 
314

 
61

 
 
 
 
 
 
Cat 1733 (May 15-18)
 
323

 
57

 
 
 
 
 
 
Cat 1734 (May 27-28)
 
628

 
84

 
 
 
 
 
 
Cat 1738 (June 16-19)
 
154

 
52

 
 
 
 
 
 
T.S. Cindy (June 21-25)
 
555

 
105

 
 
 
 
 
 
Cat 1742 (Aug 5-8)
 
120

 
42

 
 
 
 
 
 
Cat 1743 (Aug 25-31)
 
309

 
77

 
 
 
 
 
 
Cat 1744 (Sept 11-15)
 
3,622

 
992

 
 
 
 
 
 
Cat 1746 (Oct 7-9)
 
292

 
103

 
 
 
 
 
 
Cat 1751 (Oct 23-24)
 
147

 
19

Misc cats less than $100k
 
453

 
144

 
Misc cats less than $100k
 
243

 
51

Total Before Reinsurance
 
$
18,516

 
3,508

 
Total Cat losses
 
$
14,280

 
3,216

Less: Reinsurance (Cat 1857)
 
(9,378
)
 
 
 
 
 
 
 
 
Total Net Cat Losses
 
$
9,138

 
 
 
 
 

 
 
 
 
 
 
 
 
 
 
 
 
 
Non-cat wind & hail
 
$
6,792

 
2,025

 
Non-cat wind & hail
 
$
5,649

 
1,596


During 2018, we were impacted by 19 catastrophe events producing 3,508 policyholder claims totaling $18,516,000 on a gross basis and, $9,138,000 net of reinsurance recoveries. The primary contributor to 2018 reported cat losses was Hurricane Michael. On October 10, 2018, Hurricane Michael made landfall along Florida's Panhandle near Mexico Beach. At landfall, Michael was a Category 4 hurricane with winds of approximately 155 mph. Based on data collected from the National Weather Service, Michael was the third most intense hurricane to make landfall in the continental United States with minimum pressure on the afternoon of landfall at 919 millibars. As Hurricane Michael moved inland into southeast Alabama and southwest Georgia, it remained a very strong Category 3 storm before finally weakening to a tropical storm as it moved through central Georgia and South Carolina. We had policyholders in Alabama, Georgia and South Carolina exposed to hurricane or tropical storm force winds from October 10th through October 11th. Hurricane Michael contributed $13,378,000 in reported losses on a gross basis ($4,000,000 net of reinsurance recoveries). Net of tax, Hurricane Michael losses reduced net income by $3,160,000 or $1.25 per share.

In 2017, the P&C segment was impacted by 26 catastrophe events generating 3,216 claims totaling $14,280,000. Because each of these events remained below our $4 million catastrophe reinsurance retention, none were covered by reinsurance. Our 2017 catastrophe losses were a Company record for retained catastrophe losses. Net of tax, 2017 catastrophe losses reduced net income by $9,425,000 or $3.74 per share. The single largest catastrophe event in 2017 was Hurricane Irma, which caused $3,622,000 in reported losses in 2017 from 992 claims. Hurricane Irma impacted our policyholders in Alabama, Georgia, South Carolina and Tennessee. Georgia was the primary state in our coverage area impacted by Hurricane Irma comprising approximately 85% of reported claims.

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Non-catastrophe wind and hail claims reported in 2018 totaled $6,792,000 compared to non-catastrophe wind and hail claims reported in 2017 totaling $5,649,000; an increase of $1,143,000 or 20.2%. During 2018, the P&C segment had 2,025 non-cat wind and hail claims reported (an average of $3,400 per claim) compared to 1,596 claims reported during 2017 (an average of $3,500 per claim). Non-cat wind and hail claims reported during 2018 accounted for 19.0% of total P&C segment incurred losses and LAE in the current year. Non-cat wind and hail claims reported during 2017 accounted for 14.9% of total P&C segment incurred losses and LAE in the prior year.

Year to date policyholder benefit payments were down in the property and casualty segment due to a decrease in frequency of reported losses from catastrophe events; however, reported fire losses were up in 2018 compared to 2017. Reported fire losses were up $993,000 or 7.1% in 2018 compared to fire losses reported during 2017. The P&C segment had 479 fire losses reported for the year ended December 31, 2018, totaling $14,968,000 compared to 486 fire claims reported for the same period in 2017 totaling $13,975,000. The average cost per claim was $31,200 for fire losses reported in 2018 compared to $28,800 for fire losses reported in 2017. Reported fire losses in 2018 added 27.3 percentage points to the combined ratio compared to 25.4 percentage points to the 2017 combined ratio.
Deferred policy acquisition costs totaled $2,759,000 in 2018 compared to $2,777,000 in 2017. Deferred policy acquisition costs were 5.0% of net earned premium revenue for 2018 and 2017. Deferred policy acquisition costs consist of amortization of previously capitalized distribution costs, primarily commissions.
Commission expense for 2018 was $7,267,000 (13.3% of premium revenue) compared to $7,380,000 (13.4% of premium revenue) for the same period in 2017. The primary reason for the $113,000 decrease in commission expense was a reduction in bonus commissions to agents in 2018 compared to 2017.
General and administrative expenses in the property and casualty segment totaled $8,472,000 in 2018 compared to $8,087,000 in 2017; an increase of $385,000 or 4.8%. General and administrative expenses were 15.4% of premium revenue in 2018 and 14.7% of premium revenue in 2017. The primary reason for the increase in general and administrative expenses in 2018 compared to 2017 was an increase in actuarial fees associated with rate filings in the P&C segment.

Insurance taxes, licenses and fees were $1,937,000 through December 31, 2018 compared to $2,237,000 for the same period in 2017. Insurance taxes, licenses and fees were 3.5% of premium revenue in 2018 compared to 4.1% of premium in 2017. The primary reason for the decrease in taxes, licenses and fees in 2018 compared to 2017 was an increase in 2017 taxes due to a one time charge for state taxes in the P&C segment totaling $185,000.

The P&C segment ended 2018 with pretax income of $506,000 compared to a pretax loss of $1,502,000 for the same period in 2017. The $2,008,000 increase in pretax income was primarily due to the reduction of claims incurred from catastrophe losses in 2018 compared to 2017.

Property & Casualty Combined Ratio:
A measure used to analyze a property/casualty insurer's underwriting performance is the combined ratio based upon generally accepted accounting principles (GAAP). It is the sum of two ratios:

The loss and loss expense ratio, which measures losses and loss adjustment expenses incurred as a percentage of premium revenue.

The underwriting expense ratio, which measures underwriting expenses incurred (e.g., agents' commissions, premium taxes, and other administrative underwriting expenses) as a percentage of premium revenue.

The results of these ratios by significant component for the past two years were as follows:
 
2018
 
2017
Loss and LAE Ratio (Non-Cat)
48.50
%
 
42.32
%
Loss and LAE Ratio (Cat)
16.67
%
 
25.67
%
Underwriting Expense Ratio
37.26
%
 
34.26
%
Combined Ratio
102.43
%
 
102.25
%
Maintaining a combined ratio below 100%, which indicates that the company is making an underwriting profit, depends upon many factors including hurricane activity in the Gulf of Mexico and the southern Atlantic coast, strict underwriting of risks, catastrophe reinsurance costs, severe thunderstorm frequency and the ability to obtain adequate and timely

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premium rates. A major hurricane hitting the coast of Alabama, Georgia, South Carolina, Mississippi or Louisiana could cause the combined ratio to fluctuate materially from year to year. In addition, most of the states that we write business are prone to severe thunderstorm and tornado activity with significant variations in the level of activity from year to year. The property and casualty subsidiaries maintain catastrophe reinsurance to minimize the effect of a major catastrophe; however, the geography of our coverage area, frequency of smaller catastrophe events and prohibitive cost of maintaining lower catastrophe deductibles and/or catastrophe aggregate coverage prevents us from further mitigating catastrophe risks.

During 2018, the P&C segment experienced an increase of 0.18 percentage points in the combined ratio compared to 2017. While catastrophe loss is the primary source of variability in our combined ratio, as noted in the table above, over the past two years, non-catastrophe losses and LAE were the primary source of the increase in our combined ratio in 2018 compared to 2017. Non-catastrophe losses increased the P&C segment combined ratio 6.18 percentage points in the current year compared to the same period in the prior year. Offsetting this increase was a 9.0 percentage point decrease in the catastrophe loss component of the P&C combined ratio, in 2018 compared to 2017. Management continues to improve rate adequacy, reduce significant exposure concentrations and implement other risk management strategies in order to further improve underwriting profitability, mitigate earnings volatility and reduce downside risk to our capi